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Too big to govern

13 March 2015

News Analysis: Too big to govern - Read more

The battle lines must be drawn by boards to fight misconduct

Could large financial firms really have become too big to govern? This has been the question for many since Stuart Gulliver, HSBC’s Chief Executive, commented on the aggressive tax avoidance revelations by its Swiss banking arm.

In a moment of self-pity that skirted dangerously close to Tony Hayward’s disastrous plea of ‘just wanting [his] life back’ during the BP oil spill, Mr Gulliver asked how he could possibly be expected to know what every one of his 257,000 employees was doing.

Whether or not it is really necessary for CEOs to maintain a watchful eye over the shoulder of each of their employees is debateable; however, building a framework to mitigate bad practice is far from an impossible task. The group board must build an effective internal safety net and govern the firm by example with a unifying culture, maintaining a system of best practice so that even in massive companies good governance can be acheived.

When scrutinising HSBC over the recent Swiss episode, a little context is helpful. Some of the transactions which led to the tax avoidance revelations are more than eight years old, and the regulatory landscape of 2015 in Switzerland is significantly different to that of 2007.

MIFID II, the new Swiss Federal Financial Services Act and a torrent of other post-crisis regulatory reforms are having a huge impact on the work undertaken by all banks. Many of the operational failings that allowed the Swiss avoidance to take place have been addressed since then. Equally, the business practices and cultural norms in Swiss private banking are significantly different now than they were then.

Second line of defence

This illustrates how important it is for a board to invest efforts into its second line of defence: principally the control functions, including risk and compliance. Financial watchdogs have tightened the regulatory belt, but a tiered system of checks on activity is more than a regulatory burden, it is a vital tool for the board to manage large organisations. Underinvesting in these functions is no longer an option and HSBC is pumping roughly $1 billion a year into developing these areas, according to the Economist.

The Economist also found that HSBC’s tremendous growth since the global financial crisis has seen it more than double its number of employees. Grappling with tightening regulation which is costly to implement and bringing staff into an environment where revenues are depressed is a post-crisis reality for any financial institution. However, gaining complete control of governance and control functions is a vital step towards being able to identify and mitigate compliance issues in advance. Boards should plan to build their compliance teams in line with growth early, before rapid expansion creates areas where governance is struggling to keep up.

Fighting for talent

HSBC faces a challenge here, as it is not the only firm looking to hire more compliance professionals. The well-publicised fight for talent currently being waged between financial firms to find the right quality and quantity of compliance staff needs to be acknowledged.

Modern forms of legal, risk and compliance management were only invented over the past 30 years and, as a non-revenue producing function, now have a higher value than ever. The talent shortage within the financial services sector is already starting to push firms to think laterally in hiring decisions; increasingly raiding law firms and consultancies within the professional service sector, as well as the regulators themselves, to plug these gaps.

Unified culture

Ensuring there are full and well-integrated control functions to guarantee compliance with the necessary regulation is both a requirement and a benefit to modern finance operations but it cannot be the only tool the board uses to govern its business. The board has a responsibility to instil a culture of best practice towards conduct, risk and clients within the business units themselves. This would greatly reduce the burden of regulatory compliance and aid internal audit. This corporate culture however, consists of intangible traits that need to be coached and developed rather than just prescribed.

The board and executive committee of large financial institutions must lead by example and take ownership of developing these practices throughout the business. These are part of a gradual change that requires specific training programmes. Eventually, these intangible traits will become part of a prescribed role – but one might argue that we must wait to see a generation of people leave the industry before there is a true change in mentality.

Long-term thinking is what organisations need to look to their leaders to provide, which should make instances such as those that HSBC recently endured less frequent, harder to miss and inexcusable.

Ultimately, the scale or headcount of an organisation is not the sole measure of its ability to ensure best practice and ethics across its operations. A holistic approach is vital to ensure oversight and exemplary behaviours reach all staff, no matter how many or how dispersed. Boards must be confident in the ripple effect their example provides to their entire organisations. They must also be mindful of their responsibility to create a culture and development network that crowds-in best behaviour, ethics and a commitment to identify and address problems. When this is supported by a well-resourced team of compliance and governance, which draws from the best talent available, even massive global firms will find ensuring best governance well within their reach.

Chris Rowe is Director at Leathwaite

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