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Reckless risk taking

26 September 2016 by William Granger

Banking: Reckless risk taking - read more

Convicted former UBS trader says ‘profits first, ask questions later’ culture is still alive and well

Kweku Adoboli is the former UBS trader convicted of fraud. He accepted responsibility for a $2.2 billion loss at UBS Bank, part of a shared $50 billion trading book. He was acquitted on four of the charges because it was accepted that his actions had nothing to do with trying to achieve personal financial gain. UBS was fined and censured for creating the culture that resulted in the losses. The regulator concluded that ‘the failure by senior management to adhere to the Bank’s own policies [was] indicative of a lack of focus on instilling a culture of compliance.’

Profits-first culture

Adoboli recently lost his appeal against being deported and repeated his observations during the trial and investigation that the ‘profits first, ask questions later’ banking culture is still alive and well. He says that recent discussions indicate that many are ‘still struggling with the same conflicts and pressures to achieve no matter what’ and that ‘where people fall into this grey zone. I think [fraud] could absolutely happen again’. He went on to say that ‘the only way to generate the same level of profits is to take more risk’ and concludes ‘it’s about culture. The culture is set at very senior levels of the industry. They [bosses] have as much responsibility for what the outcomes are as those pushing the buttons.’

This raises questions about how far banking culture has changed since the 2008 debacle; what has been done to address the wrong kind of risk taking and what still needs to be done? Adoboli is out of the loop somewhat as there has recently been an extensive programme of regulatory changes addressing exactly these issues by the regulators. He may be right, however, to question whether banking culture has changed despite these regulations.

Greater accountability

The changes are part of the accountability regime which encompasses senior managers, certification, referencing and whistleblowing, as well as updated conduct rules and detailed changes to remuneration structure and market abuse protection. These regimes are regularly commented upon but it is the question about cultural change that is particularly important; whether banks are merely compliant and have not achieved fundamental change.

Christine Lagarde, CEO of the IMF, explained: ‘Whether something is right or wrong cannot be simply reduced to whether or not it is permissible under law. What is needed is a culture that induces bankers to do the right thing, even if nobody is watching’.

There was uproar when the regulators announced in January that they would not be publishing their review into banking culture at the same time as George Osborne replaced FCA CEO Martin Wheatley. That was not because banking culture is off the agenda, but because culture itself goes beyond regulation and there is no template to fit all banks.

Andrew Bailey, the incoming FCA CEO, said ‘I want to start with an unambiguous statement, that the culture of firms and the people that make them up is of the utmost importance to financial regulators. But we are not able, and should not try, to determine the culture of firms. We cannot write a regulatory rule that settles culture. Rather, it is the product of many things, which regulators can influence, but much more directly which firms themselves can shape’.

Beyond compliance

There has been a lot of work by banks on culture that goes beyond compliance. It remains to be seen if this has been effective or if there will be a lapse back into bad practice. The history of banking regulation would indicate the latter.

At its simplest culture is ‘the way we do things around here’ and is a valuable differentiator for banks. A fuller definition is ‘a firm’s shared values, attitudes, standards and beliefs and how they are aligned across their goals, strategies, structure and approaches to its people, customers, investors and the greater community’.

Recent research from Charles Russell Speechlys observes that there is a risk that the sheer volume and complexity of regulation can stifle innovation instead of driving better behaviour. Many firms with good culture and less historical baggage are not finding it hard to adapt, but others are struggling. There is a history of innovation that is compatible with acceptable risk taking and those companies that are channelling the entrepreneurial spirit of the City.

Business ethics

There is also an adjustment disorder. Even the phrase ‘business ethics’ in financial services is changing and being replaced as the balance between law, regulation and ethics is tipping. Ethics begins where law ends but the handover point is not fixed. When trust in the banking sector’s ability to manage itself and maintain high ethical standards declines, as in the financial crisis, regulation will naturally move in to fill the gap that is seen to have been vacated by ethics, which is largely institutional self-discipline. It can only be a good thing that there is a redefinition.

Identifying banks with the wrong culture is not as simple as distinguishing those that are fully compliant from those that game the regulations to increase profit. There seems to be broad consensus that good culture needs to address more than the codes, regulations, duty to customers, conduct rules and the administration of justice. Although not uniform, culture needs to engage with social responsibility; doing what is right in a way that aligns with strategic business objectives, practices and reward, and with stakeholders.

A leadership issue

Culture is a leadership issue. Values and good culture drivers should come from the top, and then become lived; part of the fundamental assumptions, beliefs and motivations of all. The FRC commented: ‘Codes put forward principles for best practice that make bad behaviour less likely to occur; and public reporting can make it harder to conceal such behaviour. But, by itself, a code does not prevent inappropriate behaviour, strategies or decisions. Only the people, particularly the leaders within a business, can do that.’

The same goes for remuneration. Is tighter regulation working or is it having a negative impact on recruitment and retention? The level of pay that employees within financial institutions receive often antagonises the public, but there is little evidence that the restructuring of remuneration within financial institutions is changing behaviour. There is concern that this is having no impact and that remuneration structures may now be over-engineered. Incentivisation needs to be aligned with the culture of the firm across performance metrics. Remuneration structures and the measurement of contribution by reference to cultural adherence need to improve. We expect to see a cultural dimension to each of a bank’s people processes, assessing not just what they did but also how they did it.

Banking culture

Only time will tell if banking culture has changed, but many share Adoboli’s pessimism. Other whistleblowers will come forward as part of the process of forced culture change, as there is a need to expose wrongdoing. Reputation risk advice tells organisations that scandals and fines are toxic to brands, far beyond a drop in profit.

The new whistleblowing regime which came into force from 7 September introduces a range of measures for firms including: to appoint a whistleblowers’ champion; present a whistleblowing report to the board at least annually; put in place a new whistleblowing policy and process (including extending protection for raising any concerns to the regulator even if not about a breach); greater victimisation and confidentiality protection from courts and regulators; new training and information; reduced ability to bury issues in settlement and increased liability for those that harm whistleblowers (which will go directly to the fitness and propriety of individuals responsible).

Some say that this will catalyse change, yet others believe that the protection for those who come forward is not enough. Like other change management levers, too much negative reinforcement around liability and punishment can overlook the need to focus on positive change. An effective whistleblowing policy dovetails with and promotes a culture in which speaking up and challenging is encouraged.

Until the public and politicians give banks a cleaner bill of health, regulators will have to keep pressing. Early indications from the government suggest a focus on improving governance and accountability.

The Banking Standards Board is starting a study of how standards of behaviour and competence are set and shaped by law, regulation, codes and other standards, and to ask whether this balance is working effectively, and what this might imply for the industry. It states: ‘This is not a study devised to conclude that less regulation would be beneficial. It is, rather, asking what needs to be in place alongside regulation to produce the highest standards of behaviour and competence in banking; what is needed to fill the space beyond the “boundaries of regulation”, for that regulation to be not only bounded, but to work effectively.’ Despite the resistance some feel, entrepreneurs will see opportunities in challenges and understand that regulatory constraints do not need to be stifling.

William Granger is a Partner at Charles Russell Speechlys

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