“The Blame Game” – Accountability in Financial Services

In 2012, following a succession of corrupt practices and governance failures within the financial services sector, the Parliamentary Commission on Banking Standards (PCBS) was appointed by the House of Parliament in response to mounting public pressure on the Government to take legislative action on the industry.  Now, almost a decade on from the global financial crisis, regulators across the globe are beginning to implement accountability regimes to provide clear lines of responsibility to senior managers and the significant influence functions they oversee.  This includes the Senior Managers and Certification regime in the UK (SM&CR) although a number of other countries have introduced similar regimes, such as the BEAR (Banking Executive Accountability Regime) in Australia (1).  It is fair to say, we are entering a new era of financial services where senior managers will no longer be able to “wash their hands” of responsibility, and profess ignorance to governance failures due to long and murky chains of process driven work-streams.  It is important to understand why accountability has been such an important focus of the regulator in recent years, especially in the years since the financial crisis unfolded.

In July 2008, financial authorities were forced to step in to assist America’s two largest lenders, Fannie Mae and Freddie Mac and later in September 2008, Lehman Brothers collapsed after the Federal Reserve opted not to step in with a bail out.  As the magnitude of the issue became realised, the Fed were forced to step in with a bailout of $85 billion to save AIG, after the firm became over-exposed to Collateralized Debt Obligations (CDO’s) in the form of bundled mortgages (2).  The economic downturn that followed thrust banks, investment firms and other financial services providers such as mortgage lenders to the forefront of media attention and public scrutiny.  Chief Executives, Managing Directors and Financial Officers of the world’s largest financial institutions were being forced into the spotlight to explain how they had overseen and failed to intervene in what was developing into the most profound period of global recession since the Great Depression.  Often, these explanations did not abate public dissatisfaction and it displayed more clearly than ever, the astronomical divide that existed in society regarding the remuneration of these individuals, and how they could walk away from impending disaster and be, seemingly rewarded.

The financial crisis tested the resilience and patience of citizens within North America and the European Union.  In the years following the crisis, this patience was tested yet further, especially within the Eurozone.  Between May 2010 and June 2012, Greece was bailed out twice and cash injections were arranged for Ireland, Spain and Portugal (3).  One month later, in July 2012 the London Interbank Offered Rate (LIBOR) rigging story broke, and it could be argued that this was the final straw for public odium towards the industry’s conduct.  Taxpayers had accepted the failures in governance that had led to the financial crisis, they had accepted, albeit begrudgingly, that bailing out financial institutions was in the best interests of all consumers and had accepted that within the UK alone, the cash outlay (£133 billion) was the equivalent to £2000 for every person in the UK (4).  However, the LIBOR scandal proved to all consumers that the conduct of those in prominent positions within the industry, perfectly encapsulated exactly what was wrong with the industry, it was rotten to the core.  The revelations that rate rigging had been taking place as early as 2005 (5), meant that even before the onset of the financial crisis, malpractice was an industry standard, highlighted also in the Payment Protection Insurance (PPI) saga that is still being settled to this day.  Perhaps what was harder for consumers to accept was that even after taxpayers around the world bailed out their respective financial institutions, they pursued profit at all costs and in doing so, took consumer trust in the industry to new lows and displayed the industry as not only incompetent, but morally bankrupt (5).  Perhaps if all of these events had occurred years apart, there might not have been the same call for accountability and the same response from regulators.  The rapid succession of the negative news coverage, and a lack of apparent accountability for senior figures within these organisations, meant it was time for a real paradigm shift in banking culture.

Consumer trust is a key component of the industry, if it is to regain any shred of integrity and re-engage with the taxpayers who provided the funds necessary for many of their operations to continue.  As highlighted by Stephen D. King, former chief economist at HSBC, the failure of policy makers has not only led to a collapse in trust within financial services, but also in economic policy itself.  In Western society, politicians have made promises on health care and standards of living that current economic policies cannot deliver (6).  The Financial Services Research Forum (FRSF) Trust Index began in 2005 and highlights the scale of the problem:

Figure One:

Figure Two:

“Higher Level Trust” is associated with benevolence and shared values, the degree to which the industry or individual financial services institutions care about the interests of their customers (7).  Figure 1 displays the average rate of higher level trust in various sectors of the financial services industry.  Banks scored at the lowest end of the scale with just around half of people surveyed claiming they feel their banks care about their interests.  Figure 2 shows the average levels of trust within financial services and displays the overall trust, again hugging the 50% rate (7).  Bearing in mind this measure was taken before the LIBOR scandal broke, it is certainly alarming that one in two people surveyed in the UK did not have trust in the financial system.  This is perhaps a contributing factor to the regulator taking a more proactive approach to the role of senior management, for the first time, setting their sights on governance from the top.  If we are to strip back the entire financial services sector to banking alone, the very profession itself is an expression of trust.  That a depositor entrusts their capital to an institution is the very origin of the industry and without consumer trust, there cannot be an open market place for depositors.   

It is quite incredible to think that only now, in 2017 are we beginning to see the introduction of regimes to provide clear lines of senior management responsibility.  In the UK, this takes the form of the Senior Managers & Certification Regime (SM&CR) which was a consequence of the PCBS meeting in 2012.  This proposed a Senior Managers Regime to assess and regularly reassess the fitness and propriety of those performing senior management functions and a Certification Regime which requires relevant firms to assess the fitness and propriety of certain employees who could pose a significant risk to the firm or any of its customers.  Although technically already in force for banks, building societies, credit institutions and certain investment firms, this will be extended to all FCA regulated firms, by autumn 2018.  This will mean training initiatives will need to be prepared to ensure the smooth transition into this regulatory environment.  The recruitment and promotions process should take the need for training and certification into account, along with the requirement for regulatory references covering six years (8). 

While the intentions of the regulator appear to have consumer’s interests as their primary focus, it remains to be seen if the SM&CR will have enough scope to really make a difference.  It must be noted, the general view from both financial institutions and from regulators is that culture within the industry has changed markedly in the past decade.  The compliance departments of all Tier 1 investment banks are increasing in size, a Telegraph article suggested in the first 6 months of 2015 financial companies in London alone had hired 15,500 new staff as demand for consultants and compliance specialists has outweighed continued cost cutting at many of the major banks (9).  For some time banks have relied on the three lines of defence, beginning in the front office, with compliance as the second line and independent assurance/audit as the third line.  With the rapid expansion in compliance, since the financial crisis, the major banks have clearly been interested in extending the scope of the second line of defence.  This is interesting to note, as the vast majority of malpractice and risk is associated with the front office and the first line of defence.  The SM&CR seeks to address this by trending towards greater accountability for non-financial risk in the front office, while attempting to promote a positive culture throughout an organisation (10).

Firms are realising the benefits of a good compliance culture and the importance of the hiring process, to employ individuals from a diverse range of backgrounds and to have the correct people within the correct divisions.  This is also an era of financial services where, more than ever, large firms will need to outsource aspects of their compliance functions to be able to meet the reporting standards now required by regulators.  In terms of consumer trust, the signs are positive. The Edelman Trust Barometer shows that in 2017, two out of five financial centres are trusted; USA and Singapore, and figures are up from the previous year in all five financial centres (11).

The financial services industry plays a crucial role in all economies and banks must act as a pillar of society.  It is common to see high-street banks take up residence in natural limestone buildings, to symbolise strength, safety and stability.  Although regulators globally are beginning to make headway, it is now time for financial institutions to fully redecorate the interior to match the façade.

Bibliography

1.  https://treasury.gov.au/consultation/c2017-t222462/ (accessed 21/10/2017

2. http://www.investopedia.com/articles/economics/09/american-investment-group-aig-bailout.asp (accessed 21/10/2017)

3. https://www.theguardian.com/business/2012/aug/07/credit-crunch-boom-bust-timeline (accessed 21/10/2017)

4. National Audit Office, HM Treasury Resource Accounts 2011-12, The Comptroller and Auditor General's Report to the House of Commons, July 2012, p 91 Back

5. http://www.bbc.co.uk/news/business-18671255 (accessed 04/12/2017)

6. When the Money Runs Out: The End of Western Affluence; Stephen D. King (2013).

7.https://www.nottingham.ac.uk/business/businesscentres/crbfs/documents/researchreports/paper98.pdf

8. https://www.scotsman.com/news/opinion/mark-hamilton-fca-regulated-firms-need-to-ensure-they-are-prepared-for-their-new-challenges-1-4612145 (accessed 04/12/2017)

9. http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/11922574/Londons-finance-jobs-grow-despite-bank-layoffs.html (accessed 04/12/2017)

10). Front-office control functions, What’s next for capital markets banks; Ernest and Young (February 2017).

11. https://www.edelman.com/post/accelerating-trust-in-financial-services/ (accessed 04/12/2017)

Philip McAuley 

Philip McAuley joined FinTrU through our third Financial Services Academy in 2016 after graduating from Queen’s University Belfast with a BSc hons in Geography.  Philip had a keen interest in Financial Services and joined FinTrU to gain first-hand exposure to the industry.

Since joining FinTrU, Philip has worked as a member of the Electronic Trading Risk Management team providing EMEA coverage for a Tier 1 Investment Bank.  More recently, Philip has joined the Global Financial Crimes team for the same Tier 1 client, working first in Transaction Monitoring, before moving over to perform Enhanced Due Diligence reviews on High and High-Plus Risk clients.  Philip has gained exposure to many aspects of the new initial onboarding process that regulators expect of all Tier 1 investment banks.

Philip has been very enthusiastic about his Continuous Professional Development and since joining FintrU has completed all 3 modules of his Investment Operations Certificate with the CISI and has currently completed two thirds of his Diploma in Investment Compliance, also with the CISI, and will complete this in June 2018.

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