Public trust in the banking sector continues to take a battering after a series of scandals and fines. “Conduct risk” is the new buzz phrase, but can it be clearly defined and how can it be managed effectively for competitive advantage?
The scale of recent fines issued to banks in the US and UK is staggering: $8.9bn to BNP Paribas, $2.6bn to Credit Suisse, $1.9bn to HSBC and $1.5bn to UBS, to name a few. The fines cover a range
of offences, from sanctions violations and helping citizens avoid tax to rigging foreign exchange markets and insurance mis-selling.
And banks are still earning negative headlines from past crimes and misdemeanours. Earlier this month, HSBC*, which is under investigation by regulators on both sides of the Atlantic, dismissed Stuart Scott, its London-based head of currency trading for Europe, the Middle East and Africa, in connection with the forex scandal.
However, while some reputations are at a nadir, most banks in both the retail and investment sectors are making strenuous efforts not only to mend their ways but also to change their cultures. The process is being spurred by more than just the regulator’s stick – banks are gradually recognising that failure to clean up their acts will lose them customers as well as reputation. Conversely, an ethical, responsible operation with customers’ interests at its heart can mean good business, in both senses.
Although “conduct risk” has no standard definition, its management is now a regulatory requirement for UK financial services. It obliges companies to manage the risk of unfair outcomes to clients or financial markets, i.e. any general impairment of market integrity. For instance, the UK’s Financial Conduct Authority (FCA) is imposing fines for systems breakdowns that hamper customer access to online banking or cash machines on the street. If customer service levels are brought into question through outsourcing or offshoring in call centres, that is also conduct risk, and banks are expected to take precautions in those areas too.
Conduct risk is at the top of the FCA’s agenda and is starting to feature more prominently in other regulators’ remits as well. It also covers points such as employee behaviour on the trading floor, crossborder issues, conflict of interest and market conduct. This issue has gathered momentum since the UK Parliamentary Commission on Banking Standards last year called for a range of reforms. It said senior bankers guilty of reckless misconduct should be jailed in future and also demanded that the retail sector be made more competitive.
“Too many bankers, especially at the most senior levels, have operated in an environment with insufficient personal responsibility. Senior executives were aware that they would not be punished for what they could not see and promptly donned the blindfolds,” the commission’s report stated.
But progress on conduct risk has been patchy and, according to analysts, most banks have a long way to go before they have grasped what is required, let alone implemented the structural and cultural changes necessary to make a difference. However, some bolder players, including newcomer Metro Bank in London, are starting to focus visibly on “customer outcomes”, which is a major plank of conduct risk.
Danielle Sheerin, a consultant at NixonMcInnes, says conduct risk covers planning, product design, operations and marketing. Crucially, it is also about empowering all employees to challenge strategies and decisions rather than slavishly follow procedures, if they perceive them to be against customers’ interests. Overall, it’s about doing the right thing. Sheerin agrees with the FCA that a review of conduct risk needs to start with leadership examining their own perceptions and biases around money, risk and trust so that they can understand how these shape strategy and culture. Then, she says, they need to define their company’s purpose and values and use these to develop the customer outcomes they want to achieve.
“This is no easy task but it is achievable,” she says. “In many big retail banks there’s a lot of panic going on rather than understanding the reality. Boards are entirely focused on risk as the fines levied in recent years have been so costly – there’s also an anxiety about maybe being held personally to account. But too often it’s still a box-ticking mentality: have we got a framework in place? Are we covering ourselves?” Sheerin cites a Thomson Reuters report that found 84% of respondents did not yet have a working, firm-specific definition of conduct risk, although most (76%) identified an organisation’s culture as the key component for delivering against the conduct risk requirement. “Some big high street banks think they are really far ahead with their conduct risk agenda but they don’t seem to understand that this goes a long way beyond just cascading internal comms messages down through staff levels – it’s about a more fundamental cultural shift at all levels,” she says.
Part of the problem is the sheer scale of some retail banking operations. Sheerin says: “There’s quite a decentralised culture, a big gap between head office and the teller. It’s really hard to keep that connection to the customer throughout the whole business.” It is vital that bank leaders help develop a culture that rewards employees who apply judgment, empathy and insight to the right ends, Sheerin says. However, it is often difficult to evaluate customer outcomes in investment banks because they are so complex.
Timothy Hudson, Global Head of Conduct Risk at UBS, says the bank has undertaken a lot of work in this area, particularly since 2011/12. Measures include banning the use of mobile phones on trading floors, tougher regulation of chatrooms and enhanced supervision, as well as significant IT investment. There has been a good dynamic of information-sharing across the industry on frameworks and techniques, which shows a willingness to improve, Hudson says.
"We want to see progress across our entire risk taxonomy. One of the main points we have impressed on our people is that primary ownership of conduct risk is with the front office – that’s key. At senior level, regular review across a whole suite of conduct risks is required.
“Then you get the second line – performing monitoring and surveillance, and challenging conduct. We’ve done a lot of work pulling together a coherent framework. We’ve made a lot of effort to identify key processes in governance bodies to ensure those risks are properly considered on their agendas.
Identifying the drivers of conduct risk is something else UBS has spent a lot of time on, Hudson says. Traditionally across the industry a lot of operational risk analysis has been inward looking – i.e. not necessarily considering all of the impacts on markets and clients, he says. It has also tended to be activity-focused rather than analysing strategy and business models.
“That is an area on which the industry will focus more closely. What kind of clients are you servicing? What kind of products are you selling? Which jurisdictions are you active in? All these bake conduct risk into your business before the activities even begin.
“Then the culture, the principles, behaviour – there has been a huge amount of effort across UBS in this space. We have run programmes to promote integrity and how to challenge effectively, and on collaboration – all of which are important elements in identifying conduct risk and preventing it.”
Another aspect where UBS has focused attention is incentives and rewards: these can be big levers in affecting or directing what people do, Hudson says.
“The Parliamentary Banking Commission repeatedly mentioned the bonus culture. If you don’t have the right objectives and if you incentivise people wrongly, then, as we saw back in 2007/08 with our own subprime losses, it can lead to disastrous results.
“The entire industry can and must do better,” he says. “Clearly some of these lessons need to be refined and maybe extended.”
A balance needs to be struck between penalising bad conduct and rewarding good, sending a clear message that identification and mitigation of risk might not always be as obvious a virtue as winning new revenue – but can be even more important.
“Rewarding good behavior is extremely important, and the industry can do more in this respect,” Hudson says. “The costs of neglecting reputation have been staggeringly high in recent times, both directly and indirectly.”
“We place a very high value on our reputation: it can be a huge competitive advantage. Clients are increasingly asking us about our conduct risk programme and how we manage it – it is clearly very important to them.”
Tracey McDermott, director of enforcement and financial crime at the FCA, says retail and investment banks are a long way from reaching a point where “the conversation is about what the industry does to help people and businesses rather than the latest scandal”. But she is heartened by the growing recognition within the sector that banking’s woes are not the result of “a few rogues”, as had been previously claimed, she told an enforcement conference in London earlier this month.
“When industry leaders talk about the errors of the past I have no doubt that they are speaking genuinely; they truly want to create a better culture and are trying to instil one in their respective organisations,” McDermott said. “This is not driven solely by some high-minded moral or ethical approach but because it is good business sense. Firms and their shareholders cannot afford, and will no longer tolerate, the financial and reputational costs of poor conduct. But it is not easy to change a way of thinking that has existed for years if not decades, and focused on revenue over other considerations.”
Regulation and enforcement alone are not the answer, she added, citing a 27% increase in the amount of guidance issued by the FCA’s predecessor, the Financial Services Authority, between 2005 and 2008. “It was this very period that was a breeding ground for many of the conduct cases we’re still dealing with today.” Instead, a shared ethos not unlike the medical profession’s “above all, do no harm” needs to be instilled, according to McDermott.
“For me, the answer lies in making everyone involved in financial services better aware not just of their responsibilities to their employer or to themselves, but of the wider impact their work has on individuals and societies.” And this will feed back into reputation. Hudson of UBS says: “We would place a very high value on our reputation – it can be a huge competitive advantage. Clients are increasingly asking us about our conduct risk programme and how we manage it – it’s clearly very important to them.”
*This article was written before the recent Panorama expose, which contained allegations against HSBC of organised and illegal tax evasionbanks Conduct Risk Ethical banking finance good conduct risk