Importance of values, good conduct in financial markets

In the last week’s article, I indicated how the ten years’ experience since the 2008 financial crisis has brought in some new knowledge and insights on how regulators of financial markets should go about conducting their business and fulfilling their mandates. I said that based on what we observe, the regulatory response to the prudential crisis has been profound, equal to the significance of the crisis itself and in trying to mitigate the repeated happenings, at least if it has to do with similar contexts.

The response from the learned insights has redefined and reshaped the financial markets, especially the banking industry. Examples of ringfencing and separation of investment banking from commercial banking activities are some of clear indications. The introduction of IFRS 9, which is due for operational from this January of 2018, is such other example.

I went further to indicate that for a keen observer of the conduct of financial markets’ regulators, one will learn that from their different points of views, they perceive such aspects related to their mandates as well as market conduct as not just being the cause from business conducts of firms operating in the financial markets – but rather more into it there are personal and individuals conducts too that impacts the happenings. That sometimes people who are afforded with fiduciary duties to oversee these businesses and those responsible for their operations in some cases gets ahead of themselves for various motives.

As a result, for example, having individuals within financial firms being held personally accountable for their work has shown to affect outcomes positively. For instance, there is evidence related to accounting and financial management practices, even here at home, which indicates an increasing perceived individual accountability, such as by requiring audit engagement partner to sign the audit report with their own name, rather than the company name, with the aim of improving both the quality of the audit and decreasing manipulative practices – this has indicated positive results.

As it is with other societal issues and challenges, firms operating in the financial markets whether they are listed or not listed are focusing on the aspect of culture too. For instance, we now hear in boardrooms relentless discussions of culture and we often are being asked how senior managers in firms that operate in the financial markets should measure their culture and how regulators, could measure and set targets for their businesses’ culture. Many regulators have recently opted to assess what management is doing to manage issues of culture within their firms by using four types of lever.

The first lever is a clearly communicated sense of purpose and approach. Clearly communicating the ‘what’ and the ‘how’ are very important to getting a firm to work effectively and efficiently. But they pale into the background when contemplating the power and effect of a well communicated and resonant ‘why’. It is the tacit understanding, shared by employees, of a company’s true purpose. This may not necessarily what is articulated formally in a company’s mission statement and values. I often learn more about a firm’s sense of meaning by reading the strategic plans. And I suspect that employees do too.

The second lever available to senior managers is ‘tone from the top’ – what staff hear and see from senior management. What are the behaviours that senior managers role model to their employees?

The third lever is the formal governance processes and structures, the policies and systems that specify expected behaviours and decisions. From a conduct culture point of view, regulators look for a well thought through conduct risk framework: is there a clear exposition of conduct risks, the systems and controls for mitigating them and risk indicators for monitoring them?

Finally, there are people related practices, including incentives and capabilities. Remuneration, promotion and recognition criteria all matter. Does a firm’s pay structure reward misconduct? Is the pressure to turn a profit driving employees to act against consumers’ interests?

People capabilities are becoming more and more important to having the right culture. It’s not enough to be motivated to behave in a new way; people also need to understand how to be successful with the new behaviours.

The accountability regime reinforces this view of culture and its key drivers. It sets a standard for the outcomes of culture and has an important impact on senior managers, on how a firm is governed and on people’s capabilities. How does it do this?