Culture is a vital but difficult topic to regulate. Across the globe, regulators have increasingly come to the view that poor firm culture has been at the root of the financial and conduct failure cases they have had to deal with in recent decades.
But how can regulators assess something that is influenced by – and itself influences – all of a firm’s activities? After all, culture is, as FCA head Andrew Bailey memorably observed, “everywhere and nowhere”.
As Deloitte observes in its paper, Management information on culture – connecting the dots, culture is different from compliance, which is about what you can do, whereas culture is about what you should do. Some may even argue that culture cannot be regulated at all, and attempting to do so may be harmful, perhaps because individual decisions with an essentially moral dimension are not overly susceptible to outside direction.
Rebuilding trust
All this makes the FCA’s recent discussion paper, Transforming culture in financial services, particularly interesting and timely. Jonathan Davidson observes in his foreword that “given its impact and the role it needs to play in rebuilding trust in financial services, firms’ culture is a priority for the FCA”.
Mr Davidson leaves little doubt that the regulator is concerned about the effects of poor culture. He says: “Culture in financial services is widely accepted as a key root cause of the major conduct failings that have occurred within the industry in recent history, causing harm to both consumers and markets.”
The paper’s title itself suggests that 10 years on from the financial crisis, the FCA considers this “transformation” has yet to be completed.
The watchdog has used discussion papers in the past to kick-start debate on what have subsequently become important policy areas. Transforming culture can therefore be taken as a serious and credible attempt by the FCA to drive a meaningful debate on culture and the role of regulation. The supervision of culture is likely to be, again quoting Mr Bailey, a topic that will “run and run”. What conclusions can be drawn at this stage?
First and foremost, to meet regulatory expectations all financial services firms need to demonstrate they are working to establish the right culture and disseminate it throughout the firm. Mr Davidson, in his foreword, characterises the aims of the Senior Management & Certification Regime as “to hold firms’ leadership to account for their own behaviour and for taking reasonable steps to manage the behaviours of those in their areas of responsibility.”
Key Points
• The FCA is trying to tackle the topic of culture in a recent paper.
• Changing culture takes time and effort from leaders.
• Regulatory policy should involve enough of a nudge without being overly burdensome.
In practice, achieving sustained changes in behaviour – in other words, changes in culture – is complex, and takes time, effort and persistence from senior leaders. Supervisors will not expect overnight results, but they will expect to see strong board engagement, a clearly-defined target culture, a programme to disseminate it, and evidence that progress is being achieved and monitored. In response to these expectations, firms’ board and committee agendas are increasingly including explicit cultural considerations.
Here, the question of how to measure culture becomes important. As culture is intangible and not, in itself, quantifiable, it is difficult to measure objectively.
One approach is to measure it through two complementary mechanisms: first, feedback can be gathered, for example from a firm’s employees, and aggregated to form a picture of culture across different populations within the firm, providing a profile of positive and negative culture ‘hotspots’.
Second, information can be gathered on indicators of culture. Examples include analysis of ‘near-misses’, instances of desirable and undesirable behaviours, and how staff at all grades are held to account for undesirable behaviours and how behavioural successes are celebrated.
Monitoring progress
Both of these mechanisms can be used to produce valuable management information that boards can use to assess and monitor culture, as evidenced in behaviours, and the effectiveness of management initiatives in areas such as communications and training. These cultural assessments can also be benchmarked, providing boards with a picture of how their organisation compares with peers and firms in other sectors.
Critically, neither of these mechanisms, nor the information they produce, is immediately available to supervisors. A common thread running throughout transforming culture is that different firms have different cultures, and that it is not the role of regulation to prescribe a single preferred culture.
Cultural information tends to require subjective assessment, expert judgement and interpretation, and hence is not generally suitable for producing standardised supervisory reporting. Rather, culture sits firmly within the practical supervision remit of the FCA, as a topic to be addressed firm by firm through the regular supervisory relationship. Supervisors are therefore likely to rely on firms’ own measurement, monitoring and reporting of their culture.
‘Whole-system approach’
In addition, transforming culture places great emphasis on what the FCA describes as a “whole-system approach to culture”. This acknowledges the influence and importance for a firm’s culture of the entire “system” that surrounds each individual in an organisation. This system includes cultural influences that are both internal to the organisation, for example, reward, and external societal norms, and those that are formal (performance targets) and informal (recognition and appreciation).
Importantly, a whole-system approach recognises the complexity of human behaviour and culture, and the challenges that these will create for a regulator seeking to supervise firms’ culture. As the FCA has acknowledged, regulatory intervention in the form of rules – such as how staff should be remunerated – has an effect on behaviour, but sometimes not wholly the effect intended.
There has been variable success in achieving behavioural change through rules and incentives – the mandatory 5p carrier bag charge in the UK being a notably successful example. Proportional policymaking and regulation should generally be the art of applying just enough of a nudge to achieve a policy outcome without overburdening the regulated with prescriptive rules and a tick-box approach.
Understanding how regulation feeds into the system of cultural influences is a question that merits a great deal of further consideration by regulators and firms.
Role of supervisors
While transforming culture undoubtedly reflects the FCA’s intent to foster open debate on culture and the role of regulation, it is by no means the start of its focus on this topic. Culture has been a long-standing concern of regulators, particularly since the financial crisis. Front-line supervisors have had a responsibility to consider culture in financial services firms for many years, in terms of ‘tone from the top’ and how this translates into a firm’s operating culture in areas such as risk, sales, compliance and conduct. The FCA has even highlighted the importance of a “secure culture” to build firms’ cyber resilience.
Supervisors are experienced and adept in identifying shortcomings in culture through assessment of the behaviours and outcomes that they observe in firms during the supervisory process.
In our view, culture is of paramount importance to supervision because it can either reinforce or undermine firms’ formal governance, risk and control processes, as well as determining the consumer’s experience when dealing with a financial services firm.
With the debate that transforming culture initiates, we expect to see this topic achieve still more prominence in the coming years.
In short, cultures that deliver positive consumer outcomes make firms more appealing to work with and for, and thus building their long-term sustainability. Cultures that do not deliver, risk the firm’s long-term future as well as regulatory scrutiny and censure in the short term.
Andrew Bulley is a partner and Henry Jupe is associate director at the Centre for Regulatory Strategy at Deloitte
