Monday, March 19,
2018 11.35AM / FCA
Being A Speech By Andrew
Bailey, Chief Executive Of The FCA, At The Transforming Culture In Financial
Services Conference delivered on march 19, 2018 (as drafted).
• Work on firm culture
is embedded in the work of our supervisors and is an important priority
for the FCA.
• Essays in our
Discussion Paper on transforming culture in financial services indicate
that culture is about encouraging and incentivising good things, not just
stopping bad things from happening.
• The Senior Managers
Regime and measures to govern the payment of remuneration are important
developments in creating incentives for good culture.
Cast your minds back just over 2 years
to New Year’s Eve 2015. Why? The FCA was criticised for announcing that it was
placing the lead responsibility for its culture work under its Business Plan
with its Supervision Departments. It was interpreted as a downgrading of the
importance of this work. As a Board member at the time, I found this reaction
odd. Work on firm culture is naturally embedded in the work of our supervisors,
for whom it is an important priority. It has been pursued diligently by
Supervision ever since, and will continue to be so, and today’s conference and the
publication are a part, but only a part, of our work.
There is, though, an important point
about culture which underlines why it should be an important task of conduct
supervision. Culture is not naturally pursued by a regulator like the FCA by
making rules. We would not achieve much by making a rule which said that all
firms should have a good culture. I want to be clear however, and I will come
back to this point, that culture in firms is influenced by the rules we make
and the incentives they create, so there is a very important role for our
rules, but it is not a direct prescribing of culture.
Moreover, there are important elements
of culture that are outside most of the direct influences of our rules. We do
expect people to come to work and follow good values without needing to make a
rule to require it. Of course, in reality what happens varies a lot, and it is
the job of our supervisors to observe and through their interactions with firms
to set expectations consistent with our public interest objectives. There are
times in my career as a supervisor when I have summoned a firm in and said ‘we
expect better from you’. And, of course, we have to use supervisory and
enforcement tools when misconduct is identified or suspected.
Unfortunately, if you look back over
the last decade and more, we have seen too many instances of misconduct, some
of which we are still dealing with. As supervisors, our objective is to prevent
misconduct, not just clear up the messes when they happen. No supervisor can
guarantee good conduct at all times, much though we wish it, but we do expect
to act to pre-empt and anticipate poor conduct, and society has a right to
Understanding drivers of poor conduct
If you follow this line of argument, I
think it is natural that as a public interest authority, we want to do all we
can to understand the drivers of poor conduct so that we can seek to prevent
them. A little over a year ago, I did some work to prepare for a speech
I gave in Hong Kong on culture in which I looked back at the history of corporate
executive remuneration in the US since the Great Depression of the 1930s. I
found the evidence very interesting.
In essence, the system that operated
from the Great Depression until the 1980s had relied on the legacy of the 1930s
and an almost unstated code in society that the remuneration of senior
corporate executives should not increase beyond a quite limited multiple of
average pay on the basis that to breach this relationship would be viewed as
ostentatious and breaking a norm that acted as a glue in society more broadly.
Things changed from around the early
1980s. You can label it the ‘Greed is Good’ era if you can remember the first
Wall Street film with Michael Douglas. It is also often labelled as the era in
which so-called agency theory came to prominence, in which corporate governance
was used to change the policies under which a manager (agent) operates, and
thereby emphasise the interests of the owner (principal). This led to a rapid
increase in senior executive pay as the limits of the previous social norm were
replaced by an approach which used remuneration to incentivise performance.
Broadly, this approach held up to the global financial crisis, certainly in
This ‘glue in society’ is
interestingly reflected in the overall pattern of income growth in the US.
Between 1917 and 1948, the real income of the lower 90% of earners in the US
grew at 1.43% per annum, more than double the 0.50% growth rate per annum for
the top 10%. For the 1948-1972 period, the real incomes of both groups grew
markedly more rapidly, at an average of 2.58% per annum, more than double that
of the 1917 to 1948 period, and while the real incomes of the lower 90% grew by
2.46% per annum, those of the top 10% grew by 2.65%, quite a remarkable
uniformity. And then it changed. Between 1972 and 2013, average real income
growth for all employees was 0.48% per annum, but with the top 10% growing at
1.42% per annum and the lower 90% at -0.17% per annum. That is a notable change
in income distribution.
One of the intellectual origins of
this shift away from the traditional post-Depression approach came in September
1970, in an article written in the New York Times by Milton Friedman. It went
under the title: ‘The Social Responsibility of Business is to Increase its
Profits’. If you will let me indulge, I am going to read the first paragraph.
‘When I hear businessmen speak
eloquently about the social responsibilities of business in a free-enterprise
system, I am reminded of the wonderful line about the Frenchman who discovered
at the age of 70 that he had been speaking prose all his life. The businessmen
believe that they are defending free enterprise when they declaim that
business is not concerned ‘merely’ with profit but also with promoting
desirable ‘social’ ends; that business has a ‘social conscience’ and takes
seriously its responsibilities for providing employment, eliminating
discrimination, avoiding pollution and whatever else may be the catchwords of
the contemporary crop of reformers.
‘The discussions of the ‘social
responsibilities of business’ are notable for their analytical looseness and
lack of rigor’.
So, there you have it. The seeds of
the financial crisis of 2008 were sown by Milton Friedman 38 years previously
almost to the day. Well, not quite, because to my mind there is an even more
interesting quote 3 paragraphs later, which I am also going to read.
‘In a free-enterprise,
private-property system, a corporate executive is an employee of the owners of the
business. He has direct responsibility to his employers. That responsibility is
to conduct the business in accordance with their desires, which generally will
be to make as much money as possible while conforming to the basic rules of the
society, both those embodied in law and those embodied in ethical custom’.
Friedman starts by setting out the
essence of agency theory. People I know who know the piece tend to stop there.
But let’s go on, because the interesting part for me is when he said that the responsibility
to make as much money as possible should conform with the basic rules of
society, as embodied in the law, and ‘in ethical custom’. Here to my mind we
have the essence of the issue around culture.
There are ethical customs and laws
that rightly constrain private interests. They are the representation of the
public interest. And that public interest is not just the responsibility of
public authorities like regulators; rather it is firstly the responsibility of
firms, their managers and owners. The reality is, with the benefit of
hindsight, that the point made by Friedman about ethical custom, and also the
law, was not followed consistently, with disastrous consequences in the
financial crisis. Since then, we have set about rebuilding the system and
rebalancing the incentives. I would also note that I think Friedman was wrong
to suggest that ethical custom must always come in to firms from outside – from
‘society at large’. Firms are part of that society, as such they have public
interest duties. I think this lack of connection between firms and societal
duties in terms of the responsibilities of firms is where the culture debate
and practice subsequently went wrong.
Consistent with this wrong direction,
there is little doubt in my mind that prior to the financial crisis, the
culture towards the public interest and ethical custom were essentially
permissive, to the point of anything goes. It was evident in the advocacy of
light touch regulation, the view that left to themselves firms would succeed,
and to paraphrase, just as a rising tide lifts all boats, so the public
interest would benefit. It didn’t work out that way.
We are left then, I think, with the
conclusion that the interpretation of the public interest and ethical customs
has changed over time. But this also means that the interpretation can be
influenced, which brings us back to the importance of work on culture.
Friedman’s insight was deeper than
many interpretations have suggested, but open as we have seen to
misinterpretation. Nevertheless, the proposition that the interpretation of
what I will call an ethical culture serving the public interest can change over
time, means that there is an important role for the incentives created by
regulation and supervision of firms and their culture.
Developments of recent years
In our world, I would single out 2
developments of recent years as important for creating the incentives for good
culture, namely the advent of the Senior
Managers Regime for banks, which will shortly be implemented for other
financial services firms and measures to govern the payment of remuneration to
Senior Managers of banks.
It is important that regulatory
measures such as the Senior Managers and remuneration regimes are rooted in
clearly understood and applied basis principles and objectives. The basic
principle of the Senior Managers Regime is that of responsibility and
accountability. A senior manager has to take responsibility for the activities
under their control. Likewise, they should be accountable for that
responsibility. These concepts – responsibility and accountability – are
disarmingly simple and direct. But such things tend to be the most powerful. I
remember some years ago speaking at an event on the introduction of the Senior
Managers Regime and being challenged that responsibility could not be defined
and thus not enforced against either. We got into a debate, and then a lady in
the audience put it more effectively than I had; she was teaching her children
responsibility, and didn’t get what the problem my opponent in the debate had
in understanding such a simple concept. Good culture rests on simple but
powerful ideas was a lesson I took from that incident.
Another major cultural change post
financial crisis has been the introduction of remuneration regulation for
banks. As I noted earlier, the pre-financial crisis period was marked by strong
growth in the remuneration of many bankers. But it wasn’t so much the level of
remuneration that concerned us, but the incentives created by the structure of,
particularly, variable remuneration, made up in good part by bonuses. You would
imagine that the structure of variable remuneration would reflect the
incentives to strong performance by the individual and their firm. When we
looked at the pre-crisis period, sadly we often did not fund such incentives
working. Rather, for instance, bonuses were awarded on the basis of the firm
achieving higher levels of return in equity, which sounds ok until you realise
that this is an incentive for higher leverage and weak capitalisation. Or,
commission selling based pay was awarded with little scrutiny in the
remuneration award process of just how the commission was being earned.
In the UK we have taken the approach
towards regulating remuneration of creating so-called ‘skin in the game’. In
other words putting a significant part of the variable remuneration at risk
over coming years, which means using policies of requiring deferral for some
period of time, and backing those policies up with others requiring so-called
‘malus’ and ‘clawback’.
Put simply, malus operates when the
deferred but unvested remuneration is taken back by the firm as a consequence
of some discovered misdemeanour or another problem subsequently discovered at
the firm. Clawback is essentially the same, except that this involves taking
back remuneration after it has been paid out.
In my view, over the last 10 years we
have seen a major change in attitudes to, and the operation of, remuneration in
banks. Early on, I was told quite often that deferral would not be accepted and
would fail as a policy. I have not heard that refrain in recent years, which in
itself illustrates that cultural values and attitudes of this sort do change
Interestingly, I think that deferral
of vesting of remuneration achieves some of the incentive effects of the old
partnership structure, in the sense that both create skin in the game. For
partners, this meant leaving equity capital in the firm. This system died out
as the major firms grew rapidly and needed to raise capital on a scale which
went beyond the resources of partners.
For culture, the lessons I take from
these examples are about the power of simple ideas, responsibility, commitment
as represented by skin in the game, accountability. None of these big ideas is
new, in fact quite the opposite. Nor do they require sophisticated tools to
apply and monitor. They go with the grain of good incentives, and they act to support
the public interest and its objectives.
But, they do require effective and
consistent implementation. This is where good governance comes in, a strong
role for senior management and particularly boards. And, there is in regulated
industries an important role for regulators to back up effective governance and
very clearly espouse the public interest. It is interesting to reflect here
that a decade ago, and this went on for a few years after the crisis, it was
quite typical as a supervisor to be told by boards that very high levels of
remuneration had to be paid whatever the state of the firm, for fear of losing
key staff. I don’t hear that refrain today and haven’t done so for some years.
That is a major and welcome cultural change in my view.
But, it would be at best incomplete to
characterise the drivers of culture as being the activity of stopping bad
things from happening, important though that is. As essays in our volume
indicate, culture is about encouraging and incentivising good things, positive
ethical customs to use Friedman’s phrase. It would not be a winning pitch for
business to describe a culture as preventing the bad things that would
otherwise inevitably happen. ‘No thanks’ should be the response. Nor should
good culture just be about investigating when things go wrong.
At the FCA, one of our fundamental
principles for business is that firms should treat customers fairly, which is
not the same as firms seeking to prevent the otherwise inevitable unfair
Positive culture, as I will call it,
goes right to the heart of what firms and their staff are, what values they
represent and the positive ethical customs.
It also requires that we all, and I
include very much include bodies like the FCA in this, as regulator and
employer, are prepared to pursue cultural change for the better, in our own
world and as part of society more broadly. And, to be clear in the Friedman
context, this is entirely consistent with observing the law and pursuing good
Good diversity at the workplace
I want to take one very prominent and
topical example of good values and culture, namely pursuing and ensuring good
diversity at the workplace. I always put forwards 2 arguments within my
workplace for why this matters. First, I don’t want, as a matter of personal
choice, to work in an environment which is not diverse. It would be dull, and
it would be at risk of groupthink. We all need to be challenged, to avoid being
set in our ways, and diversity plays an important part in achieving that. The second
argument is that in order to properly understand and represent the public
interest, we need as organisations – in the public and private sector – to bear
a reasonably good resemblance to the society that we serve.
I would suggest that put like this,
such arguments are pretty hard to refute. But, of course, history tells us that
we should take nothing for granted, and they have pretty shallow roots. This is
another way of emphasising that culture and its values matters, and we should
take good care to nurture it. Like most people, I was shocked by events at the
Presidents Club. It was a wake-up call – I don’t take good cultural values for
granted, don’t assume we live in a society where these things have changed
But there is also a much deeper reason
why diversity matters, and why it must be part of our culture, in workplaces
and in society. That is because it represents the commitment to equal
opportunities to all in society. It doesn’t matter what someone’s background
is, what their gender, ethnicity, age, sexuality are. We welcome such diversity
of background and character. I am very proud of the consistently strong scores
at the FCA in our staff surveys for those questions which ask our staff to
assess our performance as a tolerant and open workplace which espouses the
public interest. We don’t always get universal acclaim for what we do, but our
culture is one of always seeking to serve the public interest. That’s a big
part of our culture.
One of the important issues in
diversity and culture is the use of targets and measurement. I have to say that
I have come round more to supporting measurement, targets and transparency as
time has gone by, and now I am a fully paid up member.
Why? Predominantly, because I think
that otherwise there just isn’t the same incentive to get things done and
improve our state. So, we have adopted targets for gender and ethnicity, and we
report our gender pay gap, as we should.
But I want to dwell for a moment on
the argument that a culture which values and promotes diversity is one that
favours equal opportunities in society. There is a deeper point here I think.
A culture that pursues diversity and
equal opportunities is I think one that will have much wider benefits for an
organisation. It suggests a culture that is open-minded, tolerant, aspiring to
improve and considerate. When I look back at the cultures that I have seen
where things have gone wrong, those are not descriptive terms that I would
Let me have a go at pulling all of
this together. Our Discussion
Paper on transforming financial services culture is focused on 4 themes,
namely: is there a ‘right’ culture in financial services; managing culture –
the role of regulation; the role of reward, capabilities and environment in
driving behaviours; and leading culture change. I will have a go – with due
modesty I should emphasise – at suggesting some answers. There is no single
‘right’ culture. It depends on circumstances, and there are certainly cultural
characteristics which are highly suggestive of good outcomes.
The role of regulation in culture is
not to attempt sweeping rules, but rather to use rules and supervision to
create the right incentives and to provide tools to diagnose the key
characteristics. And, we can prompt and persuade.
On the role of reward, as I have
discussed it is another influence to create the right incentives for good
And, finally, on leadership, there is
no question in my mind that it plays a crucial role in shaping culture.
I can safely predict that the issue of
culture and its role in the conduct of firms will run and run, as it should,
because it should not stand still.