Roger McCormick On Sustainable Banking

18 03 2013

1df0f60Workshop on the Financial Sustainability of Banks, Speaker: Professor Roger McCormick (London School of Economics) Chair: Professor Emilios Avgouleas (University of Edinburgh) held at UCL Faculty of Laws, Bentham House, Endsleigh Gardens, WC1H 0EG on Feb 6, 2013. 

A league table of Bad Banks might lead to improvements in the ethics of Banking, argued LSE’s Professor Roger McCormick at a UCL’s Centre for Ethics and Law event on Sustainable Banking. He drew on evidence to the Banking Standards Committee criticising the idea that what Banks needed were more lawyers and compliance staff. Doubting the efficacy of Codes of Conduct, he advocated a focus on steps that might genuinely influence banking conduct. If it is the case that codes and process measures can simply be worked round and recognising that basic values may be important it was necessary to find other techniques. Structures played a role: Professor McCormick pointed to the de-federalisation of Barclay as a positive sign that the Bank might be taking control of the compliance and ethics problems it faced, with reporting lines direct into the CEO.

But there was a profound need to realign the interests of boards who had often not been informed of illegalities and other problems in their Companies.

One approach was to look for proxy indicators of poor culture and magnify attention on those. Interestingly, Banks’ Sustainability Reports do not, he emphasised, contain information on regulatory findings and fines in spite of guidance that they ought to. McCormick has been developing a tabular format for collating and simplifying the information into a league table to make the information more impactful. The information is collated by researchers including fines and the nature of any breach. 
Professor Emilios Avgouleas of the University of Edinburgh applauded the initiative and warned against too superficial a reliance on the notion of cultural change. To understand what we meant by a sustainable bank we had to think about what the purposes of a bank were and how those purposes could best be served. Complexity and incentives meant that utility banking, hedging and speculation had merged into a melange of one purpose where gambling and outsmarting competitors had become more important than long term financial health. For Avgouleas incentives were the key; at the moment they encouraged manipulation and short termism. Steps like McCormick’s league table had potential, he thought but regulators needed to concentrate on incentives not culture. In particular, a naming and shaming approach would not prevent a serious financial sustainability event in the future.

With the seminar taking place on the day the Francis Report was published, a member of the audience posed the broader question: isn’t cultural failure a broader social phenomenon? And if so, where does that failure stem from? The audience member felt that was a failure of societal values. An interesting area of deliberation which the Centre is involved in encouraging dialogue, is what role if any law and regulation has to play in shaping such values.

Blog Editor Comment

Ever wonder which banks were the most sustainable? Have a look at the 2012 Financial Times (FT) short list here, the general FT page here and the sustainable banking and finance special report (June, 2012) here.

With all of us, who study the financial markets and banking and finance law, extremely excited about next month’s legal cutover to the Financial Services Act 2012 (which brings in the new regulators, the Financial Conduct Authority and Prudential Regulation Authority), one thing is for certain. The Financial Services and Markets Act 2000 (FSMA) has come to be so heavily amended that even seasoned lawyers are experiencing difficulties digesting all the changes.

Just with the LIBOR scandal in mind consider the follow summary. Section 7 (extension of scope of regulation) of the 2012 Act amends section 22, inserting a new section 22(1A) of and Schedule 2 to FSMA by expanding the Treasury’s power within the meaning of section 22 to specify by order what activities are “regulated” activities (and thus subject to the general prohibition in section 19 of FSMA). Moreover, section 11 (permission to carry on a regulated activity) of the 2012 Act also inserts a new Part 4A into FSMA. Furthermore, as noted earlier, Part 7 of the 2012 Act in section 89 (misleading statements), section 90 (misleading impressions) and section 91 (misleading statements etc in relation to benchmarks) creates new criminal offences; for interpretive purposes, the types of relevant agreements and investments are set out in the Financial Services Act 2012 (Misleading Statements and Impressions) Order 2013. The activities connected to specified benchmarks are inserted to the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 by the Financial Services and Markets Act 2000 (Regulated Activities)(Amendment) Order 2013 and the latter also amends the meaning of “consumer” as contained in section 1G of FSMA. As far as regulation is concerned, this is just the tip of the iceberg and one could go on and on …

While regulation the above regulation is not undesirable, surely there must be another way to do things?

LSE Sustainable Finance Project: International Comparative Legal Risk

Note: the Project is still looking to complete its funding package; please email R.S.McCormick@lse.ac.uk, rsmccormick@btinternet.com or call +44 (0)7802 604 316

The concept of Sustainability is frequently discussed in the context of  financial markets. Many banks issue Sustainability Reports (by whatever name called) every year and nearly all of them wish to be perceived as having an acceptable response to the demands of the ESG agenda. They do not want to be seen, for example, as financiers of “dirty projects”, users of child labour or manufacturers of cluster bombs. But does this response go far enough in view of the issues thrown up by the financial crisis?

It is an important part of the LSE Sustainable Finance Project to consider  how society’s understanding of the scope of the ESG agenda should embrace more effectively the sustainability of (a) retail and wholesale financial market practices; (b) business models and cultures (including their operational risk management effectiveness) within individual banks; and (c) the financial system itself. The project centres around the question: what does Sustainability mean in the context of banks and the financial system?

Recent remarks by luminaries such as Mervyn King and Andrew Haldane suggest that the public is very much in the dark as to the financial position of banks. (Haldane referred to auditors having to pin the tail on a “boisterous donkey” when trying to assess bank balance sheet items). It would seem to be even more in the dark about the “cultures” that operate within banks and the impact they have on governance and risk management. The LIBOR Scandal (see the UK test case Graiseley Properties Ltd & Ors v Barclays Bank Plc [2012] EWHC 3093 and Graiseley Properties Ltd & Ors v Barclays Bank Plc & Ors (Rev 1) [2013] EWHC 67) has caused questions of culture and ethics to climb society’s agenda in relation to bank reform (as evidenced, for example, by the establishment of the Parliamentary Commission on Banking Standards and its reported proceedings). At the same time, concern over banks’ ongoing difficulties with operational risk,  which continue to result in substantial losses as well as the imposition of heavy fines, has  increased. The legal risks (deemed by Basel II to be an example of operational risk) attendant on poor op risk management are becoming increasingly serious, as are the reputational risks.

The International Comparative Legal Risk work programme seeks objective (or “concrete”) indicators in relation to  such “cultural” (or behavioural) issues and suggests way of assessing them and presenting them in an accessible format. It also raises questions about the relationship between Sustainability and governance and the differing practices of regulators in different jurisdictions (both as to substantive behaviour and the accessibility of information). Analysis of the immediate financial consequences of poor op risk management is a central feature of the exercise.

The principal long-term objectives of the ICLR programme are as follows:

  1. Enable comparisons to be made of how individual banks have performed in relation to regulatory disciplinary measures and comparable op risk (or legal risk) issues; key “indicators” of performance are selected for this purpose;
  2. Compare accessibility of information across relevant jurisdictions relating to Objective 1;
  3. Compare disciplinary records of financial regulators regarding fines levied against major banks and comparable measures;
  4. Compare how banks have sought to comply with applicable corporate governance rules and standards in their home jurisdictions;
  5. Establish objective indicators of bank under-performance in relation to ESG matters;
  6. Explore possible correlations between a bank’s record on disciplinary matters and its record and policy on ESG matters and corporate governance;
  7. Encourage dialogue and explanation;
  8. Promote greater transparency and accessibility of information; and
  9. Encourage banks to take active steps to improve their performance and develop a shared understanding of “best practice” in the key areas.

The motivation for the programme stems in part from a desire to make progress on the adoption of stronger governance practices and ethical principles by banks and to understand  how such progress  can be verified and how civil society can get beyond the “square one” represented by the ongoing expressions of disaffection and protest relating to banks and bankers generally. It is envisaged “square two” should include a greater analysis of the social aspects of individual bank behaviour. In this connection, “social aspects” means those aspects of behaviour that relate to (i) the “riskiness” of the behaviour (whether in relation to the bank’s shareholders, its customers, other stakeholders or the financial system (and thus society as a whole)) or (ii) a perceived disregard of the values that are adopted by the society that the bank is, in principle, supposed to be serving. For analysis to be worthwhile, it is felt that the results should be presented (a) in as accessible a format as possible and (b) in a way that enables comparisons amongst banks to be made. The four Phases of work described below have been devised by the ICLR Steering Group (which includes academics from LSE, UCL and QM) with this in mind.

Proposed Work Programme

The Work Programme currently under consideration for 2013 (and then for repetition in subsequent years) is described below

1) In the period up to end [      ] (Phase 1): to commission researchers to compile information on 10 banks covering the period to end December 2012, using the form which is summarised in the attachment as ICLR 1, for completion by [    ]. The 10 banks would all be household names and significant participants both internationally and domestically. (They may also be “SIFIs” but it is not intended that, as the project progresses, its scope should be limited to SIFIs).  4 would be from the UK, 4 from the US and 2 from continental Europe. There is no “magic” in the number chosen: if we had more resources, we would enlarge the exercise. But 10 is a reasonable number to start with. The jurisdictions covered would be, principally, the US, the UK and the other EU countries. Others may be added as long as it is practical to do so, given the need to treat all 10 banks in the same way.

2) The result of the work described in 1) is not a “league table” of “bad banks” as such, even though the data could easily be used to draw one up (simply by reference the monetary totals). But the data would also be relevant for:

a) comparing regulators and jurisdictions with each other;

b) comparing the amounts paid in relation to the different heads (set out in Form ICLR 2, attached);

c) considering which of those heads seem to be most problematic for (i) particular jurisdictions and (ii) particular banks; and

d) studying trends (per bank, per jurisdiction and per “head” of problem) over the period of time (5years) covered by the study.

3) After the completion of Phase 1, the steering group would study the results and determine the best way of presenting them (Phase 2).

4) After Phase 2, each of the banks concerned would be given an opportunity to comment on the findings to date that relate to that bank. (Phase 3)..

5) After Phase 3, the completed findings would be published (in [    ]), with an accompanying seminar/meeting at LSE. (Phase 4)

6) Subject to the results of the 4 Phases, the exercise would subsequently be repeated to bring the findings up to date for the 12 months ending December 2013, so that a rolling five year finding (this time for the 5 years ending December 2013) starts (with the cycle being repeated each year).

Senior regulators have been reported as wanting to “pry more closely into how well banks are tracking and reducing risks” (FT, front page 26.11.12). This work programme offers a methodology for doing that in relation to some of the most important op risks faced by banks.

Roger McCormick

18.3.13

Form ICLR1                                                                          Draft 1

Name of  bank/

group

Date

Event description

Full name of legal entity involved

(and place of incorporation and principal place of business)

Source of information

[1]

Code (See form ICLR 2)

Jurisdiction

where event occurred (e.g. where fine imposed)

Name of regulator or other authority

(e.g. court) — if relevant to event

Amount (GBP)

Any specific observations of compiler

     

 

 

 

 

 

     

 

 

 

 

 

 

 

 

 

 

 

 

               

Notes

1)     Amounts originally denominated in non-GBP  to be converted to GBP at a rate set annually (as of November 2012: 1.2 for euros and 1.6 for US $)

2)     Amounts only to be included when they have crystallised (e.g. a judgement has been given, a settlement agreed, or a provision made in accounts). Mere allegations do not “count”

Form ICLR2                                                      Draft 2

List of Codes applicable to Form ICLR1

PPI PPI provisions, as published by bank
AML Money laundering-related issue
MAB Market abuse related issue (incl. insider dealing)
SAN Sanctions contravention
MIS Mis-selling other than PPI (e.g. swaps)
CLA Adverse judgement/settlement in class action v bank (or one or more officers)
CON Defective internal controls (incl. rogue trader)
SEC Breach of confidentiality
CLI Client money failing
DIS Failure to disclose as required by law or regulation
TAX Payment related to tax irregularity (incl. failure to comply with undertaking)
LOS Egregious loss due to bad judgement (e.g. “London Whale”) (not incl. rogue trader)
ENV Environmental issue
EMP Employment issue
HRI Human rights issue
OPE Operational Risk issues not covered by any of the above categories
OTH           Other event indicating governance/management failure (not falling within any of above categories)

[1]NB. A separate back-up file should be kept (hard and soft copy)

 


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1 11 2014
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[…] The FEMR intends to conduct an exhaustive and dynamic evaluation of the manner in which wholesale financial markets operate and over and above helping to restore trust in the Fixed Income, Currency and Commodities (FICC) markets the FEMR also aims to influence the international debate on trading practices. Earlier in the year (August 2014), the FEMR recommended and consulted on bringing another seven major UK-based FICC benchmarks into the regulatory perimeter originally rolled-out to regulate LIBOR. […]

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