Hunter into Prey: City Watchdog Exposes its Achilles’ Heel – Part 2

6 07 2015

HeelThe issues in the last post must be examined in light of the scandal which erupted in late 2014 when the FCA came under heavy fire from the Davis Report because of the highly irresponsible way in which it had leaked sensitive data to the media earlier in March that year. Simon Davis, a partner in the Magic Circle firm Clifford Chance, stressed that there had been nothing less than systemic failure. Davis was adamant that the FCA failed to address the issue of whether the information given out might be price sensitive. The conclusion was unsurprising because the leak culminated in an article in the Telegraph headlined Savers locked into ‘rip-off’ pensions and investments may be free to exit, regulators will say which claimed that the regulator was planning an investigation of 30 million pension policies, some sold as far back as the 1970s. Consequently, big insurance companies had billions wiped off their share prices. The misapprehension that selected annuity products would be picked out meant that major UK insurers saw their share prices plummet. The insurers called for Wheatley’s resignation. Even the Chancellor George Osborne bemoaned he was “profoundly concerned” by the episode. In his inquiry, Davis unearthed multiple failures symbolic of a dysfunctional organisation, and he emphasised that the regulator was “high-risk, poorly supervised and inadequately controlled.”

Davis – who was unsparing in his criticism – held the FCA’s Board responsible for the flaws in the regulator’s controls on the identification, control and release of price sensitive information. The buck ultimately stopped with the board because it “failed in its oversight of the FCA’s executive and … failed to identify the risks inherent in the FCA’s communications strategy.” The episode required urgent action and an external organisation needed to review the board’s practices and effectiveness. So serious were the mechanical failures of corporate governance of the City watchdog. To scotch the confusion, in light of public hearings that ensued, on 17 March 2015 the House of Commons Treasury Select Committee (the Treasury Committee) published Thirteenth Report (2014-2015): Press briefing of information in the Financial Conduct Authority’s 2014/15 Business Plan (HC881).

As an institution, the regulator fully accepted the criticisms and apologised for its mistakes. But some top officials failed to accept direct responsibility for their actions. The Treasury Committee examined whether the error of judgment in relation to inappropriately courting the press was a one-off or whether something was seriously amiss about the FCA’s culture and standards. It concluded that a full inquiry needed to be held. It said that the FCA is a dysfunctional organisation and deserved to be put into special measures.

Evidence was taken from witnesses, including a number of prominent personalities, over four days in December 2014 and January 2015. Andrew Tyrie MP – Chair of the Treasury Committee and also the ex-Chairman of the PCBS which laid the foundation for the present reforms – shared the Davis Report’s view that the regulator had caused lasting damage. According to Tyrie, the FCA had fallen well below the standards it requires of the firms (approximately 73,000) it regulates because:

The catalogue of errors made across the organisation is shocking – and some of the errors went to the top.

“The system broke down” because “there were inadequate controls in relation to the control of the media,” concluded Davis in his subsequent oral evidence tendered to the Treasury Committee on 10 December 2014.

Because of the severity of the FCA’s failings, important points highlighted by the Treasury Committee include:

  • In selectively releasing information to the press about its work, the FCA put these statutory objectives at risk. By effectively breaching its own listing rules, the FCA itself created a false market in life insurance shares. This is a matter of serious concern.
  • The FCA would have considered this kind of conduct from a listed firm to be a serious failure, and it is reasonable to believe that the FCA might well have imposed a substantial fine on the firm or firms involved. The fact that the FCA failed to meet the high standards it expects of firms put its credibility at risk.

The Treasury Committee acknowledged that it is advantageous for the FCA to seek media coverage for its work because such coverage can particularly benefit consumers by helping to inform them about scams and other risks. But the Treasury Committee thought that the FCA’s strategy had “gone too far” by giving the Telegraph the exclusive scoop and the Parliamentary watchdog was of the view that:

  • It is inappropriate for the FCA to use the media to communicate specific regulatory information to firms. The FCA’s focus on achieving media coverage of its work led it to hand over editorial control of the announcement of its life insurance review to the media. In turn, this allowed certain aspects of the FCA’s intended message to be miscommunicated. The FCA’s communications strategy was therefore a major cause of the market disruption in March 2014. It is concerning that the FCA still does not acknowledge that it was flawed.
  • The FCA needs to make sure that its communications strategy is consistent with achieving its statutory objectives, and does not create the risk of moving markets unintentionally.
  • The FCA should refrain from offering “pre-briefings” or “exclusives” on forthcoming FCA announcements altogether, unless it publishes those announcements at the same time that any stories appear in the media.

In addition to the Treasury Committee’s findings, it is worth remembering that the PCBS had concluded that the FSA – the UK’s unsuccessful financial regulator for both prudential and conduct supervision – had failed to regulate conduct effectively and left the UK poorly protected from systemic risk. Notably, Wheatley’s arrival as the head of the FCA was meant to herald a new era of efficiency and not one of brinkmanship with the City. The new model of regulation embodied in the FCA intended to erase the wholesale incompetence that had historically plagued the blunderbuss supervision of the FSA and by imposing skyrocketing fines for misconduct Wheatley has created a hard-line image for his organisation. But has he gone too far? Reminiscent of a tyrant (or at best a trigger happy policeman), Wheatley, of course, autocratically declared that he:

has the power to shoot first and ask questions later.

Later, in oral evidence tendered to the Treasury Committee on 27 January 2015, he retracted the statement and expressed regret about what he had said. Against that, stressing the debilitating effects of historic incompetence (which remains unresolved without a “good deal of further work”), a bewildered Tyrie lamented yet again: “the FCA has needed to grapple with the legacy of the serious problems it inherited from the FSA.” In contrast to the FCA Practitioner Panel, which acknowledged that the disaster was an “unavoidable consequence of the direction of travel of the FCA’s media policy”, as regards the FCA’s conduct Tsar the Treasury Committee concluded that:

Martin Wheatley did not accept that the FCA’s communications strategy was to blame for the events of 27 and 28 March … It is incorrect to claim, as Martin Wheatley has done, that the communications strategy was not in some way to blame for the events of 28 March 2014. The Committee is concerned that Mr Wheatley still does not acknowledge this.

Yet Wheatley – who is known as the “grey vampire” in the FCA and is considered to be an introverted and insipid individual by insiders – rejected reality and maintained: “I don’t accept that it’s a dysfunctional organisation or that we need a root-and-branch review.” Wheatley had personally approved the type of press pre-briefings – representative of a high-risk media policy which remained oblivious to the price sensitive nature of the information delivered to the Telegraph – which resulted in the debacle. Ultimately, such hard facts make a telling paradox for a man who refuses to be captured by the industry but was dealt quite a bitter blow for his attempts to capture the press.

The lack of confidence from the Treasury Committee is quite a damning indictment for Wheatley who, in his recent Debating trust and confidence in banking speech, wants to make cultural change or the “honesty norm” to be the benchmark to measure conduct. The Treasury Committee, whose lack of confidence is the final nail in any official’s coffin, opined that the media strategy – which aimed to maximise the potential audience through media coverage – made the fiasco “not just possible, but likely”. Appallingly, totally oblivious to exposing the market to danger, the reckless FCA ran the obvious risk of its message being distorted because the media coverage induced by the watchdog handed more control to journalists over its affairs “than was appropriate for a regulator.”

Unsurprisingly, ensnared in the above scandal, other weighty officials such as Clive Adamson (the head of supervision) and Zitah McMillan (the director of communications) were ultimately cashiered by the FCA for their unmitigated negligence. As noted above, the beleaguered CEO Martin Wheatley, who barely batted an eyelid over the cock-up, refused to step down. Instead, his punishment came in the form of being divested of bonus money amounting to £115,000.

Wheatley’s resistance to reality has come to personify the culture of disbelief and incompetence in the FCA. The same point is amplified by the FCA’s inexorable stance that it did not consider that Macris was identified in the notice. To be sure, coupled with the failures discussed in the Davis Report and the Treasury Committee’s subsequent findings, it is strongly arguable that the FCA’s own lapses in conduct while taking enforcement action have turned the watchdog into easy prey. Baffled by bankers’ rights, the hunter has been turned into the hunted under Wheatley’s overaggressive leadership because, if anything, his reticence to accept reality only shows that the FCA is failing in its overarching statutory objective to make sure that the relevant markets work well. It is equally failing in its objective of protecting and enhancing the integrity of the UK financial system and the orderly operation of the financial markets. With its Achilles’ heel exposed, if the current state of negligence endures, the watchdog will need more than a miracle to save itself from total meltdown. Importantly, Wheatley is no newcomer to controversy. Prior to his arrival on the UK scene, effigies of him were burnt in Asia because in his role as the head of the Securities and Futures Commission in Hong Kong, Wheatley approved $2 billion of financial products linked to Lehman Brothers which were sold to Hong Kong investors prior to the bank’s collapse. This caused people to take to the streets and express their outrage. It is therefore unsurprising that the jury is presently out on Wheatley and the FCA. Its scorecard is looking more and more like its predecessor’s and is arguably even on a par with the banks.

By contrast, the Bank of England paints a less gung-ho picture of itself. It expects its senior management to meet the highest standards of professional conduct, has introduced a new code of conduct and will “in principle” apply the core principles of the Senior Managers Regime (SMR, laid down in the FEMR) to its own senior staff, including the Governor. This pledge given by Mark Carney aims to demonstrate his commitment to the public that “the Age of Irresponsibility is over.” The SMR will operate in addition to scrutiny from the courts, Parliament, the media and the general public. The Bank of England attributes its desire to streamline its efficiencies to the Grabiner Report, a controversial document which cost £3.5 million as regards which the US Department of Justice has concerns (and the Treasury Committee has also criticised).

The SMR, which is examined in more detail below, locks regulatory attention on a smaller set of senior persons than the Approved Persons Regime (APER/APR) and it limits regulatory pre-approval to the most senior individuals in banks, building societies, credit unions and PRA-designated investment firms, known collectively as Relevant Authorised Persons (RAPs). Firms will be required, as part of the regulatory pre-approval, to submit statements of responsibilities setting out the areas for which a prospective senior manager will be responsible. “Clear lines of a accountability,” are the goal and these are underpinned by a “presumption of responsibility” with the result that, unless managers can satisfactorily demonstrate to the concerned regulator that reasonable steps to prevent such breaches were taken, senior managers in RAPs will be held accountable for misconduct within their spheres of responsibility.

New Rules and the FEMR

The FEMR’s terms of reference require it to consider the impact of its work on (i) the stability, efficiency and effectiveness of the financial sector, and its capacity to contribute to the growth of the UK economy in the medium and long run; (ii) the need to maintain vibrant competition in wholesale financial markets; (iii) the competitiveness of the UK financial and professional services sectors and the wider UK economy; and (iv) the resources needed for implementation. The PCBS, the underlying bedrock of reform, was clear, at para 930, that the FCA’s predecessor the FSA “suffered from insufficient expertise amongst its supervisory staff” and unlike the Bank of England and the Treasury it was unable “to attract the brightest and the best” and was being run by “extremely inexperienced people.” From what we can see, the FEMR’s terms of reference, do allow some leeway for self-criticism because the stability, efficiency and effectiveness of the financial sector do ultimately depend on the competence and fitness of the regulators. As noted above, the PCBS also said that the FCA should replicate the Bank of England’s stated intention for the PRA to operate at a lower cost than its equivalent part of the FSA.

Chapter 5 of the FEMR’s final report is devoted to raising standards of professionalism and it states that in the run up to the financial crisis firms were plagued by low levels of accountability because of three “key trends”. First, senior management remained remote and unaccountable for the maintenance of standards in day-to-day trading operations. Second, senior managers faced few apparent consequences for failing to ensure that their teams upheld appropriate standards of market practice. Third, there was an increasing shift in power within firms and their management teams towards trading staff. Moreover, the FEMR also stressed that staff with a poor conduct record must not be recycled. In that respect the provisions of the Financial Services (Banking Reform) Act 2013 (the 2013 Act) are important as Part 4 of this key legislation relates to the architecture that underpins the future conduct of persons working in the financial services sector. The 2013 Act also creates a new criminal offence, under section 36, in relation to decisions which have caused a bank to fail.

The 2013 Act implements the final recommendations of the Independent Commission on Banking (ICB), established in June 2010. In particular, the ICB recommended that retail banking should be separated from wholesale or investment banking, and that this should be achieved by ring-fencing. These issues shall be examined in another post. In the present context, the 2013 Act functions as a mechanism to implement the recommendations made by the PCBS in light of the widespread LIBOR and forex manipulation and mis-selling. As regards terms of reference, PCBS was created by Parliament in June 2012 in order to consider and report on (i) professional standards and culture of the UK banking sector, taking account of regulatory and competition investigations into the LIBOR rate-setting process; and (ii) the lessons to be learned about corporate governance, transparency and conflicts of interest, and their implications for regulation and for Government policy.

Because public trust in banking had hit rock-bottom, the PCBS was of the view that introducing a new framework for approving and holding individuals to account would restore trust and improve culture. The measures recommended to achieve this included:

  • a Senior Persons Regime (subsequently rebranded as the SMR) to replace the Significant Influence Function (SIF) element of APER for deposit-takers and PRA designated-investment firms with a Senior Management Function, covering a narrower range of individuals;
  • a Licensing Regime (subsequently rebranded as the Certification Regime) operating alongside the SMR and applying to other bank staff whose actions or behaviour could significantly harm the bank, its reputation or its customers, and;

Under section 19, the 2013 Act enables the PRA and the FCA to specify a function as Senior Management Function (SMF) and Individuals performing an SMF specified by the PRA will require pre-approval by the PRA with the FCA’s consent. Those performing an SMF specified by the FCA will require pre-approval by the FCA only. The combined list of FCA and PRA related SMFs shows 18 listed functions. The said functions range from “SMF1” (Chief Executive function) to “SMF18” (Significant Responsibility SMF).

Despite being different in some respects, the PRA’s and FCA’s proposed rules for SMFs intend to operate together as a single cohesive/composite regime in practice. The combined scope of the new regime is designed to cover every individual on the board of every relevant firm so that all key decision-makers falling within the regulatory perimeter are captured by the enhanced accountability requirements. The combined list of SMFs is divided into the following controlled functions: Chief Executive function SMF1 (PRA), Chief Finance function SMF2 (PRA), Executive Director SMF3 (FCA), Chief Risk function SMF4 (PRA), Head of Internal Audit SMF5 (PRA), Head of key business area SMF6 (PRA), Group Entity Senior Manager SMF7 (PRA), Credit union SMF (small credit unions only) SMF8 (PRA), Chairman SMF9 (PRA), Chair of the Risk Committee SMF10 (PRA), Chair of the Audit Committee SMF11 (PRA), Chair of the Remuneration Committee SMF12 (PRA), Chair of the Nominations Committee SMF13 (FCA), Senior Independent Director SMF14 (PRA), Non-Executive Director SMF15 (FCA), Compliance Oversight SMF16 (FCA), Money Laundering Reporting SMF17 (FCA) and Significant Responsibility SMF18 (FCA).

To facilitate these arrangements, section 20, which amends section 60 (applications for approval) of FSMA, requires senior managers to furnish a statement of responsibilities detailing the areas of the firm which the prospective senior manager will be responsible for managing. The 2013 Act also gives both regulators the power to approve senior managers subject to conditions or time limits. As a system, the total breadth of the FCA and PRA’s regimes captures members of a relevant firm’s board.

Moreover, section 30 empowers the FCA to make rules of conduct. Furthermore, by inserting sections 63E and 63F into FSMA, section 29 (Certification of employees by relevant authorised person) of the 2013 Act empowers the regulator to specify in its rules functions which, although not controlled functions requiring approval, are “significant-harm functions”, i.e. functions which may give rise to a risk of significant harm either to the firm or to its customers. In relation to the Certification Regime (CR), the following roles are all “significant-harm functions”: CASS oversight, benchmark submission and administration, proprietary trader, significant management, functions requiring qualifications, managers of certification employees, functions that have a material impact on risk.

The new section 63F provision lays down the rules under which a RAP may issue a certificate to one of its employees. The RAP must be satisfied that the person concerned is a fit and proper person to perform the function covered by the certificate. Consideration must be provided to whether the RAP possesses the qualifications, training, level of competence and personal characteristics required by rules made by the regulators in relation to the function in question. The certificate, which will be valid for twelve months, will not only describe the role to which the person concerned is being appointed but will also confirm that the person is fit and proper to act in that role. Where the RAP decides not to issue such a certificate, it must give the person concerned written notice of that fact, including details of the steps the RAP proposes to take in consequence and the reasons for them.

The term RAP is defined by section 33 of the 2013 Act. The provision inserts a new section 71A into FSMA which captures RAPs for the purposes of Part 5 of FSMA. All deposit-takers, including building societies and credit unions, and those investment firms which are authorised by the PRA are caught by the provision but it does not cover any insurers which are permitted to take deposits under FSMA. As regards RAPs, the terms of the 2013 Act only cover institutions incorporated in the UK or formed under the law of any part of the UK. On the other hand, by virtue of new section 71A(4) of FSMA, the Treasury enjoys the power to extend by order the definition of RAPs to include branches of non-UK credit institutions and investment firms of a specified description.

In other words, the new SMR, which replaces the present APER, applies to individuals who are subject to regulatory approval. The SMR thus focuses on senior individuals who hold key roles or have overall responsibility for key areas. As highlighted above, the roles of chairman, senior independent director, the chairs of the risk, audit, remuneration and nominations committees are all non-executive director roles that will fall within scope of the SMR.

Furthermore, the CR under section 29 of the 2013 Act applies to staff who could pose a risk of significant harm to the firm or any of its customers. As observed above, the CR applies to members of staff who administer benchmarks, give investment advice or execute client orders. In contrast to the SMR, the CR under the 2013 Act requires firms themselves to assess the fitness and propriety of certain employees, without regulatory pre-approval. The FEMR refers to these two systems collectively by telescoping them as the Senior Managers and Certification Regimes (SM&CR) and the framework, which will enter into force in March 2016, is said to “give teeth” to the regulatory oversight mechanism. The upshot is that regulators will be able to hold individuals accountable for misconduct by requiring all traders and other relevant individuals to comply with the following fivefold formula prescribed in Individual Conduct Rules:

Rule 1: You must act with integrity.

Rule 2: You must act with due skill, care and diligence.

Rule 3: You must be open and co-operative with the FCA, the PRA and other regulators.

Rule 4: You must pay due regard to the interests of customers and treat them fairly (exclusive to FCA).

Rule 5: You must observe proper standards of market conduct (exclusive to FCA).

According to the watchdogs and the policy makers, the above will provide a strong incentive for individuals to achieve higher standards of market conduct because individuals will be personally accountable for any breach of a Conduct Rule. Moreover, the new Senior Manager Conduct Rules are clear that:

SM1: You must take reasonable steps to ensure that the business of the firm for which you are responsible is controlled effectively.

SM2: You must take reasonable steps to ensure that the business of the firm for which you are responsible complies with the relevant requirements and standards of the regulatory system.

SM3: You must take reasonable steps to ensure that any delegation of your responsibilities is to an appropriate person and that you oversee the discharge of the delegated responsibility effectively.

SM4: You must disclose appropriately any information of which the FCA or PRA would reasonably expect notice.

Consultation Paper FCA CP14/13, PRA CP14/14 Strengthening accountability in banking: a new regulatory framework for individuals was distributed in July 2014 and in light of the responses the feedback was published in March 2015. The statutory requirements of the 2013 Act will be transposed into the FCA’s Handbook through the Individual Accountability Instrument 2015.

From March 2016, the Code of Conduct sourcebook (C-CON) will be inserted after the Senior Management Arrangements, Systems and Controls sourcebook (SYSC) in the block of the Handbook entitled High Level Standards. Moreover, the Individual Accountability Instrument will also amend the following modules of the FCA’s Handbook: Glossary of definitions; Senior Management Arrangements, Systems and Controls sourcebook (SYSC); the Fit and Proper Test for Approved Persons (FIT); Supervision manual (SUP); and Decision Procedure and Penalties manual (DEPP).

The principles of the Individual Conduct Rules and the new Senior Manager Conduct Rules which are extracted above contain very detailed, albeit non-exhaustive, examples of what does amount to a breach of the new rules.

The requirements of the new regime are also incorporated into the PRA Handbook through the PRA Rulebook: Glossary Instrument, PRA Rulebook: Senior Management Functions Instrument, PRA Rulebook CRR Firms: Allocation of Responsibilities Instrument, PRA Rulebook: Certification of Employees Instrument, PRA Rulebook: CRR Firms: Fitness and Propriety Instrument and PRA Rulebook: CRR FIRMS: Conduct Rules and Notifications Instrument.

Moreover, a similar mechanism can be found in the proposed Senior Insurance Managers Regime (SIMR) which incorporates aspects of the SM&CR within the existing legal framework for insurers. The SIMR works in a similar manner to the SM&CR, but without the ‘presumption of responsibility’, and it will require insurance firms to adopt clearer governance arrangements, and set clearer allocations of responsibilities and accountabilities for senior managers. Among other things, PRA Consultation Paper CP26/14 Senior insurance managers regime: a new regulatory framework for individuals dealt with the SIMR (which adopts the same five Conduct Rules noted above) and resulted in Policy Statement, PS3/15 Strengthening individual accountability in banking and insurance – responses to CP14/14 and CP26/14.


“The integrity of the City matters” to Wheatley’s alter ego George Osborne. Undeterred by the damage to London’s reputation as a hotspot for financial excellence, the Chancellor wants to resurrect London to its former glory and make the metropolis the gold standard for professionalism and ethical conduct. In order to reinforce confidence in the fairness and effectiveness of the Fixed Income, Currency and Commodities (FICC) markets the FEMR has recommended the following course of action. First of all, near term actions to improve conduct in FICC markets (i) raise standards, professionalism and accountability of individuals; (ii) improve the quality, clarity and market-wide understanding of FICC trading practices; (iii) strengthen regulation of FICC markets in the UK; and (iv) launch international action to raise standards in global FICC markets. Moreover, other long-term the principles to guide a more forward looking approach to FICC markets are underpinned by (v) promoting fairer FICC market structures while also enhancing effectiveness; and (vi) forward-looking conduct risk identification and mitigation.

This series of posts began by studying the case of Macris, which is important because misconduct had been accepted and yet the FCA’s swift settlement procedure sacrificed third party rights and the efficacy of the regulator’s quick-draw approach has become the subject of an important appeal to the Supreme Court. The provisions of the 2013 Act and the impact of the new regimes for senior managers and certification on the FCA and PRA’s combined Handbook would most certainly have helped in regulating people such as Macris – who would have been subject to the enhanced stringency of Significant Responsibility SMF18 (FCA) rather than Controlled Function CF 29 (significant management) – and his colleagues.

However, despite its vision of revolutionary change, with the greatest of respect to the acumen of its authors, the FEMR is a bit one-sided. Its thesis is purely regulatory and it is a one-way street. It is overladen with maxims like “culture”, “integrity” and “standards” for the regulated but does little to address issues surrounding the incompetence and misconduct of regulators who have become a law unto themselves – a point clearly embodied in the FCA’s “shoot first and ask questions later” policy.

The adoption of this type of aggressive attitude by regulators – such as the Takeover Panel, the UK Listing Authority and the FCA – has not been impressing business leaders. “Regulators are the new dictator class of our society,” wrote Sir Richard Lapthorne only the other day. According to Lapthorne, the Chairman of Cable and Wireless Communications, the market must be professionally policed to maintain “a balanced society.” He concedes that point squarely but finds “bullying unacceptable”. No doubt with characters like Wheatley in mind, Lapthorne concludes that:

[T]he zealots who behave in a non-transparent and unfair manner cannot be allowed to mimic dictators of old. Like those dictators they too can destroy lives by exercising unrestrained power.

The FEMR, a crucial monograph and an indispensible instrument of learning and change, considers greater transparency to be a priority and invites firms to improve disclosure of fines and other misconduct:

Fines are published in different ways by different regulators, and firms are under no obligation to disclose conduct costs, often aggregating fines with other legal costs in their annual reports. Greater clarity in reporting by firms would help shareholders monitor progress on conduct issues.

Surely everyone will agree with this. However, Professor Roger McCormick – the Managing Director of the Conduct Costs Project – explains that debating conduct related issues with banks “has been disappointing” because despite the soaring fines finding real answers to such questions remains on the “back burner”. Hype around mantras like “culture”, “integrity” and “standards” keeps intensifying but nothing much ever happens and so Roger McCormick is eager to use “a good opportunity to make a positive start in a discreet area where the issues to be addressed are straightforward and solutions should not be hard to find.” Pleased with the FEMR “honing in” on the problem of conduct costs being passed on to millions of innocent British pension savers, ShareAction’s CEO Catherine Howarth agrees and looks forward to institutional investors holding banking stocks being “more proactive in their support of improvement to the reporting of conduct costs.” I respectfully agree with both of these practical points, which offer strong counter-arguments on how to build a conduct mechanism which strikes the right balance, and can only add that both views show considerable traction the weighty theory proposed by Professor Christopher Hodges that “many regulatory systems can only function effectively if they can be integrated with in-firm compliance systems, rather than operating adversarially.” (Viewed from that angle, despite my criticism of the future rules, the new CR seems to be sensible.)

Analysed against the extreme rule changes set out in the new regime which I have detailed above, a much more convenient, reputation based and viable engine of change can be found in the Conduct Costs Project’s recent proposal for a framework for the public self-disclosure (self-reporting) of conduct costs by banks within their Annual Reports. In comparison to the black letter law of the new conduct regime, the proposal, which aims to resolve the issues with current disclosure practices in this area, is for a Conduct Costs Report to be annually produced and disclosed within the Annual Report and be subject to senior management appraisal in the context of the bank’s agenda to restore trust among its investors and wider stakeholders. As an alternative to hard-edged enforcement, this approach will produce a counterculture in institutions which will not only promote transparency but also contribute to the “honesty norm” articulated by Wheatley.

In the past, I have relied on the project’s results to evaluate the conduct of household names such as Barclays and HSBC, with whom I interact for my day-to-day banking requirements. Although financial scandals are quite well covered by the media, the complexity of the gamut of issues at stake makes things hard to grasp even for the smartest person. Hence, as I have argued before, the utility of the project’s results for everyday people with banking needs cannot be overstated because we can shun mischievous banks with high scores for misconduct. From that angle, the league table diverts power back into the hands of the disempowered majority. Or so I have argued in the past as a “stakeholder” as regards the banks where I have accounts (and it was never my intention to bash those banks). Outside of the law and the complex world of regulation, the real question, as articulated by Roger McCormick in 2013, is one of ethics:

Can we expect these costs to start going down soon if these banks have sound ethical cultures? If not, why not?

The soi-disant “global blueprint” for the future of reform and conduct contained in the FEMR does ask the vital question: “Where are the remaining gaps?” But quite tellingly, by focusing exclusively on firms, it shies away from engaging with the regulator side of the equation. Instead, the proposed unicentric model relies on the regulators to flawlessly perform their functions without prejudice to firms and the market. It does nothing to assess the efficacy of the regulators and conveniently takes the view that standards can be improved by using the SM&CR to give stronger “teeth” to voluntary codes, by extending its application and by mandating a more specific form for regulatory references to minimise the risk of “rolling bad apples”.

No critical self-reflection for regulators is recommended by the FEMR and the unipolar new world order envisaged by its authors turns exclusively on conduct issues for firms. But the scope of the conversation cannot be so one-sided as to exclusively deconstruct the behaviour of the banks. I do not mean to bash Wheatley or single his FCA out but, with the greatest of respect, making grandiose speeches and pontificating about culture and change remain quite hollow pursuits in the absence of accepting responsibility for serious negligence (such as leaking sensitive data about “zombie” insurance companies to the media). Carney has pledged that the SMR will in principle apply to him and the Bank of England. Wheatley, who is not a banker, has understandably not made any such announcement about himself and his FCA. On the contrary, Wheatley thinks that the banking industry has reached a “turning point” and he has unusually said that “neither the Senior Managers’ Regime, nor the presumption of responsibility, correspond to a ‘heads on sticks’ strategy.”

FCAAs identified by the Davis Report and the Treasury Committee’s subsequent findings, the problem is also one of process and good practice. Things are not happening in a vacuum and, as argued by Sir Richard Lapthorne, the conduct of regulators is of critical importance not least because through their own conduct they need to set a positive example of how firms should operate. As reasonable people, regulators must be a part of the solution and not a part of the problem. Ultimately, gentrification by way of reform cannot be reduced to genuflection before the regulators’ throne because it is inherently paradoxical for us to expect the banks to behave and let those in charge of conduct misbehave.

How can a negligent regulator expect a crooked bank to behave properly? Surely, after all the anarchy of the financial crisis such a double standard can longer be tolerated.

According to the FEMR, enforcement action and feedback from market participants demonstrate that prior to the onset of the financial crisis a culture of impunity was pervasive because of a perception that misconduct would not be detected or would go unpunished. Indeed, the fearless and blatant way in which rigging occurred is confirmed by the text of messages such as “if you aint cheating you aint trying.” The FEMR offers a fourfold rationale for this apparent sense of impunity – (i) underinvestment in tools for monitoring the behaviour of staff and counterparties; (ii) a perception of limited formal guidance on standards and external scrutiny; (iii) a reluctance to punish misconduct by high performers in some firms even when it was detected; and (iv) a perception that civil or criminal enforcement by the authorities was not a commonly used tool and the existence of gaps in the law which had not kept abreast of market forces.

A large regulatory tool kit is not only expensive but is also unlikely to make a real difference to the existing state of confusion which is more likely to improve if the regulators are able to set high standards by praising doing the right thing and the use of positive role models. Minouche Shafik explains that “banker bashing will end when banks are safe and have good standards of conduct.”

But from a fair and effective point of view, unless regulators like the FCA give bankers and traders a level playing field they will remain culpable in promoting a culture of impunity. From that perspective, the thrust of the FEMR does seem rather unicentric in light of the fact that by behaving in a questionable manner, like Wheatley did in the aftermath of the Davis Report, regulators ultimately become the symbols of the very thing that they seek to eliminate, i.e. misconduct. The FEMR has made it clear that a heftier, more turgid, rulebook is inevitable but the regulators’ ability to cope with the new rules cannot simply be assumed. The nagging question, especially in light of the Macris litigation discussed is the last post, therefore hangs over whether the FCA is capable of doing its job by coping with a more intensive duty to regulate. How long will we have to wait before its officials dismount from their seemingly endless ride on the whirligig of failure? Where can we find the counterculture to correct the longstanding failings of the regulators and their legacy of impotence?

For Sir Howard Davies, who looks set to replace Sir Philip Hampton as the chairman of RBS in August, “the strongest bulwark against another financial crisis is fear.” Banks do not want another near death experience and Davies argues that meaningful reform must be forged by way of “a new sustainable Social Contract between the public authorities and financial markets” because directly controlling the markets is very expensive for the taxpayer and also damaging for the positive functions of governments. The markets, which make us prosper, require the approval of society in the form of “a social licence” explained Carney in a similar vein at Mansion House 2015. Remedying the breaches to the conditions of the licence remained at the heart of the Governor’s message and the need for everyone to do more to make things work was at the forefront of his thoughts. Conscious of the criticism surrounding the Grabiner Report, which he fully backs, Carney appeared eager to appease critics who argue that Lord Grabiner did not go far enough in pressing the Bank of England’s former currency chief Martin Mallet about what he knew. But Carney’s problems do not end there and he faces heavy criticism for the Bank of England’s stress tests being fatally flawed for setting easy to clear hurdles and creating a false sense of security about the robustness of the financial system. “[T]he UK banking system is in very poor shape,” argues Professor Kevin Dowd, a Senior Fellow of the Adam Smith Institute, in his succinct study entitled No Stress. He argues that the stress tests should be scrapped because they are “worse than useless” and “methodologically flawed” and a proper interpretation of the Bank’s own results is indicative of the fact “that the UK banking system is actually very weak.”

Lastly, weighing the Davis Report, the Treasury Committee’s findings and the Court of Appeal’s judgment in Macris on one side of the scales, and the hubris and incompetence of the FCA on the other, we can only rest assured that the time for the long-awaited improved world order for proper conduct is yet to come. In relation to the story in the Telegraph, rather than staying on until 2016, Martin Wheatley should read the writing on the wall and take his cue from Howard Davies who accepted “his error of judgment” and resigned as the Director of the London School of Economics because of concerns arising out of the institution’s decision to accept money linked to the deposed totalitarian regime of deceased Libyan strongman Muammar Gaddafi.



4 responses

10 07 2015
Conduct of Persons in Financial Services: Causing a Financial Institution to Fail | Global Corporate Law

[…] The Financial Services (Banking Reform) Act 2013 (the Act) is yet another Leviathan statute. The Act is spread out over eight parts encompassing one hundred and forty-eight sections and contains ten schedules. First of all, this wide-ranging legislation implements the recommendations of the Independent Commission on Banking (or ICB, chaired by Sir John Vickers). Equally, it also implements the recommendations of the Parliamentary Commission on Banking Standards (or PCBS, in relation to the LIBOR scandal) which aim to improve culture and standards in the banking sector. Moreover, under section 17, the Act also provides the Bank of England with the new stabilisation “bail-in option” under the Banking Act 2009. See updates here and here. […]

17 08 2015
Terminated: City Sheriff Shot Down | Global Corporate Law

[…] the Senior Managers’ Regime, nor the presumption of responsibility, [see here] correspond to a ‘heads on sticks’ […]

12 09 2015
The Senior Managers Regime | Global Corporate Law

[…] he said that: “neither the Senior Managers’ Regime, nor the presumption of responsibility, [see here] correspond to a ‘heads on sticks’ strategy.” But what does all this add to the notion of […]

10 05 2016
“Land Banks” and Collective Investment Schemes: Supreme Court on s.235, FSMA | Global Corporate Law

[…] attractive maxims, as members of the public, we can only hope Bailey can change the culture of shirking responsibility and negligence at the FCA […]

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