Zeena Saleh, associate, and Chris Brennan, partner, at White & Case on corporate culture
The concept of corporate culture was the focus of much discussion at the Legal Business Financial Regulatory and Disputes Summit 2020 (the Summit). Since the 2007/08 financial crisis, culture is a concept that has become an increasingly important priority for financial services firms and conduct regulators across the globe. There is no doubt that firms and their senior managers are more aware of the importance of ensuring a good corporate culture throughout their business. However, with more reports of financial and non-financial misconduct within the market, it seems likely that regulators will consider further work needs to be done.
What is corporate culture? Most people are able to describe the culture of their employer and take a view on whether they like or dislike the environment they work in and the behaviours that some of their colleagues present, but can they really define their employer’s corporate culture?
‘The FCA recognised it could not assess whether a firm was likely to encounter misconduct simply by reviewing its second-line controls, and that it needed a more holistic approach.’
The Oxford English Dictionary defines corporate culture as ‘the philosophy, practices, and attitudes of an institution, business, or other organisation’. These are nebulous concepts that are not fixed but flex over time depending on factors such as the composition of a group of employees, the perspectives they hold and, to a certain extent, societal attitudes. Culture is by its very nature difficult to legislate for.
The history of culture within financial services
Institutional culture was not always a significant priority for the Financial Conduct Authority (FCA). It was first introduced in 2007 when the regulator, then the Financial Services Authority, published a discussion paper focused on the concept of treating customers fairly.
The idea of culture was not referred to as a stand-alone priority until around 2013. This was after the financial crisis, the outcome of the Parliamentary Commission on Banking Standards’ review and the outcomes of enforcement actions relating to various scandals, including PPI and certain benchmark manipulation cases. Since then, regulators, including the FCA, have become increasingly focused on culture present within financial services and how this can prevent or drive misconduct within firms.
‘Firms are more aware than ever of the importance of culture. It has become part of firms’ decision-making processes which generally leads to better engagement with FCA rules.’
This increased focus on culture took place together with a reduction in the regulator’s focus on controls being the sole method of preventing misconduct. The FCA recognised it could not assess whether a firm was more likely to encounter misconduct simply by reviewing its second-line controls, and that it needed to take a more holistic approach. The approach of the FCA is now to give more detailed consideration to the business model of firms, their strategies, culture and front-line processes, as well as looking to the senior management of firms to set the ‘tone from the top’ and to ensure that tone is easily and appropriately translated within their businesses. This approach was reflected in the introduction of the Senior Managers and Certification Regime in 2016, which sought to formally establish individual accountability and improve culture within firms.
What does this increased focus look like and has corporate culture significantly improved?
Since 2015, the FCA has defined culture as ‘the habitual behaviours and mindsets that characterise an organisation.’ Perhaps in recognition that concepts such as behaviours and mindsets cannot be fixed, the FCA has not set out what it thinks ‘good culture’ looks like; instead of assessing ‘mindsets and behaviours directly; … [it] recognises that there are many drivers of behaviour which firms can identify and manage’. The FCA therefore looks at certain behaviours and how these are effective in reducing potential harm arising from a firm’s business model.
As noted by many at the Summit, the FCA takes a twin-track approach when supervising a firm: is that firm’s business model sound and does it fit within an environment of good culture? This approach involves the FCA assessing:
- Purpose – does a firm’s business model have a clear sense of purpose and does it have alignment between strategy, culture and its values? Is this purpose, desired strategy, culture and values adequately communicated across the firm?
- Leadership – is a firm’s leadership team communicating the culture of the firm clearly? Does the leadership team behave in a way that is aligned with that culture and does it encourage others to do the same? Does it challenge behaviours or firm culture that do not meet the required standards?
- Approach to rewarding and managing people – does a firm’s approach to rewarding and managing its people promote good outcomes for its customers and the market?
- Governance – does a firm’s culture reinforce good governance and controls?
A key takeaway from delegates at the Summit was that firms are more aware than ever of the importance of culture. On the whole, firms are prioritising good culture; it has become part of firms’ decision-making processes which generally leads to better engagement and compliance with FCA rules. It was also recognised, however, that while there may be an increased awareness, ensuring a consistently good culture will not be an easy task. Firms and their senior management now have much broader considerations to take on board to ensure good culture. For example, when hiring a new employee, what consideration is given to that employee’s personality and how it will impact the culture of the firm? How do firms deal with powerful personalities, ensure enough diversity within the firm to prevent group-think, and safeguard against the risk of a blame culture so that employees feel comfortable challenging aspects of a firm’s culture or behaviours? Even if firms take account of all that, how do they then deal with examples of bad behaviour or poor culture that are seen to fall outside of the strong purpose and examples of good behaviour it has set for its employees?
The FCA has recognised that ‘Changing culture is very difficult and… takes time’. However, given continuing reports of misconduct, both financial and non-financial, are firms doing enough?
The number of open FCA enforcement cases relating to culture and governance has increased significantly in recent years. There were six open enforcement cases relating to culture and governance as at 1 April 2016. This figure jumped to 15 as at 1 April 2017, then 61 as at 1 April 2018 to 70 as at 31 March 2019. These figures suggest that firms may still have a long way to go. This position is somewhat supported by the recent results of the Banking Standards Board (BSB) survey, intended to provide firms ‘with evidence, support and challenge to help them achieve and maintain high standards of behaviour and competence’. These results showed that while there was some improvement in behaviours demonstrated by firms since the first survey in 2017, this has been followed by a sideways trend.
The fact that more needs to be done to improve culture in financial services has also been reflected in the increase of non-financial misconduct across the industry. As noted by Nausicaa Delfas, the FCA’s executive director of international in her June 2019 speech at the Women in Finance 2019 Conference, ‘An emerging theme in the last year or so has been non-financial misconduct, such as serious personal misbehaviour, bullying, sexual discrimination or sexual misconduct in the workplace. This type of serious misbehaviour is toxic to a working environment and can lead to bad outcomes for customers, staff, stakeholders and the firm. In our view, tolerance of this sort of misconduct would be a clear example of a driver of unhealthy culture. This area clearly requires management attention and a broader change in the firms’ mindset.’
The FCA has equally made clear that workplace culture will be considered as part of its assessment of the reasonable steps taken by senior managers to prevent misconduct.
So what can firms (and senior managers) do now and what should the future focus be in terms of tackling culture?
The future focus
Setting, reviewing, improving and/or changing corporate culture cannot be seen as a one-off event. Culture has to be considered by firms continuously and constantly reinforced. As indicated by the outcome of the recent BSB survey, if this does not happen, the process of continuously ensuring good culture could stagnate. It is therefore important that firms and their leadership teams continue to hold culture in the forefront of their minds. While difficult to measure, frequent discussion of culture at board and relevant committee meetings is likely to be considered good practice.
The FCA sees its continued focus on the culture and governance of firms as important to its objective of delivering protection for consumers. While it does not want to set out what good culture looks like via the implementation of specific rules and regulations, it would like to see a ‘healthy culture, focused on delivering consumer outcomes, [and that] helps individuals in firms to make the right judgements that do not result in consumer or market harm’. The concept of culture therefore needs to be considered more widely. It is not simply about business strategy and how to ensure this strategy is met within the confines of the FCA rules, but includes how a firm achieves its strategy and how it fosters a culture that means its employees are making the right decisions not just for the business itself but also their customers, and (to a certain extent) the market and society as a whole. While perhaps seemingly at odds with the traditional sense of a corporate environment, the FCA is looking for a culture that leads to the primary purpose not being the generation of profit but doing the right thing.
‘The FCA wants firms to look at diversity more widely. Rigorous debate and challenge of culture and behavioural norms are encouraged.’
‘Tone from the top’ is not a new concept. While the culture of a firm will inevitably be set and communicated by its leadership committee, regulators are now also keen to encourage what has been termed the ‘tone from above’, ie, that middle management must also take the lead in encouraging good behaviours and outcomes that are aligned with their firm’s cultural purpose. It is therefore increasingly important that this purpose is clearly defined and communicated throughout a firm at the outset.
The FCA has also recently been vocal about the importance of diversity and inclusion. This is not simply in relation to diversity and inclusion among groups with protected characteristics, such as gender and race. The regulator wants firms to look at diversity more widely to guard against group-think. Rigorous debate and challenge of culture and behavioural norms are encouraged and it is thought that a diverse group of people will allow for alternative analyses of culture.
‘Psychological safety is a priority for the FCA. The regulator wants to see the elimination of fear cultures that may lead to the risk that mistakes are covered up at a lower level.’
The concept of psychological safety is also a priority for the FCA. The regulator wants to see the elimination of fear cultures that may lead to the risk that mistakes or poor culture are suppressed or covered up at a lower level. The culture of a firm needs to be such that employees feel comfortable sharing opinions and ideas or acknowledging errors without fear of repercussions from management. The FCA has indicated that poor escalation procedures will be an issue. Equally, poor handling of issues escalated to senior management with the relevant oversight will be relevant to the question of whether that senior manager is considered fit and proper for the role, even in circumstances where the misconduct or issue in question does not involve that senior manager directly.
Conclusions
While delegates at the Summit recognised that corporate culture is a priority for firms, it was widely recognised that more can and should be done to ensure firms are getting culture right. While there is no one-size-fits-all solution, the resounding theme from the regulator is that firms are expected to do the right thing, and not just for themselves. Where there continues to be firms that are found lacking in this area, enforcement action in relation to culture and governance will continue to increase.