Apr 17 2014

LSE Conduct Costs Project – Lunchtime Workshops

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For additional information, please see Invitation [PDF].

Posted by: Posted on by Tania Duarte

Mar 24 2014

Bridging the divide between Conduct Risk, Conduct Costs and Materiality*

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Calvin Benedict
Research Associate at Seven Pillars Institute for Global Finance
and Ethics Qualifications: BCon (Hons) in Commercial Law – 1st Class

*I am most grateful to Professor Roger McCormick and Christopher Stears for their comments on earlier drafts. I alone am responsible for any errors.

The analysis of this paper is structured in two parts. Part A examines the Financial Conduct Authority’s regulatory focus on conduct risks, including definitional issues and its relationship to conduct costs. Part B presents my view on the materiality of conduct costs. The materiality discussion looks at the evolution of corporate reporting to accommodate shareholder and stakeholder needs, the impact of public interest and danger of ‘accountability’ arbitrage. Continue reading

Posted by: Posted on by Tania Duarte Tagged with: , ,

Mar 3 2014

Conduct Costs Project 2014

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There are now four parallel teams working alongside LSE on this project. They are based in France, Italy, Portugal and Israel. The banks they are covering are shown below.


Fig. 1 – Banks covered by teams.


Fig. 2 – Banks covered by country (HQ).


We would like to add more teams to the project, so do get in touch if this interests you.

Posted by: Posted on by Tania Duarte

Feb 25 2014

LSE CC Project’s Response to the Banking Standards Review Consultation Paper

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Following the CC Project’s initial reactions to the Banking Standards Review Consultation Paper,  the Conduct Costs Project team publishes here the complete LSE Conduct Costs Project Response (PDF).

Roger McCormick, Chris Stears and Tania Duarte


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Feb 14 2014

Banking Standards Review, Consultation Paper – CC Project’s Initial Response

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Roger McCormick
Christopher Stears
Tania Duarte

1.    The status of the “new organisation” (the “organisation”)

1.1.    We broadly agree with the Consultation Paper’s (“the Paper”) governance, disclosure and public reporting proposals.

1.2.    We agree that its independence will be crucial to its credibility. It must not be (or look like) the “same old, same old” dressed in new clothes. This goes to its place in the overall social/political/industry structure and also to the composition of its governing body and relevant committees. It should be fiercely independent, sceptical of tradition and able (and feel encouraged) to ask awkward questions, not just of banks but also of regulators, politicians and others who may influence or be affected by bank conduct and behaviour.

1.3.    This leads us to the conclusion that the organisation should not report to the FCA, the PRA or any body of politicians (such as a Parliamentary Committee). It has to report to someone, however. We would tentatively suggest it reports to the Governor of the Bank of England. Although the Governor is, of course, part of the regulatory structure, we feel that there is more public confidence in his/her independence and freedom from “regulatory capture” threat and political agendas than is the case with the alternatives.

1.4.    We do, however, see the importance of the organisation having strong links with regulators. Subject to our comments at 2 below, we suggest that the organisation seek a Memorandum of Understanding with the regulator(s) covering matters such as mutual assistance and exchange of information. The organisation might also benefit from establishing a ‘Regulatory Liaison Committee’ charged within overseeing the MoU and maintaining a synergy between the organisation’s objectives and the regulatory system.

1.5.    We would like to see some representation from “challenger banks” as well as more established commercial/retail banking in the organisation. We would be sceptical about the need for many City  Establishment figures.

2.    The conduct principles being developed by regulators

2.1.    The Paper attaches some understandable importance to these (see, for example, the foot of page 13). Whilst any standards adopted by a bank must of course be in conformity with what regulators require, we feel that the organisation should see such regulatory requirements as a minimum and steer away from an approach that relies too heavily on “reverse engineering” what regulators have laid down into a bank’s own organisational structure and deeming that to be sufficient.

2.2.    Banks should be encouraged to start afresh, notionally, with a “tabla rasa” when devising “ethical” rules for how they wish their staff to behave in the light of the experiences they have had. They should then, when they have developed some substance to such rules, check back against what is required by regulation and ensure that no regulatory requirements have been omitted. The difference in approach is important. One approach involves a mindset that poses, as a first question: what are the regulators making us do? The other poses the first question: what do we think is right? The banks’ “restore trust agenda” (which should be more about deserving trust than simply regaining it) is not about an ongoing struggle to get the compliance function to work effectively. It is about re-thinking, for each person in the bank, why he/she goes to work every day and what makes him/her proud of a job well done.

2.3.    It follows from the above that we would encourage banks to surpass the standards of regulators not merely to “meet or surpass” them. We agree that the organisation should benchmark the banks’ efforts in this area against good practice. We see the organisation’s role in the cross-pollination of ideas that lead to good practice as crucial.

3.    Training

3.1.    Whilst training in conduct matters is, undeniably, a “good thing”, staff should not need to be trained in order to understand the importance of honesty – if they do, the bank really does have a problem. Sadly, however, it is want of honesty that seems to have given rise to some of the most prominent scandals of recent times.

3.2.    Notwithstanding 3.1 above, we do think that all concerned in the industry (including regulators) need to develop a better common understanding (which they should share with the organisation and the public) of where some of the boundaries lie in relation to, for example, “manipulation” and taking advantage of another’s ignorance or error (leaving aside consumers, who are a special case). To use a celebrated example of language from a recent scandal, is it ever appropriate to regard a counterparty as a “muppet” and milk him for what you can get? There is a danger that we set up training programmes for the sake of appearance and overlook some of the fundamental right vs. wrong judgement issues, which still require a more substantive debate in the industry – a debate that might include the continued efficacy and modifying the application of parts of COBS in regard to eligible counterparties.

3.3.    The extent of the need for training in banks should, one would think, depend on how well the staff of any given bank understand (a) what honesty means and how it affects decisions and behaviour in their work and (b) how decisions should be taken in the inevitable “grey areas”. A “programme” of training designed for all banks may, by its nature, be somewhat crude (looking as though it has been devised in a “one size fits all” workshop) and, as a result, not taken very seriously. We do not believe it is being suggested that all banks have the same training programme but we would caution that the idea of assessment of training by the organisation should not lead to this result.

3.4.    Training needs to address the potential confusion for staff that can arise when there is a sharp change in values and the bank’s judgement on right and wrong behaviour. What was OK yesterday, even encouraged, may not be today. And vice versa. No one criticised generous bonuses in years leading up to the Crisis and much of the now-condemned “excessive” and aggressive behaviour was well known and not regarded as a sign of serious moral decay or reputationally problematic for banks (or something to which regulators should respond). Now things are different. And the changes in culture that post-Crisis scrutiny of banks will require is not yet a closed list. The implications for conduct are fundamental.

3.5.    We believe that on-line training should be discouraged (because it is unlikely to be effective) and face-to-face training encouraged.

3.6.    We would suggest that training initiatives should include off-site “schools” where staff from different banks can compare experiences and seminars and workshops are arranged at which examples of best practice, “lessons learned” etc. can be openly discussed. Confidentiality of a bank’s sensitive information needs to be respected but it is a characteristic of a “profession” (if that is what we are trying to set up) that fellow-professionals meet each other and talk about matters of shared professional interest (especially questions of professional ethics) reasonably regularly. (NB These occasions should not be arranged so as to be marketing opportunities for outside advisers).

4.    Benchmarking

4.1.    We believe that the organisation should place banks under a good practice obligation to record instances of conduct failure within a database accessible by the Board, Board Committees, Legal, Risk & Compliance and Sustainability & CSR. The organisation should work to promulgate a minimum level of detail (metrics) to be recorded in relation to a particular conduct failure.

4.2.    Devising a system of regular reporting by banks on matters that relate to their conduct (such as the level of conduct costs experienced) and requiring the reporting to be done in a manner that enables comparisons to be made (even a “league table” to be drawn up) is of key importance.

4.3.    We would like to suggest the following guiding principles in this area:
•    ”Concrete” indicators are always preferable;
•    Behaviour counts for more than words;
•    Facts count for more than opinions;
•    Hard evidence of actual experience counts for more than surveys; and
•    ”Anecdotal” evidence is unreliable.
4.4.    It follows from the above that we would not place as much reliance on surveys, interviews, codes of conduct and internal reports (or reports commissioned by bank management) as the Paper appears to be suggesting. As will be apparent, we place rather more emphasis on the “story” told by conduct cost history for each bank and are pleased to see that such costs would be part of the benchmarking exercise.

4.5.    A definition of conduct costs will be essential. We have proposed one in the LSE Conduct Costs Blog.

4.6.    We do not understand the reference to “relationships with, and interventions by, the regulators” at the top of p.18 of the Paper. What is this expression intended to cover other than conduct costs?

5.    Disclosure and Reporting

5.1.    We suggest that the organisation looks to hold banks to account on the adequacy of their conduct costs reporting.

5.2.    We would like to see the organisation encourage a much greater degree of transparency, from regulators and banks themselves, about how and why conduct costs are incurred and what measures banks are taking in order to avoid recurrence of the problems that lead to them. It is, in our view, unacceptable for a major UK bank (for example) to announce that it has incurred several hundred million pounds worth of new “legal costs” but “decline to comment” on what they are for. We accept that where a bank makes provision for an as yet unsettled, but nevertheless anticipated, conduct cost, there is a sound commercial necessity for the particulars of that provision to remain confidential. However, as soon as the cost crystallises (the bank settles), the bank should disclose and report on the settlement – irrespective of its balance sheet ‘materiality’. We do not consider the ‘flood gates’ argument to be a sound basis for the opacity in Bank conduct cost disclosure.

5.3.    In connection with transparency, we would make the technical point that traditional accounting requirements as to materiality as a test for disclosure should be disregarded in relation to the disclosure requirements to be imposed by the organisation. Because the major banks are so big, many important costs (even, in theory, a record FCA fine) tend to be, or could be, aggregated into larger, more opaque disclosures than is in the public interest – because they are not considered ‘material’ enough to the balance sheet to warrant specific disclosure. All instances of misconduct should be recorded and reported to the organisation and within the banks’ public disclosures.

5.4.    We would suggest that the organisation should review the adequacy of bank reporting of conduct-related matters within their sustainability reports. We have observed that despite purportedly reporting pursuant to the Global Reporting Initiative Index, banks, in relation to the ‘core conduct indicators’ of EN28, SO8 and PR9, either i) do not report or ii) simply cross-refer to the annual report and accounts. Our various interviews with banks have not produced any credible defence of the excessive secrecy in this area and the lack of frankness on this topic  in a document such as a Sustainability Report seems to us to work against the very image (of being a responsible corporate citizen) that banks are trying to project in that document.

5.5.    We would suggest a code of practice for conduct costs disclosure and reporting, at least similar to that previously provided to the organisation.

5.6.    Our experience suggests that much of the information on conduct costs is not currently easily found in the public domain and that banks will have to be required, in clear terms, to produce that information (which they are currently reluctant to do) if a comprehensive picture is to be produced for any one bank or the industry as a whole.

6.    Membership of the organisation

6.1.    We broadly agree with the approach suggested in the Paper, i.e. membership at bank level, at least initially. We do think, however, that a consequence of this is that the organisation must take positive steps to be accessible to the many communities that make up large banks and not channel all communication through “senior management”. These communities could include (a) those who work on the sustainability and CSR sections of the bank (b) the younger employees (c) those who work in retail branches (d) those who have recently joined the bank and (d) those who work overseas.

7.    Other

7.1.    We would like to know what is proposed as a sanction for banks who do not meet the expectations of the organisation. Could this tie in, in some manner, with the rules regime of the regulators? Or does that make the organisation little more than a “meta-regulator”?

7.2.    Consideration should be given to the organisation being given immunity from suit.

Posted by: Posted on by Tania Duarte Tagged with: , ,

Feb 13 2014

A professional banker? Behavioural change and conduct costs

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Christopher Stears
Lead Research Analyst, Conduct Costs Project, LSE
and Candidate for PhD, Institute of Advanced Legal Studies

The disparate backgrounds, interests and incentives evident amongst individuals working within global financial institutions will cause the greatest difficulty in engineering an appropriate culture or more specifically, controlling behaviour and promoting ‘good’ outcomes. It is precisely this issue, being a product of consolidation and growth (geographically, in speciality and in complexity) of banks over the past couple decades that has lead one commentator to observe that “there is no such thing as the banking profession” (John Gapper, Financial Times 13 February 2014).

An appropriate culture can have an influence, but (and equally in regard to a code of conduct) it  is without teeth unless individuals fear the cost of misconduct (or a poor customer outcome) more than they stand to gain from the potential benefit. Human beings rarely act altruistically. Incentives drive positive behaviour. At its simplest, ‘expectation’ (of internal and external clients) should meet with ‘obligation’ – requiring a fiduciary duty has been meted out as a means to achieve this (although the efficacy of imposing a fiduciary standard, in certain relationships, must be questioned).

One must also consider the corollary of positive behaviour, that is avoiding bad behaviour. This is where we must also focus our efforts: increasing the cost of pursuing self-interest at the expense of the client or in violation of the spirit (as well as the letter) of the law. Principles and enforcement work well and efforts to militate the moral hazard resulting from vicarious liability etc are making good headway.

The Banking Standards Review consultation paper sets out a vision to hold banks (and individuals) to account on the basis of both conduct and competence. The mission will dovetail with the objectives of the regulators; and regulatory synergy in this regard is essential. For us at the CC Project, we believe that the BSR’s intention to benchmark banks’ conduct performance is given its due weight, although, we would emphasise, that surveys, interviews, codes of conduct and internal reports, while providing some qualitative feedback, will be no substitute for the ‘story’ objectively told by a banks conduct costs over time.

Posted by: Posted on by Tania Duarte

Feb 10 2014

Banking Standards Review – Consultation Paper

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Attached is the Consultation Paper of the Banking Standards Review, published today.

Posted by: Posted on by Roger McCormick

Jan 31 2014

Research Position

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We are looking for researchers to assist in our 2014 programme.
Please email Roger McCormick at rsmccormick@btinternet.com if you are interested.

Posted by: Posted on by Tania Duarte

Jan 29 2014

Banks and corporate accountability: The challenges of shareholder primacy and rise of social accounting*

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Calvin Benedict 
Research Associate at Seven Pillars Institute for Global Finance and Ethics
Qualifications: BCom (Hons) in Commercial Law – 1st Class

1. Introduction

“[The] divorce between accountability and power strikes at the heart of any notion of democratic governance. [It] is not just economic. It is also constitutional” (January 14, 2014) – Martin Wolf, chief economics commentator at the Financial Times.

Beyond the requirements of the law, beyond compliance there is an ongoing debate as to whether banks have a greater external moral and social obligation. These obligations typically fall under the dynamic and extensive literature on corporate social responsibility (CSR). Several definitions of CSR currently exist. However, in essence, CSR examines the role of corporations in society beyond their respective regulatory requirements and the positive societal outcomes of their operations. Post the Global Financial Crisis (GFC), there have been echoing calls across the public and political spectrum for banks to sacrifice profits derived from “socially useless” exotic financial products that have little, if any, broader social benefit. These calls have triggered a powerful contemporary phenomenon termed by the author as the ‘socialization of financial markets’. The phenomenon shines a light on the rising popularity of the belief that banks must account for broader social welfare in their financial and business decisions. This phenomenon implicitly dictates that it is no longer possible for banks to assess their activities and decision-making within the solitary confines of profitability. However, against this backdrop, bank management are faced with a fiduciary duty to act in the best interests of in the corporation, which – as this paper argues – has insofar become wrongfully synonymous with maximizing shareholder wealth. The doctrine that corporations have a single, exclusive purpose of focusing on shareholders’ interest by maximizing their wealth is known as ‘shareholder primacy’.

The information asymmetry concern of how do we measure and assess the CSR of banks is one that this paper seeks to discuss. At present, corporate accountability disparities exist between what banks are doing and what they are reporting. The disparities to some extent emanate from the observation that there is very little market transparency, despite the vast amount of available information. Therein lies the paradox observed by Professor McCormick:

“The difficulty arises when one tries to analyse the large amount of material made available, separate the hard facts from the statements of opinion, acknowledgements of room for improvement (which tend to be scarce) from self-acclaim (which tends to be plentiful) and find any kind of data that enables one bank to be compared with another”.

As such, this paper surveys (i) how shareholder primacy is shaped by the socialization of financial markets and (ii) the efficacy of the integrated reporting initiative being undertaken in the evolutionary field of corporate accountability. To give a sense of concreteness to the relationship between CSR and corporate accountability it is useful to envision the following two-part scenario:

  1. If the board of a retail bank discovers that a financial product sold by a commission-driven sales team is earning them substantial profit margins – do they commend the sales team for their successes and increase sales targets, or do they ask searching social responsibility questions to ascertain whether the product is truly in the consumer’s best interest, and whether there are sufficient controls in place to offset any dangers posed by moral hazard ?
  2. If the bank is later approached by regulators, who have verifiable evidence of the toxic nature of the said financial product, and subsequently agree to enter into a settlement (with no admission of guilt and criminal charges, of course) – how and to what extent does this bank disclose their corporate [ir]responsibility to shareholders and stakeholders alike?

Continue reading

Posted by: Posted on by Tania Duarte

Jan 13 2014

Conduct Costs: Definition and Reporting Issues

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As we developed our research programme for the first phase of this project, our working definition of Conduct Costs evolved, informally, as the experience of research brought up various questions for “in or out” decisions. The working definition is reflected in the Overview of the Project set out in this blog.  Defining Conduct Costs is important because one of our objectives, as regular readers will know, is to persuade banks to report Conduct Costs voluntarily. We sense that many of them, in principle, would not be opposed to this although none is terribly keen to be first mover. Another factor which may be inhibiting banks is the question of whether there is yet sufficient consensus as to what Conduct Costs actually means. Now that we are moving into phase two of the Project (to cover 2013 numbers and an expansion of banks covered) we feel that we should try to develop that consensus and so we are setting out a suggested more formal definition of Conduct Costs that could be used for reporting purposes.

This is as follows:

Conduct Costs means all costs borne by a Bank in connection with any of the following:

  (i)    Regulatory proceedings, specifically (but not exhaustively):

      a)  fines or comparable financial penalties imposed on the Bank by any Regulator;

      b)  any sum paid to a Regulator or at the direction of a Regulator in settlement of proceedings of any kind;

      c)  any sum paid to, or set aside to be paid to, any third party or parties to the extent required by any Regulator; and

      d)  any sum paid, or set aside, for the purchase (or exchange) of securities or other assets to the extent required by a Regulator and (if such information is available) to the extent such sum exceeds the open market value of such securities or other assets as at the date of purchase;

  (ii)  any costs, losses or expenses which are directly related to an event or series of events or conduct or behaviour of the Bank or a group of individuals employed by the Bank for which any fine or comparable penalty has been imposed or any censure issued by a Regulator;

  (iii)  any sum that has become payable as a result of, or in connection with, any breach of any code of conduct or similar document entered into, or committed to, at the request of, or required to be entered into or committed to by, any Regulator or any public, trade or professional body;

  (iv)  any loss of income or other financial loss attributable to a requirement imposed by a Regulator to place money on deposit with a central bank or other institution at below the market rate of interest, being a requirement imposed in connection with a breach of law or Regulatory requirement;

  (v)   any sum paid in connection with any litigation (whether ordered to be paid by a court or tribunal or in settlement of proceedings) where the litigation involved allegations of material wrongdoing or misconduct by senior officers or employees of an institution which were not refuted;

  (vi)  any other sum, cost or expense, not falling within any of (i) to (v) above that is paid pursuant to an order or requirement of a Regulator and which is a result of any breach of any regulatory requirement or law.

We are very happy to take comments on this definition. Evidently, not all of the above heads are free of controversy. We have not, for example, included losses flowing from the activities of a “rogue trader” (although we would include any fine imposed on the bank) since we feel that the activities of such an individual cannot generally be attributed to the bank that employs him/her. Losses flowing from a “London Whale”- type scenario, on the other hand, would be included because such scenarios implicate more people than just an individual “rogue”.

We do not, in the definition, address questions as to the “fairness” of fines or settlements although such questions would certainly seem to exist, for example, in relation to pre-acquisition “sins”.

Our view is that, in an ideal world, the data relating to the above heads would be produced voluntarily by banks and presented by them in a readily comprehensible and comparable format rather than (if they are published at all) scattered around (and often obscured within aggregated entries) within a variety of voluminous, jargon-ridden documents where the facts can, effectively, be hidden from the view of ordinary members of the public. We would also encourage banks to let us have such data voluntarily as this project goes forward. It is, of course, their call but we feel that there would be very sound reputational and risk-management advantages in adopting such a practice. There must surely be a strong desire within the better banks to see these costs better managed and to take steps that will result in their sharp reduction. The data must therefore be properly compiled for internal purposes. This information should be shared with banks’ stakeholders. A bank that truly wants to “restore trust” should welcome the opportunity to engage in this way.

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