The Senior Executive Accountability Regime: The Central Bank’s Expectations and Insights for Boards - Director General Derville Rowland

Address by Derville Rowland, Director General, Financial Conduct, to the Financial Services Industry Board Member event at Deloitte

Introduction

Good afternoon. It gives me great pleasure to address this Financial Services Industry board member event organised by Deloitte. I would like to share with you some thoughts on the Central Bank’s proposals for a Senior Executive Accountability Regime (SEAR) and to offer some practical insights for directors. But first, let me set out why we are proposing the changes in the first place.

Banks Once Highly Trusted

It may come as a surprise to people in this room that the banking industry historically ranked among the most highly trusted industries since the end of World War II. However, trust declined sharply during the financial crisis of 2008/2009 and even today remains low compared to pre-crisis levels.

Matters have not been helped by the very long list of global misconduct scandals that have continued to surface in recent years - including money laundering, bribery and “fees for no service’’ scandals to name but a few.

Closer to home, the Tracker Mortgage issue further eroded the already fragile trust in the Irish banking system.

Indeed, in the decade since the financial crisis, the banking industry has paid at least $350 billion in penalties for conduct-related matters while here in Ireland the retail banks have spent roughly €1 billion sorting out their tracker mortgage issues. For the boards of the firms in question, these eye-watering sums represent stark failure. It is clear that governance, oversight and challenge was wholly insufficient.

Looking to the future, banks and their boards cannot afford to be complacent about their trust and reputational problems, especially in light of emerging competition from alternative providers. Further, as the G30 has pointed out, the reputational fallout from misconduct is often not limited to the offending institution but has a contagion effect on other players. It can also damage the wider economy if money that banks might otherwise have lent to personal and business borrowers is swallowed up on fines for misconduct and related costs.

So we can probably all agree why we have a shared interest in rebuilding trust in our financial services sector. Certainly, as a conduct regulator, the Central Bank wants to ensure that the best interests of consumers and investors are protected and that markets operate in a fair, orderly and transparent manner. Our vision is for a trustworthy financial system supporting the wider economy where firms and individuals adhere to a culture of fairness and high standards.

The Evolving Regulatory Landscape

Internationally, it is recognised that a lack of individual accountability is a key cultural driver of misconduct, prompting the Financial Stability Board to recommend that national authorities hold individuals accountable.

The process is already well underway in some countries.

In 2016, the UK introduced the Senior Managers and Certification Regime (SMCR) to enhance individual accountability.

In 2017, the Australian government announced the introduction of the Banking Executive Accountability Regime (BEAR) to improve standards of accountability, while a Royal Commission this year proposed extending the regime to other regulated financial services institutions.

Hong Kong and Singapore are also implementing senior accountability regimes.

As many of you know, last year the Central Bank carried out a review in to the Behaviour and Culture of the Irish retail banks. The reviews were carried out at the request of the Minister for Finance amid public concern that the retail banks were dragging their heels on redressing and compensating customers who had been denied a tracker mortgage or put on the wrong rate.

The good news is that the reviews found that all five retail banks had recently taken steps to reinforce the consideration of the consumer interest. However, the consumer-focused cultures at the banks remained under-developed and all five banks still had a distance to travel.

In response, and utilising our existing powers, we have made clear our intention to focus on bank boards as part of our ongoing supervisory work, to ensure they are providing the appropriate levels of governance, oversight and challenge.

The Culture Report sets out our proposals for an enhanced Individual Accountability Framework including the Senior Executive Accountability Regime (SEAR). We believe that our proposed reforms will create a framework to facilitate the embedding of cultural change and ensure greater individual accountability.

Individual Accountability – The Story So Far

It is important to mention that individual accountability is not a new area of focus for the Central Bank. We already have a range of powers and we use them – both to keep unfit individuals out of the financial services industry and to pursue wrongdoing where it occurs.

The Administrative Sanctions Procedure, or ASP, provides for individuals to be sanctioned when they participate in wrongdoing in the management of a regulated firm. I would encourage you to read the outcomes, which we publish on our website, as they contain important messages about our understanding of what constitutes ‘serious misconduct.’ We have also taken action against individuals under the ASP including the imposition of monetary penalties and lengthy disqualifications.

The Fitness and Probity regime, introduced in 2011, aims to ensure that individuals who hold certain positions in regulated firms are committed to high standards of competence, integrity and honesty.

For the most senior roles in the industry, the Central Bank acts as gatekeeper, and must approve proposed appointments. This regime has been instrumental in the Central Bank’s work to ensure that the right people occupy senior management roles in the financial services sector.

The Central Bank recently wrote to the senior management of regulated firms reminding them of their legal obligations under the regime.

I want to stress today that the regime is central to our role as a gatekeeper for the financial system, ensuring that we can fully assess whether the most senior people working in the financial services industry are fit and proper. This is critical to the protection of the public interest and to ensuring that there is public trust and confidence in the financial system.

Not all of our work in the sphere of individual accountability results in public outcomes. As gatekeepers, we find that where we raise the prospect of refusing to approve individuals for senior roles, proposed applications are in most cases withdrawn.

Since 2012, 66 applications for senior positions have been withdrawn following challenge by the Central Bank; 18 of these withdrawals were made in 2018 alone, and a large number of those withdrawn applications were for positions on the boards of medium- to high-impact institutions.

Global and national experience indicates that in order for a regulatory framework to work well, it needs to drive strong and effective governance within firms.
To achieve this, the allocation of responsibilities within firms needs to be clear and comprehensive, individuals need to know what they are responsible for, to be clear what standards are expected of them, and to recognise that if their actions fall short, they will be held accountable.

That is why the proposals for individual accountability set out in the Culture Report contain four key elements.

First, we proposed enforceable Conduct Standards. These set out the behaviour the Central Bank expects of regulated financial services providers and the people working in them. Examples include the binding obligations on firms and individuals to conduct themselves with honesty and integrity, to act with due skill, care and diligence in the conduct of their business and to co-operate with relevant regulatory authorities. There should be nothing surprising in these Standards. Staff in firms should already be complying with them, and most already are.

We propose to extend the Standards to cover all of those who work in financial services because we are aiming for an effective culture, which should be evident in the behaviour of staff at all levels.

We are proposing additional Conduct Standards for individuals in senior roles, including the requirement to take all reasonable steps to ensure the area of the business for which they are responsible is controlled effectively and complies with any regulatory requirements. There will also be principles for businesses applicable to all regulated firms.

Where firms or individuals fall below these basic standards, the Central Bank may decide to take regulatory action and impose sanctions where necessary. The standards will also provide a sense of shared values and empower individuals at all levels in the organisation to speak up and challenge issues that arise in their firms.

Second, we proposed a Senior Executive Accountability Regime, or “SEAR”, to ensure clearer responsibility and accountability by placing obligations on firms and senior individuals within them to set out clearly where responsibility and decision-making lie for their business.

Broadly speaking, these senior executive functions would include board members, executives reporting directly to the board and heads of critical business areas.

We are proposing that each in-scope firm would be required to produce “responsibility maps’’ documenting key management and governance arrangements. For example, such maps would include matters reserved to the board, terms of reference for key board committees and document other key reporting lines.

Taking a risk-based approach, we are proposing the SEAR would focus initially on a sub-set of the financial services industry including credit institutions, certain insurance undertakings and investment firms. Over time, it would be rolled out more widely. This phased approach will help ensure efficiency, effectiveness and proportionality.

I should note that the experience of other countries who have implemented similar regimes has been positive, broadly speaking. In the UK, the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) applied a senior accountability regime to banks, building societies, credit unions and banking firms in March 2016. Since then, its scope has been extended - first to insurers in December 2018 and will be extended to all regulated firms by December 2019.

It would not have been extended had it not been considered a success, at least by the regulator. It is perhaps of note that the feedback to the latest consultations by the FCA on extending the regime (published in July 2018) was also positive. The “vast majority” of the 225 responses supported the regulator’s proposals. While there may be operational challenges for regulated firms and the individuals who work within them, we take the view that these are a price worth paying.

Third, we proposed further enhancements to the current F&P Regime, to strengthen the onus on firms proactively to assess individuals in controlled functions on an ongoing basis. We also proposed enhancements to overcome some current limitations of the Central Bank’s F&P oversight function; for example, the ability to investigate people who performed controlled function roles in the past.

Finally, we proposed a unified enforcement process, which would apply to all breaches by firms or individuals of financial services legislation. We also recommended that the hurdle of participation be removed such that the Central Bank could pursue individuals directly, rather than only where they are proven to have participated in a firm’s wrongdoing.

Combined, the SEAR, the F&P Regime and the Conduct Standards will support the objective of individual accountability - to embed a culture of ethical compliance in regulated firms.

You may wonder what the next steps are on our side. There is of course a considerable body of work to be done on the underlying detail of these proposals. That will take some time and will, in due course, be subject to public consultation. We are currently engaged in discussions with the Department of Finance who, along with the Oireachtas, will have the ultimate say as to what the new regime looks like. While the passing of legislation is not a matter for us, we are committed to doing all we can to assist the government in implementing our proposed reforms.

Bad Apples or Bad Barrels

Given the persistence of misconduct scandals in the global financial services sector, there is a question as to whether unethical behaviour is driven by individual bad apples or the nature of the workplace itself – bad barrels if you will.

While the role of bad apples cannot be ignored, there is increasing interest in the role of workplace culture in driving misconduct. Against that background, research suggests firms should focus on maintaining a “good barrel’’ - or an environment that influences individual choices for good.

Culture is a matter for each individual bank in the first instance, and no two cultures will be precisely the same. However, organisations that have an effective culture share a commitment to high standards and values with consumers at the heart of their decision-making.

I recognise that the majority of directors are diligent and professional in the exercise of their responsibilities and committed to ensuring well-run, well-managed, responsible firms. And that is precisely what we want to see.

We expect regulated firms to achieve a sustained improvement in culture by focusing on values and conduct that are the building blocks of culture. We expect firms’ ‘desired’ values and conduct to be reflected in the daily habits and practices of their employees.

What an Effective Culture Looks Like

So, let me give you a few examples of what an effective culture looks like:

Values & Behaviours

• Firms have a set of values and expected behaviours in place that clearly articulate the intended culture of the firm.
• Values are designed so that employees feel accountable for their actions towards consumers.
• Expected behaviours are clearly articulated, easy to remember and act on, and written from an employee’s point of view.
• Firms are open to constructive internal feedback and have in place formal and informal channels to encourage and support employees to ‘speak up’.

Senior Accountability & Tone from the Top

• Each firm’s leadership team is highly visible in championing the firm’s desired values and conduct.
• Accountability for consumer protection at board/ committee level and at an individual level throughout the firm is formalised.
• Firms sanction employees for behaviour that is not aligned to consumer protection e.g. mis-selling.

Performance Management, Reward & Incentives
We want to see the expected behaviours reinforced at every stage of the employee lifecycle – recruitment, induction, training and development, promotion, for example:

• Promotion and remuneration policies and practices are designed to encourage employees to behave in a consumer-focused way.
• Employees are not assessed on short-term performance and financial metrics only.
• Disciplinary processes promote behaviour that is consistent with the firm’s values and expected behaviours.

Think Big!

This desired cultural shift will require leadership, persistence, and consistency and will not be achieved overnight.

But I am heartened by some of the developments we have seen over the last year or so.

I would point to some improvements in gender balance at senior levels in the financial services sector, particularly in banking. While there is more to be done, the Central Bank welcomes these improvements given that we are of the view that diversity, including gender diversity, helps guard against groupthink, improves decision making and facilitates internal challenge.

I am also pleased to see the Irish retail banks have set up the Irish Banking Culture Board with its intended focus on behaviour, ethics and culture and its proposed advocacy for the interests of bank customers and a sustainable banking industry. Meanwhile, the Institute of Banking is providing educational qualifications on leading cultural change and ethical behaviour.

While certainly not a substitute for effective regulation, assertive supervision and robust enforcement, these initiatives have an important role to play in challenging industry on these key issues.

These are important first steps on the road towards restoring trust in the banking sector – though not before time. But I would urge you as members of the boards of banks and financial services firms to think big and to seek to reclaim the position you once held as among the most highly trusted business sectors.

Acknowledgements: I would like to thank Kathleen Barrington, Seána Cunningham, John Lynch and Paul O’Brien for their help with this speech.