The key to winning the corporate culture wars

If financial institutions really want to change their culture, they need to better align incentives with behaviour.

ASIC chair Greg Medcraft speaking at the Finsia event with RBA deputy governor Philip Lowe, and APRA chairman Wayne Byres on a panel. Photographer Adam Yip.

The theme of the Australian Securities and Investments Commission’s annual forum that ended last night was “Culture Shock”. It could just as easily have been titled “Shocking Cultures”.

After a string of scandals and revelations of egregious behaviour within the financial services sector in recent years, here and offshore — where banks have been fined something close to $US250 billion since the financial crisis — authorities have intensified their efforts to convince those they regulate to focus on improving the cultures within their organisations.

Last week, the Australian Prudential Regulation Authority’s Wayne Byers told a parliamentary committee that culture was an issue that APRA was “delving into” across all the sectors it supervises.

“Our interest in culture reflects our prudential mandate. A good culture helps protect against poor outcomes,” he said.

ASIC’s Greg Medcraft, speaking at the ASIC forum on Monday, said the commission was now incorporating culture into its risk-based surveillance reviews, while Treasury Secretary John Fraser said yesterday that culture was critically important to the health of an institution and to the whole financial system.

Fraser made the point that while, post-crisis, there had been a big investment in compliance and risks by financial institutions, ultimately, the culture and knowledge of the people within the business is more important.

All the regulators have made the point that culture isn’t something that can be regulated with black letter law or dictated to organisations. It is self-evident from the magnitude of the fines, the recent financial advice and insurance scandals and the alleged manipulation of the bank bill swap rate that the conventional threats of fines, or worse, don’t prevent breakdowns in culture.

Whether the action ASIC recently launched against ANZ Bank for unconscionable conduct and market manipulation in relation to the bank bill swap rate is successful or not, the crude chat room conversations of its employees have severely embarrassed the group.

It has vowed to improve the rough and macho culture the transcripts of those chats and ugly insights from other legal actions involving the group have revealed. Those “chats”, however, aren’t much different to what has come out of the records of conversations in other trading rooms here and offshore, over many years.

While the threat of fine or the banning of individuals might — as the extraordinary activities that have surfaced since the crisis would suggest — be ineffectual, it has been obvious that the potential financial returns from undue risk-taking, conflicted behaviours and outright illegal activity drive the kind of conduct that the regulators are so concerned about.

The experience of the past few years would suggest that it doesn’t matter how many statements of values or codes of conduct are put in front of them, if there are markets to be rigged there will be traders who try to rig them and if there unsophisticated consumers to fleece, there will be advisers anxious to fleece them.

Compliance systems, surveillance and arm’s-length supervision can help, but ultimately it is almost always the incentives — financial and non-financial — that drive the marginal behaviours that the regulators and, indeed, the community are concerned about.

The regulators understand that. In the immediate aftermath of the financial crisis, APRA focused heavily on tightening bank remuneration policies and governance. Its target was excessive risk-taking by institutions, rather than individuals, but the substance of the issues is the same.

If organisations are rewarded for risk-taking, they’ll take risks, as will individuals. The response from organisations concerned about their reputations and their cultures ought to be to better align their incentives with the behaviours they want to encourage.

Part of the response ought to involve those outside the organisations, particularly institutional shareholders.

There’s been a discussion this year, initiated by Black Rock’s Leon Fink, about the big global fund managers banding together to develop a conduct of conduct to encourage companies to invest and think longer term.

Incentives within the funds management sector itself, both organisational and individual, tend to promote short termism within the sector that flows through to the companies they invest in and spills into the incentives structures and signals to executives and other employees that the companies develop.

Boards are under immense and continuing pressure to deliver consistent short-term performance, which may undermine their ability to strategise and invest longer term.

Incentives structures that don’t deliver near-instant financial gratification — that don’t have a near-term pay-off — might help reduce the temptation for people within an organisation to behave badly, putting their company’s reputation and even, in the more extreme instances, financial stability at risk.

While an effective response to poor cultures may not be a black letter law response, regulators along with corporate and professional leadership groups can promote remuneration and incentive structures that provide less encouragement for poor behaviours and which reward good behaviours.

As Commonwealth Bank demonstrated (in a different, pre-scandal, era), using non-financial criteria like an improvement in customer satisfaction metrics to drive the bulk of employees’ incentive-based remuneration can have quite powerful results.

In financial services, where all the institutions have some form of licence, APRA and ASIC have some significant and powerful leverage and discretions beyond fining companies for their employees’ misconduct.

If senior executives or even board members of an institution that is proven to be a repeat offender had their individual roles, reputations and careers at risk, they’d be very motivated to ensure that the compliance and incentive systems within their organisations reflect the corporate culture they are seeking.

Fining companies and banning low-level employees after-the-event isn’t driving significant change quickly enough, so other less conventional options should to be explored to shrink the gulf between high-minded corporate aspiration and some individual, incentive-driven, behaviour.

The regulators clearly understand the linkages between incentives and outcomes.

While encouraging companies to promote strong and positive cultures and develop robust compliance and surveillance systems is both worthy and worthwhile, if the misbehaviours of the few aren’t to tarnish the reputations of the many — and damage the reputation and the bank balances of organisations and their shareholders in the process — that is the link that needs to be realigned.