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AM regulatory insights

AM regulatory insights - From conduct to culture

AM regulatory insights - From conduct to culture

From conduct to culture

Governance and conduct are global regulatory preoccupations, and 'culture' is now firmly on the agenda, too. This shift in regulatory expectations on the industry can be seen in a number of ways, including overall supervisory approach, a focus on individual accountability, and the linking of good governance models with diversity.

As we describe in the Evolving Asset Management Regulation report 2019, the public is more than ever an influencing factor on the regulatory agenda and the role of supervision. A number of financial services scandals worldwide, combined with the huge growth in social media, has created a new constituency of concerned, and sometimes, angry consumers. The public loudly demands that firms serve their clients with skill and care.

The overarching message is clear: it is no longer enough for firms simply to adhere to rules and regulations. They are being required to think more broadly about the impact of their culture and conduct.

Culture: the evolving supervisory approach

There have been many instances across the financial services industry where poor culture or conduct was the main driver of poor customer outcomes. An emphasis on culture could prove difficult in jurisdictions where the letter of the law is king, but it could deliver a number of benefits for supervised firms and supervisors, and most importantly for customers. A supervisory focus on culture places accountability on firms to ensure that 'tone from the top' and 'echo from the bottom' are genuinely aligned.

This change of regulatory focus and inclusion of culture as a supervisory tool represents a material departure from the approach that most supervisors currently adopt:

  • Rules-based: Many supervisors oversee firms based upon their adherence to an explicit set of rules and guidance. Firms are expected to design and implement an appropriate control environment to monitor adherence to the rule. The supervisor will assess whether the control is working effectively.
  • Conduct-based: Some supervisors are more interested in firms meeting the spirit of a rule rather than adopting a narrow and legalistic application to the specific wording of a requirement. Firms are expected to take responsibility and to think more about the outcomes they generate rather than only on meeting the specifics of a requirement. The supervisor will assess whether the firm is delivering good customer outcomes.
  • Culture-based: A handful of regulators are now adopting a more cultural approach to supervision (alongside a conduct-based approach), which considers whether the firm has, implements and maintains a customer-centric culture in everything it does. This is designed to ensure an appropriate balance between the commercial interests of the firm and its customers.

Rise of individual accountability

There are increasing demands worldwide for individuals within the financial services industry to be held personally to account for their actions. Within Europe, the revised regulations setting out the responsibilities and powers of the European Supervisory Authorities now include specific references to the supervisory approach to the fitness and propriety of key function holders. We wait to see what ESMA, in particular, will do under this header, but in the meantime a number of the national regulators (NCAs) have been focussing on this area.

Back in the summer of last year, the CSSF issued a circular for AIF depositaries (PDF, 287KB), introducing a requirement to appoint a person responsible for the depositary business line, who should either have adequate professional experience or be in charge of a team that collectively has such experience.

In April 2019, the CBI issued a “Dear CEO” letter (PDF, 305KB) to all Irish regulated firms, reminding them of their obligations under the fitness and probity regime. It said there was “a lack of general awareness” of the rules, which impose significant obligations on firms to ensure that senior and other key personnel comply with the regime's requirements.

And in the UK, the Senior Managers and Certification Regime (SMCR) will be extended to asset managers in December 2019. “Firms' culture and governance is pivotal to building public trust and confidence in the UK's financial services industry”, said Andrew Bailey, CEO of the FCA (PDF, 4.1MB) . The SMCR is a key tenet of the FCA's drive to cultivate appropriate behaviours, aiming to reduce harm to consumers and strengthen market integrity, by requiring firms to set the tone from the top. Asset managers will have to list risk-takers in a publicly-available FCA directory, which will provide a record of job histories of all “material risk takers”.

Governance: re-defining what 'good' looks like

Diversity and remuneration policies are under scrutiny and are being explicitly linked to what 'good governance' looks like.

A year ago, the CBI warned Irish firms it would impose gender diversity requirements if improvements are not made. Sharon Donnery, Deputy Governor said gender balance can help ameliorate issues such as “groupthink, insufficient challenge, poorly assessed risk and problems with culture”, which, she says, contributed to the financial crisis. “We would prefer to see the firms we supervise taking steps to increase diversity levels on a voluntary basis. But in the absence of improvements [we] will have to consider whether it is necessary to put specific requirements in place.” The CBI is actively monitoring developments.

Meanwhile, diversity has also become an important supervisory issue in the UK. Christopher Woolard, Executive Director of Strategy and Competition at the FCA, said in a speech in December 2018 that diversity has moved from “nice to have” to a commercial imperative. How a firm approaches diversity and inclusion tells the FCA a lot about its culture, he said.

In the Netherlands, an AFM 2019 priority is to investigate the impact of remuneration and valuation on the culture of the organisation and the behaviour of staff at large financial organisations. This follows government plans, unveiled in December 2018, to compel Dutch asset management employees to hold on to company shares they receive as part of their fixed remuneration for at least five years.

The new EU Investment Firm Directive (IFD) and Investment Firm Regulation (IFR) - see the April edition for more details - explicitly permit NCAs to impose a cap on individual firms if they are not happy with the firms' remuneration policies. The rules, which take effect in 2021, also require shares and derivative options to represent at least 40 percent of variable bonuses, and that at least half of bonuses should be deferred over a five-year period.

Questions for CEOs:

  1. 1. Are we simply seeking to adhere to rules and regulations, or can we evidence that we are thinking more broadly about the impact of our culture and conduct?
  2. 2. Does our governance model conform to new regulatory expressions of good practice and increasing client expectations, including remuneration and diversity?
  3. 3. Does our conduct conform to new regulatory expressions of good practice and increasing client expectations, including individual accountability and good stewardship?
  4. 4. Does our culture conform to new regulatory expressions of good practice and increasing client expectations, including 'tone from the top' aligned with 'echo from the bottom'?
  5. 5. Are we prepared for an evolving supervisory approach, under which the national regulators will be increasingly concerned about the appropriate balance between the commercial interests of the firm and our customers/investors?

Further information

For more details on conduct, culture or governance in the asset management industry, please get in touch with Niamh Mulholland, Asset Management Regulatory practice lead, via this form.

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