On 6 November, FCA Chief Executive Andrew Bailey gave a speech looking at the role of regulation in encouraging good culture.
What is the regulator’s view on the link between regulation and cultural compliance?
Can a rulebook dictate culture?
Bailey started by saying that ‘In the traditional world of regulation, rules act as prescriptive statements that forbid, require or permit some action or outcome – thus forbidding, requiring or permitting must be present in a rule’.
He went on to say that you could therefore assume that ‘if you can make enough rules, and of course the right ones, the culture will be good, and trust will be built and maintained’.
In practice, however, this doesn’t always work. A rulebook can in fact be counter-productive, with the potential to undermine what needs to be done because ‘it is unlikely that a rulebook will be able to predict and determine every situation that a regulated party can face’.
And alongside the impracticality of creating a rulebook that allows for every eventuality, the regulator’s preferred approach is very much a ‘hands-off’ one, focused on encouraging firms to improve cultural compliance by being more proactive, rather than via ‘tick box’ regulation.
A proactive approach to regulatory compliance
In his speech, Bailey talked of a desire for an environment ‘in which regulated parties are encouraged and incentivised to exercise their own judgment reliably and regularly, drawing on their own competence and honesty’.
While regulation needs to focus on ‘forbidding, requiring and permitting’, he believes it should also be ‘enabling, encouraging and incentivising’.
Cultural compliance in investment management
Bailey looked specifically at the investment management sector – where AUM grew from £8.1 trillion in 2016 to £9.1 trillion in 2017.
It is an industry that is increasingly central to the UK’s financial landscape; to retail as well as institutional investors, with its institutional element representing pensions and investments held by individuals. Bailey estimates that around three-quarters of UK households are either direct or indirect customers of investment managers.
Trust – a key component of the investment management market
When it comes to investment management, Bailey was keen to point out that it ‘is an area where we are asking a lot of individuals’ (in terms of understanding often complex products) and therefore ‘it is reasonable that they will want to put their trust in experts who can assist with advice and guidance on decisions on saving and investment’.
This reliance on advisers and investment managers to untangle the complexity of the retail investment market means that investors need to be able to have the highest trust in them.
While the market doesn’t seem short of competition, there are potential issues around transparency (something the new Cost Transparency Initiative is trying to address, as we reported recently). The Initiative is one of the remedies introduced following the FCA’s Asset Management Market Study.
The key things that impact culture and trust
Bailey honed in on a couple of issues and the effect they can have on culture and trust.
As mentioned, this is a key focus for the regulator right now. Bailey noted that the FCA’s research showed that investors were often disengaged
from the fees and charges they were paying, and therefore unaware of the impact on their savings.
Bailey made the point that ‘transparency on its own is not enough. It has to go along with effective communication’. The answer to problems
with information is not, he says, ‘to present more and more of it and then wonder why the consumer does not respond with clarity, and
behaviours do not change’.
The effectiveness of consumer communication is – in Bailey’s eyes ‘a test of culture’. Cultures, he says, often err towards complacency,
ignoring indicators that suggest a lack of engagement or effectiveness in favour of those that support the current approach. We have explored
this before, asking whether your board is complacent about compliance.
Communications need to come under critical scrutiny to ensure they are meeting consumer needs. Bailey believes that ‘Good culture supports
this, and in my view the role for regulators is as much to encourage it as it is to require it’.
3. Regulation vs supervision
This is ‘one of the eternal debates’ in the regulatory world, While the two terms are often used interchangeably, Bailey believes this is wrong.
While regulation tends to be focussed on rule-making and the formal enforcement of those rules when things go wrong, supervision is about
the FCA ‘exercising judgment based on the framework of rules, to get the outcomes we want to see consistent with our public policy
This is also something we’ve looked at previously, asking whether a regulator that focuses on incentives rather than fines would encourage
firms to move towards this self-governance approach. Read more about what a ‘culture of compliance’ is and how can you achieve it.
An evolving approach from the FCA
The FCA’s approach is expanding, in part to help facilitate change in the sector. Bailey cites its work on innovation and technological change, via the regulator’s Project Innovate and regulatory sandbox.
This, says Bailey, represents a major change in culture, shifting the FCA’s role from regulator as enforcer and forbidder to regulator as enabler.
This – along with investment trends such as the move towards ethical investment, something inherently wrapped up with trust and cultural issues – is changing the regulatory landscape.
A need for trust, and for firms that can be relied on to deliver in terms of compliance, transparency and clear communications, will be central to the future of the financial services industry. And in turn, a culture of good governance is central to this. You can read more about how to create this culture in our whitepaper, How to embed a culture of compliance in your business. You can download a free copy here.
Nothing in this document should be treated as an authoritative statement of the law. Action should not be taken as a result of this document alone. We make no warranty and accept no responsibility for consequences arising from relying on this document.