Timing is everything: A toolkit to mitigate misconduct risk
07/05/2018
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The Financial Stability Board (FSB) is the international body of national financial authorities and international standard-setting bodies that develops and promotes the implementation of effective global bank regulatory and supervisory policies. APRA’s regulations, by agreement, need to be consistent with FSB principles and guidelines, including all the regulation on banker pay and governance.

On 20 April 2018 the FSB released its latest report providing a toolkit for banks and regulatory supervisors to use to mitigate misconduct risk. To an extent, some of the tools in the kitbag can be usefully applied by companies other than banks. We note, for example, a similarity to the new draft ASX Corporate Governance Council’s Principles and Recommendations (see HERE).

As they say in the classics, “timing is everything”! While clearly not the case, it seemed the FSB’s latest release was timed for the middle of this latest round of the Hayne Royal Commission hearings. It is a good summary for bank boards of what to expect from themselves and APRA.

The FSB announced the development of the toolkit in its workplan in 2015. This announcement followed the widespread misconduct in the financial sector including the global scale manipulation of wholesale markets and retail mis-selling on a broad scale that created mistrust, weakened the ability of the markets to allocate capital to the real economy which in turn may give rise to systemic risks.

The toolkit identifies 19 tools that companies and supervisors could use to address three overarching issues identified by the FSB as part of its earlier work on misconduct, namely:

  • Mitigating cultural drivers of misconduct: tools to effectively develop and communicate strategies for reducing misconduct in banks and for authorities to effectively supervise such approaches.
  • Strengthening individual responsibility and accountability:tools to identify key responsibilities and functions in a company and assign them to individuals to promote accountability and increase transparency. Guerdon Associates notes that readers will recognise the hallmarks of the BEAR.
  • Addressing the “rolling bad apples” phenomenon: tools to improve interview processes, onboarding of new employees and background checks to avoid hiring individuals with a history of misconduct.

Rather than setting a standard or prescriptive approach, the FSB has provided the toolkit as a set of options derived from the shared experiences and perspectives of FSB members in dealing with misconduct issues.

Recognising that APRA will have regard for the different tools that have been proposed by the FSB, bank boards and senior management will be keen to understand how they can be best applied in their own companies to assist in mitigating misconduct risk.

Tools 1 to 3 are for the purpose of identifying cultural drivers of misconduct.

Tool 1: Senior leadership of the company articulate desired cultural features that mitigate the risk of misconduct.  Companies should have a clear understanding of the cultural drivers within their organisation. This clear understanding will ensure that time and resources are targeted at the most significant challenges to the desired culture. To inform the cultural vision, senior management could adopt a risk-based approach that evaluates and prioritises the most significant cultural drivers of misconduct risk.

Tool 2: Identify significant cultural drivers of misconduct by reviewing a broad set of information and using multidisciplinary techniques. The identification process could involve collecting data and other information that provides insight on behaviours that could lead to misconduct. Then, companies could apply multidisciplinary analytical techniques to that information to better understand the drivers of behaviours.

Tool 3: Act to shift behavioural norms to mitigate cultural drivers of misconduct.  Senior management could  take  actions to  shift  attitudes and  behaviours  within the  company toward  its cultural vision and to reinforce the governance frameworks designed to mitigate misconduct risk. These actions might include:

  • informal measures: deliberate efforts by leaders  to  respond constructively  to  mistakes in  order  to create  a  safe environment  for  a candid  dialogue and escalation of issues;
  • formal measures: for example, enhanced whistle blower protection, escalation procedures and effective compensation and related performance management mechanisms.

Tools 4 to 7 are for the benefit of regulatory authorities like APRA.

Tool 4: Build a supervisory programme focused on culture to mitigate the risk of misconduct. Regulatory authorities could consider building a programme with a focus on supervising culture.  Supervisory reviews could be led by company-specific or subject-matter expert teams. The tool suggests that if the authority has governance or culture specialists, the specialists could work jointly with line supervisors to link observations on culture at the company with other supervisory issues at the company.

Tool 5: Use a risk-based approach to prioritise for review the banks or group of banks that display significant cultural drivers of misconduct.

Tool 6: Use a broad range of information and techniques to assess the cultural drivers of misconduct at banks. Qualitative and quantitative information collected from companies could be used to provide insight into behavioural norms and culture of the company.

Tool 7: Engage companies’ leadership with respect to observations on culture and misconduct. Dialogue between the supervisor and the company’s leaderships could be useful to understand and bolster a company’s proposed actions to strengthen culture to mitigate misconduct risk.

Tools 8 to 12 are for strengthening individual responsibility and accountability. Tools 8, 9 and 10 are directed to companies and/or national authorities because they may be achieved through governmental action (legislative, regulatory, supervisory or enforcement) or company-driven decisions or some combination of the two.

Tool 8: Identify key responsibilities, including mitigation of the risk of misconduct, and assign them.Identifying key responsibilities and clearly assigning them to the holders of various positions within the company promotes individual accountability and increases transparency within the company and for other stakeholders.

Tool 9: Hold individuals accountable. Individuals could be held accountable through a combination of:

  1. legislative and regulatory provisions
  2. a company’s internal processes including employee contracts
  3. supervisory action, and
  4. regulatory enforcement

Tool 10: Assess the suitability of individuals assigned key responsibilities.

Tools 11 and 12 are directed at national authorities like, in Australia, APRA and ASIC.

Tool 11: Develop and monitor a responsibility and accountability framework. Regulatory authorities could assess the implementation of a framework for responsibility and accountability that includes, inter alia:

  1. the identification of key responsibilities for individuals in the company
  2. allocation of those responsibilities to specific individuals, and/or
  3. holding individuals accountable for the responsibilities to which they have been assigned.

Australia’s government and APRA are well ahead in this regard with the recent introduction of the Banking Executives Accountability Regime (BEAR) that is directed at specifically mapping responsibilities and accountabilities for the purpose of holding individual executives accountable. The BEAR will commence with effect from 1 July 2018. (See HERE.)

Tool 12: Coordinate with other authorities.

Tools 13 to 19 are for addressing the rolling bad apples phenomenon

Tool 13: Communicate conduct expectations early and consistently in recruitment and hiring processes.

Tool 14: Enhance interviewing techniques.There is merit in the recruitment process considering the behavioural competency and conduct history of the candidate as well as their potential for adhering to the form’s values.

Tool 15: Leverage multiple sources of available information before hiring.

Tool 16: Reassess employee conduct regularly.

Tool 17: Conduct “exit reviews”

While tools 13 to 17 are for the consideration of banks, tools 18 and 19 are directed at national regulatory authorities.

Tool 18: Supervise forms’ practices for screening prospective employees and monitoring current employees. An assessment of companies’ employment and disciplinary policies and practices could be embedded in the supervisory process.

Tool 19: Promote compliance with legal or regulatory requirements regarding conduct-related information about applicable employees, where these exist.

The FSB’s toolkit is comprehensive and provides much information gathered from FSB members around the globe over the last five years. Some of the tools have already been adopted by APRA and Australian companies and many others will already be considering the use and potential application of many of the tools and the underlying rationale provided by the FSB.

For the full FSB report see HERE.

© Guerdon Associates 2021
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