UK: Regulating Corporate Culture – Wrestling With Clouds Or Herding Sheep?

Corporate culture is fast becoming a key focus of global financial sector regulators and is a trend which has significant implications for financial sector organisations. Although culture in a corporate setting is a somewhat nebulous concept, regulators in Australia have recently provided guidance as to what they consider to be "good corporate culture" and the enforcement options open to them if they uncover evidence of poor corporate culture.

The regulation, oversight and shaping of corporate culture is fast becoming a key focus of global financial sector regulators. The trend has significant implications for financial sector participants. We look at recent developments in Australia and the United Kingdom.

In March 2014, the Financial Conduct Authority (FCA) in the United Kingdom renewed its focus on the culture within financial services organisations. In a guide entitled "The FCA's Approach to Supervision for C3 firms" issued in March 2014, the FCA stated that it would examine the governance, business models, strategy, culture, front line business processes, systems and controls of organisations to assess how they put the integrity of the market and fair treatment of consumers at the heart of their business.

More recently, the Chief Executive of the FCA, Martin Wheatley observed in a speech delivered at the ResPublica Vocational Banking event in London on 28 May 2015, that it was clear that there is a responsibility for financial services organisations to support the creation of an environment that can reduce the incentive for misconduct, creating an "honesty norm".

The views expressed by the FCA are reflected in commentary made by other regulators around the world, including the Australian Securities and Investments Commission (ASIC) and the Australian Prudential Regulation Authority (APRA). Both regulators also identify corporate culture as a key area of focus, emphasising the importance of a strong corporate culture in financial organisations, in order to re-build the eroded trust and confidence in the financial industry.

Australian Prudential Regulation Authority

The Chairman of APRA, Wayne Byres noted in his recent speech to the Symposium on Asian Banking and Finance in Singapore on 28 May 2015, that capital and liquidity reserve requirements will only offer a partial remedy to the problems experienced by the banking and finance industry, unless there are also behavioural changes within financial firms as well.

Mr Byres acknowledged that culture is a "nebulous concept", however he stressed that there is room for improvement in the inter-related areas of governance, culture, remuneration and that:

"...strengthening culture, like strengthening capital, is critical to long-run stability."

The APRA Chairman was particularly critical of the ethics of leadership teams within financial firms, as he expressed the view that "something serious is amiss" in an industry ultimately founded on trust. He noted that APRA have regularly observed instances where financial services organisations fail to ask themselves if their actions are ethically correct, but instead assess whether they can get away with it.

APRA's public comments regarding the central role which corporate culture plays in driving behaviour within the financial industry indicates that it will be increasing its surveillance of this aspect of the entities they regulate through engagement with the boards and management on their corporate culture.

Australian Securities and Investments Commission

Corporate culture is also a high priority and current focus for ASIC, as both the ASIC Commissioner Greg Tanzer and ASIC Chairman Greg Medcraft have noted that corporate culture is a key risk area. In a recent speech at Thomson Reuters' Third Australian Regulatory Summit on 27 May 2015 entitled "The importance of culture to improving conduct within the financial industry",  Mr Tanzer stated that corporate culture is a key risk area due to the strong connection between poor culture and poor conduct within the financial industry. He provided guidance on what ASIC considers to be "good conduct":

"Good conduct means not just ensuring compliance with the law and not just avoiding the boundaries or grey areas of the law. It means focusing on and preferring the interests of consumers and investors in the long term."

In appearing before the Australian Senate Economics Legislation Committee on 3 June 2015 in Canberra, Mr Medcraft spoke at length about corporate culture as a key risk area identified by ASIC. ASIC has signalled a relatively hard line approach to enforcement action for misconduct stemming from corporate culture. Mr Medcraft flagged that if ASIC finds a problem with conduct at a particular firm:

"ASIC can seek to remove the firm's licence on the basis that it's not providing its services efficiently, honestly and fairly."

Mr Medcraft also drew attention to section 12.2 of the Commonwealth Criminal Code, under which a company can be responsible for a breach of certain Commonwealth laws if the company's culture encouraged or tolerated the breach. "Corporate culture" is defined under the Code as including attitude, policy, rules and course of conduct or practice. ASIC's position on the application of this section is that where an officer breaches a law that ASIC administers and that culture is responsible, then the officer and the firm should in turn be responsible.

It is clear that the purpose of ASIC's approach to enforcement action is to ensure that strong corporate culture starts from the top down by raising the stakes for the company and its officers, by making them subject to potential civil penalties and administrative sanctions for breaches of corporations laws stemming from poor corporate culture.

However, ASIC also acknowledged the limitations of the existing legislation in terms of enforcement, as the Criminal Code provisions do not apply to Chapter 7 of the Corporations Act 2001 (Cth), which deals with the licensing and regulation of the conduct of financial services businesses. Therefore while criminal sanctions may currently be somewhat limited, it demonstrates that ASIC's enforcement powers in this regard are currently the subject of broader review and consideration.

What does it mean for your business?

Although a somewhat nebulous concept, it is clear that the topic of corporate culture and its impact on outcomes – for both regulated entities, and their customers – has now firmly reached the mainstream regulatory landscape.

Operators in the financial sector especially, but also in other non-financial services sectors, will need to carefully consider the ramifications of this new focus, and its practical consequences for their internal operations, compliance and governance structures. It also has significant implications, from a potential financial exposure perspective, for boards and senior management.

In the insurance sector, professional liability classes, particularly directors and officers and professional indemnity underwriters, will need to follow and understand the practical implications from an underwriting and exposure perspective.

ASIC has publicly stated that it is planning to incorporate culture into its role as a conduct regulator by including culture in its risk-based surveillance reviews and will be targeting the following areas where poor practices may increase the potential for poor conduct:

  • remediation policy and procedures
  • reward and incentive structures, including promotions
  • recruitment and training policies
  • whistleblowing policies
  • conflicts of interest
  • complaints, and complaints handling processes
  • staff engagement
  • corporate governance framework to support a customer-centric culture

APRA has made similar comments in terms of focusing on corporate culture in its engagement with the boards and management of the entities that they regulate.

Given the comments from regulators domestically and internationally on the significance of corporate culture, regulated entities should review their compliance policies and corporate governance framework to ensure that a positive corporate culture is reflected in the policies and procedures and promoted on a "top down" basis.

Regulated entities should also ensure that robust processes are in place to ensure that compliance and governance frameworks are followed; the entire organisation understands that everyone is responsible for good corporate culture; and the long-term interests of consumers are prioritised.

We will follow the developments and provide further updates in due course.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Yvonne Lam
 
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