The Risk of Regulation

Do senior managers in financial services have a legitimate complaint when it comes to being overwhelmed by regulation? Or, as Frank Hore and David Low FRSAs argue, is something else going on and what can be done?

If you wanted to have a pop at the financial services sector, you would have to take your turn at the end of a very long queue. We all want a flourishing economy; and we know we need able-bodied insurers and banks to help make it happen. But at the same time, we just cannot help hurling rotten fruit: it’s a heart-rules-the-head thing.

It could be that the UK’s recovery is being hindered by another ‘heart-and-head thing’ happening inside those very organisations. Over the last couple of years, we have met an alarming number of senior people in the financial services sector struggling to manage their day jobs. They seem to have little enough time or focus to cope with today’s ‘business as usual’, let alone the future of their organisations; and they put it all down to the time they are forced to spend implementing the demands of their regulator.

Is it true? Regulation is supposed to be there to give us confidence. It is there to protect consumers and to reassure markets that key companies, critical to our economy, are not going to fall off a cliff. But it seems that there is every chance that managers are being frozen in the headlights of regulation; the very same managers whom our economy depends upon to rebuild their organisations – restructure their industries, even – as a prerequisite to the UK’s recovery.

If it is true, is the same thing happening elsewhere: in Europe, say? And if so, is this a problem created by poor management, such as the misallocation of resources? Or is it simply griping? You could reasonably expect negative reactions from people whose priorities are being set by a third party. Particularly as their organisations try to come to terms with their pariah status in the media. Morale is not going to be the bounciest when your sector, your bank, even, has played a significant part in bringing the world economy to its knees. So perhaps all we are witnessing is biters bit?

We have got to assume that the regulator knows their stuff. Surely the volume of activity that it has been demanding – systems and procedural changes, training and communications and their knock-on implications – could not alone be responsible for the extreme reactions we have observed in insurers and banks? They call it a ‘firestorm of regulation’; they say it is taking over their agendas, their lives. We start a conversation and try without success to talk about anything else. We talk to distribution directors who do not have space in their heads to talk about distribution!

So, could the drive for regulation itself bring about the effect it’s trying to head off? If regulation and management is sound, what is it that is taking over such a frightening slice of general management’s mental energy?

The work of Wilfrid Bion, an early pioneer in the field of group behaviour, might cast some light here. Among other things, his experiments led him to believe that many ‘dysfunctional’ groups work to an unspoken, covert agenda; one that every member signs on to subconsciously.

One of these classic ‘agendas’ is flight-fight, whereby everything the group does is subconsciously driven and shaped by keeping an enemy outside the gates, or running away from it. It is a defensive reaction to a perceived threat; and typically the threat could be posed by head office, or a tough personality… or a regulator.

One of the problems that this ‘hidden agenda reaction’ poses is that it can permeate an organisation and colour the way people behave (perhaps people completely untouched by the ‘threat’ as it were). It becomes a basic assumption behind thoughts and actions: a given, an accepted backdrop. ‘The task’ then takes a very secondary place in people’s minds, which become filled with worry, gossip and politics.

The crash alone, I suspect, could have created excellent conditions for stress and uncertainty to thrive in the financial services sector. It prepared the way for systemic paranoia, and remember, just because people are really out to get you, does not mean you cannot be paranoid. But if that were not enough, many, many organisations these days have already been through the mill: increasingly over the last 10 years or so, we have encountered organisations which have experienced so many knocks – via restructuring, mergers and acquisitions upheaval, applying for own-jobs and so on – that their capacity to accommodate further change is severely constrained. People have become more fragile at a time when we are asking more and more of them.

We imagine that it would not take very much these days for a regulator’s pronouncements to overwhelm an entire industry; not simply by the physical demands they make but by the impact that their demands may have on organisational behaviour. Here is the paradox: the harder the regulator drives to eliminate risk, the more risk it could be driving in.

So what is the way forward? Well, not to leave it to the organisations themselves to get on with, clearly. For regulators to work more supportively, learning some of the lessons that OFSTED are beginning to put into practice. To act in a quasi consultancy manner, pacing their input without pushing organisations too far beyond their capacity to cope. To watch for symptoms, and not take comfort from boxes ticked. But above all, to understand who you are dealing with and what makes them tick.

This is not an argument against regulating insurers and banks. Like everyone else in the queue, we want to see a healthy sector. But there are some sinister symptoms emerging and the last thing we want is treatment that leaves a dead patient!

  • Steve Cowie

    The compliance department can often be called the ‘Business Prevention unit.’ with dictats that change or modify the extent of ‘good practice.’ I detected a sense of weariness in that sector because the focus was on compliance or what not to do, rather than what they could do. The attitude was often what they could ‘get away with’ in the exception rather than the general rule.

    Part of the problem I think lies in recruitment; Like prefers to recruit like; which leads to hires with a particular mindset (along with a relevant C.V in a similar position and market sector).

    That mindset can lead to participation in the group behaviour mentioned in the article.

    The solution may be a change of perspective in compliance. Culture led rather than rules led.

  • Ann

    I agree with your thinking guys.

    Perhaps it is getting worse but it was pretty bad during my time at a financial services company on the south coast. I think you will remember this? About 7 years ago.

    With an FSA inspection due, the whole company did nothing else but prepare for this for about 6 months! Every exec, every junior manager rehearsed every line and took internal tests to make sure we were all word perfect.

    Strategic thinking, business development, innovation during this period? Absolutely none! Bizarre times…

  • R obert W

    It is not being overwhelmed that concerns me as much as being driven in the wrong strategic direction by the regulators. I operate in South East Europe and my parent company is Austrian so my bank is supervised and governed by institutions such as the EU, Bank for International Settlements (Basel II and III) and the European Banking Authority in addition to the Austrian Financial Authority. These faceless regulators are literally and figuratively hundreds of miles from the commercial realities of my operating region and life at the sharp end. Their conservative, risk averse and bureaucratic supervision is creating product development out of line with customer needs and deteriorating customer service due to over engineered customer facing processes. Risk weightings, capital requirements and liquidity buffers are what drive our plans and objectives today, not customer needs, innovation and market growth. This is not sustainable. The long term effect is shrinking margins,reduced profits and declining returns on investment. For the first time in over 10 years in the region I now hear talk of product, segment and even country exit strategies.

  • M Shaw

    The challenge must be for companies to find a way to better align the interests of the company with those of the regulator, so that the requirements of regulation do not add an extra layer of complexity and confusion. Regulators after all have the interests of customers as their first priority, so companies that build into policies and processes a customer-centric bias will inevitably find the weight of regulation more manageable. And when that isn’t the case they have a better argument for suggesting that the regulation isn’t proportionate or producing the right effect.

  • David Gardiner-Hill

    The biggest issue is controlling compound risk at the top level of the global systemically important banks. [G-SIBs] If they can find a way to normalise risk across silos and make it really visible to the main board in near real time.

    We may then see governments may relax a bit, and this will decelerate product level regulation in my view.

    This data aggregation principle will come to apply across all multi asset class organisations over time as per BCBS239.

    At NyayaRisk, a niche management consulting house specialising in risk, we are looking at solutions to this complex issue, we believe we have one, but we need someone to try it out on! Semi-automated integration to underlying risk systems is the key – sounds like rocket science – it is certainly very clever!

  • A F

    I own and manage an investment business in the north of England. We use a compliance consultant who works for a number of other similar-sized organisations. Both working on our behalf and that of other consultees, the consultant has encountered singularly inappropriate behaviour from the FSA at least twice in the last few years.
    Our case was relatively mild, but it dragged on for months, and included personal credit checks as part of an FSA fishing expedition. The other case involved the falsification of records by the FSA. Although action was taken in both cases, the FSA showed themselves to be incapable of admitting anything had gone wrong, and incapable of any form of apology.
    Our various experiences of encounters with FSA staff suggest that many of them are out of their depth and poorly trained, they engage with the industry with a chip on their shoulder and a guilty before proved innocent attitude, and that when they get things wrong, they close ranks and obfuscate.
    I don’t know about others, but I find that such an unprofessional, if not alien, modus operandi that I will spend time ensuring that I have nothing to do with them ever again, apart from filing reports and paperwork on time and in good order. With twenty-five years of this profession under my belt, I can safely say that IMRO did a better and more professional job, which is, I guess, as good an argument for self-regulation as I can make.
    On a more general note, I would observe that regulatory costs have increased sharply since statutory regulation was introduced. The burden of compliance with the blizzard of guff that has emerged from Canary Wharf weighs heavily on the industry, and I note that many of the recent fines have not been for wrongdoing, but rather for a lack of trust letters or insufficient reconciliation of pooled monies.
    Structurally, in the past the FSA has made indifferent law, communicated it poorly, judged harshly and penalised heavily and publicly. MiFID offered a simpler, cheaper and potentially just as effective means of regulation. The UK has scored an own goal, loading costs onto the industry, forcing larger players to charge more and driving smaller players out of business.
    The philosophy of regulation has taken a wrong turning. Good regulation should encourage good behaviour and discourage bad. Ask any successful Head teacher if OFSTED help or hinder their progress. Ask any Hospice if their NHS inspections contribute anything worthwhile. I would be very surprised if they admitted they did.
    What UK-style regulation does, it seems to me, is to force the good and the bad to fill in and file bits of paper, and then it inspects those bits of paper. The good ones answer truthfully, and the bad ones lie. And the FSA haven’t been very good at identifying the liars. Their answer has been to hire more paper-inspectors and do demand more filling and filing. What they should have been doing was to look at it from a different angle. Martin Wheatley did signal a change of stance, but there is not much evidence of it in the vast reams of paper that continue to stream out from Docklands.