Culture Audit in Financial Services

Reporting on Behaviour to Conduct Regulators

Roger Miles

• Publisher: Kogan Page
• Year: 2021
• ISBN:
  9781789667769
• Edition: 1
• Topic: Negocios y empresa
• Subtopic: Servicios financieros

In the next wave of conduct regulation in financial markets, from 2021 conduct regulators in the UK and elsewhere expect firms to produce evidence on how they are improving behaviour and culture. Facing this, many practitioners are anxious that their current reporting and management information (MI) are irrelevant to meeting as-yet unclear regulatory expectations. This book provides the insights and tools firms need to report on culture, securing both enhanced business value and the regulator's approval. Culture is now seen as a key contributor to good governance, feeding into existing discourse on environmental, social and governance (ESG) factors and the emerging dialogue on 'non-financial (mis)conduct', but conventional measures of business quality are unfit for the new reporting agenda. Culture Audit in Financial Services follows the arc of 'behavioural regulation' to examine what the regulator really wants, before offering guidance on how culture audit differs from conventional auditing, how to put the latest pure-research findings to work, and the key features of well-designed conduct and culture reports. Written by an impartial author and a variety of contributors with extensive experience working with practitioners, regulators, and many of the world's finest academic initiatives, this book is filled with practical, grounded advice on how best to approach this new challenge and avoid infractions.

04

What’s the big idea? (1)

How conduct regulators use behavioural science

ROGER MILES

Introduction

This chapter will explore why we in the financial sector behave as we do – starting, parochially but importantly, with why regulators do what they do. It then delves into two key approaches to understanding human behaviour, using the science that conduct regulators themselves use when preparing their assessment frameworks.

Understanding the science not only alerts us to where the regulator is coming from, it helps us to see more clearly why we all do what we do, in the workplace and in life generally (especially when we wrongly assume we’re doing ‘the right thing’); how we make sense of the world at individual level; and the ways that we work together in groups. This not only keeps us ahead of the rules, it makes for a more robust and resilient business.

Next there is a summary tour of the essentials of brain science (neurology and psychology) – just those essentials that we need to understand narrowly, for now, what will be expected to feature on a firm’s culture self-assessment of its progress in overcoming any harmful assumptions. Two relevant headline culture audit questions will be: How’s your firm getting on at recognizing and overcoming the mental bias effects that drive people to make unsound decisions? How well are you building a purposeful culture, supported by psychological safety and cognitive diversity?

To get behind biases requires a basic knowledge of the cognitive science of risk perception. The version offered here is as summarized as I can make it for this narrow purpose; accordingly, apologies in advance: if you happen to be a trained medical doctor, psychologist or anthropologist, you’ll find the first section of this chapter quaintly simplistic. On the plus side, as long as you’re not from one of those professions this chapter will save you five years of doctoral study, or at least several days wading through the hugely important (but also quite hard going) work, Thinking, Fast and Slow by Daniel Kahneman.

The final part of this chapter takes three strands of science and shows how they have started to inform firms’ (and regulators’) efforts to intervene positively to improve culture. We’ll take a first look at how they inform those key terms, purposeful culture, psychological safety and cognitive diversity as they’ll be used by culture assessors. You may be assured that those three items are going to start featuring prominently in your firm’s culture reporting from now on.

THEMES AND CONCEPTS IN THIS CHAPTER

biases: are they ‘all bad’? – bias effects that distort decision-making – cognitive diversity – conduct conversation – ‘floor-walk’ culture assessment – financial vs non-financial misconduct – groupthink (collective blindness, motivated reasoning, assumed framing, fundamental attribution error) – ‘healthy culture is good for business’ – in-groups and out-groups – is ‘de-biasing’ possible? – psychological safety – purposeful culture – situational awareness (‘tells’) – Thinking, Fast and Slow (theory of dual-system brain) – three science ‘keys’ to culture assessment – unintended consequences of policies

Tying culture assessment to ‘brain science’

As seen in Chapters 2 and 3, all around the world conduct regulators are busy developing new rules. Before diving into the deeper behavioural science that informs the shaping of the rules, there is a major piece of the ‘mental landscape’ of regulation that we really need to deal with first: what motivates all conduct regulators? In plain terms, why do they do what they do? Perhaps more saliently, once we know the answer to this, what can we do that will satisfy their expectations?

Over many years I’ve engaged with that question. To find fresh answers, one has to acquire – like Liam Neeson in Taken, but without the violence – a very particular set of skills. For me, these skills have included cognitive psychology, behavioural observation and language analysis.

As well as directly asking regulators what they do (then discourse-analysing their answers), I’ve interviewed many hundreds of attested senior managers about what Conduct means to them; watched, with an anthropological lens as regulatory case officers and financial practitioners interacted; and asked all kinds of financial practitioners to ‘tell me a story about what just happened’, soon after external shocks such as a market crash, pandemic, or a Section 166 notice (see box) – again then using thematic analysis to deconstruct their replies. And here’s the result.

SECTION 166 NOTICE

The dreaded ‘Section 166’ warning from the UK Financial Conduct Authority, also known as a Skilled Person Review notice, is the regulator’s way of compelling a firm to open its records and senior personnel to close scrutiny by an experienced independent inspector (the ‘skilled person’).

It may be issued simply on suspicion that an offence has been committed, when the situation is still unclear. The review is a form of extreme audit of the fitness-for-purpose of the firm’s controls, processes and people. It’s widely seen as a punishment, though not formally communicated as this; most firms regard it as a regulatory question mark against their reputation for good conduct, pending the skilled person’s assessment.

What motivates all conduct regulators: seven key themes

As the conduct regulator talks to you, there are roughly seven themes, or motivations, whirring simultaneously in their head. And, by the way, with the 2021 arrival of culture assessments, regulators increasingly will want to talk to you and to others throughout your firm, one-to-one in person: see the ‘floor-walk’ section below.

Here are those themes:

• They want to raise public trust in financial providers, by encouraging the best possible customer/client outcomes and preventing harm; by keeping their political sponsors happy, and by maintaining orderly markets.
• They want the financial firms that they regulate to give a better account to the public of their own behaviour.
• As part of that, they want to see everyone in regulated firms thinking for themselves – not simply ‘box-ticking’, rote-learning or delegating conduct initiatives. This includes behaving (and showing you’re behaving) in ways such as: involving senior managers, and then everyone, with a personal sense ‘doing what’s right’; welcoming challenge; and looking to improve, including learning from our (and others’) mistakes.
• A big idea behind this is that social purpose matters; good behaviour – being ‘pro-social’ – is more important than just making money. People in a well-conducted firm will often reflect on the firm’s wider purpose, how the firm is ‘good for the world’, not just paying its owners.
• Conduct regulators see it as an essential task of their own – since it’s what they are striving to regulate – to understand the raw material of conduct through studying the science of human behaviour. To prevent future c...

Table of contents

• About the authors
• Foreword by Christopher Hodges
• Acknowledgements
• 01 A culture quest for ‘better behaviour’
• 02 How regulators’ ‘behavioural approach’ went global – with culture its latest focus
• 03 The house is on fire: How regulators’ own research has pointed to ‘culture reset’
• 04 What’s the big idea? (1): How conduct regulators use behavioural science
• INTERLUDE 1 From poacher to gamekeeper to poacher… to scientist: A supervisor’s tale
• 05 What’s the big idea? (2): Regulators’ challenge to firms: framing ‘purposeful culture’
• 06 A ‘behaviour-at-risk’ agenda emerges: Questioning purpose, lost trust and cultural coercion
• 07 The new mindset and language of culture: Assessing financial and non-financial conduct
• 08 Audit basics: How the practice of culture audit differs from conventional auditing
• 09 The new management reporting information (MI) for culture Part 1: Getting past the old MI
• 10 The new reporting Part 2: Developing the framework: from culture models to better questions and indicators
• INTERLUDE 2 Case example: Culture rating in a retail bank
• 11 Interventions and enforcements: How regulators have responded to a ‘culture crisis’
• 12 Intelligence gathering versus surveillance: Tried and failed methods; putting the latest research tools to work
• INTERLUDE 3 A sector-wide group seeks culture ‘tells’: (Observing indications of good and poor conduct)
• 13 Putting respected research tools to work, example 1: Tools for cultural transformation: Barrett Analytics
• 14 Putting respected research tools to work, example 2: Using the CultureScope ‘combined analytic’ to deliver measurably better culture
• 15 What regulators really want: Wrap-up and look ahead
• Glossary
• Recommended reading
• Index