Ethics – an appropriate subject for regulation?

Nick Gibson, FCSIDirector of Compliance SolutionsChase Cooper Limited

Agenda

• Some definitional issues

• Regulatory challenges

• A dilemma..

• FSA’s stance on ethics and the RDR

• Ethics within a governance framework

• Assessing compliance with behavioural requirements

• Anticipated outcomes and benefits

What is “ethical”?• Disposition • Habit• Morals vs ethics• Ethics vs culture• Personal vs societal• Bad act with good outcome• Good act with bad outcome• Objective or subjective?• Free will

What sort of ethical code ?

• Consequential – focus on the outcome which, if “good”, justifies the means?

• Deontological – examination of actions without focus on outcomes, to judge if meet “good”?

• When should you tell the truth?

• When should you lie?

What is “regulation”?Collins English Dictionary:

• the act or process of regulating

• a rule, principle, or condition that governs procedure or behaviour

Regulation is the practical application of a political outcome, an expression of public policy and choice. It codifies our expectations as to how regulated entities must act in order to remain financially ‘sound’, socially acceptable and to continue in business…and it changes constantly.

What is a regulator?

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What are the regulatory challenges?

• It’s dangerous territory

• As a good man once said, let he who is without sin….

• Who defines “socially useless”? Lord Turner? Why is it up to him?

• Setting yourself up as a moral authority means you must remain spotless yourself or lose all credibility – quis custodiet ?

What are the regulatory challenges?

In practical terms:

• How does the regulator avoid “culture” becoming just another tickbox?

• Where are the proportionate incentives and penalties?

• Who decides what is ethical and unethical?

• For instance…

People need to eat…• …chocolate!• “Armajaro is recognised as one of the world’s

leading suppliers of cocoa and coffee”

• “Armajaro has become the preferred partner to an established customer base that includes most of the major global chocolate manufacturers”

• - Amajaro also runs a series of hedge funds

• - Amajaro does not manufacture cocoa based products - so is not an end user

People need to eat…• July 2010 – hedge fund Armajaro CC+

takes physical delivery of £650mn of cocoa (c.7% of world output)

• Possible motivations for purchase of that size by hedge fund under the same parentage as commodities broker?

• Likely impact on market?

• Does anyone see this as an abusive squeeze under MAD?

People need to eat…

• Is making a profit ethical?

• If I risk a significant amount of capital and understand the risk, I should make a large profit or loss if the risk is high….

• Is the risk/reward equation a contributor to the ethical question, or irrelevant?

• Where are the boundaries?

FSA’s stance on ethics and the RDR

Total

confusion!

FSA’s stance on ethics and the RDR

• DP18 – Oct 2002 – An ethical framework for financial services (philosophy and dilemmas)

• FS 08/06 – Nov 2008 – Retail Distribution Review Feedback Statement:“We believe that a consistent and visibly-enforced code of ethics is essential for improving consumer outcomes and changing consumer perceptions. Statutory powers would be desirable to enable effective enforcement..”

FSA’s stance on ethics and the RDR• CP 09/18 – June 2009 – Distribution of

retail investments: Delivering the RDR

“We plan to…institute an overarching Code of Ethics…”

“We envisage that the Code will amplify existing standards, and will be published for consumers as a succinct statement of standards of ethical behaviour that they can expect of investment advisers.”

FSA’s draft code of ethics – CP 09/18

NB. essentially a summary of the CISI Professional Code Principles…

An alternative code?1. An approved person must act with integrity

in carrying out his controlled function.

2. An approved person must act with due skill, care and diligence in carrying out his controlled function.

3. An approved person must observe proper standards of market conduct in carrying out his controlled function.

4. An approved person must deal with the FSA and with other regulators in an open and cooperative way and must disclose appropriately any information of which the FSA would reasonably expect notice.

Perhaps supported by a number of evidential provisions containing examples of non-compliant behaviours…?

FSA’s stance on ethics and the RDR

• “Ultimately it is in a firm’s commercial interest to recruit, train and retain good quality individuals but regulation ensures that standards of competence and ethics are maintained at an appropriate level.”

- Sheila Nicoll, 4 June 2010, on CP 10/12

• “Oh, really?”

- Nick Gibson, September 2010

FSA’s stance on ethics and the RDR

• CP10/12 Competence & Ethics– Is it just me, or are these odd bedfellows?

• “The cost of adhering to a code of ethics is in the region of £80 per year per individual.” (CP10/12)

• Two elements to be added to APER as evidential provisions– “deliberate acts, omissions or business practices that could

be reasonably expected to cause consumer detriment”

– “paying due regard to the interests of a customer”

Hector changes his mind…

“I think this word – ‘ethics’ - is not precise enough and carries too much baggage for regulators.”  

“The better focus for regulators would be culture, which no doubt reflects the ethical framework of the organisation.  I am not, however, proposing for a regulator to define ‘an acceptable culture’.”

Hector Sants, 17 June 2010

Hector changes his mind…

“In summary, I do believe that determining an ethical framework is for society as a whole, not an unelected regulatory agency.”

Firms should each create a culture that: “..encourages individuals to make judgments and deliver outcomes that we want and that at all times we want an undertaking to act with integrity…”

Hector Sants, 17 June 2010

FSA’s current stance on ethics and the RDR?

• An ethical framework decided by society

• A clear cultural imprint decided by each firm, except that it must be based on:

• A hybrid consequentialist/deontologist cultural (rather than ethical) framework, where both inputs and outputs must be “good”.

• Regulatory reliance on APER

The difference between ethics and culture?

• When I hear the word culture, I reach for my Browning! (misattributed to Hermann Göring)

My perspective:• Culture is neutral – ‘good’ or ‘bad’ – and

observed or described• Ethics are only ‘good’, and can be codified• Values and morals are personal, not

corporate

Ethics Culture within a governance framework

• The corporate culture has to live and breathe

• It has to be visible and reinforced

• It has to be simple and comprehensible

• It has to be real, not just rhetoric

• It can not be applied differently within the hierarchy – one requirement for all

• There must be incentives, and penalties

Ethics Culture within a governance framework

• The most senior management must – devise it, – own it, – publicise it, and – live by it themselves

• It must be acceptable to shareholders and to regulators

• It needs to be calibrated – with clear, published tolerance levels

• There needs to be an ‘escalation’ route

Assessing compliance with behavioural

requirements – challenges, dilemmas and actions

• How do we assess cultural compliance?

• Middle management must assess and modify their own staff’s behaviour

• Senior management must assess and modify middle management behaviour

• This is a bit random without a clearly articulated cultural standard…

Assessing compliance with behavioural

requirements – challenges, dilemmas and actions

• How do we allow staff to challenge the behaviour of peers and managers within a safe environment?

• Who do they go to with doubts, questions or for clarification?

• Compliance? No

• Business management? Yes

• Who do business management go to?

Anticipated outcomes and benefits Macro:

• Regaining public trust

• More room for the exercise of judgment- by firms, staff and regulators

• Less enforcement activity

• Markets more attuned to ‘end users’

• Broadly appropriate compensation

• Greater economic stability and social contribution

Anticipated outcomes and benefits

Micro:

• Better control of risk

• Organisation-wide team culture

• Fewer silos

• Better management of consumer expectations

• Balance between rights and obligations

• Less focus on short term profits

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