I was one of the speakers at a round table discussion yesterday about rewarding firms for ‘doing the right thing’. The debate was organised by the Centre for the Study of Financial Innovation and my co-speakers were Prof. Christopher Megone of the University of Leeds and Prof. Paul Dembinski of the Observatoire de la Finance. Here’s what I had to say.
I believe the best way to motivate companies to ‘do the right thing’ is to adopt established market mechanisms such as choice, reward and failure. The language will be familiar and the dynamics of fear and cost, of reward and recognition, will be second nature.
You need to keep it simple. This means motivating companies by either increasing the rewards and recognition for doing the right thing, or increasing the fear and cost of doing the wrong thing.
Unfortunately, in the present economic climate, good firms won’t find it easy to earn much of a premium from doing the right thing. It’s difficult to charge more for something that consumers assume you’re doing already.
When I talk about the fear and cost of doing the wrong thing, what I don’t mean is an increase in the amount of regulation – I don’t want to widen the scope of the rulebook. And I don’t think the public wants more rules either.
What I believe is needed is more visible and intrusive enforcement of existing regulations to increase the fear of being caught, coupled with greater fines for those who do get caught.
The FSA may have levied a record amount of fines in 2012, but the amount is still pretty small compared with the level of fines dished out by US authorities. I believe the FSA should consider expanding its penalty framework in a similar way to the US Sentencing Guidelines.
In weighing up a financial sanction, the US Sentencing Commission looks at seven indicators of a firm’s ethical culture. Those who can demonstrate that overall their company has been doing the right thing find their fine reduced, while those who can’t so demonstrate find their fine increased.
What that visible connection of penalty to ethics does is get many companies off the fence and paying some attention to their ethical culture. It hasn’t stopped the worst offenders from doing the wrong thing, but it does seem to have tilted the US playing field a bit more in the right direction.
So, to sum up
- No need for more regulation
- There is a need for more intrusive enforcement
- And fines should be linked to evidence of an ethical culture
Another way in which firms can be penalised for poor ethical culture is through insurance provided by members of our host, the Chartered Insurance Institute. Underwriters of policies such as bankers blanket bonds, professional indemnity and directors & officers, should think about the extra risk they carry from the moral hazard of a ‘why bother’ attitude to ethical behaviours.
I’ve advocated in the past that indicators of ethical culture should be used to underwrite these types of policies. At the moment, it looks like the premiums of good firms are subsidising the risks run by poor firms. Remove that subsidy and the good firms will start to get a return from ‘doing the right thing’.
Another way in which firms doing the right thing can be rewarded is in the form of a ‘regulatory dividend’, with the FSA rewarding firms that demonstrate high standards of professionalism with less onerous oversight.
So, for example, corporate members of the Chartered Insurance Institute have been devoting a lot of energy to achieving Chartered Firm status, through compliance with a range of professional standards. At the same time, on a group basis, many firms in the insurance market have joined together under the Aldermanbury Declaration to deliver greater professionalism across the market as a whole.
These firms didn’t take these steps with the expectation of receiving a regulatory dividend, but the regulator should at least consider how that commitment could be nurtured and sustained through the regulatory framework. It’s worth remembering that the insurance market has been making great strides in its professionalism, resulting in an institute membership 10 times that of its banking equivalent.
The challenge of course is to make sure that firms wearing the badge of professionalism really are ‘walking the talk’ when it comes to doing the right thing’. If you want to be paid for doing good, you need to be able to justify the payment.
This means that initiatives like Chartered Firms and the Aldermanbury Declaration need to be able to demonstrate real traction in how their commitments have been turned into changes of behaviour. They need to say goodbye to the world of ‘tell me’ and ‘show me’ and prepare for the world of ‘prove to me’.
So how do you prove to someone that your firm is doing the right thing’? Enron demonstrated that publishing an ethics policy tells you very little. Yet a decade on from Enron, I’m not sure the lessons have been learnt across all jurisdictions. Most UK firms have an ethics policy, but most UK firms don’t know whether they’re moving forward, backwards or sideways on ethics, because they don’t have any measures for ethics. It’s this type of challenge that now needs to be overcome.
One example that is worth tracking at the moment is how the Monetary Authority of Singapore will respond to a review into the conduct of financial advisers there. A few weeks ago, an expert panel recommended that regulated firms adopt a set of approved KPIs for ethical conduct, to be monitored independently of the advisers themselves. Failure to meet these conduct KPIs would mean managers – quote – incur heavy penalties from their own remuneration.
So, to sum up,
- The market needs to show greater determination in pricing for moral hazard
- There needs to be a regulatory dividend for firms doing the right thing
- But harder evidence is needed from firms that they are achieving an ethical culture
- Singapore could be an interesting example to watch at the moment.