Financial regulation is dead, long live financial regulation



In December 2015, the FCA announced that it was not going to pursue an inquiry into the culture of the banking sector. A series of critics have followed this announcement, arguing that the Treasury has pressured the FCA to adopt a softer type of financial regulation. The chief executive officer of the FCA, Tracey McDermott, has quickly reacted, saying that “we are not going soft on the banks, we’re not being told what to do by the government”. Leaving the political arguments aside, this recent episode underlies a recurring concern, at the level of the financial services industry, and with a particular relevance for the investment management industry, which is worth tackling. Are financial regulatory agencies well equipped to deliver effectively, against their objective of implementing a culture of responsible behaviour, in the future and how can such a culture be operationalised?

An effective financial regulation?

In 2015, across some of the main financial centres, namely the US, the UK and Hong Kong, one main observation could be made – the number of enforcement cases remained high. Of course, this can be explained through the fact that financial regulatory agencies are better equipped, from both a human capital and technological capital point of view, for detecting irregularities within the financial sector. This is certainly a factor to retain. However, it also highlights that the past eight years of financial regulation have somehow been unsuccessful in instaurating a culture of responsibility, despite heavy pressures in this sense. As a point in fact, in 2015, a report entitled ‘Banking Conduct and Culture: A Call for Sustained and Comprehensive Reform’, published by the Group of Thirty (G30), highlighted that overall the financial sector has failed to implement across-the-board cultural and conduct reforms. How can this be? The answer is pretty simple: as long as a precise set of criteria for measuring responsible behaviour does not exist, it is rather hard to implement responses for fostering a culture of responsible behaviour. According to financial regulatory agencies, an effective culture of responsibility is defined as a culture that has, at its core, the fair treatment of customers and behaviours that do not harm market integrity. Yet, the translation of this definition into a measurable set of criteria is difficult to operationalise.

Measuring the degree of responsible behaviour within a financial firm is particularly complex for three main reasons. Firstly, responsible behaviour, or the lack thereof, is hard to isolate because it is pervasive across agents within a given financial institution. Secondly, responsible behaviour, or the lack thereof, is influenced by a number of internal and external factors, which are part of a self-reinforcing loop. And finally, responsible behaviour, or the lack thereof, is a very wide concept and for any measurement to be effective, the specific target responsible behaviour should be defined. In other words, the irresponsible behaviour that the financial regulatory agencies are planning on changing, and the responsible behaviour that these same agencies are planning on reinforcing, should be clearly defined and translated into a measurable set of criteria. In addition, depending on the context, answering the question of whether an agent behaved responsibly or not cannot be solely divided between a ‘yes’ and a ‘no’. Indeed, studies in behavioural finance and corporate responsibility, are pointing toward the fact that agents might well suffer from an ethical bias. This means that there is a difference between an agent’s interpretation of his behaviour and the external observation of his behaviour. Understanding how and when this bias occurs is probably one of the biggest challenges to tackle for implementing a culture of responsible behaviour. Unfortunately, financial regulation, by its very design, is rather ill equipped for preventing irresponsible behaviour from occurring.

A different direction for financial regulation?

Does this mean that financial regulatory agencies should increase their presence on financial services firms’ sites in order to observe, collect the data and design an index of responsible behaviour? We can rule out this option because the operational cost would be huge. Not to mention that this option could not be deployed across all financial services firms. We can also rule out the option of calling on more blame and shame methods for implementing responsible behaviour because, over the past years, this has not been effective.

An option, which we could retain, would be to foster a culture of ‘everyday responsible behaviour’. In concrete terms, at the level of the financial services firms, this would include: (i) setting up a Commission, composed by members of the senior management, in charge of identifying occurrences of irresponsible behaviour, defining the characteristics of these occurrences, and setting targets and objectives for reducing the likelihood of such occurrences; (ii) fostering an environment where the presence of multiple stakeholders is perceived as an incentive for increasing outcome desirability across all actors, as opposed to a factor of conflict of interests; and (iii) fostering an environment focused on motivations and how these differ across groups of agents (based on their level and function), and their underlying circumstances, as opposed to an environment of blame and shame. In addition, the regulatory relationship itself should be shifting towards a more collaborative model. As part of this model, financial regulatory agencies would collect, annually, the data received from financial services firms and through the use of advanced analytics, could derive patterns across the firms and within a same firm (once longitudinal data has been collected), to monitor the progress of these firms and help them become more effective.

The question of a culture of responsible behaviour within the financial sector is going to remain a hot topic over the coming years, especially given the new challenges of the digital economy within the financial sector. However, in order for a culture of responsible behaviour to be effective, it must be a process of transformation driven from within the financial services firms. But be careful; as Professor Carl Rhodes said, “the language of ethics is used as a means to fend off the potential of increased regulation”.


Alexandra Dobra is a Swiss National Science Foundation Assistant Diplômé and Doctoral Fellow at HEC Lausanne. She can be contacted on +44 (0)754 320 3016 or by email:

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Alexandra Dobra

HEC Lausanne

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