State of relations: financial institutions and regulators


Financier Worldwide Magazine

March 2017 Issue

March 2017 Issue

The past 12 months has been a period of considerable political, social, technological and economic upheaval across the globe, with new empires rising and others potentially crumbling.

For the financial services sector, it has also been a time of substantial change; change necessitated by a tightening regulatory backdrop that has prompted financial institutions (FIs) to reflect and reposition, and propelled their relationship with regulators straight to the top of the agenda. At the same time, the LIBOR and Forex cases, probes and investigations cast an international shadow.

Indeed, how FIs go about redefining the nature of their relationship with regulatory bodies is a key issue amid a world wrapped in political and economic uncertainties. The tougher approach being taken by regulators – comprising investigations, fines, penalties and sanctions – has the scope to engulf FIs in a sea of costly legal battles, criminal liabilities and reputational damage.

In addition to such measures, firms and individuals also face the prospect of withdrawals of permission, prohibitions and suspension orders. Regulatory bodies such as the Financial Industry Regulatory Authority (FINRA) and the Financial Conduct Authority (FCA) are also increasingly adopting criminal sanctions as a means of dealing with serious instances of market misconduct such as insider dealing, misleading statements and market manipulation.

Representing the essence of the current regulatory backdrop are the sanctions imposed in two particular cases in 2016, involving Credit Suisse and Deutsche Bank – both of which related to malpractices first uncovered in 2008. Following complex and wide-ranging investigations, Credit Suisse was fined $5bn and Deutsche Bank, $7bn. Early in 2017 there was further regulatory muscle flexed with the announcement that litigation instigated by the US Department of Justice (DoJ) had resulted in the Royal Bank of Scotland (RBS) setting aside $3.8bn to cover a spate of fines. Furthermore, some commentators have suggested that RBS's overall US penalty could be somewhere between $12bn and $20bn.

With regulated entities and individuals duty-bound to be as open and cooperative as possible in their dealings with regulators, they themselves being required to act proportionately and fairly when investigating issues of concern, balancing these respective agendas is no easy task when the penalties levied for transgressions are considered.

As we move further into 2017, the state of relations between FIs and regulators is as complex and compelling as ever, with the latter throwing down a regulatory gauntlet that the former must pick up as swiftly as possible if their exposure to an increasingly stringent regulatory environment is to be as limited as they would undoubtedly prefer.

The FI and regulator dynamic

According to Tomasz Braun, a partner at Dentons, a great deal of the relationship between FIs and regulators depends on products offered, client care, market conditions, shareholder activism, internal culture and past relationships. “In general, regulators are holding up the financial sector to greater scrutiny than ever before, while FIs are struggling to keep up with the regulatory burden and the pace of change,” he says. “The biggest challenges are market uncertainty, and perhaps more than ever, the dependence on political dynamics. However, internal preparations are also a big challenge, and institutions will need to be able to prove that they have reviewed their processes and introduced appropriate compliance measures.”

How FIs go about redefining the nature of their relationship with regulatory bodies is a key issue amid a world wrapped in political and economic uncertainties.

One regulatory compliance expert who does feel there has been an improvement in the state of relations between the regulated community and financial regulators is Eversheds Sutherland partner, Gregory Brandman. This is particularly the case within the banking industry where relations were at a very low ebb following the big benchmark misconduct and mortgage-backed securities scandals that emerged during the last financial crisis.

“There is still much work to be done to rebuild trust and confidence – on both sides,” believes Mr Brandman. “From the FIs’ perspective, this can be best achieved by a continuing process of demonstrable improvement in their culture and governance, including holding senior managers to account for conduct failings. This is gradually happening in practice, but cultural change, in particular, takes years rather than months or weeks to achieve.”

In terms of what regulators can do to help, aside from reducing the proliferation of rules and regulations, Mr Brandman is keen for them to attain a greater understanding of FIs’ business so that oppressive and disproportionate regulatory judgments can be avoided, both in a conduct and a prudential context. “Regulators need to invest in their staff and ensure that they have senior personnel of the right quality and experience, including real industry experience, engaging with FI senior management on the material issues of concern,” suggests Mr Brandman. “Symmetry of information, experience and intellectual firepower on both sides, the regulators and the regulated, is in everyone’s best interests.”

Culture and governance realignment

Massive fines are among the potential penalties for an FI confirmed to have perpetrated a regulatory misdemeanour. Consequently, it makes sense for FIs to realign their culture and governance to ensure that the adverse behaviour of an individual or individuals does not have a disproportional impact on their organisation as a whole.

“Regulations like the Senior Managers and Certification Regime (SMCR) are making sure firms take governance and individual responsibility seriously,” says Phil Smart, head of insurance and investment management at KPMG UK. “Firms cannot just treat the SMCR as a box-ticking exercise. Smart firms are taking pre-emptive action, bringing about positive change in their culture. Implemented well, this regulation will develop a blueprint for accountability, helping make our finance industry safer and more accountable.”

Organisations fined in the past for malfunctioning risk processes have had no choice but to review their structures and the way they operate. But the universal perception is that this should be done as a matter of course. “Many organisations have introduced mechanisms to hold wrongdoers accountable,” attests Mr Braun. “Much of the problem is to do with culture – often new control processes or mechanisms attributing responsibility are perceived as unnecessary bureaucratic burdens rather than a real need. Memory can be short and employees tend to forget that the financial world came out of a major structural crisis just few years ago.”

Potential implications of Brexit

Brexit is among the most significant events to have challenged the economic and political status quo. However, despite endless speculation as to the impact the UK’s decision to leave the EU will have in all corners of the world, there has thus far been no major response (even of the knee-jerk variety) to Brexit from financial services’ regulators. That said, withdrawal from the EU is hugely significant for the UK finance market, both directly in terms of access to European markets and to talent, but also indirectly as the macroeconomic, competitive and regulatory environments evolve.

“UK financial institutions – particularly banks with their European hub in London – rely on European passports to access EU markets,” says Bernd Geier, a partner and co-head of the European Financial Institutions and Financial Institutions Regulatory groups at Dentons. “If they lost their passporting rights, the business impact would be painful. Theresa May and Davis David have confirmed that the UK will opt for a hard Brexit and leave the common market, but also that the UK would ideally like to negotiate trade agreements to allow London banks to continue operating in the EU. Since we are not able to predict the outcome of such negotiations, financial institutions should start contingency planning now.”

Whatever route is chosen, the path ahead will be strewn with hurdles. “The reality is that it would be very challenging indeed for the UK to dispense with large swathes of existing financial services regulation, whether conduct or prudential, simply because, for some time, much of this regulation has been driven at a global and EU level,” says Mr Brandman. “If the UK wishes to maintain its relative global pre-eminence as a financial services jurisdiction, it will be obliged to maintain regulations which at the very least conform to global and, in many respects, EU standards.”

Alterations and accommodations

Potential implications thrown up by Brexit aside, there are still major challenges remaining for FIs as they tackle systemic conduct issues, not to mention accommodating regulatory disputes and investigations as and when they arise. “FIs can either approach regulatory disputes and investigations as an opportunity to make improvements, or they can fight and defend their past positions,” says Mr Braun. “With greater expectations of transparency and information in the public and on social media, as well as the growing choice of alternative players on financial markets, large financial institutions can no longer hide behind a curtain of secrecy, exclusivity and the necessity of their existence. More and more, the public will demand openness from FIs and their active cooperation in resolving past malpractices.”

Not helping FIs to satisfy the increased appetite for openness is what seems like a steady stream of new regulations in the years since the financial crisis. Of course, the more complex and pervasive the rules, the more likely it is that people will break them. Furthermore, however unintended the transgression, breaches still need to be investigated, reported and, potentially, litigated with regulators.

“The widening of regulators’ jurisdiction, the enhancement of their regulatory tool kits and their willingness to impose ever more draconian sanctions probably give rise to the principal investigations challenges,” says Mr Brandman. “For example, tens of thousands more banking staff now fall within the FCA’s disciplinary jurisdiction and are subject to rules around their business conduct. This will potentially lead to a much greater investigative and also training, monitoring and reporting burden. The FCA has also been given a competition remit, which is already resulting in enforcement activity.”

Future harmony

Although it is clear that a great deal of work has been done, particularly within the banking industry, to address the concerns raised by the public, governments and regulators as to the wayward culture and behaviour of many leading financial institutions, it is also clear that there is some way to go before the issue is truly under control.

Moreover, with financial markets and new products evolving rapidly against an ever-tightening regulatory backdrop, establishing an effective approach with regulators is a key requirement for FIs. Not only can this help to reduce exposure to an often adverse regulatory environment, it may also prove useful should an FI find itself the subject of an investigation, litigation or fine.

Of course, finding and building a harmonious relationship is no easy task in any walk of life, but for FIs and regulators, the consequences of a failed liaison can be costly indeed.

© Financier Worldwide


Fraser Tennant

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