“How much do ethics count in the City of London?” This was the question that Richard Lambert, the former editor of the Financial Times, strived to answer as he gave the Securities Institute’s Annual Lecture in 2002.
Lambert (now Sir Richard and about to head a new banking standards body) spoke at a time when the dust seemed finally to be settling on the City after the scrum of self-interest that had followed 1986’s Big Bang. The financial deregulation heralded by the Thatcher government had summoned such momentous change that traditional City values, codes of conduct and the “Old Boys’ network” had been turned on their head.
The traditional partnership structure, where employees shared an interest in their firm’s reputation, prosperity and trading losses, was replaced by something less personal, far more aggressive and potentially ruinous to shareholders and guarantors. The scale of financial activity increased dramatically as a result, and a great deal of direct human contact was removed from the art of financial trading. The lines between different types of business became blurred, relationships weakened and the chances of making bigger money increased.
The regulatory system could not keep up. Suddenly, ethical behaviour and self-interest, having previously been aligned, were out of kilter. Few would seriously suggest that individuals working within the City were more ethical before the Big Bang, or that the City was scandal-free until that point. But the environment in which it formerly operated was more conducive to ethical behaviour.
Nevertheless, from a vantage point only eleven years ago, Lambert revealed what now seems a quaint optimism that this was all about to change, citing six reasons why integrity over the next decade was likely to become a competitive advantage.
The first was cyclical. As John Galbraith observed of the 1929 crash, in a bull market (such as the City was experiencing in 2002), people are trusting and willing to involve themselves in dodgier deals. But when the bad times come, commercial morality drastically improves, since money is watched with a suspicious eye.
Second, the City was entering a period of consolidation following the upheaval of Big Bang. In a more stable environment, firms pay attention to the development of a cohesive, corporate culture. Similarly, the new regulatory system was bedding down, the Financial Services Authority making it clear that industry leaders would be made accountable for the behaviour of their employees.
Thirdly, ethical behaviour would be borne out of practical necessity. From a minimalist regulatory structure based on values, a written rule culture had emerged. But with new rulebooks running to thousands of pages, regulators would soon realise that a return to a values system was the only practical option.
Lambert also felt intuitively at that point that the returns going forward would not be as high as they had been, and that offering bucketloads of cash would regardless be insufficient to attract the best talent. Recruits would instead be drawn to firms that they could respect.
Fifthly, citizens were increasingly having to take responsibility for their own financial futures and would therefore be much savvier. Trust would be the new competitive advantage.
Finally, the risks of not behaving ethically were increasing, with Enron acting as the game-changer.
“Once a financial bubble comes to an end,” Lambert concluded, “it becomes clear that ethical behaviour is not just an optional extra. It’s the glue that holds businesses together”.
Re-reading his lecture in 2013, Lambert’s words seem, oddly, to be both prescient and completely wide of the mark. The elusive ethical turning point he spoke of never came. Instead, we experienced a violent financial crash in 2008 whose consequences, for all the talk of “turning a corner”, we are still grappling with. If you ask the man in the street how much ethics count in the City, I suspect most would say, “Not a lot”. Yet the approach of aligning self interest with ethics is assuredly needed now more than ever. The question we need to answer today is not whether ethics count or not, but how we make them count.
I have observed many times since 2008 that one of the most damaging costs of the financial crisis has been invisible – the loss of trust. Trust in the system is the crucial lubricant that oils economic transaction, and the integrity of the City of London has for years been fundamental to its commercial offering. I have always felt that the key to restoring that trust and realigning self-interest with ethical behaviour lies in sewing transparency, personal responsibility, fear of failure and lively competition into the heart of the system.
How well have we done so far in that realignment? In some ways, very well. In August, City AM reported that, according to the Financial Stability Board, the UK is storming ahead of all its global rivals when it comes to openness and transparency in financial services. A raft of practical changes has been brought in following the work of the Vickers Commission on banking and the Parliamentary Commission on Banking Standards. The financial reward structure is changing – in some institutions undeserved bonuses awarded in the past are being clawed back. Meanwhile, current bonus funds are being used to pay off fines for scandals such as Libor – and greater conditionality is being attached to any short term rewards. Penalties for poor conduct are beginning to outweigh the financial incentives.
Good ethics is about action taken when nobody is looking, acting within the spirit of rules not just their letter. Britain’s bankers are beginning publicly to acknowledge that. Bob Diamond’s successor at Barclays, Antony Jenkins, has told his staff to sign up to a new ethics code at the bank or leave, in a bid to reconnect Barclays with its Quaker roots. There has been endless national discussion on the restoration of ethics to the financial services, with even religious leaders weighing in.
Yet in other ways, I am not so optimistic. The financial crisis was seen as the death of light touch regulation. I am certainly not advocating its return. But in its place has come a Government that guarantees against financial failure. There has been ever more meddling in banks’ operations and enormously complex and regularly changing regulation has been coming thick and fast from both the UK authorities and Brussels. Immoral conduct thrives in the absence of clarity, with history showing that tougher regulation in the banking sector is a driver for new, innovative and riskier off-balance sheet vehicles – indeed, the explosive expansion of such vehicles over the past decade came about in the aftermath of imposing new regulatory measures following the collapse of Enron and WorldCom.
The weight of complex and confused new regulation is also crowding out one of the most effective ways of aligning ethics with self-interest – competition. By this, I mean the type that is remorselessly skewed towards the interest of the consumer, not competition between investment bankers as to who can pay the highest salaries. The recent decision by the Co-operative to quit retail banking in the UK augured ill, and although this month’s changes to the account-switching process may make it easier for new players to enter the market, there is still much work to be done. Furthermore, British banks still operate with an implicit government guarantee that anaesthetises them from the fear of failure. Similarly, if customers and creditors are guaranteed, they are less concerned about scandal, less likely to view excessive risk taking dimly and press banks for change.
The restoration of trust in the banking industry and the realignment of self-interest with ethical conduct will be a lengthy process, and one in which we all must actively engage. Governments must create an environment conducive to ethical conduct, ensuring banks are insulated from neither the risk of failure nor competition and making clear that regulation cannot eliminate risk or act as a substitute for ethical behaviour. Every operator in the financial services should seek to build a corporate culture that helps maintain the integrity and trust of the City at large. Consumers must be demanding, alert and appreciative that engagement with the financial system always involves a degree of risk, no matter how small.
Sir Richard, who shortly embarks upon a new role to raise banking standards, was not wrong in his insights eleven years ago. But his aspiration that economic nature would take its course proved misplaced. Ensuring ethics count is an ongoing project whose progress must be watched vigilantly.