Is sustainability the new conduct risk?
Sustainability is a nebulous risk identified from an existential crisis, similar to the emergence of Conduct Risk after the 2008 Global Financial Crisis. We can learn plenty from the last 10 years of how the Conduct Regime developed in the UK, including that we can flip the whole thing from a painful chore to a value creating exercise. The best approach is to:
a) Get ahead of the curve, do not wait for regulators to set the agenda, the fundamentals are clear and without change costs will rise fast (especially as firms become partially accountable for their suppliers, employees and customers decisions).
b) Keep ownership, but make it real - thread the principles through the purpose, strategy and behavioural drivers and metrics of the firm to align everyone. This will create productivity gains and regulatory benefits that deliver surprisingly high, measurable financial returns on investment. I have done this with several firms.
c) Do not rely on the big consultants who know not much more but who have a conflict of interest – to sell their own solutions and make firms adapt to them. These solutions often disrupt but rarely deliver.
ESG and sustainability requirements, in particular climate change, are now business risks. All firms face an uncertain but accelerating regulatory environment - especially highly regulated industries such as Energy and Financial Services. Of the latter, Asset Managers face the added challenge of changing and diverse expectations from investors who are also influenced by social and demographic shifts.
The evolution of the Conduct Regime in the UK from 2013 offers a likely roadmap for how the Sustainability agenda will impact the industry. The profile is similar:
· Nebulous wide-ranging subject.
· Fragmented unclear regulatory environment (for now).
· High-profile political and public priority due to a global crisis.
Sustainability rule-books are already evolving quickly and many firms will be left on the back foot if they wait for clarity. So, what can we learn from the example of UK Financial Conduct Regime?
At first “conduct risk” was hard to pin down. Even the new Financial Conduct Authority would not define it. But within three years the regulatory focus tightened and new requirements came thick and fast: SMCR; the five conduct questions; vulnerability; culture and governance; innovation data and data ethics; treatment of existing customers; access to financial services, operational resilience, diversity and inclusion, demographic change and more recently, consumer duty. Some of these non-financial conduct risks reflected emerging ESG standards.
The reaction to the evolving Conduct Regime by regulated firms followed three models:
a. Proactive outsourcing but in a silo – paying large sums for complex solutions from consultants - these either required the firm to change its business model to fit an off-the shelf solution or were created in a silo that looked good on paper, but were impossible to implement (the FCA knew when a programme was created externally and penalised accordingly). Most common with larger firms.
b. Reactive and minimal - a tick box approach to avoid fines or censure. This often involved relabelling existing market, customer or regulatory risks as Conduct Risks, then carrying on a s before, with dashboards created for regulatory reviews that were bespoke and last minute. Most common with smaller firms, but some well-known Investment firms went down this route too as Conduct was a “Retail issue”.
These superficial approaches did not really address the underlying intent to improve Conduct, or behaviour. Without threading a behavioural element into the business model, they had little impact on decision making and so usually did not deliver the changes expected by the regulator. I have developed a third approach for clients which avoids these shortcomings and additionally creates value as well as offers a competitive advantage.
c. Outcome-focussed, strategic and business-wide - a few of the more enlightened firms recognised that this could be a commercial opportunity, if handled correctly. With my help they understood that the principles and intent of the Conduct regime – i.e. to change behaviour to minimise inappropriate decisions that cause harm to customers, the markets or the economy as a whole – can have positive layered benefits to the business. This means managing a culture, adapting systems or processes and integrating values into the business model and psyche of the whole firm - from the Board to the post-room - that enhances long-term value creation, not just short-term profit, for the wider stakeholder community.
This approach requires a far more self-aware and innovative mind-set, to take the bull by the horns and reconsider the purpose of the firm and the industry in the new economic, social and political reality. The benefits are logical, can be modelled and measured.
· Productivity - the most valuable resource, human intellect, is fully engaged in line with clear, authentic, respected objectives, via behavioural levers such as intrinsic motivation models, and innovative metrics to support better decision-making at all levels, thus reducing management time, remediation costs and crystallisation of risks (including fines).
· Financial - the potential returns are substantial and measurable – in one example from a Conduct project we were able to model a 25-40% return on prioritising investment in the behavioural programme, with new metrics that aligned with the firm’s guiding principles. These were newly developed to deliver a strategy designed for a business purpose that went beyond the regulatory line or short-term financial targets to benefit its customers, clients, local communities and the economy - as well as its investors.
I believe Sustainability offers the same potential for value creation, as it becomes increasingly critical for customers, investors and governments. It will take inspirational leadership to align Strategy, Behaviour and Risk Management, with innovative, targeted metrics that foster the behaviours essential to deliver a well-articulated purpose, which embraces a clear sustainability agenda as illustrated below.