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Governance, Risk & Compliance: Part 3

This week we come to final part of the GRC trilogy: Compliance

Of course, it is about a lot more than just rules, regulations and policies. In fact, that is the easy bit. 

Let’s go back to our running example of Toyota to consider how they frame the topic of compliance: 

“honour the language and spirit of the law of every country and region and undertake open and fair business activities to be a strong corporate citizen of the world.” 

Toyota believes that adhering to this principle helps to fulfil duties in corporate social responsibility and ensure compliance… 

Toyota promotes creating a framework to adopt and enforce the Code of Conduct as well as other means of human resource development, including training… 

Let’s unpick this in a little more detail. 

Language & Spirit 

Unfortunately, in recent times we’ve seen far too many instances where high profile individuals choose to interpret the rules in a different manner to what they were intended. No need to name names here. Instead, let’s pick on Manchester City football club. 

Manchester City successfully appealed to the Court of Arbitration for Sport (CAS) against the two-year ban from the Champions League handed down by UEFA. 

City were handed a two-season Champions League ban and ordered to pay a €30million fine after being found guilty of breaches of Financial Fair Play (FFP) regulations and UEFA Club Licencing rules by the governing body’s Club Financial Control Body (CFCB). 

Manchester City, backed by the billionaire brother of the ruler of Abu Dhabi, was punished in February after a lengthy investigation by UEFA concluded the club had committed “serious breaches” of so-called financial fair play rules, regulations designed to prevent clubs from spending beyond their means. 

City has been fighting the allegations of overspending since 2018. The club has long claimed that it has ‘acted properly at all times’. Properly, in terms of language or spirit?

If we bring it back to financial services, we know this is exactly the same premise as the FCA. Take this quote from Andrew Bailey’s speech at the Annual Public Meeting 2019: 

‘We view incidents like the Woodford affair as an example of this – where firms are following the letter, but not the spirit, of the rules’ 

If you are not familiar with the Woodford affair then you can read more here

Principles 

This soundbite also ties with the regulatory move away from principles towards outcomes-based regulation. Far too often in the Libor and misconduct post-mortems senior managers argued that they operated within these ‘principles’. 

It posed quite the issue for the FCA to truly hold such individuals to account, and a driving force to the introduction of the Senior Manager and Certification Regime (SMCR). Concepts such as reasonable steps force such managers to be personally accountable for their actions and explain what they do and why. 

So beware – you must act within both the language, i.e. the legal bit, and the spirit

Hmm, so what do we really mean by spirit? 

Conduct 

We all know and understand the code of conduct expected of us. We diligently complete online training and attest to being a good corporate citizen. But that is often ‘day 1’ or once a year. And unfortunately, this is where it often falls down. 

Risk 

Compliance is a risk and a significant factor in the overall risk framework of all firms. 

It is not limited to simple compliance with laws and regulations; it also encompasses sound fiduciary principles, prudent ethical standards, client documents, internal policies and procedures, and other contractual obligations… 

This framework shows the multifaceted approach needed: 

Is it Legal? 

This part is the more obvious and seemingly easier to navigate. It is why firms have Legal & Compliance experts who seek to understand, define and translate complex regulatory obligations into working practices. 

MiFID II is a good example of this. MiFID II is 196 pages long. The European Securities and Markets Authority (ESMA) has translated this into 406 pages of technical standards!!!!!! 

Despite this, armies of experts were on hand to decipher and ensure the relevant parts were passed down the line, so that everyone knew what they could and couldn’t do. 

Yes, there will always be grey areas that are not as obvious, but the do’s and don’ts are quite clear. When something falls in the middle there are new business committees and forums to decide the right approach. 

Is it fair and Is it right? 

These questions take us into different territory. You may argue that these sound more like philosophical questions, or calling on one’s personal compass. 

It also brings up the question of fair and right to whom? 

Let me use an example to illustrate the point…. 

I came across an interesting conduct issue on a structured product. 

The client was a pension fund whose local regulator applied investment criteria that restricted it from buying more than 10% of a single issue of a security. 

The client approached the bank with a request to create a particular structure for which it was not obvious whether there will be demand from other clients, although they argued the structure was common in their jurisdiction. 

They asked the bank to issue $100m of the security, selling them for $10m while retaining $90m on the balance sheet. The client suggested that the bank should seek to sell the balance but in the event of it not being possible they would be happy for all or some of the balance to be cancelled. 

No doubt you see the issue straight away. Seems ok at first, a 10% holding, but should the remaining 90% get cancelled then potentially there is a loophole with the client left holding more than 10%. 

But where it gets really interesting is that the transaction itself got legal approval – in other words was it legal? Yes, it was. Of course, with a big underscore on the remaining 90%. 

You’d expect the structured desk to proceed with caution, maybe ensure other client demand was met first but no, they went ahead anyway – client is always right? WRONG! 

When the desk head found out (yes, good question how did it go ahead without his agreement?!) let’s just say the desk quickly reversed course. In other words, it went out and sold off the remaining 90% at a big loss to prove there was demand. An emerging market and volatile currency to boot, ouch! 

Why did they act in this way? Partly due to the regulatory concerns but mainly due to the reputational impact and how would this look in the market. Even if it was legal, could you say it was fair? Fair to other clients in the market, and the right thing to do. 

Judgement 

One of the best phrases I was told by a former colleague was the difference between what you can do and what you should do is judgement

I think that sums it up nicely. But judgement can be tricky, open to subjectivity and all too often missed. 

It’s especially hard (you could argue) earlier on in your career, as experience certainly helped shaped my judgement. 

But that aside, it ain’t rocket science. 

In the end, remember this: 

If it looks like a fish and smells like fish … it usually is a fish … 

Stay safe, stay curious and keep learning! 

About this author

Matt Fotherby

Financial Markets, Compliance & Regulations

Matt Fotherby

Matt is our Founder and a passionate trainer.

His interest in education stems from his 10 years as an Account Executive looking after Global Hedge Fund and Asset Management clients. This led Matt to join the coveted Financial Markets Education team at UBS, a unique in-house education team that specialised in running a curriculum of financial market and product classes for both UBS employees and clients. Matt was responsible for building out the client offering; managing programs, creating content and teaching courses.

As financial markets entered a significant period of regulatory change Matt pivoted to take his client experience and market knowledge to focus on Regulations and Compliance topics.

Look who’s back, back again!

The most recent of these in late 2019 took a slightly different approach hosting Conduct Roundtable sessions with 18 wholesale banks. Each was represented by a group of 10 staff at a ‘Vice President’ (VP) level of seniority or similar. They came to refer to this group as ‘the Engine Room’, acknowledging their importance to firms.

It’s a good read and I thoroughly recommend it but if you don’t have time to sift through the 34 pages I’ve picked out some key highlights and comments for you to ponder over.

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