Brunswick Review Issue 7

Banking's new rules

Having been at the heart of the storm as chief UK regulator during the financial meltdown, Sir Hector Sants tells Brunswick's Andrew Garfield about his new role at Barclays and the changed expectations for banks

Unlike most bankers, Hector Sants has been on both sides of the regulatory fence. After years working as an investment banker at UBS and Credit Suisse First Boston, he became head of the Financial Services Authority (FSA), the UK’s banking regulator, at the height of the financial crisis in summer 2007. Sants has been credited for his role in helping to avert a banking system collapse, earning praise from George Osborne, even as Britain’s Chancellor of the Exchequer bitingly criticized the FSA itself and moved to replace it from April 2013.

This year, Sants moved to British bank Barclays – ranked seventh in the world by assets in Global Finance magazine’s 2012 survey. Although it avoided a bailout, it has had a rough ride since the financial crisis, most recently when it admitted attempted manipulation of the LIBOR benchmark. By hiring Sants and putting him at the head of a new function within the bank, Barclays is signaling its intention to focus on restoring trust by rebuilding its compliance apparatus and strengthening the bank’s relationship with regulators. Here, Sants explains his vision for the role and discusses how he will build bridges between his former employer and his new one.

Your job at Barclays – Head of Compliance and Government and Regulatory Relations – is a newly created role. How would you define it?

First of all, it makes sense to bring together the regulatory-relationship component and public affairs in order to have an integrated input into policy determination. Second, it makes sense to combine that with compliance, the function that ensures we adhere to those policies.

The other point which I would emphasize is that the role of the new group is more than just to ensure people adhere to compliance policies. What I would like to see is a re-orientation of compliance away from the traditional, rather narrow view of advising how to comply with the policies, to a broader one which makes sure that those values are given substance.

So, it is about ensuring alignment with the values rather than just alignment with the rule books. And it is not for compliance to decide what Barclays’ values are – they are set by the board, by the executive committee, and by the wider management. Compliance’s role is to articulate how those values are applicable to individual judgments, and then to make sure decisions are made within those frameworks.

We are not trying to turn compliance into an organization that second-guesses business. But compliance should articulate the boundaries within which the decisions can be made and explain how those boundaries are created and what they mean; and if someone steps outside the framework it is compliance’s job to make sure the appropriate sanctions are applied.

The outside world, no doubt, will see the need for a culture change at Barclays and that hiring you is strong signal. But in concrete terms how do you engineer this shift?

As the chief executive [Antony Jenkins] has already indicated in a number of speeches and interviews, this will be a major cultural change for Barclays, to emphasize much more clearly and forcibly the obligation of the bank to contribute to the wider goals of society, to be aligned with what society would expect from a bank, rather than prosecute a strategy that is more aligned with employees’ needs. We need to recognize that there has been a shift in the whole climate in terms of what society expects from banks as a result of the financial crisis.

It seems the public mood is for something more prescriptive – more rules-based than principles based, if you like – given recent decisions by European lawmakers and Swiss regulators to cap executive pay. Would you agree?

The view had been that you cannot write rules for every eventuality, so the best way to get effective behavior was through articulating the general principles. That sat alongside the view that markets were self-correcting and could be self-policing. The catastrophic consequences of the financial crisis on the prudential side and, as we’ve seen recently, on the conduct side have caused people to re-evaluate that framework and to push the dial more toward rules. I think that is right for the regulatory system, but for an individual institution the goal is to focus on delivering a set of clearly defined goals that employees can understand. So what you do in individual institutions is not necessarily what you do in the regulatory system.

One of the consequences of the crisis is that society, in my view quite rightly, is asking, ‘Where are the people being held to account? Where are the sanctions?’ In order to have regulators who can effectively sanction and hold to account wrongdoers, you do need a strong rules-based component, otherwise the legal process becomes bogged down. But the balance of principles-versus-rules in a regulator is different for prudential, different for conduct, and different from what you need in a firm. So I think they must be seen as two different issues.

How has your perspective changed since you moved to Barclays from your old job?

I don’t think my views on what is good oversight and a good risk management system have changed since coming to Barclays – they have evolved over the past eight years, partly through the learning experience of being involved in the largest financial crisis in modern times. I think I have described that in the public forum before now as a ‘searing’ experience, and that’s entirely right.

Having been in such a public role, how do you see the role of communications in your new job?

Successful communication will be a key component. We need to effectively communicate to employees not just what is expected of them but how to deliver against what is expected of them. The central challenge is to get employees to live the high-level vision and to see the benefits to them as individuals, to the institution, and to society. Compliance has a central role to play in that, but so does everyone else. Change starts at the top, as the phrase goes. It has to start with the chairman, the board, the chief executive, the executive committee.

There is an external challenge, too. There has been a significant loss of confidence in the global financial system and global financial institutions. Barclays certainly has been one of those institutions where confidence has been significantly eroded. Rebuilding confidence – with customers, clients, regulators, the political system, the media – is necessary for Barclays to prosper and to make the contribution it would like to make to society. I am not the only person involved, but clearly I am looking forward to and expecting to play a meaningful role in that external communication agenda.

You make it sound fairly straightforward, but surely after the experience of the last few years you have a difficult task ahead of you?

We are starting from a very poor position where confidence has clearly been lost in financial institutions as a whole, and Barclays is no exception. We are starting from a position where a number of fundamental misjudgments have been made by the regulators about the rules they applied to the banking system. The consequence of that is that there has been a major financial crash which has reduced the well-being of many citizens around the world and they feel, understandably, that the banks should be held to account for what has happened. Nearly everyone in the community feels aggrieved and uncomfortable about events.

So, the starting point is a difficult one, but do I think the goal – where we would like to get to – is absolutely an achievable destination? Definitely. I think that goal reflects many elements of where the banking system was 30 or 50 years ago. I am not saying it was all perfect, of course, but there clearly was a perception – among the vast majority of employees, from management to government and politicians – that the banks were primarily there for the benefit of the community and the economy they served. Somewhere along the line that sense of purpose was lost. I think trying to get back to that place is a perfectly realistic and sensible objective, but it is going to be a lengthy and difficult journey.

What about the role of risk in the banking crisis? What changes do you expect on that front?

The system was significantly over-leveraged. So there has been this ‘50-year intellectual mistake’ [to borrow a phrase from Lord Turner, the FSA’s last chairman], in relation to capital and liquidity restraints, which is being corrected through the new regulatory rules. But reducing the leverage that the banks have available will make it more challenging to obtain the returns that shareholders are looking for. When leverage was the main source of growth it was relatively easy to focus on revenues rather than costs. But the next period for banking will have a far greater focus on costs and I have no doubt that there is a lot of scope to take costs out of the banking system. Barclays’ cost reduction agenda will be one of the key challenges, to recalibrate to a world where revenue growth is very modest and to get back to an acceptable level of return for shareholders, which is primarily achieved by taking costs out of the system, both through greater efficiencies – operational efficiencies, technology – and by employees taking a smaller share of the cake.

You’ve said you expect closer regulation of banking in the future. Will that help to restore confidence?

I always say this very carefully: you need to distinguish between prudential regulation and conduct regulation, they are two very different issues. One really interesting element of the financial crisis is that it started off being seen as a prudential crisis, but events exposed behavioral and conduct issues subsequently which became the defining issues that people reacted to. But the conduct and prudential issues are different. I think moving to the ‘twin peaks’ approach in the UK is the right approach; they are different types of risk. [From April 2013, the FSA ceased to exist and two new organizations were created: the Prudential Regulation Authority, which is part of the Bank of England, and the Financial Conduct Authority, in charge of monitoring, investigating, and prosecuting financial miscreants].

Will the new approach work?

Well, I think there is no question that the tougher and more demanding capital and liquidity framework will reduce the likelihood of failures of the magnitude we have seen. Will they eliminate them? Absolutely not. History tells us that when financial crises do come around again, the regulator’s role is to reduce the impact on society. Individual banks definitely will fail and, in fact, probably will fail with a greater frequency as a result of resolution mechanisms being put in place.

On the conduct side, I think that is much more debatable. The tougher deterrent framework in the UK, in Europe and potentially the US, together with the new consumer framework, will have the effect of deterring some but not all bad behavior. It is not going to eliminate the possibility of consumers getting the wrong product and, to some degree, you will always have an obligation for the consumer to make a judgment – they may not always turn out be the best judgments.

A BIGGER SLICE FOR SHAREHOLDERS

One key constituency riled by the banking crisis is shareholders. As Barclays shifts its priorities, they are very much on Hector Sants’ mind. “Before I joined Barclays, I said I thought one of the key elements of the new world is that shareholders need to feel they have the bigger share of the cake,” he says.

A study last year by the Financial Times showed that banks’ shareholders had been, in the words of one fund manager, a “residual consideration” by comparison with the resources devoted to bank staff. Looking at 13 big international banks, the FT found that from 2006 to 2011 staff costs had risen from 58 percent to 81 percent of a total pot comprised of net profit and staff costs, whereas dividends had dropped to 4.5 percent from 15 percent.

Sants says, “I was supportive of the view articulated in [Barclays’] recent set of results of its intentions to rebalance the share of return between shareholders and employees.

“You can look at some relatively easy-to-articulate financial objectives and say the shareholders should have a better share of that cake. It is more difficult to say you are rebuilding trust with the community. That clearly is a more difficult long-term challenge.”

HECTOR SANTS

Hector Sants joined Barclays in January 2013 as Head of Compliance and Government and Regulatory Relations.

Prior to that he was the Chief Executive of the Financial Services Authority from July 2007 until July 2012. He was also Deputy Governor Designate of the Bank of England and CEO Designate of the Prudential Regulation Authority between June 2010 and July 2012.

During this period he served as a member of the interim Financial Policy Committee of the Bank of England. He joined the FSA in May 2004 as a Managing Director, prior to which he was Chief Executive Officer of Europe, Middle East and Africa at Credit Suisse First Boston.

Sants is Chair of the Said Business School at Oxford University, and was knighted in 2012.

Andrew Garfield is a Partner in Brunswick’s London office and focuses on financial institutions and cross-border work.

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