UBS culture problems

Interesting analysis piece in today's Financial Times by Megan Murphy and Haig Simonian. They argue that leading investment banks are struggling to redefine their identities amid tough market conditions. While the article singles out UBS, also in the frame are Bank of America Merrill Lynch, Morgan Stanley, and Royal Bank of Scotland.

As interim UBS CEO Sergio Ermotti wrote to all his staff last week, "We must now summon our collective strength to demonstrate what UBS stands for." About time too, many UBS employee would say. As Murphy and Simonian note:

UBS insiders say the constant influx of new staff, plus a virtual merry-go-round at the top, had already made it hard to knit together a cohesive culture. The investment bank has reshuffled its executive committee more than 10 times in three years, bringing in senior people from Deutsche Bank and other rivals who frequently brought clashing management styles. Insiders cite a structure where the equities and fixed income divisions are led by four global co-heads – only one of whom worked at the bank before July 2009 – as particularly problematic.

Across the investment banking sector, efforts to find sustainable profit lines now like the US Army's hunt for Saddam Hussein's missing WMD - great prizes promised for those units that find the 'treasure' but no evidence that it actually exists.

So what does UBS (and indeed the other banks) stand for now? It's time for industry leaders to stop blaming markets, regulators, rogue traders for their woes and start telling us where they stand amidst the maelstrom. 

Where do we go from Vickers?

After a long summer's lobbying, the final report of the Independent Commission on Banking (the Vickers' Commission) was finally published earlier this month. After digesting the report and its commentary (including the massive governance breech at UBS which nicely demonstrated the timeliness of the debate), the outcomes for the governance and culture agenda appear to be:

• the proposed ring-fence around banks' retailing operations will entail measuring and managing cultures on both sides of the fence. As Vickers says: 'It is difficult for regulations to work effectively if they are operating against the grain of corporate culture. So, alongside financial restrictions, the governance of a ring-fenced bank should reflect and encourage an appropriate relationship with the rest of the group.' (74) A view endorsed in a Financial Times editorial.
• the onus of managing corporate culture will fall on banks' management rather than the regulator. As Vickers says: 'While corporate culture cannot be directly regulated, these measures should assist in building a separate, consumer-focused culture in UK retail banking, and a distinctive identity within the ring-fenced bank.' (76) A view partially endorsed in a briefing by the right-wing think tank Adam Smith Institute
• there is much to play for here still. As Michael Cohrs (member of Bank of England’s Financial Policy Committee) said in a Financial Times roundtable on Vickers: 'The report does talk a lot about culture and the need for cultural change between certain types of banking operations. I think if I were critical of the report the one place would be maybe not enough attention was put on how do you create or how do we create different cultures, the retail culture which is quite different from the wholesale culture.'

In view of this ongoing debate, the 'Governance Beyond the Boardroom' team has brought together a number of researchers and practitioners to support the next stage of project. The project team is now led by Dr Andrew Tucker (Brunel University) with Dr Simon Ashby (Plymouth University) and Prof Ken d'Silva (London South Bank University). A number of banks and relevant organisations have joined the advisory board and committed their time to help the project operationalise the governance culture toolkit framework published here in January. 

The main outputs that we expect to deliver are as follows:

• A process tool that highlights the essential stages and decisions associated with the implementation of effective governance arrangements.
• An audit tool, which allows institutions to compare themselves against identified examples of good practice and assess the gaps in their own practice.
• A suite of recommended metrics (both qualitative and quantitative) that are used to monitor the performance of new or existing governance arrangements. This will include metrics that allow institutions to assess their governance culture.
• Case studies to illustrate good practice.
• Face-to-face training sessions and bundled e-learning modules.

If you would like to be part of the ongoing project, we look forward to hearing from you. Please contact andrew.tucker@brunel.ac.uk.

The costs of the wrong culture

Intriguing article in last week's FTfm section (the Financial Times's weekly review of the Fund Management Industry) on an unpublished draft report from IBM's Institute for Business Value that states:

"The document, seen by FTfm, claims the industry is 'paid too much for the value it delivers' and that 'destroying value for clients and shareholders is unsustainable'".

The report goes on to warn of large headcount reductions in sell side research, credit rating agencies research, traders, fund of hedge funds, hedge funds, traditional portfolio managers, and financial advisers.

The question is, in an industry that is allegedly singularly motivated by delivering return on investment, how is there so much slack in the system? Beyond any discernible business reason, the fund management industry seems to have a culture that tolerates massive waste, duplication, and value destruction.

According to FTfm, the unpublished IBM report puts a figure of '$1,300bn' on this egregious waste. Getting this culture more aligned with strategy has the potential for huge cost savings and much greater client and shareholder value.

Update: Peter Elston, investment strategist at Aberdeen Asset Management Asia, defends the industry here by arguing that (i) the costs of slack in the system are overstated and (ii) acceptable when compared to the potential privatised benefits of beating the market. 

Does Vickers Commission Interim Report change the conversation?

So the Independent Commission on Banking has provided an answer to one of the big questions raised by the financial crisis. We can't stop a repeat but we can mitigate its impact.

Despite the predictable sound and fury around the Interim Report from the ICB, the big banks seem to have won the argument for resisting a break up. The Commission's structural approach is to inject more competition into the high street banking sector, ring-fence retail from investment operations, and make the cost of capital more realistic.

Intriguingly, these changes may have significant effects on banks' culture although this is not explicitly mentioned by Vickers.

• Greater high street competition will drive transparency on fees, simplicity in products, and improved customer service
• Ring-fencing the retail operations, even if some cross-subsidisation remains, will help the high street side push back against the higher risk-takers from the investment side
• More market-rate capital will undermine the 'fingers-in-the-till' mentality of the investment side using the retail side as a source of cheap credit

Unless George Osborne perpetrates an even larger Government U-turn than tuition fees, most of the Vickers recommendations will ultimately change the governance culture of the banking sector. Whether this is for the better depends on the small print, as ever. However, Vickers seems like the tentative beginnings of a new conversation for UK Banking. Should we tell the cheering bankers that they aren't out of the woods yet?

McKinsey's culture in question

An interesting column in today's Financial Times by John Gapper. He argues that the charging of the ex-CEO Rajat Gupta with insider trading is a severe strain on the firm's perceived governance culture. Gapper makes the perceptive point that McKinsey that:

It is hard to believe that trading on price-sensitive inside information from clients is rife inside the puritan, strait-laced firm – if evidence of that emerged, it would soon collapse, as Arthur Andersen did after Enron. But the accumulation and sharing of privileged knowledge is integral to how it works and it cannot afford its corporate and government clients to pull the shutters down.

This goes to the heart of McKinsey business model and is another useful piece of evidence in establishing the link between corporate culture and strategy. It is also an interesting reflection on a weakness of the McKinsey 7S model - that Shared Values (at the heart of the model) may well not be shared with your key client base. I wonder what their own consultants would advise?

Is the FSA going soft on governance culture?

Interesting Clare Distinguished Lecture in Economics and Public Policy speech recently by Lord Adair Turner, Chairman of the FSA, on whether the current reforms of the financial services sector are going far enough. Short answer is No - because the current fixes patch up the existing system without reforming it sufficient to prevent another crisis.

As rightly Lord Turner points out:

An appropriately radical response to the financial crisis requires that we take into account explanations of financial market imperfection and instability which go beyond the identification of specific information asymmetries or incentive problems.

However, having rightly pointed to broader fixes that include learnings from behavioural analysis, insuperable information asymmetries (a la Joseph Stiglitz), and the inherent irreducibility of some uncertainty (a la Frank Knight), Lord Turner simply suggests regulators should retain a discretionary macro-prudential capacity to intervene when they smell danger:

As a result, fixing poor incentives - such as those created by 'too big to fail' banks or by perversely designed bonus arrangements - while a necessary part of the regulatory response, cannot be sufficient. Our policy response needs also to include policies which focus on the complex dynamics of the whole system, above all through higher equity capital requirements, and macro-prudential policies which can arise even in a system where individual agents' incentives were always well designed.

Surely the recent crisis has demonstrated the FSA's shortcomings in acting as an all-seeing deus ex machina? Instead, they should actively research micro-prudential tools with which to regularise behaviour of individual agents. Something with which this group has made some headway. We await Lord Turner's call...

The Good and the Bad of Governance Beyond Boardroom

Running counter to the current commentary on the financial services sector, a big cheer to Goldman Sachs and a big raspberry to Barclays for today's reports.

On the upside, it appears that Goldman's new governance culture (see previous post) does have some teeth. It is reported today that Kevin Connors, co-head of global forex sales in G10 currencies, was fired last week for breaking internal compliance rules. However, and here the cheers are deserved, he had not acted illegally nor harmed clients. So undermining the firm's culture and reputation, even if no external rules have been broken, is now a sackable offence. I wonder if other financial services firms will follow suit...

On the downside, Barclays was fined £7.7m by the FSA for misselling Aviva funds. The reaction from IFAs has been a little predictable. However, this fine comes on top of having to refund £60m to complainants. This is a significant governance situation and evidence of a sales culture misaligned to corporate strategy. Whether senior management announces a recovery programme in the next few days will be a sign of how seriously they are taking their governance culture mistakes.

Governance reform in the NHS

In all the commentary this week around the Government's plans to radically devolve power in the NHS, there has been little about the governance challenge this represents (honourable mention to the exceptions: the Chartered Management Institute here and Michael Tremblay here).

Are GPs ready to take control of 80% of the NHS's £100bn annual budget? While some run thriving SMEs, the management challenge to take on commissioning their services is a step change from a small rural practice.

In particular, do GPs have the right governance culture for their new role? By this I mean no disrespect to GPs but simply question whether their existing culture - necessarily elitist, authoritative, closed, collegiate - is the right culture to fit the new NHS strategy.

Working with a plethora of private sector providers requires acute attention to contractual detail, considerable strategic vision of the kind of services mix required, entrepreneurialism, innovation, and (dare I say it) some marketing nous as the reforms bed down and GP consortia start competing for business.

According to my insider sources, these are not the cultural values taught in medical schools nor fostered by the Royal Colleges. It seems like the NHS reforms represent a considerable research and practice opportunity for Governance Beyond the Boardroom network. Please drop me a line if you wish to pursue it.

Goldman Sachs governance report

As an example of what leading financial service firms are doing in terms of their governance culture, this week's report from Goldman Sachs sets three interesting precedents for the sector.

1. The extent of the reputational damage when a firm's actions stray so obviously from its espoused business standards. 

Goldman's first business principle is: 'Our clients' interests always come first'. This ideal looks a little hollow as the details of Goldman's investment in Facebook have leaked out. Their last business principle is: 'Integrity and honesty are at the heart of our business'. Again, hard to square with the news that Goldman lost an additional $5bn in proprietary trading in 2008 but have only just announced the loss.

2. Getting your culture right is key to overcoming reputational woes. As the report notes (p. 6):

'The firm's culture has been the cornerstone of our performance for decades. We believe the recommendations of the Committee will strengthen the firm's culture in an increasingly complex environment. We must renew our ... constant focus on the reputational consequences of every action we take. In particular, our approach must be: not just "can we" undertake a given business activity, but "should we".'

3. Firms are right to be concerned about the intuitive link between culture, governance, and reputation. As the report says (p. 8):

'[Goldman's reputation] can be affected by any number of decisions and activities across the firm. Every employee has an equal obligation to raise issues or concerns, no matter how small, to protect the firm's reputation. We must ensure that our focus on our reputation is as grounded, consistent and pervasive as our focus on commercial success.'

Despite the poor reception the report has generally received on Wall Street, Goldman might again be ahead of the pack in one major aspect. Instead of addressing governance failures in a simple rearrangement of committee armchairs and more internal procedures, they have taken a more root and branch approach. Under the rubric of improving governance, they aim to address: improving client relationship management, making adherence to the Business Principles reportable, better oversight of new products, taking transparency seriously, and incorporating culture and values into KPIs.

At least Goldman is coming up with a public response to the seriously flawed culture of banking that led to the financial crisis. I hope, but don't expect, more international banks will follow Goldman's new approach to governance reform.

Governance Beyond the Boardroom in Oil Industry

Deepwater Horizon Oil Spill

Yesterday's scathing report by the presidential commission into the April 2010 Deepwater Horizon oil spill paints a picture of a disfunctional corporate culture at BP and across the oil industry. The report is very useful in explaining what exactly went wrong in the build up to the explosion. But the most interesting aspects for this blog's readers lie in the 'Overarching Management Failures by Industry' section [p. 122]:

"The most significant failure at Macondo—and the clear root cause of the blowout—was a failure of industry management. Most, if not all, of the failures at Macondo can be traced back to underlying failures of management and communication. Better management of decisionmaking processes within BP and other companies, better communication within and between BP and its contractors, and effective training of key engineering and rig personnel would have prevented the Macondo incident. BP and other operators must have effective systems in place for integrating the various corporate cultures, internal procedures, and decisionmaking protocols of the many different contractors involved in drilling a deepwater well." 

As this case demonstrates clearly, some of the greatest risks in the oil industry are faced along way from the boardroom. Without a robust governance culture that proactively addresses the integration of various corporate cultures, internal procedures, and decisionmaking protocols" of the various contractors", the report concludes that:

"the root causes are systemic and, absent significant reform in both industry practices and government policies, might well recur."

This isn't the current governance culture of the industry. Rather, it is summed up by BP engineer Brett Cocales in an email a few days before the explosion [quoted p. 116]:

“But, who cares, it’s done, end of story, [we] will probably be fine and we’ll get a good cement job.”

Open Source Toolkit Framework goes live

The project team is very pleased to announce that the 'Governance Beyond Boardroom' toolkit framework has gone live on the website today. It is open source and freely available here.

Please all have a play and test it to destruction! I'm sure there are things we may have missed so let us know where we can improve. It's an ongoing research and practitioner project so all ideas for improvements most welcome!

In the next few months we hope to be using the toolkit framework with some pilot sites. We have some volunteers already but are happy to work with more first movers. If your organisation would like to be involved in this innovative approach to governance, please let us know by replying to the project team at andrew.tucker@pol-soc.bbk.ac.uk.