In December 2009, President Obama famously criticized what he called “a bunch of fat cat bankers on Wall Street.” He continued:
“The people on Wall Street still don’t get it. They don’t get it. They’re still puzzled why [it is] that people are mad at the banks. Well, let’s see. You guys are drawing down $10, $20 million bonuses after America went through the worst economic year that it’s gone through in decades, and you guys caused the problem… Why do you think people might be a little frustrated?”1
In KPMG International’s recent paper Moving on – The scope for better regulation2 we suggest that we have reached a tipping point where the cost of new regulation is beginning to outweigh the benefits. We argue that all stakeholders – the industry, investors, consumers and regulators – need to re-assess where they are going and whether greater balance is required. If the industry wants other stakeholders to engage, it needs to be very clear in demonstrating that it “gets it”. Further progress is needed by the industry to meet its side of the bargain. The truth is that nearly five years after the collapse of Lehman Brothers in September 2008, the world in which financial services must operate has changed radically. Financial services professionals will never see a return to pre-crisis conditions in the remainder of their working lives. So it is worth revisiting the question. Has the financial services industry learnt its lesson? Or do they still not get it?
Some do, some don’t
There are many positive indications that senior bankers have understood how profoundly the environment has changed, and that there are fundamental implications for their business models. But many junior management, and the other segments of financial services – insurance and investment management – continue to act as if the crisis has no direct business implications for them. Of course they complain about new regulation – sometimes quite rightly – but in the context of the macro-objectives of stability, interconnectivity, customer trust and protection there seems a sense of denial about how society’s demands on the financial services industry have changed. So in broad terms the answer is probably: no, on balance, many still don’t get it. To some extent, the different responses of banks and the rest of financial services are understandable. Banks were at the center of the crisis, and in the main it is banks which have gone bankrupt or had to be bailed out by taxpayers. So they are more likely to appreciate the scale of the change now occurring. By contrast, the insurance industry has been fighting a defensive battle to avoid being subject to restrictive new regulation. Some asset managers have argued forcibly that far from sharing responsibility for the crisis, they were the ‘good guys’, providing liquidity to the market and helping the price discovery process. However, this differentiation within financial services is increasingly untenable. Virtually all of the fundamental forces reshaping the industry today apply to all sectors. The world is going to be as different for insurers and asset managers as it is for bankers. There is no going back for any of them. Those who hope for a return to ‘business as usual’ in its earlier form are likely to be disappointed. The question is why?
Politics and regulation – the one size fits all approach to life
There is a political imperative to be seen to be doing something, regardless of specific rationales and whether regulatory change will objectively increase stability and reduce risk. Since the G20 took the lead in orchestrating the response to the crisis, the appearance of action has been in some ways as important as actual action. In some cases, action may have been ineffective or even inconsistent: an unfortunate side effect of regulatory competition between jurisdictions in an environment of continued economic stagnation is increasing domestic protectionism which, if it becomes excessive, will both increase costs and reduce stability.
Regulators have to turn political direction into action. There is a serious concern as to whether the intensive level of political scrutiny is actually making the process slower, less optimal and inefficient – but this is a wider debate. Across the globe regulators are pursuing a number of core themes which will eventually have profound implications for all financial services firms, including:
- tighter controls on firms deemed to pose systemic risk (systemically important financial institutions – SIFIs), in whichever sector they occur both domestically and internationally; assertions by the insurance sector that their business models were fundamentally different from those of banks has not prevented a number of large multinational insurers being provisionally designated as SIFIs
- recovery and resolution planning requirements, allowing SIFIs which are in trouble to be restructured or dissolved without causing damaging contagion
- controls on remuneration: these are being targeted not primarily at the absolute quantum of remuneration – although political rhetoric remains seriously hostile – but at bonuses and their relation to performance; at the danger of excessive short-termism; and at the structure of incentives and conflicts of interest. It is difficult to see how the political imperative will not impact as much on insurers and asset managers as on banks in the long run
- the conduct agenda: all firms in the industry will be subjected to new regulation designed to ensure that they act fairly and transparently; while the details vary from one jurisdiction to another, the requirement to act in the best interests of customers is a profound modification of the free-market caveat emptor principle, which will impact on insurers, asset managers and bankers alike.
Consumers and the trust agenda
Consumer confidence in the financial industry has been seriously damaged. Survey after survey shows distrust, verging on hostility, directed at the whole of the financial services sector. We all struggle to appreciate how far and how deep this distrust extends. Bankers are perceived as stifling the economy through excessive deleveraging; insurers are piling on premium increases while doing everything they can to avoid paying legitimate claims; investment managers continue taking fees while delivering negative real returns. The press line is that all involved are seen to be more concerned with lining their own pockets than with serving customers fairly. Not fair necessarily – but we all know that perception is often the best test of reality. Rebuilding trust will take many years, and requires genuine and fundamental culture change, not just lip service being paid to new orthodoxies. The challenge will be even greater as long as economic recovery remains subdued, and while consumers continue to suffer real declines in income, wealth and future expectations. Change is a long-term program. The Salz Review of Barclays’ business practices emphasized this point: “It will take time before it is clear that sustainable change is being achieved… It will take time to change mind-sets and [this] will need to be led clearly from the top. It involves two-way communications, both internally with all staff, management and the Board, and externally with all stakeholders – including, importantly, regulators. It involves better listening.”3 Many good initiatives are underway already, but these will take years, rather than months, to turn consumer perceptions and trust around.
The nature of the industry itself is changing rapidly, blurring the traditional distinctions between sectors. There is much more interconnectivity, especially in the retail market, with products and services being marketed in integrated packages combining, say, banking and insurance or insurance and wealth management. The business model of life companies is moving closer to asset management. The large multinational companies are offering one-stop services, and increasingly looking to cross-sell as a route to increased volumes and profits. New entrants into mature markets will break down the traditional boundaries further. In addition, markets and exchanges are increasingly interconnected. Custodian banks provide services such as safekeeping, compliance reporting and administration to the whole spectrum of banks, insurance companies, mutual funds, hedge funds and pension funds. Institutions of all kinds take advantage of the reinsurance market to manage risk. Financial infrastructure such as payments systems and clearing tie together all kinds of institutions. Third party service providers and outsourcing companies underpin the industry on a global scale. Despite patchy economic performance in a number of regions, the globalization of financial services continues as it did before the crisis, despite the fact that regulators are becoming increasingly “localized” in their outlook. But it is the external context which has changed most fundamentally, in relation to politics, regulation and to public and consumer perception. All of the trends driving change here apply across the board, and investment managers and insurers need to understand and respond to them as much as bankers do. There seems little doubt that risk transfer and inter-connectivity across the wider financial services sector means that a serious issue in one segment will impact on the wider industry.
It is difficult to measure whether finance professionals as a body realize that society’s expectations of their business activities in the future have changed. The crisis has crystallized a vague unease at the perceived excesses of the industry into a clear determination that financial services will play a fundamentally different role in future, more akin to that of a utility than to a dynamic, high growth, high profit industry. Of course there will be niche players who will continue to operate in the margins, but core financial services and large players will continue to be in the spotlight. There will be no return to the ‘good old days’, whether for insurers, asset managers or bankers. Those firms that still don’t get it will, at worse, fail and at best see their reputations with regulators and consumers damaged with the obvious consequences. If the industry does not play its part, the change in direction of regulatory policy we argue for in Moving On will not be possible, as the other stakeholders will continue to throw down the accusation of “they just don’t get it”.
13 December 2009 2
KPMG, May 2013 3
Salz Review, An Independent Review of Barclays’ Business Practices, April 2013