The importance of fitness, probity and ensuring responsibility - Director General, Financial Conduct, Derville Rowland

Speech delivered at Institute of Directors’ Briefing Webinar on 10 June 2021

Good morning everyone,

I am delighted to speak to you on the importance of effective culture in firms, the contribution fitness and probity can make, and how we see the forthcoming Individual Accountability Framework further reinforcing effective culture.

I’ll come to each of those topics in turn. But first let me say that the Central Bank and the Institute of Directors have overlapping visions.

The Central Bank serves the public interest by safeguarding monetary and financial stability and by ensuring that the financial system operates in the best interests of consumers and the wider community.

Our aim is to ensure that the financial system can provide services that households and business require, both in good times and in bad, and that they do so fairly. That means a well-run, resilient and effectively regulated financial services sector that works in the interests of the community.

The Institute’s vision is to be the leading authority on, and influencer of, good corporate governance standards in Ireland for directors and boards and a dynamic and relevant membership body for directors and senior business leaders, supporting them through the lifecycle of their business lives.

Our organisations share the desire for good corporate governance standards – and in that sense, our work is mutually reinforcing. You are focused on driving a continual uplift in standards across industry. We are focused on ensuring the firms we regulate are well run, appropriately governed, and have effective risk management and control functions and effective cultures.

In my remarks today, I will focus on the individual element of that common purpose.

Namely: how do we ensure key role holders in regulated firms are fit and proper, take appropriate responsibility for the work they deliver, and contribute to effective culture in firms?

This is a question you no doubt grapple with extensively in your roles as directors.

From our perspective, the fitness and probity (F&P) regime is an important contributor to our efforts to deliver on this common purpose. So too will be the forthcoming Individual Accountability Framework, which will complement and bolster the F&P regime, while also driving effective culture, improved corporate governance and enhancing individual accountability.

I believe both can be a significant support to directors too, and I’ll explain why, beginning with a few words on the overarching need for effective culture.

The importance of effective culture

The Central Bank’s work is wide and varied, fundamentally interconnected and important for the wellbeing of the community. This ranges from monetary and macro-prudential policy to firm-level supervision and consumer and investor protection. Our broad mandate allows us to take a comprehensive view and tackle challenges across the entire system, including as an integral part of the European Union and its institutions and frameworks.

Within that mandate, we regulate more than 10,000 firms across various sectors.

I think it’s fair to say no two firms will share precisely the same culture. Culture is, by its nature, a matter for each individual firm in the first instance.

However, those organisations with effective culture have something in common nonetheless: a commitment to high standards and practices together with values and a mindset that drive their behaviours around decision-making, leadership and so forth. These driving forces and resulting behaviours ultimately culminate in the outcomes that both we and the public experience and see.

Effective organisational culture builds on shared purpose and standards such as professionalism, honesty, integrity and accountability to deliver fair outcomes that have the interests of consumers and investors at heart.

The Central Bank expects to see such standards and values embedded in all the firms we regulate. The importance of tone from the top, and the critical role of directors, cannot be overstated. For example, the manner in which a board handles deviations from good practices, breaches of policy or procedure, or lack of respect for control functions, sets the standard within a firm. While fully accepting that responses need to be proportionate, inaction can implicitly endorse questionable behaviour and normalise it within a firm. People in companies need to be living these standards day to day to ensure that when they are faced with a dilemma or a moment of pressure, their natural instinct is to do the right thing, not the questionable thing. The directors have a role in setting the culture, living by it themselves and calling out and addressing poor behaviours when observed.

Organisational culture is not, of course, a new field of study – any former sociology students here will no doubt recall their first encounters with Max Weber, for instance.

I think it’s fair to say, however, that the empirical study of the precise impact of effective – or ineffective – culture on issues like an organisation’s risk appetite, risk management and resilience and financial performance is relatively newer by historic standards.

Nonetheless, we can say some things with certainty. The evidence is continually increasing in the financial services sector that ineffective culture is bad for business – both for a firm itself and the consumers or investors it serves. Much of that research I’ve spoken about before and you will be familiar with yourselves, as well as the critical connection between effective culture and trust.

But it may be helpful to cite one recent example. Emerging staff research from the Bank of England finds “strong evidence of a link between organisational culture and bank risk – banks with poorer cultures are substantially more risky”. The estimated size of the effect is “substantial”, and holds regardless of how the researchers compute the summary culture score or which measure of bank risk they use.

That connection between culture and risk matters for us as regulators. It matters for you as directors. It matters for shareholders. And critically from our perspective, it matters for customers and investors alike.

Consumer and investor protection is embedded in the Central Bank’s work. It is at the heart of our mission.

But consumer and investor protection begins with firms themselves. The provision of regulated financial services is a privilege, not a right, and firms must earn that privilege.

Firms are responsible for selling products and services that meet their customers’ needs both now and in to the future. There is, therefore, an onus on firms to have effective cultures and set the right standards.

These standards must be reflected across a firm in every aspect of how it conducts its business, from corporate governance structures to individual accountability; from strategy-setting to product development; from risk management to people management; and from internal challenge to how whistle-blowers are treated.

Culture is developed and evolves within individual firms. As regulators, we cannot prescribe or mandate a culture for firms. We can, however, monitor, assess and seek to influence culture within firms in order to guard against conduct risk and drive better outcomes for consumers and investors. This is an area of increased focus for us in recent years and in that respect, we expect firms to understand the risks faced by their consumers and investors and develop and embed comprehensive risk management frameworks to manage such risks effectively.

We see the F&P regime, and the forthcoming Individual Accountability Framework, as central to our work in this regard – and as valuable tools for your work too.

Fitness and probity – a decade on

Effective culture is about people – the right people focused on the right things and doing their work in the right way. People are at the heart of the F&P regime; both in terms of its overarching purpose (protection of consumers, investors and financial stability) and its methodology (people in key roles in regulated firms must be fit and proper).

This year we are marking ten years of the F&P regime. It was introduced as part of a comprehensive set of legislative reforms arising from lessons learned from the financial crisis. Prior to its introduction, there was no statutory framework in relation to fitness and probity applicable across the financial services industry in Ireland.

The F&P regime seeks to ensure that regulated firms and individuals who work in those firms are committed to high standards of competence, integrity and honesty, and are held to account when they fall below these standards. The regime has been instrumental in our work in seeking to ensure that the right people occupy key roles in the firms we regulate. The regime has three component pillars that, between them, capture both the need for fitness and probity upon entry to a senior role and the need to maintain suitability for the role.

Pillar one: Regulated Firms’ Ongoing Obligations

The first pillar is the ongoing obligations of the firms themselves. There are very serious ongoing obligations on firms under the F&P regime to ensure their key employees meet with the required standards.¹ As with regulation more generally, be it prudential or conduct, firms have the first line of responsibility when it comes to fitness and probity. Firms must proactively conduct ongoing due diligence screening of staff to ensure there has been no change in circumstance that may affect the fitness or probity of the individual. If a firm becomes aware that there may be concerns in respect of an individual’s fitness and probity, the firm should investigate and take action without delay.

Pillar two: Gatekeeper

The second pillar of the regime is the Central Bank’s role as gatekeeper. We assess the fitness and probity of individuals proposed for certain senior roles in firms and act to keep unfit individuals out of the industry.² Firms have a core obligation in this respect, as they must not appoint individuals to those roles without the Central Bank’s prior written approval.

We approve individuals for appointment to roles only where we are satisfied that they meet the required standards. In 2020, there were 4,486 PCF applications assessed and during that period some 20 applications were withdrawn by firms following referral to a specialist fitness and probity team based in our Enforcement Division.³

In general terms, the firm is best placed to assess the fitness and probity of an individual, both in applying for a pre-approval controlled function (PCF) role and on an ongoing basis. We expect all firms to carry out a comprehensive and thorough assessment of the individual’s fitness and probity for the proposed role before submitting the application to the Bank and we expect that firms are able to evidence this.

We expect full and frank disclosure in the IQ and surrounding material submitted to us for the PCF assessment. If there is adverse information about an applicant or any doubt about its materiality to the assessment, you should disclose the information to us. Apart from the duty on firms not to provide false and misleading information, there is a benefit to firms and individuals in being open and cooperative as this will assist and expedite the approval process.

As part of that firm assessment, there are also obligations at board level, something which is often overlooked. You will be aware of our Dear CEO letter issued in November 2020, following a thematic review of compliance with the F&P Regime. In that letter, we identified shortcomings in board involvement in PCF appointments. Specifically, we reminded firms that boards should be actively involved in approval, discussion and challenge of proposed PCF appointments.

We also reminded board members of their obligations when appointing members to the board. Our review highlighted that board appointments were generally not subject to the same level of scrutiny or formality as other PCF/CF appointments. We want to see meaningful board discussion around the suitability of a candidate both individually and as a member of the collective senior leadership team. We expect to see a record of interview notes and suitability assessments being carried out and some evidence of board discussion and challenge. We know some of you do this. But it needs to be documented and available for the Central Bank to see when our supervisory colleagues are carrying out an inspection.

I recognise there may be a view in some quarters that this is burdensome. But I hope that directors see this as an effective regulatory tool that can assist you in the process of ensuring the right people are appointed to senior positions within your firms.

In that spirit, today we are launching our new publication, the Fitness and Probity Interview Guide, to assist prospective applicants and firms.

Launch of Interview Guide

We use interviews as one of the tools to assess proposed appointments to senior roles. They can play an important role in gathering information that cannot be obtained from desk-based reviews. PCF applicants should be well-prepared for an F&P interview and should not underestimate the robustness of the interview.

We understand that for some applicants there may be uncertainty around the interview process, particularly where they have not gone through the process before. To that end, and as part of the Central Bank’s drive to bring increased transparency to our processes, we are launching the Interview Guide. Its purpose is to assist PCF applicants who have been called to attend an interview with us and to assist firms in supporting them.

It provides practical assistance and is a one-stop shop for all the information that a PCF applicant and firm may need. It is available publicly on the Central Bank’s website.

Pillar three - Investigations

Finally, the third pillar of the F&P regime is our power to investigate current role-holders. We may issue a prohibition notice if we form the opinion that an individual is not of appropriate fitness and probity. Since 2015, we have issued nine prohibition notices, each prohibiting an individual from performing one or more controlled functions at one or more regulated firms for a specified period or indefinitely.

Of course, it is also important to note that, separately to the F&P regime, we have also taken action against individuals under the Administrative Sanctions Procedure (the ASP), and when carrying out enforcement investigations, we consider all possible angles, including individual roles, responsibilities and actions.

Future developments: F&P and individual accountability

The F&P regime is a powerful tool, and one of a number in our suite of regulatory powers. However, given the importance of our public service mission, it is imperative for regulators to learn from experience - both ours and others - keep a firm focus on the future, and constantly ask ourselves how we can improve. The community we serve expects nothing less.

I expect that everyone present can speak to the ever-increasing complexity and challenge of their roles and the levels of attention, diligence and experience required to do these roles well. The Central Bank has high expectations in relation to the quality of governance and oversight in firms and the stewardship of directors is a critical component. We expect the board, as a collective, to have the necessary skills and expertise to oversee the business. At an individual level we expect directors to be active and proactive in establishing strategy, understanding risk and challenging the executive. Boards and their members need to understand what they need to know and get to grips with that.

As we reflected on our existing powers, as we dealt with a series of consumer and investor failures across financial firms, and as we developed our thinking on culture, it was clear to us that individual accountability needed to be reinforced.

Global and national experience indicates that in order for a regulatory framework to work well, it needs to drive strong and effective governance within firms. To achieve this, the allocation of responsibilities within firms needs to be clear and comprehensive.

Individuals need to know what they are responsible for, to be clear what standards are expected of them, and to recognise that if their actions fall short, they will be held accountable.

Hence the proposal for an Individual Accountability Framework, including the introduction of conduct standards for individuals in regulated firms, conduct standards for the firms themselves, and the Senior Executive Accountability Regime (SEAR). We have also sought enhancements to the F&P Regime and the ASP. For example, one of the key F&P enhancements being sought is the certification requirement whereby firms will be required to certify that their key individuals are fit and proper persons. We see these as necessary enhancements to our supervisory and enforcement toolkit to support effective culture in regulated firms.

We view the various aspects of the Framework as separate but very much complementary – both to each other and to the existing F&P regime. F&P focuses on ensuring that the people who occupy key roles in the financial services sector are suitable for those roles, and that both they and their firms are cognisant of their ongoing obligations in this regard. The Individual Accountability Framework, specifically SEAR, will impose obligations on in-scope firms to set out clearly where responsibility and decision-making lies within the firm, and will provide for senior executive accountability. In addition, the conduct standards will set out the standards of behaviour expected of individuals and firms and, being directly applicable legal obligations, provide a mechanism by which those who fail to comply with them may be held to account as and when appropriate. Taken together this will, over time, result in improved governance across the financial sector.

We are working closely with the Department of Finance to progress the Framework.

Diversity and Inclusion

Finally, it’s relevant to note the importance of diversity and inclusion in the shared purpose we have to uplift governance standards. We believe that D&I is intrinsically intertwined with behaviour and culture, as does the Institute of Directors. In your 2019 Report, “Diversity in the Boardroom”, 83% of respondents somewhat agreed or strongly agreed that board diversity leads to enhanced board effectiveness.⁴

Because of its intrinsic link to behaviour and culture, we are placing significant focus on diversity and inclusion, and the F&P regime is one of the ways in which we are measuring progress.

The Central Bank’s Demographic Analysis Report 2020 shows that there continues to be a low level of gender diversity in senior roles in firms. More needs to be done to increase the diversity of experience, thought, background and attributes at senior levels to improve decision-making and risk management in firms in Ireland.

As my colleague Ed Sibley has said, we will continue to require improvements in this area; undertake detailed and thematic reviews; and publish research and information on the issues and progress (or lack thereof) in improving diversity and inclusion in regulated firms.⁵

The Central Bank expects to see all regulated firms commit to addressing, and significantly improving D&I. For example, firms should have and implement a board-approved D&I strategy, which aligns to the business strategy of the firm.

This is even more important as we deal with the changes in how we work that have been accelerated by the pandemic. Some of these changes will have an effect on how we approach D&I in the workplace. With this in mind, firms should rethink their governance structures, processes, policies and procedures including talent management through a D&I lens, not only to address previous shortcomings but also to tackle the challenges new working practices will present. Not only will firms need to re-think D&I in light of changing work practices, but we will also be re-examining how we approach measuring the effectiveness of firms’ strategies and processes dealing with D&I in this changed environment.

Over the medium to longer-term, the Central Bank will continue to expect to see evidence of the effectiveness of culture, behaviours, structures and controls such that diversity of candidates is clear in PCF applications, in the talent pipeline and succession plans of companies and in appointments.

Conclusion

In concluding, let me acknowledge that many firms and the people within them run their business to very high standards and put their skills to good use for their customers and their business.

In that respect, I don’t think the Individual Accountability Framework, and the F&P enhancements, will be an imposition for most firms - because the majority of firms we regulate would tell us these are precisely the standards and behaviour they already expect of their staff. They already know the importance of effective culture to their business.

Our primary focus on culture, including diversity and inclusion, is to act as a driver for positive behaviours.

I hope in that respect both the F&P regime and Individual Accountability Framework can be helpful in the execution of your own roles.

Thank you for your attention and I am happy to take any questions or hear any feedback you may have.

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¹ Central Bank of Ireland: Fitness and Probity Standards (Code issued under Section 50 of the Central Bank Reform Act 2010) (2014) (or the Fitness and Probity Standards for Credit Unions (Code issued under Section 50 of the Central Bank Reform Act 2010) (2015)) and Minimum Competency Code (2017).

²  The Central Bank also works closely with our supervisory colleagues in the European Central Bank in the execution of its gatekeeper role. We sit on interview boards with our colleagues in the ECB and assist them with fit and proper assessments across the Single Supervisory Mechanism.

³ Central Bank of Ireland: Pre-Approved Controlled Functions: Current List.

⁴ Institute of Directors: Diversity in the Boardroom (2019).

⁵ Ed Sibley, Deputy Governor, Central Bank of Ireland; “Lack of progress in gender diversity at senior levels of regulated firms is disappointing with much more needed to be done” (8 March 2021).