17 May 2018

Financial Stability Board publishes toolkit for mitigating misconduct risk

The Financial Stability Board (FSB) has published a toolkit for financial undertakings and supervisors, aimed at strengthening governance frameworks. The toolkit is part of the FSB’s 2015 work plan on measures to reduce misconduct in the financial sector. Drawing on the findings of its 2017 stocktaking exercise, the FSB provides nineteen tools in three main areas identified as part of its earlier work on misconduct.

The toolkit should not be treated as guidance or a recommendation for a particular approach. Financial undertakings and authorities can decide whether and how to use the toolkit to address the different drivers of misconduct. It does illustrate, however, that in the eyes of the FSB and its members – in the Netherlands, the Dutch Central Bank and the Ministry of Finance – effective corporate governance is critical to financial stability.

In 2015, the FSB agreed on a work plan to address misconduct in financial undertakings from a viewpoint of preventing systemic risk. The FSB’s work plan consists of three elements: (i) examining whether reforms to incentives, such as governance and compensation structures, are sufficiently effective in reducing misconduct, (ii) improving global standards of conduct in the FICC markets, and (iii) reforming major financial benchmarks. The new toolkit is part of the FSB’s work on the first of these elements.

Within this first area, and relating to governance structures specifically, the FSB has further researched and subsequently developed tools for financial undertakings as well as regulatory authorities to:

  • Mitigate cultural drivers of misconduct (tools 1-7).

    As the FSB found that the culture of a financial institution can be a major influence on its governance framework, it provides tools to effectively develop and communicate strategies for reducing misconduct in the undertaking, and for authorities to effectively supervise these strategies. An example of such a tool is to have senior leadership articulate desired cultural features that mitigate the risk of misconduct (tool 1). A clear cultural vision is envisaged to guide appropriate behaviour within the financial undertakings. Leaders could adopt a risk-based approach, taking into account the most significant cultural drivers of misconduct risk that may be inherent to their undertaking. The FSB formulates several steps that may be useful for a financial undertaking to consider when identifying its desired cultural features.

  • Strengthen individual responsibility and accountability (tools 8-12).

    The FSB wants to promote accountability and transparency and ensure that individuals clearly understand their responsibilities. This starts with the identification of key responsibilities, including mitigating the risk of misconduct, and how those responsibilities are assigned (tool 8). A short description of the significant functions or a statement of the activities for which each senior manager is responsible could be used to devise a “responsibilities map” showing how key responsibilities are allocated across the firm.

  • Address the rolling bad apples phenomenon (tools 13-19).

    This refers to individuals who engage in misconduct, but are able to obtain subsequent employment elsewhere without disclosing their earlier misconduct to their new employer, and who repeat their misbehaviour. The FSB provides tools to improve the interview process and the onboarding of new employees, and for regular updates to background checks to avoid hiring an individual with a history of misconduct. One of these tools is to communicate conduct expectations early and consistently in the recruitment process (tool 13). The FSB notes that financial undertakings have many opportunities during the recruitment process to address potential employee-conduct issues. Communicating clear, consistent messages about conduct expectations could deter bad apples from pursuing employment at a financial undertaking that emphasises both high integrity and high performance. By contrast, silence about expected employee conduct could signal that the issue is less important to the financial undertaking.

We have highlighted here only three of the nineteen tools that make up the toolkit. To view the complete toolkit, click here.