Thank you for the opportunity to speak to you today. I will discuss why the culture of the financial industry is important to the New York Fed, the nature of the problem we are trying to solve, and some of our various initiatives in this area. Please note that my comments today are my own and do not necessarily represent the views of the Federal Reserve Bank of New York or the Federal Reserve System.1
Why Organizational Culture Matters
My perspective on culture has been shaped by my experience at the New York Fed. I currently serve as Deputy General Counsel, but have had the opportunity to work in other non-legal roles over time as well. The New York Fed is an interesting place to work, because we wear a number of different hats. Among other things, we implement monetary policy for the Federal Open Market Committee; we supervise financial institutions as part of the broader Federal Reserve System; and we run a major wholesale payments system. In all of these missions, we need to work on and through the financial system to promote the well-being of the real economy. So it matters greatly to us that the financial system is operating in a way that is safe, fair and transparent, and that serves to intermediate effectively between borrowers and savers to the benefit of all, not just a narrow few.
Unfortunately, we have not always seen that. I started at the Fed in 2005, in the years before the financial crisis. Since that time, we have seen numerous misconduct scandals plague the financial markets in which we operate and upon which we rely. In 2013, misconduct in foreign exchange markets, following closely on the heels of similar misbehavior in reference rate markets, moved our former President, Bill Dudley, to remark upon the “deep-seated cultural and ethical failures at many large financial institutions.”2 He set us upon a work program to address financial institution culture. This emphasis has continued and evolved under our current President, John Williams. And, it has been taken up by many other authorities around the world.
Misconduct by financial institutions can cause out-sized damage. The most important harm of misconduct is on the consumers, counterparties or competitors directly affected, but the ripple effects can extend far beyond. Misconduct can affect the stability of the firms that engage in it. There is the immediate, pecuniary effect of sanctions on the firm’s balance sheet but, just as importantly, there is the damage to an individual firm’s reputation—a loss of trust by consumers, investors, regulators, and the general public.3
Beyond the individual firm, there is a broader cost to the markets themselves if the public loses confidence in their fundamental fairness. We are seeing right now an enormous and global public and private effort to move off of the use of LIBOR as a reference rate. This costly effort resulted, in part, from exploitation of flaws in the design of that crucial rate by unethical traders for their own gain. More broadly, when a scandal of this dimension happens, it calls into question whether the financial system is doing the job the public expects. The resulting lack of trust can impede the ability of the financial system to perform its intermediation function, and this in turn affects the well-being of the real economy. For example, turning back to reference rates—they affect almost everyone, whether you need credit to buy a house or a car. When those rates are manipulated, it has an effect outside of the financial markets themselves.
The Nature of the Culture Problem
I think this recognition—that misconduct always has a tail that hits the real economy—has led to the New York Fed working to improve financial institution culture. That said, I think people also have recognized that this is a type of problem that differs from some others that we tackle at the central bank. Two differences are worth discussing.
First, and very importantly, organizational culture is an issue that the institutions themselves need to solve. Legislators and regulators set the rules for financial firms to follow. These set the legal boundaries of behavior. Regulators and enforcement agencies can, should, and do penalize firms when they cross those boundaries, as we have seen time and again over the past several decades, including in the foreign exchange and reference rate contexts. But regulators are not in a position to prescribe one model of organizational culture that will lead firms to avoid crossing these legal boundaries in the first place. That said, I will also note that authorities in other countries have used regulation innovatively to improve conduct standards, short of prescribing a model culture. I understand, for example, that the Senior Managers and Certification Regime here in the United Kingdom combines enforceable conduct rules with enhanced vetting and accountability requirements for directors and senior officers.
Practically speaking, though, there will always be a need for individuals to exercise ethical judgment when interpreting the rules that apply to them, regardless of how detailed the regulation is which applies to a particular market. It is an organization’s and an industry’s culture which sets the norms that guide that judgment, and that is where firms and the industry at large need to step up. Jay Clayton, the Chair of the U.S. Securities and Exchange Commission called this “filling in the gaps” in a visit to the Fed last year. He explained that even if the law permits a range of actions, that range is not the end of the road for ethical decision-making. Some choices, even if possibly permissible, may be wrong, and may be more likely to get you and your firm in front of a governmental authority—and not in a good way. I am a member of the legal profession, and a proud one, but the law only has so much imagination—it cannot cater for every possible situation that an individual working in financial services might find themselves in. There is a need to fill in the gaps between the outer boundary of what is allowed and what is wise from a firm, system, and ethical perspective.
Where a decision about what to do or not do can cause significant harm, those on the front lines need a touchstone to guide their choices.4 These gaps are not a failure of regulation. They are a natural consequence of the complexity of many financial services markets, which are international, multi-faceted and constantly evolving. Even for markets that are structurally less complex, the behavioral norms that underpin them can be complex because (at least until the robots take over) it is ultimately imperfect human beings who deliver financial services. That can be a strength when ethical judgment is exercised responsibly, and a weakness when not.
It is that complexity that is the second aspect of why culture is such tricky terrain. At this conference last year, my colleague, Kevin Stiroh, the head of our Supervision Group, explained that culture reform is a "complex" issue—meaning it is marked by the interconnectedness of a large number of factors, constant evolution, feedback loops, “unknown unknowns,” and unpredictable outcomes.5 But you do not throw up your hands because culture is somehow unknowable and squishy, or because people will always be people, and hard to understand and control. That is not the approach that we take to other important problems, and it would be odd if it was adopted here. You need be focused, determined and persistent in order to wrestle the problem to the ground. But with a complex problem, there may not be one linear path to resolution. Instead, you may need to work several margins at once, embracing a number of approaches and tools, and you must be prepared for your strategy to evolve over time. Diverse perspectives, professional training, and life experience are also critical to challenging assumptions and pointing out uncomfortable truths.
New York Fed’s Culture Initiative
These two aspects of the organizational culture issue—that it is not an area where the official sector can simply dictate everything, and that it is, by nature, a “complex” problem—have informed the approach that the New York Fed has taken to it. At the New York Fed, we believe that the official sector has a vital role to play in helping industry to achieve positive change via the raising of behavioral standards. Our President, John Williams, describes this role using three principles—“connect,” “convene,” and “catalyze.”6 Connecting people with the latest data and research gives them the insights and tools they need to make change. “Convening” means bringing together stakeholders to share ideas, perspectives, and approaches. “Catalyzing” is about using the New York Fed’s unique position to create change.
I’ll start by describing our efforts to “convene” and “connect.” The New York Fed has hosted five major culture conferences7 which proved to be valuable fora to exchange ideas, challenges and approaches. We first focused on recognizing that the industry has a culture problem, exploring drivers and outcomes of that problem, followed by a workshop in which representatives of the major firms provided an update on progress and challenges in different elements of culture change—performance management, incentives, accountability frameworks, and leadership. Over the years, we have increased the diversity of voices that are represented—because a complex problem needs complex solutions. Philosophers, economists, psychologists, industry leaders, government officials and many others have contributed valuable perspectives to the conversation.
In addition, we regularly host a Supervisors Roundtable for Governance Effectiveness. This is a group of around 20 supervisory agencies from 15 jurisdictions around the world who share emerging and evolving practices for supervisors to use in the assessment of culture and behavior at firms. We are always keen to engage with and learn from our international counterparts, and we watch with interest the various initiatives that are in train such the FCA’s Culture Sprints, which aim to empower mid-level managers to find innovative solutions for culture transformation.8
One of our newer initiatives, that we are quite excited by, is the Education and Industry Forum on Financial Services Culture. This forum grew out of meetings that we convened with business schools and industry leaders to talk about how the business schools could educate the ethical judgment of future bankers. The aim of the “EIF,” as it’s known among my colleagues, is to provide regular opportunities for senior representatives from business schools and financial institutions to identify challenges with regard to culture and conduct, and identify possible areas of collaboration to address them.
We are currently working on a series of case studies of ethical dilemmas faced by junior employees, which would become an integrated part of business school curricula, undergraduate economics courses, recruiting, and employee training. The goal is for these case studies to help to raise awareness of, and hone, ethical judgment in a practical context, working collaboratively with some of the key communities (business schools and employers) that individuals starting out in the financial sector are part of. Our aim is to reach the next generation of leaders in finance.
Filling in the Gaps
Finally, we have been heavily involved in the last several years in promoting the development of industry best practices and codes. The point here is to “fill in the gaps”—to provide touchstones around which individuals at firms can orient their behavior when there is not a specific law telling you to stop or to go, but when there is some market integrity interest potentially at stake. The goal is to convene industry in such a way that they can raise the bar for their own behavior, both individually and organizationally.
Our efforts have focused particularly on those markets that we operate in as a central bank. For example, we sponsor a Treasury Market Practices Group9, comprised of a diverse set of participants in the U.S. Treasury market. Over time, the TMPG has articulated recommendations on a variety of matters, such as how to manage large positions with care, and how to handle confidential information appropriately. This group has remained active and engaged over time, continuing to make sure they are articulating appropriate standards of behavior in various corners of the market.
Working closely with our international counterparts, we have also been heavily involved with the development and launch of the FX Global Code. This was a significant effort set in motion by central bank governors around the world in the wake of the foreign exchange rate manipulation scandals. Facilitated and guided by central bank staff, the Code represented a cooperative effort by participants in foreign exchange markets around the world to articulate and raise standards of behavior. It represents a single global standard of good practice in this market that is crucial to the real economy, and has been endorsed by the foreign exchange committees in 17 jurisdictions across the world.
Importantly, from my perspective as a lawyer in the United States, these practice codes are not law; they have not been set as a minimum standard of behavior using governmental authority. This is a feature and not a bug. I fully believe in the power and importance of law, regulation and robust enforcement; but these practice codes represent another tool in the toolkit. They are an opportunity for market participants to articulate and embrace better standards of behavior for themselves. They can also provide an anchor for compliance and risk officers who can play a vital role in raising conduct standards, and a benchmark for testing whether those standards are being achieved.
Those firms and market participants that are serious about seeking to reduce misconduct risk can face a coordination problem, as short-term competitive pressures can make it difficult for individual institutions to work together to make long-term investments in cultural capital if other firms are not also making the same investments. Such coordination failures can prevent private actors from achieving a common objective, even if it is in their collective best interest—and again, if they are actually committed to change.10 Our facilitation of practice code efforts is a mechanism toward overcoming that coordination problem. While the realization of that opportunity depends upon the will of market participants to engage and implement change, the official sector can play a role in catalyzing that change.
To conclude, I would like to reiterate a message from John Williams, the current President of the New York Fed. In a recent speech, he stated that while the journey toward reforming culture in the financial services industry is a long one, we are optimistic that we can and we will make progress.11 With that in mind, I look forward to further innovation, adaptation and iteration of the various tools that we have to tackle this very complex issue.