Ethics and the Fiduciary Trust

Finance is an industry which relies on two qualities above all else: the financial soundness of its institutions, and the confidence of society in the ethical standards of those working in it, what has been called the Fiduciary Trust.  One reason that the Financial Crisis that we have been experiencing for now over 5 years has gone on for so long, and has proved so difficult to solve, is because the Crisis has severely damaged not just one of these two qualities but both of them.  Too many of our institutions are still financially unsound, and in the eyes of many in the general public, the industry as a whole is morally unsound.

The challenge for the Authorities is that much of the work deemed necessary to repair, restore and strengthen the financial standing and soundness of the industry – all the new regulation, the extra requirements and restrictions – shouts from the roof-tops that the moral standing and soundness of the industry remains deeply suspect.  Every new investigation into past misdeeds merely reinforces in the public mind the view that all bankers are crooks.  Every new set of regulations hemming in this activity or ring-fencing that one adds to the feeling that the industry cannot be trusted, that given even a sliver of a chance, everyone in finance is out to rip the customer off.

This has led to a general mistrust of finance, and is immensely damaging – as for example in the public antipathy to pensions. It is worth reflecting here though that this is part of a wider leitmotif of our times:  there is a general lack of trust in all authority, for example MPs, the press, the police, the church, and so on.  And finance is in one sense no different.  But in another sense, and as I observed earlier, the need for trust in finance makes this especially damaging – more so than if the general public distrusts the press or the political class, say.  And what is certainly true is that politicians who try to put all the blame for the Crisis on the moral bankruptcy of the financial sector (not least to hide their own share of culpability) have stirred up a witch-hunt they now risk not being able to control.

How has this come about? How have we reached the stage where to many, it seems that the overriding ethos in the markets has become “if it is not actually illegal it is OK”?  We seem to have reached a point where there is a complete absence of any moral code in Finance to go alongside the legal code.

This is very different from the world of yesterday. Without claiming that the City of say 40 years ago was in any way “better” than today’s financial services industry, it is the case that the whole of the moral code of the markets of that era could be summed up in just 11 words.

First, “My Word is my Bond” – which really did mean something.  It was the driving principle for every market, not just the Stock Exchange whose proud motto it is.

Second, “Nothing to Excess” – everyone knew there was good money to be made in the City, even in the 1970s, but one tried not to be too obviously or egregiously greedy.  It was never defined what constituted Excess, but I am fairly sure much of the population think some of the City’s remuneration approaches it, at the very least

And finally, “Remember the clients” – for even then, bankers knew that repeat business only came from those who felt they had been fairly treated.

This is not an obviously less comprehensive or effective code than the modern corpus of ethical regulations, which employs hundreds of people at the FSA, thousands of compliance officers in the industry at large and runs to tens of thousands of lines of legal documentation.

Indeed, it is tempting to think that one could replace the whole of modern regulation by the single sentence “Don’t take advantage of your position, don’t put your interests ahead of your clients’, don’t do anything you could not defend if it became public knowledge, and use your common sense.”

But in fact, you couldn’t. Because – and this I think is why we cannot turn the clock back to a more innocent past – because the appeal to “common sense”, and with it the implied appeal to a common set of moral understandings of what is right and what is wrong, is no longer possible.  This is not simply a case of it being unreasonable to expect markets to show a moral tone when society at large seems to operate in more of a moral vacuum, though there is undoubtedly an element of that.  I think it goes beyond this.

One of the features of a global world is that we do not all have the same instinctive understanding of the right way to behave. To take one extremely simple example, a sign outside a barber’s shop saying “Haircut, 17 (pounds, or dollars, or whatever)” would be taken by most Europeans to imply that it will cost 17, by most Americans to imply “with tip that means 20” and by many in the rest of the world as the starting price and “would they do it for 12?”

And so, in the absence of an underlying, unstated and implicit basic common moral code that we can assume everyone will by and large adhere to, we have to try to craft an explicit code through regulations. Even leaving aside the fact that it is extremely difficult to make people good by fiat, the challenge here is that in creating an overtly rules-based culture, we have no longer got an overarching moral ethos the authorities can expect financiers to obey and can rely on to backstop the gaps in the legal code.  So they have to respond to all innovations with yet more rules.

This has two very damaging consequences. Firstly, the authorities are always in reactive mode:  the rules are usually incomplete and always post hoc, and so regulatory lacunae and arbitrage are built into the system.  And if they are there, someone will seek to take advantage of them – indeed in many cases executives are criticised by shareholders and the market if they do not, if they fail to maximise profits.  Chuck Prince’s famous comment in 2007 that “If the music is still playing you’ve got to get up and dance” was deeply cynical, but absolutely the sentiment of the time.

And secondly, the more extensive the legal code, the more the attitude of relying on it as the sole arbiter of right and wrong grows, and the sentiment that, as I mentioned earlier, “If it is not actually illegal it is OK” takes deeper root. After all, so the thinking goes, since the authorities claim the right to regulate everything the industry does or says, then if they are silent on something, and do not actually forbid it, they must be happy to allow it.  And the outsourcing of personal responsibility to the rule-makers continues.

I do not know the answer to this challenge. No-one, from Moses onwards, has been able to make people good simply by commanding it.  But once you pass a certain point, once the use of rules to regulate behaviour reaches a tipping point, you have no option but to try, because you have neutered society’s alternative and more traditional codes of behaviour.

We have in my view reached that point. Society’s distrust of the financial sector is now complete, and deeply damaging not just to the financial industry but to society itself.  We need not just a healthy and financially sound industry but also a respected and trusted one.  There are many within the industry who understand this, and increasingly there are also people prepared to speak out about it.   But I look in vain for signs that the authorities, and still less the political class, have any sense of the urgency of rebuilding the fiduciary trust, or of the damage that their ongoing assault on the industry, through extensive regulation and overtly populist and hostile attacks on past behaviour and current practices is having.

Let me be quite clear. I am not saying this because we want to exonerate the banking system and allow past misdeeds to be overlooked.  Much less is it because the banking system deserves our forgiveness.  Too many in the sector are still – 5 years later – in denial, still believe that nothing much in the culture of finance needs to change.  No, it is because as a nation we need to, in much the same way that when RBS failed, we needed to rescue them, unpleasant, undeserved and expensive though that was.

Later, the question must be how the banking sector responds to this generous act by society, and I hope the response contains both a degree of humility and a commitment to a more ethical industry. But first, we need to ensure our financial system survives.

This essay is based on a speech given at the Cambridge Legal and Regulatory Symposium, September 2012