Governance, compliance and human resources

The Human Resources function doesn’t get a great press in most organisations.

The financial markets - like any markets - are almost entirely people businesses. Transactions are still predominantly created through interactions between individuals:

Regrettably, in many places in the financial markets, the HR function is still seen as a poor substitute for efficient management, crossed with a self-perpetuating job creation/policy generation scheme, rather than an expert support group for business management.

This situation clearly needs to change, and is currently being given a helpful push by policy-makers and regulators in the world’s leading economies.

The last three years has changed the landscape in the financial industry beyond recognition. Effective governance, risk management and compliance arrangements are now the key benchmark for financial services businesses from the regulators’ perspective, supported by clear, meaningful, enterprise-wide analytics and management information.

The structures, controls and processes must be operated by suitably experienced people, incentivised in the right way, supported by - and themselves supporting - a strong culture.

Compliance and HR

In the best organisations, both Compliance and HR are seen as enablers rather than preventers, translating the requirements that circumscribe the organisation into practical and effective arrangements that are clear and simple to operate, and providing expert advice and guidance to business management on navigating safely through the shoals of financial services regulation and employment law.

How does UK financial services regulation impact HR’s role?

There are a number of areas in this environment where the HR and Compliance functions have overlapping or complementary roles in supporting business management. In many firms, this will already be in place:

• The recruitment and appointment of Approved Persons
• Creation, documentation and maintenance of full management and accountability structures, supported by:
  • Comprehensive and consistent job descriptions across the organisation;
  • Comprehensive and consistent appraisal processes and documentation.
• Management of firm-wide training processes and procurement, covering business, skill, and compliance based training;
• Support to executive and board management in identifying, escalating and resolving inappropriate behaviours within the organisation, particularly where these are demonstrated by senior managers and business leaders;
• Management and control of the remuneration processes to avoid skewed risk/reward incentives;
• The administration and documentation of exceptions to key organisation HR policies following proper authorisation processes;
• The increasing number of internal inquiries and externally driven investigations into firms and individuals;
• Issues around the departure of Approved Persons, particularly in circumstances involving Compromise Agreements.

The recruitment and appointment of Approved Persons

In the FSA’s own, relatively recent words, it is disappointing that at the moment many firms fail to conduct adequate due diligence on their candidates or make sensible judgements on their suitability, resulting in delays and more intensive investigations on the part of the regulator.

According to the Financial Times, since FSA made major changes to the relevant processes at the end of 2008, 10% of Approved Person applicants have withdrawn (or had their applications withdrawn by the firm) after the application had been submitted.

The FSA released its new proposals on governance, following the Walker review, in February.  The proposals seriously up the ante on the appointment of staff to significant influence functions, with particular focus on non-executive and independent directors in large organisations, together with those discharging significant management functions.

Whereas traditionally FSA has focused on the financial propriety and reputation of potential appointees, they have now declared a much greater, equal interest in competence, knowledge, experience and expertise. For non-executives, the focus is on whether the appointee has the skills and knowledge to challenge and hold the executive board and management to account? A potentially unwelcome spinoff from this approach will be to limit the number of individuals prepared to put themselves through the new process and reduce the pool of talent available to exercise a steadying influence on the financial markets.

Counterpointing this, it is interesting that HSBC, arguably the British bank that has appeared to navigate the initial crisis with least reputational and financial damage (given Barclays’ Qatari investment), actually had a preponderance of non-executives with little or no banking experience.

Assuming that FSA’s proposals around the Approval process pass (and it appears they are already operating to them) executive recruitment processes within firms need to be watertight. This demands:

• Documented policy and procedural standards for the appointment of new staff at every level, including appropriate approval processes;
• Proper competency-based selection, with gaps in necessary competence identified up front, and planned and agreed (with the candidate) approaches to closing those gaps or making expert support available on a continuous basis to render them acceptable. All of this needs to be thoroughly documented;
• Mandatory taking-up of references, with validation - to the extent possible - of the bona fides of the referees. All of this needs to be thoroughly documented;
• Proper explanation and preparation for senior appointees ahead of the FSA interview process in order to avoid embarrassment.

It is clear that FSA already feels it appropriate to demand evidence of due diligence on candidates, supported by detailed information on those candidates and the processes followed which have resulted in the firm’s determination that the candidate is suitable for the role, including the references taken up.

There is recognition on the regulator’s part that obtaining references can be difficult where a candidate joins from a competitor - particularly where litigation may be involved - but it will be for the firm to demonstrate that, where a reference is refused, they have taken alternative steps to satisfy themselves as to the candidate’s suitability.

Finally, a stick and a carrot are both present, in that FSA has said that good quality processes may remove the need for interviews of candidates from those firms; whereas any pattern of insufficiently rigorous processes and diligence will be taken unapologetically as an indicator about the firm’s general standards of systems and controls and therefore bring much broader regulatory intrusion.

Management and accountability structures - governance

It has long been a requirement under the FSA’s Systems and Controls regulations (SYSC) that it must be transparent to staff and to the regulator precisely who (from Board members to processing staff) is responsible and accountable for what within the organisation, together with the scope and limitations of each person’s authority.

This has, post-crash, become a matter of abiding interest for the FSA.

To achieve this, organisation charts and job descriptions must be comprehensive and up-to-date, with competence requirements and the scope of authority clearly delineated within those job descriptions.

Of course, most organisations change shape like amoebae, with change being the only constant within departments and across divisions. Documenting the change is often an afterthought.  The new environment means that any such change needs to be accompanied by a reconciliation of existing structural documentation to ensure that the current set of documentation accurately reflects the current organisation.

Appraisal processes are not just important for supporting bonus decisions (remember those?). The appraisal process is now the key tool for recording the demonstration of competence and, more importantly, of gaps in competence in order to identify and deliver on training needs - essential to meet the FSA’s requirements on maintaining competence.

Training processes and procurement

HR functions often encompass the training function, and should be using the aggregated results of the appraisal process in discussion with business management and, where relevant, Compliance to source and administer training needs across the organisation.

This encompasses both subject matter and delivery mechanisms, with business and compliance management understanding what is needed, and HR understanding what works (particularly from the perspective of maximising the chance of employee engagement) and where to go to get it.

Much compliance training, in particular, has been a dry and uninspiring recitation of new and changed regulations. HR functions should be working with Compliance to feed back and improve what is being delivered: as staff have to undergo this training, we may as well try and make it both interesting and relevant.

Identifying, escalating and resolving inappropriate behaviours

There is now a great deal of talk about culture, ethics and leadership - coming in particular from the FSA.

This is perhaps the key area for HR to work on with business management and compliance.

The ‘tone from the top’ has to be visible, and frequently communicated, both in terms of the organisation’s expectations as to how staff will conduct themselves, and in terms of behaviour for which there is low or no tolerance.

This is all very well, but everyone is familiar with stories about staff who generate material returns for the organisation, or are particularly senior in the hierarchy, being treated differently when there is a material incident.

That is the fastest way to convince the entire organisation that the firm’s values, culture and expectations are nothing but rhetoric.

Where there is a material incident, HR must be involved at an early stage - not just to provide advice on proposed actions and their employment implications, but to take a view on the essential fairness of actions in the light of precedent and obligation.

Where relevant business management appear to be taking a softer course based on the seniority or profitability of the employee involved, that is a matter that must be escalated by HR - probably in partnership with Compliance - up through the organisation until someone understands the message and appreciates its importance.

Remuneration processes

This is not a point we need to labour, given the FSA’s (and the media’s) grip on the issue, other than to say that the new requirements require new standards of evidence internally.

Principally, where remuneration decisions are being taken based to a large extent on revenues and profitability, the documentation needs to show that remuneration decisions have taken into account formal input from compliance and risk functions.

Exceptions to HR policies/processes

There are occasions when business management will override or defer elements of material HR processes in order to get the business done, get the new employee started, or keep key staff members happy.

Whilst this is not necessarily a problem, it is absolutely necessary to be able to show that a reasoned recommendation has been made, considered and appropriately authorised in advance by more senior management (who thereby accept the responsibility).

Internal inquiries and externally driven investigations

We face a regulator that is increasingly enforcement-driven - a fact that is acknowledged by FSA themselves. For the first time, employees in Board level roles at significant banking institutions have been subject to disciplinary proceedings including material fines and exclusion from the industry, whilst the FSA’s drive against market abuse means that sales staff, traders, analysts and fund managers are increasingly likely to be the subject of internal and external investigations.

This is the most difficult area of interface between senior business management, Compliance and HR, especially when a material issue or allegation first arises but is unproven. The firm finds itself facing double jeopardy in that unduly lenient treatment of such employees during this period can create significant problems with the regulator, whereas anything that can be perceived with hindsight as being unduly harsh can create a significant liability, as well as breakdown of trust, with the employees concerned.

Typically, HR walks the line between the employee and the firm.

HR must be concerned in such cases to advise both on fairness to the employee, and on the employment law consequences of decisions such as suspending an employee pending a proper internal investigation, switching from an inquiry to a formal disciplinary process, or deciding to terminate employment based on a balance of probabilities in the findings.

Clearly, during any pre-disciplinary investigative phase, employees are not subject to the protections of the disciplinary process. This requires a comprehensive understanding between HR and Compliance - particularly about the point at which informal investigation and questioning switches into a formal process, and the safeguards that need immediately to be introduced.

The departure of Approved Persons

The overwhelming majority of employees in Approved Person roles leave their employers and switch jobs on good terms.

Things become very complicated when they do not leave on good terms, either for disciplinary or quasi-disciplinary reasons or because they are joining a competitor and potentially causing commercial damage to the current employer.

Particular questions arise around making qualifications on the FSA Withdrawal form, ranging from whether a qualification could be perceived to be made from pure commercial malice, all the way to whether a qualification should be made but the firm would rather avoid it if possible. Discussions like these must be full and frank, and involve compliance, management and HR.

It also appears that the sanctity of Compromise Agreements is under significant threat from FSA, who may demand to see them…

Conclusion

The maelstrom of change that we are currently dealing with represents a serious opportunity for Compliance and HR teams to reach a new understanding, each deferring to the proper expertise and influencing power of the other. Financial services regulation is having a significant impact on the policies, processes and practices within the purview of the HR function, making them a more significant part of the structure that an organisation uses to demonstrate compliance to the regulator, and a more necessary advisor to senior business management in establishing proper governance.

Reproduced with the kind permission of Powerchex Ltd. First published on 7th September 2010

Nick Gibson, Editor
nick.gibson@chasecooper.com