By John Gubert
Since I retired from HSBC, one of the most popular buzzwords to appear in management speak is “stakeholders”. There is nothing new with the concept but plenty wrong with the way it is being adopted.
I spent over a decade happily working on a matrix management basis with colleagues in aligned businesses, geographical locations and specialised functions. At times the relationship was difficult to manage. But it was always value added subject to certain criteria. The aligned businesses needed to be shown that collective or collaborative management, especially in areas such as agent selection, common utilities or technology strategy, brought clear financial value at a lower risk to both businesses. The geographical locations needed to be shown that the business brought with it a local P&L that met local business targets, with a low use of capital and a sound operational risk management process. Specialised functions, such as financial institutions (FI) relationship management, IT or HR, depended on teamwork and a common goal.
The major driver for a successful approach to the matrix was credibility, performance and trust.
The current stakeholder process adopted by many firms is not focused on business strategy, which used to be the focus of management in my matrix, but on the day-to-day management process. There obviously has to be the right governance. The business has changed in the last decade and is now much more a risk business than ever before. That militates for closer involvement of all stakeholders. But closer involvement must not descend into micromanagement.
The entire matrix is paranoid now that it may lose control. With the blame culture that is becoming ever more prevalent in banking, this is not surprising. But it is undesirable. The stakeholders, too often, want to be involved in the minutiae of day-to-day management of the business. I put this down to the perverse regulatory environment in which we live and also down to a genuine misunderstanding of the real risks of the business.
What has happened on the regulatory front? Regulators are concerned, quite rightly, that systemically large institutions have the ability to cause chaos in times of crisis. Perversely they also want the large balance sheets of those same institutions to give them comfort that claims will never be made again on the public purse. Regulators need to step back from micro-reactive management. Putting nominees in a supervisory role in institutions will not necessarily reduce risk; it will merely create process and destroy innovation. Regulators need to ensure that bad behaviour is punishable by legal action where there is intentional malpractice and by withdrawal of a person’s authorisation where there is negligence or other misconduct. That will have a far greater impact than an obese rulebook or over-zealous involvement.
And where are the misunderstandings? Quite simply, the biggest risks we have in the day-to-day operations of our business are in client onboarding and process management. The major losses I have seen or heard of, over my long career in the securities business, have resulted from one of two ways: either from a sales-dominated culture leading firms to take on clients they did not understand and then cannot manage through a crisis, or from a blatant failure of procedure. Client onboarding needs to be managed with stakeholders such as Risk, Compliance and, above all, FI Groups where they have overarching credit accountability. Process management has to depend on the location of the process and local management compliance with procedures, which need to be centrally driven but will always require “local flavour”. They need to be audited both by a central business management team and by the bank audit function, with the latter, unfortunately, often being ill equipped to understand the detail of the business process as, in commercial banks, they rarely come with deep securities knowledge.
There have been prime examples of bad practise in the industry. We have seen foreign exchange rate gouging, yield chasing with collateral from stock lending, enhancement of deposit returns through credit degradation, loss of control of assets through rehypothecation or price corruption on portfolio transformations. There remain areas of high risk in the business such as intraday credit, the use of prime brokers as sub agents, lip service to agent due diligence, poor understanding of complex instrument pricing and the opaqueness of the regulatory process. It is these business risks that should take the lion’s share of the attention of the stakeholders. I always asked auditors, when I chaired risk committees, whether there was a risk that we had not covered or not covered in sufficient depth. That same question should be asked of the business heads in our industry by their stakeholders, and retention of their bonuses, as well as the tenure of their jobs, should depend on the integrity of their response! That would be far more effective than the current trend to a bureaucratic control process that divorces management from their true responsibilities.
Some years ago risk managers in a major house decided to place credit limits on their custodians’ settlement exposures. It did not work because you could not tell clients not to deal, because, for example, there was an open position due to failed settlements perhaps caused by that very custodian. Others have toyed with the idea of caps on the assets they are willing to hold in a market. But that is crazy as a client could be barred from a market because another client had accrued a large position. Exposure to agents remains a major risk but it is inherent in the business and inappropriate restrictions on fund access sits badly with fiduciary responsibilities.
Stakeholders should consider the risks in this business and decide if they wish to assume them. I get the impression that the appetite of many has become more fragile. I question, though, if it is due to ignorance about the business or a real assessment of the risks.
When I retired, a regulator asked me what I thought of their supervision process. My honest answer was that I was never asked about the things that kept me awake at night. The scale of my intraday position, the laws of ownership, systemic risks in markets, complex instrument pricing and, above all, the excess leverage, especially pre the Crisis, of the securities industry.
I believe that the current climate is unhealthy and will, in time, lead to several firms exiting the business. If the survivors understand the business better and can manage the matrix more effectively, that will be a good thing. And it would also be healthy to take out some of the excess capacity that is leading all to under-price risk.