I've written before about the problems caused to financial services by the narrowness of agency theory - the idea, first put forward by Milton Friedman and others in the 1970s, that the sole purpose of public companies should be to increase shareholder value.
Andrew Bailey also critiqued it in March last year, when he rebooted the FCA's approach to culture and promoted SM&CR, implemented for banks and insurers in 2016 and due to be extended to other regulated firms next year, as a large part of the answer.
There are lots of aspects to the growing debate about agency theory, many of which are covered in Rana Foroohar's FT article quoted below. For now, I want to focus on how it fits (or not) with financial services regulation, including the mantra - frequently heard from both regulators and firms - of "putting customers at the heart of the business". And to start to explore how firms might tackle some of the resulting tension.
Since the crisis, there has been much regulatory obsession with the "tone from the top" of firms, but less clarity about what this really means. In particular, too little attention has been paid to the role of shareholders as a driver of Board and Executive behaviour. Albeit implicitly, SM&CR provides some tools regulators are likely to use to try and rebalance this.
No matter what your view of agency theory, you only need to pause for a moment to recognise the importance of shareholders in shaping a firm's strategy and approach. Targets for growth, profit, ROE etc. are all shaped by shareholder expectations.
Before the crisis, and to some extent since, it was common to hear targets of double digit ROE. In practice, even with QE, the combination of low interest rates, reduced household income, rising capital requirements for banks, and the increasing cost of regulation (including redress for misselling) has made reaching such targets unrealistic. Yet, so long as this shareholder pressure exists, it will affect firms' attitudes and behaviour. The prospect of missing targets, even unrealistic ones, inevitably creates perverse incentives towards poor conduct.
In my experience, firms tend to view regulation and corporate governance through different lenses. So too do regulators. However, there are good arguments for seeing them as all of a piece, and the separate but parallel introduction of SM&CR and the revised UK Corporate Governance Code, provides a good opportunity to create an integrated set of standards for Boards.
SM&CR Conduct Rules will create new individual expectations for Directors around customers, while the Code declares the Board's function is to "promote the long term sustainable success of the company, generate value for shareholders and contribute to wider society." Properly used by regulators and Boards themselves, this could act as a powerful counterpoint to over-aggressive shareholder expectations, not least as a communication tool.
One last thought… From what I’ve seen, too little thought is being given to the extent to which regulators – both PRA and FCA – are likely to change their behaviour as a result of Ringfencing. Given its origin and the rhetoric surrounding it, it’s hard not to imagine there will be a marked difference from now in how both new entities - ringfenced and non-ringfenced – are supervised.
Larry Fink’s most recent annual letter to BlackRock shareholders, which included a demand for more “purpose driven companies”, was a big turning point in the backlash against the shareholder value theory that has been the guiding force for companies for four decades.