This article was first published in the February 2016 international edition of Accounting and Business magazine.

Mega-fines dished out by financial services regulators around the world helped drive the total value of penalties to record highs in 2014. But 2015 was set to top these values as more fines were handed out in the wake of the foreign exchange and Libor scandals, while other markets such as the gold fix remained under investigation.

2015 saw six major banks hit with a record £3.7bn in fines from the US Department of Justice for exchange rate manipulation, following on from November 2014’s £2.6bn of fines handed out to five banks by the UK’s Financial Conduct Authority (FCA), and the imposition by the US Commodity Futures Trading Commission (CFTC) of a further $1.475bn (£0.95bn) on the same banks. During 2015 the FCA also handed out a further £866m in fines to banks for forex, Libor, PPI and custody transgressions. This included the £72m fine imposed on Barclays in November following an investigation into a £1.88bn transaction with a number of ultra-high net worth clients. And with the likes of Mark Carney, the Bank of England’s governor, setting out new rules that will widen the pool of individuals who can be tackled over areas such as market abuse and unethical behaviour, the level of fines, and possibly length of prison sentences, could increase yet further in 2016.

A report from Kinetic Partners, part of corporate finance advisers Duff & Phelps, reveals a trend towards higher but fewer fines, in a bid to target key areas as part of a deterrence strategy. Its analysis shows that the number of enforcement actions grew at the US Securities and Exchange Commission (SEC), while the FCA, CFTC and the US Financial Industry Regulation Authority (FINRA) all saw a decline in the number of cases filed. Yet the value of total fines has skyrocketed. Kinetic’s conclusion is that regulators around the world are pursuing a small number of cases aggressively to encourage the rest of the industry to comply.

As Monique Melis, Kinetic’s global head of regulatory consulting, says: ‘Regulators are focused on cases of market integrity and consumer protection, as they face continued pressure from politicians to demonstrate to the public that the industry is moving in the right direction. The large fines imposed in these areas of enforcement act as a valuable tool for deterrence.’

Kinetic’s report warns that new enforcement actions relating to such high-profile scandals will continue to be felt in future years, but that the industry must be wary of the danger of budgeting for such massive fines, ultimately passing the costs on to shareholders and consumers. If this were to happen, the whole point of severe sanctions would be lost.

This is a point made by Standard & Poor’s, the credit rating agency, which has highlighted how the UK’s four largest banks – Lloyds Banking Group, Barclays, HSBC and Royal Bank of Scotland – have shouldered some £42bn in conduct and litigation charges in the five years to 2014. This figure was expected to rise a further £19bn between 2015 and 2016. In its report Carry That Weight, S&P says: ‘We think that conduct and litigation charges are now “a way of life” for the UK banking industry, and that some form of charge seems probable every year for the larger banks and every other year for the smaller institutions.’ 

John Liver, financial services head of regulatory reform at EY, says the fines are part of a wider scene, with regulators around the world endeavouring to make the financial services market safer for investors, and more resilient. ‘Importantly, the regulators want the individual actors to be more responsible,’ he says. ‘This goes through everything – board engagement with the risk agenda, understanding it and challenging it. It is not acceptable from a public policy perspective that the system has needed so much public support and yet has been seen to be not treating customers fairly or to be challenging market integrity. In fairness, I think all the actors in the industry have got that message loud and clear.’

Liver adds that the enforcement regime is designed to change behaviour. For instance, the reasons behind charging fines are for the penalties to be meaningful, for them to grab the headlines and for them to have consequences, both at the corporate and individual level.

‘There was always going to be a shift in the level of penalties if they were to provide a credible deterrence,’ agrees Arun Srivastava, head of Baker & McKenzie’s financial services group. ‘The fines were too small. This caused the FCA to change its fining policy to result in higher fines. But have we reached a stage where we will see fewer jumbo fines? I think it will very much depend on whether the regulators are satisfied they have brought about a change in culture.’

Given that financial institutions and banks have now implemented internal schemes aimed at changing behaviour and identifying market abuse early, Srivastava believes the industry may have reached a high water mark for the level of fines.

‘It is difficult to remove the risk of an individual beating the system and doing something stupid, but where the institutions have gone wrong in the past is that they haven’t been able to demonstrate that they had robust procedures in place,’ he says. ‘But now the institutions have a renewed focus on systems and controls, and the ability to demonstrate that they have been proactive in identifying improper conduct,’ he adds.

Asian fines

The trend towards increasing fines is not just a UK/US thing. According to the Kinetic report, it extends to Asia as well, with Hong Kong’s Securities Futures Commission increasing its » average penalty by 50% between 2013 and 2014. And the Monetary Authority of Singapore, which has launched few enforcement investigations in the past, levied its highest civil penalties in April 2015, fining two individuals £5.6m.

However, the focus of regulators around the world can differ, even if they are demonstrating similar trends. According to Kinetic, such differences are unsurprising. Legislation continues to be less harmonised globally than many would hope, with the consultancy pointing to differences between the US Dodd Frank legislation, the European Markets Infrastructure Regulation (EMIR) and the Markets in Financial Instruments Directive (MiFiD). And even within the European Union, the discretion given to countries in implementing European directives means consistency is hard to achieve.

That is not to say there will not be cooperation between regulators around the world. For instance, investigations into the Libor scandal saw close coordination between regulators in the US, UK, Europe and other regions, while hundreds of requests for assistance have also been sent between the SEC, FCA and SFC.

And it is a trend recognised by the financial services sector itself, with 25% of senior executives in the industry saying that a single set of global regulatory standards was the most important factor in maintaining an effective regulatory system.

Climate of fear

But an emphasis on tough punishment could have a counter-productive effect on financial services. According to a joint PwC/London Business School study, Stand out for the right reasons, a get-tough approach to poor performance in financial services is creating a climate of fear that risks breeding more unethical conduct, not less. And this is, of course, exactly the opposite of what regulators, businesses and the public want. The report goes on to say that threats of fines, bonus clawbacks and even prison will not on their own prevent further mis-selling and market-rigging scandals because anxiety disrupts people’s capacity to make good decisions, which in turn leads to unethical behaviour.

‘We are not suggesting that rules and penalties for bad behaviour should be abandoned, as it’s essential that people know what is acceptable and what isn’t, and criminal behaviour should be punished,’ says Duncan Wardley, PwC’s people and change management director. ‘This is about the sorts of pressures that push ordinary, well-meaning people into behaving less ethically than they would want to.’

Wardley suggests that regulators and financial services leaders can change behaviour within companies by an increasing emphasis on the positive outcomes of good performance instead of focusing on the negative outcomes of the bad conduct.

Whether such sentiments meet with global approval remains to be seen. Certainly, the former US attorney-general Eric Holder has come round to the view that mega-fines work. Holder, who oversaw the biggest post-crisis financial investigations in history, told the Financial Times that prosecutors had been right to level record-setting penalties against institutions rather than trying to make examples of individuals. ‘Given the nature of the penalties that were extracted, given the interactions that we had with people at the banks, with those attorneys who represented the banks, I think cultures have changed,’ he said.

‘We are never going to go back to pre-crisis days,’ says Srivastava. ‘Everyone has to accept we are going to be in a permanently tougher environment with high fines, more aggressive regulators and not so many friendly chats. The question is, where do we recalibrate to? One can hope that there will be less recourse to enforcement or fewer large fines, with the level lower than where we are at the moment, but higher than before.’

Liver agrees: ‘Meaningful enforcement will continue to be an important part of the regulators’ armoury. But the big fines have been for a relatively small number of issues, and I don’t see them being applied in other areas. They will be used in the most egregious cases, but they won’t go away.’ 

Philip Smith, journalist

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Increase in average financial penalty size, 2013–14

  2013 2014 % increase
SFC (HKD) 2.7m 4.0m 50%
SEC (USD) 5.0m 5.5m 10%
FCA (GBP) 9.9m 36.8m 272%
CFTC (USD) 20.7m 48.8m 135%
FINRA (USD) 0.04m 0.1m 146%

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As at May 2015, the CFTC had imposed more than $4.4bn in penalties in 15 actions against banks and brokers to address foreign exchange, Libor and ISDAFIX benchmark abuses.

May 2015 Barclays $400m
Nov 2014 Citibank $310m
  JP Morgan Chase $310m
  RBS $290m
  UBS $290m
  HSBC $275m

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Apr 2015 Deutsche Bank $800m
Jul 2014 Lloyds $105m
May 2014 RP Martin $1.2m
Oct 2013 Rabobank $475m
Sep 2013 ICAP $65m
Feb 2013 RBS $325m
Dec 2012 UBS $700m
Jun 2012 Barclays $200m

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May 2015 Barclays $115m