Firms' recruitment procedures require change to meet regulators' diversity and suitability requirements

Firms' recruitment policies and procedures require substantial change if they are to meet regulators' new diversity requirements and improve their ability to attract and retain suitable individuals. Firms will also need to recalibrate further their remuneration polices to support the kind of culture and governance standards regulators envision.

"Even when you get the attempts to deal with physical diversity and the obvious 'let's make sure the photo looks like a Benetton ad', firms are often not thinking about cognitive diversity. But it's more than that. I don't think many companies have fully thought through what skill sets they actually need their employees to have, and how they can hire those sorts of people as well," said Christian Hunt, founder of Human Risk, a behavioural science-driven ethics and compliance consultancy.

Focus on fit and proper

Firms' recruitment and remuneration policies continue to attract regulatory scrutiny.

UK regulators recently published a diversity and inclusion discussion paper urging firms to hire from a broader cross-section of society and suggesting ways to measure progress. The Financial Conduct Authority (FCA) wrote to remuneration committee chairs in August saying more work is required to embed diversity and inclusion. It asked for an "explanation of how you have assured yourself that your firm's overall remuneration policies support your firm's purpose, business strategy and values and incentivise the right behaviours; and how your firm's approach to paying variable remuneration will be considered in the continuing context of the pandemic".

"What companies need to do is look at who they're hiring, assess the profile of the people that they're hiring and be concerned about [how new hires will affect] the culture in the in the firm. Culture comes from three things: the behaviours of people; [the] values of the people versus the behaviours of people; and then the reward system. A poor reward system can actually drive bad behaviours," said John Byrne, chief executive at Corlytics, a Dublin-based regulatory intelligence technology company.

In July 2020 the European Banking Authority (EBA) and the European Securities and Markets Authority (ESMA) jointly published a consultation paper of proposed amendments to the 2018 guidelines on the assessment of the suitability of members of the management body and key function holders in banks and investment firms. That included making a board member responsible for anti-money laundering regulations and asking banks to improve gender diversity.

In May, the Bank of Italy finally set out its fit and proper criteria as required by the Capital Requirements Directive IV. Its rules will bar anyone sentenced for money laundering, mafia and terrorism from the position of director at a bank. This regime goes further than others which only contemplate banking and financial crimes.

Central Bank of Ireland

The Central Bank of Ireland recently criticised boards' awareness of fitness and probity obligations, which was evident particularly in making board appointments. In a thematic review it found firms were failing to conduct effective due diligence when recruiting to ensure compliance with fitness and probity standards. "Issues identified included a lack of evidence of qualifications, reference checks and suitability searches," said the CBI in November 2020.

"What [CBI] is really saying is the firms are not doing enough in terms of seeing if people are fit to hold the position or not on. They're doing an awful lot of things that are HR-related, such as how are you recruiting people, and how are you checking them out, how are you screening them, you know, assessing their fitness; how are you assessing their probity?" Byrne said.

Skill sets

The way firms recruit and pay employees, however, are not set up to accommodate for physical or cognitive diversity.

"I see the mission of compliance as influencing human decision-making. You've got a tonne of people in [the compliance] function that are not fit-for-purpose, frankly, and you're not going to be hiring fresh people because you're going to be hiring in the mould of what you had before," Hunt said.

Firms need to reconsider the kinds of skills candidates should possess.

"One of the conclusions I've reached, and this is true pre-pandemic, but it's got worse during the pandemic, is the fact that the skill set banks are hiring for is often not the skill set they actually need. Firms hiring a compliance person, for example, are usually looking for someone that understands the rules. No thought is given to skills like influencing, communication, particularly through the [video communications] format. If they want to be effective, today's compliance officers need to learn to read people through the screen. They need to be able to engage people, to become a performer, to be emotionally intelligent," Hunt said.

It is not just in terms of compliance, however, where firms are failing to hire those who demonstrate the behaviours regulators believe will positively influence culture and purpose.

"One of the big problems of boards that I see [is that] there is arguably too much laziness. That's your classic free rider problem. There are a lot of directors that take on too many directorships and are not really doing a good job of it — it's a demanding role. Taking that job seriously and challenging the executive in the way you're supposed to and really getting involved in strategic decisions is a massive responsibility," said Professor Elizabeth Sheedy a risk governance expert based in the Department of Applied Finance of Macquarie Business School in Australia, on the Human Risk podcast.

Executive remuneration also remains a barrier to attracting and retaining individuals likely to meet regulators' aspirations. Executives bristle against remuneration changes and claim it will prevent them attracting the best and the brightest. Experiments on remuneration structures conducted by Sheedy and her colleagues have found that behaviour is a lot better in employees who opted for a deferred remuneration structure than those who opted for a traditional one. Those who took a deferred structure were given a premium.

"I think we can be reasonably confident that a benefit of deferrals is you're going to get better behaviour. More of the bad risk-taking and non-compliance will get picked up. That was expected. What surprised us was the productivity. It turned out when we looked at who chose to go into the deferred structure pool and who chose to go for the case of immediate payment, the most productive ones were happy with the deferral," Sheedy said.

Retaining talent

Recruiting and retaining experienced compliance and senior managers — particularly money laundering reporting officers (MLROs) — has been a barrier to entry for crypo asset firms seeking FCA registration under the Money Laundering Regulations (MLR 2017).

A recently published FCA supervisory notice on Dolfin Financial notes inadequate human resources as a reason to restrict its authorised activities.

"Dolfin has been unable to successfully identify, recruit and retain suitable individuals in key roles. In particular, in December 2020 Dolfin's replacement chief executive officer (CEO) resigned at short notice and Dolfin dismissed its newly appointed money laundering reporting officer (MLRO) such that, at the present time, it does not have a permanent CEO or MLRO in place," the FCA wrote.

Financial services' culture itself is a barrier to attracting and retaining individuals representing good values who bring cognitive diversity to a firm. Firms tend to crush freethinkers, Hunt said.

"Firms haven't really got the constructs in place for people to be able to criticise. Let's imagine they've got recruitment right and were bringing in these fresh-thinking, open, new ideas people. They will get crushed by the organisation. Even if firms open the doors to those people, they would leave. When I look at the recruitment question, I think about it as if I'm buying some new seeds for my garden, but actually, is the soil the right kind of soil for those plants, or are they just going to go bad? My contention would be in most cases, particularly in financial services, [that] there is a strong sense that the soil is not conducive to those new seeds," he said.

"It's no exaggeration to say large corporates, particularly financial services, are frequently massive destroyers of human capital. I don't I mean they're killing people, but I think they're inadvertently destroying the true potential value of the people they're hiring," Hunt said.

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