We are very grateful to those who have taken the time to reflect on, and respond to, our brief description of the work we are doing at the Balliol Interdisciplinary Institute in Oxford.

The financial services industry provides a wide range of essential services to any modern economy. In the UK, particularly, we are dependent on it for our continued economic well-being. The firms and individuals within the industry occupy a privileged position, from which it is possible for them to extract significant rents. Their actions affect fundamentally the well-being of their fellow citizens, and – as we are now observing in Europe – can bring whole economic systems to the brink of collapse. It is not unreasonable, we believe, for Society to expect honest, professional and (at least some) pro-social behaviour from them in return.

The difficulty we all face is that it is very difficult to enforce such behaviour. The legal system struggles, in the face of well-resourced and persistent lobbying (as well as huge resources from which to pay legal fees), to implement and enforce fiduciary duties and duties of care. Such penalties as it does succeed in imposing are often seen by the industry as a ‘cost of doing business’, rather than a signal that underlying behaviour should change. Regulatory agencies are typically less well-resourced than the firms they seek to regulate. The innovation and dynamism of the industry means that it readily adapts to avoiding any new rules that may be introduced. And so on.

Our hope in pursuing ‘the Oxford Project’ is that a way can be found to persuade those who work in the industry that more professional and pro-social behaviour will lead to greater approbation from their fellow-citizens, that they will value this approbation, and that in the long run it will lead to a more sustainable world for us all. We are encouraged in this hope by the writings of Adam Smith in his ‘Theory of Moral Sentiments’. And we take comfort from the fact that other industries have developed professional standards, and that they succeed in enforcing these standards.

Deen Sanders, while applauding our objectives, fears that modern day political realities will act against such a possibility. He argues that the self-regulatory arrangements that emerged for doctors, accountants and lawyers were a product of the particular conditions of the time, and that successful implementation reflected a pressing political necessity to impose such discipline. Governments today, he argues, will not allow the financial services industry the room to develop such self-regulation, even if they wished to do this. The political imperative today is for certainty, for strict rules and administrative arrangements which enforce those rules, and this is antithetical to the flexibility required to achieve a negotiated accommodation with the industry.

This does appear to be true, but a desire by governments to act in this way may be unrealistic and may be damaging in this industry. In the UK we have systematically dismantled a quite well-developed self-regulatory apparatus over the last 40 years and replaced it with a large and complex bureaucracy which is supposed to implement a rapidly growing number of rules. Europe has progressed even further down this path. Basel I and II attempted something similar, with disastrous consequences. In the US, the SEC and others have always followed a rules-based approach with huge compliance costs. None have worked very well, with hindsight, and in some cases the unintended consequences have exacerbated the problem. Although many of the regulatory reforms now being implemented in the UK and US (for example Dodd-Frank and the recommendations of the Vickers Commission) are potentially helpful, they are likely to be watered down by persistent lobbying. And in any case they only tackle a subset of the myriad problems that the industry faces. All of this means we see our work as helpful, and hope that it may persuade governments and the industry to look again at the possibility of effecting behavioural change as a collaborative venture.

Melvin Dubnick reminds us, however, of the dangers of seeking simplistic solutions to complex problems, and of getting dragged down by partisanship and ideologies. He emphasises Smith’s belief that a “Moral Being is an Accountable Being”, but recognises the difficulties Smith highlighted in extending trust beyond a local community. He is right that solutions need to be built on a deep understanding of the micro-foundations of financial markets, enabling trusting and accountable relationships to be rebuilt.

We emphasised in the article that started this series the key role that trust plays in this industry, and how one of the major problems we face is that that trust has been eroded. Without trust, all kinds of helpful relationships break down. This is an issue that Seamus Miller elaborates, relating the concept of trust to ethical or moral virtue. Integrity systems are the primary vehicle which can be used to ensure that ‘ethico-professional obligations’ are discharged. Such systems embrace legal and regulatory arrangements, but have a wider and dynamic compass including both reactive and preventative elements. He emphasises the triangle of reputation, financial self-interest and virtue. If – as perhaps has driven some other self-regulatory systems – enhanced reputation can lead to greater personal or institutional gain, then the elements can reinforce each other. A well-designed integrity system might contribute to this goal. But, he emphasises, the ‘devil is in the detail’, which reinforces the need for serious endeavour in the financial services case.

One of the problems is the sheer and growing complexity and scope of the financial services markets. George Gilligan explores how the ‘sociologies of trust’ have become extenuated over time and across international borders, in a way that ‘has the capacity to go spectacularly wrong’. If even JP Morgan can lose in excess of $2 billion through defective governance (especially in an environment where focus on such matters is intense), he argues, then some additional ‘circuit breakers’ are needed to reduce the probability of such events. Whistle-blowers provide a valuable function, as they did in uncovering Enron, Worldcom and the practices that led to Sarbanes Oxley.

We have explored whether John Coffee’s ideas about how to restore the ‘Gatekeeper’ function (played by auditors, lawyers, ratings agencies and financial analysts) can help develop the integrity of the industry. It is possible that if such professionals cared more about their reputations then they might resist the demands of financial sector managers that they connive in (or at least do not expose) unethical behaviour more effectively. Andrew Lumsden debates whether this is a function that corporate lawyers can be expected to play, given the commercial realities of modern-day practice. He sees the role of lawyers as guardians rather than gatekeepers, with their primary responsibility being to their clients, and argues that they do not, and cannot, ‘have imposed on them duties to the wider market beyond their general ethical duties’. However, he does accept that there ‘is a place for ethics to help the lawyer help our client company, its executives and directors act as a good agents’. Hopefully this can be developed, although we agree with his remarks that the answer to our question is ‘not as simple as better rules’.

Joan Loughrey highlights the tension between professionalism as a method of promoting ethical behaviour and its use as a method of supporting ‘anti-competitive self-interested cliques, concerned to protect their market position and promote their status’. Lawyers often face difficult choices between their duties to clients and their duties as officers of the judicial system. Reputation for most lawyers is based on ‘unswerving commitment to client interests’, which leaves little room for it to fulfil wider ethical or pro-social objectives. Codes of ethics stand little chance when pitted against the commercial interest of a professional, and those of his or her client, especially when that professional is subject to the pressures of a large bureaucracy or a competitive market. In the end, Loughrey argues, a strong regulator is needed to fill such a void. But we do not believe that it is sufficient.

An encouraging perspective about the valuable facilitating role regulators can play is provided in the two pieces provided by Steve Mark and Tahlia Gordon from the New South Wales Legal Services Commission (LSC). Mark and Gordon describe how their regulatory system has evolved to ‘entrench professionalism, integrity and ethics’ and thus ‘allow profit and ethics to peacefully co-exist’. The tension between commercial pressures and ‘traditional professional obligations’ is once again highlighted, but can be combatted, they argue, by an appropriately designed integrity system. LSC requires firms to establish and maintain an ‘ethical infrastructure’, which it audits but permits the firms to design themselves. This has been a proven success, with impressive falls in the numbers of complaints.

Shann Turnbull advances network governance – of the type employed successfully by John Lewis in the UK and Mondragon in Spain – as a solution worthy of study for financial services. Network governance, he argues, can ‘share power’ with stakeholders for mutual benefits, requiring Compliance, Ethics, Deterrence, Accountability and Risk (CEDAR) to become subsumed into the need ‘for the firm to operate effectively’. Properly implemented, this can reduce the need for the ‘costs and intrusiveness of external regulators’, and regulators can then be evaluated mainly on how far they enable such desirable outcomes to emerge.

A barrier to wide acceptance of the need for behavioural change is the ‘groupthink’ described by Justin O’Brien. He highlights just how difficult it is to change the ‘established wisdom’, and how misguided ideas can become not only embedded but ‘almost impervious to challenge’. Even well-regarded experts (such as Raghuram Rajan) can feel like ‘an early Christian who had wandered into a convention of half-starved lions’ if they dare to question the ruling ethos. Even when exhaustive investigation has been carried out – for example of the RBS failure, by the FSA in the UK – there seems to be little that can be done to hold anyone accountable.

O’Brien emphasises the need, within the CEDAR framework, to design ‘systems of oversight that embed integrity into an organizational design framework that links compliance and risk management’, perhaps in a way similar to that that has been achieved at LSC. Guaranteeing accountability requires disputes over interpretation to be resolved in a way which is ‘proportionate, targeted, and…. conducive to the building of warranted trust’.

In summary, our over-arching objective in the ‘Oxford Project’ is to find a method whereby those who are in positions of authority in the financial services industry take proper responsibility for their actions, and be held accountable, especially when these actions adversely affect the interests of those unable to protect themselves, or of society as a whole. We do not believe that this can be achieved by legal or regulatory actions alone, and hence that fundamental behavioural change is needed. Achieving this will require the industry to accept that this is the only way to rebuild trust, and that this in turn is essential for the long-term sustainability of the financial system. This acceptance cannot be imposed from outside, it has to emerge from the ethical and moral standards of the industry itself.

This article was co-authored by David Vines, Fellow of Balliol College and Professor of Economics at the University of Oxford.