SYDNEY: 5 April 2013 – “Princes and governments are far more dangerous than other elements within society,” warned Machiavelli. He was wrong as the Independent  Review into Business Practices at Barclays, the latest in a series of reports into the corrosive nature of investment banking, makes abundantly clear.

The probe into the manipulation of benchmark interest rates at Libor ultimately resulted in a £290m million settlement by Barclays with US and British regulatory authorities in June 2012.  In February 2013, Barclays surprised everyone when it revealed that it had set aside £1 billion to cover mis-selling as part of a damages bill for Payment Protection Insurance (PPI) and the cost of compensating small businesses, bringing its overall estimated legal liabilities to £2.6 billion.

Barclay’s behaviour did not just impact on the bank’s shareholders and the public’s trust in the entire British financial system. It hit the exchequer, and ultimately the taxpayer, with lower tax returns.

A controversial tax avoidance unit within the bank, known as the Protium scheme within the Structured Capital Markets (SCM) division, devised a system of minimising tax bills. The Cayman Islands-based vehicle was used by the bank to outsource its problematic portfolio of highly toxic credit markets assets. This scheme served to distort Barclay’s bottom line and therefore facilitated extraordinary profit returns in 2009, despite the financial crisis hitting hard.

This gave the bank a competitive advantage among its peers. Hence, as reported in the Financial Times, the bank’s minuscule £113m corporation tax bill in 2009, a year when it made a record £11.6b in pre-tax profits. In 2012, the exchequer was the beneficiary of just £82 million despite top line profits of £7bn. In essence, the taxpayer substantially lost out because Barclays self-regulated the value of its own debt. In the 11 years to 2011, the Protium scheme generated £9.5bn in revenue for the bank. "Industrial scale tax avoidance" is how it was described by Lord Lawson, the former Conservative chancellor on the parliamentary commission on banking standards. Although the new chief executive of Barclays, Antony Jenkins, committed to shutting down the Protium scheme, what actual consequences were there? Chairman Marcus Agius resigned on a £750,000-a-year pension. Chief executive Bob Diamond resigned with on a severance package of around £2m and is now reported to be considering launching a hedge fund.

The release of the independent review, commissioned in the immediate aftermath of the LIBOR settlements, does not change that reality. The aim of the report is to evaluate the bank's  “values, principles and standards of operation – the historical culture - and to make recommendations for change.” Anthony Salz a leading corporate lawyer in London was tasked to interpret these broad terms of reference. Published this week, the 236 page review references “culture” 424 occasions and not surprisingly gives prominent coverage to the widely reported Protium debacle.

Protium, Salz believes, illustrates how the SCM scheme “damaged Barclays’ reputation in the eyes of its regulators and the market”. It was a complex transaction that the bank “believed complied with the rules”. This “mis-judgment” by Barclay’s management was part of “unusual incentive arrangements” within the bank. Salz concludes rather vaguely “if Barclays is to restore its reputation and rebuild trust, it needs to consider much more thoroughly the reputational impact of businesses and transactions in which it is engaged, such as the activities sanctioned by the SCM. 

Perhaps it is not unusual that a star corporate lawyer turned chair of the BBC board of governors turned investment banker proposes to widen the net of culpability to all and sundry. If everyone is to blame then no one is to blame. If it is no one’s fault, then of course, no one can be held accountable. For instance, the report has a section on "people" yet not one person is identified. The report shrewdly avoids focusing on individual failings. Instead, the bank’s collective “corporate character” is at fault. The “imbalance between high pay (at least for some), high risk, and treatment of customers and other stakeholder interests” developed a specific "culture" based on "the struggle for survival, independent of government, (which) dominated its activities," the report concludes.

Yet it was individuals that financially benefited from this collective culture. The average managing director bonus at Barclays was 350% of base salary in 2011, reducing to 210% in 2012. These “overly generous bonuses” as Salz describes them had no peer equivalent. The bank’s 70 top executives achieved 35 per cent more than peers at other banks in 2010. Salz makes the rather obvious conclusion that "elevated pay levels inevitably distort culture, tending to attract people who measure their personal success principally on compensation."

The importance of culture on framing behaviour has long been recognised. In his analysis on the World Bank, Galit A. Sarfat demonstrated how socialisation conditions employees “through recruitment procedures, training, informal conversations with peers, and rituals that validate the organisational culture. Norm socialization processes inculcate employees with the generally accepted values and expected behaviour in the organization.” Salz puts it more bluntly: “leadership plays an important role in collectivising the unconscious processes." 

This frame of cultural analysis and its focus on leadership, restructuring notions of personal accountability, values and emphasis on trust, is in vogue. The review follows a palpable trend in other international banking reports with its focus on how culture can magnify systematic failings. Here, Salz describes it rather uniquely as 'cultural corruption' while elsewhere, as in Ireland for example, it is referred to as 'group-think.' 

Salz is existential and philosophical in his approach and proposes to reintroduce emotion, of all things, into risk assessment - "Rationalised wishful thinking allows us to detach ourselves from the emotions that would normally signify risks," he notes. Salz attempts to recalibrate the balance between risk and personal ethical responsibility. “These emotions start with anxiety and can escalate to shame and then genuine guilt. In an absence of acknowledging these emotional states, we are in a semi-delusional state of mind (or a corrupt state of mind) in which, rather than admit responsibility, or learn from our mistakes, we create rational logical arguments which explain our actions.”

The report places extraordinary emphasis on how prior culture incentivised and condoned certain conduct. A set of beliefs, attitudes, opinions and norms ultimately decided what types of behaviour was considered acceptable. In Barclays, a particular set of values placed particular significance on informal rules of behaviour which elevated the importance certain behaviour. This “culture” didn’t happen by accident or in a leadership vacuum. It was deliberate and delivered colossal financial gain for the bank and its employees.   

The 34 recommendations of the Salz Review focus on five broad areas - culture, regulatory and tax matters, compensation, leadership and governance and the nature of investment banking itself. However, given that the terms of reference precluded any detailed examination of matters under legal privilege, the review itself and therefore the recommendations do little to advance the critical question of how to regulate culture. As Simon Nixon of the Wall Street Journal cogently put it, the report "is largely comprised of statements of the obvious...Anyone looking for fresh insight into the extraordinary failures that led to the resignation of the bank's chairman, chief executive and chief operating officer will have been disappointed."

The unresolved question is whether there has been an admission of responsibility, guilt or shame within Barclays. Without it, no credible reform is likely, a fact recognised by Salz. The real value of the report will only become clear when the bank demonstrates that cultural norms have changed and that is an empirical question.