In the years since the financial crisis, the UK’s largest banks have experienced successive misconduct problems and Barclays has been no exception. These scandals have included manipulating the global benchmark interbank exchange rate LIBOR, mis-selling protection insurance (PPI) and relaxing investigatory requirements, which safeguard against fraud and money laundering for ultra=high-net-worth clients, resulting in multiple fines from the UK and US regulators.
The offences, combined with revelations about the bank’s tax avoidance strategy, pointed to a fundamental cultural problem that would need to be addressed throughout this complex organisation and led with unrelenting commitment from the board and senior executives.
Barclays’ reliance on its investment banking division, which after the crisis was required to hold much higher levels of capital by regulators, was also strategically challenging. This increase in capital intensity resulted in an inability to fully cover its cost of capital, impairing its capital adequacy ratio, as the loss-making unit carried £79 billion in legacy risk-weighted assets (RWA).
Hermes EOS has had an ongoing engagement with the bank, seeking to ensure that it is run in the interests of long-term investors. We identified several key issues that the bank needed to resolve: chair and CEO succession, board composition, employee conduct, alignment of pay, performance and portfolio strategy, with a particular focus on the restructuring necessary to ensure the investment banking division is able to achieve economic returns.
What we did
While we have been engaging with Barclays since 2008, we only began to make tangible progress in 2012 when several incumbent board members stepped down in the wake of the LIBOR scandal. The bank’s chair and the then-CEO aimed to reform the culture of its workforce and took senior executives on an away-day designed to kick-start this change and address the underperforming parts of the bank. However, it took the bank’s senior team some time to execute the plan devised in 2012.
In early 2014, we raised concerns about the profitability of the investment banking division, which did not justify its capital requirements. Furthermore, we raised concerns about the apparent anomaly of increasing bonuses for employees in the investment bank despite its falling performance in 2013. Barclays defended these payments as necessary in the short term to ensure the retention of key employees and allow it time to initiate plans to restructure the division. As a result, we recommended that investors support the remuneration vote by exception.
In May 2014, recognising the concerns of investors, Barclays presented a clear plan for reforming its investment bank, highlighting its competitive advantages and vowing to reduce the less commercially viable elements. However, the departure of the retail banking-focused CEO in mid-2015 raised fresh concerns about these plans. The bank’s senior management team assured us that progress on restructuring and culture change would not be impeded by the change in personnel – instead it would be accelerated.
Barclays has made substantial changes in all of the areas we engaged on, particularly its culture. It has targeted positive behaviours, including three-year citizenship plans, and has focused on issues such as making financial products more accessible to a wider range of people and sustainable investment. It has also made efforts to improve the diversity of its workforce, which has been shown to improve performance across the business world, through mentoring, thought leadership programmes and strategic headhunting.
Wider events at the bank have suggested that its governance has changed for the better. In particular, the appointment of a new CEO in late 2015 was relatively efficient, following the departure of his predecessor. This left its chair in an executive role for a limited time only, a situation which could have become problematic if it had continued for longer.
In an effort to lower the capital intensity of its investment bank, Barclays pledged to reduce the division’s RWA to no more than 30% of the entire lender’s total and successfully reduced this by £37 billion, or almost 47%, between 2012 and 2014. It has focused on its debt and equities businesses, where it has existing competitive advantages, while significantly reducing headcount in other areas and improving its advisory franchise, which does not demand a lot of capital. The bank committed to further streamlining its operations in its 2015 full-year results, announcing that it would sell its African business and expedite the disposal of non-core assets.
The bank’s improving capital coverage was demonstrated when it passed the Bank of England’s stress-tests in 2014 and 2015. In addition, Barclays’ retail and commercial banking arms now contribute as much revenue as the investment bank, helping to smooth earnings volatility and strengthening the company’s ability to service its debts. However, its profits fell in 2015, due largely to the ongoing costs of addressing PPI mis-selling.
Notwithstanding the positive progress, we believe that Barclays still has much to do. Its cultural transformation continues as it deals with the conduct issues of its past and the cost/income ratio within its investment bank is still much higher than that of its peers. However, the bank’s senior management says it is motivated to rectify these matters. This, together with its commitment to addressing employee conduct, corporate governance and other ESG concerns makes it more likely to be sustainable as a business and serve the needs of its customers, support growth in the real economy, as well as provide a long-term investment returns.