Hard- and soft law in the years after the credit crunch : an exploratory study about the perceived interaction between hard- and soft law by employees in the banking industry

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Master Thesis

Hard- and soft law in the years after the credit crunch

An exploratory study about the perceived interaction between

hard- and soft law by employees in the banking industry

Student: H. Kortes Student number: 6257283 Date of submission: 2 March 2015

Version: Final

Study: MSc. in Business Studies - Strategy Track Institution: Amsterdam Business School, UvA

First supervisor: dr. F.J. de Graaf Second supervisor: dr. M.L. van der Veen

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The years after the credit crunch are dominated by the introduction of new law in the financial sector, such as the EMIR regulation per 2012 and the introduction of the banking oath in 2015. This requires financial institutions to adopt and integrate new regulations, called hard law, in their organizations whereby they also need to consider their own business values and rules, called soft law.

This thesis aims to find an answer or direction towards the central research question:

“How do bank employees perceive the interaction between hard- and soft law?”

Qualitative research has been applied whereby an exploratory case study has been performed at a Dutch bank. Interviews with employees, various annual reports and branch specific publications are used as input to answer the research question.

This thesis concludes that hard- and soft law are perceived as complimentary and/or parallel types of law. As such soft law can act as an extension of hard law: by serving as practical translation of hard law into daily practices, by serving as internal rules to do more than strictly obliged by hard law and by serving as overarching law to overcome differences in interpretation of hard law in an international setting.

Employees recognize a difference between awareness and understanding of hard- and soft law in the way they are communicated. In order to properly understand the expectations of law –including the potential link between hard- and soft law– dialogue sessions between managers and employees, exemplary conduct by (senior) managers and if possible embedding law in technical system solutions are considered as methods to embed the expected internalization and compliance with law in the organization.

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Chapter 1 - Introduction

1.1 The sky has reached the limit

The year 2008 has brought major troubles in the financial markets. The collapse of Lehman Brothers, a huge American investment bank, introduced an episode in what we now call the credit crisis or credit crunch (Sieczka et al., 2011).

One of the major reasons can be found in the process of securitization, whereby mortgages are refinanced by composing mortgage packages which are then sold to other banks (Ashcraft and Schuermann, 2008). Such transactions are done bilaterally between banks, without involvement of an exchange, using Over-The-Counter (OTC) derivatives whereby the value of the product is depending on an underlying asset. As result of the product complexity and the fact that banks refinanced existing packages into new packages, the actual value of the packages became difficult to be determined. Moreover, banks failed to perform a thorough risk assessment of such transactions (Graafland and Van de Ven, 2011). When the value of the mortgages was no longer aligned with the actual decreased property value, followed by mortgage owners that were not able to pay their debt, banks had to depreciate the value of their loans (Huizinga and Laeven, 2012). Because the loans were refinanced via less transparent securitization constructions to other banks, many banks were impacted (Agarwal et al., 2012). As a result distrust between banks arose: not only the property market came to a halt, also the interbank lending market stagnated (Orlowski, 2012).

The central regulators had only limited grip on financial markets as they trusted on the assumptions of the neoclassical model based on ‘perfect information, perfect capital markets, and perfect competition’ (De Graaf and Williams, 2009) whereby a liberal view by deregulation or ‘regulation by markets’ was promoted instead of pre-defined and regulated structures. Furthermore, as result of the 'Basel I' regulations banks were allowed to reduce bank minimum reserves and many banks had insufficient buffers in place to cater for value decreases (Feinman, 1993; Cabral, 2013). Lower minimum reserves worked well during the years of economic growth but appeared to be insufficient during the credit crisis.

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In contrast to the existing regulations towards reporting of exchange traded transactions there was no reporting obligation for OTC traded derivatives (Morgan, 2008) as banks and their counterparties were supposed to be trusted as professionals that would keep risks within acceptable boundaries (De Graaf and Williams, 2009). As a result regulators were not able to identify unacceptable risks and hence they were not able to intervene on the market: the financial crisis was a fact and could not be prevented. Self-regulation has failed.

1.2 Law as a regulatory answer

Today regulators demand higher capital and liquidity levels of financial institutions, which will help to buffer for unexpected or uncovered risks (Cabral, 2013). Similarly the temporary European Financial Stability Facility (EFSF), which is now officially merged into the European Stability Mechanism (ESM), is meant as a financial buffer and as a statement towards the financial markets to show 'safety and stability' (Winkler, 2011).

Although such mechanisms could potentially help to handle new financial disruptions it does not prevent them nor does it provide instruments to identify risks. For that reason new regulations have been introduced that should resolve the gap of identifying unacceptable risks, by forcing banks to report all their OTC derivative transactions and periodically reconciling trade portfolios between counterparties. Each region has defined its own legislation towards the OTC derivatives reporting obligation. The United States concluded on the Dodd-Frank Act which provides a set of mandatory obligations for the financial sector. Europe came up with European Market Infrastructure Regulation (EMIR) as an answer to the recent credit crunch in order to get more control on the OTC derivatives market (McBride, 2010; Sharma, 2011).

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One could argue that introducing regulatory reporting obligations will not resolve nor prevent the core failures that caused the credit crunch (Cabral, 2013): it will only result in making the existence of the traded products and their pricing –hence the theoretical risks– visible to regulators however it will not necessarily change the mind-set or incentives of bank employees (Quirk, 2012). The UK Financial Services Authority (FSA) therefor made a clear statement towards the role of supervisors: their focus should be on business models and strategies rather than systems and processes (Turner, 2009). Similarly the Kay Review argues that regulation should focus on the banks' structure and incentives, aiming for long-term value instead of a focus on 'control of behaviour' (Kay, 2012). Long-term value also implies that bank employees should get a good understanding of what sustainable relationships and product offering means. Additional regulations do not result in a change of moral consciousness as long as bank employees do not change their attitude towards a wider group of long-term stakeholders (Graafland and Van de Ven, 2011). A situation in which employees take care of the interests of their stakeholders –not limited to clients and trading partners but also including the society the company operates in– cannot be achieved by a moral change triggered by individuals only. In order to embed long-term values across the organization it is required that stakeholders interests are taken into account when shaping the governance structure of companies (De Graaf and Herkströter, 2007). The credit crunch has impacted the whole society, also impacting people that might not be recognized as key stakeholder by companies in the past. Companies have now started to take those interests into account as well and pay additional attention to corporate codes of conduct.

1.3 Perceived interaction hard- and soft law

The public and governmental demand to prevent for new crises has resulted in the introduction of various new laws such as EMIR and Dodd-Frank as a regulatory answer to the credit crunch. How does this regulatory law (the so called hard law) interact with already existing organizational rules and values (the so called soft law) and the continuous evolvement of both types of law? Previous research indicated that hard law can result in soft law and vice versa and they can function in parallel, as complementary but also as antagonist (Shaffer and Pollack, 2010a). It is however unknown how bank employees perceive the interaction between hard- and soft law.

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1.4 Central research question

This central research question for this thesis is:

How do bank employees perceive the interaction between hard- and soft law?

In order to find an answer to this research question three sub questions have been defined:

Sub question 1: Do employees perceive a complementary, parallel or antagonistic relation

between hard- and soft law?

The way employees perceive and adopt law is depending on how these are communicated within the organization and the culture of the organization (Orlitzky & Swanson, 2002). For that reason two sub questions have been defined to assess the impact of communication and culture on the perceived interaction of hard- and soft law.

Sub question 2: What are according to employees the drivers to comply with hard law? Sub question 3: How do employees perceive the communication of hard- and soft law?

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1.5 Thesis structure

This thesis is structured as follows:

Chapter 2 contains the literature review and will elaborate on what is already known about hard- and soft law and their interrelationship. This chapter is based on the three sub questions and provides a number of propositions. Furthermore the chapter concludes with the conceptual model used for this research.

Chapter 3 continues with the data and method that will be applied to this research. Qualitative research will be applied whereby semi-structured interviews with bank specialists and secondary data will be used.

Chapter 4 will describe the results and discussion of the propositions based on the interview results, whereby various publicly available bank publications will be used for comparison, as well as other relevant publications from journals and the Dutch Banking Association (NVB).

Chapter 5 concludes on the findings of this research, the contribution towards literature and suggestions for further research.

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Chapter 2 - Literature Review

2.1 Relation between hard- and soft law

Sub question 1 aims to find an answer to the question: ‘Do employees perceive a complementary, parallel or antagonistic relation between hard- and soft law?’, based on the theoretical framework of Shaffer and Pollack (2010a). Prior to defining propositions a proper understanding of hard- and soft law is required.

2.1.1 Definition of hard- and soft law

First of all distinction must be made in two types of law: hard law and soft law. Different views on the definition of hard- and soft law exist. Schaffer and Pollack (2010a; 2010b) identified the following views:

- Legal positivists define the difference between hard- and soft law based on a simple binding versus non-binding character;

- Rationalists define the difference between hard- and soft law based on ‘binding commitments’ in law;

- Constructivists focus on the effectiveness of law when implemented, which can make it either ‘hard’ or ‘soft’.

All of the above views agree that hard- and soft law can complement each other or can be used as alternatives depending on the circumstances.

Abbott and Snidal (2000) define hard law as “legally binding obligations that are precise and that delegate authority for interpreting and implementing the law”. As such the view is even stricter compared to the view of the legal positivists. The same authors define soft law as a “broad class of deviations from hard law” whereby one or more of the factors of obligation, precision and delegation are weakened. As such soft law can act as guidelines that a certain group of stakeholders consider important although not legally binding.

In this thesis the definition of hard- and soft law according to Abbott and Snidal (2000) will be used as this provides a clear distinction between hard- and soft law.

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2.1.2 Examples of hard- and soft law

The regulatory obligations for banks as stated in the Sarbanes-Oxley Act and more recently in EMIR and Dodd-Frank are clear examples of hard law whereby law follows ethical demand (Blodgett, 2012). These laws are legally binding, precise and can be measured by authorized parties such as national central banks.

Soft law can be agreed guidelines that an industry decides to follow. In the past drivers for guidelines were mainly focused on economics, the classic demand for ‘optimal shareholder value’. This has changed into additional attention for other long-term stakeholders interests that go beyond economics, such as the social environment of the company or –even more basic– the human dignity of the society (Poruthiyil, 2013).

Companies can decide to incorporate long-term stakeholders’ interest by embedding these interests in the business ethical values or business principles of the company. Business ethics define what the organization considers as key corporate values (Jiang, Lin and Lin, 2011). Most financial institutions have introduced a set of core internal ethical values that are considered mandatory to be adopted in the daily operations of their employees (Blodgett, 2012). Whilst hard law is defined precise (Abbott and Snidal, 2000) the definition of soft law via core internal ethical values gives a general direction and hence can be valued differently depending on the subject and context. These internal ethical values often share one or more of the following components: trustworthiness, respect, responsibility, fairness, caring and citizenship (Schwartz, 2005) as elaborated in table 1.

Universal values for Corporate Codes of Ethics (Schwartz, 2005):

1. Trustworthiness (including notions of honesty, integrity, transparency, reliability, and loyalty); 2. Respect (including notions of respect for human rights);

3. Responsibility (including notions of accountability, excellence, and self-restraint) ; 4. Fairness (including notions of process, impartiality, and equity);

5. Caring (including the notion of avoiding unnecessary harm);

6. Citizenship (including notions of obeying laws and protecting the environment).

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When organizations define their business ethical values based on the combination of what they consider as mandatory according to laws and also include values for which there is no direct regulatory obligation nor key economical driver then business ethics will function as a way of self-regulation whereby it becomes more likely that the company will be seen as ‘socially responsible’ and ‘stakeholder-friendly’ (Norman, 2011).

2.1.3 Characteristics of hard- and soft law

Defining hard- and/or soft law does not guarantee effectiveness and perceived results towards ‘resolving’ the ethical issues that triggered the introduction of the law. In this section characteristics will be discussed that can either stimulate or jeopardize the results.

Characteristics hard law:

- Hard law can be effective, resulting in transformative change “when the regulatory context creates a state of shared values and mutual problem-solving among parties” (Rupp and Williams, 2011);

- Hard law stimulates commitments as violation of hard law can often result in increased costs (sanctions) in case of law violation (Shaffer and Pollack, 2010b);

- Hard law makes it possible to easier monitor compliance with the law as it is defined precise and has a delegated authority (Shaffer and Pollack, 2010b);

- Hard law can be ineffective in case politicians interpret ethical demand incorrectly whereby new law does not focus on the root cause of the underlying issue (Jensen and Meckling, 1994);

- Hard law can be ineffective when conflicting interests result in resistance to comply with the new regulation (Jensen, 1994). Companies can decide to find gaps in the law or to create new equivalent products and structures in unregulated markets, undermining the intended goal of the law;

- Hard law can have a negative effect in case the numerous rules have a suffocating effect on the business. For example the costs involved in order to be compliant can increase in such a way it will kill the business, either from the perspective of the party offering the service or from a client perspective (Jensen and Meckling, 1994).

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- Soft law is easier and less costly to negotiate (Shaffer and Pollack, 2010b)

- Soft law is more flexible to deal with uncertainty and diversity (Shaffer and Pollack, 2010b);

- Soft law helps to create normative covenants (Abbott and Snidal, 2000); - Soft law can help to develop shared ideas and to build trust (Trubek, 2005);

- Soft law allows to be more ambitious and stimulates cooperation, compared to a situation when it would be enforced by hard law (Shaffer and Pollack, 2010b);

2.1.4 Interaction between hard- and soft law

Hard- and soft law should not be seen as independent categories of law. Interaction between hard- and soft law exists whereby the choice for one or the other depends on a variety of stakeholders interests such as the level of (un)certainty, expected results, public support for a supervising authority and costs involved (Abbott and Snidal, 2000; Shaffer and Pollack, 2010b). Shaffer and Pollack (2010a) highlight that existing views in literature are primary considering hard- and soft law as alternatives or as complements. The authors notice a classic view in which soft law is considered to fill the gap where the coverage of hard law ends. Although they do fully agree that hard- and soft law can act complementary (e.g. non-binding soft law can lead to binding hard law and, the other way around, binding hard law can result in soft-law instruments) they highlight that various factors can also result in contradictory law whereby hard- and soft law function as antagonists.

Some examples in which hard- and soft law can result in antagonists:

- International laws can result in disagreements about costs and benefits involved. Individual parties can decide to create hard- or soft law that is in conflict with existing hard law (Shaffer and Pollack, 2010a);

- When parties responsible for the implementation of hard law are not involved in the definition of the hard law there might be an issue of incorrect interpretation of the hard law which can undermine the results (Shaffer and Pollack, 2010a);

- In case there is no agreement on the hard law it selves then it might be possible that parties conclude on soft law to undermine the results and feasibility of executing the hard law (Shaffer and Pollack, 2010a).

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Shaffer and Pollack (2010a) conclude that when the regime of hard- and soft law is more complex and when there is less agreement on the purpose and scope of the law –which they define as ‘distributive conflict’– the risk of antagonistic interaction between hard- and soft law will become more likely, as reflected in table 2.

Hard- / soft law Distributive conflict low Distributive conflict high Single, isolated regime Complementary interaction Possible antagonistic interaction

Complex regime Possible complementary interaction Likely antagonistic interaction

Table 2 - Expected interaction hard- and soft law (Shaffer and Pollack, 2010a)

The new hard law exposed to the financial markets is considered to be complex and implementation is far from easy. Hennessy (2014) emphasizes that in case supervisors appointed by the regulators cannot verify or guarantee effectiveness of the new implemented hard law it will result in requests for law revision. By then a new decision will have to be made by all stakeholders involved if the request should result in additional hard- or soft law or a combination of both. Lack of law effectiveness measurability, law implementation or interpretation issues in it selves can result in increased distributive conflicts and hence the risk of possible antagonistic interaction between hard- and soft law. In case the distributive conflict remains low then possible complementary interaction can occur. This leads to the following propositions as defined for sub question 1:

between hard- and soft law?

- Proposition A: if employees recognize business principles in hard law then this results in a complimentary perception of hard- and soft law.

- Proposition B: if employees do not recognize business principles in hard law then this results in a parallel perception of hard- and soft law.

- Proposition C: if employees recognize conflicts between business principles and hard law then this results in an antagonist perception of hard- and soft law

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2.2 Drivers to comply with law

Sub question 2 is positioned as a control question and aims to find an answer to the question ‘What are according to employees the drivers to comply with hard law?’.

Rupp and Williams (2011) distinct three system orientations of regulation: Compliance, Identification and Internalization, as reflected in table 3:

System orientation

Rupp and Williams (2011)

Driver Driver characteristics

Hooghiemstra and Van Ees (2011), Abbott and Snidal (2000)

Compliance

(self-interest)

Economic Positive driver: stay in competition Negative driver: to avoid sanctions Social To avoid reputational damage

Identification

(relations)

Impose influence Participate in law working groups

Internalization

(ethics)

Values Recognize business values in hard law Moral obligations Translate meaning of law into daily practices

Table 3 - drivers to comply with law based on Rupp and Williams (2011)

 Compliance - this implies that a company acts in accordance with regulation that is

imposed to the company, driven by self-interest. Hooghiemstra and Van Ees (2011) identified the following related drivers:

o Economic: positive motivation – to be able to stay in the competition negative motivation – afraid of sanctions in case of violation o Social: to receive buy-in from other stakeholders in order to avoid soft

sanctions that cause reputational damage. Reputational

damage can result in clients unwilling to buy products and/or shareholders not willing to invest anymore.

 Identification - act in accordance with regulation to create a positive relationship in

which it is possible to impose influence, driven by social relations. A possible way for banks to influence law is by participating in branch orientated working groups that have direct connections with law makers (Abbott and Snidal, 2000).

 Internalization - act in accordance with regulation as values between the company and

the governing body are similar. This is driven by ethics / values. Companies or employees are not just acting according to law because of negative impact if they refuse to do so but they act according to law as they understand the intention and feel the moral obligations.

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Sub question 2 has been defined as a control question to assess the employees’ view on hard law. If they have a too narrow view on the drivers for hard law it could potentially limit their perception of perceived interaction between hard- and soft law.

As hard law is compliance orientated this would therefore assume that economic and social drivers are perceived as key drivers to comply with hard law. This results into the following proposition belonging to sub question 2:

Sub question 2: What are according to employees the drivers to comply with hard law?

Proposition: economic and social drivers are perceived as the key drivers to comply with hard law (Rupp and Williams, 2011; Hooghiemstra and Van Ees, 2011)

2.3 Communication of hard- and soft law

A key point in the adoption of values and the perception of hard- and soft law by employees is based on the organization’s culture and the methods used to communicate expectations. Sub question 3 aims to answer the question ‘How do employees perceive the communication of hard- and soft law?’.

Obviously employees can simply read the hard law (regulation) and soft law (business principles) however it is essential how management defines their strategy and attitude which impacts the organization’s culture and the altitude of individuals. Management will have to take into account the external obligations and the already existing internal business principles, however they will also have to consider the social expectations of their stakeholders (Orlitzky & Swanson, 2002).

2.3.1 Communication via compliance integrity programs

There are various ways how management can communicate their strategy and expectations to their employees. A common way to communicate business principles in organizations is via compliance integrity programs. Research has indicated that bank integrity-based compliance programs that try to embed core ethical values in the company have a positive impact on the attitudes of employees, their norms and moral obligations (Hess, 2006).

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2.3.2 Embedding soft law in formal communication and strategy

Studies have indicated that if management embeds corporate Bank Values (soft law) clearly in their communication and strategy it will have a positive influence on employees' adoption of these values (Wallace, De Chernatony and Buil, 2011). The same authors suggest that because of the culture within banks –which is dominated by structure and control– there is a natural effect: since employees follow the bank's structure they are also likely to adopt the bank values when these values are embedded within the bank strategy.

2.3.3 Communication via management dialogs

Last but not least the aspect of trust is important. Via proper dialogs management can bring forward the expected behaviour and social expectations to their employees. This can make a key distinction if expectations are perceived as merely self-interest, hence compliance orientated, or as part of ethics, hence internalization oriented (Orlitzky & Swanson, 2002).

2.3.4 Concluding remarks on communication of hard- and soft law

In sum it is key that law is clearly communicated to employees. It is not only about ‘mentioning the rules’ but also setting the expectations for daily practices in order to ensure they get well understood and adopted by the employees. This impacts how employees perceive hard- and soft law.

As communication impacts the way hard- and soft law are understood and adapted by employees, and consequentially the perceived interaction between hard- and soft law, it will be explicitly analysed in a dedicated sub question:

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2.4 Conceptual model

This conceptual model states that employees adopt/shape values based on various aspects: 1. Employees can get to know hard law when they are involved in the implementation of

the implications of hard law in their organization. This can be either by making changes to the organization or by having to comply with certain rules in daily practice. Management need to respond to hard law as well by defining their strategy whether and how to adopt and implement this hard law.

2. The curved lines between management/employees and hard law are dotted because there is no direct influence on the creation of hard law, however hard law can be shaped based on how management and employees act, either in a socially accepted or unaccepted way (Blodgett, 2012). Furthermore banks can participate in working groups that have direct connections with law makers (Abbott and Snidal, 2000). In those cases banks have a platform by which they can help to shape hard law.

3. There is direct interaction between management/employees and soft law. Soft law is frequently embedded in the organization by defining corporate bank business principles or business values, which are based on the organizational culture and expectations from the various stakeholders (Jiang, Lin and Lin, 2011). Employees are expected to act in accordance with these values.

4. The line between management and employees reflect the communication about expectations towards hard- and soft law.

5. The dotted line between hard- and soft law reflect the perceived interaction between both types of law by the employees.

Hard Law (regulation) Soft Law (business principles/values) Employees (adopted values) Management (strategy) Culture 1 1 2 2 3 3 4 5

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2.5 Summary of research questions and propositions

Although a combination of hard- and soft law can both serve the financial markets, the years after the credit crunch have illustrated that demand for precise and forcible (binding) measures has been increased which resulted in a strong focus on hard law (Hennessy, 2014). It is however not known yet what the results of the new hard law implementation will be and how the interaction with soft law will be perceived, e.g. will it be complementary or will it result in conflicts as antagonist? This research gap leads to the central research question of this thesis.

Central research question:

How do bank employees perceive the interaction between hard- and soft law?

In order to answer the central research question the following sub questions are defined:

between hard- and soft law?

- Proposition A: if employees recognize business principles in hard law then this results in a complimentary perception of hard- and soft law.

- Proposition B: if employees do not recognize business principles in hard law then this results in a parallel perception of hard- and soft law.

- Proposition C: if employees recognize conflicts between business principles and hard law then this results in an antagonist perception of hard- and soft law

Sub question 2: What are according to employees the drivers to comply with hard law?

Proposition: economic and social drivers are perceived as the key drivers to comply with hard law (Rupp and Williams, 2011; Hooghiemstra and Van Ees, 2011)

Sub question 3: How do employees perceive the communication of hard- and soft law?

As stated in the conceptual model the organization’s business principles/values will serve as concrete type of soft law in this research. The recently introduced and implemented EMIR and Dodd-Frank regulation will serve as concrete examples of hard law.

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Chapter 3 - Data and method

3.1 Type of research

At this moment the financial markets are dominated by changes as result of mandatory regulatory obligations. There is currently not much known about the practical implications of the interaction between hard- and soft law (Shaffer and Pollack, 2010b; Dunoff and Pollack, 2013), hence an exploratory research is the most suitable approach to achieve understanding of this research area (Saunders et al., 2009), so an inductive approach will be followed.

A case study has been performed at ING Bank, one of the banks confronted with the new regulatory obligations as result of EMIR and Dodd-Frank1_{, but also previously impacted by} MiFID2_{. A case study can be described as “a strategy for doing research which involves an} empirical investigation of a particular contemporary phenomenon within its real life context using multiple sources of evidence” (Robson, 2002).

3.2 Data sources and method

The interaction between hard- and soft law could be perceived differently per group of bank employees. For that reason data will be collected from two different orientations:

1) Internal orientation: employees involved in the process of implementing changes as result of new service offerings and regulatory obligations. This includes detailed analysis of law implications and guidance and control of product development. These employees have limited to no direct contact with bank clients.

2) External orientation: employees responsible for product development / service offering to clients. This includes guidance and explanation of hard- and soft law to clients and the way the bank deals with these laws. These employees have intensive contact with bank clients.

1_{Dodd-Frank: United States equivalent of EMIR regulation, introducing similar controls like transaction reporting and trade reconciliation.} 2_{MiFID: Markets in Financial Instruments Directive. EU law to harmonize trading and to protect client interest. Amongst other obligations}

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Orientation Data source

1. Internal _{1a. Senior analysts from reporting and IT departments} 1b. Program manager new regulations

1c. Senior Compliance Officer

2. External _{2a. Executive from business/sales departments} 2b. Program manager new regulations

2c. Official bank publications

Table 4 - Target data sources

Input from employees will be obtained via semi-structured interviews with bank specialists working in the ‘Financial Markets’ domain which is part of the Commercial Banking organization of the bank. This part of the bank is involved in trading complex derivative products globally.

The group of interviewees as listed in table 4 have been selected as they all have minimal 3-5 years of experience within the Financial Markets domain –either within ING or another bank– and all of them are involved in the implication of recent EMIR/Dodd-Frank hard law as from day one. The employees are working for multiple departments and have different responsibilities in order to avoid a narrow view on this subject.

In the interviews the recently introduced EMIR and Dodd-Frank regulations will serve as examples of hard law. Basis for soft law will be the common business ethical values identified by Schwartz (2005): trustworthiness, respect, responsibility, fairness, caring and citizenship. The business ethical values of ING Group N.V. (2009) are closely linked to the general common values and will be used for reference during the interviews: integrity, respect, open & clear and responsible. These business values are known as the ING business principles which get refreshed every five years in order to ensure relevance with the actuality and were first introduced in 1999. The third version of the ING business principles are published in 2009 and cater for the years 2009-2014 and have been introduced after the start of the credit crunch in 2008.

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The interviewees will be requested to mention the ING business principles in order to assess their current awareness of these business ethical values (soft law) before comparing it to hard law. The questions that will serve as basis for the semi-structured interviews are listed in ‘Addendum A - interview questions’. The overview of interviews conducted is available in ‘Addendum B - publicly available documents & interviewed employees’.

The interview transcripts will be labelled/coded based on the combination of axial coding and open coding (Mortelmans, 2007). Axial coding implies coding based on pre-defined subcategories within the concept. This will be enriched with open coding when other relevant codes are detected when processing the transcripts.

The interaction between hard- and soft law will be measured against the four types of interaction as identified by Shaffer and Pollack (2010a) in before mentioned table 2:

complementary, possible complementary, possible antagonistic and likely antagonistic interaction. The drivers to comply with law will be measured against the drivers as listed

before in table 3:

System orientation

Rupp and Williams (2011)

Driver Driver characteristics

Hooghiemstra and Van Ees (2011), Abbott and Snidal (2000)

Compliance

(self-interest)

Economic Positive driver: stay in competition Negative driver: to avoid sanctions Social To avoid reputational damage

Identification

(relations)

Impose influence Participate in law working groups

Internalization

(ethics)

Values Recognize business values in hard law Moral obligations Translate meaning of law into daily practices

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3.3 Secondary data

The data found in interviews will be contrasted against communication of ING in which aspects of recent hard law, business principles and organization culture are reflected from a senior management perspective. This makes it possible to compare the intended communication of hard- and soft law towards the actual perceived communication by the employees in order to validate how this potentially impacts the perceived interaction between hard- and soft law.

Triangulation of the data obtained via interviews will take place by using the following secondary data:

 ING Bank Annual Reports;

 ING Bank Sustainability Reports, sections about ‘Customer Centricity’ and ‘Governance & Compliance’;

 Dutch Banking Act (2009), sections about business principles;  ‘Application of the Dutch Banking Code by ING Bank N.V.’ (2014);

 Publications in Bank/Financial journals and publication in financial newspapers.

The complete overview of used reports is available in ‘Addendum B - publicly available documents & interviewed employees’.

3.4 Limitation of scope

Research will be performed within the Financial Markets domain of the banking industry that is involved in the Over-The-Counter (OTC) derivatives trading. Other domains such as the Retail will remain out of scope.

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Chapter 4 - Results & Discussion

This chapter describes the results of the research conducted, followed by the discussion of these results. The results and discussion are structured around the three research sub questions followed by the central research question of this thesis.

4.1 Perceived relation between hard- and soft law

This section describes how employees perceive the relation between hard- and soft law, whereby distinction has been made between the perceived impact of soft law on hard law and, vice versa, the perceived impact of hard law on soft law. This distinction has been made as the conceptual model describes an indirect possibility to influence hard law whilst soft law can be influenced in a direct way.

4.1.1 Results of perceived interaction Soft Law  Hard Law

The interviewees indicate that they see similarities between the business principles and hard law when it comes to recognition of business values in recent new regulations. This question has been asked to six interviewees and all of them mentioned the values ‘Open & Clear’ and four also mentioned ‘Responsible’ as internal business principle recognized in recent hard law. “You are forced to report, so you have to be open. So I see a direct link between law and the ING business principles.”, “You need to take the responsibility to report, also for your client eventually.”, “Open & Clear, yes I do recognize that as well, as the non-transparent products are disappearing from the markets now.”, “Open & Clear is evident. The entire transaction reporting. You have to be complete, accurate and timely. That is a one to one.”, “Open & Clear, reporting of transactions has market transparency as a goal. Then it becomes clear which parties impose risk.”. The two other business principles ‘integrity’ (3x) and ‘respect’ (1x) are less recognized in recent new regulations by the interviewees.

The respondents mentioned two possible ways of how banks can influence hard law. Whilst all respondents immediately mentioned the various working groups and interest groups also three interviewees mentioned the use of lobbyist to influence law. ISDA, ESMA and the NVB are frequently mentioned as working groups. “The influencing takes place via large interest groups such as ISDA.”, “Were possible ING delegates people to participate in working groups.”,

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“I know that lobbying takes places regarding regulations.”, “We have lobbyist that visit all regulators to share our interests.”, “Lobbying. That is being performed actively. Both individually but also in interest groups.” General consensus is that it depends on the size of the company in the playing field and the regulator involved (e.g. national or international) what the actual effect of influence is. “We are a relatively small player on the market, so bigger parties from the UK could impose more influence.” and “We are just one bank in this world, so don't expect we can change the complete world. On the other hand, in your own country influencing is possible. Depends on your size.”. Furthermore there are consultation rounds with market participants before new law comes into place. “There are consultation rounds. That is also applicable for the new MiFID regulation and also applied to EMIR. Yes, there are platforms.”

The focus and purpose of new hard law is already defined by law makers when consultation rounds with financial institutions start, which means the influence that can be imposed on hard law is mainly focused on practical feasibility. “Especially the interpretation of some pieces of law provides the ability for some influencing.” and “Not the purpose of the law, that is not possible. It is however possible with respect to practical feasibility and impact.”

4.1.2 Results of perceived interaction Hard Law  Soft Law

The interviewees see various types of interaction whereby hard law impacts soft law:

1. One interviewee recognizes the interaction by creating awareness, emphasizing the business principles but forced by hard law: “I see that the current regulation kind of forces to comply with the business principles. (…) And I hope this will result in a different mentality in the business world. I hope that new generations consider this as standard values.”

2. Another interviewee mentions that hard law results in new or changed soft law such as internal processes and procedures. In those cases soft law becomes an extension of hard law with focus on behaviour and expected way of working from a practical point of view: “Regulation does not provide guidance how employees have to behave/act. It just states: ensure to do this and that, but it does not tell what we expect from the people. (…) there is a huge task for management and compliance to ensure that people are aware of the responsibilities that are expected from them.”.

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3. Linked -but not equal- is extension of hard law via soft law by demanding something in addition compared to what is strictly required by hard law: “New regulation can be presented whereby it is stated: ‘the law expects this, and if you act accordingly then you comply’. ING can say: we go further than that. For example because of reputational risk or image risk whereby we decide to extend the law internally. (…) also considering environmental and social risk.” “We do not limit our view to what is allowed at this point in time but also towards the future when this might be interpreted differently.”. 4. The interpretation of hard law in an international setting can differ per country. In

these cases soft law can overcome these differences, as stated by two employees: “In most cases external regulation is leading. However, what you see is that the most strict of all of them becomes the internal rules. For example three countries have their own interpretations and the most strict one –often The Netherlands– becomes the internal guidance to be applied worldwide.”

The interaction between hard- and soft law can also result in friction. Two interviewees mention the example of the value ‘Open & Clear’, whereby the degree of openness can result in friction with hard law (fulfil the law by presenting transaction details to regulators) and the business principle ‘integrity’ (protect client data). “A client must be able to expect that a bank provides openness when needed, but providing details of a contract… that results in friction.”

4.1.3 Discussion perceived relation Soft Law Hard Law

The general feedback from the interviewees is that they recognize the business principles in recent hard law. Especially the business principles ‘Open & Clear’ and ‘Responsible’ are mentioned frequently. Hence similarity is recognized between soft law and hard law. One exception was made by one respondent in the business principle “Open & Clear” whereby some friction might occur between hard- and soft law.

Perceived shared values or agreed soft law within the branch of industry can result in influencing hard law in two ways. The possibility to share input via working groups is mentioned by all interviewees and confirms that this bank is making active use of the possibility to influence hard law in the stage where theoretical regulation is transformed into daily practices, a possibility mentioned by Abbott and Snidal (2000). A second possibility that was mentioned by a number of respondents which was not identified upfront by literature is

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lobbying of banks at regulators. This appears to be used actively and this helps to potentially influence hard law in an early phase even before law is created. The impact of lobbying on the actual results in law and the extent to which this results in a beneficial situation for either the bank or other stakeholders is subject for further investigation.

4.1.4 Discussion perceived relation Hard Law Soft Law

Upfront not much was known about the relation of hard law towards soft law, besides that one could result in another (Shaffer and Pollack, 2010b). In the previous section the influence of soft law on hard law has been discussed, in this section it is the other way around. The results of this research indicate that soft law largely results from hard law, although this is not limited to an ‘extension were hard law ends’ (Shaffer and Pollack, 2010b). Although this ‘extension’ has been mentioned as one of the reasons, in total three cases are perceived applicable:

- Translate hard law into soft law by making it practical for the organization/branch - Extend were hard law ends as environmental and social aspects demand for it

- Ensure that soft law provides proper internal direction as interpretation of the same of similar hard law can differ per country where the organization performs their business.

The second item could be linked to Shaffer and Pollack (2010b). The other two items cannot be linked directly to existing theory but these items show to fill a gap that could not just be covered by hard law alone when it applies to an international setting.

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4.1.5 Discussion perceived relation Hard- and Soft Law (vice versa)

Another aspect to take into account when reflecting on the interaction of hard- and soft law is the extent of the ‘voluntariness’ of applying soft law. When considering secondary data reflecting on the Dutch Banking Code3_{(ING Bank N.V., 2014b; Nederlandse Vereniging van} Banken, 2010) then this seems not voluntary at all anymore. ING explicitly refers to the ING Business Principles when they explain how ING Bank N.V. has applied the Dutch Banking Code. One of the aspects of the Dutch Banking Code is that banks should ensure that a moral and ethical conduct declaration should be ‘translated into principles that form guidelines for the behaviour of all of the bank’s employees’. ‘Every new employee shall be required to comply with these principles’ and a reference to these principles should be part of the contract of employment.

The ING report related to the Dutch Banking Code (ING Bank N.V., 2014b) mentions that the ING Business Principles are included in employee contracts. Furthermore the same report mentions that there are ‘various initiatives’ to make sure that all employees understand how to act in a correct manner. Finally, it is also mentioned that the ING Business Principles are an integrated part of the so-called Integrity Programme. During the interviews all respondents – without any exception– have mentioned the Integrity Programme as the mechanism how the ING Business Principles are presented to them. However none of the interviewees have mentioned the Business Principles in relation to the contract they have signed. It could be possible that either employees cannot remember this anymore as a contract is not a recurrent document that requires attentions of the employees very often or it could be possible that employees were already employed before the ING business principles became part of the contract template.

As a result of the Dutch Banking code the ING Business Principles which were introduced in 1999 (and get updated every five years) transformed from a voluntary form of soft law into mandatory soft law. Although the Dutch Banking Code provides banks freedom in the way how they translate the principles of the Dutch Banking Code into companies’ business principles it still means it is now considered to be a mandatory element of organizations’ internal soft law.

3_{The Dutch Banking code has been published in 2010 by the Dutch Banking Association (NVB) and describe a}

set of principles that Dutch banks are expected to follow regarding corporate governance, risk management, audit and remuneration.

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4.1.6 Validation of propositions ‘perceived relation Hard- and Soft Law’

According to Shaffer and Pollack (2010a) there might be a complementary, neutral (parallel) or antagonistic interaction between hard- and soft law depending on regime complexity and distributive conflict between hard- and soft law, which resulted in sub question 1:

Sub question 1: Do employees perceive a complementary, parallel or antagonistic relation between hard- and soft law?

Based on this sub question three propositions were defined:

- Proposition A: in case employees recognize business principles in hard law then this results in a complimentary perception of hard- and soft law.

- Proposition B: in case employees do not recognize business principles in hard law then this results in a parallel perception of hard- and soft law.

- Proposition C: in case employees recognize conflicts between business principles and hard law then this results in an antagonist perception of hard- and soft law.

The employees recognize in most cases at least two business principles in recent hard law: ‘Open & Clear’ and ‘Responsible’ and identified no major conflicts between the business principles and new regulations. Sometimes additional considerations such as environmental and social aspects result in extension of hard law that results in doing more than strictly obliged by hard law. However in other cases it is considered to be a practical translation of hard law into daily practices and expected behaviour / way of action, and sometimes as an overarching law to overcome differences in local laws or differences by countries / regulators in the interpretation of hard law. This provides indication of a partial support for proposition A and B.

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The findings in this research do not indicate an antagonist perception of hard- and soft law, however in an international context employees do experience different interpretation of the same hard law between individual countries or even conflicting hard law as created by different regulators. As such, hard laws amongst each other can operate as antagonists. In those cases soft law can function as an overarching law that takes the variety of interpretations or even conflicting parts into consideration, resulting in internal soft law applicable for the whole organization in a global setting. This provides indication that proposition C is not supported (see table 5).

The above results therefore provide indication that a complimentary and/or parallel perception of hard- and soft law exists, which is in accordance with Shaffer and Pollack (2010a) since upfront the distributive conflict of recent new regulations was considered to be low. As indicated by the interviewees the interpretation of the same new law by regulators of individual countries could sometimes be different which would then suggest that the risk on a distributive conflict could increase and hence could result in a likely antagonistic interaction. The outcome of this research however indicates that soft law could overcome these differences, preventing an antagonistic interaction.

Hard- / soft law Distributive conflict low Distributive conflict high Single, isolated regime Complementary interaction Possible antagonistic interaction

Complex regime Possible complementary interaction

(supported)

Likely antagonistic interaction (not supported)

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4.2 Perceived drivers to comply with hard law

4.2.1 Results of perceived drivers to comply with hard law

The interviewees have been asked to indicate the perceived key drivers why their organization wants to comply with hard law. This resulted in the following drivers:

- ‘Compliance’ (1x): “We have to be compliant, so we simply have to do this. (…) The most important reason is the law, which you have to fulfil.”

- ‘Stay in competition’ (5x): “Yes, you are in or you are out.”, “Continuity, absolutely. If you do not fulfil then you do not exist anymore after a short period of time.”, “If you want to continue your business, you have to.”, “If we want to continue our business, then we simply have to fulfil these obligations.”, “Most important: the external market. If you cannot fulfil then you cannot enter the business.”

- ‘Reputational risk’ (4x): “The driver of the bank is reputation. Not complying with these rules results in a front page in a financial newspaper and hence reputational risk.”, “Second is image”, “That has a direct link with reputations risk or image risk.”, “I notice, especially the last times, that many decisions are made in relation to reputation.” - ‘Avoid sanctions’ (2x): “There is no escape, if you do not comply then sanctions will

follow.”, “If you don't you will most likely first receive a warning, but after that a fine.” - ‘Economic benefits’ (2x): “There are more aspects of this law which also have benefits

for the banks (…) such as risk reduction.”, “Every change in law (…) is a commercial opportunity for the bank in cases where it impacts our clients.”

- ‘Moral obligation’ (2x): “also considering environmental and social risk.”, “But especially last time: moral reputation towards society.” Furthermore hard law makes it possible to pick up new activities, whereby the driver is based on more obligations as found in soft law. The example of so-called ‘delegated reporting’ is provided a couple of times, whereby banks fulfil a mandatory reporting obligation on behalf of the client: “For example delegated reporting, whereby you can take on responsibilities” and “This is an example whereby we do not have to offer this according to regulation, but it is presented to the clients as a service and I think that responsibility is very important here. (…) So I see that ING takes responsibility here to do this.”

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4.2.2 Discussion perceived drivers to comply with hard law

Sub question 2 was defined as a control question to assess the employees’ view on hard law, because if they would have a too narrow view on the drivers for hard law it could potentially limit their perception of perceived interaction between hard- and soft law.

Sub question 2: What are according to the employees the drivers to comply with hard law?

Based on the framework of Rupp and Williams (2011) and Hooghiemstra and Van Ees (2011) the following proposition was defined:

- Proposition: as hard law is compliance-orientated economic and social drivers are perceived as the key drivers to comply with hard law.

Without exception all interviewees have mentioned the category ‘compliance’ as the primary driver to comply with hard law. As sub category the positive economic driver to ‘stay in competition’ was mentioned most frequently, followed by the social driver ‘to avoid reputational damage’ and the negative economic driver ‘to avoid sanctions’. Furthermore another economical driver was mentioned which intends to benefit from new law by offering new products that were previously not possible. This could be seen as an additional positive economic driver. Both the economic and social drivers belong to the main category ‘compliance’. This confirms the proposition that hard law is perceived as compliance-orientated whereby the economic and social drivers are perceived as the key drivers to comply with hard law (Rupp and Williams, 2011; Hooghiemstra and Van Ees, 2011).

A second category that was highlighted by the interviewees is related to the internalization-orientation and more specific on the driver of moral obligations. Although not mentioned as primary driver the environmental and social aspects were mentioned as a driver as well. Two interviewees described the example of the banks’ service of delegated reporting to emphasise that because of moral obligations to customers additional services are provided for those customers who are not likely to be able to fulfil all hard law obligations themselves. This could be confused with a similar driver ‘economic benefit’ whereby the same example of delegated reporting was mentioned as a possible way to increase economic benefits, however in this case it is mentioned as a single moral obligation.

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In sum the proposition is confirmed in the sense that the primary perceived driver to comply with hard law is compliance orientated, which supports the key driver as mentioned by Hooghiemstra and Van Ees (2011). However as a second driver the moral obligations which are internalization oriented (Rupp and Williams, 2011) are considered important as well whereby the employees and the organization do more than strictly required by law. This provides indication that hard law is not only considered as a ‘must-do’ but is also resulting in acting according to the intention of the law. This does not imply that there would be a shift from a compliance orientation towards an internalization orientation with respect to the drivers to comply with hard law, but it does provide indication that the internalization orientation is gaining momentum in the years after the credit crunch.

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4.3 Perceived communication hard- and soft law

The results of perceived communication of law will be split between hard- and soft law as the conceptual model makes distinction between interaction of employees & management with hard law versus the interaction of employees & management with soft law.

4.3.1 Results of perceived communication hard law

The interviewees make distinction between two types of hard law:

1) Hard law that does not directly require change of behaviour and/or acting of the employees: e.g. focused on delivering output to a regulator or law that requires specific steps in the internal processes that can be largely forced by system behaviour 2) Hard law that requires a change of behaviour and/or acting of the employees

“I see a clear split between cases that impact how people act (…) and law focused on content”. “We implement law by changing our systems. If an employee then starts to work with the system he will not really experience the law directly.” “The only way to ensure that law is executed according to the letter of the law is by forcing it system technically.” “We create online tests to check if the employees understand the law changes.”

As indicated by all interviewees the communication of new regulations such as EMIR is obtained primarily via official documents from regulators, whereby employees perform their own research based on either personal interest or via received recommendations from other colleague analysts or specialist from Legal and/or Compliance departments. External communication is mainly obtained via websites and newsletters. Internal communication within the organization is mainly obtained via email, phone calls and meetings. “Based on documents published by ESMA (…) and based on these documents information has been obtained about what we have to do, what we have to fulfil as a bank.”, “Reading. Reading official publications, interpretations as being provided by consultancy firms and law firms.”, “For a large part you have to search it yourself. Furthermore a number of sites form your regular sources, e.g. the website of AFM, ESMA, consultancy firms.”, “Via own research of course. (…) We have to proactively search in order to ensure we are aware of the latest developments.”, “I have been directed to related information. I received some information from colleagues and I searched via Google.”, “It started with information available on intranet and internet as an important source. We have conversations with colleagues from Legal,

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Compliance and Operations that are also impacted by these regulations.”, “…besides that we also have a lot of specialized literature such as Treasury & Risk Magazine, types of literature that go in more detail than Financieel Dagblad or Financial Times. And conversations with Law firms and accountants.”, internal communication “Mostly via email, sometimes a meeting.”, “Very ad-hoc. (…) via mail or phone.”

Other than the above mentioned sources for knowledge and awareness of hard law, none of the interviewees made a reference to their management as a source when they were initially asked about how hard law was communicated to them.

Communication of hard law by management is perceived differently. Only in case of hard law that requires a change in the way of acting there are two out of the seven respondents that could remember that their manager put attention to it during meetings. “My direct manager, (…) no, only for individual cases as for following trainings related to reporting of possible fraudulent transactions, that is what he pointed out, the mandatory trainings that must be performed.” and “He tries to -also because it is our role-, we organise multiple meetings, together with legal experts. And then we discuss these type of elements.” The other interviewees highlight that they do not experience such attention on hard law by managers. “No, he rarely provides it.”, “No, not explicitly. (…) I would not say that people have directed me.”. One respondent questions the need for such communication of hard law: “In my opinion there is no task for the manager to highlight the urgency, the urgency comes from the regulation it selves.”

When it comes to the communication from senior management then only limited involvement is experienced, whereby two respondents mention that communication of senior management is actually covered in a different way as projects are set up to implement new law across the organization. “If it is a big piece of regulation, such as MiFID, EMIR then projects are set up.” The information shared by senior management is often limited to statements on intranet or per email. “No, actually not. (…) If you search for it, there might be something on the intranet about the purpose and importance of certain regulation, but I have not….” and “As for top management (…) I wrote two messages that were distributed by them. But it is more like email messages sent by the senior management team.” “Senior management, no, barely. Unless very project driven, then sometimes they highlight on an aspect that we should take into account for the project.”

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4.3.2 Results of perceived communication soft law

First a validation of the awareness of the Business Principles was performed in order to assess if the employees could remember the core values of the bank. Most respondents were able to mention at least one business principle with two exceptions: one person could recall none and one had a score of 100%. Integrity has been mentioned 4 out of 7, Open & Clear 3 out of 7, Respect 2 out of 7 and Responsible 1 out of 7. In two of the seven interviews ‘honesty’ was mentioned, although this is not one of the business principles. After sharing the full list of Business Principles all respondents stated they act according to the principles in their daily practices. “If I see them, based on my own perception, I apply them all. (…) They are key values that fit me as a person.”, “I see the presented key values as part of my personal way of acting. It fit's my way of life.”, “I think I apply all of them.” and “I can say that I try to apply all of them.”

There is a general understanding (6 out of 7) that the business principles are communicated broadly, mainly via online tutorials /trainings. “I have seen them in a nice module, a course.”, “Of course in the online trainings attention is paid to this on regular basis.”, “We have had quite some trainings in this area.”, “I think we have done an online training, I guess they appeared in there as well.”. Furthermore 4 respondents could remember that the four business principles were placed on the desk pc wallpaper and/or on the screensaver. “What you see in the hallway or on your pc.” , “Also on flyers” and “I see them sometimes on my screensaver.”. The Compliance specialist also emphasizes that the business principles are available on intranet and that usually official publications or announcements from senior management refer to the business principles: “each message published by senior management has a direct link to the business principles.”. For sake of completeness: none of the other interviewees have mentioned their direct manager or senior management as a source when it comes to the communication of the business principles.

Hard- and soft law in the years after the credit crunch : an exploratory study about the perceived interaction between hard- and soft law by employees in the banking industry

Master Thesis