“Industries characterised by weak accountability-or by individuals seeking to protect themselves on a ‘Murder on the Orient Express’ defence (it wasn’t me, could have been anyone) – are almost invariably less financially stable, and more prone to misconduct.” Martin Wheatley, FCA Chief Executive, March 2015
Much has been written about organisational accountability, ethics, culture and effective governance over recent years. While it is important that values and behaviours are demonstrated at all levels within an organisation if an effective outcome is to be achieved, it is extremely important that those at board level lead by example.
Corporate Governance
Corporate governance has been a focus since the Cadbury Report (1992), then the Walker Review (2009) through to the current Financial Reporting Council’s UK Corporate Governance Code which provides good practice principles and a ‘comply or explain’ approach. The Code expects that FTSE 350 firms will conduct an externally facilitated evaluation of board performance every three years and the regulators expect financial services firms to follow this approach. Increasingly both the PRA and the FCA seem to apply the UK Corporate Governance Code to regulated firms, with medium sized non-listed firms not covered by the Code included too.
In May this year PRA published its consultation paper CP18/15, ‘Corporate governance: Board responsibilities’. Although the paper does not contain anything surprising, it does illustrate the regulator’s areas of interest when it comes to boards and it highlights the role of the Corporate Governance Code. I believe that part of the reason for its publication at this time is the concern that has been expressed by some that the Senior Managers Regime focus on individual accountability would weaken the collective accountability of Boards. Indeed the consultation states
“The draft statement underscores the collective responsibilities shared by board members. As such it complements the individual accountabilities which the PRA is introducing through the Senior Managers and Senior Insurance Managers Regimes.”
Individual Responsibility
The 2008 financial crisis exposed shortcomings in the governance and culture of some firms and the fact that regulation alone was not able to prevent banks from failing. Since then further scandals have continued to damage the reputation of the sector and exposed a culture of greed and a focus on short term profitability. External and internal reviews of individual firms have revealed poor corporate governance and culture as a route cause of these failings. The ‘tone from the top’ is now seen as key, with the board and senior management setting the core values and purpose for the organisation.
In June 2012, the Parliamentary Commission on Banking Standards (PCBS) was established to consider and report on professional standards and culture of the UK banking sector. Their recommendations were published in ‘Changing Banking for Good’ (June 2013), which stated that “a lack of personal responsibility has been commonplace throughout the industry.” They believed that the existing Approved Persons regime was no longer fit for purpose for the whole of regulated financial services sector. The PCBS recommendations aimed to improve individual accountability amongst senior management. These recommendations included replacing the Approved Persons regime; making individual accountability a reality; and reinforcing that each bank is responsible for its own soundness and maintenance of standards.
The regulatory response to the PCBS recommendations and the resulting legislation, the Financial Services (Banking Reform) Act 2013, is the Senior Managers Regime. Corporate governance is an important element of this new accountability regime with a focus on those at board level. Other areas addressing the concerns of the PCBS include changes to remuneration policy and procedures for whistleblowing.
Board Evaluation
Another example of the increased regulatory focus on corporate governance and board effectiveness is regulatory interventions, with some 46% of FCA and PRA s166’s in 2013/14 commissioned in relation to governance. A recent report by Grant Thornton highlighted that reaction to regulatory pressure was not the key driver for boards commissioning an assessment of their own effectiveness; adhering to market best practice came top at 54% and regulatory interaction at only 27%. Our own experience would suggest that a higher percentage of reviews are regulatory driven and certainly the PRA often insists, overtly or otherwise, on external reviews where none have been done in the last three years. The advantage of an external independent review is that it can give a view of how the board is doing compared to its peers, providing both challenge and reassurance. Additionally it may well be easier for an external independent consultant to conduct confidential interviews with board members and then present any difficult or sensitive messages.
Professionally executed a board evaluation will add real value and not just keep a regulator happy
Directors have a duty under the Companies Act to promote the success of their company and I would argue that an effective board is a crucial element of this. Professionally executed a board evaluation will add real value and not just keep a regulator happy. Reviews help the board to identify any shortcomings or barriers to their effectiveness and help support the implementation of any necessary changes as a result. It is of course vital that any recommendations and action plan resulting from the external evaluation is followed up while you still have the momentum. This approach will contribute to improvement in performance in the way the organisation is run, the boards own performance and the individual board members contribution. It will also increase your regulators confidence in your board.
The Chairman often has the biggest single impact on the effectiveness of the board and has a key role to play in a board evaluation, often being the person who decides on the scope of the review and the methodology to be used. The role of the Chairman in ensuring the competence of other non-executive board members has also been highlighted by the Senior Managers Regimes. Various aspects will form the basis of a review including the processes, the board composition and behaviours. In terms of the processes these are usually assessed as part of a desk based review of board and committee papers, minutes, Terms of Reference and development plans. The other areas are explored through questionnaires, face to face interviews and a direct board observation.
Issues that are commonly identified relate to the quality and length of board packs; the timing of meetings and the interaction with board committees; the size of the board; the split between executives and non-executives; the competence, behaviour and diversity of board members; and a lack of succession planning.
With increased regulatory scrutiny and the reputational damage our sector has faced it could be argued that being a board member of a UK financial services firm is becoming a less prestigious and more dangerous position. If the sector wants to continue to attract the brightest and the best to these board positions it needs to ensure that those at board level receive the necessary support, information, knowledge and skills to mitigate that perceived individual risk.
