Tracking governance and the role of the Board

Elisabeth Stheeman, senior advisor, Bank of England on the role of senior management and the importance of cross sector learning.

The UK has a long history of corporate governance that emphasises the collective responsibilities of the directors of a company’s Board. In the recent financial crisis, a number of financial sector firms failed or came close to it, calling into question the effectiveness of their Boards. Furthermore, the lack of regulatory enforcement action against individual directors reinforced a public perception that collective responsibility shielded individuals from being held to account for their own decisions or actions.

A two-pronged approach to governance

In response, the Prudential Regulation Authority (PRA) at the Bank of England (BoE) has developed a two-pronged approach: at a collective and an individual level. The first approach is to clarify the expectations of the Board of regulated entities and its collective responsibility for the governance of the firm. This emphasises the responsibility of Boards to establish strategy, set the risk appetite, monitor risk across the business and hold management to account. [pullquote class=”right”]The lack of regulatory enforcement action against individual directors reinforced a public perception that collective responsibility shielded individuals from being held to account for their own decisions or actions.[/pullquote]The second is the development of the Senior Managers Regime (SMR) implemented in the UK in March 2016. The regime is designed to ensure individual accountability of senior managers for a range of areas, including their own conduct, overseeing the business conduct of the key individuals reporting to them, and the on-going safety and soundness of their firms.

Matching the governance structure to the firm

It is our experience that the design of an appropriate governance framework is dependent on the complexity of the firm’s business model, its geographical spread, and the tone and culture set by senior management. We also believe that the framework is best designed and owned by the firm itself. So rather than requiring a particular model, the PRA works with firms to address perceived weaknesses in their approach.

“Show us your culture”

In a speech on ‘Culture in financial services’ last year, Andrew Bailey (then CEO of the PRA) summarised this as follows: “As Supervisors, we cannot go into a firm and say ‘show us your culture’. But we can, and do, tackle firms on all the elements that contribute to defining culture, and from that we build a picture of the culture and the detriments.” This can be a lengthy process. Applying the same principles to a significant subsidiary of a wider group adds greater complexity, particularly in the composition of Boards and Board Committees.

Tracking governance through the board’s activity

During the discussion it emerged that one of the ways of tracking governance and behaviour is by focusing on the activities of the Board, including both individual directors and Non-Executive Directors (NEDs). In addition the different board committees such as Audit and Risk or Remuneration Committees can provide an indication of how well the board operates.

Growing complexity challenging boards

Over the years we have seen that the role of the Board in financial services has become more complex, to some extent due to the increasing amount and complexity of regulation. In the discussion it emerged that this experience was shared in other industries as well, especially those which are highly regulated, such as utilities and healthcare, to name just a few. It was also surprisingly consistent across different industry sectors (ranging from the National Statistics Office to the Food Standards Authority). Given the complexity (of both firms and the role of the Board) a clear distinction between the role of the NEDs and the executives is an important element of maintaining good governance and a measure of tracking its quality. This view too was mostly shared across the sectors represented in the discussion.

Cultural and legal context matters

But these differences must also be viewed within the legal and cultural contexts in which they exist. For example, there are greater differences between Unitary Boards (such as in the UK) and Supervisory Boards (such as in Germany and other Continental European countries) given the different roles boards play in those countries due to other corporate governance codes than in the UK.

The importance of the tone from the top

[pullquote class=”left”]One of the ways of tracking governance and behaviour is by focusing on the activities of the Board.[/pullquote]The discussion also highlighted that governance can be challenging in different types of industries, ranging from financial services, through energy and food standards. It was rather surprising to see how many similarities there are across different sectors, such as the importance of the “tone from the top” and an integrated risk management approach. Themes such as the importance of a strong chair, who leads from the top, and open communication between regulators and regulated entities, were often mentioned. Different sectors also share the common challenges of creating tangible metrics for tracking governance.

Common themes hold key to tracking governance

It is unlikely that a simple set of metrics can be devised for tracking governance, but exposure to common themes across a wide range of sectors and an understanding that others face similar challenges that are not unique to financial services is a good starting point to examining these solutions.

‘The Governance Trap: Tracking Behaviour and Change’ is the second event in a series of collaborations between Solvency II Wire and the Centre for Analysis of Risk and Regulation (CARR) at the London School of Economics.

The event was held in London on 3 November 2016, hosted by   Dentons. If you’d like to learn more about or read articles from the first event in this series, The Governance Trap and the Future of Regulation, please click here. To receive the next article in the series directly to your inbox and subscribe to the Solvency II Wire mailing list for free, click here. [widget id=”mp_featured_posts-28″]]]>

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