The UK financial services industry has responded positively to the Walker Review, an independent review of corporate governance in the UK banking industry, which has recommended substantial changes to the way the boards of banks and other financial institutions (BOFIs) function in particular through boosting the role of non-executives in the risk and remuneration process.
In the report, Sir David Walker, currently a senior advisor to Morgan Stanley, identified weaknesses in risk management, board quality and practice, control of remuneration, and in the exercise of ownership rights that need to be addressed in the UK and internationally to minimise the risk of a financial crisis recurrence. Better governance will not guarantee that there will be no repetition of the recent highly negative experience for the economy and for society as a whole, but will make a re-run of these events materially less likely.
Sir David Walker said: “These proposals are designed to improve the professionalism and diligence of bank boards, increasing the importance of challenge in the board environment. If this means that boards operate in a somewhat less collegial way than in the past, that will be a small price to pay for better governance.”
The review process has led to 39 recommendations grouped together under five main headings:
- Board size, composition and qualification.
- Functioning of the board and evaluation of performance.
- The role of institutional shareholders: communication and engagement.
- Governance of risk.
Specific proposals include:
- Board level risk committees chaired by a non-executive director (NED).
- Risk committees to have power to scrutinise and if necessary block big transactions.
- More power for remuneration committees to scrutinise firm-wide pay.
- Remuneration committee to oversee pay of high-paid executives not on the board.
- Significant deferred element in bonus schemes for all high-paid executives.
- Increased public disclosure about pay of high-paid executives.
- Chairman of remuneration committee to face re-election if report gets less than 75% approval.
- NEDs to spend up to 50% more time on the job.
- NEDs to face tougher scrutiny under Financial Services Authority (FSA) authorisation process.
- Chairman of board to face annual re-election.
- Financial Reporting Council (FRC) to sponsor institutional shareholder code.
- FSA to monitor conformity and disclosure by fund managers.
- Institutional shareholders to agree a memorandum of understanding (MOU) on collective action.
The FRC was quick to welcome the Walker Review. Sir Christopher Hogg, chairman of the FRC, said: “While Sir David has made it clear that his principal focus is on the governance practices of banks and other financial institutions, the FRC will need to consider to what extent his recommendations are also applicable for some or all listed companies in other sectors and how best to implement them. We will also seek views on these questions as part of our review of the Combined Code.”
The FRC will issue a progress report on its own review of the impact and effectiveness of the Combined Code before the end of the July, with a final report before the end of the year. Any proposed changes to the Combined Code will be subject to a separate consultation.
The second phase of the consultative process is to seek comment and reaction, and interested parties are invited to comment not only on the recommendations here, but also on any relevant issues that they do not cover.
Need for International Uptake
The UK Government ‘strongly’ welcomed Walker’s proposals but highlighted the need for international uptake of similar proposals. Lord Myners, the financial services secretary to the Treasury, said: “Corporate governance failures were a major contributor to the financial crisis. The responsibility for the actions that led the global financial sector to the brink of collapse ultimately rests with the people who sat around the bank board tables and those who approved their appointment. Board members in future must ask tougher questions of their chief executives. They need to spend far more time fulfilling their responsibilities. Shareholders must ensure that directors have the skills necessary for the tasks required.
“International adoption of similar measures would also reinforce corporate governance and contribute significantly to financial stability. Therefore, the Government will take steps to ensure that proposals to improve corporate governance are considered internationally,” he said.
British Bankers’ Association (BBA) had a similar response. Chief executive Angela Knight said: “The Walker Review is about strong governance – it is about ensuring leadership by boards and proper risk controls across the business in both banks and other financial institutions, and it is also about getting the debate on pay packages into the right place by ensuring reward structures look to the long term. It is also about addressing thee responsibilities of the major investors to look at long-term strategies and not just short-term returns. They are owners, not just investors.
“These proposals added together make very substantial changes to the rules. The next step – and the key step – will be to get similar high standards adopted internationally,” she added.
PricewaterhouseCoopers agreed that these were necessary steps but not without challenges – the firm warned that care was needed if the UK is not to be put at a competitive disadvantage as a result of remuneration proposals.
Phil Rivett, financial services assurance practice leader at PwC, said: “This is an important review and we particularly welcome the recommendations for non-executive directors to receive increased support, training and access to external experts in areas such as risk and remuneration. The long-term result should be greater understanding of the impact of risk on the strategy of BOFIs and an enhanced ability to challenge in board discussions. The requirement for a board level risk committee to be established is already best practice. However, identifying an adequate number of NEDs with relevant experience and knowledge to fulfil the roles may present, at least in the short term, a major challenge.”
Jon Terry, reward practice leader at PwC, said: “We support the concept that significant periods of deferral can support a culture of prudent risk-taking. However, we believe that the importance of risk adjustment of performance to determine incentive compensation in the first place is under-emphasised, and actually more important in terms of developing a risk-aware culture. The formulaic approach proposed is also unlikely to be fit for purpose across all aspects of banking operations. Care needs to be taken that overly prescriptive requirements do not put UK institutions at a competitive disadvantage. Seeking advice from the board risk committee should help reinforce the role of risk-adjusted performance.”
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