The final report of the ‘Review of Corporate Governance of UK Banking Industry’ has recommended overhauling the boards of banks and other big financial institutions by strengthening the role of non-executives and giving them new responsibilities to monitor risk and remuneration. It also recommends a stewardship duty on institutional shareholders to play a more active role as owners of businesses.
Sir David Walker, currently a senior adviser to US bank Morgan Stanley and author of the report, said: “The fundamental change needed is to make the boardroom a more challenging environment than it has often been in the past. This requires non-executives able to devote sufficient time to the role in order to assess risk and ask tough questions about strategy.
“Institutional investors should be less passive and prepared to engage earlier if they suspect weaknesses in governance. They enjoy the privilege of limited liability whereas taxpayers have ended up assuming unlimited liability in respect of the big banks. Early preventive medicine through shareholder engagement can save everyone substantial time and money later on,” he said.
On pay, the Walker Review recommends extending the role of the remuneration committee to cover firm-wide remuneration policy, as well as giving the committee direct responsibility for the pay of all highly-paid employees. At least half of variable pay or bonuses should be paid in the form of a long-term incentive scheme with half vesting after three years and the rest after five years. Two-thirds of cash bonuses should also be deferred.
In addition the report recommends greater pay transparency in the big banks by requiring public disclosure of the number of employees earning more than £1m, broken down by bands of pay.
Other specific recommendations in the report include:
- Active investors to sign up to a new independently-monitored Stewardship Code.
- Financial Reporting Council to sponsor Stewardship Code.
- FSA to monitor investor conformity with the Code.
- Chairman of board to face annual re-election.
- Chairman of remuneration committee to face re-election if report gets less than 75% approval.
- Most non-executives to spend substantially more time on the job.
- Induction process for all non-executives and regular training.
- Non-executives to face tougher scrutiny under Financial Services Authority (FSA) authorisation process.
- Banks should have board level risk committees chaired by non-executive.
- Risk committees to scrutinise and if necessary block big transactions.
- Chief risk officer (CRO) to have reporting line to risk committee.
- CRO can only be sacked with agreement of board.
- Remuneration committees should disclose right of high-paid employees to receive enhanced benefits.
Walker said: “We need to get governance back to centre stage. Of course major regulatory issues need to be addressed to assure the soundness of the financial system but there will be significant downside if the regulatory pendulum swings too far. It could harm the ability of banks to provide customers with the financial services they need and lead to substantial increases in fees and charges. Improved governance can play an important complementary role by instilling greater confidence in the way banks are being run by their boards and overseen by their owners. This should help regulators to strike the right balance.”
The Walker Review proposes that most of the recommendations are enforced through inclusion in the Combined Code on Corporate Governance or a separate Stewardship Code for institutional investors, both operating on a ‘comply or explain’ basis. It would be for the Financial Reporting Council (FRC), which has been closely consulted and is currently reviewing the Combined Code, to decide exactly how this would be done. The FSA will consider how to take forward the recommendations applying principally to financial institutions. It is proposed that the recommendations on pay disclosure should be enforced through legislation in the forthcoming Financial Services Bill.
The Labour government has said that it will “move quickly” to implement the reforms of bank pay and governance. Specifically, the government’s Financial Services Bill will allow the Treasury to issue regulations forcing banks to disclose in bands the number of staff earning more than £1million per annum. It will issue draft regulations for consultation in the New Year and bring them into force as soon as practicable after enactment of the Bill. This will force disclosure for the 2010 performance year.
Chancellor of the Exchequer Alistair Darling said: “Banks failed because some of the top people running banks failed to do their jobs. Tougher regulation, including stronger capital and liquidity requirements, reform of the mortgage market, greater competition, consumer protection, and living wills will help to make our system safer for the future. But the culture of the banks themselves must change. Sir David’s proposals are the blueprint for how banks must be run in the future.”
Commenting on remuneration aspects, Jon Terry, partner and head of reward, PricewaterhouseCoopers (PwC), said: “The Walker Review, and any consequent changes to the Combined Code, may represent a last opportunity for the ‘comply or explain’ approach to governing executive pay in the UK – it would be a shame if companies did not take it.
“The potential for multi-tiered regulation across sectors and countries has very real repercussions in terms of affected organisations’ ability to compete for talent – a level regulatory playing field remains critical. Particular care needs to be taken so that overly prescriptive requirements do not put UK institutions at a competitive disadvantage – their appetite for change is being jeopardised by the inconsistent speed of change in other countries,” he added.
The FRC proposes to adopt the recommendations in the Walker Report that it considers are appropriate for all companies. Sir Christopher Hogg, chairman of the FRC, said: “The Combined Code on Corporate Governance and its related guidance provide a framework for all listed companies.”
The FRC will issue a report on its own review of the impact and effectiveness of the Combined Code in early December, together with a draft revised Code, which will be subject to consultation. Subject to the outcome of that consultation, and the necessary changes to the Listing Rules, the updated Code will apply to all listed companies with a Premium Listing for financial years beginning on or after 29 June 2010.
In addition the government has asked the FRC to take responsibility for a stewardship code for institutional investors as recommended by Walker. The FRC has agreed to do so, subject to consultation designed to ensure it can be operated effectively.
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