Earlier this year Sir David Walker was asked by the UK Government to examine corporate governance in the banking industry. His consultative report was released in July and caused a stir with its far-reaching recommendations about the role of non-executive directors, the establishment of board risk committees and remuneration. There was a lot of chatter in the news about the fact that the Government was not going to adopt these recommendations. Were they too unpopular? Too wide-ranging? Too complicated? Probably a bit of all of those.
What started out as a report into the state of banking was extended to cover other financial institutions, where the recommendations were applicable. It was an extensive study of what could be better, including how financial incentives for board members impact the propensity to manage risk effectively, the balance of skills, experience and independence required on boards and whether the UK approach is consistent with international practice. The overarching message throughout the report is one of poor governance practices, and Sir David is clear about the lack of control. “Serious deficiencies in prudential oversight and financial regulation in the period before the [economic] crisis were accompanied by major governance failures within banks,” he writes. “These contributed materially to excessive risk taking and to the breadth and depth of the crisis.”
So what does this all actually mean for banks and other financial institutions? Sir David has set out recommendations covering:
- Board size, composition and qualification
- Functioning of the board and evaluation of performance
- The role of institutional shareholders specifically around communication and engagement
- Governance of risk
This final point includes one of the most talked about recommendations – executive pay. The report suggests that for the FTSE 100-listed banks and comparable unlisted entities such as the largest building societies, the remuneration committee reports from 2010 should disclose the number of employees earning over £1million. Alongside the reward package should be an indication of the area those people work in. The purpose of doing this is to give shareholders an informed view on the governance of the companies they invest in and the appropriate alignment of incentives. They will be justified in asking questions if shareholder payouts are poor but the top executives are taking home multi-million pound packages. However, while a lot of the Walker recommendations have been picked up internationally, not many non-UK banks have jumped at the chance to roll out this particular reform.
“The UK continues to show the way on reform, which means we now need the international community to take up his recommendations, particularly on the disclosure of pay packages for senior staff,” says Angela Knight, chief executive of the British Bankers’ Association. “The banks have heard the call to publish this information, but they also see the risk in doing so, given that too many countries show no sign of following suit. The UK is a large international centre and it is essential that other countries make the same changes at the same time.”
Are we going to see that? “Aligning executive compensation with long-run performance of the banks is a good idea,” says Dr. Rosa Abrantes-Metz, a principal with LECG’s securities and antitrust practices. “Given that the financial sector is already highly regulated and that governments across the world are backing up these institutions and not allowing them to fail, it is to be expected that government should step in and regulate this aspect as well. However, the relevant policy objectives might be achieved without requiring public disclose of compensation packages. I think that such disclosure will likely have the detrimental effect of pushing away the most talented people in the field due to public pressure to decrease compensation.”
The Government’s Financial Services Bill will set the stage for the disclosure of income. Draft regulations are due in the new year and after a consultation period the plan is to bring them into force as soon as the Bill is enacted – making the disclosure of reward packages for 2010 and onwards compulsory.
This doesn’t go far enough for some commentators, who want remuneration committee reports to name names. “No evidence has been produced that this would be likely to yield any enhancement in the governance of risk in major institutions,” writes Sir David. The report does not suggest that pinpointing individuals is necessary, although no doubt the tabloids will pour over the reports to try to deduce who is who.
The Role of Women on Boards
There are also some commentators who expected the report to talk in more detail about the role of women on boards, but Sir David is interested in getting the most talented people into top roles, not which gender they are. He does say that the number of people sitting on a board has fallen since 2002, and that means fewer executive directors on boards – this is where most people get their board experience. Once you’ve had some board experience on your own company board you can go on to be a non-executive director (NED) on someone else’s board.
The drop in numbers of board members means fewer places to learn what being on a board is all about which has a knock-on impact on board diversity. It’s hard to broaden the base for recruitment of new NEDs when the pool of talent hasn’t been able to get any board experience.
“It would be unrealistic to expect to reduce the present unfortunate gender imbalance by ‘parachuting’ into boardrooms as NEDs women without executive board or senior executive experience elsewhere,” writes Walker. Although he says that a review of gender inequality on boards was out of the scope of his investigation he has used the platform of the report to highlight that the focus of gender initiatives should be on promoting women into senior and executive roles, which will in turn boost the diversity of the talent pool for when companies come to fill NED positions.
Time to Step Up
It might not have met everyone’s expectations but the report is a start. The Government now has to implement the recommendations, which is going to involve a lot of industry bodies. Sir David’s report recommends action to be taken by the Government itself, the Financial Services Authority, the Financial Reporting Council, bank owners, and the banks themselves. So while the Government is quickly stepping up to do its bit, we might have to wait for some of the other groups (and other countries) to catch up.