The FSA has published a speech by Hector Sants (Chief Executive, FSA) entitled The regulators role in judging competence.  

In his speech Hector Sants (HS) discusses the shortcomings exposed by the financial crisis in the governance and risk management of regulated firms.  

According to HS the crisis has demonstrated that:  

  • Some management decisions have revealed a degree of incompetence, and at times a rather cavalier approach regarding risk management.
  • Regulators must be careful not to place excessive reliance on senior management judgements.
  • The necessary challenge was missing from governance structures, in particular boards.
  • There may be questions that can reasonably be asked about the openness of firms’ dealings with regulators, shareholders and their customers.

HS then focuses his remarks on the changes the FSA is intending to make in the area of governance and risk management and what the FSA’s role is when judging competence.  

HS starts by explaining how the FSA’s intensive supervisory approach is critical to achieving greater effectiveness in the area of governance and risk management. He then discusses what this means in practice, particularly for non-executive directors (NEDs) and executives. He then concludes his speech by briefly covering how the FSA is enforcing against these issues, the credible deterrence philosophy.  

HS states that the financial crisis has demonstrated that the FSA can no longer rely on senior management judgements. In the future it will seek to make judgements on the judgements of senior management and take action if, in its view, those actions will lead to risks to its statutory objectives. However, the FSA still believes that senior management carry primary responsibility for their actions and their resulting consequences. This responsibility is shared between NEDs, shareholders and auditors.  

HS then discusses the regulators role in judging competence and what this means in practice for NEDs and executives. The FSA, through its supervisory process, will be working to ensure that NEDs have relevant and diverse expertise, have a willingness to challenge, have independence of thought and the ability to avoid the ‘herd mentality’. This will mean a different calibre of NED, with a different mindset.  

According to HS NEDs will need to raise their technical skills in order to exercise rigorous oversight. They will need to demonstrate competence with regard to risk management, regulation, and the business model of the firm.  

This will require NEDs to work on a full time basis and be compensated accordingly. NEDs will also need to be properly supported to strengthen their technical expertise. The FSA would like to see greater use, by them, of advisers employed in an independent advisory fashion. Similarly, the Risk Committee should have the ability to co-opt risk experts from outside the firm.  

HS states that all financial services firms need an effective risk-management function with clear, independent reporting lines to the Risk Committee. Effective risk managers need a combination of technical competence, communication skills and stature in the organisation to provide genuine challenge to business managers. HS believes that this will only happen if there is an executive director solely responsible for risk on the main board.  

As part of the Significant Influence Function (SIF) review, the FSA has introduced interviews for candidates for a number of the key functions in an authorised firm. The presumption is that any application submitted by a high-impact firm for the roles of chair, CEO, finance director or risk director will result in an interview.  

The FSA’s assessment of SIF competence in post will be based around evidence to support the following areas:  

  • Knowledge. Does the individual have and use the generic knowledge of the sector and the specific knowledge of the firm necessary to fulfil the role?
  • Skills. Does the individual demonstrate the business and interpersonal skills required to fulfil the role and to meet the required standard?
  • Behaviour. Does the individual demonstrate the attitudes and standards of ethical behaviour required to fulfil their role?
  • Expertise. Does the individual achieve positive and fair outcomes and meet the performance standards expected for the post?

HS states that delivery of the FSA’s intensive supervisory approach and effective regulation in general, can only be achieved in partnership with firms, shareholders and auditors. All involved in oversight must ensure that the right business strategies and behaviours are pursued.  

HS also adds a note of caution. The FSA needs, in the changes it is seeking, to create a culture of challenge without creating conflict. The FSA does not want to set up NEDs as a competing governance mechanism against the executive. It is more about making both much more effective.