The UK Government has recently announced a far-reaching review of bank and financial institution corporate governance arrangements. The review is due to be completed by the end of 2009 and follows UK Financial Services Authority proposals to step up the regulatory scrutiny and accountability of directors and senior management of financial institutions by defining the role expected of non-executive directors and by making certain members of senior management of parent companies directly accountable to the FSA for the first time. The FSA’s proposals will be of particular significance to international groups which are headquartered outside the EU.

Corporate Governance Review

The corporate governance review announced by HM Treasury will focus on the following:

  • The effectiveness of risk management at the board level, including the incentives in remuneration policy to manage risk effectively;
  • The balance of skills, experience and independence required on the boards of banking institutions;
  • The effectiveness of board practices and the performance of audit, risk, remuneration and nomination committees;
  • The role of institutional shareholders;
  • UK and international best practice.

The review is the latest in a series of developments focusing on bankers’ remuneration and senior management responsibility within financial institutions.

Senior management proposals

One such development, a recent UK Financial Services Authority consultation paper (click here to read) proposes greater regulatory scrutiny over senior management of FSA authorized firms, including new rules for non-executive directors and those individuals in parent undertakings and holding companies who exercise a “significant influence” over a UK authorized firm. The FSA is seeking to ensure that it can hold these managers accountable should they fail in their duties. Previously, the FSA has tended to focus on cases of dishonesty or lack of integrity involving senior managers, but going forward, the FSA will also focus on competence and capability. It has taken a strategic decision to investigate a greater number of individuals and will also do so at the “vetting” stage when individuals seek approval to hold positions of significant influence affecting FSA-regulated firms.

Regulated firms may need to re consider their own due diligence in relation to the hiring and suitability of senior management as a result of the proposals. In particular, the FSA paper proposes:

  • To extend the FSA’s “approved persons” regime to certain individuals in a regulated firm’s parent company. This means that many people exercising “significant influence” over an authorized firm who are based in UK or non-EEA parent undertakings or holding companies will, in future, need to be registered with the FSA. Affected individuals will become subject to the FSA’s rules and code of conduct for approved persons and potentially liable to FSA disciplinary action. Persons falling within this category include those whose decisions, opinions or actions are regularly taken into account by the governing body of the FSA regulated firm.

This proposal could potentially entail a fairly significant burden for international firms in terms of:

  • identifying affected persons;
  • carrying out FSA registrations;
  • delivering appropriate training for the individuals concerned;
  • ascertaining how, in practice, significant managers can comply with the rules (since for example, the relevant FSA code of conduct requires the managers to seek to ensure that the firm complies with applicable FSA rules in the business area where the relevant person operates); and
  • considering the availability and extent of D&O insurance coverage.
  • To clarify the role of non-executive directors of financial institutions. The draft new rules propose that non-executive directors must seek to establish, and continually maintain their confidence, in (among other things) the conduct of the firm, the performance of senior management, the firm’s risk management and adequacy of financial controls, the appropriateness of remuneration and the appointment and replacement of key personnel. The FSA will seek to hold non-executive directors accountable, as well as executive directors and the firm itself, if there is evidence to suggest that the non-executives have failed to exercise the requisite competence and/or integrity in the execution of their duties.

Although the new rules purport only to clarify, rather than to extend, the rules applicable to non executives, they may, in practice, make it harder for financial institutions to find and appoint non-executive directors—a task which has been difficult enough for many institutions in the past. Would be non-executives should also have more reason to pause for thought before accepting non-executive appointments in the future and will need to analyze whether they have the skills and competence to perform the job. However, the clarification by the FSA of the areas that non-executives should focus on may, in theory, mean that regulated firms will have to improve the flow of appropriate information to non executives in order to allow them to perform their role.

International groups would be well-advised to start considering these issues and the implications for their businesses sooner rather than later.

The FSA consultation will remain open until March 31, 2009, with the new rules expected to be published during the second quarter of 2009. A six-month transitional period would then be put in place before the rules came into force in order to allow firms time to obtain approvals for people who are newly caught by the rules.