Introduction
Board practices
Senior management
Risk management and internal controls
Compensation
Complex or opaque corporate structures
Disclosure and transparency


Introduction

On October 4 2010 the Basel Committee on Banking Supervision issued a final set of Principles for Enhancing Corporate Governance(1) in the banking sector. The principles are intended to assist both banking organisations(2) in enhancing their corporate governance frameworks and supervisors in assessing the quality of those frameworks. The committee published initial guidance in 1999, with revised principles in 2006. However, since the adoption of the 2006 principles, there have been a number of corporate governance failures and lapses, many of which became apparent during the financial crisis that began in 2007, including:

  • insufficient board oversight of senior management;
  • inadequate risk management; and
  • unduly complex or opaque bank organisational structures and activities.

The revised principles address the following key areas:

  • board practices;
  • senior management;
  • risk management and internal controls;
  • compensation;
  • complex or opaque corporate structures; and
  • disclosure and transparency.

Board practices

With respect to board management, the principles emphasise that the board has ultimate responsibility for the bank's business and risk strategy, organisation, financial soundness and governance. Accordingly, the board should approve and monitor the overall business strategy of the bank, thereby taking into account the bank's long-term financial interests, its exposure to risk and its ability to manage risk effectively.

Moreover, the board should approve and oversee the implementation of the bank's:

  • overall risk strategy, including its risk tolerance/appetite;
  • policies for risk, risk management and compliance;
  • internal control systems;
  • corporate governance framework, principles and corporate values, including a code of conduct (or comparable document); and
  • compensation system.

The board should also provide effective oversight of senior management. In discharging these responsibilities, the board should:

  • exercise sound objective judgement;
  • have and maintain appropriate qualifications and competence, individually and collectively;
  • follow appropriate governance practices for its own work as a board; and
  • be supported by competent, robust and independent risk control functions that are subject to the board's oversight.

Senior management

Under the direction of the board, senior management should ensure that the bank's activities are consistent with the business strategy, risk tolerance/appetite and policies approved by the board. In this regard, senior management should implement appropriate systems for managing both financial and non-financial risks to which the bank is exposed, including a comprehensive and independent risk management function and an effective system of internal controls (see below).

Risk management and internal controls

Banks should establish an effective internal controls system and a risk management function (including a chief risk officer or equivalent for large banks and internationally active banks), with sufficient authority, stature, independence, resources and access to the board. Risks should be identified and monitored on an ongoing, firm-wide and individual entity basis, and the bank's risk management and internal control infrastructures should be adjusted promptly to reflect any changes in the bank's risk profile (including its growth) and the external risk landscape. In addition, the bank's risk exposure and strategy should be communicated, with sufficient frequency, throughout the bank (ie, both horizontally across the organisation and vertically up the management chain).

Compensation

With respect to compensation, banks should fully implement the Financial Stability Board (FSB)(3) 2009 Principles for Sound Compensation Practices and the accompanying Implementation Standards, or the applicable national provisions that are consistent with the FSB principles and standards.(4) Although the FSB principles and standards are intended to apply to significant financial institutions, national jurisdictions may also apply them to smaller, less complex institutions.

The principles further state that the board should actively oversee the compensation system's design and operation. Board members who are most actively involved in the design and operation of the compensation system (eg, as members of the board's compensation committee) should be independent, non-executive members. The principles also emphasise that compensation should be:

  • effectively aligned with prudent risk-taking;
  • adjusted for all types of risk; and
  • symmetric with risk outcomes.

Complex or opaque corporate structures

The board and senior management should know and understand the bank's operational structure (ie, the roles and responsibilities of its different units and entities within the organisation, as well as the formal and informal links and relationships among the different entities and with the parent company). This includes understanding the legal and operational risks and constraints of the various types of intragroup exposure and transactions, and their effect on the group's funding, capital and risk profile. Where a bank operates through special purpose or related structures, or in jurisdictions that impede transparency or do not meet international banking standards, the board and senior management should understand the purpose, structure and unique risks of these operations and also seek to mitigate any identified risks. Operating in jurisdictions that are not fully transparent or that do not meet international banking standards, or operating through complex or non-transparent structures, may expose the banking organisation to financial, legal, reputational and other risks.

Disclosure and transparency

The governance of banks should be adequately transparent to their shareholders, depositors, other relevant stakeholders and market participants. Banks should disclose relevant and useful information that supports the key areas of corporate governance identified above. In general, banks should follow the guidelines set forth in the disclosure and transparency section of the 2004 Organisation for Economic Cooperation and Development Principles of Corporate Governance and disclose any information on the bank's:

  • objectives;
  • organisational and governance structures and policies (in particular, the content of any corporate governance code or policy and the process by which it is implemented);
  • major share ownership and voting rights; and
  • related party transactions.

Banks should also disclose their incentive and compensation policies following the FSB principles and standards related to compensation. Any disclosures should be proportionate to the size, complexity, structure, economic significance and risk profile of the bank.

The committee has emphasised that the principles are not "intended to establish a new regulatory framework layered on top of existing national legislation, regulation or codes". Rather, the application of corporate governance standards in any jurisdiction is expected to be pursued in a manner consistent with applicable national laws, regulations and codes. In this regard, the principles are expected to play a significant role in the implementation of recent financial reform legislation, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act in the United States and similar legislation in the European Union.

For further information on this topic please contact Connie M Friesen at Sidley Austin LLP's New York office by telephone (+1 212 839 5300), fax (+1 212 839 5599) or email (cfriesen@sidley.com). Alternatively, contact Leonard Ng at Sidley Austin's London office by telephone (+44 20 7360 3600), fax (+44 20 7626 7937) or email (lng@sidley.com).

Endnotes

(1) The Basel Committee on Banking Supervision Principles for Enhancing Corporate Governance are available on the Bank for International Settlements website at www.bis.org/publ/bcbs176.pdf.

(2) The terms 'bank' and 'banking organisation' as used in this update and the principles generally refer to banks, bank holding companies or other companies considered by banking supervisors to be the parent of a banking group under applicable national law, as determined to be appropriate by the respective entity's national supervisor.

(3) Formerly known as the Financial Stability Forum.

(4) The FSB Principles for Sound Compensation Practices are available at www.financialstabilityboard.org/publications/r_0904b.pdf, and the Implementation Standards are available at www.financialstabilityboard.org/publications/r_090925c.pdf.

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