The Office of the Superintendent of Financial Institutions (“OSFI”) has issued a final version of its new guidance with respect to the governance of Canadian chartered federally regulated financial institutions (“FRFIs”) (the “Revised Guideline”). The Revised Guideline does not apply to branch operations.
The Revised Guideline replaces OSFI’s 2003 Corporate Governance Guideline. OSFI notes that corporate governance practices have evolved significantly over the past ten years and that, in recent years, a number of regulators, international standard-setters and various commentators have published reports highlighting industry best practices and standards with respect to the effective corporate governance of financial institutions. The publication of the Revised Guideline follows an extensive period of consultation with the financial services industry including professional advisers. At the time of the publication of the Revised Guideline, OSFI also published a summary of the key comments received and an explanation of how the issues raised by commentators were dealt with in the Revised Guideline.
The process leading to the finalization of the Revised Guideline can be traced back to the establishment by OSFI in 2010 of a dedicated Corporate Governance Division and the subsequent cross sector review of the corporate governance practices of certain larger FRFIs in 2010 and 2011.
OSFI indicated that the main objectives of the Revised Guideline were to ensure that FRFIs have prudent corporate governance practices and procedures that contribute to their safety and soundness; industry best practices in corporate governance are promoted; the Revised Guideline is consistent with OSFI’s updated Supervisory Framework (2011); and that the guidance addresses international standards, as articulated by organizations such as the Financial Stability Board (FSB), the Organization for Economic Cooperation and Development (OECD), the Basel Committee for Banking Supervision (BCBS) and the International Association of Insurance Supervisors (IAIS).
In implementing the Revised Guideline, OSFI has sought to enhance the effectiveness of the Board of Directors of FRFIs (e.g., Board responsibilities and competencies); strengthen the risk governance of FRFIs (e.g., the requirement to develop a ‘Risk Appetite Framework’ to guide FRFIs’ risk-taking activities); and bolster the overall internal control framework of FRFIs (e.g., the role of the Chief Risk Officer and Audit Committee). OSFI notes that such changes are consistent with OSFI’s Supervisory Framework, current industry best practices and international standards.
OVERVIEW OF THE REVISED GUIDELINE
Under the Revised Guideline, OSFI expects Boards and Senior Management to be proactive, and to be aware of best practices related to corporate governance that are applicable to their institution and, where appropriate, institutions should adopt these best practices.
OSFI notes that a FRFI’s Board and Senior Management are ultimately accountable for the FRFI’s safety and soundness and compliance with the law. In the Revised Guideline, as in OSFI’s Supervisory Framework, the roles of the Board and Senior Management are purposively distinguished. The Board is made responsible for providing stewardship, including direction-setting and oversight of the management and operations of the entire FRFI. Senior Management is ultimately accountable for implementing the board’s decisions and for directing and overseeing the effective management of the operations of the FRFI.
The key sections of the Revised Guideline, focus, respectively, on three fundamental components of corporate governance for FRFIs: the role of the Board of Directors; Risk Governance, described as a distinct and crucial element of corporate governance for FRFIs; and the role of the Audit Committee.
THE ROLE OF THE BOARD
OSFI notes that in addition to the roles and responsibilities outlined in the applicable federal legislation, the Board should approve the FRFI’s: short-term and long-term enterprise-wide business objectives, strategy and plans, including the Risk Appetite Framework (described below); significant strategic initiatives or transactions; internal control framework; appointment, performance review and compensation of the CEO and, where appropriate, other members of senior management including the heads of oversight functions; succession plans with respect to the Board, CEO and, where appropriate, other members of senior management including the heads of oversight functions; mandate, resources and budgets for the oversight functions; and external audit plan.
The Board should also review and discuss the FRFI’s: significant operational and business policies; business and financial performance relative to the Board-approved business strategy and the Risk Appetite Framework; compensation policy for all human resources, to be consistent with the Financial Stability Board Principles for Sound Compensation and related Implementation Standards; implementation of internal controls; organizational structure; and compliance with applicable laws. The Revised Guideline notes that the latter functions are primarily the responsibility of Senior Management. However, through thorough review and discussion, OSFI notes that the Board has a critical role in providing high-level guidance to senior management. Further, OSFI indicates that the Board should establish processes to periodically verify the assurances provided to it by Senior Management. In response to commentaries from stakeholders the Revised Guideline indicates that Boards of parent companies should determine what board structures would best contribute to effective oversight of the subsidiary operations.
In respect of board effectiveness, OSFI indicates that the Board should regularly conduct self-assessment of the effectiveness of Board and Board Committee practices, occasionally with the assistance of independent external advisors. OSFI notes that relevant financial industry and risk management expertise are key competencies for the Board of an FRFI and that there should be a reasonable representation of these skills at the Board and Board Committee levels. Further, OSFI indicates that Directors should seek internal or external education opportunities in order to fully understand the risks undertaken by their FRFI, as well as the developments in corporate and risk governance practice.
OSFI indicates that the Board should be independent from Senior Management. Beyond the principle of separating the roles of Chair and CEO, OSFI does not view any one board structure or process as guaranteeing independence. The Revised Guideline notes that the Board’s ability to act independently of Senior Management can be demonstrated through practices such as having regularly scheduled Board and Board Committee meetings that include sessions without Senior Management present. In addition, OSFI recommends that the Board should document and approve a director independence policy that takes into consideration the specific ownership structure of the institution. Where appropriate, director tenure should also be factored into the independence policy.
In respect of the Board Chair, the Revised Guideline recommends that the role of Chair should be separated from that of CEO, as it is indicated that this is critical in maintaining the board’s independence, as well as its ability to execute its mandate effectively.
Interface with Senior Management/Oversight Functions/Internal Controls
The Revised Guideline notes that in order for the Board to fulfill its duties, the Board relies on Senior Management to provide it with sound advice on the organizational objectives, strategies, structure and significant policies of the FRFI. Further, the Revised Guideline indicates that OSFI expects the FRFI to establish oversight functions that are independent from operational management. In addition, the Revised Guideline indicates that the Board should have unfettered access and, for functional purposes, a direct reporting line to the Board or the relevant Board Committee (e.g., Audit, Risk).
The Revised Guideline indicates that the Board should regularly assess the effectiveness of the FRFI’s oversight functions and processes and occasionally the Board should conduct a benchmarking analysis of those functions or their process with the assistance of independent external advisors.
As regards internal controls, the Revised Guideline indicates that the Board should approve the overall internal control framework and monitor its effectiveness.
OSFI notes that risk governance is a distinct and crucial element of corporate governance of an FRFI.
Risk Appetite Framework (RAF)
The Revised Guideline directs each FRFI to have a Board approved RAF that guides risk taking activities of the institution. The RAF should set basic goals, benchmarks, parameters and limits, as to the amount of risk an FRFI is willing to accept, taking into account various financial operation and macroeconomic factors. It should also consider the material risks to the institution, as well as the institution’s reputation vis-à-vis policy holders, depositors, investors and customers.
Oversight of Risk
The Revised Guideline indicates that depending on the nature, size, complexity, and risk profile of an institution, the Board should establish a dedicated Board Risk Committee to oversee risk management on an enterprise-wide basis. The Revised Guideline also notes, in response to comments from commentators, that for small less complex institutions, in the place of establishing a separate Risk Committee, the Board should ensure that it has the collective skills, time and information to provide effective oversight of the risk management on an enterprise-wide basis.
Chief Risk Officer (CRO)
The Revised Guideline provides that each FRFI should have a senior officer who has responsibility for the oversight of all relevant risks across the firm. The CRO should have sufficient stature and authority within the organization, and be independent from operational management. The CRO should have unfettered access, and, for functional purposes, a direct reporting line to the Board or Risk Committee (as applicable).
ROLE OF THE AUDIT COMMITTEE
OSFI notes that it is an international best practice for all members of the Audit Committee to be independent and that many FRFIs have moved to this standard. It originally proposed this standard for FRFIs. In the face of opposition from commentators, the Revised Guideline does not seek to change the current standard noting that the current legislation only requires each FRFI to establish an Audit Committee comprised of non-employee directors, a majority of whom are not affiliated with the institution. The Revised Guideline highlights that the Audit Committee, not Senior Management, should recommend to the shareholders, the appointment, reappointment, removal and remuneration of the external auditor and should also agree to the scope and term of the audit engagement and the approval of the engagement letter.
In a final section of the Revised Guidelines, OSFI describes the role of corporate governance in OSFI’s supervisory process and notes that effective oversight of an institution by its Board and Senior Management is essential to the maintenance of an efficient and cost effective supervisory system.
OSFI expects FRFIs to conduct a self-assessment of compliance with the Revised Guideline and to establish a plan to address any deficiencies. FRFIs should advise their OSFI Relationship Manager in writing of the results of their self-assessment and the related action plans by May 1, 2013. OSFI indicates that the self-assessments are to be retained by the FRFI and made available to OSFI upon request. Full implementation of the Corporate Governance Guideline by FRFIs is expected by OSFI no later than January 31, 2014.