Recently, the Treasury announced plans to extend the Rules of Conduct under the Senior Managers Regime to non-executive directors (NEDs), in Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA) regulated firms. The speech on 3 November 2015 by Andrew Bailey, CEO of the PRA on governance, spoke on the role of boards as being essential in shining light on the PRA’s expectation regarding the role of NEDs and support expected from executive directors (EDs). In particular, this offers possible relief for NEDs concerned about the increasing burden of their responsibilities. The messages expressed in the speech are useful not only for PRA firms but, in our view, also for FCA firms.
Key messages for firms
- A NED’s main role is to provide constructive challenge
- A firm's culture should promote discussion, debate and honest challenge
- EDs must be able to explain complex matters to NEDs and provide effective Management Information to enable challenge
- NEDs must demand the necessary time and support from EDs where they feel they are not receiving it
Restating the main purpose of the board
The main purpose of board is to set strategy and risk appetite and oversee implementation.
Recently, the Treasury announced plans to extend the Rules of Conduct under the Senior Managers Regime to non-executive directors (NED
De-emphasising the importance of technical knowledge
The PRA "may at times have gone too far in the direction of individual technical knowledge" and the PRA would no longer be expected to interview people “taking up standard NED positions”.
Reiterating the purpose of NEDs on the Board
As a supervisor, the PRA:
- expects boards to exercise good judgement in overseeing the running of the firm and to do so on a forward-looking basis.
- takes the view that judgment is improved by good constructive challenge from NEDs - a firm's culture should promote discussion, debate and honest challenge.
- depends on NEDs, under the leadership of the Chair, to challenge the executives in all aspects of the firm's strategy, including the viability and sustainability of the business model and the establishment, maintenance and use of the risk appetite and management framework.
- relies on NEDs to mentor and coach executives.
The role of Executive Directors in ensuring the effectiveness of NEDs
In response to the challenge of complexity for NEDs, the PRA’s view is that it is the job of executives to:
- be able to explain complex matters to NEDs in simple and transparent terms.
- understand the uncertainty around judgments, in what circumstances they could be wrong, and how there can reasonably be different ways to measure things like liquidity.
- provide good Management Information and enable challenge and thus accountability.
NEDs should not be left to find the answers for themselves. In Mr Bailey’s words, “they should not be pointed towards the haystack with warm wishes for the search ahead”. If they do not feel they can meet the expectations placed on them, they should demand the necessary time and support from executives to enable them to do so.
A change in approach from the PRA?
Mr. Bailey indicated that the PRA is sympathetic to the view that the demands on NEDs "have risen to the point where it is time to stand back and take stock and find ways to improve the approach".
Next steps for the PRA
Currently, the PRA is carrying out work to overhaul its approach to the supervision of governance in firms as it relates to the PRA's statutory objectives. The PRA "will always be cautious" of executives who seem to perceive NEDs as some form of threat. It believes that the really effective executives are those who see NEDs' experience and knowledge as a means of improving the effectiveness of the board’s judgement through constructive support and challenge.