[No. 107] New Heads Up on Review of Corporate Governance in UK Banks

In post No. 87 I wrote about an independent review of corporate governance in the United Kingdom led by Sir David Walker. The review is aimed at examining corporate governance in the UK banking industry and making recommendations to improve the system in view of the financial crisis, including in the following five areas:

1. the effectiveness of risk management at board level, including the incentives in remuneration policy to manage risk effectively;
2. the balance of skills, experience and independence required on the boards of UK banking institutions;
3. the effectiveness of board practices and the performance of audit, risk, remuneration and nomination committees;
4. the role of institutional shareholders in engaging effectively with companies and monitoring of boards; and
5. whether the UK approach is consistent with international practice and how national and international best practice can be promulgated.

His consultation document of mid June 2009 can be found here.

While we are waiting for the consultation period to expire in November 2009, the UK Financial Services Authority has today introduced a new code that will require large banks, building societies and broker dealers in the UK to establish, implement and maintain remuneration policies consistent with effective risk management. The FSA regulates the financial services industry and has four objectives under the Financial Services and Markets Act 2000 (1.  maintaining market confidence, 2. promoting public understanding of the financial system, 3. securing the appropriate degree of protection for consumers and 4. fighting financial crime); it basically aims to promote efficient, orderly and fair markets, help retail consumers achieve a fair deal and improve its business capability and effectiveness. The new code, that applies to some 26 institutions, came with the following side-info from the FSA:

The new code is designed to achieve two objectives: firstly, that boards focus more closely on ensuring that the total amount distributed by a firm is consistent with good risk management and sustainability; and secondly that individual compensation practices provide the right incentives. Eight principles have also been added to the FSA’s handbook to ensure firms understand how the FSA will assess compliance. The code makes clear that it is not expected that firms will enter into contracts with individuals which provide guaranteed bonuses for more than one year. It is also expected that for senior employees two-thirds of bonuses will be spread over three years. Firms are expected to provide the FSA with a remuneration policy statement by the end of October. This will have to be signed off by remuneration committees and will enable the FSA to check compliance with the code. Non-compliant firms could face enforcement action or ultimately, be forced to hold additional capital should they pursue risky processes.

The new code can be found here. For some first reactions in the UK go here.