Philip Weights – Founder & MD of Enhanced Banking Governance GmbH
The Basel Committee on Banking Supervision has stated that corporate governance for banking organisations is arguably of greater importance than for other companies, given the crucial financial intermediation role of banks in the economy. It is essential to achieving and maintaining public trust and confidence in the banking system.
Problems and solutions
The US Government’s Financial Crisis Inquiry Report, issued in 2011, concluded that dramatic failures of corporate governance and risk management at many systemically important financial institutions were key causes of the crisis. This article suggests that in order to fully restore public trust and confidence in the banking sector, further measures need to be taken to enhance banking governance. For banks, this includes these two measures:
■ Appointing a chief governance officer (CGO)
■ Creating a governance committee with board oversight
Enhancing banking governance is not only about the rules and regulations. It concerns the need for more robust implementation, to all levels of the organisation, in all regions, with improved monitoring, auditing and board oversight, enabled by assigned responsibility and accountability.
Loss of trust in banks and bankers
The financial crisis and financial scandals have caused a loss of public trust and confidence not only in banks and bankers, but also in the entire financial system. This includes the regulators, auditors, rating agencies, politicians and even countries. During the height of the financial crisis there was an estimated $900 billion of bank bailouts, failures and crisis mergers/acquisitions.
According to the IFC-World Bank Group, the central irony of the governance failures that became apparent in the crisis is that many took place in some of the most sophisticated banks operating in some of the most developed governance environments in the world, such as the US and UK. At the last count, according to the CCP Research Foundation, the global banking industry incurred more than £166 billion in fines, settlement fees and provisions between 2009 and 2013.
Offences range from those related to the US subprime housing crisis (mis-selling mortgage backed securities, abusive foreclosure practices), Libor rigging and currency market manipulation, breaching sanctions against Iran and Sudan, money laundering for Mexican drug barons, Swiss banks facilitating client tax evasion and UK banks mis-selling payment protection insurance (PPI).
So little wonder that banks and bankers are suffering the lowest reputation in their history. Even the conservative Economist magazine was provoked to carry a cover titled ‘Banksters’ in July 2012, the same month that the Daily Mail carried an article with the banner ‘Yes, the bankers who robbed us all are criminals. Now let’s throw them in jail!’. A 2014 survey report by PwC in the UK titled How Financial Services Lost Its Mojo – And How It Can Get It Back charts the decline of the relationship between the UK financial services sector and its customers. The survey confirms that a legacy of the financial crisis is a comprehensive loss of trust after years of perceived poor service and a litany of scandals. Its research evidences that consumer perceptions are heavily influenced by factors such as business ethics, executive remuneration and governance.
In July 2015, Globescan, a major market research company, published the paper Seven Years On From The Financial Crisis: Trust In Banks Remains At All Time Low. This shows the public’s trust in banks and financial institutions to be deeply in negative territory and concerns about trust and confidence in banks and financial institutions show no sign of diminishing. The global survey identified ‘operating ethically’ as the most important issue the industry needs to address. Therefore, ethics lies at the core of the trust deficit. This theme is also covered by Edelman, a large public relations firm. For 15 years, the Edelman Trust Barometer has measured trust in business, media, NGOs and government.
“The financial crisis and financial scandals have caused a loss of public trust and confidence in the entire financial system”
In 2015, they surveyed 33,000 respondents in 27 countries. Its survey report The State of Trust in the Financial Services Industry highlights this being the least trusted sector, with additional troubling signs of fear and distrust coming from attacks by hackers, cyber-terrorists and rogue players gaming the system to create unfair advantages.
Improving banking governance is necessary to repair the image and reputation of banks and restore client and investor trust and confidence – equally, the trust of the public and the banking regulators. Just as important is to address issues within the banks, where the morale of many banks is reported to be low. It has become increasingly difficult to attract and retain top talent. Regulatory pressure, increased scrutiny (including an enhanced possibility of personal liability) and bonus caps have driven many experienced individuals out of traditional banking. The risk-reward trade-off is changing. Politicians have strengthened pay codes to limit bonuses and imposed substantial rights of claw-back over payments to executives. The FCA has been granted new powers to prosecute and, if deemed appropriate, imprison top banking executives and directors.
Press reports from October 2014 suggest that an HSBC non-executive director and senior member of HSBC’s audit and risk committee had resigned in protest at these new rules. The HSBC chairman subsequently admitted the director had some incremental concerns surrounding the application of the new ‘Senior Managers Regime’ to non-executive directors.
The question is, how can the financial services industry dig itself out from a black hole of mistrust, damaged reputation and regulatory stress? Clearly, demonstrating a robust governance of the industry is essential and the creation of the role of chief governance officer is a key element to achieving this.
In researching the history of the development of the role of the chief governance officer, it is evident there are two separate and distinct approaches. The first, which dates from the 1970s, is derived from the ‘policy governance’ model, a system of organisational governance developed by Dr. John Carver. Dr. Carver has trained hundreds of consultants and directors at the Policy Governance Academy and authored several books including Boards That Make a Difference and Reinventing Your Board. There are 10 principles of policy governance: principles 1-3 define an organisation’s ownership, the board’s responsibility to it and the board’s authority; principles 4-7 specify that the board defines in writing policies identifying the benefits that should come about from the organisation, how the board should conduct itself and how staff behaviour is to be proscribed; and principles 8-10 deal with the board’s delegation and monitoring. The Carver Policy Governance guide Adjacent Leadership Roles: CGO and CEO describes the chief governance officer as a “specially empowered member of the board who ensures the integrity of the board’s process and the completion of its products”. It describes the assigned result of the CGO’s job being that the board behaves consistently with its own rules and those legitimately imposed on it from outside the organisation. In defining that the CGO is empowered to chair board meetings, the policy governance approach considers the chairman of the board to be the chief governance officer.
The second approach is to take action within the management structure. This involves adding the title of CGO to an existing executive position already possessing a corporate governance role. Typically, this is the corporate secretary, chief legal counsel or, less frequently, the head of compliance or risk. In March 2013 Peterson Sullivan LLP, a Seattle-based CPA firm, published a paper titled CGOs Make Corporate Governance A Top Priority. The paper notes that to ensure corporate governance matters get the attention they deserve many companies are appointing chief governance officers. It suggests that a ‘central command’ with a formally appointed CGO sends a powerful message to investors and other stakeholders that integrity, transparency and accountability matter to the company. This theme is also picked up in the Nov/Dec 2011 edition of the Trustee Workbook of the Center for Healthcare Governance in its paper titled The Role of the Chief Governance Officer. It describes the core responsibilities and key competencies of a CGO within the hospital/healthcare sector. More recently, in August 2015 the Canadian Society of Corporate Secretaries held its 17th Annual Corporate Governance Conference in Montreal. The Opening Plenary Session on 18 August was titled The Chief Governance Officer: The New Role of the Corporate Secretary and it discussed the evolving role of the corporate secretary. The prominence of corporate governance requirements in law and practice continues to grow and mature and so does the role and responsibility of the corporate secretary function, now being retitled chief governance officer in many organisations.
For the financial services industry the ideal solution is a combined approach. Within banks, the approach could be for boards to adopt the Corporate Governance Principles for Banks revised in July by the Basel Committee on Banking Supervision. As outlined in Principle 1 ‘board’s overall responsibilities’: “The board has overall responsibility for the bank, including approving and overseeing management’s implementation of the bank’s strategic objectives, governance framework and corporate culture.” This Principle requires a combined approach, with approval and oversight at the board level and implementation by management. Under the ‘duty of care’ on Principle 1, the board should “oversee implementation of the bank’s governance framework and periodically review that it remains appropriate in the light of material changes to the bank’s size, complexity, geographical footprint, business strategy, markets and regulatory requirements”. Compliance with this duty of care implies the creation of a governance committee and the appointment of a corporate governance officer. The creation of a specialised board committee for governance is in fact recommended in Principle 3 (point 77) of the Basel Principles. It can be standalone, or combined with ‘nominations’, ‘ethics’ or ‘compliance’.
CGO role and responsibility
The CGO role varies from company to company depending on factors such as size, structure, complexity, risk, profile and culture. A CGO might, for example:
Assess and monitor the governance framework: The CGO provides an ongoing evaluation of the company’s board structure and governance practices and recommends modifications as the company’s circumstances or regulatory environment changes.
Ensure compliance: This involves coordination with various corporate departments, internal audit, compliance, risk, legal, human resources and investor relations, to ensure the company complies with laws and regulations related to corporate governance.
Develop policy: The CGO helps the company develop code of conduct/ethics/conflict-of-interest standards and other governance policies.
Educate the board: The CGO keeps the board of directors and management up to date with the latest corporate governance trends, regulations and best practices.
Support the governance committee: The CGO should support the creation of a governance committee and assist in developing the terms of reference and subsequently the activities of the committee in supporting the board fulfil its governance oversight responsibility.
Validate external governance reporting: Review and recommend to the board the bank’s annual disclosure of its corporate governance practices.
Assess subsidiary governance: Ensure the preparation of an annual report on subsidiary governance.
In this regard, it is not sufficient for banks to only have good governance in head office and the main group board. The CGO is positioned to take a global and holistic view on governance at all levels, in all regions, where the bank operates. The CGO should be guided by Principle 5 ‘Governance of group structures’ of the Basel Corporate Governance Principles for Banks.
“When appointing a corporate governance officer, banks should strive to make this an independent full-time, high-level position reporting to the chief executive”
When appointing a corporate governance officer, banks should strive to make this an independent full-time, high-level position, reporting directly to the chief executive. This is especially important for stock exchange-listed banks with global operations and entities already classified as ‘Systemically Important Financial Institutions’ (SIFIs), i.e. a bank, insurance company or other financial institution whose failure might trigger a financial crisis. Risk governance and the related internal control systems, involves the business (front office) as the first line of defence, risk and compliance as the second line of defence and internal audit as the third line of defence.
In many instances there can be substandard coordination and communication between the different actors in the governance and control systems within banks. It is therefore critical for the CGO, as the governance central command, to maintain strong, effective and frequent contact with all three lines of defence.
Global developments in CGO appointments
There is evidence of an increasing trend to appoint a chief governance officer or chief corporate governance officer – in one case (Bank of Ireland) chief governance risk officer – in banks, financial services institutions and many other companies. Research indicates the existence of such positions in Deutsche Bank, Allianz SE, Citibank, New York Community Bancorp Inc, Bank of New York Mellon Corporation, Prudential Financial, HSBC, Royal Bank of Scotland Group, Royal Bank of Canada, Bank of Ireland, Danske Bank, ABN AMRO Bank, Saudi Hollandi Bank, Development Bank of the Philippines, African Development Bank, Depository Trust & Clearing Corporation, Intesa Sanpaolo, HSH Nordbank, Bank Forward and the Gruppo Banca Leonardo. In most cases, banks with a CGO have also established a corporate governance committee.
Some banks have created a corporate governance and business ethics committee or combined governance with nominations through a corporate governance and nomination committee. In one bank (HSBC), the governance responsibility is handled by the ‘financial system vulnerabilities committee’ which has non-executive responsibility for governance, oversight and policy guidance. Such committees should be board-designated, preferably chaired by either the chairman of the board or a senior independent non-executive director and should be responsible for the appointment and dismissal of the CGO and the annual appraisal of the CGO performance.
Corporate governance matters to investors and credible sources (McKinsey, OECD, World Bank, IFC) support the view that there is an investor premium for companies with good governance. This adds value and increases the stock price. Evidence shows that companies benefit from governance initiatives by expanded access to finance, reduced organisational inefficiencies and improved strategic decision making, enhanced brand and better shareholder/stakeholder relationships, reduced risk, improved growth outlook and increased potential for long-term business sustainability. According to a 2010 IFC survey Corporate Governance Matters to Investors in Emerging Market Companies, investors often avoid investing in emerging market companies with poor governance.
Looking to the future
There is a need for full-time CGOs to be appointed to all systemically important financial institutions and stock exchange listed banks and companies. Education and certification is essential. To this end there is a need for CGO training qualifications and at the country level the formation of Institutes of Governance Officers. As with other professions in banks (such as audit, risk and compliance), there should be international standards for CGOs. Ideally, impetus for the CGO function could come from the guidance of the financial regulators.
Strong corporate governance can go a long way toward helping banks regain the trust of investors, government regulators, employees, customers and other stakeholders. Trust is the life blood that allows business to function. Given the complexity of corporate laws and regulations today, appointing a chief governance officer and creating a governance committee with board oversight, will help banks demonstrate they are serious about making governance a priority and will assist in restoring the reputation of the industry.
About The Author:
Philip J. Weights is the MD of Enhanced Banking Governance GmbH in Zurich. The firm provides corporate governance services to boards, audit committees and management of banks. Previously Philip was Chief Auditor of a Swiss Private Bank.