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A review of corporate governance in UK banks and …

A review of corporate governance in UK banks and other financial industry entities Final recommendations 26 November 2009. 1. Contents A review of corporate governance in UK banks and other financial industry entities Final recommendations Contents Preface 5. Executive summary and recommendations 9. Board size, composition and qualification 14. Functioning of the board and evaluation of performance 15. The role of institutional shareholders: communication and engagement 17. governance of risk 19. Remuneration 20. Chapter 1: Introduction, context and scope 23. Introduction 23. Context for this review of corporate governance 25. The FRC and the Combined Code 28. Scope and criteria for this review 30. Chapter 2: The role and constitution of the board 33.

Contents A review of corporate governance in UK banks and other financial industry entities Final recommendations Chapter 4: Functioning …

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1 A review of corporate governance in UK banks and other financial industry entities Final recommendations 26 November 2009. 1. Contents A review of corporate governance in UK banks and other financial industry entities Final recommendations Contents Preface 5. Executive summary and recommendations 9. Board size, composition and qualification 14. Functioning of the board and evaluation of performance 15. The role of institutional shareholders: communication and engagement 17. governance of risk 19. Remuneration 20. Chapter 1: Introduction, context and scope 23. Introduction 23. Context for this review of corporate governance 25. The FRC and the Combined Code 28. Scope and criteria for this review 30. Chapter 2: The role and constitution of the board 33.

2 Statutory and other foundations of the board 34. Unitary versus two-tier board structures 34. Respective roles of executives and NEDs 35. Potential contribution of the NED 36. Forced break-up and corporate governance 37. Flexibility through comply or explain 38. Mitigation of NED liability 39. Summary on the role and constitution of the board 40. Chapter 3: Board size, composition and qualification 41. Board size and composition 41. Required experience and competence 43. Induction, training and development 46. The need for internal support 47. Time commitment 47. The regulatory authorisation process for NEDs 49. A review of corporate governance in UK banks and other financial industry entities Final recommendations 2. Contents A review of corporate governance in UK banks and other financial industry entities Final recommendations Chapter 4: Functioning of the board and evaluation of performance 52.

3 Challenge on the board 52. Job specification for a BOFI NED 55. Responsibility and qualification of the chairman 56. Election process for the chairman 60. Role of the SID 62. Evaluation of board performance and governance 63. Chapter 5: The role of institutional shareholders: communication 68. and engagement Introduction 68. Time horizons and investor strategies 69. Institutional shareholders in the recent crisis 71. Institutional Shareholders' Committee 72. Benefits and difficulties in engagement 73. Response to change in the share register 76. The engagement option 77. Communication in normal situations 79. Responsibilities of the chairman and the SID in 80. communication with shareholders Role of the corporate broker 81. Embedding principles for engagement 82.

4 Enhanced resource commitment and collaboration 85. Voting and voting disclosure 87. Chapter 6: governance of risk 90. Regulation and risk 91. The back book of risk and future risk strategy 92. Composition and role of the board risk committee 95. Independence of the enterprise risk function 98. External advice to the board risk committee 100. Role of the board risk committee in a strategic transaction 102. Risk disclosure and risk governance 103. A review of corporate governance in UK banks and other financial industry entities Final recommendations 3. Contents A review of corporate governance in UK banks and other financial industry entities Final recommendations Chapter 7: Remuneration 106. FSA consultation and policies on remuneration in BOFIs 107.

5 Reach of remuneration committee oversight 108. Disclosure of high end remuneration 110. Parallel disclosure by overseas-listed UK-authorised banks 113. Risk adjustment of performance, incentives, deferment and clawback 114. Retention arrangements 118. Risk adjustment of remuneration arrangements 118. Voting on the remuneration committee report and the committee chairman 119. Remuneration of the chairman and of NEDs 121. The scope for possible further disclosure in remuneration committee reports 122. Best practice standards for remuneration consultancy 123. Annexes Annex 1: Terms of reference for this review 127. Annex 2: Contributors to this review 128. Annex 3: Discussions of statutory and other foundations of the board 135. Annex 4: Psychological and behavioural elements in board performance 139.

6 Annex 5: Suggested key ingredients in a board evaluation process 147. Annex 6: Patterns of ownership of UK equities 148. Annex 7: Possible regulatory and legal impediments to collective engagement 151. Annex 8: The Code on the Responsibilities of Institutional Investors 153. November 2009 (Stewardship Code) and the ISC position paper (5th June 2009). Annex 9: Data on UK BOFI board level risk committees 165. Annex 10: Elements in a board risk committee report 167. Annex 11: Considerations relevant to Recommendation 33 on high end 168. remuneration structures Annex 12: Updated code of conduct for remuneration consultants in the UK 170. Annex 13: Chapter footnotes 177. Annex 14: Implementation of the Walker recommendations 179. A review of corporate governance in UK banks and other financial industry entities Final recommendations 5.

7 Preface Preface In February 2009 I was asked by the Prime Minister to review corporate governance in UK banks in the light of the experience of critical loss and failure throughout the banking system (the review ). The terms of reference are as follows: To examine corporate governance in the UK banking industry and make recommendations, including in the following areas: the effectiveness of risk management at board level, including the incentives in remuneration policy to manage risk effectively; the balance of skills, experience and independence required on the boards of UK banking institutions; the effectiveness of board practices and the performance of audit, risk, remuneration and nomination committees; the role of institutional shareholders in engaging effectively with companies and monitoring of boards.

8 And whether the UK approach is consistent with international practice and how national and international best practice can be promulgated. The terms of reference were subsequently extended so that the review should also identify where its recommendations are applicable to other financial institutions. I published the preliminary conclusions and recommendations of this review in July in the form of a consultation paper with a request for comments and responses by 1 October. Indicative of the very substantial interest in the subject matter from a wide range of stakeholders, over 180 written submissions were received from the organisations and individuals listed in Annex 2 and, with the exception of the minority of submissions that were described as private and confidential , all of these are available on the review website These written responses were complemented by a substantial sequence of discussions with interested parties including chairmen, chief executives, executive and non-executive board members of banks and other corporates, the accounting and legal professions, representatives of A review of corporate governance in UK banks and other financial industry entities Final recommendations 6.

9 Preface smaller shareholders and consumer interests and many others, both within the UK and internationally. This document sets out the conclusions and final recommendations of the review in the light of this consultation process. The principal focus of this review throughout has been on banks , but many of the issues arising, and associated conclusions and recommendations, are relevant if in a lesser degree for other major financial institutions such as life assurance companies. The recommendations in relation to engagement by institutional investors and fund managers as owners were prepared with particular regard to their shareholdings in banks and other financial institutions (BOFIs) but have wider relevance for their holdings in other UK companies.

10 It is not the purpose of this review to assess the relative significance of the many different elements in the build-up to the recent crisis phase. But the fact that different banks operating in the same geography, in the same financial and market environment and under the same regulatory arrangements generated such massively different outcomes can only be fully explained in terms of differences in the way they were run. Within the regulatory framework that is set, how banks are run is a matter for their boards, that is, of corporate governance . In an open market economy, the achievement of good corporate governance reflects successful balancing among an array of influences which is probably at its widest in the case of banks . A critical balance has to be established between, on the one hand, policies and constraints necessarily required by financial regulation and, on the other, the ability of the board of an entity to take decisions on business strategy that board members consider to be in the best interests of their shareholders.


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