Bankers beware: a new era of regulation looms

“It is clear that governance failures contributed materially to excessive risk taking in the
lead up to the financial crisis. Weaknesses in risk management, board quality and
practice, control of remuneration ,and in the exercise of ownership rights need to be
addressed in the UK and internationally to minimise the risk of a recurrence. Better
governance will not guarantee that there will be no repetition of the recent highly
negative experience for the economy and for society as a whole but will make a rerun of
these events materially less likely.”

Sir David Walker, ‘A review of corporate governance in UK banks and other financial industry entities’ (July 2009)

In the middle of 2008, when the enormity of the credit meltdown was becoming apparent and big names had started to tumble, I met the CEO of a leading bank and warned him: “Be very afraid. Your industry has screwed up, big time. Banks and financial companies have become the bugbears rather than the enablers of enterprise. Soon the people will start to scream and the politicians will look around for scapegoats. And then, the current global regulatory framework will look like a cakewalk. You will hark back to the good old days of Basel II and Sarbanes-Oxley, once new fear-driven regulations come out.”

Well, the first shots are being fired. The UK’s Walker Report is out for consultation, and has some recommendations that will chill the spine of many a banker. If you sit in the upper echelons of the financial industry, I suggest you pay attention, sharpish. This report will set the tone for many others around the world.

Walker’s first concern is about pay and bonuses. He feels excessive remuneration and badly structured incentives promoted the wild risk-taking culture that fuelled the global credit crisis. The review wants to bring all bank directors and senior officers into the spotlight, with disclosure of total remuneration. The review also recommends giving powers to board remuneration committees to examine pay and incentive structures and assess the possibility of risky behaviour, and disallow the encashment of variable incentives over a short time-frame.

A second highlight concerns the role of the board and independent directors. The review concludes that effective boardroom challenge of the executive is necessary before any major strategic decision is taken. This demands a closer look at board composition and credentials. In particular, financial-industry experience and independence of mind is highlighted. The report suggests that non-executive bank directors will need to devote much more time to their work – a minimum of 30-36 days per annum is recommended. You work it out – you had better be spending 3 full days a month on one board. This commitment should be spelled out in a letter of appointment, and Walker suggests it will limit your ability to hold other board positions.

The role of bank chairpersons is particularly in the spotlight. Walker states that the role demands “both exceptional board leadership skills and ability to get confidently and competently to grips with major strategic
issues. With so substantial an expectation and obligation, the chairman’s role will involve a priority of commitment that will leave little time for other business activity.” I can hear many of you shuddering now…

And finally, the area of risk. Walker recommends full independence in the risk management function, with an enterprise-wide Chief Risk Officer whose tenure and remuneration is determined by the board alone. A board risk committee, separate from the audit committee, should conduct due diligence of all major strategic transactions and have the power to veto them.

Some may be spluttering into their coffee. There’s more in the full report (39 recommendations in all). Wherever you are in the world, some of these measures are coming soon to a board near you. Forward-looking directors and officers would start thinking about them now.

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