UK: financial firms' governance - creating a culture of challenge

Hector Sants, the chief executive of the Financial Services Authority, delivered a speech today at the Securities and Investment Institute Conference 2009. He focused on the role of the FSA in assessing the competence of regulated firms' senior management. An overview of the speech is available here. Mr Sants' speech is wide-ranging but of particular interest are his comments on the functioning of financial firms' boards, the role of non-executive directors and their relationship with the FSA. Mr Sants observed:

We need ... to create a culture of challenge without creating conflict. We do not want to set up NEDs as a competing governance mechanism against the executive. It is more about making both much more effective. We therefore continue to support the ‘unitary board’ model, but it must be recognised that such a structure runs the risk of encouraging the herd instinct, both in the sense of encouraging ‘follow the leader’ behaviour and in the sense of the reluctance to ‘break away from the pack’ and express an independent view.

I should say that ensuring individuals have the necessary resolve to restrain over-bearing CEOs is undoubtedly a challenge, and I do believe here the regulators have a role in providing support and encouragement. I would expect a key component to be a greater direct communication between NEDs and the regulators. I would also say that the wider corporate community has to be willing to place a premium on such independence ...

... the structure of governance in financial companies does not need radical overhaul. The attitudes and competence of the individuals who conduct that governance does. In particular we need to create governance arrangements that foster challenge without creating conflict. The effectiveness of governance is the key issue and addressing this challenge is the responsibility of all of us, not just regulators and boards.

Interestingly, Mr Sants provided some information about the FSA's interviews of candidates for significant influence functions (SIF) within firms (part of the approved persons regime). Mr Sants stated:

The presumption is that any application submitted by a high-impact firm for the roles of chair, CEO, finance director or risk director will result in an interview. Other SIF candidates may also be interviewed at the supervisor’s discretion – for example, if there are concerns about the compliance culture of the firm or the track record of the candidate. In the first six months of the enhanced approval process, 51 SIF interviews were carried out. In a number of cases applications were or are being refused as the FSA was not satisfied the candidates had demonstrated fitness and propriety. We published a Consultation Paper (CP08/25) in December 2008 which outlines a number of proposed changes to significant influence controlled functions under the approved person regime. We expect to publish a further statement on these alongside Sir David Walker’s review on governance".

At the risk of making this a lengthy post, it is worth pointing out that the Combined Code makes clear what is expected of non-executive directors (supporting principles from section 1, A.1.):

As part of their role as members of a unitary board, non-executive directors should constructively challenge and help develop proposals on strategy. Non-executive directors should scrutinise the performance of management in meeting agreed goals and objectives and monitor the reporting of performance. They should satisfy themselves on the integrity of financial information and that financial controls and systems of risk management are robust and defensible".