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While society as a whole has an interest in the good governance of financial institutions and perhaps especially financial conglomerates, there is a key question to be answered: what is the most appropriate mechanism for delivering that good governance? The ICGN would argue strongly that the most effective mechanism for delivering good governance is for shareholders to play their full role as owners of these businesses, holding their boards accountable and driving better decision-making over time. While regulators may seek to set and enforce minimum standards, it is only the shareholders which are capable of seeking, and have the necessary incentive to seek, progress towards best practice and the highest possible standards of governance. The ICGN would therefore caution the Joint Forum not to ignore, not indeed to crowd out, the role of shareholders in encouraging better corporate governance at financial institutions.
The starting point for any quality corporate governance for the financial sector must be that their boards undergo fit and proper tests. The board must also set and clearly articulate, internally and externally, the organisation’s risk appetite. With regard to risk appetite, the ICGN believes it is necessary for financial institutions to know who their counterparties are and to know the structure of the businesses from their counterparties. It is explicitly necessary to have a clear understanding of the derivates used by counterparties. Establishing risk appetite also means that financial institutions should run risk systems which show a manager which risks exist and how they evolve. The risk system should be complementary to having in place appropriate arrangements for capital and liquidity management.
Part of the complexity in financial conglomerates may arise as the organisational structure of a financial institution can sometimes differ from its legal structure. Shareholders, but also managers, need to have clear insight into the legal structure. The ICGN notes that the differences between the organisational and legal structures can sometimes lead to the existence of conflicts of interest. There is also the issue of conglomerates including regulated and unregulated entities, as well as entities regulated by different regulators. There is a crucial role for regulators in ensuring that this complexity does not allow issues to drop between the cracks of regulation, and to enable sufficient transparency such that the shareholder role can be effectively played in relation to the unregulated entities in particular – where there can be no substitution by the regulator for this role. A corporate governance framework should make sure that both regulated and unregulated businesses are lead by the same ethical and management standards.
The ICGN would encourage the Joint Forum to add a further principle specifically on conflicts of interest and the role of the group board in overseeing the associated risks, in particular where conflicts of interest arise between the different elements of a financial conglomerate. The aim of such policies on conflicts of interest must be to protect the interests of the clients of the financial conglomerate and to preserve long-term value in the group as a whole.
The ICGN welcomes the presence of a principle in the Joint Forum’s proposed standards with regard to remuneration. The ICGN particularly welcomes the call in the principle and its elucidation in the implementation guidance of the need properly to integrate risk analysis into remuneration framework. However, the ICGN is not sure that this articulation goes far enough: stating that pay should be aligned with prudent risk-taking only goes so far and the ICGN would argue that a further step ought to be taken in the implementation criteria such that it clearly states that a risk analysis needs to be integrated into any assessment of performance on which remuneration awards are based. One further element of best practice remuneration structures which the ICGN believes should be mentioned in the Joint Forum’s discussion of this issue is that the cost of capital associated with a particular activity needs to be integrated into the calculation of any rewards for those participating in this activity.
Finally, the ICGN would argue that the Joint Forum’s proposals need to provide for the creation of resolution plans, in case bank recovery should ever become necessary. There need to be arrangements in place to deal with the failure of a financial institution, something that is of particular importance in relation to financial conglomerates.