Governance > NEDs an onerous position

  

Published: 9th April 2009

The FSA puts Non Executive Directors in an onerous position

As you will know the Turner Review and Discussion Paper 09/2 from the FSA indicate that the financial services industry in the UK will be facing much more intrusive regulation. Furthermore H.M. Treasury has asked Sir David Walker to lead an independent review of corporate governance in the UK banking industry. What does this mean for you?

Reference to S. 2.8 of the Turner Review gives you some indication. “The crisis …led to many cases where internal risk management was ineffective and where boards failed adequately to identify and constrain excessive risk taking.”

Although many different factors contributed to today’s problems I think you will agree that the Walker review will make some anticipated recommendations. Namely NEDs will be expected to be conversant with risk. Risk will need to be firmly quantified. NEDs will be expected to know how these measures work and their strengths and weaknesses. NEDs will be expected to provide robust challenge. The immediate consequence for you will be the huge increase in time that you need to devote to being a NED at a financial firm. Let’s put this into perspective.

The Turner Review alone takes about five hours to read and digest and it was clearly written. But have you looked at the FSA’s CP/08 22 Strengthening Liquidity Standards?

This certainly isn’t straight forward. It runs to 166 pages including the appendix and has some very important implications for you and your firm. To quote “In the first instance the responsibility of the board and senior management of a firm is to maintain adequate liquidity.” 

Your firm will currently be focusing on how to deal with this regime due to be implemented by October this year. In your Board pack you will have noticed a flurry of new liquidity reports. Have they been properly explained to you? In your opinion do they adequately show you the risks for which you are now accountable?

CP/08 22 will also alter profitability. Holding more treasury bills and Gilts is costly. The liquidity risks posed by internet based accounts and the need to attract long term retail deposits also affect net interest income. Have you considered the changes you need to make to the balance sheet? 

Another result of the crisis is the approach the FSA has taken to principle based regulation. Perhaps we should look at a recent speech made by Hector Sants, Chief Executive of the FSA.

“….Furthermore, the limitations of a pure principles-based regime have to be recognised. I continue to believe the majority of market participants are decent people; however, a principles-based approach does not work with individuals who have no principles…..” 

How do you interpret this? It tells me that the FSA are going to be much less accommodating. They will want hard facts and evidence that the rules are being adhered to. How does that affect you? 

I’m not certain what type of interest risk measures you use but the clients I work with use a mixture of gap, basis point value, value at risk, earnings at risk and stress tests. They all have their strengths and weaknesses. There is no one answer and the key is to compare individual reports. Policy statements are written in terms of a “conservative approach to risk and limits”. But exactly how do you determine the level of market risk you run? How does it compare with your expected profitability? In the future you are almost certain to face much more detailed questioning about these issues.

One of the things I have learnt over the years is not to trust risk reports without applying some due diligence. They normally contain a number of inaccuracies and assumptions (which can be erroneous). You need to know about these too. How can you find out? 

In the last decade it has been normal for the Board to receive papers from risk managers explaining the quantitative and qualitative methods used. When I have spoken with NEDs some tell me that the papers are poorly drafted and difficult to understand. Is that surprising? No. Many risk managers forget the audience they are writing for. 

In the future I believe that the fundamental relationship you have with risk will alter. (Indeed this is hinted at in the Turner Report). NEDs will require greater access to risk in order to carry out their duties effectively and where appropriate challenge executives. 

As we used to say in dealing rooms “How does that leave you?”

It’s made life as an NED much more onerous and time consuming.