Financial Services Authority
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Delivering effective corporate governance: the financial regulator’s role

Hector Sants, chief executive of the Financial Services Authority (FSA) delivered a speech yesterday in which he reviewed the progress of regulatory reforms since the financial crisis and, in particular, focused on how more action is needed to deliver effective corporate governance.

He stressed that this was crucial to delivering financial markets and institutions that we can trust and that act in the interests of everyone.   

He explained that the principal regulatory deficiency, pre-crisis, was the inadequate capital and liquidity standards in banking. A great deal of progress has been made in addressing this deficiency and this will go a long way towards dealing with the symptoms of the crisis but he warned that less progress had been made on the specific issue of delivering effective corporate governance and that this needed to be urgently addressed.

Hector Sants said:

“Management are responsible for running firms and ultimately firms fail because of the decisions taken by their boards and their management. These decisions are made within a firm’s corporate governance framework.  The crisis exposed significant shortcomings in the governance and risk management of firms and the culture and ethics which underpin them.  This is not principally a structural issue.  It is a failure in behaviour, attitude and in some cases, competence.” 

He stressed that:

“Ultimately, the purpose of financial markets is to serve everyone, not the personal interests of individuals.   We will only really have learnt the lessons of the crisis when this is recognised by all.” 

He highlighted the regulator’s role in achieving this goal and talked about the Significant Influence Function (SIF) interview process.  He explained that, in his view, the crisis exposed that there were many senior executives and non-executives in key board positions who lacked the technical skills to manage the risks in their banks.  There was, in consequence, a general recognition that the regulator should seek to address this problem.  The FSA does this by assessing the suitability of a candidate to undertake a role, and crucially, by ensuring an appropriately robust, rigorous and yet proportionate appointment process is undertaken by the firm.  This assessment needs to take into account the overall composition of the board as well as the individual’s knowledge and competence.

Importantly, however, he said:

“The FSA is certainly not trying to be ‘gate keeper’ to everyone.  When we revised our SIF process we made clear that our focus is on the Chair, the senior independent director, the chair of the risk and audit committee and on the principal executive functions: CEO, finance director and chief risk officer. Outside of these functions the need for an interview for other individuals is judged on a firm specific basis.”

He explained:

“Except in rare circumstances the FSA will not interview non-executives unless they intend to occupy senior non-executive roles. There may be exceptions to this but in those circumstances firms should expect their supervisors to explain the reasons behind this decision.”

He also made clear that the FSA is assessing whether the board collectively understands and can address the breadth of the business.  The FSA does not expect all non-executive directors to be technical experts in financial services and it does not expect every member of the board to have the same degree of technical knowledge.  Indeed, if that were the case, it would bring a different set of issues. 

He said:

 “A diverse board encourages creativity and is less likely to demonstrate ‘group think’ and ‘herd mentality’.”

Hector went on to discuss the role that incentives play, explaining that too often reward structures continue to encourage short-term gain and excessive risk-taking. 

He said:

“It is also important to recognise that whilst progress is being made in relation to these issues, this will need patience and resolve in the face of the market’s remorseless focus on the next earnings announcement.”

Crucially, he concluded by explaining that, central to achieving good governance, is a firm’s culture.  He re-emphasised it is not for the regulator to determine culture. 

He said:

“Ultimately, however, even a successful regulatory regime will not be sufficient to ensure good outcomes. Crucially, firms need to have an appropriate culture and one that is focused on the firm delivering the right long-term obligations to society. The right cultures are rooted in strong ethical frameworks and the importance of individuals making decisions in relation to principles, rather than short-term commercial considerations. In particular, this means that when a regulator expresses a clear instruction then firms should not continue to resist for reasons of expediency and short-term gain.”

He concluded that history has shown that we cannot rely on the self-motivation of individuals alone and that we do need credible enforcement to require individuals to be driven by principles rather than just by commercial expediency. 

He said:

“Commercial success should not place an individual above the law.”

Notes for editors

  1. The FSA regulates the financial services industry and has four objectives under the Financial Services and Markets Act 2000: maintaining market confidence; securing the appropriate degree of protection for consumers; fighting financial crime; and contributing to the protection and enhancement of the stability of the UK financial system.
  2. The FSA will be replaced by the Financial Conduct Authority and Prudential Regulation Authority in 2013. The Financial Services Bill currently undergoing parliamentary scrutiny is expected to receive Royal Assent by the end of 2012.

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