UK Governance Review - November 2009

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UK Governance review

The Walker Review

Following the consultation period concerning Sir David Walker’s review of Governance in UK Banks and other Financial Institutions (BOFI’s), the final recommendations were published at the end of November.

The five key themes of the review have been improved and sharpened through the full consultation process. However the only proposal for primary legislation relates to mandatory disclosure of the remuneration of senior employees on a banded basis.

The final report contains a detailed examination of what are described as ‘deficiencies in BOFI boards relating much more to patterns of behaviour than organisation’. The review identifies on some boards the failure to challenge the executive board, by individuals or non-executive directors as a group, on substantive issues as distinct from having a conventional box-ticking focus on process. There can be strong pressure for conformity on boards, generating corresponding difficulty for an individual board member who wishes to challenge group thinking; such challenges can be seen as disruptive, non-collegial or, even, disloyal. The danger is that without it, an illusion of unanimity of the board can prevail and silence can be assumed to be acquiescence. This type of tension can increase with board size leaving an individual who wishes to challenge, at risk of feeling, or indeed being, isolated.

Sir David suggests that the demeanour and capability of the CEO is critical to the success of the challenge process in any well-functioning board. Achieving a balance amongst potential conflicts is frequently the most difficult part of the overall functioning of the board, and this challenge is laid firmly at the feet of the chairman. In some cases this will call for a material change of culture so that disciplined but rigorous challenge on substantive issues comes to be seen as the norm, and inability or insufficient strength of character to participate will throw into question the continued suitability of a particular board member.

There is also a suggestion that there should, be in effect, an informal contract between the non-executives and CEO under which the non-executives are understood and expected to be challenging: but when a board decision is reached, the CEO has the full support of the board in implementing it. The final report notes that the balance actually struck before the recent crisis phase was much too close to the acquiescent or supportive end of the spectrum in several important cases.

The UK Corporate Governance Code

The Financial Reporting Council (FRC) has confirmed they want to adopt the recommendations made by Sir David Walker and have announced that revisions to the UK Corporate Governance Code (formerly the Combined Code) will include changes to the Code structure, intended to encourage a greater focus on board behaviour.

There are proposed new principles on: the roles of the chairman and non-executive directors; including the need for the board to have an appropriate mix of skills, experience and independence; the commitment levels expected of directors; and clarification of the board’s responsibility for defining the company’s risk appetite and tolerance. Board evaluation reviews should be externally facilitated at least every three years and the chairman should hold regular development reviews with all directors.

The Annual Report should include an explanation of the company’s business model and overall financial strategy.

The FRC has put forward two options about the re-election of directors. They have suggested that either the chairman should be re-elected annually or that all directors should be re-elected annually and have asked for comments.

Changes to the section of the Code dealing with remuneration are proposed to emphasise the need for performance-related pay to be aligned with the long-term interests of the company and to the company’s risk policies and systems and to enable variable components to be reclaimed in certain circumstances.

The FRC is to take responsibility for a Stewardship Code for institutional investors as recommended by Sir David Walker, subject to consultation designed to ensure it can be operated effectively. It is also considering options for producing practical guidance on good practice engagement between companies and investors.

The consultation period on the proposed changes will be open until 5 March 2010 and the intention is that the revised Code will apply to all listed companies with a Premium Listing for financial years beginning on or after 29 June 2010.

The Final report is available with details of the consultation paper and process at
www.frc.org.uk/corporate/reviewCombined.cfm

The final Walker Recommendations are published at www.hm-treasury.gov.uk/d/walker_review_261109.pdf

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