Tuesday, October 05, 2010

UK FSA Chief Says Regulation of Corporate Culture Part of Sound Governance

n a groundbreaking speech at Mansion House, UK FSA Chief Exceutive Hector Sants said that sound corporate governance demands that regulators ensure that the proper corporate culture is in place to support effective risk management and executive compensation that encourages long-term value creation. Noting that the FSA does not do ethics and quoting the evergreen words of former FSA Chair Howard Davies that the FSA does not seek to act as the ``conscience of the square mile,'' Sants assured that the FSA would not define or mandate an acceptable corporate culture since such can come in many forms. It is neither feasible nor desirable for regulators to specify the type of culture a firm should have, said yje Chief, nor the metrics by which such should be assessed. 

Rather, the regulator should focus on the outcomes that the corporate culture delivers and whether the firm can show that it has a framework in place for assessing and maintaining the culture that can produce proper outcomes. The regulator must focus on the actions the company takes and how the board ensures that it has the right culture. There are tools available to the regulator to oversee corporate culture. The regulator can access the judgments of senior officers and the outcomes of their decisions. For example, regulators can use the corporate culture and make behavioral judgments when assessing senior risk management decisions. The outcomes of these judgments are very tangible and assessable against the regulatory objective of effective risk management and sound governance.

The FSA has other tools to promote a sound corporate culture. It can incentivize good behavior and influence the compositon of management. On incentives, the FSA wants to ensure that compensation structures do not encourage poor risk management practices. Taking this a step further, the compensation scheme must reinforce the concept of custodianship of the company and foster a sense of long-term ownership. Firms should also be encouraged to give greater weight to behavior in the compensation process.

This is a seminal speech that may move corporate governance to another level where, in the view of Mr. Sants, it is crucial to improve corporate behavior and management judgments and to do this regulators must address the role that the corporate culture plays in shaping behavior and judgments. The starting point for regulators is to ensure that a firm has a culture that encourages individuals to make proper judgments and deliver the outcomes that regulators are seeking and that codes demand.

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