A more effective enforcement and sanctions regime against individuals is the centerpiece of a proposed sweeping and radical revision of the regulation of financial institutions proposed by the U.K. Parliamentary Commission on Banking Standards. As the
moves towards legislation ring fencing investment banking from retail banking
in its version of the Volcker Rule, the attribution of individual
responsibility will, for the first time, provide for the full use of the range
of civil powers that regulators already have to sanction
individuals, including fines and a ban from the industry.
In the case of failure leading to successful enforcement action against a firm, there will be a requirement for relevant senior officers to demonstrate that they took all reasonable steps to prevent or mitigate the effects of a specified failing. Those unable to do so would face possible individual enforcement actions, switching the burden of proof away from the regulators. In addition, a criminal offense will be established applying to senior management carrying out their professional responsibilities in a reckless manner, which may carry a prison sentence. Following a conviction, the remuneration received by an individual during the period of reckless behavior would be clawed back through separate civil proceedings.
The Commission recommends a new criminal offense for reckless misconduct in the management of a financial firm. Be in no doubt about the difficulty of securing a conviction for such a new offense, said the Commission. But, it should be implemented based on the reasoning that the possibility of criminal liability for recklessly carrying out professional duties would give pause to the senior officers of
institutions. The Commission recommends that the offense be limited to
individuals covered by the new Senior Persons Regime, so that those concerned would
have no doubts about their potential criminal liability. Further, the Commission
would expect this offense to be pursued in cases involving only the most
serious failings, such as where a financial firm failed with substantial costs
to the taxpayer, lasting consequences for the financial system, or serious harm
Corporate Governance. The Commission also proposes a deep and far reaching reform of corporate governance so that there are individual and direct lines of access and accountability to the board of directors for the heads of the risk, compliance and internal audit functions and much greater levels of protection for their independence. There should also be direct personal responsibility on the board chairman to ensure the effective operation of the board, including effective challenge by non-executive directors, and on the Senior Independent Director, supported by the regulator, to ensure that the chairman fulfils this role. Whistle blowing procedures should be overseen by a named non-executive director, who would be held accountable when an individual suffers detriment as a consequence of blowing the whistle.
Ass part of the reform of corporate governance, the Commission calls for an end to box checking by regulators and a move towards judgment-based financial regulation. Regulators should identify the risks to a judgment-based approach from overly prescriptive international rule books and ensure that Parliament is kept fully informed of them. Importantly, there should be mandatory dialogue between regulators and the external auditors of financial statements and a separate set of accounts for regulatory purposes.
Very importantly, the Commission emphasized that non-executive directors in systemically important financial institutions should have a particular duty to take a more active role in challenging the risks that businesses are running and the ways that they are being managed. For non-executive directors to be more effective, they may need to make more use of their current powers under the U.K. Corporate Governance Code to obtain information and professional advice, both internally and externally. In this context, it is essential that the office of the board chairman be well-resourced so that it can provide independent research and support to the non-executive directors.
More granularly with regard to corporate governance, fundamental reform may be needed to the nominating process, especially concerning non-executive independent directors. The Commission asks the Financial Reporting Council, which has oversight of the U.K. Corporate Governance Code, to publish proposals, within six months, to address the widespread perception that some natural challengers are sifted out by the
There is a danger that non-executives directors are self-selecting and self-perpetuating. In the interests of transparency, and to ensure that such directors remain as independent as possible, the Commission recommends that the regulators examine the merits of requiring each non-executive vacancy on the board above the ring-fence threshold to be publicly advertised.
The obligations of directors to shareholders in accordance with the provisions of the Companies Act of 2006 create a particular tension between duties to shareholders and financial safety and soundness. For as long as that tension persists, said the Commission, it is important that it be acknowledged and reflected in the UK Corporate Governance Code and in the new Senior Persons Regime. The Commission has several recommendations in the light of this, which should at the very least apply to financial institutions above the ring-fence threshold.
The UK Corporate Governance Code must be amended to require directors of financial institutions to attach the utmost importance to the safety and soundness of the firm and for the duties they owe to customers, taxpayers and others in interpreting their duties as directors. In this respect, Section 172 of the Companies Act of 2006 should be amended to remove shareholder primacy and require directors to ensure the financial safety and soundness of the company ahead of the interests of its members.
In a radical move, the Commission recommends that the Senior Independent Director should, under the proposed Senior Persons Regime, have the specific duty to annually assess the performance of the board chairman and, as part of this duty, ensure that the relationship between the CEO and the chairman does not become too close and that the chairman performs his or her leadership and challenge role.
The Commission expects the regulators to maintain a dialogue with the Senior Independent Director on the performance of the Chairman. In fact, the Senior Independent Director should meet with the regulators each year to explain how the Chairman has held the CEO to account, encouraged meaningful challenge from other independent directors and maintained independence in leading the board.
Each board should have a separate risk committee chaired by a non-executive director who possesses industry knowledge and strength of character to challenge the executive effectively. The risk committee should be supported by a strong risk function, led by a Chief Risk Officer, with authority over the separate
business units. Boards must protect the independence of the Chief Risk Officer, and personal responsibility for this should lie with the chair of the risk committee.The Chief Risk Officer should not be able to be dismissed or sanctioned without the agreement of the non-executive directors, and his or her remuneration should reflect this requirement for independence.
The Commission proposes a new tool, special measures, which are designed to provide for the deployment of a broader range of regulatory powers when the Financial Conduct Authority and the Prudential Regulation Authority are concerned that systemic weaknesses of leadership, risk management and control leave a firm particularly prone to standards failures.
Special Persons Regime. As the primary framework for regulators to engage with individuals, said the Commission, the current Approved Persons Regime is a complex and confused mess. It fails to perform any of its varied roles to the necessary standard. It is the mechanism through which individuals can notionally be sanctioned for poor behavior, but its coverage is woefully narrow and it does not ensure that individual responsibilities are adequately defined, thereby restricting regulators’ ability to take enforcement action.
The proposed Senior Persons Regime should provide far greater precision about individual responsibilities and would serve as the foundation for some of the changes to enforcement powers. The new regime will encourage greater clarity of responsibilities and improved corporate governance and establish beyond a doubt the individual responsibility that can provide a sound basis for the regulators to impose remedial requirements or take enforcement actions.
Remuneration. The current remuneration regime must be reformed to align risk and reward and stop incentivizing poor behavior. The Commission recommends that a new Remuneration Code be introduced on the basis of a new statutory provision.
The Commission recommends that statutory remuneration reports be required to disclose expected levels of remuneration in the coming year by division, assuming a central planning scenario and, in the following year, the differences from the expected levels of remuneration and the reasons for those differences. The disclosure should include all elements of compensation and the methodology underlying the decisions on remuneration. The individual remuneration packages for executive directors and all those above a threshold determined by the regulator should normally be disclosed, unless there is a good reason for not doing so. The Commission further recommends that the remuneration report should be required to include a summary of the risk factors that were taken into account in reaching decisions and how these have changed since the last report.
The Commission did not go so far as to recommend the setting of levels of remuneration by Government or regulators. However, the Commission reminded financial firms that many consider the levels of reward in recent years to have grown to grotesque levels at the most senior ranks and that such reward often bore little relation to any special talents.
Ideally, remuneration requirements should be mandated internationally in order to reduce arbitrage. The Commission expects
U.K. authorities to strive to
secure international agreement on changes which are focused on the deferral,
conditionality and form of variable remuneration, and the measures for its
determination, rather than simply the quantitative relationship to fixed
remuneration, because it is changes of this kind that will most improve behavior
in the long term. In particular, the Government should ensure that the standards
under the CRD IV Directive contain sufficient flexibility for national
regulators to impose requirements in relation to instruments in which deferred
bonuses can be paid which are compatible with the reform.