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Fortitude International (FI) is a large authorised financial services firm, based in the UK with an international client base.
Consequently FI is subject to the dual regulation of the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA).
The FCA has responsibility for regulation of FI in conduct (consumer protection) and conduct of business matters and also has powers to investigate and prosecute insider dealing and market abuse.
This is supported by three operational objectives:
(i) Consumer protection – to secure an appropriate degree of protection for consumers
(ii) Integrity – to protect and enhance the integrity of the UK financial system
(iii) Competition – to promote effective competition in the interests of consumers
The PRA has responsibility for exercising prudential regulation over FI in order to minimise the likelihood of the adverse effect on stability to the financial system caused by failure of the firm.
Under the Financial Services Act 2012, PRA which is part of the Bank of England has two statutory objectives:
(i) To promote safety and soundness of PRA authorised persons (systemically important businesses i.e. banks, building societies, credit unions, insurers, major investment firms)
(ii) For insurers – to secure an appropriate degree of protection for policyholders
Following the Parliamentary Commission on Banking Standards (PCBS); Changing banking for good, the PRA has been given a secondary objective: to facilitate effective competition.
Both regulators are subject to periodic performance reviews conducted by an independent party and reportable to the Treasury. Review will have cause to measure economy, efficiency and effectiveness in carrying out their respective duties.
In 2016, new requirements for management and governance were introduced through the Senior Managers and Certification Regime (SMCR). This introduced enhanced standards for UK firms on apportionment of key responsibilities and associated individual accountability.
For the purposes of this paper and in particular relation to corporate governance, focus will deliberately be towards the UK Corporate Governance Code.
Under UK company law, the UK Corporate Governance code (UKCGC) has defined principles and provisions for corporate governance which is particularly aimed at listed companies. It sets out best practices and standards in relation to board leadership and effectiveness, remuneration, accountability and relations with shareholders. The importance of the code is driven by the Financial Conduct Authority’s Listing rules and is overseen by the Financial Reporting Council (FRC).
Under FSMA, public listed companies have to disclose their compliance with the code and explain any deviation or non-compliance in what UKCGC refers to as ‘comply or explain’. Whilst private companies are encouraged to comply with UKCGC, there is no requirement for them to disclose their compliance or non-compliance. A principles-based approach has been adopted in setting out UKCGC as it provides best practices and guidelines of corporate governance.
UKCGC was initially created based on the publication of the Cadbury Report in 1992 which was a response to various corporate scandals in the UK which occurred due to governance failures. The Cadbury Report emphasised that “one size doesn’t fit all” and made the following three basic recommendations, which covered financial, auditing and corporate governance matters:
- roles should be separate i.e. CEO and Chairman
- boards should have non-executive directors, who have no financial or personal ties to executives
- have an audit committee composed of non-executive directors
In 1995, a ‘study group’ was established to review the Remuneration of Directors and in July 1995 a report was published called the “Greenbury Report”. The report made recommendations to make changes to the existing principles as per below and also recommended that a review is performed every 3 years.
- have a remuneration committee composed without executive directors, but possibly the chairman
- directors should have long term performance related pay, which should be disclosed in the company accounts and contracts renewable each year
Therefore, in 1998, the Hampel Report suggested that all the recommendations from the Cadbury and Greenbury reports are combined into a single “combined code” and that:
- the Chairman of the board should be seen as the “leader” of the non-executive directors
- institutional investors should consider voting the shares they held at meetings, though rejected compulsory voting
- all kinds of remuneration including pensions should be disclosed.
In 1999, “Turnbull Report” was produced which informed the directors of their responsibilities for keeping good “internal and audit controls” in relation to the financial reporting and to catch any fraudulent activities.
Since then a series of other reports were issued, particularly in 2003 the “Higgs Report” which focused on the role of non-executive directors and audit committee’s and their effectiveness as a result of the collapse of Enron, WorldCom and Tyco in the US.
The “Walker Review” was produced which focused on the banking industry and made recommendations for all companies, following the Financial Crisis and collapse of Northern Rock in 2009. In 2010, FRC issued the Stewardship Code as well as publishing a new version of the governance code.
In July 2018, FRC published a revised version of the Code and updated its Guidance on Board Effectiveness, which replaces the 2011 version. In this version, some principles have been either removed or incorporated into the new principles or provisions. Whilst some principles have also been moved into the FRC’s Guidance on Board Effectiveness. The revised Code has five sections:
- Section 1—Board leadership and purpose
- Section 2—Division of responsibilities
- Section 3—Composition, succession and evaluation
- Section 4—Audit, risk and internal control
- Section 5—Remuneration
The new UKCGC has placed greater emphasis on corporate governance in relation to Section 1 – Board leadership and purpose whilst other sections have remained unchanged given the last update in 2016.
UKCGC provides firms with a set of principles and best practices which if followed correctly helps better management of the company whilst avoiding the ethical violations that could be encountered during the course of day to day operations. Running a large corporation like FI can be difficult and can potentially become easy to violate certain rules and regulations therefore having a robust corporate governance can be very beneficial in many regards.
By being diligent about corporate governance, FI’s reputation will be strong and it will be easier to attract investors and developing strong relationships with our customers. Corporate governance can also help reduce the likelihood of expensive fines or regulatory actions, thus leading to long-term benefits for FI.
FI needs to have the right balance of corporate governance, which complies with both the legal requirements and meet our own needs. Below are some examples of best practices in corporate governance, which we can implement and prove beneficial to FI.
- Have a strong board of directors. Our boards needs to consistent of directors who have the expertise and knowledge relevant to our business. They should be qualified and competent, and have strong ethics and integrity. They should have diverse backgrounds and skill sets, and sufficient time to commit to their duties.
- Define roles and responsibilities. We need to have clear lines of accountability among the Board, Chair, CEO, Executive Officers and management:
- Have written mandates for each committee and the board setting out their roles and responsibilities
- Where possible delegate certain responsibilities to a sub-group of directors
- Have written job descriptions for everyone including, the Board Chair, Board committees, the CEO and executive officers
- Have separate roles for the CEO and the Board Chair i.e. the CEO reports into the Board and looks after the day to day management whilst the Chair leads the Board and looks after the company’s future.
- Have integrity and ethical dealing. We need to ensure we have a robust conflict of interest and Whistleblowing policy which all employees have to adhere to and declare their conflicts of interests. Our directors should refrain from voting on matters in which they have a conflict and we need to have a culture of integrity and be compliant with the laws and policies.
We need to define a clear process for reporting and dealing with non-compliance. In Dec 2018, FCA fined and prohibited an individual £20k for failing to declare conflicts of interest.
In May 2018, FCA and PRA jointly fined an individual £642k for breach in relation to conflicts of interest and failing to act with due skill, care and diligence in relation to whistleblowing.
- Review performance and compensation decisions. The Board should:
- Set directors’ fees that will attract suitable candidates, but won’t create an appearance of conflict in a director’s independence or discharge of their duties.
- Tie compensation to performance by establishing measurable targets for executive officers (including the CEO) and regularly assess and evaluate their performance.
- Have a Compensation Committee which consists of independent directors to help develop and oversee executive compensation plans.
- Effective risk management. We need to identify, assess and manage the risks we face on an ongoing basis.
- The Board should have a defined risk appetite and accountabilities for risk management whilst focusing on the strategic vision.
- They should regularly review the adequacy of our controls in place to identify, assess, mitigate and monitor risk and the sufficiency of its reporting.
- Directors should understand the risks we are facing both near term and long term and the implications they can have on FI’s performance. Where appropriate they should challenge the adequacy of the risk management processes and procedures and any assumptions made by management.
Most recent failure of corporate governance in the UK is Carillion, where it was noted that the necessary checks and balances that are required were not in place to manage and mitigate risks. In this case, there have been questions raised about director’s pay and why the directors were continued to be paid even after the collapse. There were also questions around the lack of oversight from the board and shareholders.
Another example is Carlos Ghosn at Nissan and his deferred compensation again this maybe a result of poor board oversight and not having clearly defined roles and responsibilities between the CEO, Chair and Board.
Since the failures of BHS, Monarch and Carillion, the UK government has new reforms to ban directors who have dissolved companies and directors can be fined or be disqualified from running a business.
Increased Reputation & Trust
By having good corporate governance policies which detail how they work and making them transparent by publishing them, we will be able to attract more stakeholders to come and work with us. When our stakeholders feel they are able to rely upon the data we provide this will lead to increased levels of trust and we will develop stronger, longstanding relationships with our stakeholders. This can benefits us in various ways i.e. getting better credit terms from suppliers to repeat business from our customers.
Less Fines & Regulatory Actions
As part of corporate governance we need to ensure that we take necessary steps to stay compliant with all applicable regulatory and legal requirements in every jurisdiction of operation. This in turn means we won’t be under regulatory review and won’t have to pay any fines if we don’t break any rules or regulations. With the help of good governance we will be able to quickly identify and resolve any issues caused by poor systems or controls which in turn leads to reducing the cost of any fines or remediation. As an organisation we will be better equipped to respond to any events that may occur in the future and the governance process will help manage the risk of such an event and our reputation.
You as the board of directors have fiduciary duty to act in the best interest of FI. You can be held liable, if you breach them by not being honest and showing prudent care. In Dec 2018, RSA Insurance Ireland was fined €3.5m following accounting irregularities and regulatory breaches.
The breaches were related to failure in robust governance process, lack of internal controls and inadequate administrative and accounting procedures.
Positive Behaviours & Reduced Conflict
Good corporate governance will encourage positive behaviour amongst our employees and reduce any potential conflicts of interest as well as fraud. For example, our conflict of interest policy requires all employees to disclose and avoid any conflicts. Each year we have an external audit such that they can independently verify our accounts and help reduce any errors or potential fraud.
Regulators are increasingly focusing on the culture of an organisation and having clearly defined policies and processes helps us from future failures and set expectations of the type of culture we want in our company. In Mar 2018, FCA published a paper on transforming culture in financial services. It’s important that our board set’s the right tone at the top level and has clear communications with everyone across the firm. If they embrace the policies and procedures and set the right culture and behaviour then the “tone from the top” will have a positive impact on the future of FI.
We can reduce our cost of capital by having implemented a good governance framework which is important in today’s volatile environment. If we are seen as a stable and reliable company who is able to manage and mitigate potential risks then we could benefit from many ways including better rates on loans.
Corporate governance provides us with a framework of rules and procedures that we can follow at all levels within FI and extends to our customers and shareholders. It helps FI make the right decisions smartly and in accordance to the law. We should ensure that flow of information and communication is transparent between the board and management as well as with all our stakeholders and shareholders.
For FI to be efficient and effective at managing corporate governance we need to ensure that we bring together all the management systems in order to understand what is happening an when and giving us a transparent, visible and traceable cross department collaboration. We need to ensure that all our employees have the ability to log risks, incidents and vulnerabilities across the organisation.
We need to ensure that all our policies, procedures and processes are clearly defined with expectations, roles and responsibilities. These should be reviewed on a regular basis and communicated to every one of any changes or updates. We should have an annual certification programme which evidences that all employees have read the policies and procedures and understood them and will comply with them.
We need to have a regular internal audit programme which will help us identify any unknown risks and issues and provide us with an opportunity to re-asses our risk appetite thus allowing us to have better risk management and put necessary mitigations in place.
By incorporating the best practices of corporate governance within FI, it enhances the company’s value, trust and safety within FI and in the market. FI’s management need to ensure that all of its employees including executives follow the best practices and act in a responsible and ethical manner through their day to day activities. As we integrate and implement the corporate governance, we do so without overlooking operational efficiency and strategic management of FI.
In order to ensure FI fulfils its commitment on being open, transparent and having good corporate governance we will set up 3 main governing bodies:
- Shareholders General Meeting
- Board of Directors
- Executive Committee
Whilst there will be lots of overarching objectives for these governing bodies, the main objectives are:
- Ensuring FI’s sustainability from economic-financial, social and environmental point of view;
- Foster an ethical environment for all employees and prevent any unethical behaviour;
- Establish necessary policies and procedures by having an effective framework of corporate governance;
- Ensure stakeholders are actively involved in corporate governance to maximize value;
- Manage FI’s reputation and create long-term value through sound management decisions;
- Ensure accuracy and transparency of the financial information published;
- Ensure efficiency through monitoring operational management and where necessary improve the processes and procedures.
As a result of poor risk management and corporate governance, our customers can lose faith and it’s the responsibility of the board to ensure we continue to improve our governance and compliance policies across all areas.
Good corporate governance can be achieved at FI through implementation of best practices which supervises the relationships between the different governing bodies we have at FI and our stakeholders. These best practices will be transparent and provide rigor to our management. A core aspect of our corporate governance will be to fight corruption, which will be supported through our internal mechanisms that help detect and prevent such occurrences.
We need to have a corporate compliance program, which is aimed at detecting and preventing any conduct which could result in a regulatory action or fine, we can establish a robust process which enables us to ensure full compliance with all the necessary regulatory and legal requirements. A clearly defined Code of Conduct and training along with risk maps will help us analyse any corporate risks that may pose to us and help prevent any criminal activity.
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