John Liver gives his verdict on the implications of the Walker review
Weak governance within some financial institutions is blamed for causing, or at least contributing, to the financial crisis. But the extent of this culpability, largely attributed to the way risk is handled by boards, is hotly debated. Regardless of where your loyalties lie, you cannot ignore the public’s unequivocal verdict: ‘It was the directors’ fault’.
In response to this Sir David Walker and his review, published on Thursday 16 July, offers a reprieve: an opportunity for the sector to put things right and, more importantly, to be seen to be doing so. This is why we agreed to contribute to the review, and remain optimistic that it can help the sector and wider economy to pull through the crisis and emerge stronger and more trusted than before.
What the Walker review means for financial institutions
Executive directors will be expected to provide better information to their boards on the future risks faced by their businesses. The aim is to help ensure the board has a more comprehensive understanding of proposed business strategies and, in particular, the nature of the inherent risks and how they will be managed. For some institutions this will require significant changes to their operations and governance, because in recent years more emphasis has been placed on retrospective risk reviews where boards have received a confirmation of the risks undertaken, and assurances on the way they were managed.
Information and reporting infrastructures have developed to support these backward-looking reviews. Consequently, the need to assess future risks will, in most cases, require changes to the composition (measurement and reporting) and flow of information to the board, with a corresponding increase in the ability of the board. There will also be increased pressure on the board, in particular non-executive directors, to comprehend that information and make use of it when reviewing future business strategies.
“For some institutions this will require significant changes to their operations and governance.
An important means to help facilitate this change will be the introduction of an independent risk committee. This will provide a focus for receiving and evaluating information on risks, including remuneration and bonus schemes, in support of board-level decisions on the level of risk it is prepared to accept and reporting that to shareholders. This will place more demands on the role of the non-executive director, and not just those who participate in this committee.
In addition to new reporting infrastructures, a greater level of sustained support (information, training, time and resource) will be provided for non-executive directors to augment their general business awareness. Walker identifies the need for this to be supplemented with a focus on risk insight, complemented by an external perspective.
What it means for companies in other sectors
Unfortunately, there can be no containment of the effects of the financial crisis, but we believe there ought to be a confinement of the solution where possible. It is important that all due consideration should be given before any of the changes proposed by Walker are extended to other sectors. This is because the same extent of change may not be necessary for sectors outside banking and finance, especially in regards to corporate governance.
For example, it is unlikely in our view that other company sectors and respective infrastructures have to manage the same high level of systemic risk. So it follows that corporate governance and particularly risk management should have greater significance in banking and finance compared with other sectors.
“This will place more demands on the role of the non-executive director.
Ironically, if there was a cross-sector change in the regulation of these activities it could have the opposite effect to the one intended for the financial services sector. This is because it would involve tampering with a set of governance principles, enshrined in the UK’s Combined Code, which have successfully helped to promote good governance across most business sectors in the UK, together with requirement of the Companies Act 2006.
We expect the review to follow the government’s Regulatory Code and recommendations of the Better Regulation Executive, namely: regulatory change which is targeted, proportionate and value for money. This review, if applied in the spirit intended, should meet most if not all of these requirements.
John Liver is regulatory and risk management partner at Ernst & Young
See also: Lessons from the financial crisis.