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The PRA has recently published CP 18/15 (the CP), in which (in its own terms) it identifies some key aspects of good board governance to which the PRA attaches particular importance. While the CP does not form part of the suite of publications comprising the PRA's rules and proposed rules in relation to Senior Managers, the PRA terms it complementary to that new regime. In particular, the CP touches on one of the key issues of disquiet for banks implementing the Senior Managers regime (SMR), the role of the non-executive director (NED)1.
The BBA and AFME (in their joint response to initial consultation on the SMR) pointed to a risk that, if the new requirements were imposed on NEDs in full, it would have the effect of embedding them within firms in order to "man-mark" members of the executive. NEDs would thereby lose their independence. Following that round of consultation, the FCA and the PRA announced that they would not seek to apply the SMR to all NEDs, but only to those performing specific roles2.
Assuming that the PRA and the FCA are not persuaded to depart from that position, the SMR will apply to a relevant firm's Chairman; Chair of the Risk Committee; Chair of the Audit Committee; Chair of the Remuneration Committee; Chair of the Nomination Committee; and Senior Independent Director3.
The PRA will require firms to assess the fitness and propriety of all NEDs not falling within the scope of the SMR, and notify the PRA of appointments. The PRA also proposes that firms require that certain of the new conduct rules the PRA introduces should be observed by such NEDs.
Both the PRA and the FCA have published draft supervisory statements and guidance respectively as to how they expect the SMR to apply to those NEDs within its scope. The CP represents an attempt by the PRA to articulate the proper role of NEDs more generally.
The CP does not purport to revolutionise the role of the NED. It is notable that the BBA's response to the regulators' initial consultation in relation to the SMR suggested that they provide guidance to the effect that NEDs have a more limited role than executive directors. It was also suggested that such guidance be aligned to the UK Corporate Governance Code, and that thought be given as to how to avoid the new regime undermining the concept of a unitary board and collective responsibility for board decisions. It is by no means clear that the CP is a direct response to these comments, but it does refer to the UK Corporate Governance Code, and it does reiterate the PRA's acceptance of the unitary board.
The CP says, in effect, that while boards are collectively responsible, certain individuals may have particular responsibilities providing leadership in relation to specific issues. By way of example, the CP makes it clear that the setting of strategy is a core responsibility of the board, but states that the chairman and chief executive will have "leading individual roles to play" in the development and maintenance of the firm's business model. Similarly, while culture is the responsibility of the whole board, the chairman has particular responsibility for leading its development.
The CP states that the board is responsible for the oversight, not the management, of the firm's business. It states that, from the PRA's standpoint, an effective board is one that:
establishes a sustainable business model and a clear strategy;
articulates and oversees a clear and measurable statement of risk appetite against which major business options are actively assessed; and
meets its regulatory obligations, is open with regulators and sets a culture that supports prudent management.
The CP states NEDs must have sufficient knowledge and expertise "to understand the key activities and risks involved in the business model and to provide effective challenge across the major business lines of the firm". It goes on, however, to say that boards should not be a "collection of specialists" where responsibility for major decisions is delegated to the individuals considered to be specialist in the relevant area. NEDs do not need to know about everything, but they must have sufficient experience and capacity to provide effective challenge, and have access to expert professional advice where needed.
The issue of the composition of a board is going to be a delicate exercise for firms subject to the SMR. While some members of the board (including some NEDs) will be approved by the regulators, the remaining NEDs will not, and firms will have to try to ensure that they appoint candidates who meet the PRA's required skill-set without having its direct input. Firms' notifications to the PRA of the appointment of NEDs not subject to the SMR will, however, require them to explain how the appointment complements the existing board, and ensures the appropriate level of experience. As the BBA's response to the initial consultation in relation to the SMR states, not all NEDs come from a financial services background. The PRA plainly has not shut the door on attracting NEDs from other sectors, but firms may continue to find it difficult to know in practice just how much knowledge a NED needs.
Part of the PRA's answer to this may be that firms should be willing to train their NEDs on an ongoing basis, and provide them with some proper induction to their new roles. The PRA also says that firms should provide practical assistance such as office space and staff support. It appears that the PRA will no longer expect NEDs to turn up just to attend board meetings. The CP suggests that they will, as appropriate, need to spend sufficient time within the business to get the information they need in order to perform their role. The difficult word is, of course, "appropriate". NEDs need, in simple terms, to be adequately informed in order to ask the right questions. How they do that without, in the BBA's language, embedding themselves within firms to the extent that they become partisan, may be a difficult exercise.
The importance of good management information is a recurring theme in recent regulatory statements. The CP makes it clear, in particular, that the PRA expects boards to receive good enough management information to allow them to exercise effective oversight of risk management and controls.
This, in the PRA's view, involves a Goldilocks exercise of making sure that information is sufficient, but not so voluminous that it becomes unwieldy. It is said to be for the chairman and NEDs to manage the nature, specific content and frequency of management information provided. It is not explicitly stated, but it must follow, that the NEDs will all need a good enough understanding of the business to enable them to know what information to ask for: they cannot rely on being spoon-fed by the executive.
NEDs should also, according to the CP, have "unrestricted access to a firm's employees and information as needed to enable them to carry out their duties". This again raises practical questions for firms as to the assistance that needs to be provided to NEDs in order to achieve this level of access. Some firms have thousands of employees, and information is no longer stored on paper. How NEDs identify what they need, and who helps them to do so, will provide practical challenges.
The CP and the introduction of the Senior Managers regime undoubtedly raise issues both for relevant firms and for NEDs. The PRA's vision seems tolerably clear: it wants boards staffed with NEDs who are willing and able to spend time on their role, who are capable of understanding the business properly and asking the right questions in relation to it, and who will push the executive in order to ensure that the business is managed to plan and without undue risk. From that perspective, the difficulties of arranging a desk or an additional secretary here or there may seem relatively trivial, and the BBA's concerns about "embedding" may seem misplaced. After all, it is possible in other walks of life to be embedded within an organisation and still ask it the right questions.
From firms' perspectives, however, things might not seem so simple. Those firms subject to the SMR will have to contend with two different "tiers" of NEDs: those who are performing SMFs and those who are not. The NEDs who are will need to be trained accordingly, and will be subject to a greater risk of facing enforcement action personally. This will inevitably mean that they feel their performance of their roles to be subject to higher risks than other NEDs do. NEDs who perform SMFs are likely to have an eye on the FCA's draft guidance in relation to the presumption of responsibility. for example. That guidance sets out a non-exhaustive list of 16 factors to which the FCA will have regard in determining whether an individual took reasonable steps to avoid a contravention occurring in his or her area of responsibility. In the (likely) event that this becomes something of a checklist for Senior Managers, firms will have to provide the relevant NEDs with the means by which to tick all the boxes. Are they to provide other NEDs with the same resources? Is one group to be slightly more "non-executive" than the other?
The CP does not address these questions, and it may be that the PRA's and the FCA's further statements in relation to the Senior Managers regime will, but it does make it clear that firms cannot ignore the information needs of any of their NEDs.
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