Walker - Better policing is the key  

by Ben Blackett-Ord, Director, Bovill 

Sir David Walker's interim report, published in July this year provides a thorough analysis of the workings of bank boards in the run up to the banking crisis. If the interim recommendations are fully adopted bank corporate governance may be about to change for ever. Or will it? Walker points the finger not only at bank boards but also at institutional shareholders for failing to hold bank boards to account.

The five themes of the Walker Review are, in brief, that firstly the Combined Code of the Financial Reporting Council remains fit for purpose, secondly that the principle deficiencies in corporate governance related more to patterns of behaviour than to organisation, thirdly that board level engagement in risk processes should be materially increased, fourthly that shareholders should do more to engage with the boards of the companies they own and finally that substantial enhancement is needed in board level oversight of remuneration policies.

Many of Walker's 39 recommendations are sensible and will make a real difference to corporate governance standards with proper implementation and proper sanctions for failure to implement, without such sanctions behaviour is unlikely to change significantly.  

Whilst Walker acknowledges that the way his recommendations should be taken up by government, the FRC and the Combined Code and the FSA is for a decision after the consultation process, his preference is clearly for implementation via the Combined Code. Given the criticism that Walker makes in relation to the current state of shareholder's engagement with boards, too much focus on implementation though the Combined Code, with arguably no real sanctions for non compliance, risks a failure at the final hurdle.  

Nine of Walker's recommendations go to the issue of the lack of engagement by institutional shareholders and he comments:

"As a matter of public interest, a situation in which the influence of major shareholders in their companies is principally executed through market transactions in the stock cannot be regarded as a satisfactory ownership model." 

This may be so, but for all the reasons outlined in his report, including the resources required on behalf of fund managers to fully engage with boards, legal uncertainty (particularly in relation to perceived concert party arrangements), confidentiality, board resistance and the effect on the share price associated with unpopular voting, all point to an uphill struggle to really change shareholder engagement.   

Walker's remedy is to extend the remit of the FRC in this area to develop a new set of Principles for Stewardship (to be overseen by the FRC and based on the existing principles that institutional shareholders are encouraged to follow). He recommends that fund managers should subscribe to the principles on a "comply or explain" basis and that long only shareholders should enter into memoranda of understanding with each other in order to further enhance engagement with company boards. These suggestions are all very well in theory but sound a little unconvincing in terms of whether they will achieve real change.

Given the current lack of engagement by institutional shareholders and the difficulties that will need to be overcome to change this, to suggest implementation of the majority of his recommendations via a mechanism that explicitly relies on investors engagement, namely the Combined Code, seems to be over optimistic.  Institutional shareholders, albeit acting on the basis of a revised and toughened Combined Code won't make bank corporate governance better by themselves.

At least equal responsibility for taking matters forward needs to be given to regulators.

It was not Walker's role to criticise the conduct of the FSA in relation to the supervision of banks and other financial institutions but parallels can be made between board failures and FSA's failures. Since the creation of the existing regulatory regime the FSA has been equipped with the tools necessary to hold directors (including non-executive directors, chairmen and chief executives) to account through the approved persons regime and associated statements of principle. The fact that it has not done so is more a failure of enforcement than of lack of power.

Walker makes a comment that it was more the pattern of behaviour than organisation that led to corporate governance failure. One could say the same about the FSA

The FSA has recently, if belatedly, raised its game in this area and if corporate governance in banks  and major financial institutions is to be changed then it needs to continue to focus on the scrutiny of senior management and to enforce its existing requirements in this area. It's not new rules that are required but better policing.

You never know if it does a good job it may yet achieve a stay of execution.....

Ben Blackett-Ord is a director of Bovill, a financial services regulatory consultancy.