Make it easier for boards to manage risk

Should the new corporate governance rules force directors to play a much bigger role in risk management?

by
Last Updated: 31 Aug 2010

The consultation period for the Financial Reporting Council’s review of the corporate governance code closed last week, and we suspect there were a few strong views aired. After all, the events of the last 12 months – particularly in the financial sector – have shown that UK plc’s current approach to governance isn’t quite up to scratch. But how can the FRC help boards avoid the kind of crazy risks that brought down Northern Rock and co, without making directors’ lives a compliance hell?

‘There’s nothing wrong with the principles in the code. The issues that have emerged as a result of the financial crisis are around the implementation of those principles,’ says Jonathan Lewis, CEO of Governance Integrity Solutions (a consultancy that helps companies monitor their compliance). Risk management is the biggest problem, he says – and there’s plenty of recent evidence to support that. Take RBS, where directors failed to hold Sir Fred Goodwin’s strategy to account, or HBOS, which brilliantly sacked its head of regulatory risk for warning about the bank’s risky strategy.

One important step, Lewis argues, is to have more risk specialists in the boardroom – an area where many big banks have fallen short. By having named experts with specific financial expertise, ideally as part of a Risk Committee (which is separate to the audit committee and can hold it to account), boards will be able to take on more responsibility for managing risk in the organisation. Currently, he suggests, there isn’t enough emphasis on the board’s role in determining the correct level of risk and making sure that it’s consistently applied throughout the company.

The one general principle that does need revisiting, according to Lewis, is sustainability. ‘There’s been a lot of damage done by this global financial crisis. It has rattled people’s faith in the economy and even capitalism to the core. To try and restore faith and confidence in the system, there has to be a greater focus on sustainability issues: values, ethics, CSR, environmental concerns and so on.’ He wants best practice guidelines, with standardised disclosure guidance.

But there’s a major caveat to all this. The post-Enron Sarbanes-Oxley regulations were disastrous for the US’s standing as a corporate centre, so Lewis thinks the FRC must avoid over-reaching regulation. Instead, he favours a ‘comply or explain’ approach – i.e. boards don’t have to follow the rules, as long as they have a good reason not to. After all, if directors spending all their time worrying about compliance, they’re unlikely to do a good job of managing the CEO and protecting shareholders’ interests.

The only question is: will boards be able to find suitably qualified non-execs who are willing to take on this kind of extra risk responsibility? Given the potential downside (ask Sir Tom McKillop and co), it’s a bit hard to see why many would bother. And if they do, they’ll probably be much more expensive...

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