This article provides a quick overview of the changes introduced by the MAS in relation to corporate governance for financial institutions and provides a quick overview of some of the changes that have taken place in the US and the UK.
Changes to Corporate Governance Regime for Financial Institutions
Much of the corporate governance regulation reform following the 2008 financial crisis has been centred on regulating compensation / remuneration, given the popular view that compensation practices at financial institutions are, amongst others, a factor that contributed to the financial crisis. According to the Organisation for Economic Co-operation and Development (“OECD”),“[t]he financial crisis revealed severe shortcomings in corporate governance. When most needed, existing standards failed to provide the checks and balances that companies need in order to cultivate sound business practices.”
Notable amongst the changes that came about is the Financial Stability Board (“FSB”), previously known as the Financial Stability Forum (“FSF”), which was “established to coordinate at the international level the work of national financial authorities and international standard setting bodies (‘SSBs’) in order to develop and promote the implementation of effective regulatory, supervisory and other financial sector policies” published the FSF Principles For Sound Compensation Practices(“Compensation Principles”) in April 2009 and the FSB Implementation Standardsfor the same on 25 September 2009. Both the Compensation Principlesand Implementation Standardsare adopted by and appended to the amended Guidelines on Corporate Governance for Banks, Financial Holding Companies and Direct Insurers Incorporated in Singapore (“Guidelines”) introduced by the Monetary Authority of Singapore (“MAS”) on 9 December 2010.
Although compensation is important in incentivising profit maximisation, the key is to achieve a good balance between incentivising executives and discouraging excessive risk taking. According to the FSB, three principles focus on making compensation sensitive to risk outcomes: (i) compensation outcomes must be symmetric with risk outcomes; (ii) compensation payout schedules must be sensitive to the time horizon of risks; and (iii) the mix of cash, equity and other forms of compensation should be consistent with risk alignment.
The FSB, in the Compensation Principles, sets out the effective principles of governance. These include the following:
1. The responsibility of the Board for the compensation system’s design and operation;
2. Ensuring that staff engaged in financial and risk control should be compensated in a manner that is independent of the business areas they oversee and commensurate with their key role in the firm;
3. Ensuring that compensation should be consistent with risk alignment; and
4. Supervisory review of compensation practices should be rigorous and sustained and deficiencies should be addressed promptly with supervisory action.
Highlights of Key Changes in Singapore
On 7 December 2010, the Banking (Corporate Governance) Regulations (“Corporate Governance Regulations”) under the Banking Act (Cap 19), which were issued in 2005 and which were subsequently amended in 2007, were further amended by the Banking (Corporate Governance) (Amendment) Regulations 2010. Additionally, as noted in the introduction, on 9 December 2010, the MAS issued the amended Guidelines.
The amendments to the Corporate Governance Regulations and the Guidelines follow in the wake of the recent financial crises that hit the world, most notably in the US and Europe and, as stated, follow moves by financial regulators across the world to re-examine existing regulations and strengthen corporate governance structures in the financial services sector. A key point to note in relation to the changes in Singapore is that the amendments went further than simply focussing on compensation.
We discuss the amendments to the Corporate Governance Regulations and the Guidelines in the paragraphs that follow below.
Amendments to the Corporate Governance Regulations
The Corporate Governance Regulations apply to all banks incorporated in Singapore and their financial holding companies. A key new requirement implemented by the amended Corporate Governance Regulations is the requirement for a bank to have a Risk Management Committee. Failure to adhere to this requirement is an offence and carries, on conviction, a fine not exceeding $25,000 and, in the case of a continuing offence, to a further fine not exceeding $2,500 for every day or part thereof during which the offence continues after conviction.
The Corporate Governance Regulations provide that the Risk Management Committee must comprise at least three members of the Board of the bank and that at least a majority of directors (including the chairman of the Risk Management Committee) should be non-executive directors. The Risk Management Committee must at the very least be responsible for overseeing the following:
1. The establishment and the operation of an independent risk management system for managing risks on an enterprise-wide basis; and
2. The adequacy of the risk management function of the bank, including ensuring that it is sufficiently resourced to monitor risk by the various risk categories and that it has appropriate independent reporting lines.
Whilst the concept of the Risk Management Committee is not new and was a common feature in many companies, it was not an ubiquitous feature. Thus, the introduction of the mandated requirement for a Risk Management Committee reflects an important and welcome change to ensure adequate Board supervision over risky practices in the banks and added protection for the financial stability of the bank. However, as pointed out by Senior Minister Mr Goh Chok Tong, in his speech at the Singapore Corporate Awards 2010, “… corporate governance is not simply about complying with rules or reporting requirements. Boards of directors and senior management need to internalise the values, spirit and purpose behind the rules … The corporate casualties during the global financial crisis showed how this could have devastating consequences. To prevent this, the Board’s role must extend beyond corporate reporting to using the information to exercise proper oversight of risk management. This includes setting the risk appetite of the company and monitoring that risks are managed properly on an enterprise-wide basis.”
Where previously undefined, a further key amendment to the Corporate Governance Regulations stipulates that the term served by a director on the Board of a bank should not exceed three years.
Amongst other requirements, a bank incorporated in Singapore must have at least a majority of directors who are independent directors and at least a majority of directors on the Remuneration Committee and the Nominating Committee (including the chairman of the Remuneration Committee and the chairman of the Nominating Committee) must be independent directors. The definition of “independent director” has been narrowed in the new Corporate Governance Regulations to include a provision that an independent director must not have served on the Board for the bank (or financial holding company) for a continuous period of nine years or longer.
The amendments highlight the importance of Board independence to ensure that corporate decisions are undertaken objectively and independently and to ensure that no individual or groups of individuals, including any substantial shareholder or financial holding company should be allowed to dominate the decision making process of the Board.
A final key amendment to the Corporate Governance Regulations highlighted is the power of the MAS to remove principal officers of a relevant financial holding company where it “is satisfied that a chief executive officer, deputy chief executive officer, chief financial officer or chief risk officer of a relevant financial holding company
(a) has wilfully contravened or wilfully caused the relevant financial holding company to contravene any provision of these Regulations;
(b) has, without reasonable excuse, failed to secure the compliance of the relevant financial holding company with any provision of these Regulations;
(c) has failed to discharge any of the duties of his office; or
(d) such officer has had execution against him in respect of a judgment debt returned unsatisfied in whole or in part; or a prohibition order under the Financial Advisers Act (Cap 110), the Insurance Act (Cap 142) or section 95 of the Securities and Futures Act (Cap 289) made against him that remains in force.”
Such an amendment goes much further than the traditional approach of specific responsibilities placed on board members to ensure that they are individually and collectively as a board, complying with all of their legislative and fiduciary responsibilities, as well as ensuring adequate oversight of and keeping a pulse on the risk concerns arising out of activities by management. Given the importance of the individuals on the board and key management personnel working in a financial institution, whilst it may appear to many to be micro-managing, having the regulator take an active step such as this could reduce potential elevated risks being taken, leading to possible collapses. From a public policy perspective, such a step must be lauded if only because the strength and continuity of a financial institution forms a critical backbone to the continuity of the economy as a whole of any country.
Amendments to the Guidelines
The amended Guidelines, which are “relevant to all banks, financial holding companies and direct insurers” (“financial institutions”) incorporated in Singapore, place greater emphasis on the role and responsibilities of the Board of directors (“Board”) of the financial institution in ensuring that corporate governance structures are put in place and proper supervision of risks is undertaken. According to the preamble to the amended Guidelines, “[t]he [MAS] recognises that the Board plays a critical role in the successful operation of a Financial Institution. The Board is chiefly responsible for setting corporate strategy, reviewing managerial performance and maximising returns for shareholders at an acceptable level of risk, while preventing conflicts of interest and balancing competing demands on the Financial Institution.”
It is worth highlighting that although the Guidelines are advisory in nature and not binding on financial institutions incorporated in Singapore, the MAS, which regulates and licences all financial institutions incorporated in Singapore “expects every Financial Institution to observe the Guidelines … to the fullest extent possible”. In this regard, the Guidelines are issued pursuant to the regulations and so do nevertheless have weight, although as stated, not binding. All financial institutions listed on the Singapore Exchange are required by the Singapore Exchange Listing Rules to disclose their corporate governance practices and explain deviations from the Guidelines in their annual reports. Financial institutions which are not listed on the Singapore Exchange are similarly expected to disclose the same on their websites.
In the paragraphs that follow, we discuss some of the key provisions of and amendments to the Guidelines.
The Guidelines set out the roles and responsibility of the Board in relation to, amongst other matters, the control and risk assessment framework of the financial institution and the review of management performance in the financial institution. There is also guidance on the organisational structure of the financial institution, which would include ensuring that adequate corporate governance frameworks and systems are in place across the financial institution, as part of the Board’s conduct of affairs.
Specifically, the Guidelines provide that in the case of a Group, the Board of the ultimate holding company should refrain from setting up complex structures “given the inherent risks of such structures”. What this is likely to mean is that the more complex the structures, given that enforcement is handled through “decentralised” administration in a Group, the more difficult it is for the Board of the ultimate holding company to supervise operations and, more importantly, to manage risk. In this regard, the Guidelines provide that in the case of a Board of a subsidiary, the Board of the ultimate holding company “should ensure that any reliance placed on Group-level corporate governance practices are in accordance with the local regulatory requirements.”
The Guidelines also call on the Board to take a more “hands-on approach”, providing that the Board should be responsible for the appointment and removal of senior management of the financial institution, setting out (and documenting) the role, responsibilities, accountability and reporting relationships of senior management.
In relation to Board composition, the Guidelines emphasise the importance of a “strong and independent element on the Board, which is able to exercise judgement on corporate affairs independently, in particular, from Management.” There is also guidance on, amongst other matters, whether there is a need to appoint a lead independent director to the Board. In this regard, the Guidelines provide that in deciding whether there is a need to appoint a lead independent director to the Board, the financial institution should consider if the Chairman has any other relationship with the financial institution. Such relationships include the following:
1. The Chairman is a director being employed by the financial institution or any of its related companies for the current or any of the past three financial years.
2. The Chairman has an immediate family member who is, or has been employed by the financial institution or any of its related companies as a senior executive officer. A family member is defined as per the Singapore Exchange Listing Manual to mean a spouse, child, adopted child, step-child, brother sister and parent.
3. A director, or an immediate family member, accepting any compensation from the financial institution or any of its subsidiaries other than compensation for Board service for the current or immediate past financial year.
4. A director, or an immediate family member, being a substantial shareholder of or a partner (with five per cent or more stake), or an executive officer of, or a director of any for-profit business organisation to which the financial institution or any of its subsidiaries made, or from which the financial institution or any of its subsidiaries received significant payments in the current or immediate past financial year. The Guidelines state that as a guide, payments (for transactions involving standard services or routine and retail transactions) aggregated over any financial year in excess of S$200,000 should generally be deemed to be significant.
Further and in addition to the existing requirements on the nomination of directors by the Nominating Committee to the Board, the Guidelines provide that the Nominating Committee should satisfy itself that each nominee is a fit and proper person, taking into account the nominee’s track record, age, experience, capabilities and skills. In addition, the Guidelines provide that the Nominating Committee should develop a framework to identify necessary skills required for the Board and that an assessment should be undertaken on at least an annual basis on whether the respective Board Committees lack any skills to perform their roles effectively and identify steps to improve the effectiveness of the Board and the respective Board Committees.
These are not new requirements with regards to listed companies broadly, but they are a timely reminder in particular for Nominating Committee members of financial institutions concerning their potential personal responsibilities for failure to take the above steps.
In relation to the Board’s access to information, a key specification introduced by the amendments to the Guidelines is that management should provide the Board with information on all potentially material risks facing the business (eg, credit, market, liquidity, legal and operational risks) to ensure effective supervision and risk management. The issue on whether Boards are provided with sufficient information is a vexed one, with views divided. The consensus must nevertheless be that Boards could be provided with more relevant information and in a timely fashion, with members of the Board having a personal responsibility to seek more where they feel they have not received adequate information to make a proper decision.
Appointing an Executive Committee
The amended Guidelines have introduced new provisions which expressly allow the Board to establish an Executive Committee (“Exco”) to assist in the discharge of its duties and “to deliberate on matters requiring Board review that arise between full Board meetings. The composition of the Exco should mirror that recommended for the Board in relation to representation of independent directors. The Guidelines provide, however, that the Exco should not have the authority to exercise all the powers of the Board and that “the role of the Exco is to carry out Board functions and not to take on the functions of senior management”.
Such a requirement raises several questions. For one, are financial institutions now moving towards a two-board structure? Before there are hollers that the two-board structure is not the intention, to clarify, if there is an Exco to be formed which mirrors in structure that of the main Board, the practice would be to have the Exco more involved in the strategy and other policy aspects of the financial institution as well as to be more alert to the risk management concerns. Note that this could potentially dilute the role of the Board as a whole. More importantly, it raises the question of how more actively involved are non-executive and independent directors to be if they sit on the Exco as well. A further query arises as to the scope of the liabilities that Board members who also sit on the Exco face. These are not issues that can be resolved in this short overview article, but certainly are important ones that must be studied carefully and played out in industry to ascertain where the dice will eventually fall.
Accountability and audit
Whereas the previous Guidelines provide for the establishment of an Audit Committee and the duties of the Audit Committee, the amendments to the Guidelines in line with the greater emphasis on the Board’s role and responsibilities specify that the Audit Committee should be responsible for reviewing the accounting policies and practices of the financial institution. Further to the above, the Guidelines provided by the MAS include guidance on the responsibilities of the internal auditor. The internal auditor’s responsibilities include the following:
1. Evaluating the reliability, adequacy and effectiveness of the internal controls and risk management processes of the financial institution;
2. Reviewing the internal controls of the financial institution to ensure prompt and accurate recording of transactions and proper safeguarding of assets; and
3. Reviewing whether the financial institution complies with laws and regulations and adheres to established policies, and whether Management is taking the appropriate steps to address control deficiencies.
Proper risk supervision and management is crucial to the business and indeed, survival of a company. Indeed, much of the discussion thus far calls for strengthened risk management processes in financial institutions, essentially to ensure a more organised risk management strategy. The reason for this is that risk management is the stalwart of proper corporate governance. It is thus, that the Regulations set out the requirement for the Risk Management committee. The amended Guidelines additionally provide that Financial Institutions incorporated in Singapore should ensure that their Management has established an adequate risk management system to “identify, measure, monitor, control and report” risks. The amended Guidelines also set out the responsibilities of the Board in relation to the managing of the risks of the financial institution. These include the following:
1. Overseeing the establishment and operation of an independent risk management system;
2. Ensuring the adequacy of risk management practices for material risks (eg, credit, market, liquidity, legal, compliance, fraud, regulatory and operational risks) on a regular basis;
3. Reviewing the risk profile, risk tolerance level and risk strategy of the financial institution;
4. Ensuring that the risk management function has adequate resources and staffed by appropriately experienced, qualified and independent employees; and
5. Maintaining records on all meetings pertaining to risk management.
The amended Guidelines further provide that depending on the scale, nature and complexity of the business of the financial institution, the Board may appoint a chief risk officer to oversee the risk management function or establish a dedicated Board Risk Management Committee. As previously stated in paras Accountability and Auditand Risk Managementabove, the Corporate Governance Regulations require all banks incorporated in Singapore to establish a Risk Management Committee.
Related party transactions
In relation to related party transactions, the amended Guidelines emphasise that the financial institution should establish policies and procedures on related party transactions, including establishing definitions of relatedness, limits applied, terms of transactions and the authorities and procedures for approving, monitoring, and where necessary, writing off such transactions. Material transactions should be disclosed in the annual report of the Financial Institution and care must be undertaken to ensure that related party transactions are monitored and that terms and conditions of related party lending or credit provided should not be more favourable than credit granted to non-related obligators under similar circumstances.
Highlights of Key Changes in the US
In the US, the US Treasury implemented regulations aimed at recipients of funds under the Troubled Asset Relief Program (“TARP”), a program established under the Emergency Economic Stabilization Act of 2008. Among other things, the regulations included the following:
1. Limits on executive compensation, bonuses, retention awards and other incentive compensation;
2. Measures designed to address unnecessary and excessive risk; and
3. Requirements that executive compensation be subject to a shareholder vote (“Say on Pay”) for firms receiving governmental assistance.
On 21 July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) was approved by President Barack Obama and made law. The Dodd-Frank Act is a comprehensive and hefty new law to, inter alia, “promote the financial stability of the United States by improving accountability and transparency in the financial system, … end ‘too big to fail’, … protect the American taxpayer by ending bailouts, [and] … protect consumers from abusive financial services practices”.
The Dodd-Frank Act creates a Financial Stability Council to identify and address systemic risks posed by large, complex companies, products, and which threaten the stability of the US economy. Additionally, the Dodd-Frank Act seeks to eliminate loopholes for certain instruments which allow risky and abusive practices to go on unnoticed and unregulated – including loopholes for over-the-counter derivatives, asset-backed securities, hedge funds, mortgage brokers and payday lenders. In relation to executive compensation and Corporate Governance specifically, the Dodd-Frank Act provides shareholders with a Say on Pay and corporate affairs with a non-binding vote on executive compensation.
Highlights of Key Changes in the UK
In the UK, a Treasury-commissioned review was undertaken by Sir David Walker into corporate governance in banks and financial industry entities (the “Walker review”) following the financial crisis. The measures proposed by the Walker review were addressed in the Financial Services Authority (“FSA”) consultation paper, Effective Corporate Governance, which was published in January 2010 and subsequently the Policy Statement (“PS”) by the FSA, which was issued in September 2010. The PS sets out a summary of the responses to the consultation paper received by the FSA the final “Handbook text” that will implement the FSA rules, which will be effective from May 2011.
Amongst other things, the Walker review proposes that the Board of a financial institution should establish a Board Risk Committee separately from the Audit Committee “with responsibility for oversight and advice to the board on the current risk exposures of the entity and future risk strategy” This is similar, for example, to the requirement for the establishment of a Risk Management Committee under the Singapore Corporate Governance Regulations.
Other recommendations by the Walker review include expanded remit for Remuneration Committees of financial institutions with extended terms of reference of Remuneration Committees to include oversight of remuneration policy and remuneration packages in respect of all executives for whom total remuneration in the previous year or, given the incentive structure proposed, for the current year exceeds or might be expected to exceed the median compensation of executive board members on the same basis and, greater disclosure for “high end” compensation packages.
Good corporate governance structures and practices are crucial to the financial stability of financial institutions and indeed to other companies outside the financial services sector – listed or private. The enhanced Corporate Governance Regulations and Guidelines bring greater clarity and specificity to the standards of corporate governance for financial institutions and other companies in Singapore. The recent financial crisis has, however, re-emphasised the important lesson that good corporate governance policies, regulations and statements are insufficient without internal implementation and values – effective corporate governance policies are those which are not only stated in company regulations, but followed throughout the organisation. The roles and responsibilities of the Board and the respective Board Committees in a company in overseeing and enforcing the risk management processes are paramount to success of the corporate governance regime in the company.
Rajah & Tann LLP
E-mail: [email protected]