Financial services bulletin - Striking a balance
19 June 2012

Since the beginning of the financial crisis the financial sector has taken a battering and society’s confidence in the boards of financial firms has been significantly eroded.

The lack of confidence has led to a number of initiatives concerning the delivery of effective corporate governance, notably the final recommendations of Sir David Walker in 2009, the amendments to the Combined Code which led to the creation of the UK Corporate Governance Code in May 2010 and more recently the Government publishing the Enterprise and Regulatory Reform Bill which, if passed into law, includes provisions concerning executive pay reform.

At the heart of the corporate governance debate is a simple truism that unless managers within firms can take risks they will not generate returns. However, the chances of management making the right decisions are thought to be improved if they are supported by good corporate governance. This is a key point concerning the corporate governance debate in that the reforms introduced seek to reduce the risks of management making bad decisions but do not eliminate them entirely (hence why there are regulatory initiatives concerning the failure of a firm like recovery and resolution plans).

Completing the corporate governance structure is the framework that the regulator operates under. We have heard many times that the FSA has ‘radically’ changed over the past 5 years, operating a more ‘intensive’ approach to supervision which involves making forward-looking judgments about firms. Much has been written about the FSA’s ability to carry out this type of supervision with some in the market noting that this is still work in progress but matters have generally improved.

However, a further component of corporate governance lies outside the formal structure and relates to culture and ethics. In a speech published last month Hector Sants encouraged firms to do more to give greater weight to non-financial metrics, particularly the fair treatment of customers, in determining an individual’s remuneration. The problem though is the markets’ constant focus on the next earnings announcement. Sants rightly said that there is an important question that both regulators and society need to debate. Should all conduct and behaviour be driven by pure financial incentives or should there be some level of expectation that people leading financial services organisations be driven by the desire to ‘do the right thing’?

Simon Lovegrove is a lawyer with the financial services team at Norton Rose LLP