If Australia goes down the path that the UK is taking we may need to be very concerned at how we are going to source competent NEDs.  Their answer of more work, more pay and “provisional NEDs” may not be workable.

Last month we noted that the UK has flagged that it wants more to be regarded as within the work scope of its NEDs, and that “more” might be translated into a full time work commitment for the individual (see HERE).

At a conference on 7 May, Hector Sants, the head of the UK’s FSA, said:

“NEDs will therefore need to commit to raise their technical skills in order to exercise rigorous oversight.  Ultimately, they will need to demonstrate competence with regard to risk management, regulation, and – importantly – the business model of the firm.  We do, however, recognise that there will need to be an appropriate mechanism to allow this competence to be acquired which may result in a ‘provisional’ NED.  We will certainly, as a minimum, expect the chairman and senior independent director to demonstrate the full set of competencies.”

We are not sure how the idea of a provisional NED can be accommodated into our current fiduciary framework.  You are both fully and equally accountable or you are not.  We are not sure judges or shareholders would accept “provisional” as an excuse.  Nor are we sure that current NEDs see training new NEDs as part of their job description.

Mr. Sants continued, effectively ramping up the direct costs to shareholders of this new world:

“Clearly, this will require NEDs to work on a more full-time basis and be compensated appropriately.  NEDs also need to be supported properly to strengthen their technical expertise.  We would like to see greater use, by them, of advisers employed in an independent advisory fashion.  Similarly, the Risk Committee should have the ability to co-opt risk experts from outside the firm.”

As external board advisers we begin to appreciate Mr. Sants’ point of view.  But we are also aware of the barriers that have to be overcome.  Many boards begrudge the use of external experts because they do not like to impose additional cost burdens on their CEO that are outside of his/her operational budget (and perhaps they do not like to admit a need for additional expertise input from professional advisers).  For change to happen, boards must be more willing to exercise their right and duty to employ external expertise as required.

But, it may not be all external advice that adds to the cost of governance.  The UK Parliamentary Treasury Committee’s review of banker pay and governance concluded that non-executive directors at banks, for one, need “dedicated support or a secretariat to help them to carry out their responsibilities effectively.”  (see HERE).  And that committee also managed to add to the time requirements by suggesting remuneration committees gather regular input from employees and other stakeholders (an issue, by the way, that the Australian Productivity Commission has highlighted).

But it is not just the board that needs to put in more.  The same report noted that shareholders “failed in…the effective scrutiny and monitoring of the decisions of boards and executive management in the banking sector.” In particular, funds had failed as wielders of ‘say on pay’ powers. This latter point is an issue that the Australian Productivity Commission has put up for response.

But we digress – back to more costs, as Mr. Sants indicated that:

“All financial services firms need an effective risk-management function with clear, independent reporting lines to the Risk Committee.  Effective risk managers need a combination of technical competence, communication skills (to be able to convey arcane subjects in an accessible way) and stature in the organisation to provide genuine challenge to business managers.  This will happen, in my opinion, only if there is an executive director (GA emphasis) solely responsible for risk on the main board.  We need to raise the risk officer up to the level of business unit heads.”

Interestingly, the UK regulator seems disposed to impose on the board’s turf by engaging itself in the appointment of management:

“In many cases, as with NEDs, executives could have greater technical skills and we the regulator should seek to ensure that is the case through the authorisation process.

As part of the Significant Influence Function (SIF) review, the FSA has introduced interviews for candidates for a number of the key functions in an authorised firm. The presumption is that any application submitted by a high-impact firm for the roles of chair, CEO, finance director or risk director would result in an interview. Other SIF candidates may also be interviewed at the supervisor’s discretion – for example, if there are concerns about the compliance culture of the firm or the track record of the candidate.”

Apart from interference in a board’s function, this is also somewhat outside FSF guidelines (see HERE).

The full text of Mr. Sants’ comments can be seen HERE.

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