Ambivalent attitude angers FSA

“We can no longer rely on senior management judgements… there are some management decisions that have revealed a degree of incompetence and, at times, a rather cavalier approach regarding risk management.”

So said Hector Sants, chief executive of the Financial Services Authority, in a speech to the Securities & Investment Institute Conference on 7 May. He said that as a result of flawed management thinking, the regulator warned it will take “more action against senior management where there is evidence of culpable misconduct”.

Sants outlined a number of problems that need to be resolved if corporate governance and risk management are to improve. He said there needs to be a more effective challenge in the boardroom, particularly from non-executives. He also said companies need to be more open in their dealings with regulators, shareholders and customers.

“The historical philosophy was that supervision was focused on ensuring the appropriate systems and controls were in place and relied on senior management to make the right judgements,” Sants told the audience.

“In future, we will seek to make judgements on the judgements of senior management and take action if… those actions will lead to risks to our statutory objectives.”

Non-exec failures
Non-executive directors were particularly singled out for criticism. Sants said that non-executives “have struggled to fulfil their role of providing strong independent oversight of the executive management,” adding that while it remains “reasonable” not to expect non-executives to have detailed quantitative knowledge of risk measurement, “it is surely reasonable to expect them to have a clear understanding of the nature of the risks and be able to ask the right questions.

“Ensuring individuals have the necessary resolve to restrain over-bearing chief executives is undoubtedly a challenge, and I believe, here, the regulators have a role in providing support and encouragement. I would expect a key component to be a greater direct communication between non-executives and the regulators,” said Sants.

Sants warned that non-executives will need to commit to raise their technical skills in order to exercise rigorous oversight, adding that “they will need to demonstrate competence with regard to risk management, regulation and the business model of the firm.” He added that non-executives will need to work on a more full-time basis and be compensated appropriately for the extra time they will need to put in.

Sants also said organisations should have an executive director solely responsible for risk sitting on the main board. “We need to raise the risk officer up to the level of business unit heads.”

But the FSA does not put all the blame on non-executives. He also says that shareholders have a duty to raise objections. “Shareholders must take responsibility to be active individually and, more importantly, in collaboration with other investors, to engage with senior management and non-executive directors in companies and question the effectiveness of the construct of their boards,” said Sants. “They should also challenge management to ensure business plans are credible,” he added.

Sants said the regulator would crack down on people who are not suitable to take on senior positions in financial firms. As part of its Significant Influence Function (SIF) review, the FSA has introduced interviews for candidates for a number of the key functions in an authorised company. The presumption is that any application submitted by a “high impact” business for the role of chairman, chief executive, finance director or risk director, will result in an interview.

Raising concerns
In the first six months of the enhanced approval process, 51 SIF interviews were carried out. In a number of cases applications were withdrawn following interviews which raised questions concerning the candidate’s fitness and p ropriety. The number of SIFs under investigation increased threefold in the past 12 months. Some notable recent cases include the decision to prohibit Milan Vukelic, the former chief executive of a business unit of General Re and the decision to fine Land of Leather and its chief executive, Paul Briant, for failing to prevent mis-sales of payment protection insurance.

Sants tried to reassure audience members that the FSA does not want to impose more rules on financial services businesses. Rather, it is seeking to test the effectiveness of those in charge, as well as the measures to keep boards in check. “The structure of governance in financial companies does not need radical overhaul,” said Sants. “The attitudes and competence of the individuals who conduct that governance does.”

Do you have the right stuff?
The FSA will be carrying out assessments of those people proposed to lead key functions in financial firms. The key areas the regulator wants assurance on are:
• Knowledge Does the individual have and use the generic knowledge of the sector and the specific knowledge of the firm necessary to fulfil the role?
• Skills Does the individual demonstrate the business and interpersonal skills required to fulfil the role and to meet the required standards?
• Behaviour Does the individual demonstrate the attitudes and standards of ethical behaviour required to fulfil their role?
• Expertise Does the individual achieve positive and fair outcomes and meet the performance standards expected for the post?

Useful links
To read Hector Sants’ speech, go to www.fsa.gov.uk/pages/Library and search for ‘judging competence’