There's no escaping the new regulatory world

2010 will see a real clash of cultures. All those business reviews will turn into reports and will be implemented. In the banking and financial services field, that means the Walker Review. For the rest of the corporate world, it is the new UK Corporate Governance Code from the Financial Reporting Council (FRC) – formerly the Combined Code on Corporate Governance – that will focus minds, or the lawyers who will be advising on what the real implications are. And in the background there will be a turmoil of Turner reports and all the other efforts at trying to keep the business world stable, afloat and not so prone to alarming the populace as it has been in the past couple of years.

The problem will be in this clash. All of these reports are based on the idea that if you can get the regulation right, then all will be well. But, as the revised FRC Code emphasises, it is human behaviour that is at the heart of keeping everything on the straight and narrow (as well as off it). And human behaviour, famously, does not click onto the tramlines and run in a true, fair and straight line for evermore.

That means all these efforts are really aimed at squaring this peculiar circle. People who know business know that regulations are very useful, but are also the artificial scaffolding round the reality of the human beings operating inside. People who don’t know business believe that, if you could only shackle the bastards inside, all would be well.

What should FDs be focusing on as the year unfolds, then? A simple task: do what needs to be done to maintain both the stability and reputation of your organisation – but at the same time make the odd noise about the irrelevant stuff that the world outside seems to be fixated on.

Press, populace, politicians
It is easy to recognise the irrelevant stuff. At a conference I attended just before Christmas, one speaker summed up the drivers of this debate as “The Three Ps”: the press, the populace and the politicians. They are not really interested in such things as shareholder responsibilities, or board performance evaluations, or risk appetite. They are only interested in the issue of remuneration. So a huge smokescreen of activity has to be maintained by regulators on this issue to show that, indeed, something is being done. As FD, you’d be well advised to join in that fun during the year and ensure that noisy initiatives are being taken over remuneration levels, particularly if it is anything to do with bonuses.

To be fair, there is a serious point here. Remuneration, particularly in the US, has gotten steadily out of hand in the past 20 years. Partly, it is fuelled by consultants who insist that remuneration structures should always be in the upper quartile and so install a mechanism which has only an upward path. And partly it is just ego.

A newly published study of chief executive officer, Business At The Crossroads: The Crisis of Corporate Leadership, has a German CEO admitting: “I know I’m overpaid. But the benchmarks say I’m not overpaid enough.” The book argues that CEOs can be greedy, but the typical pyramid model of corporate hierarchy reinforces the pay differential. “The consequence of this standard, hierarchical model is that power and pay are invariably drawn, as if by a siphon, to a CEO space at the top insulated from normal market disciplines,” the author says.

But what you really need to do as FD is get to grips with human behaviour, take all the new proposals, particularly those from the FRC and use them to usefully bring about sensible change.

In principle
At the heart of this is what the FRC proposals enshrine as its principles. “The purpose of the Code is to promote high standards of corporate governance, in the belief that good governance should contribute to better long-term performance by helping a board discharge its duties in the best interest of shareholders,” the regulator says.

There are two areas worth looking at in detail. The first is risk management and the second is board evaluation. Risk is obviously important. The Walker Report suggests the creation of a board risk committee, for example. The FRC takes a slightly more pragmatic line. While the banks and financial institutions could hardly argue against having a greater emphasis on risk following the utter disasters of the banking world’s efforts at containing it, the rest of the corporate world probably needs to simply think a bit more about it rather than necessarily create even more systems. The systems, after all, were already there in the banks: it was just that no one thought about what it all meant.

So the FRC has followed the suggestion, floated by the Treasury Select Committee, that a useful approach would be “to insist on all listed firms setting out their business model in a short business review, in clear jargon-free English, to detail how the firm has made (or lost) its money and what the main future risks are judged to be”. The FRC, in turn, suggests that “companies should disclose their business model and overall financial strategy”.

To be frank, that is obvious. But the companies that will gain in this process will be the ones that take this very seriously. The battleground for the hearts and minds of shareholders in the future is sited exactly in this area. Companies that do it well will prosper. The rest won’t. As the FRC rightly says: “Preparation of such a statement may also serve to prompt discussion in the boardroom as to the long-term robustness of the business model.” The value is not just in the communication of the model and strategy to the outside world: it is also in the discussion of it among boards. It is my belief that the banks that fell over tended not to discuss things, but simply accepted the blather being foisted upon them by a bullying CEO. And companies, particularly non-financial ones, often find this sort of stuff difficult. It is time to put this right.

But seriously
The other area for examination is board evaluation. This represents real change. The FRC review makes it clear that, in 2003, when the idea of a regular formal evaluation of a board’s performance was first added to the Code, there was enormous scepticism. But times change and people learn from experience. “In discussions with company chairmen as part of this review, however,” it says, “the FRC found almost universal agreement that regular evaluation can be a beneficial process when taken seriously.” It is those last two words that carry the resonance.

It will be perfectly possible, under both the Walker Review and the FRC reports, for boards not to take this seriously, despite the insistence that such evaluations take place every two or three years – in the case of the Walker Review – or at least every three years, in the case of the FRC.

The extent of external facilitation could simply mean that a bunch of consultants has been hired to do a questionnaire, for example. That will all come out through the comply or explain principle, but the FRC also insists that chairmen are “encouraged” to report personally on how the principles relating to the role and effectiveness of the board have been applied. This is where the real interest should lie. A board that has tried to evaluate how far its tone from the top extends down the corporate hierarchy would be able to go a long way in showing how far human behaviour was being influenced.

This is how the clash of the cultures will be resolved. The only way those behaviours in the corporate context can hope to be regularised in any way is through the route showing that where the benefits from good behaviour are being achieved, those companies or organisations are also benefiting on the bottom line, from greater stability, profitability and the likelihood of a long-term future. Finance directors in the year ahead need to accept the new regulatory world and extract as much positive benefit from it as they can.

Walker review and UK corporate governance code: boilerplate, or real change?
The Walker Review covers banks and financial institutions. The original proposals published last summer have now been firmed up into final actions and their primary focus is on risk and remuneration in banks. The proposed revisions to the Corporate Governance Code cover all listed companies and are out for comment until 5 March 2010, with the intention that the final version will come into force for accounting periods beginning on or after 29 June 2010.

Walker Review
Much of the Walker Review represents the shutting of stable doors long after horses have bolted. Politicians and the public will be reassured. Bankers are happy.

• The review insists that all of what it refers to as ‘high-end’ employees of banks earning more than a £1m should be disclosed, but remain anonymous. This has been criticised as being of no use to analysts and investors, who could use the information on where in a bank these rascally types operate or what departments and operations, therefore, pose the implied risk
• Non-executive directors need to devote between 30 and 36 days every year to the bank’s work
• Emphasis on new risk and remuneration committees means appointing a chief risk officer, who reports to the board
• If there is less than 75% approval for the annual pay report the chairman of the remuneration committee must then stand for re-election.

UK Corporate Governance Code
The proposed UK Corporate Governance Code is intended, as Sir Christopher Hogg, chairman of the Financial Reporting Council has so colourfully explained, to remove “the fungus of boilerplate”. The proposals continue the process of refining what is already a very effective corporate governance system:

• Externally facilitated board evaluation reviews should happen at least every three years
• Chairmen have to hold regular development reviews with all directors
• Companies have to report on their business model and overall financial strategy
• It is proposed that companies should ‘comply or explain’ whether the chairman and/or all members of the board should stand for annual re-election. The overall aim of the Code is to be reinforced to emphasise the principles and importance of board behaviours. Unlike the Walker Review, which tends towards the boilerplate end of the spectrum, the Corporate Governance Code continues to stress the importance of changing human behaviours in corporate life.

Robert Bruce is a leading commentator on accountancy issues