This article first featured in Compliance Monitor Volume 24 Issue 4
The FSA is now a presence on the boards of systemically important authorised firms. But, Tom Custance and Deepak Arora ask, is this helpful hands-on supervision or regulatory over-intrusion?
In adopting a more active and intrusive form of supervision, and in pursuit of its mandate of protecting and enhancing financial stability, the FSA has started to attend board meetings of those firms that it considers pose a potential risk to the UK’s financial stability. It has taken this step in direct response to the criticisms it faced during the aftermath of the financial crisis, that it had a ‘hands off ’ and ‘tick box’ approach to financial regulation. Is this development a welcome change, or will it prove to be a case of ‘too many cooks spoil
Failures by senior managers to foresee, assess and mitigate the risks effectively (in particular in the form of inadequate SYSC provisions) are widely regarded as contributing to the financial crisis. It is argued that such errors arose as a result of the culture that
prevailed in these firms at the time and the perception that management favoured growth of business over prudence and appropriate risk management.
Under Principles for Businesses (PRIN), authorised firms are under an obligation to take reasonable care to organise and control their affairs responsibly and effectively, with adequate risk management systems in place to ensure that. To satisfy this obligation, a firm
must implement effective management and corporate governance structures and, dependant on the firm, such structures are likely to comprise of boards of directors, audit, risk and compliance committees. While they play an essential role in helping to maintain and promote financial stability, they are only part of a picture – a committee is only as efficient as the people who comprise it and the policies they implement. To obtain an effective line of sight over systemically important firms, Hector Sants regards the current progression as an approach towards an ‘eyeball-toeyeball’ method of regulation.
Inhibition rather than promotion of regulation?
A major concern voiced in the City is that an FSA presence will stifle open, honest, interactive and ultimately progressive debate, as ‘big brother will be watching’. Despite the FSA’s proclamation that its attendance is to monitor the management and senior governance of firms rather than outright interference, those at the receiving end of the ‘monitoring’ stares suggest that directors and senior managers will end up saying things that they do not really mean. A new wave of being seen to do the right thing, or ‘stage management’, could kick off. Further, the regulator’s presence may encourage more informal decisionmaking outside the confines of the boardroom. All this could in turn lead to confusion and mismanagement, and ultimately detract from what an FSA presence is trying to achieve.
Several prominent investors are concerned that FSA representatives could be regarded as ‘shadow directors’, exerting influence and driving key decision-making without being accountable to shareholders. Perhaps it is an overstatement to regard the FSA as pseudo or full shadow directors of firms, but such concerns are well founded. The Companies Act 2006 offers no statutory guidance to codify the circumstances in which a person will be found to be a shadow director, but what it does provide is that a shadow director is a person in accordance with whose directions or instructions the directors of the company are accustomed to act. Therefore, to become a shadow director, the FSA board representative must exert a real influence over the company’s affairs and direct the acts of the directors, such that the majority of the board act on such instruction as a matter of practice over a relatively long period of time. The risk of becoming a shadow director is more of a concern to the FSA, rather than firms.
As to whether the FSA (or its representative) will end up as a shadow director is ultimately a question of fact, and one which will be answered only in time. If the FSA is accurate in what it says, that it seeks to monitor rather than actively interfere, then the chances of becoming a shadow director are greatly reduced. In reality, any active influence the FSA has on boardroom decision-making is capped – directors should have been and should be making compliant decisions in any case, regardless of an FSA boardroom presence.
When passing a police car, people automatically reduce speed. Likewise, an FSA presence among directors will ensure regulation is paid greater attention and prioritised on the boardroom agenda. Even if this is purely because of the FSA presence, this is no bad thing. Greater consideration paid to regulatory compliance can only be a good thing – it was relatively ignored in the years leading up to the financial crisis, with disastrous consequences.
On the flip side, there are concerns that overprioritising regulatory compliance could impact adversely on the attention and care paid to commercial, non-regulatory matters. To achieve its outcome of financial stability, the FSA requires firms to be financially robust. A lack of profit could have its own dire consequences for the firms concerned as well as the overall stability of the UK financial system.
A better understanding
A key reason for the government’s dismantling of the UK financial regulatory structure was because no one single body had an understanding of or was responsible for financial regulation. This in turn led to firms’ serious and systematic failings going unnoticed,
leading in part to the financial crisis experienced during 2008 and 2009. The presence of the FSA at some board meetings will hopefully lead to a better understanding by the regulator of institutions it governs, and reflects the new intensive approach to regulation that the Prudential Regulatory Authority will adopt under the direction of Hector Sants and his deputy Andrew Bailey.
At the moment, an FSA presence at board meetings extends only to those firms that are most likely to fall under the remit of the Prudential Regulatory Authority – ie, the ‘largest’ and ‘most complex’ entities. However, it is possible that the FSA will, if it has not already
done so, start to adopt a similar approach to those firms that will ultimately be regulated by the Financial Conduct Authority, selling financial products to retail customers. Despite the risks associated with it, such an approach could be beneficial for banks and other large
financial institutions insofar as it seeks to make the financial system more secure and help attain the overall objective of financial stability.
The requirement for compliance with and fixture on many boardroom agendas, with the topic of profitability superseded by those such as capital ratios and tight systems and controls. A continued FSA presence will only help to ensure this in the long term, rather than ignite a short term board interest in financial regulation, (it has always been there to a lesser or greater extent). However, it is widely agreed that a fuller, more detailed understanding by the FSA of how firms operate at a senior level and what drives key commercial decision-making will help the regulator to avoid another financial crisis.
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