There's no small irony that Lloyds Banking Group will be asking 2.8 million private shareholders to back its £13.5 billion fundraising, the biggest deal of its kind in UK history, on the same day that Sir David Walker makes his final recommendations to Her Majesty's Government on how the governance of the UK financial sector governance should be overhauled.

His proposals for a range of sweeping reforms aim to make a clean break with the past, not just for banks but for shareholders too. Much of the Review should come as no great surprise for the governance community, many of whom have lobbied both Sir David and City Minister, Lord Myners, to strengthen their oversight role and reform the governance of governance.

Sir David clearly does not have the 'tin ear' that some commentators have atttirbuted to the financial sector in recent months. Announcing the Review, Sir David said: “We need to get governance back to centre stage. Of course major regulatory issues need to be addressed to assure the soundness of the financial system but there will be significant downside if the regulatory pendulum swings too far. It could harm the ability of banks to provide customers with the financial services they need and lead to substantial increases in fees and charges.

“Improved governance can play an important complementary role by instilling greater confidence in the way banks are being run by their boards and overseen by their owners. This should help regulators to strike the right balance.”

Walker on BOFI Boards:

“The fundamental change needed is to make the boardroom a more challenging environment than it has often been in the past. This requires non-executives able to devote sufficient time to the role in order to assess risk and ask tough questions about strategy".

Walker on Shareholders:

“Institutional investors should be less passive and prepared to engage earlier if they suspect weaknesses in governance. They enjoy the privilege of limited liability whereas taxpayers have ended up assuming unlimited liability in respect of the big banks. Early preventive medicine through shareholder engagement can save everyone substantial time and money later on.”

Walker on Remuneration:

An extended role for the remuneration committee to cover (BOFI) firm-wide remuneration policy as well as giving the committee direct responsibility for the pay of all highly-paid employees. At least half of variable pay or bonuses should be paid in the form of a long-term incentive scheme with half vesting after three years and the rest after five years. Two-thirds of cash bonuses should also be deferred. In addition the report recommends greater pay transparency in the big banks by requiring public disclosure of the number of employees earning more than £1m, broken down by bands of pay.

How will the Review be Implemented?

The Review proposes that most of the recommendations are enforced through inclusion in the Combined Code on Corporate Governance or a separate Stewardship Code for institutional investors, both operating on a ‘comply or explain’ basis. It would be for the Financial Reporting Council, which has been closely consulted and is currently reviewing the Combined Code, to decide exactly how this would be done. The FSA will consider how to take forward the recommendations applying principally to financial institutions. It is proposed that the recommendations on pay disclosure should be enforced through legislation in the forthcoming Financial Services Bill.

Key Code Recommendations:

• Active investors to sign up to a new independently-monitored Stewardship Code
• Financial Reporting Council to sponsor Stewardship Code
• FSA to monitor investor conformity with Code
• Chairman of board to face annual re-election
• Chairman of Remuneration Committee to face re-election if report gets less than 75% approval
• Most non-executives to spend substantially more time on the job
• Induction process for all non-executives and regular training
• Non-executives to face tougher scrutiny under FSA authorisation process
• Banks should have board level risk committees chaired by non-executive
• Risk committees to scrutinise and if necessary block big transactions
• Chief Risk Officer to have reporting line to risk committee
• Chief Risk Officer can only be sacked with agreement of board
• Remuneration Committees should disclose right of high-paid employees to receive enhanced benefits

Next Steps

The Financial Reporting Council is currently reviewing the Combined Code and is expected to publish its final report in December. There there will be now be a separate consultation on Walker's proposals to amend the Combined Code or related guidance.

Links

Walker Final Report >>

HM Treasury Walker Review Pages >>