Banking Crisis: reforming corporate governance and pay in the City - Treasury Contents

4   Corporate governance

The role of the Board

125. The Combined Code on Corporate Governance states that "every company should be headed by an effective board, which is collectively responsible for the success of the company".[202] Boards typically comprise executive and non-executive directors, including a chief executive and chairman. While we consider the role of the non-executives in more detail below it is also important to assess the role played by the Board as a whole.

126. The directors of a company can be characterised as responsible "for safeguarding the assets of the company".[203] More specifically, the Combined Code states:

The board's role is to provide entrepreneurial leadership of the company within a framework of prudent and effective controls which enables risk to be assessed and managed. The board should set the company's strategic aims, ensure that the necessary financial and human resources are in place for the company to meet its objectives and review management performance. The board should set the company's values and standards and ensure that its obligations to its shareholders and others are understood and met.[204]

127. The Companies Act 2006 lays out seven duties of Directors, reproduced in box 1.

Box 1, Duties of Directors, Companies Act 2006
(a)  1 Duty to act within powers

(b)  2 Duty to promote the success of the company

(c)  3 Duty to exercise independent judgment

(d)  4 Duty to exercise reasonable care, skill and diligence

(e)  5 Duty to avoid conflicts of interest

(f)  6 Duty not to accept benefits from third parties

(g)  7 Duty to declare interest in proposed transaction or arrangement

Source: Companies Act 2006, Part 10 A Companies Directors, Chapter 2, General Duties of Directors

128. Of particular relevance to this inquiry is the duty of directors to "promote the success of the company" which includes a requirement to have regard to the "likely consequences of any decision in the long term".[205] Shareholders in the failed banks have written to us complaining of a "catastrophic lack of competence and ability" demonstrated by the Boards.[206] PIRC argued that boards must hold "primary responsibility" for bank failures because they "approved the business strategies and products that have caused such damage".[207]

129. The bank executives we heard from appeared to acknowledge their responsibility. Mr Varley told us that he "entirely understood" the public's anger.[208] He admitted that the banks were the "the single, biggest contributor" to the crisis.[209] and could reasonably be apportioned the largest share of the blame:

If you ask me as I sit here today, "Is it understandable that the public sentiment is that the banks have the majority of blame?"—in other words, if you think about blame attributable to any particular sector, is the largest particular sector the banks?—I think that is a perfectly understandable and reasonable conclusion".[210]

130. The former Chief Executives and Chairmen of RBS and HBOS and the former Chairman of Bradford & Bingley individually apologised (see box 2 below).

Box 2, Bankers' apologies

  Lord Stevenson: "we are profoundly and, I think I would say, unreservedly sorry at the turn of events. Our shareholders, all of us, have lost a great deal of money, including of course a great number of our colleagues, and we are very sorry for that".


  Sir Fred Goodwin: "I apologised in full, and am happy to do so again, at the public meeting of our shareholders back in November. I too would echo Dennis Stevenson's and Tom's comments that there is a profound and unqualified apology for all of the distress that has been caused".


  Sir Tom McKillop: "In November of last year I made a full apology, unreserved apology, both personally and on behalf of the Board, and I am very happy to repeat that this morning. We were particularly concerned at the serious impact on shareholders, staff and, indeed, the anxiety it caused to customers".


  Andy Hornby: "I am very sorry about what has happened at HBOS; it has affected shareholders, many of whom are colleagues; it has affected the communities in which we live and serve; it has clearly affected taxpayers; and we are extremely sorry for the turn of events that has brought it about".


  Rod Kent: "absolutely the board accepts it is fully accountable for what happened … we are massively disappointed and deeply sorry that this has happened".[211]

131. The appearance of these former industry giants before the Committee had been widely trailed. Numerous press reports speculated that they would be asked, or would themselves offer, to apologize so there can be no doubt that these witnesses would have had ample opportunity to prepare what they were going to say to us.

132. Their admissions were qualified to a degree by repeated appeals to the power of global forces. Mr Hornby referred to "unprecedented global circumstances [which] affected virtually all the top banks in the world".[212] Lord Stevenson argued "the fundamental mistake … that HBOS along with many other banks in the world made was failure to predict the wholesale collapse of wholesale markets".[213]

133. It is no straightforward matter for us to judge the sincerity of these apologies. In a sense it is irrelevant: shareholders will not regard an apology as an adequate recompense for the massive fall in value of their holdings; nor will those made redundant as a consequence of later rationalisation find much solace in these words.

134. The apologies we have heard from RBS and HBOS had a polished and practised air. These witnesses betrayed a degree of self-pity, portraying themselves as the unlucky victims of external circumstances. There should be no doubt that, prior to their public fall from grace, some of whom were regarded as among the most able and competent leaders in British industry. Discriminating between the personal blame that should attach to bank executives, and that appertaining to the force of global circumstances is difficult. Yet it is self-evident that some banks have weathered the storm better than others; and some have not required taxpayer assistance to navigate through the 'credit crunch'. These facts alone make the charge of management failure impossible to resist. Banks have failed because those leading and managing them failed. Much criticism has been levelled at the city culture which encouraged excessive risk taking. The banks' boards must also take their responsibility for failing in their duty to establish a culture within their institutions which supported both innovation and risk management.

Non-executive Directors


135. An important theme to emerge during the course of our inquiry has been that of corporate governance failures in the banking sector, including failures by the boards of banks. This point was made forcefully by PIRC who urged that:

consideration is given to the role and responsibility of the boards of banks. Too much commentary on the banking crisis has overlooked or underplayed the primary responsibility that the boards of banks have for their own failures. Whilst it is of course right to consider the role of regulators and central banks, the board members of the banks that have run into difficulties must take their full responsibility too. They approved the business strategies and products that have caused such damage after all. Therefore we urge the committee to consider the role of boards.[214]

The Chancellor also stressed the overarching responsibility of the board of directors telling us that this was an "area which we overlook at our peril" given that it was "the boards of banks who are supposed to be the first line of defence in relation to their own institution".[215]

136. One important strand of this failure concerns the performance of non-executive directors in UK banks and their ability and willingness to act as a check on executive directors' at leading financial institutions as set out in the Combined Code on Corporate Governance. The Combined Code sets out as one of its main principles that every company should be headed by an effective board, which is collectively responsible for the success of the company. It goes on to state that:

The Board should include a balance of executive and non-executive directors (and in particular independent non-executive directors) such that no individual or small group of individuals can dominate the board's decision taking.[216]

Non-executive directors should constructively challenge and help develop proposals on strategy as well as scrutinising the performance of management in meeting agreed goals and objectives, and satisfy themselves on the integrity of financial information and ensure that financial controls and systems of risk management are robust and defensible.[217] The Code also gives non-executive directors responsibility for determining appropriate levels of remuneration of executive directors—an issue which we have previously discussed in this Report.

137. A number of serious charges have been made against the effectiveness of the non-executive system of oversight. More specifically, there has been criticism that the boards of major listed companies in the UK, including the boards of financial services companies and banks, contain non-executive directors without the expertise or the time to fulfil their oversight and scrutiny functions properly and that, in too many instances, the role of non-executive director is seen as an honorific gong at the end of an illustrious career.

138. A roll call of non-executive directors at the UK's leading banks reveals that in fact many non-executive positions in our leading retail banks are occupied by individuals some with a wealth of experience in financial services and almost all of whom have occupied—or continue to occupy—leading and prominent positions in leading financial and business institutions. We give a snapshot of the non-executive directors at three leading UK banks below.

139. The Board of Barclays Bank contains 12 non-executive directors and is headed by Marcus Agius, a former Deputy Chairman of Lazard LLC, who, in addition to his position as Chairman of Barclays, is also the senior non-executive director of the BBC. Another non-executive director at Barclays, Leigh Clifford, is a former chief executive of the Rio Tinto Group, and combines his role at Barclays with that of Chairman at Qantas Airways. A third Barclays non-executive, Sir Mike Rake, who chairs the Audit Committee, is a former senior partner and chairman of KPMG International. Sir Mike is also Chairman of BT Group PLC and Chairman of the UK Commission for Employment and Skills. The journalist Patience Wheatcroft, is also a non-executive director of the property investment company Shaftesbury PLC, a member of the UK/India Round Table, the British Olympic Association Advisory Board, and the Council of the Royal Albert Hall, and Chair of the Forensic Audit Panel. Professor Dame Sandra Dawson, Master of Sidney Sussex College, Cambridge University, also sits on the board.[218]

140. The Lloyds Banking Group board consists of 12 non-executive directors in addition to 5 executive members of the board. Non-executives at Lloyds include the former diplomat, Sir David Manning, who, in addition to his Lloyds responsibilities, is also a non-executive director of BG Group and Lockheed Martin UK Holdings. A second non-executive director, Phillip N Green, is also the chief executive of United Utilities, a FTSE 100 company. He combines these two roles with a directorship of Business in the Community, as well as being a member of the Government's UK Commission for Employment and Skills and a trustee of the Philharmonia Orchestra. A third non-executive director, Jan P du Plessis, is a former Chief Executive of the Rembrandt Group. Mr du Plessis combines his duties at Lloyds with the Chairmanship of British American Tobacco and also holds non-executive posts at Rio Tinto and the Marks & Spencers Group.[219]

141. The RBS board is largely of recent vintage following the resignation of seven non-executive directors of RBS in the aftermath of the bank coming into part-public ownership. Three non-executive directors did not resign and remained on the board.[220] Sir Phillip Hampton, a former finance director at a number of blue chip companies, is the new Chairman. Sir Phillip had briefly served as Chairman of UKFI immediately prior to his appointment at RBS.[221]


142. John Varley, Chief Executive of Barclays, emphasised the importance of having non-executive directors on the board who had a strong understanding of the banking industry, telling us that he found it "very helpful around the Barclays Board table to have three of our non-executive directors who have significant investment banking experience". He went on to explain that he was not advocating having "a non-executive director cadre that is made up of former bankers", but that it was:

extremely desirable to have at the board table people who understand the industry and, in particular, the most esoteric parts of it, and that would cover the investment banking world. It is no coincidence in our case that we, including our chairman, have an investment banking background. That is a very conscious decision. I certainly find it very helpful as a chief executive to know that I get that challenge from people who understand intimately the financial services industry and even the more abstruse parts of it..[222]

This point was repeated by Paul Thurston, who explained that, within HSBC's UK operations, the audit committee comprised three non-executive directors, each with over 30 years' of experience in either the banking, financial services or accountancy professions and that fulfilling these positions effectively demanded "significant experience in those roles".[223]

143. We quizzed the former Chairmen of RBS and HBOS about their qualifications for the job and, in particular, whether they had previous banking experience or banking qualifications. Both confessed to having no formal banking qualifications, but Lord Stevenson went on to say that he had been Chairman of HBOS for 10 years and that he had a background as an "entrepreneurial businessman" and had "run large businesses since then".[224] When asked about whether other non-executive directors at HBOS had banking qualifications, Lord Stevenson told us that:

we had the former treasurer of Bank of America, which is highly relevant to the thing we have been through, we had the person who had been head of all legal matters in compliance and risk for Standard Chartered, and we had Tony Hobson who had been the long serving finance director of Legal & General.[225]

Sir Tom Mckillop explained that he was a mathematician and a scientist by background and was "certainly numerate". He had also served for five years on the board of Lloyds TSB and had "extensive experience of chairing organisations" as well as "being chief executive of one of the world's largest pharmaceutical companies".[226]

144. Lord Stevenson said that boards of banks had to be "very carefully and thoughtfully composed because you need to have people on them who can really burrow down and understand what is going on". He believed that for non-executive directors to "add value":

(a) it is a good idea to have some directors who have been there [and] done it, which we did, and (b) you should not have any directors who are not prepared to invest a lot of time in going up the learning curve.[227]

He concluded by stating that there had been "a lot of talk about not enough bankers being on boards", but explained that it was "very difficult to get non-executives with banking experience on boards".[228]

145. Stephen Hester, the recently appointed chief executive of RBS, focused on the role of non-executive directors in challenging senior managers. He thought "all companies struggle with the non-executive balance" and that it was important to have executive directors in place that wanted to be strongly challenged, but that it was equally important that non-executives understood that their role involved challenging the executive.[229] He went on to say that:

Helping the company succeed does not always mean saying, yes, to the chief executive, it can mean a challenge, constructive challenge, but I have to tell you, I am not sure this is an issue of process. I think it is, unfortunately, an issue of humans and their behaviour.[230]

146. Lord Turner rejected the assertion that non-executive directors in the UK's leading banks consisted of members of the 'great and the good' who lacked the relevant expertise to carry out their roles effectively, telling us that whilst it may have been the case 20 years ago that the boards of major banks "were stuffed with a random bit of the non-relevant great and the good", this was no longer the case. He believed that the major banks have "for quite some time had people who would appear to have the relevant technical skills".[231] Lord Turner did, however, feel that there was a tangible issue around the amount of time non-executive directors in banks spent on their role:

There is an issue, I think, about simply the total amount of time that non-execs spend on businesses as complicated as banks and insurance companies. Having been a non-executive of a bank, I realised that to do it professionally you really do have to put a hell of a lot of time into it. In future I think we are going to have to think about how much time effectively even very competent people can give to really go into the detail.[232]

Lord Turner stressed that it was important to make sure that appropriate non-executives were in post, and to "make sure that they have adequate time and visibility of the issue". He concluded by saying that this was an area which he would expect banks to look far more closely at in the future.

147. Unlike Lord Turner, Lord Myners thought that problems concerning non-executive directors encompassed more than just lack of time to fulfil their duties effectively. He spoke of a pressing need to "up-skill the non-executive component of boards of directors", citing as an example, shortcomings in some non-executive directors' understanding of complex financial instruments.[233] He explained that he had long been concerned about non-executive performance, citing an article he had written over a year ago for the Financial Times, in which he pointed out "the lamentable state of independent director performance on banks". Lord Myners went on to cite an advertisement placed by Citibank seeking to recruit non-executive directors, in which they had written "Some financial experience would be helpful" as demonstration that some banks were not focusing on the need to recruit non-executive directors with specific technical expertise and experience in the banking sector.[234]

148. However, both Lord Turner and the Governor of the Bank of England were sceptical of the claim that more effective non-executive directors could have prevented the current banking crisis or was the key factor in averting future crises. The Governor said that "the fact that there is a crisis is in itself not evidence that the individuals in charge of those institutions necessarily failed".[235] Lord Turner pointed to what he considered more important issues in terms of causes of the present crisis:

If I had to identify what will decrease the likelihood that our equivalents are here in 10 years' time, it will primarily be precisely the things which the Governor has mentioned. It will be a better system of capital adequacy, a counter-cyclical system of capital adequacy, more robust and effective policies on liquidity. It is those, I think, which are most likely to decrease the likelihood of overall systemic problems in 10 years' time, more likely to do it than operating through the competence of the executives or the non-executives of specific institutions.[236]

149. The proposal that non-executive directors should have dedicated support to help them effectively carry out their responsibilities or should be required to show a greater time commitment to their role have gained a certain amount of traction, most notably from Lord Myners who floated these ideas in a recent speech he gave at the National Association of Pension Funds Investment conference.[237] Lord Myners took up this theme when he appeared before us, telling us that there was a "need to ensure that non-executive directors are sufficiently well-informed". One way to achieve this he believed was a greater time commitment on the part of non-executive directors. Lord Myners went on to call for a debate about whether the non-executive role should be a part-time one—"the idea that you turn up once a month to a meeting and the occasional committee meeting may fall short of the expectations we have now placed on non-executive directors".[238] We asked the FSA whether they saw merit in such proposals—for example, where the senior independent director worked full-time for two days a week in their role and had fully resourced staff. Both Lord Turner and Hector Sants agreed with the need for non-executive directors to have increased resources to fulfil their duties effectively and Mr Sants stressed that "fundamental reform" was needed in this area.[239] Interestingly, Mr Thurston explained that HSBC had an executive chairman, which he considered "very important for a group of our size and geographic reach".[240]

150. Finally, we also received evidence that the pool from which non-executive directors in the banking sector were recruited was far too narrow. Lord Myners was of this view, arguing that if boards consisted of:

people who read the same newspapers, went to the same universities and schools and have the same prejudices and views to sit round a board table you do not get diversity of view and input.[241]

151. The current financial crisis has exposed serious flaws and shortcomings in the system of non-executive oversight of bank executives and senior management in the banking sector. In particular, the evidence shows that many non-executive directors—in many cases eminent and highly-regarded individuals with no shortage of experience in the business and banking worlds—failed to act as an effective check on, and challenge to, executive managers. Too often non-executive directors in the banking sector have operated as members of a 'cosy club' rather than viewing their role as being that of providing effective checks and balances on executive members of boards.

152. This failure to act as an effective check on senior managers has a number of causes, which policy makers must address. First, there is the lack of time many non-executives devote to their role. We were surprised to learn that some non-executive directors appear able to combine their non-executive role with that of chief executive of a FTSE 100 company, or to hold four or five director or trusteeships. Secondly, too many non-executive directors within the banks lack relevant banking or financial experience; we wonder how, in such instances, they can effectively challenge, scrutinise and monitor business strategy and the executive management in a sector as complex as banking. Finally, we are concerned that the banks are drawing upon too narrow a talent pool when appointing non-executive directors to the detriment of diversity of views. The Walker Review must address as a matter of urgency the issue of broadening the talent pool from which the banks draw upon.

153. We believe that there are a number of areas of reform which are worthy of further consideration. Firstly, whilst there may be a case for limiting the number of non-executive director or trusteeships that an individual can hold, we believe an alternative way forward would be to apply the 'comply or explain' approach where an individual who holds more than a certain number of posts would have to provide an explicit defence of how they will be to fulfil this role in addition to their other duties. Secondly, serious consideration should be given to whether all non-executives—or a proportion of non-executives—sitting on bank boards should be required to have professional qualifications relating to banking or other areas of relevance such as accountancy. Thirdly, we believe that there is a strong case for non-executive directors in the banking sector to have dedicated support or a secretariat to help them to carry out their responsibilities effectively. Finally, there is a need to examine ways in which the relationship between institutional investors and non-executive directors could be strengthened.

Risk management by the board

154. The Combined Code on Corporate Governance identifies risk management as a key aspect of the work of non executive directors:

As part of their role as members of a unitary board, non-executive directors should constructively challenge and help develop proposals on strategy. Non-executive directors should scrutinise the performance of management in meeting agreed goals and objectives and monitor the reporting of performance. They should satisfy themselves on the integrity of financial information and that financial controls and systems of risk management are robust and defensible.[242]

The Code also provides that the Audit Committee, Risk Committee or Board as a whole should undertake to review the company's internal control and risk management systems.[243] The Turnbull Guidance, published alongside the Combined Code, requires that such a review should be performed at least annually.[244]

155. In our report on Banking Crisis: dealing with the failure of UK banks, we observed that risk management in banks had not been successful: banks falsely believed that risk had been dispersed by securitisation and falsely believed that they were successfully managing residual risks. The banks themselves have acknowledged that improvements are required. Ron Sandler, Chairman of Northern Rock, told us that a report on the risk management structures of Northern Rock was commissioned after its nationalisation. The principal conclusion of this report was that "a much more independent and much stronger risk function" was required in order "to embed principles of risk management much more deeply in the business".[245] Mr Sandler assured us that, in future, the role of risk management would be "given considerably greater priority within the affairs of Northern Rock than was earlier the case".[246] Similarly, Stephen Hester, Chief Executive of RBS, told us that RBS risk management system needed a major overhaul:

I think, frankly, the risk management systems at RBS need a lot of change, and I cannot do it all in a couple of weeks, and so we need to keep upgrading and keep improving. We are putting in major changes as we speak, but it will take some time to get those absolutely right.[247]

156. The Governor of the Bank of England suggested that banks could take a firmer line on what level of risk and complexity they were willing to tolerate:

take Dennis Weatherstone, who ran JP Morgan. He basically said to anybody who worked in JP Morgan, "You've got 15 minutes to explain this new instrument to me. If I don't understand it after 15 minutes, we are not doing it." It is the willingness to be tough and not to get sucked into the culture of saying, "The other banks are doing it. We must take part as well." That requires great strength of character.[248]

157. In order to enable a firmer approach to risk management, Mr Horta-Osório, of Abbey, argued that the risk management function should be "totally separate from the commercial function", reporting to the business at board level directly to the Chairman.[249] He maintained that where risk managers disagreed with the commercial managers, "the risk manager should have the final word".[250]

158. We believe that the scale of the current banking crisis stands as testament to the fact that risk has not been well managed by the boards of banks across the globe. It is vital that non-executive directors in particular exercise more effective oversight and resist the urge to ally themselves too closely with the managers they are charged with scrutinising. We believe that within banks, the risk management function should report directly to the non-executive members of the board. This is something that the FSA should vigorously pursue.


159. An important aspect of the failure of corporate governance, it is charged, has been the failure by institutional investors—including pension funds, insurance companies, investment trusts and other collective investment vehicles—adequately to scrutinise and monitor the decisions of the boards and executive management of banks in which they have invested and hold senior executives to account for their performance. The point was eloquently made by David Pitt-Watson, Senior Adviser to Hermes Pension Fund Management, who told us that the "key question that shareholders and their agents needed to ask themselves is whether they were partly responsible for the banking crisis". Mr Pitt-Watson also reminded us that institutional investors were investing on behalf of 'ultimate shareholders'—pensioners and ordinary people—and that whilst he had "great sympathy for the people whose pensions have been lost", he had less "sympathy for the people who are in my industry who should have done more to protect the interests of those whose money they managed".[251]

160. Concerns about corporate governance failures in the banking sector have prompted the Treasury to order an independent review of corporate governance in the UK banking industry, which will amongst other issues consider "the role played by institutional shareholders". The review will be led by Sir David Walker.[252] Lord Myners told us that Sir David would bring valuable experience to the role from his time as a Director of the Bank of England and as Chairman of the Securities and Investments Board (SIB) and that he was the right man for the job: "he is wise and he is reflective, he is measured and moderate in his approach, but he does not pull his punches".[253]

161. Sir David Alan Walker was previously chairman of Morgan Stanley International and remains a senior advisor to that firm. He has also served as chairman of the Securities and Investments Board (1988-92), Executive Director for finance and industry at the Bank of England (1989-95), and Deputy Chairman of Lloyds TSB (1992-94). In 2007 Sir David was commissioned by the UK private equity industry to produce guidelines for disclosure and transparency in private equity. His experience and professional background means that he undoubtedly fits the description of a 'City grandee'. However, we are not convinced that Sir David's background and close links with the City of London make him the ideal person to take on the task of reviewing corporate governance arrangements in the banking sector.

162. The framework for the relationship between institutional investors and the companies in which they invest is set out in the Combined Code on Corporate Governance which gives guidance on standards of good practice in terms of relations between boards and shareholders.[254] The Combined Code states that institutional investors, in their relationship with investee companies, should apply the principles set out in the Institutional Shareholders' Committee's (ISC) 'The Responsibilities of Institutional Shareholders and Agents'—Statement of Principles', which should be reflected in fund manager contracts.[255] The Investment Managers Association (IMA), which was one of the organisations to draw up the principles in 2002, explained that the principles represented the first comprehensive statement of best practice governing the responsibilities of institutional investors in relation to the companies in which they invest, on behalf of the ultimate owners.[256] The Principles set out the responsibilities of institutional shareholders and investment managers in relation to the companies in which they invest with the aim of securing value for ultimate beneficiaries—pension scheme members and individual savers—through consistent monitoring of the performance of those companies". In summary, the Principles require institutional shareholders and investment managers to:

·  maintain and publish statements of their policies in respect of active engagement with the companies in which they invest;

·  monitor the performance of and maintain an appropriate dialogue with those companies;

·  intervene where necessary;

·  evaluate the impact of their policies; and

·   in the case of investment managers, report back to the clients on whose behalf they invest.

163. The Institutional Shareholders' Committee suggests that monitoring of performance is to be "backed up by direct engagement where appropriate" and offers instances of when institutional shareholders and/or their agents may want to intervene in companies in which they are investors. These include when investors have concerns about a company's strategy, operational performance or acquisition/disposal strategy. Another concern might be if independent directors failed to hold executive management properly to account. The principles also include a range of actions that institutional shareholders may take, if they are unsatisfied with a company's response:

·  holding additional meetings with management specifically to discuss concerns;

·  expressing concern through the company's advisers;

·  meeting with the Chairman, senior independent director, or with all independent directors;

·  intervening jointly with other institutions on particular issues;

·  making a public statement in advance of the AGM or an EGM;

·   submitting resolutions at shareholders' meetings; and

·  requisitioning an EGM, possibly to change the board.[257]


164. The IMA told us that there were two broad ways in which shareholders could "exercise discipline over the companies in which they invest: by selling shares or engaging with management and boards". From around 2005 "a number of active investment managers concluded that the strategies being followed by many banks were unsustainable, and that they should not keep their clients invested in the sector". It said that the resulting sales of shares "were likely to have been one factor in the underperformance of the banking sector relative to the market as a whole, which was by some 9% in 2005", but concluded that "these market signals appear to have had little or no restraining effect".[258]

165. Peter Chambers, from Legal & General Investment Management, which is owned by Legal & General (L&G) plc, made a similar point when he appeared before us. He explained that investors fell into categories: "those who vote with their feet and those who are engaged with corporations", but went on to say that selling up was not an option which was always open to L&G. This was because most of the money they managed was in index tracking funds, with the result that "if the stock is in the index we have it, so we are not able to vote with our feet for the bulk of our funds" and that this was why engagement with investee companies was so important.[259]

166. Mr Chambers outlined how L&G attempted to engage with the banks, telling us that "during the course of the past 12 months we had 26 separate engagements with the senior directors of the major banks", which he considered to be "quite a high level of engagement". Mr Chambers painted a sobering picture of L&G's attempts to engage with banks in which they held shares with two startling examples which are worth quoting in some detail as they offer an excellent insight into the inability of investors to influence banks in which they had invested:

In the first quarter [2008] we met with the chairman/chief executive—in some cases it was both and in some cases one or the other—of all the banks to ask about capital, because it was clear following the problems faced by Northern Rock that risk profiles were quite high and we could be comfortable with that only if there was sufficient capital in place. All of them to an individual said there was no need to raise other capital. Indeed, one of the major banks was very adamant. We asked them under what circumstances they would need more capital and the response was that there were no circumstances under which they would need it. That was six weeks before the rights issue.[260]

A second example he gave us concerned L&G's attempts to secure the removal of the Chairman and Chief Executive of RBS:

In a number of cases, particularly the Royal Bank of Scotland, we suggested that the heads of the companies were no longer tenable and the chairmen and chief executives should both depart, though not at the same time because that would not be constructive. We gave that message to the chairman. We did not give him his own message; we spoke to the senior independent director. We also spoke to the chairman and the independent director twice on that subject. We were told that that message would get back to the board and we demanded action on it. We were then told that there would be action and we would be pleased by an announcement at the end of August. At the end of August they announced three new non-executive directors but said nothing about the chairman and chief executive. We engaged again and the only way in which the chairman and chief executive stood down at all was by the government requiring it as part of the capital-raising episode.[261]

Peter Chambers concluded by saying that whilst he felt L&G had attempted to engage sufficiently he was still unable to answer the question as to why they were not listened to by the banks.[262] Lord Myners told us that, upon having read about Mr Chambers' experiences, he felt that L&G "just ran into sand" and "gave up". He wanted other investors to learn the lesson that "you cannot give up" and "just stop when you see things happening of which you do not approve" and that as the owners they had "a responsibility to unit trust investors and pension policyholders and insurance policyholders to act in their very best interests".[263]

167. Alain Grisay, Chief Executive Officer at F&C Asset Management, an organisation which is known for its pro-active approach on corporate governance issues, told us that F&C had approximately 15 people engaged full-time in this area in addition to around 180 fund management professionals who took those views into consideration. Mr Grisay revealed that, in the context of British banks, over the past twelve months they had held "five meetings with the board of RBS, five meetings with some board members of Barclays and nine meetings with HSBC". He explained that much of their activity was through "private engagement" rather than via public statements so as to avoid destabilising companies with which they engaged. Mr Grisay concluded by saying that F&C could have done more in terms of their engagement with the banks and that one lesson he had taken away was that "in retrospect perhaps we should have been even more aggressive in engaging some of these companies and maybe voting".[264] We found that some shareholder engagement had encouraged increased leverage and the pursuit of more rapid growth. When questioned Mr Thurston, for HSBC, said that a number of commentators had suggested that banks such as his were "probably over-capitalised, ought to be returning capital, [and] should be leveraging the balance sheet".[265]

168. Mr Pitt-Watson appeared unsurprised that there had been a lot of engagement by institutional investors with the banks over the course of the previous year "when these issues have been in the public eye", but appeared to question the extent of investor engagement with the banks prior to the crisis. He felt that a key issue was how to ensure that, in the future, shareholder engagement was taking place so that crises were avoided rather than responded to by investors.[266] The issue of investor passivity prior to the banking crisis was also raised by Lord Myners. He noted, for example, that many institutional investors had "voted in support of acquisitions which were value destructive".[267] John Kingman, also provided us with an illustration of the lack of shareholder scrutiny and engagement with the banks. He told us that UKFI, in their role of managing Government stakes in RBS and the Lloyds Banking Group, had visited the head of risk management at the two firms where "one of those people said to me this was the first time a shareholder had ever asked to come and see them".[268]

169. Mr Montagnon acknowledged that investors had not been as effective as they could have been, but said this was not due to a lack of effort and that there had been much activity by institutional shareholders, "some behind the scenes", but that this "was not as effective as it might have been".[269] The IMA also conceded a lack of effectiveness in respect of their members' efforts to engage with the banks, but stressed that it was important to recognise that "there are limits on what engagement can achieve".[270]


170. We requested evidence as to the reasons behind weak and sometimes ineffective shareholder engagement as well as ways to strengthen investor engagement in companies they invested in, including whether shareholders required additional tools and powers if they were to carry out their role more effectively.

171. Lord Myners rejected the suggestion that shareholder ineffectiveness resulted from investors having insufficient tools or resources. He stressed that "Investors in UK companies have very substantial powers", which were "amongst the most significant powers of investors anywhere in the world". He cited as evidence of this their ability to convene meetings and remove directors which he said were "not embodied in company law in the United States of America in most states and it is not common practice in Europe". He concluded by reiterating that the question was not "that they do not have the powers … it is that they have not exercised them".[271]

172. The ABI has, however, argued for additional powers for shareholders, calling for a requirement to be introduced that all directors should submit themselves annually for re-election at the Annual General Meeting.[272] At present, directors stand for re-election on a rotational basis with re-election every three years being the norm. Mr Montagnon argued that this would be a "big change" and would "be a means of people being held to account" whilst giving shareholders the safeguard of being able to vote out directors in whom they had lost confidence.

173. PIRC argued that part of the problem lay in the lack of priority accorded to corporate governance issues by investors. It noted that beneficial owners such as pension funds typically delegated responsibility for analysing corporate governance issues and the exercise of shareholder voting to their existing fund managers, but that many fund managers did not "have the capacity, and perhaps the desire, to undertake this role effectively". PIRC went on to say that it "was hard to see how fund management houses with a handful of corporate governance staff can play this role effectively", especially as they expected the "situation to deteriorate further" given that a number of large financial institutions were already cutting back the resources that they dedicated to corporate governance analysis. PIRC's conclusion was that "a step-change in behaviour" was required with large investors such as pension funds either taking more responsibility for corporate governance themselves, or keeping a much closer watch on how their fund managers dealt with such issues.[273]

174. Both PIRC and InvestorVoice, a forum for individual stakeholders in publicly quoted companies, argued that one way to improve the focus of institutional investors on corporate governance would be the introduction of mandatory disclosure by institutional investors of their voting on shareholder resolutions for all UK listed companies.[274] Investor Voice told us that such legislation existed in other countries, but that it was only voluntary in the UK and the majority of fund managers did not currently publish such information.[275]

175. Witnesses representing institutional investors were at pains to point out that shareholders as 'outsiders' faced information barriers when attempting to monitor what was going on in the banks and that both the regulator and non-executive directors were in a far better position than shareholders to scrutinise the activities of the banks. For example, Richard Saunders, Chief Executive for the IMA, whilst acknowledging that shareholders had played a contributory part in the banking crisis, went on to contrast the position of shareholders with that of the non-executive directors in the banks:

there is a hierarchy of information. As shareholders my colleagues would have no greater access to information than is available to the market as a whole. Obviously, the non-executive directors will see much more; they will see board papers and so on and will have greater access to the state of the company.[276]

Peter Chambers used a similar argument, but contrasted the information available to regulators as opposed to investors, stressing that:

of all outside people the regulators have the first line of sight in seeing what goes on in the banks. They have information that is not accessible by the rest of us as investors in the public domain". The other group of people who have line of sight are the banks themselves and their executive directors and above that the non-executive directors. One would have to conclude that the non-executive directors were not effective in controlling the activities of the executive directors; otherwise, we would not be where we are now.[277]

176. The ABI in its submission noted that ownership of UK equities had become more fragmented in recent years with the "insurance industry now owning only around 15 per cent of the market and pension funds somewhat less". It believed that often other owners were "less concerned about governance", thus making it "easier for companies to override efforts by concerned shareholders to achieve change".[278] Lord Myners also noted that ownership was fragmented, but drew a different conclusion. He said ownership was "now so widely held across a number of institutions, none of whom own more than 2% or 3%, that nobody is much exercised to apply the care and attention that is necessary to behave in a manner consistent with ownership responsibility". He referred to this state of affairs, which he said applied to all major firms and not just banks, as a situation where "we have to some extent ownerless corporations".[279]

177. Peter Montagnon pinned part of the blame for shareholder failure on the strong presence in the market in the run-up to the boom of investors "whose interests were mainly trading rather than ownership".[280] David Pitt-Watson agreed with Mr Montagnon, stating that "primarily a lot of us are trading shares rather than undertaking the task of being good owners of companies, but said another reason why shareholders were not as effective as they could be was because "we are all very disparate".[281]

178. The ABI acknowledged that more could be done to "improve the techniques and approaches to dialogue" and said that a particular focus should be on "improving mutual understanding between independent directors and shareholders, how they interact at times of corporate stress, and on ensuring that dialogue appropriately addresses key issues such as risk management".[282] The need for greater engagement between investors and non-executive directors was a theme which Lord Myners pursued when he appeared before us:

One of the things I would like institutional shareholders to do is to have much more engagement with non-executive directors, to sit with the non-executive directors, to talk about the issues, to form a view on their competence, to understand what is going on in their minds—what are they worried about at the moment? From my experience of contact with some of the non-executive directors of some of the banks where we have intervened it is quite illuminating to know what is on their minds and, perhaps more interesting, what is not on their minds.[283]

179. Institutional investors have failed in one of their core tasks, namely the effective scrutiny and monitoring the decisions of boards and executive management in the banking sector, and hold them accountable for their performance. We note David Pitt-Watson's evidence to us which questioned the extent of investor engagement with the banks prior to the current crisis. We accept that there has been increased engagement by investors once signs of the crisis began to emerge, although some appear to have chosen to sell their stakes in the banks rather than intervene or challenge bank boards. Those that did not just sell up appear to have been asking the wrong questions or, as Lord Myners told us, just gave up. This may reflect the low priority some institutional investors have accorded to governance issues. The lack of resources devoted to corporate governance appears to reflect a range of factors including the fragmented and dispersed ownership and the costs of detailed engagement with firms—resulting in the phenomenon of 'ownerless corporations' described by Lord Myners. The Walker Review on corporate governance in the banking sector must address the issue of shareholder engagement in financial services firms and come forward with proposals that can help reduce the barriers to effective shareholder activism.

2 202  02 Financial Reporting Council, The Combined Code on Corporate Governance, July 2003, p 4 Back

2 203  03 RBS Annual Report & Accounts 2007, p 114 Back

2 204  04 Financial Reporting Council, The Combined Code on Corporate Governance, July 2003, p 4 Back

2 205  05 Companies Act 2006, Part 10 A Companies Directors, Chapter 2, General Duties of Directors, 172 (a) Back

2 206  06 Ev 286 Back

2 207  07 Ev 253 Back

2 208  08 Q 1905 Back

2 209  09 Q 2065 Back

2 210  10 Q 2064 Back

2 211  11 Qq 1614, 1641-3, 294 Back

2 212  12 Ev 431 Back

2 213  13 Q 1769 Back

2 214  14 Ev 252 Back

2 215  15 Q 8 Back

2 216  16 Financial Reporting Council, The Combined Code on Corporate Governance, June 2008, p 7 Back

2 217  17 Financial Reporting Council, The Combined Code on Corporate Governance, June 2008, p 5 Back

2 218  18, Dame Sandra Dawson resigned from the Barclays Board at the 2009 Annual General Meeting on 23 April 2009  Back

2 219  19, Jan du Plessis resigned from the Lloyds Board on 17 April 2009 Back

2 220  20 "RBS announces Board restructuring", RBS Announcement, 6 February 2009 Back

2 221  21 "Appointment of Chairman", RBS Press Notice, 3 February 2009 Back

2 222  22 Q 1978 Back

2 223  23 Q 1976 Back

2 224  24 Q 1661 Back

2 225  25 Q 1740 Back

2 226  26 Q 1800 Back

2 227  27 Q 1790 Back

2 228  28 Q 1792 Back

2 229  29 Q 1977 Back

2 230  30 Ibid. Back

2 231  31 Q 82 Back

2 232  32 Ibid. Back

2 233  33 Q 2747 Back

2 234  34 Q 2785 Back

2 235  35 Q 86 Back

2 236  36 Q 98 Back

2 237  37 Speech by Lord Myners, Financial Services Secretary to the Treasury, NAPF Annual Investment conference, 12 March 2009 Back

2 238  38 Q 2785 Back

2 239  39 Q 2231; the actual question put to Lord Turner and Mr Sants was: "Could you not envisage a model, for example, where the senior independent or somebody other than the chairman and the chief executive, not a part-timer who was also running another company somewhere else but actually had to be there two days a week, had a fully resourced staff and actually had to have a specific responsibility, and had the line management for the risk assessment department so that he or she could lean against the wind effectively?" Back

2 240  40 Q 1976 Back

2 241  41 Q 2785 Back

2 242  42 Financial Reporting Council, The Combined Code on Corporate Governance, July 2003, p 4 Back

2 243  43 Ibid., p 16 Back

2 244  44 Ibid., p 29 Back

2 245  45 Q 420 Back

2 246  46 Ibid. Back

2 247  47 Q 1963 Back

2 248  48 Q 2398 Back

2 249  49 Q 2112 Back

2 250  50 Q 2113 Back

2 251  51 Q 1009 Back

2 252  52 "Independent Review of Corporate Governance of UK Banking Industry by Sir David Walker", HM Treasury Press Notice, 9 February 2009 Back

2 253  53 Q 2786 Back

2 254  54 Financial Reporting Council, The Combined Code on Corporate Governance, June 2008 Back

2 255  55 Ibid., p 21 Back

2 256  56 Ev 235 Back

2 257  57 Institutional Shareholders, The responsibilities of institutional shareholders and agents - statement of principles, June 2007 Back

2 258  58 Ev 224 Back

2 259  59 Q 1058 Back

2 260  60 Ibid. Back

2 261  61 Ibid. Back

2 262  62 Q 1058 Back

2 263  63 Q 2795 Back

2 264  64 Q 1059 Back

2 265  65 Q 2095 Back

2 266  66 Q 1066 Back

2 267  67 Q 2793 Back

2 268  68 Q 2637 Back

2 269  69 Q 1012 Back

2 270  70 Ev 224 Back

2 271  71 Q 2792 Back

2 272  72 Ev 107 Back

2 273  73 Ev 260 Back

2 274  74 Ibid. Back

2 275  75 Ev 442 Back

2 276  76 Q 1061 Back

2 277  77 Q 1062 Back

2 278  78 Ev 157 Back

2 279  79 Q 2752 Back

2 280  80 Q 1060 Back

2 281  81 Q 1067 Back

2 282  82 Ev 156 Back

2 283  83 Q 2787 Back

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