5 Governance
171. Governance underlies everything a firm does.
It is the fundamental mechanism through which decisions are made
and a firm is overseen. Co-op operated a unique governance model.
This section examines that model further, and considers what responsibility
it bears for Co-op's failed Verde venture and the bank's financial
collapse.
Links between the bank and the
group
172. As has been described, there were considerable
links between the governance of Co-op Group and Co-op Bank. At
the end of 2008, when Co-op was deliberating on the Britannia
merger, seven of the thirteen non-executive members of the bank
board—including the Chairman—were sourced from the
elected members of the group board.[257]
By 2011, when Co-op was first considering a bid for Verde, this
figure had fallen to four out of twelve, though two group executives
also sat on the board.[258]
The remaining group representation was senior, including the group
Chairman, Len Wardle, the group Chief Executive, Peter Marks,
and the group Deputy Chairman, Paul Flowers, who was Chairman
of the bank.[259]
173. The Co-op Bank Chief Executive had, until early
2011, had a single reporting line to the banking group board.
This changed with the introduction of Project Unity, which brought
with it a requirement for the bank Chief Executive to report to
the group Chief Executive.[260]
The governance of the bank and group thus became further intertwined.
174. Neville Richardson made clear his opposition
to Project Unity, saying that it "diluted his position",
although he felt it did not result in any loss of control to the
group.[261] Rodney
Baker-Bates went further, saying that Unity "changed the
whole nature of the relationship with the group and made the group
executive and the group management have a much more direct role
in the strategic and operational overview of the bank".[262]
David Davies, Co-op Bank's second Deputy Chairman, agreed that
the bank "lost an element of independence" as a result.[263]
Mr Baker-Bates pointed in particular to the change that the amended
reporting line brought to the position of Peter Marks, saying:
With the change in reporting line from Neville
Richardson at the beginning of the year, he clearly had become
an executive. He was no longer a non-executive, at least in my
eyes.[264]
175. Lord Myners, leader of the independent review
into governance at Co-op, told us that "on many issues the
board of the bank and the board of the group were indistinguishable"
and that:
to understand what happened at the bank, you
[need] to understand what happened at the [group] board, because
the board [controlled] the bank. It controlled most of the seats
on the bank's board for a long period of time […].[265]
In particular, Lord Myners said that "the reckless
decision to acquire Britannia was very much a group board decision
rather than simply a bank board decision".[266]
Sir Christopher Kelly, however, described a lower level of Group
involvement in the Britannia deal:
In contrast to what happened some years later
in the negotiations with Lloyds Banking Group over the Verde assets,
the Co-operative Group Board and Executive played a limited part
in the Britannia transaction. […] But the Group was
attracted by the prospect of increased scale for the Bank and
by the addition of a large number of Britannia customers to its
membership.[267]
176. Following Neville Richardson's resignation,
Barry Tootell became Co-op Bank's Chief Executive, under this
same reporting line. Though appointed on an interim basis, Mr
Tootell stayed in post until May 2013. The Kelly report claims
that, although Mr Tootell "struggled" in the role, he
was kept in post because of the prolonged nature of the Verde
negotiations, and the expectation that Lloyds would provide a
new Chief Executive along with the Verde branches.[268]
Andrew Bailey said of Mr Tootell:
I do not think Barry Tootell was at all dominant.
[…] I think Barry was perfectly competent, but I do not think
he was in any sense a strong chief executive. No, I do not.[269]
An oversized board with insufficient
financial experience
177. In 2008, when Co-op Bank was considering the
Britannia merger, the bank's board of 17 members comprised one
Co-op Group executive, seven members of the Co-op Group board,
four Co-op Bank Executives and five 'Independent Professional
Non-Executive Directors' (IPNEDs).
178. Following the Britannia merger in August 2009,
Co-op Bank's board expanded in size, from 17 to 22 members.[270]
Clive Adamson, Director of the Major Retail Groups Division at
the FSA over the period of the merger, said that the board at
this stage "was both too big and the proportion of individuals
with financial sector experience was not sufficient".[271]
An external review of the effectiveness of the board, commissioned
by Co-op Bank and conducted by Dr Tracy Long in 2010, similarly
concluded that "the board's ability to work together effectively
is greatly reduced by its size [and] composition".[272]
179. Specifically on its size, Mr Adamson told us
that the board following the merger was "somewhat unruly"
and "difficult to manage".[273]
Rodney Baker-Bates said that the board was "unwieldy"
rather than unruly, and that "it was a very big board, and
as a result it was hard to have a discussion and interaction around
an issue".[274]
By 2011, Co-op Bank had taken steps to reduce the size of its
Board from 22 to 14, and also made some changes to its make-up.[275]
Clive Adamson said that, by this stage, "half the members
had some degree of financial services experience".[276]
However, while he felt the resulting mix was better, it "still
was not perfect in terms of the degree of experience on the board".[277]
Andrew Bailey said that the FSA insisted on further restructuring
of Co-op Bank's board in the summer of 2011, telling the Committee:
"There was not adequate experience on the board".[278]
He described the changes that Co-op Bank made in response:
I think some of the changes were already in train,
but between then and sometime during 2012—I cannot remember
exactly when—there was an overhaul of the board. It shrank
the number of members of the board, it replaced the so-called
democratic Co-op members to a greater extent. It also replaced
the former Britannia directors and it brought on people who had
banking expertise.[279]
The FSA remained concerned about Co-op Bank's governance
well into 2012, however, as noted in the Kelly report:
In its June 2012 Risk Assessment letter to the
bank, the FSA stated that the current Board structure "does
not provide sufficient oversight, coverage, depth of debate and
challenge to management", particularly given the large number
of projects under way at that time. In the same letter the regulator
said that it had observed over-reliance on just a few IPNEDs,
and that the balance between IPNEDs and group [non-executive directors]
on the [Co-op Banking Group] board needed to change. The bank
was very slow to make the necessary changes.[280]
180. Over the period examined by this Report, fifteen
of the Co-op Group board's twenty members were elected from Co-operative
Regional Boards, and five from Independent Co-operative Societies.
Those from Regional Boards did not need to have any background
in financial services.[281]
Peter Marks, Co-op Group Chief Executive from 2007 to 2013, had
no obvious financial services experience.[282]
The extent of overlap between the governance of the group and
the bank meant that this lack of financial services expertise
extended onto the banking group board. Rodney Baker-Bates told
the Committee:
Particularly among the democrats, as we call
them, there was not really enough knowledge of the risks and opportunities
in banking and financial services.[283]
The lack of experience, Mr Baker-Bates said, had
implications for the style of debate on the board:
[T]here was a broad spectrum of skill, and therefore
on a particular issue—let us say our capital or the reserving
in the general insurance—there was a relatively narrow set
of expertise that we deployed and then a rather more general discussion.
The way in which people looked at the issue was very diffuse,
much more diffuse than you would get on a standard plc board.[284]
David Davies described "shortcomings" in
the board members from Co-op Group, present because "they
did not have the experience of financial services".[285]
But he added that these members "were of good calibre and
quality and were very diligent and tried really hard to master
the issues that we were wrestling with".[286]
He also defended the position of these members on the board, saying:
I do not want to say they were not up to it,
because they added a different dimension to the board. They added
a whole range of looking after customers and doing the right thing
by the Co-operative Group members.[287]
Sir Christopher Kelly concluded:
It was reasonable for the Group to wish to have
representation on the CBG Board.
It is also understandable
in the light of co-operative values and principles why it should
wish some of these representatives to be democratically elected.
It is less clear that the preservation of cooperative principles
required representation in such numbers, particularly since few
of them were able to add much expertise in other areas.[288]
181. Asked whether he was confident that the board
as a whole was adequately experienced and knowledgeable to take
decisions, Mr Davies replied "Yes".[289]
However, both former Deputy Chairmen told us that what expertise
there was on the board was "too thinly spread".[290]
Mr Davies said in particular:
The same people were getting put on to more than
one committee and it was asking a tremendous amount of workload.
It is not as if all 14 of them had financial services expertise,
so that was part of the problem.[291]
182. The problem of expertise being thinly spread
was exacerbated by the wide range of activities undertaken by
Co-op Banking Group. Mr Baker-Bates said that "the board,
although it met as a single board, was in fact overseeing three
different businesses: it was overseeing a bank, a general insurance
business and a life business". The "range, scope and
complexity of the issues" that the board was attempting to
examine "made it difficult to get a focus on […] the
key issues".[292]
The composition of the board reflected this breadth in the business:
of the thirteen non-executive directors on the board in 2011—when
Co-op was submitting its initial Verde bids—six had financial
services experience, but three of these specialised in insurance;
only three non-executives had banking expertise.
183. This governance structure, lacking in suitable
expertise, is particularly surprising given the transformational
step that Co-op was poised to take with Verde. As Lord Myners
said:
[I]f they had gone ahead with Verde, the Co-op
would have changed from being a primary grocery business with
funerals and pharmacies and a bank to have become primarily a
bank with groceries, funerals and pharmacy. […]
[T]his board of directors, as I describe it,
could not possibly have been placed in control of 8% of the British
banking market […].[293]
Paul Flowers
184. The lack of appropriate financial services expertise
within Co-op's governance is epitomised by Paul Flowers. Mr Flowers
was elected to the Co-op Group board in 2008. In June 2009 he
joined the banking group board, and in April 2010 he became the
bank's new Chairman, at the same time being appointed Deputy Chairman
of the group.[294]
He reached this position despite having no experience in financial
services. When he appeared before this Committee, he struggled
with basic factual details about the bank, including the size
of its balance sheet.[295]
185. Mr Flowers was one of four candidates for the
post of Chairman.[296]
The selection process—which was run by the group as the
bank's sole shareholder—consisted of a psychometric test
followed by an interview with group Chairman Len Wardle, and two
other members of the group board.[297]
Mr Baker-Bates, who was also a candidate for bank Chairman, shared
his recollections of the recruitment process:
The interview as I recall it was primarily focused
around my knowledge, which was not as deep as others', of the
Co-operative Group and the Co-operative movement. I do not remember
much discussion about my banking and other experience, but I presume
they took that from my CV. I think there were three other interviews
and no references were asked for.[298]
The day following Mr Baker-Bates's interview, Mr
Flowers's selection as the new Chairman was announced to the bank
board. David Davies described the group's decision:
[T]he explanation that was given to the board
was that the group had chosen Paul primarily, if not entirely,
on his leadership capabilities. They cited as evidence the Walker
report where Walker had suggested that ideally you need a balance
for a chairman of the board between leadership and financial skills,
and if you were not able to have both, then leadership would be
the primary recommendation, according to Walker.[299]
Mr Baker-Bates conceded that Mr Flowers "certainly
had a much better understanding than I did of the complexity and
the politics with a small 'p' of the membership in the Co-operative
Group".[300] But
both Deputy Chairmen said they felt that Mr Flowers lacked the
financial services experience necessary to chair a bank.[301]
186. Following his selection by Co-op, Mr Flowers
was interviewed by the FSA. Under the Approved Persons regime,
individuals on the boards of banks are required to seek regulatory
approval before taking up their positions.[302]
Mr Flowers had been approved as "fit and proper" by
the FSA when he joined Co-op Bank's board in 2009.[303]
However, in 2010, there was no formal requirement for existing
board members to seek further approval if they became Chairman.[304]
Despite this, Clive Adamson decided to hold an additional interview
with Mr Flowers. He told the Committee:
That was beyond what was required by our process
at the time, but I felt it was important, as director of the division
at the time, to see an individual who was in the process of being
appointed chairman.[305]
187. Mr Adamson and two other FSA officials interviewed
Mr Flowers in March 2010, covering areas such as his technical
experience, the challenges facing Co-op Bank, and the group's
motivation in selecting him as Chairman.[306]
Mr Adamson said the fact that Mr Flowers was "deficient in
technical banking experience and financial services experience
was completely recognised by me and by him".[307]
However, Co-op's reasoning behind Mr Flowers's appointment accorded
with the FSA's own concerns about the size of Co-op Bank's board:
[T]he reason that he was proposed to be put forward
was that, at that time, the board of the Co-op Bank was 22 individuals.
It was a somewhat unruly board and it was important that somebody
was put in place to better chair that board.[308]
Mr Flowers's lack of financial services expertise
did not "make bells ring in the regulator's head", since
Mr Adamson thought he was the right person "in terms of his
ability to run a somewhat large and unruly board".[309]
Mr Adamson confirmed:
My view at the time was that Mr Flowers did have
the competence to perform the role of non-executive chairman.
Just to be clear, our view is the non-executive chairman does
not run the bank. The role of the non-executive chairman is to
run the board.[310]
Mr Adamson said, however, that "today both regulators
would insist upon financial services experience at the chairman
level".[311] Andrew
Bailey also confirmed that the regulatory approach to the approval
of senior individuals has changed since 2010: "We would not
have somebody in the role of chairman of a large bank who had
no financial services experience".[312]
188. There was unanimous agreement among our witnesses
that Mr Flowers lacked sufficient banking experience to act as
Chairman of a major bank. Notwithstanding this, Mr Flowers was
credited with performing a number of aspects of his job well.
Andrew Bailey told us:
I have been through the records and I have looked
at the comments made by all the members of the board that we interviewed,
both old and new, and none of them criticised Paul Flowers, interestingly.
They generally say that he was an effective chairman.[313]
Mr Bailey also said that Mr Flowers acted in response
to the areas of concern that the FSA raised with Co-op about its
Verde bid:
[I]mmediately after the July board meeting, we
raised explicitly with the Co-op the fact that we did not believe
that their risk function and their chief risk officer was up to
the job. I raised that with Paul Flowers, and Paul Flowers said
to me, "I understand the point you are making. He will be
replaced", and he was. They overhauled their risk. Between
mid-2011 and the end of 2011, they did that. […]
The Paul Flowers scorecard is distinctly mixed,
frankly, in that sense, more mixed than you obviously get from
the popular camps.[314]
189. Comments from Co-op directors listed in Dr Tracy
Long's board effectiveness review show that Mr Flowers was seen
to be "good at engaging people's views", and had "radically
changed the culture" of the board to be "more open".[315]
Co-op Bank's former Deputy Chairmen confirmed these views to the
Committee. Mr Baker-Bates told us that Mr Flowers "tried
hard to get the board to focus on the issues and to get everybody
to express their views, and everybody's views to be heard".[316]
And Mr Davies said Mr Flowers performed his duties as Chairman
in a manner appropriate to his lack of banking expertise:
I personally think he recognised his limitations,
and if he led us into a financial services discussion where he
was not capable, he would get found out. I think he took a consensus
view and let the discussions flow and summarised and came to a
view at the end and did not put his head above the parapet. I
do not mean that unkindly. I mean as chairman he deliberately
kept a low profile until he sought the consensus that he was looking
for.[317]
THE APPROVED PERSONS REGIME
190. Mr Flowers was appointed as a board member under
the Approved Persons Regime, under which the FSA had the power
to require certain individuals within banks to seek pre-approval
from the regulator before taking up their positions. The Parliamentary
Commission on Banking Standards examined this regime, and concluded:
As the primary framework for regulators to engage
with individual bankers, the Approved Persons Regime is a complex
and confused mess. It fails to perform any of its varied roles
to the necessary standard. It is the mechanism through which individuals
can notionally be sanctioned for poor behaviour, but its coverage
is woefully narrow and it does not ensure that individual responsibilities
are adequately defined […]. In principle, it is the means
by which the regulator can control those who run banks, but in
practice it makes no attempt to set clear expectations for those
holding key roles. It operates mostly as an initial gateway to
taking up a post, rather than serving as a system through which
the regulators can ensure the continuing exercise of individual
responsibility at the most senior levels within banks.[318]
The Commission recommended that the Approved Persons
Regime be replaced, in the case of senior individuals, with a
Senior Persons Regime. Regulatory guidelines around this regime,
the Commission said, should make clear that senior individuals
"should be fit and proper to carry out responsibilities assigned
to them, and be able to demonstrate the necessary skills and experience".
[319] The Government
accepted these proposals and introduced them as the 'Senior Managers
Regime' in the Financial Services (Banking Reform) Act 2013. The
FCA and PRA began a consultation on the workings of the new regime
in July 2014.[320]
191. The new regime applies only to deposit-takers
and investment firms regulated by the Prudential Regulation Authority.[321]
The Approved Persons Regime remains in place for other financial
services firms. During Commons consideration of Lords amendments
to the Financial Services (Banking Reform) Act 2013, the Chairman
of the Treasury Committee said:
Everyone now seems to be agreed that the APR
adds little or nothing, yet over the past few weeks we have discovered
that the discredited APR will survive in legislation. In doing
that, the regulators are perpetuating a myth that the APR affords
any real protection. It will continue to apply to several groups.
First, about 20,000 people in the financial services industry
outside banking will still be covered, mainly in fund management
and insurance.
This is unfinished business. The Banking Commission
had the remit to look only at banking. It would be absurd to retain
a system for one part of financial services that has so clearly
failed in another. The Government and Parliament both need to
encourage the regulator to look at this and do what is necessary
to extend the coverage of the new regime and to remove the APR
from other parts of financial services. To rely on the APR is
asking for trouble.[322]
192. Clive Adamson, when asked why the Approved Persons
Regime would continue to be fit for other financial services institutions,
given that it was not fit for banking, told us:
We would have preferred the new regime to apply
to all financial services firms.[323]
Governance and Verde
193. Barry Tootell, former Chief Executive of Co-op
Bank, told us that both the bank and the group had a role in Verde:
Project Verde or the acquisition of a major new
business is a matter reserved for the group board. As the shareholder
of the banking group, the bank could not acquire a major new subsidiary
or a major new undertaking without the approval of the group board.
However, it would be for the bank to decide whether it was able
and wished to do the transaction.[324]
194. However, other witnesses described more than
simply an 'approval' role for the group. Peter Marks, group Chief
Executive, was described as the "driving force" behind
Co-op's Verde bid by witnesses.[325]
In leading Co-op's Verde enterprise, Mr Marks appeared to be acting
in his capacity as group Chief Executive, not as a bank non-executive.
"This was very clearly a Group matter", Mr Davies told
us.[326] Mr Baker-Bates
agreed: "We were very clear it was a group-led project."[327]
195. Mr Marks himself accepted that he was the driving
force behind Verde.[328]
But he also said, in particular in relation to negotiations with
Lloyds, that "Barry Tootell, who was the chief executive
of the bank […], was the main person supervising the day-to-day
running of the process".[329]
Asked what qualifications he, Mr Marks, had to examine, scrutinise
and ensure thorough due diligence of a banking deal, Mr Marks
replied: "I don't think I needed it […] because the
Chief Executive of the bank was actually running the process".[330]
Mr Marks also told us he was "very careful not to interfere
with the running of the bank", and when discussing accountability
for goings-on at the bank, said:
I couldn't be accountable because I wasn't approved
by the FSA to run a bank. That was not my role in the organisation.[331]
196. Co-op Bank's former Deputy Chairmen painted
a very different picture. Mr Davies told us that Mr Marks was
"leading the negotiations and he was dealing with Lloyds",
that "the discussions with Lloyds were principally Peter
and the group team", and that Mr Marks acted as "the
main conduit of information from Lloyds".[332]
Andrew Bailey told us, however, that:
the Co-op Bank board had to take the decision
to recommend the Verde transaction to the group. Peter Marks could
not take that decision on his own.[333]
197. When asked whether Paul Flowers, like Peter
Marks, was driving forward Verde, Rodney Baker-Bates, said: "I
am less clear on that". David Davies, agreed:
I think Paul was very good at not nailing his
colours to the mast. As chairman, I thought he deliberately avoided
trying to push people in a certain direction. He let the arguments
develop.[334]
However, emails from Rodney Baker-Bates at the time
suggest a sense that senior figures within the group, including
Paul Flowers, had already made their mind up about the Verde deal
and were unwilling to listen to dissenting voices. In a message
to Paul Flowers on 28 May 2012, Mr Baker-Bates said that "I
have a strong sense that Len [Wardle, Co-op Group Chairman] and
Peter have already come to a positive conclusion".[335]
Following the Heads of Terms vote in July 2012, Mr Baker-Bates
said in an email to Ursula Lidbetter, then Deputy Chairman and
now Chair of Co-op Group:
Interestingly, after the meeting several colleagues
said they understood my arguments but still voted in favour, Group
think? What is abundantly clear is that Len, Paul and Peter want
to do this deal and seem to be "deaf" to objective risk
analysis.[336]
198. The Committee heard evidence that the banking
group board was not sufficiently involved in the Verde process
more generally. Asked whether, in retrospect, the Deputy Chairmen
were as much in the loop as they should have been in the negotiations,
Mr Baker-Bates said: "Certainly not in the negotiations.
Absolutely not in the negotiations."[337]
Mr Davies agreed, referring to Verde's status as a group-led project.
The bank board also appears not to have been fully briefed on
interaction with the regulator on Verde: both Deputy Chairmen
denied having seen Andrew Bailey's December 2011 letter to Paul
Flowers setting out the FSA's five areas of concern in respect
of the deal.[338] Mr
Davies told us: "I have tracked the board papers and I can
find nothing in the board papers to show it was shared with the
board."[339]
199. In Mr Marks's testimony to the Committee, he
did not even appear to appreciate that there were concerns about
Verde on the bank board, despite being a member himself. He told
us:
On each occasion when I asked them for their
opinion and we voted on it, it was unanimous. That was the same
in the group boardroom and the bank boardroom.[340]
It is clear from the testimonies of Co-op Bank's
Deputy Chairmen—both of whom voted against Verde in July
2012—that this was not the case.
200. The Deputy Chairmen did point to some engagement
of the bank board on Verde. Mr Davies said that "the risk
committee were briefed very thoroughly on the progress of agreeing
the parameters of the integration and all the nuts and bolts and
the risks involved", but admitted that the board was "not
engaged was the financial terms of the offer".[341]
201. Mr Baker-Bates, responding to the question of
why the bank board did not stand up for itself and insist on more
involvement in Verde, said:
I think the bank board did stand up. That assumes
that there was unanimity of opposition and I think the Committee
needs to understand that there were six, seven, eight NEDs; there
was a range of views there. I was at one end, being trenchantly
opposed to it for reasons that we have discussed; there were other
colleagues at the other end who were, in fact, strongly in favour
of it. You are trying to convey the concept of a united board
on this particular issue and the fact is there was a wide range
of views.[342]
In an email to Ursula Lidbetter in October 2011,
however, shortly after a discussion about Verde at the Co-op Group
board, Mr Baker-Bates said:
Peter appeared to have a vision (which is easy
to share), but limited grasp of the detail. His enthusiasm and
organisational power and personality seems to be driving the process.
I have had several [Co-op Banking Group] executives privately
express very valid reservations. As an aside, it is a pity they
do not have the "guts" to express them in a public forum.[343]
The Kelly report on the overall
effectiveness of Co-op Bank's governance
202. The Kelly Report considers the contribution
of failures of management and governance at the bank and group
to Co-op Bank's problems. It concludes:
The Bank Executive failed to exercise sufficiently
prudent and effective management of capital and risk. The Banking
Group Board failed in its oversight of the Executive. The Group
Board failed in its duties as shareholder to provide effective
stewardship of an important member asset. Collectively, they failed
to ensure that the Co-operative Bank consistently lived up to
its ethical principles. In all these things they badly let down
the Group's members.[344]
On the Banking Group Board specifically, Sir Christopher
said:
As in any organisation, the responsibility for
running the business lay with the Executive. It is the Executive,
and in particular the successive Chief Executives, who are accountable
for the large number of poor decisions taken during the period
under review.
But it was the role of the Board to ensure that
the Bank had the capability to do what was required of it, to
agree an appropriate strategy, and to monitor and challenge the
way the strategy was implemented. It should also approve and monitor
the Bank's risk appetite. Judging by the results, it failed in
all these areas.
Crucially, it failed to focus on capital, even
though that is an essential duty of any bank board and despite
the capital difficulties the Bank was facing. Capital was a major
preoccupation at this time for most other UK banks.
There are dangers in generalising because the
composition of the Board changed over the period. But the explanation
for the extent of the governance failure appears to lie in five
factors:
i) The capability of the Executive Team. Even
a good, well-skilled board cannot make up for ineffective Chief
Executives and senior teams. The CBG Board had little chance of
doing so.
ii) Its Chair. The chair is critical to any board.
If he or she for reasons of experience lacks the capability to
understand the business of the organisation, the board as a whole
is unlikely to be effective, whatever the quality of its other
members. This is particularly the case where the business is as
complex and technical, and as inherently risky, as banking.
iii) The small number of Board members with any
banking experience. The IPNEDs were never in a majority until
2013, and not all of them had a banking background. Their influence
on major issues was constrained accordingly, even though other
members relied on them heavily on technical issues. It is noteworthy
that the Verde negotiation continued even after the two experienced
Deputy Chairs came to oppose it.
iv) Poor process. The assessment of Paul Flowers
by his colleagues possibly reflected the fact that he ran meetings
better than his predecessor. But meetings still appear to have
been overly formal. The normal procedure was said to be for Bank
executives to deliver a presentation, followed by all Directors
being invited in turn to ask questions. That is not an approach
that encourages debate.
v) Poor management information. The Board was
presented with a lot of information, but not always in a way which
brought out the key issues very clearly. Management information
presented to the CBG Board often lacked sufficient quantitative
analysis and was sometimes one or two months out of date.
Most if not all of the IPNEDs, and some of the
other Board members, were aware of these deficiencies. But they
seemed unable to do anything about them. Some, particularly those
appointed in the latter part of the period when the causes of
the capital shortfall were already well-established, became increasingly
frustrated.[345]
In his overarching conclusion about Co-op Bank's
governance over the period his report examined, Sir Christopher
said:
It is hard to avoid the conclusion that the Group
Board, as constituted, was never likely to be able to exercise
any form of effective shareholder oversight of its banking subsidiary.
The [Co-op Banking Group] Board did include some experienced and
capable individuals. But it was greatly handicapped by the lack
of banking experience of its Chair, by poor process and by inadequate
information. If the Executive had been more capable, that might
not have mattered so much. The combination of poor decisions by
the Executive and weak governance proved very damaging.[346]
Conclusions
203. Co-op Bank's governance structure up to the
middle of 2013 was entirely inadequate for a bank of any size;
it is shocking that it was in place in an institution that came
so close to becoming a major new challenger bank. Co-op Bank's
board was dominated by members from the parent group who lacked
financial services experience. Those members with financial services
experience were responsible for overseeing a very broad range
of business. Being small in number, their expertise was spread
too thinly, and ran the risk of being over-ruled by possibly well-meaning,
but inexperienced, democratic members of the board. Yet, at least
from 2009 to 2011, the board was also too large and unwieldy to
allow for meaningful discussion and debate. The executive was
also subject to influence from Co-op Group, with the bank's Chief
Executive in a direct reporting line to the group's Chief Executive
from 2011.
204. There was a place for representation of Co-op
Group on the bank board. As sole shareholder, the group's views
needed to be heard. But this should not have come at the expense
of the experience necessary to run the bank. Indeed, in the context
of a controlling interest in the bank, the group's board structure
and inexperience should have been of more concern to the regulator
than it apparently was.
205. The deficient composition of Co-op Bank's
governance was embodied in Paul Flowers, who lacked any of the
requisite financial services experience to act as Chairman of
a bank. In this regard he appointed two experienced Deputy Chairmen
to strengthen the advice to him and the board. Mr Flowers was
appointed on the basis that he would be able to navigate the 'politics'
of Co-op Group and chair the board. We took evidence that he had
performed these functions well. But this was an inappropriate
basis for his appointment. An effective bank Chairman should usually
possess a good deal of experience of financial services. He or
she should be at least capable of understanding financial issues.
Mr Flowers lacked both the desirable experience and the minimum
essential skills. He should not have put himself forward for the
role. Co-op should not have selected him. The regulator should
not have permitted his appointment.
206. Clive Adamson and Andrew Bailey have said
that an individual with as little financial experience as Mr Flowers
would not be appointed as Chairman of a bank today. That he was
allowed to perform the role at all is further proof, if it were
needed, of the inadequacy of the Approved Persons Regime. This
regime, in principle the means by which the regulator can ensure
that those who run banks have the requisite expertise, is in practice
a narrow box-ticking exercise. It operates mostly as an initial
gateway, providing very little subsequent oversight of those at
the most senior levels in banks. The new Senior Managers Regime—recommended
by the Parliamentary Commission on Banking Standards, given statutory
underpinning by the Government and now being consulted on by the
regulators—seeks to address these deficiencies. Properly
implemented, the regime provides a better prospect that the most
senior individuals will have sufficient financial expertise to
perform their roles effectively, or at least have the capacity
to understand the questions put before them and to ask some of
their own.
207. While the Approved Persons Regime will be
abolished for the banking industry, it will be retained for many
in the remainder of the financial services industry, including
insurance and asset management. Given its manifest failings, this
appears hard to justify. Clive Adamson, Director of Supervision
at the FCA, appeared in oral evidence to agree with this view.
The Government and the regulators should at the earliest opportunity
make proposals to extend the coverage of the Senior Managers and
Certification Regimes to, and remove the application of the Approved
Persons Regime from, other parts of the financial services industry.
208. Co-op's governance was not the source of
all the bank's problems. The bank was also hampered by an ineffective
executive team. Failures of risk management within the bank itself
are to blame for taking on and obscuring excessive risk. But defective
executive management can only persist if there is ineffective
board oversight. The bank's board was incapable of providing the
necessary guidance and challenge to the executive.
209. All boards make mistakes, and take decisions
that, in retrospect, they should not have taken and which may
incur large losses. But the previous governance of Co-op Bank—in
its structure and its composition—seems to have invited
the risk of failure, whether in the decision to merge with Britannia,
in the failure to uncover the bank's impairments, or in the failure
to act decisively on the regulator's warnings about the Verde
deal. What's more, the previous management of Co-op Bank presided
over the bank's prudential and conduct failures while presenting
customers with the façade of a prudent and ethical business.
210. Evidence heard and seen by the Committee
during this inquiry paints a picture of specific, serious governance
failings at the Co-op which contributed to the losses in the bank.
In pointing out these governance failings the Committee is mindful
that other financial institutions with more conventional PLC boards
also collapsed in recent years at huge cost to the taxpayer.
211. Rodney Baker-Bates and David Davies, Co-op
Bank's two Deputy Chairmen, opted to resign from the bank's board
because they dissented on Verde. In the circumstances, they took
an honourable course. However, board members should not always
feel obliged to resign merely because they disagree with a major
business decision or transaction. Resignation can deprive a board
of valuable skills and experience. But there may be circumstances
in which there is no alternative to resignation. Such circumstances
may include non-executives believing that the firm's future is
endangered by the board's failure to heed their warnings, or senior
board members obstructing constructive criticism. The FRC should
examine whether there is value in providing guidance in the UK
Corporate Governance Code on the circumstances that might call
for a board member to resign, and the factors that board members
should take into account when making their decision.
212. Peter Marks has been identified by our witnesses
as the driving force behind Co-op's Verde bid. He appeared to
lack any of the financial services experience that would warrant
such a role. He also lacked the necessary regulatory approval,
being approved only as a non-executive yet appearing to have acted
in a de facto executive capacity. Barry Tootell claims to have
had responsibility for the Verde deal as bank Chief Executive,
but other witnesses have described Mr Marks as leading the negotiations,
and were clear that Verde was a group-led project.
213. The Committee has heard that Verde would
not have gone ahead unless the bank had approved it. But the group's
dominance on the bank board and the apparently cursory engagement
of the experienced board members on the detailed Verde negotiations
made credible dissent unlikely. Moreover, what disagreement there
was—from the bank's two Deputy Chairmen—appears to
have been forgotten or ignored by Peter Marks, who told the Committee
that Verde at all times had the unanimous support of the bank
board. Rodney Baker-Bates also described Peter Marks, Len Wardle
and Paul Flowers as being "deaf" to objective risk analysis
of the deal. This was scarcely the way for a bank to consider
a major acquisition.
214. Earlier in this Report, the Committee concluded
that the management of Co-op Bank in place during the Verde bidding
process was unlikely to have been able to address the regulator's
concerns about the bid. This same management, and all those in
Co-op Bank's management since the Britannia merger, bear some
responsibility for the manner in which the deal ultimately collapsed.
Co-op Bank should have come to terms sooner with the risks it
was running; having done so, it might have decided not to pursue
Verde. As it was, the leadership of Co-op Bank proved incapable
of appreciating and addressing the problems in the bank, and the
Verde deal was allowed to continue, driven by the enthusiasm of
a small number of Co-op Group members, until Co-op Bank's capital
shortfall finally emerged.
257 Sir Christopher Kelly, 'Failings in management and governance',
(30 April 2014), page 118, Exhibit 30 Back
258
Ibid. Back
259
The Co-operative Bank plc, 'Financial statements 2011', page 10 Back
260
Andrew Bailey (PV 16) page 5 Back
261
Ibid. Back
262
Q 1762 Back
263
Q 1907 Back
264
Q 1830 Back
265
Oral evidence taken on 7 May 2014, HC (2013-14) 1265, Q 42 Back
266
Ibid. Back
267
Sir Christopher Kelly, 'Failings in management and governance',
(30 April 2014), para 3.34 Back
268
Sir Christopher Kelly, 'Failings in management and governance',
(30 April 2014), paragraphs 14.5-14.6 Back
269
Q 1963 Back
270
Sir Christopher Kelly, 'Failings in management and governance',
(30 April 2014), page 118, Exhibits 30-31 Back
271
Q 1428 Back
272
Dr Tracy Long (PV 31) page 3 Back
273
Qq 1316, 1342 Back
274
Qq 1748, 1802 Back
275
Sir Christopher Kelly, 'Failings in management and governance',
(30 April 2014), page 118, Exhibit 30 Back
276
Q 1428 Back
277
Ibid. Back
278
Q 1962 Back
279
Q 1954 Back
280
Sir Christopher Kelly, 'Failings in management and governance',
(30 April 2014), paragraph 13.53 Back
281
Oral evidence taken on 7 May 2014, HC (2013-14) 1265, Q 4 Back
282
Sir Christopher Kelly, 'Failings in management and governance',
(30 April 2014), paragraph 9.8 Back
283
Q 1748 Back
284
Q 1802 Back
285
Q 1750 Back
286
Q 1749 Back
287
Q 1752 Back
288
Sir Christopher Kelly, 'Failings in management and governance',
(30 April 2014), paragraph 13.36 Back
289
Q 1910 Back
290
Q 1911 Back
291
Q 1910 Back
292
Q 1748 Back
293
Oral evidence taken on 7 May 2014, HC (2013-14) 1265, Q 42 Back
294
The Co-operative Group, 'Annual Report and Accounts 2008', page
33; The Co-operative Bank plc, 'Financial statements 2009', page
14; The Co-operative Bank plc, 'Financial statements 2010', page
11 Back
295
Qq 680-685 Back
296
Q 1347 Back
297
Financial Services Authority (PV 23) page 1 Back
298
Q 1789 Back
299
Q 1797 Back
300
Q 1793 Back
301
Qq 1796, 1800 Back
302
Financial Services Authority, 'CP10/3: Effective Corporate Governance',
(January 2010), paragraphs 2.4 Back
303
Q 1318; Financial Services Authority (PV 22) Back
304
Financial Services Authority, 'CP10/3: Effective Corporate Governance',
(January 2010), paragraphs 2.4-2.7 Back
305
Q 1320 Back
306
Financial Services Authority (PV 23) Back
307
Q 1327 Back
308
Q 1316 Back
309
Q 1327 Back
310
Q 1316 Back
311
Q 1379 Back
312
Q 1946 Back
313
Q 1964 Back
314
Qq 1954, 1964 Back
315
Dr Tracy Long (PV 31) page 7 Back
316
Q 1803 Back
317
Q 1834 Back
318
Parliamentary Commission on Banking Standards, 'Changing banking for good',
HC 175-I, paragraph 86 Back
319
Ibid. paragraph 100 Back
320
Financial Conduct Authority and Prudential Regulation Authority,
'Strengthening accountability in banking: a new regulatory framework for individuals',
30 July 2014 Back
321
Financial Services (Banking Reform) Act 2013, Section 33 Back
322
HC Deb, 11 December 2013, col 267 [Commons Chamber] Back
323
Q 1434 Back
324
Q 490 Back
325
Qq 1607, 1829 Back
326
Q 1830 Back
327
Q 1875 Back
328
Q 289 Back
329
Q 352 Back
330
Q 300 Back
331
Qq 304, 272 Back
332
Qq 1840, 1873, 1846 Back
333
Q 1963 Back
334
Q 1833 Back
335
Rodney Baker-Bates (PV 29) page 14 Back
336
Ibid. page 17 Back
337
Q 1875 Back
338
Qq 1886-87 Back
339
Q 1888 Back
340
Q 483 Back
341
Qq 1875, 1913 Back
342
Q 1915 Back
343
Rodney Baker-Bates (PV 29) page 6 Back
344
Sir Christopher Kelly, 'Failings in management and governance',
(30 April 2014), paragraph 2.1 Back
345
Sir Christopher Kelly, 'Failings in management and governance',
(30 April 2014), paragraphs 13.48-13.51 Back
346
Ibid. paragraph 13.54 Back
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