Banking Standards

Submission from Board Intelligence (S002)

· Board Intelligence provides services to boards and executive committees to drive board effectiveness and improve the quality of decision making. We specialise in improving the scope and quality of the information that board directors receive and with which they formulate their judgement and challenge.

· We have reviewed over 80 board packs in the past year alone from a range of sectors (including, but not limited to financial services). We observe board meetings to help us tailor our solutions to the specific needs of each client and as such we have considerable exposure to current practice within the boardroom.

· We welcome the opportunity to participate in the Parliamentary Commission on Banking Standards Inquiry.

Response Summary

We have limited our consultation response to those issues about which we feel qualified to comment. Our response is therefore limited to elements of questions 4 and 5 as set out by the Commission.

1. Question 4: What caused any problems in banking standards and the weaknesses in corporate governance?

And question 5: What can and should be done about it?

Since the financial crisis, the governance of banks has rightly been in the spotlight but we believe this spotlight has been too narrowly cast, being focused almost exclusively on board composition. In our view, there are four other factors that have inhibited board effectiveness and that warrant a greater profile in the debate:

a) Firstly, most boards are blindfolded as they do not receive adequate information.

b) Secondly, the challenge of ‘seeing what matters’ is compounded by the complexity of many large banks. Expectations on any board are arguably superhuman, but the scale and complexity of the financial service conglomerates creates an additional strain.

c) Thirdly, we believe that the way boards spend their time is inefficient: by habit and convention, too much of it is spent in board meetings and the time that is spent in board meetings is rarely used to great effect.

d) And finally, we observe a number of weaknesses in the unitary board structure, including the challenge it presents for the non-executive, given the very people they are there to supervise are peers of equal status.

2. Question 4: What caused any problems in banking standards and weaknesses in whistle blowing?

And question 5: What can and should be done about it?

We propose two ideas as food for thought, in addressing the weaknesses in the arrangements for whistle-blowing:

a) The establishment of an Ombudsman Program by Pfizer provides an independent and neutral channel through which employees can raise issues in confidence, similar to the role that is performed by the Partners’ Counsellor within the John Lewis Partnership.

b) The roll-out of a programme of continuous employee insight sourcing (with a cross section of the workforce polled every month and all employees polled at least twice a year) creates a culture of openness and, in line with Richard Thaler’s ‘nudge’ theory, it makes it easier for employees to raise matters of concern. We do not propose that legislation or regulation should mandate such practices, but we wish to raise the profile of best practice and its benefits.

Full Response

1. What caused any problems in banking standards and the weaknesses in corporate governance?

What can and should be done about it?

1.1. The sheer number of near-death experiences and compliance scandals that have afflicted the banking sector in recent years suggests systemic failure amongst boards as company supervisors and stewards. Following each scandal, the conclusion has been drawn that the people on the board were the wrong people. By extension, appointing the right people (with the right skills, experience, commitment and diversity) has widely been proclaimed as the answer to an effective board.

1.2. It is our belief that this is an incomplete analysis and that the focus of attention has been cast too narrowly on board composition. We would like to raise the profile of four additional factors that we believe impede the effectiveness of banking boards and that should feature more prominently in the debate:

a) The inadequacy of the information boards receive

b) The scale and complexity of many financial institutions

c) The way boards allocate and manage their time

d) The pitfalls of the unitary board structure

These four challenges are shared by the boards of companies in every sector, however, many are particularly acute in banks, and still more so in large banks.

a) The inadequacy of the information boards receive

1.3. No matter how knowledgeable, experienced and diverse a board of directors may be, they are effectively blindfolded until they are provided with the information around which they formulate their judgment and challenge.

1.4. ‘Information risk’ is arguably one of the biggest risks faced by the board: our banks have not been plunged into crisis because of a lack of problem-solving prowess – but because, for far too long, they didn’t know they had a problem. The principal source of information for most non-executives (outside of the board meeting) is the board pack and in our experience, the state of most company board packs does little to mitigate this risk. To highlight a few of the most widespread failings of company board packs:

1.4.1. Size: They are too big to read: A FTSE 100 board pack averages 288 pages (excluding committee papers) which would take over nine hours to read [1] – and yet directors admit that they allocate just three hours. The problem is even more acute amongst FSA regulated firms, as management strives to disclose every possible detail that (in hindsight) the regulator may have deemed relevant to the board. Banking boards are drowning in paperwork and it is a monumental challenge for any director to digest their briefing papers, let alone discern what really matters at any point in time.

1.4.2. Scope: The content is too narrow in focus: Board packs are heavily weighted towards backward-looking financials and operational detail, providing little (if any) stimulus for a more strategic discussion in the boardroom.

1.4.3. Style: The reports are impenetrable: One director aptly described their board pack as ‘an obstacle to clear thinking’.

1.5. We work with the boards of some of the UK’s largest companies (usually at the behest of an executive team wanting to empower their board), where the quality of the boardroom conversation has been transformed by equipping the directors with the information they need. With the right scope and quality of information, presented in a concise and readable fashion, the board is demonstrably more effective. The directors are then better placed to supervise and ask the pertinent questions about the things that really matter. And when it comes to strategy, they have the requisite stimulus around which to add their judgment and experience.

1.6. A survey published by Korn/Ferry Whitehead Mann & KPMG earlier this year revealed that one in five non-executives felt out of depth in boardroom discussions because of the inadequate briefing materials. We have spent the past four years focused on nothing but how to equip the board with effective board packs; having witnessed the impact this can have, we would like to see board information given greater prominence in the governance debate.

b) The scale and complexity of many financial institutions

1.7. The expectations placed on boards can appear superhuman:

1.7.1. An army of many thousands of external auditors are not expected to overturn every stone within a major multinational but the regulator, shareholders and the public express astonishment when a handful of non-executives with a 30-day mandate, are taken by surprise.

1.8. However, the challenge facing the board is aggravated by complexity, which characterises many of our largest financial service firms. It is especially hard to provide effective oversight of anything one doesn’t understand or cannot see clearly. The more complex an organisation the harder it is to understand – even for the ‘experts’ whose expertise will usually reside within one or other specialism. Add to this the sheer scale of many of these organisations and the challenge of ‘seeing what matters’ is compounded further.

c) The way boards allocate and manage their time

1.9. Over-reliance on board meetings: Given the board’s duty to supervise and steward, we believe too much emphasis is placed on board meetings which, although necessary, are insufficient for the job at hand. From the confines of the boardroom a director cannot hope to gain a firm grasp on the culture of a business, the calibre of its management or the opportunities and threats it is facing. And yet most boards seek to fulfill their role principally through attending a series of board meetings (notwithstanding the occasional away day and office or branch tour). We would advocate the board draw on a wider set of tools beyond the board meeting and re-weight the time directors spend in board meetings vs the time spent in the business, speaking to external stakeholders and participating in more board away days.

1.10. Use of time in board meetings: It is not uncommon for the board of a FTSE 350 to regularly endure over 20 items on their board meeting agenda, turning the board into a highly administrative forum with no time for substantive discussion. In our experience, most boards have an appetite to reduce the burden on their agenda but they feel constrained (rightly or wrongly) by what they believe are the expectations of the regulator. We would encourage this Commission (together with the FSA and the FRC) to initiate a conversation around which items do and do not need to be dealt with at a board meeting and those that may be dealt via alternative channels (e.g. secure digital forums, conference calls or sub-committees). This would help the board meeting to be reserved for serious, in-depth discussion on the future of the organisation, free from other distractions.

d) The pitfalls of the unitary board

1.11. The unitary board is considered one of the great strengths of UK governance. However, in our opinion there are flaws to the unitary board structure (as set out below):

1.11.1. Taking first the board’s role as ‘supervisor’: We wonder whether the unitary structure may be an obstacle to the board’s fulfillment of its role as ‘supervisor’. The board seeks to supervise the executive who number among them – as such, the non-executives are supervising their peers. In most other walks of life (and for good reason), supervision is embedded within a clear hierarchy to empower the supervisor. The challenge of supervising a peer in the unitary board structure is aggravated by the asymmetry of information between executives and non-executives: with knowledge comes power and given the time they spend in the business, the executive holds the balance. Regardless of the ideals of the unitary board, power amongst directors is far from evenly spread, making supervision still harder.

1.11.2. Taking next the board’s role as ‘steward’: The unitary principles would make good sense for the purpose of formulating the strategy - were it actually the case that this was what boards do. In reality, board meetings allow little time for a meaningful discussion of strategy, and away days tend to occur only once a year (and often address more than just strategy). A series of snatched conversations at board meetings and one-day immersion in the topic is inadequate for the development of a robust strategy, especially for a major multinational. When the board engages with strategy it does so to challenge and ratify rather than originate and develop. In effect, the board engages with strategy as a ‘supervisor’ rather than a ‘steward’. And in this regard, non-executives face the same challenges as those described above.

2. What caused any problems in banking standards and weaknesses in the arrangements for whistle blowing? What can and should be done about it?

2.1. We would like to propose two ideas as food for thought, in addressing the weaknesses in the arrangements for whistle-blowing:

a) The office of the Ombudsman

2.2. As part of the settlement to a derivative action in the US brought against the Directors of Pfizer in 2010, Pfizer has created the position of an Ombudsman whose role is to provide an alternative channel for employees to express work-related concerns and, amongst other things, to facilitate whistle-blowing:

"The capacity of the board or a committee to monitor is dependent on the quality of the information that it receives… employees may feel disempowered or be concerned about exposure and retaliation should they report on wrong-doing. An Ombudsman Program can mitigate such anxieties by providing a protected channel for employees to express work-related concerns."

Affidavit for Final Approval of Derivative Action Settlement, February 2011

"The Office of the Ombudsman provides an informal place where all Pfizer colleagues can talk confidentially and off-the-record. The Ombudsman is independent and neutral."

The Blue Book, Pfizer

Closer to home, the role of the Ombudsman is similar to that of Partners’ Counsellor at the John Lewis Partnership:

"He [the Partners’ Counsellor] will encourage confidence on the part of any Partner to come to him and talk freely and confidentially without fear of repercussion…. The Partners’ Counsellor may be dismissed only with the specific agreement of the Trustees of the Constitution."

The Constitution of the John Lewis Partnership, April 2012

b) Continuous employee insight sourcing

2.4. Most large organisations poll their employees once a year to track engagement. Thanks to the ease with which web-based surveys can be administered, we advocate a far more frequent programme, polling a cross section of the workforce every month (and all employees polled at least twice a year). We advocate asking no more than 10 questions (to achieve high response rates) but covering a broader scope than just engagement, to include questions about the governance and reporting culture, as well as other risks and opportunities.

2.5. A system of monthly surveys creates a culture of openness and proactive reporting. An independent source of insight removes a monopoly on information and information no longer flows only through the single tracks of line management, reducing the inclination to conceal critical developments in the first place.

2.6. As well as fostering a healthy and open culture, a programme of monthly employee insight sourcing benefits from Richard Thaler’s principles of ‘nudge’, making it easy for all employees to communicate with senior management – whether the matter relates to misconduct or any other risk or opportunity that is visible to the workforce,  but not visible to senior management and the board.

2.7. We do not propose that legislation or regulation should mandate such practices but we wish to raise the profile of best practice and its benefits.

24 August 2012

[1] Board Intellig ence / University of Cambridge Judge Business School r esearch, 2011.

Prepared 22nd September 2012