Armstrong Bonham Carter Armstrong Bonham Carter, 1 Angel Court, EC2R 7HJ, England

Armstrong Bonham Carter's response to Sir David Walker's review of the corporate governance in UK Banks and other financial industry entities
Article by Tom Bonham Carter 01 Oct 2009

Armstrong Bonham Carter’s response to Sir David Walker’s review of the corporate governance in UK Banks and other financial industry entities.

Armstrong Bonham Carter (ABC) is delighted to contribute to Sir David’s review of the corporate governance in UK banks. ABC is a specialist consultancy which advises chairmen on how to improve the effectiveness of their boards. ABC has responded in detail to each of the 39 recommendations below but would like to first make an overall comment.
In the preface of 16th July, Sir David commented ‘that different banks operating in the same geographies, in the same financial and market environments and under the same regulatory arrangements generated such massively different outcomes can only be fully explained in terms of differences in the way they were run’. ABC fully agrees with this assessment but noted with regret that there was no further comment or research into this crucial matter. For ABC believes it is critical to understand whether some banks had by design of their business model performed absolutely and certainly relatively better (e.g. because of geographical exposure, client exposure, amount of capital retained, dependence upon the whole sale money markets) or by luck? Or alternatively did some bank boards in developing their strategies appreciated effectively the state of the economic cycle and made effective plans to mitigate against the effects of the downturn? As for the others why did the boards get it so wrong?
ABC believes this review is currently at risk of making little beneficial impact on the corporate governance arrangements of Banks as it has not fully understood the reasons for the Bank boards’ failures.
Furthermore as an example and in response to the five key themes:
1. Whilst ABC would agree the Combined Code has improved accountability, it is not, as yet, fit for purpose. ABC will be responding directly to the FRC on this matter suggesting that there needs to be improvements in transparency and in particular how boards intend to create value for shareholders for the longer term in order for all stakeholders to assess the effectiveness of boards.
2. ABC would not agree that those principal deficiencies of BOFI boards relate much more to patterns of behaviour. ABC believes the principal deficiencies are due to the poor strategic decisions taken and the lack of effectiveness of most BOFI boards in leading their organisations in the long term interests of shareholders.
3. ABC would agree that Banks seemingly did not appreciate and correctly identify the risks to their business strategies. But it is unclear whether more risk resources would automatically lead to better results.
4. The rationale for more active engagement should be at the behest of the client. The board of directors is there to look after shareholders interests. If a board follows simple corporate governance concepts of accountability, transparency and looking after shareholders interests for the long term with integrity then board effectiveness would be a straightforward evaluation process for all stakeholders.
5. ABC would agree that remuneration policies have been entirely focused on growth and the use of relative total shareholder return targets are for example not just encouraging absolute growth but encouraging relatively high rates of growth. Remuneration targets should be fully reconcilable with business strategy. This should be designed for growth in the benign phase of the economic cycle and also anticipate and execute a robust survival of the recessionary phase.

With respect to the 39 detailed recommendations, ABC believes 13 of the recommendations may have a marginal improvement to the corporate governance practices of BOFI. At present, 15 recommendations match current best practice and thus repetition has limited value. ABC feels in 11 cases the recommendations are flawed and need revision to avoid detrimental and unintended effects. The comments for each are laid out below.

In conclusion, ABC believes the review would find it beneficial to understand how BOFIs develop strategy and their success or not in anticipating the downturn in the economic cycle. From this study, recommendations may be made to ensure Bank boards manage the cycle without at least resorting to public funds during the next downturn.

If, however, there are no robust means for ensuring boards manage risk more sensitively to the cycle, which would be reasonable as the development and approval of strategy is fundamentally a subjective process, then the regulator must be properly equipped for the task of ensuring the sector is sufficiently insured for the next downturn. This means that the BOFIs must be truly transparent about their aim, strategies and plan, including the risk appetite with the Regulator. The Regulator can then aggregate these plans to understand any systemic risks emerging, both on a regional, national or global level. Indeed for the latter Regulators will either have to collude or a Global regulator will need to be created. Lastly, from the study of why banks have performed differently, Banks should be subject to variable insurance premiums or risk weighted capital charges according to their current business state and future state as laid out in their business strategy.

Finally, in terms of remuneration, ABC notes that all stakeholders laud growth and even become obsessed with growth it in an economic upturn. This is clearly shown by the investors approving over the last ten years exclusively growth focused incentive targets such as relative total shareholder return. BOFI aims, strategies and plans should be more sensitive to the economic cycle. Remuneration policy and targets must be fully reconciled with them, including the risk appetite and management rewarded for achieving the aim, strategy and plans and subject to penalties for failing to do so.

ABC hopes these views will be of interest and would be delighted to discuss matters further.

1. Board size, composition and qualification

Recommendation 1

To ensure that NEDs have the knowledge and understanding of the business to enable them to contribute effectively, a BOFI board should provide thematic business awareness sessions on a regular basis and each NED should be provided with a substantive personalised approach to induction, training and development to be reviewed annually with the chairman.

Response: ABC would agree with the recommendation but from our experience, we believe most BOFI and even listed companies believe they have this in place already. But to make this recommendation effective and ensure the FRC original recommendation is better implemented, then some measure of success is needed. Clearly having such a measure as an amount of time spent by directors in training would be arbitrary. Yet otherwise the risk remains if Boards continue to decide on the amount of training, with even a requirement to report it, that without such a measure in place, the variation amongst such programmes will remain.

Recommendation 2

A BOFI board should provide for dedicated support for NEDs on any matter relevant to the business on which they require advice separate from or additional to that available in the normal board process.

Response: From our experience and more especially according to ABC’s research findings into the effectiveness of listed company boards, the FRC’s Combined Code requirement for all members of boards to have access to independent advice has been universally adopted along with support from a company secretary and team. The board review process should include an evaluation of the support provided to the board.

Recommendation 3

NEDs on BOFI boards should be expected to give greater time commitment than has been normal in the past. A minimum expected time commitment of 30 to 36 days in a major bank board should be clearly indicated in letters of appointment and will in some cases limit the capacity of the NED to retain or assume board responsibilities elsewhere.

Response: ABC would agree that it is hard to be prescriptive on the right amount of time spent by NEDs and our experience would suggest that NEDs have spent more time than originally outlined in their letters of appointment. ABC would suggest that via the board review process, individual NEDs time commitment should be evaluated in terms of the extra amount given in their own assessment of the current state of the business and its capabilities to achieve the corporate aim within the approved risk appetite in the context of the changing business and risk environment. ABC would suggest this would preclude the appointment of the NED with a full time executive position at another company.

Recommendation 4

The FSA’s ongoing supervisory process should give closer attention to both the overall balance of the board in relation to the risk strategy of the business and take into account not only the relevant experience and other qualities of individual directors but also their access to an induction and development programme to provide an appropriate level of knowledge and understanding as required to equip them to engage proactively in board deliberation, above all on risk strategy.

Response: ABC agrees with the recommendation but would comment that BOFI boards must be entirely transparent with the FSA as to the organisation’s aim, its appreciation of the future business environment, the selection of the preferred strategy, including the assumptions underlying it and the annual plans to successfully implement the strategy including the risk management process. As a result of this, it would be evident to the FSA and the board the type of skills and experience required on the board to achieve the aim whilst managing the risks inherent in the execution of strategy and those that emerge due to the state of the business environment. The FSA could then assess the Board development plan either through recruitment and/or training to meet the required set of skills and experience.

Recommendation 5

The FSA’s interview process for NEDs proposed for major BOFI boards should involve questioning and assessment by one or more senior advisers with relevant industry experience at or close to board level of a similarly large and complex entity who might be engaged by the FSA for the purpose, possibly on a part-time panel basis.

Response: ABC would agree with the recommendation and stress the importance of the assessment of a potential NED on their understanding of leadership as well as the business of banking and economics.

2. Functioning of the board and evaluation of performance

Recommendation 6

As part of their role as members of the unitary board of a BOFI, NEDs should be ready, able and encouraged to challenge and test proposals on strategy put forward by the executive. They should satisfy themselves that board discussion and decision-taking on risk matters is based on accurate and appropriately comprehensive information and draws, as far as they believe it to be relevant or necessary, on external analysis and input.

Response: ABC’s experience would suggest this is done. But if it is felt that this area needs tightening, ABC would suggest that CEO’s should be tasked to win the hearts and minds of the board to the chosen strategy and the members should be required to vote openly on whether or not they support the strategy. The result of this vote should be disclosed in the corporate governance statement.

Recommendation 7

The chairman should be expected to commit a substantial proportion of his or her time, probably not less than two-thirds, to the business of the entity, with clear understanding from the outset that, in the event of need, the BOFI chairmanship role would have priority over any other business time commitment.

Response: ABC would agree and believe that in practice this has been accepted with some BOFI boards appointing an executive chairman. Indeed ABC would suggest that any BOFI chairman should certainly not be entitled to chair another FTSE 350 company.

Recommendation 8

The chairman of a BOFI board should bring a combination of relevant financial industry experience and a track record of successful leadership capability in a significant board position. Where this desirable combination is only incompletely achievable, the board should give particular weight to convincing leadership experience since financial industry experience without established leadership skills is unlikely to suffice.

Response: ABC would accept whilst leadership is key, the chairman must hold or be capable of developing suitably profound knowledge of banking to be able to develop a relationship of mutual respect with the CEO. ABC has observed that where a Chairman does not have a suitably comprehensive understanding of the industry in which his company operates that he is at a disadvantage in his relationship with his CEO. This may be offset if his CEO is a relatively inexperienced leader but the chairman’s ability to challenge his CEO will be reduced.

Recommendation 9

The chairman is responsible for leadership of the board, ensuring its effectiveness in all aspects of its role and setting its agenda so that fully adequate time is available for substantive discussion on strategic issues. The chairman should facilitate, encourage and expect the informed and critical contribution of the directors in particular in discussion and decision-taking on matters of risk and strategy and should promote effective communication between executive and non-executive directors. The chairman is responsible for ensuring that the directors receive all information that is relevant to discharge of their obligations in accurate, timely and clear form.

Response: ABC believes there is a lack of consensus over what constitutes an effective board and exactly what the products of an effective board are to enable all stakeholders to assess whether there is one despite the existence of the Combined Code. The recommendation outlined above is largely similar to the respective contents of the Combined Code.

Recommendation 10

The chairman of a BOFI board should be proposed for election on an annual basis.

Response: ABC would strongly disagree with this recommendation as this would leave the chairman vulnerable to his performance being assess over a short term time frame. The Chairman’s performance should be evaluated over whether he or she has created and maintained an effective board that has lead and is continuing to result in the design and successful implementation of approved strategies and programmes of annual business plans which have achieved and are achieving the agreed aim and following which shareholders have confirmed that value for them has, and is, being created.

Recommendation 11

The role of the senior independent director (SID) should be to provide a sounding board for the chairman, for the evaluation of the chairman and to serve as a trusted intermediary for the NEDs as and when necessary. The SID should be accessible to shareholders in the event that communication with the chairman becomes difficult or inappropriate.

Response: ABC believes this is best practice or even current practice amongst listed companies but would not object to reiterating this point once more.

Recommendation 12

The board should undertake a formal and rigorous evaluation of its performance with external facilitation of the process every second or third year. The statement on this evaluation should be a separate section of the annual report describing the work of the board, the nomination or corporate governance committee as appropriate. Where an external facilitator is used, this should be indicated in the statement, together with an indication whether there is any other business relationship with the company.

Response: ABC notes that currently only 47% of FTSE 100 companies have tried using a third party to manage the annual board review. Yet as this review has noted accurately a board is inherently rich in actual or potential conflicts, many of which are suppressed by the pressure to be part of the team. A board review recognises this, deals with this in a controlled and constructive way and provides evidence to all stakeholders that all members of the board are fully committed to maximise the performance of the board.

ABC would therefore agree with the recommendation of using a third party to fully and independently evaluate a board every two years with an internally led follow up process in intervening years. ABC would also suggest that boards should be encouraged to alternate their choice of consultant after a two year period to ensure their independence and objectivity of the review was preserved.

Recommendation 13

The evaluation statement should include such meaningful, high-level information as the board considers necessary to assist shareholders understanding of the main features of the evaluation process. The board should disclose that there is an ongoing process for identifying the skills and experience required to address and challenge adequately the key risks and decisions that confront the board, and for evaluating the contributions and commitment of individual directors. The statement should also provide an indication of the nature and extent of communication by the chairman with major shareholders.

Response: In ABC’s view all of this information is currently provided in most if not all corporate governance statements of the annual reports.
ABC notes with respect that both suggested exercises would be undermined if the lack of a clear and universally accepted definition of an effective board continues.

3. The role of institutional shareholders: communication and engagement

A few observations on the comments about institutional behaviour:
• Portfolio management is driven by the client’s investment return requirements, risk parameters and cash flows. Transactions will primarily be made on valuation grounds be they absolute and relative criteria or to meet cash flow requirements.
• Whilst active fund management has shown that the average fund manager underperforms an index, this has promoted the merits of passive fund management techniques and searches for other ways of consistently generating alpha. However the case for shareholder activism as a source of alpha to ABC’s knowledge has not been proven and this is underlined by the relatively small amount of asset managed according to this style. However the performance of these funds can be clearly measured.
• Investment managers’ primary duty is to their clients for whom they manage their assets and according to the investment mandate awarded. ABC would question the duty to society unless the client demands it e.g. an ethical fund.
• The board’s role is to look after shareholders interests and is required to have the requisite skills and experience to do this. The Fund managers’ duty is to have the appropriate skills, experience and time to manage clients assets and not the knowledge of how to run a bank.
• ABC notes that our entire society of politicians, bankers, industrialists etc were collectively keen to pursue growth whilst confidence was high and to take credit for success.
• Fund managers have relied on boards to look after their interests throughout the economic cycle, empowering them as they recognised they had neither the skills, experience or time to do so. So, if investors are to engage more, what is the point of a board? And is this really going to add any value if the wrong people with inappropriate skills, experience and insufficient time are involved?
• There is a real risk in this engagement process that the active shareholder will receive more useful and possible inside information. In fact true engagement must demand it. This may prevent the fund manager from meeting the needs of his client unless he has been instructed to pursue this investment style. Also after decades of efforts by past and present regulators to ensure the elimination of insider dealing and the equal distribution of information, smaller equity investors will be disadvantaged.
• Whilst boards may find it frustratingly hard to find a consensus amongst shareholders as to what they want done or how they want it done, it is a challenge facing all other leaders as, for example, politicians are required to win people’s hearts and minds to their manifestos so why should board not be required to win a mandate to execute a strategy from their shareholders?

Recommendation 14

Boards should ensure that they are made aware of any material changes in the share register, understand as far as possible the reasons for changes to the register and satisfy themselves that they have taken steps, if any are required, to respond.

Response: In ABC’s experience, boards spend considerable time and funds in internal or external investor relations and consultation with their corporate brokers trying to understand their shareholder base and the changes to it. Many reasons for change may be due to grounds that have little to do with the company itself.

Recommendation 15

In the event of substantial change over a short period in a BOFI share register, the FSA should be ready to contact major selling shareholders to understand their motivation and to seek from the BOFI board an indication of whether and how it proposes to respond.

Response: ABC would agree with this recommendation which may prove a useful exercise but at a considerable use of FSA resources. This information together with the knowledge of how much is being sold short may be a useful exercise but its validity is only going to be proven with time when the views of either the long only holder or those who are short are born out. Even here it may be undermined by the different time frames each manager operates. So ABC would agree the need for a definition of a significant change in BOFI share register.

Recommendation 16

The remit of the FRC should be explicitly extended to cover the development and encouragement of adherence to principles of best practice in stewardship by institutional investors and fund managers. This new role should be clarified by separating the content of the present Combined Code, which might be described as the Corporate Governance Code, from what might most appropriately be described as Principles for Stewardship.

Response: Fund managers as a whole must act in the interests of their clients. In ABC’s view evidence that holding shares for the longer term and actively engaging creates alpha or superior returns is unproven. Thus ABC would be cautious on this initiative and look to see more quantification and evidence of both cost and benefits of it.

Recommendation 17

The present best practice “Statement of Principles – the Responsibilities of Institutional Shareholders and Agents” should be ratified by the FRC and become the core of the Principles for Stewardship. By virtue of the independence and authority of the FRC, this transition to sponsorship by the FRC should give materially greater weight to the Principles.

Response: As per response 16 and ABC would suggest that there must be some means of judging how effective the fund managers are in engaging this initiative to work when box ticking and voting records have already been judged to be insufficient.

Recommendation 18

The ISC, in close consultation with the FRC as sponsor of the Principles, should review on an annual basis their continuing aptness in the light of experience and make proposals for any appropriate adaptation.

Response: If they are to be applied then a review process is necessary but possibly an annual review would be excessive.

Recommendation 19

Fund managers and other institutions authorised by the FSA to undertake investment business should signify on their websites their commitment to the Principles of Stewardship. Such reporting should confirm that their mandates from life assurance, pension fund and other major clients normally include provisions in support of engagement activity and should describe their policies on engagement and how they seek to discharge the responsibilities that commitment to the Principles entails. Where a fund manager or institutional investor is not ready to commit and to report in this sense, it should provide, similarly on the website, a clear explanation of the reasons for the position it is taking.

Response: As per response 16.

Recommendation 20

The FSA should encourage commitment to the Principles of Stewardship as a matter of best practice on the part of all institutions that are authorised to manage assets for others and, as part of the authorisation process, and in the context of feasibility of effective monitoring to require clear disclosure of such commitment on a “comply or explain” basis.

Response: As per response 16.

Recommendation 21

To facilitate effective collective engagement, a Memorandum of Understanding should be prepared, initially amongst major long-only investors, to establish a flexible and informal but agreed approach to issues such as arrangements for leadership of a specific initiative, confidentiality and any conflicts of interest that might arise. Initiative should be taken by the FRC and major UK fund managers and institutional investors to invite potentially interested major foreign institutional investors, such as sovereign wealth funds and public sector pension funds, to commit to the Principles of Stewardship and, as appropriate to the Memorandum of Understanding on collective engagement.

Response: To ensure effective collective engagement, it is our experience that institutional investors will generally become aware of price sensitive information which may then restrict their ability to look after their clients’ interests in an optimum manner. Generally this has limited the willingness of investors to be taken inside but this process of greater engagement may have a profound implication for the fund managers’ ability to manage their equity portfolio.

Recommendation 22

Voting powers should be exercised, fund managers and other institutional investors should disclose their voting record, and their policies in respect of voting should be described in statements on their websites or in other publicly accessible form.

Response: ABC believes this is current best practice.

4. Governance of risk

Recommendation 23

The board of a BOFI should establish a board risk committee separately from the audit committee with responsibility for oversight and advice to the board on the current risk exposures of the entity and future risk strategy. In preparing advice to the board on its overall risk appetite and tolerance, the board risk committee should take account of the current and prospective macro-economic and financial environment drawing on financial stability assessments such as those published by the Bank of England and other authoritative sources that may be relevant for the risk policies of the firm.

Response: It is hard to argue with the concept that if boards’ poor governance of risk led to the credit crunch then more dedicated resources should be provided and thus managed by a dedicated board risk committee. But the effectiveness of the risk management systems is dependent on the quality of internal controls, and the active participation of the executive management team throughout the organisation. Will the new committee with its own dedicated resources in fact create barriers to effective management of risk throughout the organisation?

Second and in ABC’s view, there has been no convincing explanation to date from the BOFI boards and the regulator as to why they did not anticipate more effectively the change in stock, risk and economic cycles. Having decided on the long term aim of a company, the board should regularly, and where necessary reappraise the environment in which the BOFI operate to understand whether the approved strategy with its consequential risk is still achievable. Along with the proper resourcing of the company and its control, this is one of three prime tasks of the board. Hence ABC would be concerned if boards were being encouraged to delegate any aspect of the development of strategy to a board committee.

Recommendation 24

In support of board-level risk governance, a BOFI board should be served by a CRO who should participate in the risk management and oversight process at the highest level on an enterprise-wide basis and have a status of total independence from individual business units. Alongside an internal reporting line to the CEO or FD, the CRO should report to the board risk committee, with direct access to the chairman of the committee in the event of need. The tenure and independence of the CRO should be underpinned by a provision that removal from office would require the prior agreement of the board. The remuneration of the CRO should be subject to approval by the chairman or chairman of the board remuneration committee.

Response: ABC would not have an issue with the allocation of more resources to the management of risk. But the CRO should be instructed to manage risk in accordance with the approved business strategy and its attendant level of risk and not to be an independent assessor of how much risk was suitable for the organisation.

Recommendation 25

The board risk committee should have access to and, in the normal course, expect to draw on external input to its work as a means of taking full account of relevant experience elsewhere and in challenging its analysis and assessment.

Response: If such a committee is created, then this committee like all other board committees should be tasked to evaluate its own performance. Taking independent advice would evidence how the Committee was able to maximise its own performance, for example, by benchmarking its own performance or the effectiveness of the risk management systems.

Recommendation 26

In respect of a proposed strategic transaction involving acquisition or disposal, it should as a matter of good practice be for the board risk committee to oversee a due diligence appraisal of the proposition, drawing on external advice where appropriate and available, before the board takes a decision whether to proceed.

Response: If such a Committee exists then it should participate in the overall due diligence the board should instruct the BOFI to conduct covering every aspect of the transaction.

Recommendation 27

The board risk committee (or board) risk report should be included as a separate report within the annual report and accounts. The report should describe the strategy of the entity in a risk management context, including information on the key exposures inherent in the strategy and the associated risk tolerance of the entity and should provide at least high level information on the scope and outcome of the stress-testing programme. An indication should be given of the membership of the committee, of the frequency of its meetings, whether external advice was taken and, if so, its source.

Response: Whether the board risk committee is formed or not, ABC would recommend that boards do report the reasons why the current business strategy and its inherent risks are still appropriate. Currently most comments on the outlook for a company tend to be rather brief. Secondly in addition to the voluminous information provided on risk registers and describing the risk management systems, the board should be required to evidence over the reporting period why they work and whether the ‘risk appetite’ was fulfilled.

5. Remuneration

Recommendation 28

The remit of the remuneration committee should be extended where necessary to cover all aspects of remuneration policy on a firm-wide basis with particular emphasis on the risk dimension.

Response: The remuneration committee should ensure that all incentives in the organisation are aligned with achieving the approved corporate aim, strategy and annual plans designed to achieved that aim within the approved risk appetite. Furthermore it should attest that the total compensation at Board level and across the organisation is no more than necessary.

Recently, it has been hard to reconcile corporate aims, strategies and plans in the banking sector with incentives and these incentives have been focused purely on growth (such as relative TSR, eps growth and ROE).

Recommendation 29

The terms of reference of the remuneration committee should be extended to oversight of remuneration policy and remuneration packages in respect of all executives for whom total remuneration in the previous year or, given the incentive structure proposed, for the current year exceeds or might be expected to exceed the median compensation of executive board members on the same basis.

Response: As per response 28, for the entire organisation.

Recommendation 30

In relation to executives whose total remuneration is expected to exceed that of the median of executive board members, the remuneration committee report should confirm that the committee is satisfied with the way in which performance objectives are linked to the related compensation structures for this group and explain the principles underlying the performance objectives and the related compensation structure if not in line with those for executive board members.

Response: As per 28, though some individuals may only have incentives linked to their business areas.

Recommendation 31

The remuneration committee report should disclose for “high end” executives whose total remuneration exceeds the executive board median total remuneration, in bands, indicating numbers of executives in each band and, within each band, the main elements of salary, bonus, long-term award and pension contribution.

Response: If the remuneration committee is mandated to do as recommended in the response to 28, it is not clear what benefit is further achieved by this recommendation.

Recommendation 32

Major FSA-authorised BOFIs that are UK-domiciled subsidiaries of non-resident entities should include in their reporting arrangements with the FSA disclosure of the remuneration of “high end” executives broadly as recommended for UK-listed entities but with detail appropriate to their governance structure and circumstances agreed on a case by case basis with the FSA. Disclosure of “high end” remuneration on the agreed basis should be included in the annual report of the entity that is required to be filed at Companies House.

Response: If recommendation 31 one is approved then this should be a requirement of all banks.

Recommendation 33

Deferral of incentive payments should provide the primary risk adjustment mechanism to align rewards with sustainable performance for executive board members and executives whose remuneration exceeds the median for executive board members. Incentives should be balanced so that at least one-half of variable remuneration offered in respect of a financial year is in the form of a long-term incentive scheme with vesting subject to a performance condition with half of the award vesting after not less than three years and of the remainder after five years. Short-term bonus awards should be paid over a three year period with not more than one-third in the first year. Clawback should be used as the means to reclaim amounts in limited circumstances of misstatement and misconduct.

Response: ABC would suggest the threshold for deferring an element of bonus should be defined as being when a bonus can exceed 100% of salary and is in line with a higher tax band e.g. £150k and not just those suggested above. Clawback should also be considered where there is clearly a case of poor performance.

Recommendation 34

Executive board members and executives whose total remuneration exceeds that of the median of executive board members should be expected to maintain a shareholding or retain a portion of vested awards in an amount at least equal to their total compensation on a historic or expected basis, to be built up over a period at the discretion of the remuneration committee. Vesting of stock for this group should not normally be accelerated on cessation of employment other than on compassionate grounds.

Response: It is clear that executives should have ‘skin in the game’ but it needs to be material in terms of the individual’s wealth. As proposed, unless the executive never sells his shareholding, then the system favours the long serving successful executive and yet can prove a considerable burden to the newly appointed executive.

Recommendation 35

The remuneration committee should seek advice from the board risk committee on an arm’s-length basis on specific risk adjustments to be applied to performance objectives set in the context of incentive packages; in the event of any difference of view, appropriate risk adjustments should be decided by the chairman and NEDs on the board.

Response: ABC believes performance targets have not been well-designed with most being a mixture of relative share price performance and profitability. This means that they do not fully reconcile to the business strategy and plan (especially LTIPs). In future, incentive targets should reconcile with the aim, strategy, plans and risk appetite.

Recommendation 36

If the non-binding resolution on a remuneration committee report attracts less than 75 per cent of the total votes cast, the chairman of the committee should stand for re-election in the following year irrespective of his or her normal appointment term.

Response: ABC recommends the resolution does become binding. Clearly all remuneration contracts that would be influenced by the vote would need to include a caveat to that effect. But remuneration policy and targets cannot be agreed in isolation. This needs to be matched by sufficient information covering the aim, strategy, plans, targets and risks inherent to appreciate the suitability of the remuneration arrangements.

Recommendation 37

The remuneration committee report should state whether any executive board member or senior executive has the right or opportunity to receive enhanced pension benefits beyond those already disclosed and whether the committee has exercised its discretion during the year to enhance pension benefits either generally or for any member of this group.

Response: ABC would agree with this recommendation.

Recommendation 38

The remuneration consultants involved in preparation of the draft code of conduct should form a professional body which would assume ownership of the definitive version of the code when consultation on the present draft is complete. The proposed professional body should provide access to the code through a website with an indication of the consulting firms committed to it; and provide for review and adaptation of the code as required in the light of experience.

Response: In ABC’s view and experience, remuneration committees have universally set their policies to attract, motivate and retain staff. The Combined Code also suggested that such committees should ensure that the remuneration paid was no more than necessary. This test has largely been met by ensuring basic salaries at least meet the median and the potential for total compensation (multiples of salary paid via short term bonus and LTIPS). Some remuneration committees then monitored staff turnover and regretted leavers to test the effectiveness of the policy. But this was not universal. Hence, in our view the remuneration consultants simply provided the means to prove relatively the remuneration packages were attractive and whether these were absolutely excessive was left to the advisory shareholder vote. Maybe this vacuum will be filled by politicians limiting the total compensation of staff at BOFI or again left up to the shareholders to decide. Either way, there is still an entirely subjective decision to be made and one which cannot be provided by remuneration consultants.

Recommendation 39

The code and an indication of those committed to it should also be lodged on the FRC website. In making an advisory appointment, remuneration committees should employ a consultant who has committed to the code.

Response: ABC would agree with this recommendation if such a code were adopted by the remuneration consultants.