Corporate Governance in Financial Institutions

As part of its work on preventing a future financial crisis and strengthening the financial system, the European Commission has launched a public consultation on reforming corporate governance in financial institutions. The financial crisis revealed significant weaknesses in corporate governance in financial institutions: board supervision and control of management was insufficient; risk management was weak; inadequate remuneration structures for both directors and traders led to excessive risk-taking and short-termism; and shareholders did not exercise control over risk-taking in the financial institutions they owned. These weaknesses played a role in the crisis and timely and effective checks and balances in governance systems would help preventing any future crisis.

The Commission considers that an effective corporate governance system, achieved through control mechanisms and checks, should lead to the main stakeholders in financial institutions (boards of directors, shareholders, senior management, etc) assuming a higher degree of responsibility. Conversely, the financial crisis and its serious economic and social consequences have led to a significant loss of confidence in financial institutions.

Corporate governance in financial institutions

The Green Paper issued by the EU submits to public the following suggested options to improve corporate governance in financial institutions:

1.Limit the number of directors’ memberships in boards, for instance to 3;

2.Require more expertise on boards;

3.Widen the ‘fit and proper test’ to include evaluation of expertise and individual qualities of candidates;

4.Enhance the role of supervisors in the review of corporate governance structures;

5.Mandate risk committees at board level tasked with setting policy on risk appetite to be discussed publicly through a risk statement;

6.Strengthen the legal liability of directors via an expanded ‘duty of care’;

7.Strengthen the authority of the risk management function potentially giving the Chief Risk Officer equal standing to the Chief Financial Officer;

8.Regulate or restrict stock options and golden parachutes;

9.Separate the functions of the Chairman and of the Chief Executive Officer;

10.Put in place a stricter duty for auditors to flag anything serious to boards and supervisors, and to look at whether they should have an enhanced role to check the risk systems. This enhanced role would be in addition to the planned review by the Commission of auditors’ existing role;

11.Mandate that institutional investors publish their voting and engagement policies and records and adhere to stewardship codes.