Summary
In this Report, the third in our series on the banking
crisis, we focus our attention on remuneration in the City of
London, as well as on the nexus of private actors—including
non-executive directors, institutional shareholders, credit rating
agencies, auditors, the media—who are supposed to act as
a check on, and balance to, senior managers and the executive
boards of banks.
Remuneration in the City of London
On remuneration we conclude that the banking crisis
has exposed serious flaws and shortcomings in remuneration practices
in the banking sector and, in particular, within investment banking.
We found that bonus-driven remuneration structures encouraged
reckless and excessive risk-taking and that the design of bonus
schemes was not aligned with the interests of shareholders and
the long-term sustainability of the banks. We express concern
that the Turner Review downplays the role that remuneration played
in causing the banking crisis and question whether the Financial
Services Authority has attached sufficient priority to tackling
remuneration in the City. The Report outlines clear failings in
the remuneration committees in the banking sector, with non-executive
directors all too willing to sanction the ratcheting up of remuneration
levels for senior managers whilst setting relatively undemanding
performance targets. We propose a number of reforms to remuneration
in the banking sector. These include enhanced disclosure requirements
on firms about their remuneration structures and about remuneration
below board-level, reforms to remuneration committees to make
them more open and transparent, and a Code of Ethics for remuneration
consultants.
Remuneration in Lloyds and RBS
Next we turn our attention to remuneration practices
in the specific cases of the part-nationalised banks. We argue
that, whilst there is a strong case for curbing or stopping bonus
payments for senior staff in Lloyds Banking Group and Royal Bank
of Scotland, we accept the argument that the position of the banks
would be worsened if they could not make bonus payments. If bonuses
were prohibited at these banks, they would struggle to recruit
and retain talented staff to the detriment of the taxpayer as
a major shareholder in both institutions. That said, we highlight
the lack of transparency regarding the exact cost of bonus payments,
including deferred bonus payments, and call on the Government
and UKFI to rectify this problem.
Sir Fred Goodwin's pension
We conclude that Lord Myners' assertion that his
precept to the RBS Board—that there should be no reward
for failure—did not represent an adequate oversight of the
remuneration of outgoing senior bank staff. Instead, it would
have been far better if Lord Myners had given a stronger, clearer
direction of Government requirements for a bank in receipt of
public funds and had assured himself by demanding to be kept informed
of the detailed negotiations that were taking place. Secondly,
we are not convinced that Lord Myners was right to take on trust
RBS's suggestion that there was no option but to treat Sir Fred
as leaving at the employer's request. It would, we believe, have
been open to Lord Myners to insist that Sir Fred should have been
dismissed. Finally, we are not convinced that the Treasury was
right to rely on the current RBS Board to handle these negotiations
without direct Treasury involvement. The RBS Board had shown itself
to be incompetent in the management of the bank, steering it towards
catastrophe, and was also possibly dominated by Sir Fred; there
were no grounds for trusting them with this operation. We suspect
that Lord Myners' City background, and naiveté as to the
public perception of these matters, may have led him to place
too much trust in an RBS Board that he himself described to us
as "distinguished".
Non-executive directors
The current financial crisis has exposed serious
flaws and shortcomings in the system of non-executive oversight
of bank executives in the banking sector. Too often, eminent and
highly-regarded individuals failed to act as an effective check
on, and challenge to, executive managers, instead operating as
members of a 'cosy club'. We pinpoint three problems: the lack
of time many non-executives commit to their role, with many combining
a senior full-time position with multiple non-executive directorships;
in many instances a lack of expertise; and a lack of diversity.
Our Report calls for a broadening of the talent pool from which
the banks draw upon, possible restrictions on the number of directorships
an individual can hold, dedicated support or a secretariat to
help non-executives carry out their responsibilities effectively,
reforms to ensure greater banking expertise amongst non-executives
directors as well as stronger links between non-executive directors
and institutional shareholders.
Shareholders
We also examine the failure of institutional investors
effectively to scrutinise and monitor the decision of boards and
executive management in the banking sector, concluding that this
may reflect the low priority some institutional investors have
accorded to governance issues, and that in some cases they encouraged
the risk-taking that has proved the downfall of some great banks.
We are particularly concerned that fragmented and dispersed ownership
combined with the costs of detailed engagement with firms by shareholders
has resulted in the phenomenon of 'ownerless corporations' described
to us by Lord Myners. We argue that the Walker Review of corporate
governance in the banking sector must address the issue of shareholder
engagement in financial services firms and come forward with proposals
that can help reduce the barriers to effective shareholder activism.
However, we are not convinced that Sir David's background and
close links with the City of London make him the ideal person
to take on the task of reviewing corporate governance arrangements
in the banking sector.
Credit rating agencies
We also examined the role played by the credit rating
agencies in the banking crisis, an issue we first looked at over
twelve months ago. We remain deeply concerned by the conflict
of interests faced by credit rating agencies, and have seen little
evidence of the industry tackling this problem with any sense
of urgency.
Auditors
We also assess the role of auditors in the banking
crisis. We note that the audit process failed to highlight developing
problems in the banking sector, leading us to question how useful
audit currently is. We also remain concerned about the issue of
auditor independence and argue that investor confidence and trust
in audit would be enhanced by a prohibition on audit firms conducting
non-audit work for the same company. We recommend that the FSA
consult on ways in which financial reporting can be improved to
provide information on bank activities in a more accessible way.
Fair value accounting
We regret the power of the European Commission to
pick and choose which international accounting standards should
be implemented in the EU and call on the Treasury to consider
the impact of the Commission's powers on the objective of establishing
a single global set of accounting standards.
Media
Finally, we also looked at the role of the media
in the banking crisis. We conclude that the evidence did not support
the case for any further regulation of the media in response to
the banking crisis. We argue that the press has generally acted
responsibly when asked to show restraint in particular areas and
that, too often, those responsible for creating the current crisis
have sought refuge in blaming the media for their own conduct.
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