Corporate governance - what will really change?

By Dr Steven McCabe on Feb 4, 13 04:20 PM in Economics

Today's announcement by George Osborne at JP Morgan's office in Bournemouth that he is now willing to back one the major recommendations arising from last year's Parliamentary Commission on Banking Standards to break up UK's biggest banks is welcome.

Significantly, Osborne also stated that if UK banks cannot implement these reforms voluntarily, they will be forced to do so.

He simply recognises that some five years into the financial crisis caused by the lunacy of the investment arms of banks, ordinary people (taxpayers who vote) feel that reform is overdue and that should another crisis occur the government could not bail them out again.

It is also to be noted that the Banking Reform Bill will be introduced in Parliament today which will require greater competition and changes intended to benefit customers such as the ability to switch accounts in no more than a week.

So that will sort out the banks?

Given that it was precisely because of the recklessness of investment banking, so called 'casino banking', was a primary cause of the financial mess that we are currently experiencing, the need to separate it from the retail banks that the majority of us have contact with would seem to be a 'no brainer'.

This was a key recommendation of the Independent Commission on Banking Chaired by Oxford Don Sir John Vickers which suggested what is termed 'ring-fencing' to make sure that should banks wish to engage in risky investment in the future, there would be no impact on the 'retail banking'.

In effect this would be a UK version of the 'Volker Rule' so named after Paul Volker, a former Chair of the Federal Reserve and has been backed by President Obama as a method of controlling American banks and ensuring that investment activities in hedge funds and equity funds are completely divorced from the parts used by the general public.

It is to be noted that any reforms made by banks are not required immediately; they have until 2019.

However, the belief that such reforms will come at a cost (estimates range from £5-7 billion) will mean that bank executives will hardly be jumping for joy.

Indeed, despite the threat from Osborne of forcing through the reforms recommended in Sir John Vickers' report, there are already rumblings of discontent.

Anthony Browne, Chief Executive of the British Bankers' Association, believes that the effects of any proposed legislation will not make the situation any better and probably lead to:

"...uncertainty for investors, making it more difficult for banks to raise capital, which will ultimately mean that banks will have less money to lend to businesses".

In the most recent edition of Private Eye (1332), a piece was published as part of the 'In the City' section which suggests that any potential banking reforms are only likely to achieve structural change and will be unlikely to address the with 'the recurring problem' of culture whereby executives in the UK banks see short-term profit as still being the imperative.

The article is excoriating in its criticism of what it believes (still) goes on:

"Testosterone tactics, big bonuses, high risk and short-termism have been embedded in the banker DNA since the Nineties. So successive layers of replacement suits promising a different approach, putting shareholders, customers and regulators first, are merely saying what the playbook now says must be said. Inside the banks, greed is still good. Traders still rule. Risk is for losers. Profits power bonuses. Shareholders pay losses and fines."

The article relates 'whispers' of what goes on inside major banks including those that have been bailed out by the taxpayer in which criticism and challenge is not welcome. As they relate, one insider at Lloyds explains that there is a culture of compliance in which you "fit in" or are sacked.

The Eye also relates how many of those recruited to very senior positions those who have come from other banks which have been accused of very serious wrongdoing. In particular they cite Barclays which was involved in selling "useless PPI policies" and has so far paid £2 billion to cover the cost of "rewarding people for making the bank money in a way which is unethical".

As the piece concludes, despite the protestations of UK banking executives that things have changed, they believe that all that really changes is the "names at the top."

The culture in banks, it would seem, needs to be altered.

In last week's Independent, 'The fat cats who scratch each other's backs', James Moore suggests that unless the way in which the remuneration system for executives in large companies is significantly altered, nothing will change.

As Moore explains, three directors should be appointed to a remuneration committee (colloquially known as 'RemCo') who are independent of the executives and other "interested parties" which would include those with significant shareholding to ensure that whatever is paid is sufficient to "attract, retain and motivate directors".

This accords with what is known as the Combined Code on Corporate Governance.
The trouble is, as Moore asserts, whilst the theory is good the practice results in a 'sham' and as evidence he recounts the testimony provided by Alison Carnwath who was the former Chair of Barclays' Remuneration Committee to the Parliamentary Commission on Banking Standards.

As Carnwath explained, in 2011 it was believed that Barclays' performance was so poor that former Chief Executive Bob Diamond should receive no payment. However, despite the fact that even Diamond described Barclays' performance as "unacceptable", Marcus Agius who was the Chairman of the Company decided Diamond should indeed be paid which is what happened.

Moore is not unique in pointing out that the RemCo system operates on having friendly executives who will happily agree to reward:

"An executive who benefits from a bad system is hardly going to rock the boat when he serves as an independent non-executive director on another board."

And the results appear to speak for themselves. According to a report published by Income Data Services, whilst workers are experiencing very small or no increases in their pay, the average package enjoyed by the most senior executive has risen by 27% to an average of £4 million.

Many commentators argue that change is urgently is required and that the composition of remuneration committees should include that membership made up of those other than senior executives.

As such commentators contend, better corporate governance is needed to restore faith in the way that large companies are run to ensure that the interests of all stakeholders - including employees - are paramount in any deliberations.

An example of the call for change comes from a spokesperson at Pirc, an advisory body to UK pension funds on how to vote at company AGMs who believe that what is required is to get rid of the "closed shop" of remuneration committees which are too often made up of executives on "stratospheric" earnings who, it is suggested, cannot appreciate the financial pressures workers are under and all too often make questionable decisions.

This view is backed by TUC General Secretary Frances O'Grady who thinks that analysis of increases in directors' pay bears no relation to the performance of companies:

"That's why the TUC has long advocated putting representatives of ordinary staff on committees to provide a much needed dose of reality, as well as openly advertising non-executive director positions."

As Moore acknowledges, any such change is hardly likely to be welcomed by senior executives and states that that some executives have been reported to have threatened to quit this country if they it became a requirement to have employees on remuneration committees.

The thing is, George Osborne recognises the fact that voters are angry at what they see as the trend for rich executives to get richer whilst their workers experience reduced spending power due to inflation that is higher than the pay increases they receive.

At the risk of being cynical, the chances of significant change in corporate governance of our large companies would appear to be slim.

As Private Eye regularly reports, business executives have the ability to lobby government to ensure that any change is to their advantage.

Besides, all politicians, especially those who have cabinet experience, are acutely aware that should lose power there will always be a good chance of gaining an extremely well-paid position in one of the companies that has lobbied them.

For change to really happen in terms of corporate governance we need leadership from politicians who forsake personal expediency to ensure that all companies can operate in a climate that is conducive to success but entirely sympathetic to inducing organisational cultures in which equity and collaboration are far more prevalent than they have been hitherto.

I won't hold my breath though.

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