Corporate GovernanceCorporate Governance

Dr John HedgesDr John Hedges

OverviewOverview

Importance within ARROW and pillar 2 Importance within ARROW and pillar 2 AssessmentsAssessments

The FrameworkThe Framework Inputs into governanceInputs into governance Outputs of effective governanceOutputs of effective governance The concept of a firm’s governance The concept of a firm’s governance

architecturearchitecture Testing the governance architectureTesting the governance architecture ConclusionConclusion

ARROW 2 GridARROW 2 Grid

A2 grid tries to mirror the organisation of a A2 grid tries to mirror the organisation of a firmfirm

Risk is analysed by Risk is analysed by Front Office (Customer, Products, Markets)Front Office (Customer, Products, Markets) Back Office (Business process)Back Office (Business process) Prudential Prudential Complemented by controls specific to these issuesComplemented by controls specific to these issues Plus overall controls including Plus overall controls including governance and governance and

oversightoversight plus capital and liquidity plus capital and liquidity Generating net riskGenerating net risk

ARROW 2 MethodologyARROW 2 Methodology

The concept of net riskThe concept of net risk Focus on inherent business risk to get some Focus on inherent business risk to get some

idea of the gross risk and then an idea of the gross risk and then an assessment of the controls to offset that riskassessment of the controls to offset that risk

The overall controls of The overall controls of GovernanceGovernance ComplianceCompliance Risk managementRisk management Internal AuditInternal Audit Clarity on the role of capitalClarity on the role of capital

GovernanceGovernance

Review of ARROW2 talk in OctoberReview of ARROW2 talk in October

A big driver of the risk scoreA big driver of the risk score

Important to have a framework that Important to have a framework that provides meaningful feedback to the provides meaningful feedback to the industry. industry.

What makes for effective governance?What makes for effective governance?

Importance of GovernanceImportance of Governance

Management versus governanceManagement versus governance Important issues seem to fall back on Important issues seem to fall back on

governancegovernance In many instances good governance In many instances good governance

becomes the golden solution for all ills becomes the golden solution for all ills but difficult to define what is meant by but difficult to define what is meant by good governance and conversely poor good governance and conversely poor governance.governance.

The search for a frameworkThe search for a framework

Importance of FrameworksImportance of Frameworks

A place to put facts/impressions and A place to put facts/impressions and assists with analysis of and an assists with analysis of and an understanding of the factsunderstanding of the facts

Assists with a common languageAssists with a common language Provides continuity when reviewing an Provides continuity when reviewing an

issueissue Can be developed as knowledge of Can be developed as knowledge of

the issues improvesthe issues improves

The Inputs of GovernanceThe Inputs of Governance

The governance framework defines The governance framework defines effective governance as:effective governance as:

The correct mix of-The correct mix of- Structure (A & O, committees, org. charts)Structure (A & O, committees, org. charts) Process (e.g. escalation processes)Process (e.g. escalation processes) Management informationManagement information Culture (the most nebulous)Culture (the most nebulous)

Taking each in turnTaking each in turn

Structure: types of issue Structure: types of issue coveredcovered

A and O structure/authority/reporting linesA and O structure/authority/reporting lines One of the most important components of structureOne of the most important components of structure

Business Unit CommitteesBusiness Unit Committees By business lineBy business line

Cross unit committeesCross unit committees By regionBy region

Legal entity boardsLegal entity boards Audit CommitteesAudit Committees

Structure: CommentStructure: Comment

CommitteesCommittees Clear terms of referenceClear terms of reference Clear authority Clear authority Clear line of accountabilityClear line of accountability Not a talking shopNot a talking shopOrganisation ChartsOrganisation Charts

Transparency Transparency Reflection of real reporting linesReflection of real reporting linesThe problem of matrix managementThe problem of matrix management

Process; types of issue Process; types of issue coveredcovered

New productNew product Reputation riskReputation risk Conflicts reviewConflicts review Infrastructure reviewInfrastructure review Controls: self assessment Controls: self assessment

Operational riskOperational risk

Risk and capital planningRisk and capital planning

Process: CommentProcess: Comment

How do things get done?How do things get done? The issue of escalationThe issue of escalation

Control sideControl side Business sideBusiness side

The issue of flexibility (speedy and safe The issue of flexibility (speedy and safe decision making)decision making)

The issue of anticipation (what happens if The issue of anticipation (what happens if something goes wrong)something goes wrong)

Management Information: Management Information: types of information coveredtypes of information covered

Financial Financial Business RiskBusiness Risk ComplianceCompliance ControlsControls TransactionsTransactions LiquidityLiquidity

Management Information: Management Information: CommentComment

Should reflect what is going on in the Should reflect what is going on in the businessbusiness

The Score Board; accurate; up to The Score Board; accurate; up to date; transparent (i.e. we can see at a date; transparent (i.e. we can see at a glance what is going on in the glance what is going on in the business).business).

Off the shelf and not tailor made Off the shelf and not tailor made The Use testThe Use test

Culture: types of issue Culture: types of issue coveredcovered

A Nebulous topicA Nebulous topic Business accountabilityBusiness accountability Multiple elevationMultiple elevation Remuneration processRemuneration process Transparency of decisionsTransparency of decisions Understanding of what is acceptableUnderstanding of what is acceptable

Culture: CommentCulture: Comment

Do you know it when you see it?Do you know it when you see it? The issue of sharing information at the The issue of sharing information at the

right levelright level Silo management and the issue of Silo management and the issue of

convergenceconvergence The issue of advertising for an Ethics The issue of advertising for an Ethics

DirectorDirector Remuneration and the balanced scorecardRemuneration and the balanced scorecard

Governance: RecapGovernance: Recap

The Framework so farThe Framework so far InputsInputs

StructureStructure plus plus ProcesProcess plus s plus Management Management InformationInformation plus plus CultureCulture

EqualsEquals OutputsOutputs Effective governance but Effective governance but

what are the outputs of effective what are the outputs of effective governance?governance?

Outputs of Effective Outputs of Effective GovernanceGovernance

Ensures Effective Controls Ensures Effective Controls Ensures Legal Entity integrityEnsures Legal Entity integrity Ensures franchise and other regional Ensures franchise and other regional

risks managedrisks managed Ensures client interface risk managed Ensures client interface risk managed

across the businessacross the business Ensures infrastructure can support the Ensures infrastructure can support the

businessbusiness

Example: Effective ControlExample: Effective Control

ComplianceCompliance Profile within businessProfile within business Appropriate resourcingAppropriate resourcing Span of operationSpan of operation

AdvisoryAdvisory SurveillanceSurveillance Spectrum of legal (advisory) compliance Spectrum of legal (advisory) compliance

(surveillance) and internal audit(surveillance) and internal audit

Legal Entity IntegrityLegal Entity Integrity

The purpose of legal entitiesThe purpose of legal entities AccountabilityAccountability SettlementSettlement Corporate identity in the marketCorporate identity in the market

Adequacy of settlement and accounting Adequacy of settlement and accounting infrastructureinfrastructure

Adequacy of regulatory capitalAdequacy of regulatory capital

Protecting the FranchiseProtecting the Franchise

Importance of franchise/reputationImportance of franchise/reputation The risk is largely a function of product The risk is largely a function of product

type and the number of markets dealt intype and the number of markets dealt in What is acceptable in the markets and is What is acceptable in the markets and is

this clearly understood within the firm?this clearly understood within the firm? Constant review of what issues might Constant review of what issues might

harm the franchise.harm the franchise.

Client riskClient risk

Protecting the firm from the clientProtecting the firm from the client A coordinated response to the client A coordinated response to the client

across business lines and marketsacross business lines and markets Importance of appointing a central point Importance of appointing a central point

of contact within a firmof contact within a firm Potential friction within the firm in Potential friction within the firm in

achieving thisachieving this

InfrastructureInfrastructure

Which comes first ; the business or the Which comes first ; the business or the infrastructure to support the business?infrastructure to support the business?

Infrastructure is likely to be behind the Infrastructure is likely to be behind the businessbusiness

The importance of MI in measuring the The importance of MI in measuring the stretch factor or gap in supportstretch factor or gap in support

High cost of management time if High cost of management time if things go wrong and rectificationthings go wrong and rectification

RecapRecap

The FrameworkThe Framework Inputs: the correct mix of-Inputs: the correct mix of-Structure Structure plus plus ProcessProcess plus plus Management Management

InformationInformation plus plus CultureCultureEqualsEquals

OutputsOutputs : : Effective controls, Legal Effective controls, Legal entity integrity, Protecting the franchise, entity integrity, Protecting the franchise, Client risk, Client risk, and and Effective Infrastructure Effective Infrastructure support for the business support for the business

The concept of ArchitectureThe concept of Architecture

The corporate governance of a firm can be The corporate governance of a firm can be viewed rather like a building; it identifies the viewed rather like a building; it identifies the business; gives it a presence to third parties business; gives it a presence to third parties and protects it from the weather of business and protects it from the weather of business risksrisks

The framework just described gives some The framework just described gives some guide on measuring the adequacy or otherwise guide on measuring the adequacy or otherwise of the firm’s governance or the architecture of of the firm’s governance or the architecture of the firm’s governance building the firm’s governance building

Verification FrameworkVerification Framework

Governance architectureGovernance architecture compared compared to Firm’s operationsto Firm’s operations

Firm’s use of Firm’s use of KPIsKPIs to measure the to measure the outputs of effective governance (top outputs of effective governance (top down approach).down approach).

VerificationVerification on the ground of how the on the ground of how the firm is managed in delivering the firm is managed in delivering the outputs of good governance (bottom outputs of good governance (bottom up approach).up approach).

Governance ArchitectureGovernance Architecture

Is the governance architecture we Is the governance architecture we see what we would expect of the see what we would expect of the firm; does it complement its firm; does it complement its operations?operations?

To continue with the architecture To continue with the architecture analogy we’d expect a house to have analogy we’d expect a house to have four walls a roof and a floor; are our four walls a roof and a floor; are our expectations met and if not why not? expectations met and if not why not?

Top Down ApproachTop Down Approach

Governance ArchitectureGovernance Architecture

The first point of testing is the The first point of testing is the governance architecture what we governance architecture what we would expect of the firm; how does would expect of the firm; how does its operations match the framework its operations match the framework of governance by:of governance by:

Structure (e.g. committee structure Structure (e.g. committee structure profile/authoririty)profile/authoririty)

Process (escalation; control and business)Process (escalation; control and business) MI (reflects the business activity)MI (reflects the business activity) Culture (transparency, remuneration)Culture (transparency, remuneration)

Measuring the outputs : KPIsMeasuring the outputs : KPIs

Firm’s KPIs for:Firm’s KPIs for: Effective controls (reconciliation breaks; fails)Effective controls (reconciliation breaks; fails) Internal Audit Review points; (risk limit breaches)Internal Audit Review points; (risk limit breaches) Legal entity integrity (regulatory capital breaches; Legal entity integrity (regulatory capital breaches;

booking errors; regulatory reporting failures -e.g. booking errors; regulatory reporting failures -e.g. transaction reporting breaches; market/regulatory transaction reporting breaches; market/regulatory fines).fines).

Protecting the franchise (complaints-client Protecting the franchise (complaints-client market, regulatory authority; poor press; entering market, regulatory authority; poor press; entering new markets; introducing new products/new new markets; introducing new products/new processes)processes)

Measuring the Outputs Measuring the Outputs (cont.)(cont.)

Client risk (AML processes robust: reports of Client risk (AML processes robust: reports of suspicious transactions; one point of contact at suspicious transactions; one point of contact at the firm nominated; aware of all client’s activities the firm nominated; aware of all client’s activities and exposure to the firm (cross selling data per and exposure to the firm (cross selling data per client; effective conflict management- information client; effective conflict management- information wall referrals and crossings) wall referrals and crossings)

Infrastructure complements the business Infrastructure complements the business (management stretch-number of reporting lines (management stretch-number of reporting lines per manager; adequate planning budget for per manager; adequate planning budget for implementation of IT and training: measures of implementation of IT and training: measures of effective IT and training-delivery according to effective IT and training-delivery according to spec and competencies achieved against budget)spec and competencies achieved against budget)

Verification from the ground up Verification from the ground up – bottom up approach– bottom up approach

Verification from the ground Verification from the ground upup

Checks/ verification on the outputs can be Checks/ verification on the outputs can be conducted by firm’s own resources (internal conducted by firm’s own resources (internal audit, compliance and where independent of audit, compliance and where independent of the business lines, risk management).the business lines, risk management).

Checks /verification are matched to the Checks /verification are matched to the particular financial activity of the firm, particular financial activity of the firm, including for example:including for example: Corporate BankingCorporate Banking Private BankingPrivate Banking Investment bankingInvestment banking Asset ManagementAsset Management

Checks/ verification continued: Checks/ verification continued: items that might be includeditems that might be included Corporate Banking (lending mandates Corporate Banking (lending mandates

and covenants)and covenants) Private Banking (Account opening, PEPS Private Banking (Account opening, PEPS

and AML)and AML) Investment banking (Trading controls Investment banking (Trading controls

limits, fails, booking valuation; and limits, fails, booking valuation; and conflict management)conflict management)

Asset Management (client mandate Asset Management (client mandate adhered to ; protection of assets; adhered to ; protection of assets; valuation of assets)valuation of assets)

ConclusionsConclusions

A framework that can be developedA framework that can be developed A framework that uses common language within A framework that uses common language within

the firm and between the firm and third partiesthe firm and between the firm and third parties A framework that can establish the status quo in A framework that can establish the status quo in

a firm and establish targets to move toa firm and establish targets to move to A framework that attempts to articulate what A framework that attempts to articulate what

good governance is and how it might be testedgood governance is and how it might be tested A framework that is scalable (applicable to both A framework that is scalable (applicable to both

large and small firms).large and small firms).

Questions and DebateQuestions and Debate