Lord Penrose's Equitable Life report puts pressure on the FSA to take a tougher stance on corporate governance. John Quigley and Joe Egerton explain
Sir Howard Davies, the last chairman of the FSA, set out the FSA's emphasis on corporate governance in June 2003, saying: "This is a foundation stone of the FSA's approach, a regulatory regime built on senior management responsibilities is absolutely essential."
Effective corporate governance in a firm permits the FSA to concentrate on high level regulation, avoiding the need for minute interference in day-to-day decisions.
In order for corporate governance to be effective, integrity needs to be embraced enthusiastically by all involved in management. Management must also infuse this compliant ethos into staff throughout the firm.
Up to now, this focus on corporate governance has been associated with "light touch" regulation. Then along came Lord Penrose's report into Equitable Life. A surprising feature of the report was that it exposed a long running failure on the part of the board to supervise the executive, a failure that led to unsupportable but guaranteed bonuses being paid out, while new members and funds continued to enter into the now fatally weakened society.
Penrose observes: "The Equitable experience suggests that there may be circumstances in which nothing but an enforceable obligation will empower effective regulatory action."
The report thus raises a fundamental challenge to the concept of light touch regulation. The driving force behind light touch regulation is a well-founded belief that the regulator cannot take over the responsibility for the day-to-day management of regulated firms and that a detailed and highly prescriptive rule book is ineffective and damaging.
If the regulator is to take a firm grip without being dragged into day-to-day decisions or back to a detailed prescriptive rulebook, it has to operate through the board and the compliance function. The FSA is likely to look at the balance of executives, in term as of
representation, allocation of responsibilities, skill-sets and experience. It is also likely to ask questions about the expertise and independence of non-executives.
The FSA may also look very carefully at the calibre of compliance officers, the resources they have available and their relationship with the chief executive, the board and the non-executives. This may have particular impact on those currently applying for authorisation. The FSA is only permitted to authorise a firm if that firm meets the threshold conditions. Effective corporate governance and effective compliance are necessary conditions for authorisation.
Applicants for FSA authorisation need urgently to review their board and compliance arrangements. Individuals who are not disposed or equipped to undertake the responsibilities that go with board membership may well feel that they should leave the board. They could then concentrate on their particular forte in client handling or deal making, rather than maintain a fictional role that exposes both the firm and themselves to serious risk.
The impact of Lord Penrose's report on Equitable Life could compel the FSA to take a tougher regulatory line on corporate governance. It could be the death knell of light touch regulation in this area and firms may expect stricter scrutiny of their board and compliance arrangements than had previously been anticipated.