Financial Services Sector Governance Part 2

LAST week we presented part of the report card on the disclosure practices of financial institutions. This instalment is the sequel and final. We also put forward recommendations on the possible corporate governance reform areas.
Board accountability and director enhancement
Less than a third of the financial institutions disclosed how they handle induction of directors and assisting them to have access to independent advice and information, with the expense of this information-search being footed by the board. This is highly laudable, in respect of the institutions that made the relevant disclosures.
One disturbing pattern observed in about a quarter of the institutions is the case of cross-sitting, with one individual sitting on more than two board committees. It could be that they are multi-talented. An explanation is in order, to justify cross-sitting, to allay fears of individuals trying to maximise their remuneration.  Is it an indication of talent gaps or a reflection of scarcity mentality? Brief explanations could have helped to suppress speculation.

Remuneration disclosure and governance
None of the financial institutions gave an integrated and detailed remuneration report in line with best practices. For one to get meaningful information concerning remuneration practice they have to go to the explanatory notes on expenditure items in the Statement of Comprehensive Income (formerly called the Income Statement). The disclosure made therein is in line with the traditional International Financial Reporting Standards (IFRS). Less than half of the financial institutions gave a detailed breakdown, separating director remuneration from employees’. Related to that, about a quarter of the institutions analysed the remuneration into components such as retirement, bonuses and salary.
In short the remuneration disclosure as per IFRS is a far cry from what current international corporate governance best practices require. Adherence to IFRS should not be used as evidence of transparency in remuneration disclosure, as this lacks rigour.  We expected the financial institutions to give us the structure of director fees for each committee such as the basic attendance fee, ad hoc meeting fees, and total remuneration received by each director, for instance. Furthermore, the detailed remuneration of senior executives whether they sit on the board or not is required. The minimum detail should have indicated separately, total guaranteed remuneration and variable pay (bonuses and incentives) received during the year. In addition, details of long-term incentive schemes in terms of the shares awarded or offered to each senior executive via share options, performance shares should be disclosed in detail. Details of any shares that vested in the course of the year should have been disclosed.
The mandates of the remuneration committees varied widely from best practice. About a third of the financial institutions have executive directors being “permanent members” of the remuneration committee. This is at variance with good corporate governance. Executive directors are only supposed to attend remuneration committee meetings by invitation and they are not supposed to sit in those committees when their performance and remuneration are being discussed. Less than 20% of the institutions showed instances where some non-executive directors failed to attend the remuneration committee meetings, compromising best practices. Specifically, a remuneration committee should comprise at least three non-executive directors, the majority being deemed independent. In the cases in question, as a result of erratic attendance by some non-executive directors, we had the remuneration committees effectively comprising two non-executive directors and an executive director, a clear breach of best norms. In one case a board member attended only one meeting throughout the year, placing the independence of the remuneration committee in question. Could this revelation provide a window into the apparent reluctance of boards to be more transparent with executive director pay?
Of the less than 30% of the institutions giving information about the remit of their remuneration committees, surprisingly, none mentioned performance evaluation of senior executives being one of their key deliverables. In any case how can they objectively assess the performance of the CEO when the CEO is a “permanent member” of the remuneration committee? Reform in remuneration governance is long overdue and visible steps in the reform path should be taken.

IT governance and human capital risk
IT governance represents next-practice in corporate governance. In fact, the King III Code identifies IT governance as a key area of governance. We were delighted to note that one financial institution made substantial disclosure of its IT risk management practices. The said firm went on to disclose that an IT committee was in place to manage IT risk. This kind of telescopic thinking, treading beyond the confines of compliance is a healthy sign that we have in this country, strategic talent, combining both vision and the necessary analytics.
One firm, different from the one alluded above disclosed in brief, how they identify and measure human capital risk. This is highly commendable, to note that the board takes human capital seriously to the extent of having formal processes for managing human capital risk, raising the bar in Zimbabwean corporate governance.

Sign-posting future governance
Financial risk management appears to be strong, judging from the detailed disclosure and attention accorded this important aspect of governance. Compliance appears to be a key focus of boards, understandably so, given that failure to comply can result in the revocation of operating licences. Resultantly, human capital issues appear to be taking a back seat. The Reserve Bank needs to consider the merits of replacing the current “comply or else” approach with an “apply or explain” regime in order to ensure that all aspects of governance are given serious attention.
With global momentum gravitating towards tighter financial institution-regulation as seen by the emergence of  financial sector-specific  governance codes such as Basel II and now, Basel III, Zimbabwe should be careful not to fall victim to the “tyranny of the urgent”. We should give equal attention to other non-financial governance areas that are very important but not urgent. Effective people and entities address issues on the basis of their importance and not their urgency. Urgency and importance is not one and the same thing.
In future, we expect reforms in the area of remuneration committees. Rigorous remuneration reports, signed off by the chairperson of the remuneration committee should be part of corporate reporting culture. CEOs must be held accountable and the remuneration committee should be given an explicit mandate to manage the performance of executives. Substance should prevail over form.
The board reform agenda should place a premium on achieving diversity in terms of gender, professional background, for instance.
The notion of sitting allowances must be discarded. Formal board accountability is the antidote to the “sitting” syndrome. Board members must be rewarded for measurable value-add. Clear direction is needed in terms of serving on multiple committees to discourage the phenomenon of “career board members”.
Turning financial institutions into pockets of governance best practice will act as an epicenter for spreading governance excellence into the rest of the sectors of the economy.
lReaders Forum: Do you think that the total remuneration of senior executives should be disclosed in detail? Visit http://humancapitaltelescope.blogspot.com to share your thoughts.

 

By Brett Chulu

 

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