Archive for the ‘banks’ Tag

Risk Management

One of the main areas in corporate governance that has caught the headlines recently is risk management.  There is a widely held perception that in recent years many boards have not managed the risks associated with their businesses well – whether that was because they did not identify the risks fully or whether because having identified the risks, they did not take appropriate action to manage them.

 Review of UK’s Combined Code

The Financial Reporting Council (FRC)’s Review of the UK’s Combined Code published in December 2009 http://www.frc.org.uk/corporate/reviewCombined.cfm states that ‘One of the strongest themes to emerge from the review was the need for boards to take responsibility for assessing the major risks facing the company, agreeing the company’s risk profile and tolerance of risk, and overseeing the risk management systems. There was a view that not all boards had carried out this role adequately and in discussion with the

chairmen of listed companies many agreed that the financial crisis had led their boards to devote more time to consideration of the major risks facing the company.’  The FRC therefore proposes to make the board’s responsibility for risk more explicit in the Code through a new principle and provision.  Moreover it also intends to carry out a limited review of the Turnbull Guidance on internal control during 2010.  

Many companies, and especially those in the financial sector, have already established risk committees whilst other companies especially smaller companies, may combine the consideration of risk with the role and responsibilities of the audit committee.

Alternative investment market

The UK’s Alternative Investment Market (AIM) expanded rapidly during the 12 years following its inception in 1995.  Then from 2007 onwards it went into decline.  David Blackwell, in his article ‘Signs of recovery seen after years of famine’ (FT, page 23, 16th December 2009) states that ‘Hundreds of companies have left the market, the number of flotations has collapsed and fines for Regal Petroleum and others – albeit for regulatory infringements dating back years – have once again sullied the market’s reputation’.  Nonetheless he points out that 2009 saw an improvement with the AIM index rising by 62 per cent over the year compared to a rise of 22 per cent in the FTSE 100. 

The lighter regulatory touch on AIM has both attractions and drawbacks.  On the one hand, companies find it easier to gain a London listing (albeit on AIM rather than the main market); on the other hand, this may bring concomitant risks for investors as they will be investing in companies which may well be riskier than their main market counterparts.

Family firms

Family firms are the dominant form of business in many countries around the world and range from very small businesses to multinational corporations.  Richard Milne in his article ‘Blood ties serve business well during the crisis’ (FT, Page 19, 28th December 2009) points out that the attributes of a typical family business will have stood it in good stead during the recent financial crisis: ‘Long-term thinking, conservative, risk-averse: the very characteristics of the typical family business seem to be the ones needed in the economic crisis of the past two years’.  Given that they tend to be more conservative, family firms will take less risks, for example, by not over extending themselves with their gearing (leverage).

Banks and financial institutions

Many banks and financial institutions were widely criticised because of the perceived overly generous bonuses paid to some executive directors and senior management at a time when the world is suffering the consequences of a global financial crisis precipitated by bankers who did not seem to fully appreciate the risks involved with some of the products they were trading in.  And yet already we see banks again paying out enormous bonuses.  Megan Murphy in her article ‘Tycoon attacks return of bankers’ bonuses’ (FT, Page 3, 28th December 2009) quotes Guy Hands, the private equity tycoon, who is highly critical of these big bonuses and speaks of bankers ‘taking home “wheelbarrows of money” on the back of taxpayers’ support’.  Moreover he is quoted as saying ‘It cannot be right to continue with a system that allows risk to be taken in the knowledge that, if things go right, bankers will take on average 60-80 per cent of the profits generated through compensation and, if they go wrong, shareholders and ultimately the government will pick up the costs’.

Asset managers

Managing risk is, of course, relevant to all parties in the business and financial world as the article by Sophia Grene ‘Managing risk is the main task ahead’ (FTfm, Pg 1, 4thJanuary 2010) illustrates.  In her article, Sophia points out that ‘many financial models failed in the past two years as markets demonstrated they did not behave according to conventional assumptions’ and that ‘the main challenge for asset managers in the coming decade is understanding, managing and communicating risk’.

Concluding comments

Managing risk and managing it well is an important consideration for boards of directors, whether in main market firms, second tier markets, or family firms.  Firms, and especially those in the banking and financial sector, need to pay particular attention to executive director remuneration packages which should not encourage adverse decision-making in terms of the impact on risk, that is, remuneration packages should be designed so that they do not lead to unacceptable risk-taking which may be to the detriment of the long-term sustainability of the company and potentially, as we have already seen, the wider economy.

Please refer to the newly published third edition of my book ‘Corporate Governance’ for updates to various national and international corporate governance codes and guidelines; board committees including risk and ethics committees; the Alternative Investment Market (AIM); family firms; remuneration packages, and the global financial crisis.  

In addition, new material on many other areas including: private equity and sovereign wealth funds; governance in NGOs, public sector/non-profit organisations, and charities; and board diversity.  Many examples, mini case studies and clippings from the Financial Times are included to illustrate the application of corporate governance in the real world.

 Chris Mallin 7th January 2010

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Rights Issues

Rights issues have been a traditional way to raise funds from existing shareholders in the UK, Europe, and Australasia.  Existing shareholders are offered the chance to acquire new shares, at a discount, in proportion to their existing holding. In general the reasons for a rights issue fall into one of three categories: raising funds for an acquisition or expansion; (ii) internal working capital requirements; (iii) restructuring of the balance sheet.  The latter often occurs in times of financial distress and it is for this reason that many of the companies seeking to raise money through rights issues are doing so now – they need to raise cash, and asking existing shareholders is one of the few ways to do it.

Banks and property companies making most rights issues

It has been noticeable that many UK companies are making rights issues at present.  Many of the companies seeking to raise funds in this way are in sectors particularly badly affected by the economic downturn:  the banking sector and the property sector.

HSBC, in the largest rights issue in UK history, is seeking to raise more than £12 billion from its investors.  Peter Thal Larsen, Neil Hume and Kate Burgess (FT, Page 1, 28th Feb/01st Mar 09) in their article ‘HSBC to seek £12bn in record offering’ state that HSBC ‘is the latest in a long line of global banks to seek to strengthen its capital reserves by issuing shares’.

Peter Thal Larsen (FT Page 19, 3rd March 09) in his article ‘HSBC’s search for capital gives market the shudders’ reports that ‘…the bank’s decision to raise £12.5bn in fresh capital from its investors and cut its dividend for the first time any of its executives can remember was bound to send a shudder through the markets’.  However HSBC is still seen as being in a stronger position than many other banks, and Stuart Gulliver, HSBC Chief Executive of Global Banking and Markets, stated ‘The rights issue is designed to get us a bullet-proof balance sheet’.

In their article ‘Segro to seek discounted rights issue’ (FT, Page 14, Financial Times 28th Feb/1st Mar 2009), Daniel Thomas and Neil Hume highlight Segro is seeking to raise 3300 million and that other property sector companies including Land Securities, British Land, and Hammerson have already approached investors with rights issues to the tune of more than £2 billion in recent weeks.

In similar vein, David Fickling, Kate Burgess and Neil Hume (FT, Page 17, 3rd Mar 09) in their article ‘Debt-laden Wolseley close to launching £1bn rights issue’ highlight the plight of Wolseley, the builders’ merchant whose ‘loss-making retail division [was] heavily exposed to the stagnant US housing market’.

Governance implications

Shareholders taking up the rights will retain the same proportion of the share capital overall as they had prior to the rights issue.  However shareholders not taking up the rights issue shares will have a lower proportion of the company’s share capital than they did prior to the rights issue i.e. their stake will be diluted.  To avoid any dilution that would occur when companies do not offer shares to their existing shareholders first, in some jurisdictions the concept of pre-emption rights (that is, new shares have to be offered to existing shareholders first) has long been enshrined in company law.  However as Oliver Ralph (FT, Page 6, 28th Feb/1st Mar 09) points out in his article ‘The begging letters start to arrive’, noted ‘The institutions are getting uppity because they, too, have been left out on certain occasions. Witness the outrage that Barclays provoked when it raised money from Middle East investors last year.  More recently, Rio Tinto has enraged its institutional shareholders by offering convertible bonds on favourable terms’.

There are clear governance implications where investors’ shareholdings are diluted and equally the investors are somewhat ‘over a barrel’ as if they wish to avoid dilution, they have to pour more money into companies for reasons, and at a time, when they may not wish to do so.

There were also some problems with rights issues last year, including low take-up rates, and claims of market abuse through short-selling, and as a result the Rights Issue Review Group was established and reported back late last year.  The full report ‘A Report to the Chancellor of the Exchequer: by the Rights Issue Review Group’ is available at http://www.hm-treasury.gov.uk/d/pbr08_rightsissue_3050.pdf

Following the Review, the Association of British Insurers (ABI), an influential body representing the collective interests of the UK insurance industry, altered its guidelines on rights issues so that companies will be able to issue new shares amounting to up to two-thirds of their existing issued share capital (previously one third) without obtaining shareholder approval. The purpose of the change is to facilitate rights issues.

Rights issue wave

It remains to be seen how many more companies will make rights issues but at the present time it seems a good option for companies, many of which are  in dire need of a cash injection, although investors may be becoming wary and viewing rights issues as a case of  good money after bad.

Chris Mallin

Banks in crisis: failures of corporate governance?

Corporate governance has been gaining more predominance around the world over the last decade.  However the last year or so which has brought the financial crisis and the ‘credit crunch’ has seen an unprecedented interest in some of the areas that are central to corporate governance: executive remuneration; boards of directors, independent non-executive directors; internal controls and risk management; the role of shareholders.

However the focus on these areas has brought into sharp relief some of the failings of the present system whether these have been brought about by greed, naivity, or a lack of real appreciation of the risk exposures of banks.

Bankers’ bonuses
Whilst many would agree that bankers have received huge payouts, often for a seeming failing company, bonuses appear likely to be cut, possibly by around 40% or more.  Peter Thal Larsen and Adrian Cox (FT, Page 13, 07/08 Feb 09) in their article ‘Barclays bankers braced for bonus cut’ highlight that even much reduced bonuses are likely to be controversial given that feelings are running high amongst the public and politicians alike.

The generous remuneration packages of executive directors of some of the UK’s largest banks have caught the headlines day after day in recent weeks.  In their article Former executives face bonus grilling’ (FT Page 2, 9th Feb 09), George Parker and Daniel Thomas mention an interesting historical fact ‘in the early 18th century, after the bursting of the South Sea bubble, a parliamentary resolution proposed that bankers be tied up in sacks filled with snakes and thrown into the River Thames’!  No doubt there are those who wish the same might happen today although a grilling before the Commons Treasury Committee may prove to be almost as unpleasant an experience!

Adrian Cox’s article ‘Barclays executives must wait longer for bonuses’ (FT, page 2, 11th Feb 09) highlights that Barclays is trying to design a pay structure that retains staff whilst rewarding long-term performance at a time when banks have been urged to show ‘moral responsibility’ in their remuneration structures.  The pay restructuring will affect not just directors but also senior employees, and other banks including UBS, Credit Suisse, RBS and Lloyds are in a similar position.

Risk Management

‘Former HBOS chiefs accused over risk controls as bankers apologise’ was the striking head of the article by Jane Croft, Peter Thal Larsen and George Parker (FT, page 1, 11th Feb 09).  Under questioning from the Commons Treasury Committee, Lord Stevenson, Andy Hornby, Sir Tom McKillop and Sir Fred Goodwin all apologised for what had happened at RBS.  Part of the questioning brought to light that a former employee had warned the board of potential risks associated with the bank’s rapid expansion.

Risk management is an area that is bound to gain a higher profile given the extent of the impact of the use of toxic assets which many feel were not well understood.

Where were the institutional shareholders?

Lord Myners, the City minister, has urged shareholders to challenge banks ‘Myners calls on shareholders to challenge reward cultures’ by Adrian Cox and Kate Burgess (FT page 3, 10th Feb 09). Lord Myners, they state, said that’ institutional investors should look at the content of remuneration reports and ask questions if the data are complex or opaque’.

My view is that it is an ongoing debate as to what extent institutional shareholders should intervene in the affairs of the companies in which they invest (investee companies).  It is widely recognised that engagement and dialogue are useful and necessary for an institutional investor to monitor the activities of investee companies.  However there is a line to be drawn between what it is feasible – and desirable – for the institutional shareholders to do, and what might be seen as undesirable and restrictive.

Sophia Grene article  ‘Funds say they did all they could to warn banks’ (FT, page 9, 8th Feb 09) highlights the view of the UK’s Investment Management Association that ‘fund managers did all they could to prevent banks hurtling to their doom, but under the current system, shareholders cannot shout loud enough to be heard’  The IMA also indicated a possible way forward for the future ‘investors can only do so much…..maybe we need to take a closer look at how investors and non-executive directors interact.  They’re privy to much more information than the investors’.

Walker Review of the Corporate Governance of the Banking Industry

Sir David Walker has been appointed to lead a review of the corporate governance of the banking industry which will look into remuneration and bonuses, risk management and board composition. The terms of reference can be found at:

http://www.hm-treasury.gov.uk/press_10_09.htm

Bankers abroad

In the US, President Obama has brought in reforms to limit the remuneration of executives to $500,000 at banks which have had a bail out.  Shares could also be given under incentive plans but would only vest once government support had been repaid, ‘Obama gets tough on pay for executives’, Alan Beattie and Edward Luce (FT page 1, 5th Feb 09).
Chris Mallin

Corporate governance at the heart of political, social, and economic debate

An unprecedented economic crisis now dominates the world economy. Comparisons with previous recessions or the great depression of the 1930s miss the point. The world economy has never been in a situation like this before. Global companies are larger, more complex and interdependent than ever before, financial markets are vast and interrelated in a way previously unknown, and questions of corporate governance – the way power is exercised over all types of corporate entity – are being asked as never before. Consider a few: 

  • Where were the directors of the failed financial institutions?
  • Why did their independent outside directors not provide the check on over-enthusiastic executive directors, that they are supposed to?
  • Did the directors really understand the strategic business models and sophisticated securitised instruments involved?
  • Did they appreciate the risk inherent in their companies’ strategic profile?
  • Where were the auditors?
  • In approving the accounts of client financial institutions did they fully appreciate and ensure the reporting of exposures to risk? Expect some major legal actions as client companies fail. Hopefully, we shall not see another Arthur Andersen – there are only four global accounting firms left!
  • Did the credit agencies contribute to the problem by awarding high credit ratings to companies exposed to significant risk? Expect some major changes here.
  • Government bailouts of failing banks have produced near nationalised conditions in some cases. That turns governments into major institutional investors. (The Chinese government is the world’s largest institutional investor: maybe there are some insight there – see chapter 8)
  • Government bailouts also raise the ethical issue of so-called moral hazard; by protecting bankers from their past reckless decisions, would others be encouraged to take excessive risks in the future?
  • Will the experts who designed the sophisticated loan securitisation vehicles and other financial engineering systems be held to account? Are their ideas and enthusiasms now under control? This key issue has not yet been addressed.
  • Where were the banking regulators? Although the extent of the crisis is unprecedented, the regulators seem to have been beguiled into complacency. There is some evidence that they might have been taken-over by the industry they were there to regulate. New rules are inevitable. But remember, the US Sarbanes and Oxley Act, drafted hurriedly in response to the Enron collapse and the loss of confidence in the market, has proved far more expensive than expected and has not been entirely successful, as we are now seeing.
  • Were any of the financial institutions’ activities illegal? Compare the situation with Enron, where some top executives continued to believe that nothing they had done was wrong, even as they approached jail. No doubt there are investigators pursuing this question right now.
  • Finally, did excessive bonuses and share options encourage short-term and unrealistic risk-taking with shareholders funds? Predictably, this has been a major focus of the tabloids. In the future, some control is likely on performance related remuneration. The news that some bankers had lost their fortunes as share prices collapsed was cold comfort to mortgagees who lost their homes, shareholders who lost their savings and employees who lost their livelihoods.

It is fascinating to see that the subject of corporate governance, though not always mentioned as such, has become central to political, social and economic thought.

Bob Tricker