Board effectiveness reviews and the proposed reforms/code
It is a truth universally acknowledged that an effective Board is key to the success of a regulated financial services firm. Regular reviews of a Board’s effectiveness can be a useful tool for improving. But how to make sure that your Board Effectiveness Review is effective?
For listed companies in the UK, the FRC’s Corporate Governance Code has long stipulated there should be annual evaluation of the Board’s performance; and since 2010 it’s been expected that there would be external facilitation of these reviews at least every three years. Despite this focus on improving Board performance there is a perception – arising from a number of high profile corporate failures – that such reviews are not as effective as they should be in promoting better Board performance.
That perception prompted changes to the Code and the associated Guidance on Board Effectiveness that was issued in 2018. In addition the Department of Business, Energy and Industrial Strategy (BEIS) invited the Chartered Governance Institute (ICSA) to conduct a review that was published in January 2021. The ICSA review report proposes a number of recommendations to promote good practice in the conduct of independent Board evaluations. While it remains to be seen whether and how these recommendations will be adopted, they provide some food for thought for Boards on how they evaluate their performance and appointing and working with external reviewers to do so.
One point rightly emphasised by ICSA is that the purpose of independent Board effectiveness reviews is to support the Board in improving its performance and not to provide assurance regarding the operation of the Board. As such, the review should assess current performance and identify areas for further consideration by the Board. Responsibility for responding to the findings of the review, identifying and prioritising actions to be taken in response, remains with the Board, who should expect to be held to account for progressing actions.
The scope of any review will need to be tailored to the particular circumstances of the Board being reviewed, although there are of course common areas of focus including leadership, individual contribution of Board members and collective dynamics, skills gaps or training needs, the adequacy of Board papers, resourcing or capacity issues. Full scope reviews should also consider the effectiveness of Board sub-committees as well as the full Board.
How much independence?
One key issue when commissioning an external review is just how independent an independent reviewer should be: can they also be employed for other services not connected with the review, or does that fatally undermine their independence? The ICSA review reflects a range of views on this issue and the difficulty of drawing a bright and universally applicable line here.
Recognising the complexities, the ICSA review concludes that it is sufficient for companies to be transparent regarding the extent of the relationship between the reviewer – both in terms of the extent of other services provided and the length of the relationship - and avoid the perception of conflict of interest; while the reviewers should explain how they manage any potential conflicts of interest. Any connection between the reviewer and the director leading the review should also be explained. Boards should take these factors into account when considering who to appoint and any recommendations provided, bearing in mind the overarching purpose and objective of a Board effectiveness review.
For reviewers, a code of practice and a register
The ICSA review stops short of introducing minimum standards by prescribing a methodology for independent Board evaluations, reflecting the absence of any data to support the choice of any one method over another and the differing needs of the Boards being reviewed. Instead its report proposes a code of practice – voluntary at first – for those offering review services. Whilst this section is aimed at practitioners, it also provides a useful reminder to Boards as to what they should be looking for and expect from their chosen reviewer.
This voluntary code is based on four principles, with supporting guidance for each.
- Competence and capability, i.e. the expertise, experience and capacity to conduct any review commissioned. Alongside these points the guidance also points to the four core elements to an independent review: use of questionnaires, bilateral interviews with directors and attendance at Board and committee meetings, input from others in addition to Board members, and review of Board papers and other documentation;
- Independence and integrity: taking steps to manage potential or actual conflicts of interest and limiting the length of any one relationship to two consecutive reviews;
- Client engagements: notably, this highlights the responsibility on firms to avoid any attempt to constrain the assessment by placing limitations on access to information or individuals, and the importance of settling the agreed scope of the review at the outset; and
- Client disclosure: where the company commissioning the review intends to disclose the results either publicly or to the regulator, these disclosures should be agreed by the reviewer to avoid the risks of their views being misrepresented.
The review also proposes that a register of signatories to the Code should be kept, and suggests an evolution over time in the requirements on and oversight of signatories.
For firms, Principles of Good Practice and further guidance on reporting
This code of practice for reviewers is mirrored by a set of proposed Principles of Good Practice for companies commissioning independent reviews – which may be of interest to unlisted companies considering reviews of their Board’s performance.
These Principles highlight the role of the full Board (as opposed to the chair or senior independent director leading the review) both in selecting the reviewer and in receiving the findings of the review. They also seek to limit the company’s ability to amend the scope of the review once it is underway and require the company to provide access to individuals and documents the reviewer requires.
The ICSA review report also sets out proposals regarding disclosures in a firm’s annual report, providing further guidance on the interpretation of requirements of the Corporate Governance Code. In relation to independent reviews, these include three areas that go beyond the requirements of the Code:
- whether the reviewer is a signatory to the reviewers’ code of practice;
- information on the length of the relationship between the reviewer and the company and the reviewer and the individual leading the review; and
- the appointment process.
How we can help
We regularly advise Boards on the effectiveness of their governance structures and processes, particularly where regulators have raised questions regarding aspects of the governance in place. This might relate to specific contributors to Board effectiveness or the broader scope of the Board’s role delineated within the Corporate Governance Code.
In doing so we draw on the experience gained from our contentious practice of the stumbling blocks to Board effectiveness, such as papers that don’t give the Board the information it needs to make fully informed decisions, a focus on one area (e.g. financial performance) at the expense of others, unbalanced Boards (including diversity considerations and regulatory expectations in this area) and Boards lacking certain skillsets (e.g. in relation to IT change).