On August 7, 2012, Canada's federal financial institutions
regulator, the Office of the Superintendent of Financial
Institutions (OSFI), released for comment a draft of its
long-awaited revised Corporate Governance Guideline (the Revised
Guideline). The draft Revised Guideline sets forth OSFI's
expectations for corporate governance of federally-regulated
financial institutions (FRFIs). Like the current Guideline, it
would apply to all FRFIs except foreign bank branches and foreign
insurance company branches.
Consistent with the direction and themes signaled in recent
speeches of the Superintendent, the draft Revised Guideline would
impose a number of significant new requirements. The draft Revised
Guideline is intended to:
- ensure that FRFIs have prudent corporate governance practices and procedures that contribute to their safety and soundness;
- promote industry best practices in corporate governance;
- be consistent with and complement:
- the respective FRFI statutes and related regulations; and
- OSFI's Supervisory Framework ( most recently revised in 2011) and Assessment Criteria; and
- address international standards as articulated by a number of international organizations.
To best meet those goals, the Revised Guideline focuses on (i)
enhancing the effectiveness of boards by providing clarity on board
responsibilities and competencies; (ii) strengthening FRFIs'
risk governance by requiring the development of a "Risk
Appetite Framework" (RAF) to guide risk-taking activities; and
(iii) improving the overall internal control framework of FRFIs by
clarifying the roles of the Chief Risk Officer and audit
committee.
The Revised Guideline is open for stakeholder comments until
September 14, 2012. Given the significant new requirements, FRFIs
and their boards will want to carefully consider the particular
implications of the draft Revised Guideline for their institution
and whether they wish to comment on the draft Revised
Guideline.
Background and Overview
History
OSFI's original Corporate Governance Guideline was published
in 2003. Since then, corporate governance best practices have
evolved significantly, including in response to the financial
crisis of 2008 and onward. Further, a number of domestic
regulators, international standard setters and various commentators
have recently published lengthy reports highlighting best practices
and standards for effective corporate governance of financial
institutions. Accordingly, OSFI believed it appropriate to update
its own guidance in the area.
OSFI also established a dedicated Corporate Governance Division in
2010 to review FRFI practices and ensure FRFI compliance with the
original Guideline. The draft Revised Guideline reflects the
results of a comprehensive cross-sector review of the corporate
governance practices of the larger FRFIs by the new OSFI Division
in 2010/2011, as well as review and comment on prior drafts of the
Revised Guideline by select FRFI directors.
Overview of the Revised Guideline
The key sections of the Revised Guideline, namely Section III, IV
and V, focus, respectively, on three fundamental components of
corporate governance for FRFIs:
- the role of the Board;
- risk governance, described as a distinct and crucial element of corporate governance for FRFIs; and
- the role of the audit committee.
As noted above, the Revised Guideline would apply to all FRFIs
other than foreign bank branches and foreign insurance company
branches. Branches do not have boards of directors and,
accordingly, the specific provisions of the Revised Guideline would
not apply directly to branch operations. Instead, OSFI looks to the
Chief Agent or Principal Officer of a branch to oversee the
management of the branch, including corporate governance matters.
Those individuals are recognized as having overall responsibility
for their respective branches and, therefore, should be aware of
the contents of the Revised Guideline. The Chief Agent or Principal
Officer of branches should refer to OSFI Guidelines E-4A or E-4B,
as appropriate.
In addition to complying with the Revised Guideline, OSFI expects
FRFI boards and senior management to be proactive, and to be aware
of corporate governance best practices applicable to their
institution. According to OSFI, this is achievable through director
orientation and training, self-assessments and independent third
party reviews. OSFI also recognizes that individual FRFIs may have
differing corporate governance practices depending on their size,
ownership structure, nature, scope and complexity of operations,
corporate strategy and risk profile.
A FRFI's board and senior management are ultimately
accountable for the FRFI's safety and soundness and compliance
with law. In the Revised Guideline, as in OSFI's Supervisory
Framework, the roles of the board and senior management are
purposively distinguished. The board is made responsible for
providing stewardship, including direction-setting and oversight of
the management and operations of the entire FRFI. Senior management
is ultimately accountable for implementing the board's
decisions and for directing and overseeing the effective management
of the operations of the FRFI.
The Role of the Board
Responsibilities
In Section III of the Revised Guideline, OSFI outlines the
following essential duties that boards must discharge, in addition
to the roles and responsibilities stipulated in the applicable FRFI
statutes. The section also differentiates between matters to be
approved by the board and matters to be
reviewed and discussed by the board.
The board should approve the FRFI's:
- short-term and long-term enterprise-wide business objectives, strategy and plans, including the RAF (discussed further below);
- significant strategic initiatives;
- internal control framework;
- appointment, performance review and compensation of the CEO and other members of senior management including the heads of oversight functions;
- succession plans; and
- external audit plan.
The board should review and discuss the FRFI's:
- significant operational and business policies;
- business and financial performance relative to the board-approved business strategy and RAF;
- compensation policy for all human resources, to be consistent with the Financial Stability Board Principles for Sound Compensation and related Implementation Standards;
- implementation of internal controls;
- organizational structure; and
- compliance with applicable laws.
The draft Revised Guideline notes that the latter functions are
primarily the responsibility of senior management. However, through
review, discussion and debate, the board has a critical role in
providing high-level guidance to senior management. The board
should establish processes to periodically verify the assurances
provided to them by senior management, but the board is not
responsible for the on-going and detailed operationalization of its
decisions and strategy - these are for senior management to
consider. While senior management should have regular interaction
with regulators with respect to the overall operations of the FRFI,
the board should ensure that regulators are promptly notified of
substantive issues affecting the FRFI.
Effectiveness
In respect of board effectiveness, the Revised Guideline sets out
a number of new recommendations/requirements, including that the
board should periodically commission independent third-party
reviews to assess the effectiveness of board and committee
practices and that boards should have a skills evaluation process
for themselves, including incorporating tools such as a competency
matrix. At a minimum, this matrix should be reviewed annually and
updated by the appropriate board committee. Directors should seek
internal or external education/training opportunities in order to
fully understand the risks undertaken by their FRFI. The Revised
Guideline notes that relevant financial industry and risk
management experience are key competencies for the board and there
should be reasonable representation of these skills at the board
and committee levels.
Independence
In respect of board independence, the Revised Guideline views
demonstrable board independence to be the core of effective FRFI
governance. Beyond the principle of separating the roles of Chair
and CEO, OSFI does not view any one board structure or process as
guaranteeing independence. The Revised Guideline also recommends
that the board should document and approve a director independence
policy that takes into consideration the specific ownership
structure of the institution. Where appropriate, director tenure
should also be factored into the independence policy.
Board Chair
In respect of the board chair, the Revised Guideline newly
recommends that the role of chair should be separated from that of
CEO, as this is critical in maintaining the board's
independence and executing its mandate.
Oversight Functions
The Revised Guideline notes that in order for the board to fulfill
its duties, the board relies upon the advice and opinions of the
various oversight functions within the FRFI. Thus, the board should
ensure, through assurances from senior management and their own
verification processes, that the persons discharging the oversight
functions have the appropriate mandate, resources and
organizational structure to fulfill their duties. As well, the
board should ensure that these persons are independent from
operational management, and are not unduly influenced by senior
management and other business unit executives.
Further, the heads of the oversight functions should have
unimpeded access to the board, including in camera
meetings with the board and its relevant committees (including the
new risk committee, as described below). The board should approve
and play an active role in the oversight functions, including the
selection, performance management and compensation of the heads of
these functions (eg. Chief Financial Officer, Chief Risk Officer,
Chief Compliance Officer, Chief Internal Auditor and Appointed
Actuary) and the evaluation of their performance and
compensation.
Meanwhile, rather than establishing specific oversight functions,
boards and senior management of small, less complex FRFIs are
expected to ensure that other internal or external functions or
processes provide the required level of controls or independent
enterprise-wide oversight.
In a further new recommendation, the Revised Guideline indicates
that the board should develop a plan to periodically commission
independent third-party reviews to assess the effectiveness of the
FRFI's oversight functions and processes.
Risk Governance
In Section IV of the Revised Guideline, OSFI proposes several
important new requirements with respect to risk management,
including the adoption of a RAF, third-party risk management
effectiveness reviews, the establishment of a Risk Committee and
the designation of a CRO. Each of these is discussed below.
RAF
In a major new proposal, OSFI is recommending that each FRFI have
a board-approved RAF that guides the amount of risk the FRFI is
willing to accept in pursuit of its strategic and business
objectives. The RAF should set basic goals, benchmarks, parameters
and limits, and should consider all applicable types of risks. The
RAF is intended to provide boundaries on the ongoing operations of
the FRFI, and details of its proposed contents are contained in
Annex C to the Revised Guideline. Proposed contents include a risk
appetite statement, specific risk tolerance limits and processes
for implementation of the RAF.
Risk Management
In respect of risk management generally, the Revised Guideline
also newly suggests that the board should periodically commission
independent third-party reviews to assess the effectiveness of the
FRFI's risk management systems and practices. This appears to
be in addition to the recommended independent third-party reviews,
described above, of the FRFI's oversight functions and
processes.
Risk Committee
In addition, the Revised Guideline directs that, depending on the
nature, size, complexity and risk profile of the FRFI, the board
should establish a dedicated board risk committee to oversee risk
management on an enterprise-wide basis. Guided by the FRFI's
RAF, the risk committee should have a sound understanding of the
types of risks to which the FRFI may be exposed and of the
techniques and systems used to identify, measure, monitor, mitigate
and report on those risks. The risk committee should have a chair
that is independent of senior management and all committee members
should be independent and an adequate number of committee members
should have sufficient knowledge in the risk management of
financial institutions. Where appropriate, the risk committee
should include individuals with technical knowledge in the risk
disciplines relevant to the FRFI.
The risk committee should be responsible for approving at least
annually the mandate, competencies and resources of the CRO. It
should approve the CRO's performance review and oversee the
succession planning for the CRO position and other key positions
within the risk management function.
CROs
In a further important new recommendation, the Revised Guideline
recommends that each FRFI have a designated CRO, with sufficient
stature and authority within the organization, and who is also
independent from operational management. The CRO should have access
to the board and risk committee without impediment, including a
direct reporting line to the board or risk committee. (In a
footnote, OSFI clarified that "direct reporting line" is
intended strictly for functional purposes - administratively, the
heads of oversight functions, such as the CRO, generally report to
the CEO.)
The new emphasis in the Revised Guideline on the role and function
of the CRO is consistent with recent speeches of the
Superintendent. The Revised Guidelines notes that the CRO should
provide an independent view to the risk committee and the board
regarding whether the FRFI is operating within the RAF and should
meet in camera with the risk committee on a regular
basis.
The Revised Guideline also states that the CRO and risk management
function should not be directly involved in revenue-generation or
in the management and financial performance of any business line or
product of the FRFI. While the CRO and risk management function
should influence the FRFI's risk-taking activities, the
on-going assessment of risk-activities by the CRO and risk
management function should remain independent.
Role of the Audit Committee
The Revised Guideline also contains updated commentary on the role of the audit committee and includes a number of significant new related proposals, including that:
- all audit committee members should be independent;
- the Chief Internal Auditor, the Chief Financial Officer and the Appointed Actuary (for insurance companies) should have "direct reporting lines" to the audit committee (subject to the same clarification as above in relation to the CRO); and
- the audit committee, not senior management, should be responsible for approving external audit fees and of the scope of the audit engagement.
Supervision of the FRFIs
In Section VI of the Revised Guideline, OSFI describes the role
of corporate governance in OSFI's supervisory process and notes
that open communication between the board and regulators helps
promote the mutual trust and confidence essential to the efficiency
of the principles-based system of supervision that OSFI follows.
OSFI notes that it will undertake a number of approaches, including
discussions with the board and senior management, to assess the
effectiveness of an FRFI's corporate governance processes and
will seek evidence that the processes exist, are operating
effectively and that the board is able to fulfill its roles and
responsibilities.
As noted above, the draft Revised Guideline is open for comment
until September 14, 2012.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.