Regulation, Diversity & Board Effectiveness

Introduction

Fidelio interviewed Sam Tymms, Managing Director at Promontory Financial Group and Non-Executive Director at IG Group, to explore how regulated Boards can ensure their effectiveness by resolving the tension between regulatory requirements and bringing the right skills around the Boardroom table to be “fit for the future”.  Sam also joined us at Fidelio’s “A Seat at the Table” Programme for senior female Executives and Directors and shed a light on this theme.

Fidelio’s focus is building Boards “fit for the future”: cross-border, cross-sector, cross-function. By combining our experience with Sam’s insight as a seasoned former regulator with 20 years’ experience in the U.K.’s Financial Services Authority and its predecessor agencies, we addressed the following:

  1. Can Chairmen of Non-Financial Services Boards learn from Financial Services Boards? Is there a transferability of skill set?
  2. For the Chair of a regulated Board, what does “fit for the future” look like? What skills and attributes will the regulated Board require?
  3. What steps can Chairmen take to develop and strengthen the existing (regulated) Board so that it becomes more effective in its oversight of a regulated entity?

The key threads of our discussion are set out below.

A. We tend to think about heavily regulated Boards in the Financial Services sector, but we are seeing other regulated sectors in the public eye, utilities for example. Can Chairmen of Non-Financial Services Boards learn from Financial Services Boards? Is there a transferability of skill set?  

Regulated Boards and Financial Services Boards are often treated as synonymous. However, Sam emphasised that there is a broader universe of regulated sectors beyond Financial Services.  These include:

  • Utilities
  • Healthcare
  • Gambling and Gaming
  • Food / Beverages

Even in large unregulated organisations, there will often be a regulated element, for example trading divisions within oil companies or the treasury function in the majority of large businesses. This trickles down: what starts in the Financial Services sector often becomes common practice for other Boards.

Financial Services regulatory skills, therefore, can be relevant for other Boards, but it is also possible for Board Members outside of the Financial Services sector to move to Financial Services Boards;  the skillsets and disciplines are very similar. Sam has seen several examples of Board Members who not only move across sectors, but also move across disciplines.

The Chair and Committee Chair Roles

However, Chairs, Committee Chairs, and Senior Independent Directors (SIDs) of regulated Boards are a different matter.  For these positions, the regulator needs to approve the appointment, focusing on particular skill sets and experience.

The Chair of an Audit Committee should have accountancy, if not audit experience.  The same goes for the Remuneration Committee – a Remuneration Committee Chair should have previous Remuneration Committee experience, even if on a different board.

One consequence of this is a greater focus on succession planning and Fidelio has also increasingly seen regulated Boards creating a pipeline for key committees Chairs. For instance, some Boards prepare by bringing in a Non-Executive as a Remuneration Committee Member for a year to enable him/her to succeed to the Committee Chair role.

B. A key focus for the Chair is ensuring the Board is “fit for the future”. For the Chair of a regulated Board, what does “fit for the future” look like? What skills and attributes will the regulated Board require?

In building a Board fit for the future including in Financial Services, the Chair must ask what the company needs from the Board to move to the next phase of its development.

Disruption is a clear challenge facing today’s regulated and non-regulated Boards, making the benefits of diversity around the Boardroom table even more significant.  Chairmen and their Boards need to be asking themselves:  what are the disruptive steps we may want to take? Do we have the right skills at Board and Executive level to oversee this? Is the Board adding value to the strategic planning process?  Is the Board open to opportunity or too narrowly focused on risk?

Identifying opportunity can come from many sources. Sam referred to an example of a Head of Strategy at an oil company who predicted that supermarkets would start distributing fuel, at the time deemed ridiculous, but now a reality. It is clear that an external perspective can have great value – the risk of group think is high if all Board Members have the same background and think in the same way.

If Boards want to benefit from disruption, it is important to consider the range of disruptors, but also to consider how they can be opportunities. For public company Boards, this is important – shareholders want to know how companies are responding to threats and disruption. They will be mindful that investment in disruptive capability will, temporarily, inflate costs, with a failure to invest being far more expensive. Increasingly, shareholders want evidence the Board has an innovation agenda and answers to disruption.

C. What steps can Chairmen take to develop and strengthen the existing (regulated) Board so that it becomes more effective in its oversight of a regulated entity?

Diversity is high on the Board agenda.  Today’s Boards are facing increasing scrutiny and pressure from shareholders and stakeholders on Board composition. The challenge for the Chair reaches beyond gender or ethnicity targets. It is to ensure that the Board has the diversity of backgrounds, skills, and capabilities needed to ensure they remain “fit for the future”.

Sam emphasised that technology, in particular, is a major challenge for today’s regulated Boards. It is often young, more junior professionals who bring innovative skills, albeit with an unfamiliar profile which may not meet the regulator’s expectations of experience. In Fidelio’s work – accessing talent cross-border, cross-sector, cross-function, we see increasingly see the benefit of attracting Board Members from very different backgrounds and the link to innovation.

According to Sam, Chairmen often face the dilemma that they would like to choose someone who is innovative but are concerned he/she may not succeed through the regulator’s interview process – they may not be able to answer detailed question on the bank capital regime, for example!  In this instance, Sam advises that the Chair flag in advance with the regulator – this isn’t a candidate with the skill set the regulator might expect, but the contribution to Board diversity and mitigating against group think are factors the Chair – and the regulator – needs. There are several instances where this approach by the Chair has worked well and the candidate with a less familiar but diverse profile has been successful.

Both regulators and investors expect that the Chair uses Board Evaluation to evaluate his/her Board collectively and individually, on an annual basis, with this also conducted by the SID in respect of the Chair.  At a recent Fidelio Board Breakfast, we welcomed institutional investor and Head of Hermes EOS, Hans-Christoph Hirt, to explore what shareholders want from Board Evaluation. He concluded that the Board Evaluation tool is an important tool for investors as it signals a willingness for the Board to question its own effectiveness and provide an opportunity to evaluate the skills around the Boardroom table.

One aspect of this is evaluation is Board composition – does the Board have the right skill sets around the Boardroom Table to be “fit for the future”? This is clearly of the utmost importance both for the Chairman and the Board, as well as investors and regulators.  Sam noted that recently regulators had started to explicitly ask about diversity and how Boards are engaging with the diversity agenda at Board and Executive level.

Governance investors are also increasingly speaking up for greater diversity. This is an influential voice that can be used to support the Chairman in bold Board appointments. Investors must be careful that they don’t add to risk aversion, by focusing on too narrow a pool of potential Directors.

The Role of the Regulator

Of course, regulators must ensure that Boards collectively are competent and their requirement for technical skills and knowledge is completely understandable. As many of the practices initially developed for regulated Boards subsequently become common practice for all public companies, it is important to have an active debate about what composition and effectiveness looks like.

For many Boards, regulation may have been regarded as intrusive.  It is critical that the regulator has people who understand the Boardroom and the importance of getting the right skills and behaviours around the Boardroom table.  Understanding how the right approach to “challenge” for example, can be effective and constructive is critical;  it is rare that a row at the Board – while superficially providing challenge – leads to a functional Board environment.  Equally, understanding  the difference between the Board and the Executive, and being clear not to blur the two, makes for a Board which can properly oversee a strategy which encompasses diversity and allows for disruption, while enabling the executive to deliver just that.

Conclusion

As Fidelio’s work preparing Boards for disruption and much research demonstrates, Boards need to reach for a new and unfamiliar diverse skill set. If Boards want to benefit from disruption, group think and risk aversion is a danger that the regulator needs to be alert to. If regulation fails in this, it could stifle innovation.

The ability to engage with regulators is a key stakeholder engagement skill that is relevant beyond Financial Services Boards. Fidelio regularly works with regulated and non-regulated Board to ensure Board effectiveness and composition.  We are seeing increasingly that through critical thinking and preparing a robust skills matrix, the Chair and the Board can ensure that the Board has the diverse skills it needs to face the disruption and challenges ahead.

At Fidelio, we are delighted to contribute to Board diversity and innovation through Search, Development, and Evaluation. For further information on how we can support your company, please contact Tim on tdiamond@fidelio.fuse-clients.co.uk. To subscribe to Fidelio Overtures, click here.

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