Address to the Chairpersons’ Forum Institute of Public Administration by Matthew Elderfield, Head of Financial Regulation

Good afternoon ladies and gentlemen. Thank you for inviting me here this afternoon. I am very pleased to be given the opportunity to launch our new Corporate Governance Code at this distinguished gathering. As chairpersons of semi-State bodies, your commitment to promoting good governance is well reflected in the important guidance materials you have developed for your members. Your manual “A Chairpersons Guide to Good Governance” is an impressive document and your more recent work setting out criteria for the composition of State boards is very timely.

It is probably regarded as somewhat of a cliché at this stage to talk about the importance of Corporate Governance within the corporate sector generally and more significantly, from my point of view, the financial services sector. But important it is. One has only to look at corporate failures in all sectors of industry in recent times to gauge the significance of sound Corporate Governance or, more to the point, the significance of the absence of sound Corporate Governance.

How to define Corporate Governance? There are many definitions – at its simplest it is the system by which companies are directed and controlled at the highest level of the organisation. Good Corporate Governance highlights the importance of the role played by the Chairman and by non-executive directors as well as having sound and effective audit and risk committees. This is particularly the case in the financial services sector.

The importance of good Corporate Governance is best highlighted by the calamities that have happened when it was not present within organisations. We have seen that in companies like Enron and Worldcom, but probably where it has most manifested itself – with catastrophic effect – was in the financial services sector and particularly banking. The financial crisis and the resulting turmoil in that sector brought about, in part, by woefully inadequate Corporate Governance triggered the provision of unprecedented government support to banks and other financial institutions. Nowhere is this more evident than here in Ireland.

Several reasons have been given for the failure in Corporate Governance. The then existing principles, while well meaning, were too general in nature and encouraged box ticking as a means of compliance. There was no statutory obligation on enterprises to comply with the recommendations which were generally issued by international organisations unable to enforce them. Boards were unwilling or unable to curtail excessive risk taking. And the same boards were unwilling or unable to exercise sufficient control over senior management.

I should also say that supervisory authorities failed in this area. They, or should I say, we, clearly didn’t press hard enough for good Corporate Governance in the institutions we regulated. This, coupled with the absence of effective sanctions or, where they existed, perhaps an unwillingness to enforce them, significantly contributed to the problem. The blame cannot of course be principally attributed to imprecise rules and weakness on the part of regulators – failures at board and senior management level were the significant factors in bringing about the near collapse of the financial system.

Situations which now, with the benefit of hindsight, seem totally unacceptable, were in some instances the order of the day – for example, the presence of CEO’s with unfettered powers who carried out their roles with clearly insufficient challenge. Apart from that it is clear, again with the benefit of hindsight, that many boards became too complacent, perhaps because in times of plenty no great effort was required. Whatever the reason, many members of boards, and I have in mind particularly non-executive directors, failed on many fronts. They failed to comprehend the risks associated with the business and the potential for disaster in not knowing or confronting these risks. In particular, it is now evident that many non-executive directors, and indeed possibly executive directors, did not understand the complex and technical nature of the businesses over which they had charge. Most disturbingly, all the evidence points to some boards that were seriously out of touch with what was happening on the ground in their organisations.

These unfortunate developments have prompted many international organisations and national regulators to put in place or revisit their Corporate Governance standards and requirements. They were very much encouraged to do so by the G-20 in its recent pronouncements on the need to strengthen Corporate Governance. In consequence, bodies such as the OECD, the Basel Committee on Banking Supervision and the International Association of Insurance Supervisors, have all recently taken initiatives in the area. In June of this year, the European Commission issued a green paper on Corporate Governance in financial institutions and remuneration policies for comment by 1 September. In the Green Paper, the Commission notes the unique position of the financial services sector where corporate governance requirements should take into account the interests of all stakeholders including depositors, savers and policy holders, as well as the stability of the financial system. Apart from the requirements that will eventually emerge from the Green Paper, many recently adopted directives and some currently under discussion will seek to specifically strengthen Corporate Governance in their respective areas, for example, the Capital Requirements Directive for banks and investment companies, the Solvency II Directive for insurance companies and UCITS and the Alternative Investment Funds Managers Directives for collective investment schemes.

In the UK, Sir David Walker completed a Treasury commissioned review of Corporate Governance in banks and other financial services entities. Also in the UK, in June 2010, the Financial Reporting Council, the body responsible for promoting high quality Corporate Governance and reporting in the UK, reviewed its existing Code and replaced it with a new one: the UK Corporate Governance Code. It is interesting to note that the two principal conclusions drawn by the Financial Reporting Council in its review were (i) that much more attention needed to be paid to following the spirit of the Code as well as its letter and (ii) that the impact of shareholders in monitoring the Code could and should be enhanced by better interaction between the boards of listed companies and their shareholders.

And where does all this leave Ireland and more specifically the Central Bank? We have taken a number of initiatives in this area, principally the issue of a new Corporate Governance Code for credit institutions and insurance undertakings, more of which shortly. The Code is part of a wider strategy to update the domestic regulatory framework. We also plan to develop Corporate Governance frameworks for other sectors of the financial services industry which we regulate. We have asked the funds industry to devise an appropriate code for its sector. We will also be devising a code for investment firms. The question of the appropriate governance framework for credit unions will be considered in the context of the forthcoming Strategic Review of the Credit Union Sector. We will carve out captive insurers from our proposals and develop bespoke standards with the assistance of the industry. Last month we issued our Code of Practice for Lending to Related Parties. We will also issue requirements on other related matters such as remuneration policies within the financial services sector and a revised fitness and probity framework. We will also develop requirements in respect of internal governance and risk management next year informed by international initiatives in these areas.

Here today I would like to talk in more detail about our Corporate Governance Code for credit institutions and insurance undertakings. As you are no doubt aware, this was the subject of a well publicised consultation process over the summer. The consultation paper was issued with a view to addressing the lack of a statutory Corporate Governance regime for both banks and insurers. The need to reform Corporate Governance within the local financial sector was highlighted in the findings of the two reports commissioned to understand the sources of Ireland’s banking crisis. These reports, by Klaus Regling and Max Watson on the one hand, and also by the Governor of the Central Bank, were published in June of this year. They both emphasised the need to reform Corporate Governance. Regling and Watson commented that “... Ireland was one of those cases where there were at least some instances of extremely serious breaches of corporate governance, going well beyond poor risk assessment, and eventually having a systemic impact”.

We received an unprecedented volume of responses to the consultation paper compared to any other consultation - over 130. We received responses from many sources including banks, insurance and reinsurance undertakings, the funds industry, stockbrokers, industry and trade associations, academics, consumer protection sources, state/semi-state bodies, the accountancy and legal professions, management consultants and individuals.

Almost invariably, all respondents welcomed the proposals in broad terms - some, however, felt that they were too draconian, others felt that we did not go far enough - I will let you decide yourself who thought that we were too harsh and who thought that we were too lax! We welcome all the responses – the topic clearly seized the imagination of many interested parties. A great deal of time and effort was put into the responses and many of the suggestions were very useful. We gave considerable thought to them all and took on board quite a number in drafting the final version of the Code. As you can imagine, this proved to be a mammoth task but I believe that the Code, in its final form, combines the best of what was contained in the consultation paper and the responses to the consultation. I know that it will not please everyone - as with the consultation paper some will think that it goes too far, others that it does not go far enough. I believe that it represents a balanced and proportionate strengthening of the Corporate Governance regime for banks and insurance companies in Ireland.

We know that the new Corporate Governance standards we are publishing in final form today are, in fact, more demanding than those in place in other jurisdictions. For example, our standards are on a statutory basis – rather than a “comply or explain” Code – and we have included restrictions on the number of Board directorships in financial institutions, an issue I will return to later. The decision to impose more demanding standards is a conscious one. We have acknowledged some of the concerns regarding the international competitive impact of our earlier proposals by adjusting the standards we are setting out for IFSC companies, or more specifically for Irish subsidiaries of companies regulated in other jurisdictions. However, in the area of corporate governance we have decided we do not want to simply match best practice internationally but wish to set a higher standard. Ireland has suffered more than most countries in the financial crisis and needs to get to grips with the home grown elements of that crisis. Poor governance has been exacerbated by the concentrated nature of corporate life in Ireland, with challenge and awkwardness in the Board room blunted by the social constraints of working and living in a small business community in a small country. Stronger remedies are needed here to shake up prevailing corporate governance practices by injecting some fresh blood and setting more exacting standards. This will improve the reputation of Ireland as an international financial centre by knocking on the head concerns about too cosy corporate governance practices.

One major theme that emerged from the responses to the consultation process was the request for clarity on the basis upon which we would adopt a proportionate approach towards imposing the proposed requirements on different types of entities. As a result, we altered the proposed requirements so as to adopt a dual approach, imposing minimum core requirements on all institutions covered by the Code and also imposing additional requirements upon those institutions which we deem to be major institutions.

In the latter respect, we have set out in our Code very high level criteria and we will make our own judgements with regard to what constitutes a major institution. We are doing it this way very deliberately because we consider black line definitions to be too inflexible for this important area. We will operate this Code in line with our risk based system of regulation and our one size does not fit all approach. We are likely to align major institution status with the structure of our risk model to cover higher impact firms. Some large IFSC firms could therefore be designated major institutions. But we will give firms an opportunity to make representations to us as to whether they are major or not – we are open to dialogue.

We will in the coming months be advising these institutions of their “major institution” status. Clearly, all banks with a significant retail presence in Ireland should fall within this category. I would of course add that there is no bar on non-major institutions deciding to implement the additional requirements should they wish to do so and indeed I would encourage other firms to consider doing just that.

Another area of concern was that relating to the proposal that each board should have a majority of independent non-executive directors. We will still retain this requirement for domestic major institutions. But for banks and insurers that are subsidiaries, we will now require that they have a significant presence of INEDs on their boards rather than a majority. For example, three independent non-executive directors out of a typical seven member board for major institutions and two directors out of a typical five member board for non-major institutions. This is a recognition of the need of the parent company to be able to direct and control its Irish subsidiary - the presence of the independent non-executive directors is to provide an independent voice that will challenge and question both the parent and the group executives within that subsidiary.

On the question of numbers of directorships, this was one of the most contentious areas of the Code and an area which resulted in us receiving hugely diverging views. Originally we proposed that directors of all credit institutions and insurance companies should be limited in the number of directorships which they could hold to 3 directorships in a bank or insurer and no more than 5 directorships in companies outside of those financial institutions. We received 99 submissions in total in relation to both of these proposals. While many agreed with our proposals, a very small number thought we should restrict the limits further to just one directorship. The majority, however, were concerned that our approach was too restrictive, that it would put stress on the limited pool of talent and overall quality of directors in companies. They favoured the abolition of any set limits preferring instead that we should adopt a case by case approach.

We disagree with these concerns. While we have given some leeway to non major institutions, by increasing the limits to 5 financial directorships and 8 non financial directorships, we have retained the limits proposed in relation to directors of major institutions. This is in recognition of the significance of these institutions and the importance of these directors. These requirements will help to ensure that independent non-executive directors devote sufficient time to their oversight responsibilities (and are in fact broadly consistent with the Walker Report recommendations on the time to be devoted to board work). We think this will allow more focus and attention on the board role and crucially, improve challenge in the board room.

Frankly, we also hope that this change will improve challenge in financial board rooms by broadening the gene pool in Irish corporate life. The TASC Report - “Mapping the Golden Circle” - published in May, set out very clearly the current limited breadth of board membership at the heart of corporate Ireland. Many submissions said that a limit on board directorships should be dropped because there were not enough existing directors to go around with our proposed limit. We believe that it is possible to bring more directors into the financial services sector in Ireland by looking beyond the existing pool of directors.

We need to bring more outsiders into the board room. We share the globally accepted view that more diversity, for example of national and international background and of gender, will help to avoid the pitfall of “groupthink” which contributed to the crisis. This is not to be ungenerous to my adopted country or to doubt the ability of Irish men and women. However Ireland is a small country and it would be healthier to bring some fresh voices and perspectives into the boardroom both from outside Ireland and from new people within Ireland who do not have the close social ties that could be blunting challenge. These will bring a different perspective and understanding of standards and practices elsewhere.

The EU Internal Market Commissioner Michel Barnier put it succinctly when he said recently “I also think more effort needs to be made for a more diverse boardroom. It is always difficult to take good decisions. But debate and different views help us to get there. And diversity in all forms creates the right conditions for a real exchange of views.”

We are mindful of the concern that limiting directorships could have a detrimental effect on the ability of directors to contribute to charitable and social development. We have therefore also excluded from these calculations directorships held in the public interest on a voluntary and pro bono basis provided always that they also do not interfere with a director’s ability to properly fulfil his or her role and functions as a director of a financial institution.

In addition to ensuring that the best directors are appointed, we believe that there should be a bigger investment in training, both in general board skills and in technical risk skills. I call on the Institute of Directors and insurance and banking institutes to rise to that challenge.

We plan to host a roundtable with the Institute of Directors (IOD), the institutes and corporate governance experts and other stakeholders, chaired by our new Commission Board member Blanaid Clarke, to see what action they can take to improve corporate governance standards, prepare more people to be more challenging in the board room and assist the industry to implement our new standards.

I recognise that our changes raise questions about remuneration. An independent non executive director (INED) role should be more demanding and take more time. So they should be paid accordingly.

In recognition of the importance we attach to the position of Chairman and CEO we are maintaining our proposed restrictions and requirements on them, in particular;

• The prohibition upon either holding such a position for more than one institution at any one time;
• The absolute requirement for the chairman to lead the board, encourage critical discussions and challenge mindsets;
• The absolute requirement for both the Chairman and the CEO to have the necessary personal qualities, professionalism and integrity to carry out his or her obligations;
• The prohibition on an individual who has been CEO, executive director or member of senior management of an institution during the previous 5 years progressing to Chairman of that institution.

These all serve to underpin the general requirement that no one individual may have unfettered powers of decision. The terrible damage done by over-dominant CEOs or directors is all too evident in some of our leading banks and insurance companies.

We have to learn the lessons of this experience and put better controls in place. Colourful and dynamic entrepreneurs are a welcome source of innovation and economic success, but when depositor and policyholder money is at risk, it is essential that strong corporate governance checks and balances exist to ensure that a dominant personality doesn’t ride roughshod over the board in pursuit of unacceptable risk-taking.

Let me pause to take a moment to reflect in particular on the IFSC firms’ concerns with aspects of CP41 regarding the impact of the ability of a parent to exert control over a subsidiary.

We believe it is important that IFSC firms too have high standards of corporate governance – both IFSC banks and insurance companies have had their problems in the not too distant past.

We are aware that Irish subsidiaries of overseas companies can be subject to their parents seeking them to take on too much risk and they need to be willing to push back. Or sometimes subsidiaries can become too remote and drift into weak practices due to a lack of local scrutiny.

However, we accept the strength of the concerns expressed. The key is to strike a balance here. We note in particular the concern over the chairman of the subsidiary having to be an INED, as a group executive often is appointed to this role, and over the number of INEDs – so we have amended these proposals to allow the chairman of a subsidiary to be a group director and have modified the standard which industry felt required a 50 – 50 balance between INEDs and other board members.

We feel this is a reasonable adjustment to our proposals to take account of the reasonable concerns of IFSC firms on these points.

Notwithstanding some concern expressed by respondents on the requirement to submit compliance statements in respect of adherence to the Code, we are persisting with this requirement. We will, however, issue relevant guidelines specifying what will be needed, which will allow industry input on this issue and we will seek to develop a balanced approach. This opens up another issue – the possible role for external auditors in providing some form of assurance in respect of compliance statements prepared by institutions. We are not looking for any such assurances in the Code but we have initiated discussions with the auditing profession on the matter. While we recognise the difficulties for auditors in providing any such assurances, it is a topic to which we intend to return, possibly in the context of discussions at EU level and in other fora on the role of external auditors, particularly in the financial services sector.

As I have explained, these new standards apply to all credit institutions and insurance companies (other than captives). However, I am often asked whether more needs to be done regarding the Boards of the domestic Irish banks, given the significant losses that have been imposed on taxpayers by these institutions. In fact major changes have already taken place in the composition of the boards of some of the covered institutions including the appointment of public interest directors. More changes are underway with the imminent government majority ownership in AIB. The new standards announced today should act as a catalyst for further changes in board composition at the banks. We will also use our new fitness and probity standards to set a higher bar for incoming directors for the banks. In addition, we have commissioned reviews of governance and risk management standards at the two largest banks and will use the results of these to consider what further changes are required in board structure and composition. I think it would be unfair to say that all board members at all the covered banks in the pre-crisis period should depart the scene, as there are no doubt different stories about what happened in the board rooms of different institutions. And even if we wanted to make such a generalisation, we clearly wouldn’t have the powers to act on it. But I think it is right that where it has yet to happen there is an orderly process of freshening up the boards at the banks and this is something we will be pursuing on a firm by firm basis.

I have set out the main changes which we would propose to make in our Corporate Governance Code. I hope you will agree when you have had time to digest the new package that it represents a reasonable and balanced initiative to foster best Corporate Governance practices in the banking and insurance sectors in Ireland. The Code will be published on our website today. It becomes effective on 1 January and institutions will be given until 30 June next to introduce the necessary changes. Where changes to board membership are necessary this period will be extended to 31 December 2011 in order to allow institutions to identify and assess candidates prior to making appointments.

We all know that rules alone are not sufficient to ensure an effective Corporate Governance Code. While it may be easy in one sense to observe quantitative requirements and to monitor adherence to them, it is much more difficult to monitor qualitative requirements. By that I mean such things as the quality and calibre of directors’ involvement and contributions. In this respect I was very taken by one of the findings of the UK Financial Reporting Council in its review to which I have already referred, namely that much more attention needs to be paid to following the spirit of the Code as well as its letter. The report noted that to follow the spirit of the Code to good effect, the board must think deeply, thoughtfully and on a continuous basis, about their overall tasks and the implications of these for the roles of their individual members. Absolutely key in this endeavour is the freshness and openness of mind with which issues are discussed and tackled by all directors. I fully endorse these sentiments and I am hopeful that they will be fully taken on board by all to whom our Code is addressed. And I can assure this audience that a key part of our supervisory process will involve making judgements about how well this is happening in practice and taking appropriate steps where we believe it is inadequate.

My basic message today is that the buck stops with the Board of Directors. We need to learn the lessons of the financial crisis by improving corporate governance practices in the financial services sector in Ireland. These new rules from the Central Bank deliver stronger standards for banks and insurance companies operating in Ireland. It’s time to bring fresh blood into the board room, which brings more challenge, asks more awkward questions and devotes more time to assessing risk. Depositors, policyholders and, indeed, Irish taxpayers have the right to expect no less from the guardians of their money.

Thank you for your attention.