Turner review: What does it mean?

While the headlines of the Turner review are about increases in bank capital, a tough new liquidity regime, leverage and funding limits and macro-prudential levers, all financial services firms will need to focus on the practical risk management and governance implications of the 300 page report published by FSA. In practice this will mean strengthening where necessary, firms’ Boards, risk and compliance arrangements and their supervisory relationship with the FSA.

Lord Turner’s economic analysis, proposed prudential levers and solutions drawn from that economic analysis are a welcome change from the organisational or legislative changes which previous failures have typically spawned, often with questionable benefits. But it is also clear as the Review indicates that there were deficiencies in governance and risk management in the financial sector – financial institutions were not merely the victim of global economic imbalances, however powerful they were. Firms still need to do more work on their governance and risk management arrangements and this Review gives some strong indicators of where FSA considers they should focus.

The Turner Review trailed some of the expected key components of the Walker Review due to report in Autumn 2009 and was effectively a call to arms for risk management professionals. FSA says the review will focus on:

• Improved professionalism and independence of risk management functions

• Embedding of risk management considerations in remuneration policy

“Firms still need to do more work on their governance and risk management arrangements.

• Improvements in the skill level and time commitment of non-executive directors

• Shareholder discipline over corporate strategies

The FSA has indicated that it intends to assess the skills and technical competence of risk managers as part of its more intrusive and intensive supervisory approach, as well as the nature of the relationship of the risk management function with Board risk committees. FSA postulates that risk management functions may only have sufficient stature to provide a genuine challenge to business managers if there is an executive director solely responsible for risk on the main board.

Remuneration, a particularly contentious topic at the present, was also commented on in the Review and firms will be required to align their remuneration policies with effective risk management. The FSA has proposed that this ‘principle’ will now be a rule to give the code (revised and updated on March 18) greater weight and enforceability. The FSA also said that its review of existing remuneration practices had shown, for example, that risk functions often had little or no input to remuneration decisions. The Code will require ‘significant input’ of Risk and Compliance and this is an issue which will have to be addressed. FSA says major firms should expect a significant increase in attention on remuneration policies. Compliance with the Code will be challenged as part of its Arrow reviews of firms.

Equally, firms are going to need to cast a critical eye over their governance arrangements. Central to this is going to be the role played by Non-executive directors (NEDs). The role of NEDs has been referred to frequently as the financial crisis has unfolded – FSA says that evidence from the financial crisis indicates that NEDs have in many cases struggled to provide the strong independent oversight of executive management needed. They will be expected to be able to understand and challenge the businesses and risk assessments being made by management, and have the expertise, experience and time to do so. Also, FSA is currently proposing to extend the responsibilities of NEDs.

“The FSA has indicated that it intends to assess the skills and technical competence of risk managers as part of its more intrusive and intensive supervisory approach.

Clearly this will be a big ask of NEDs. In future, identifying individuals who are able, and importantly, willing to take on non-exec positions may be increasingly hard and existing non-execs will be looking closely at the scale and nature of their commitments to firms.

It is clear that the FSA’s revised supervisory approach will result in an increasingly intensive relationship between firms and their supervisors – and FSA recognises that there will need to be a braver approach to decision making by its supervisors. This will be particularly impactful for those firms that are currently subject to close and continuous supervision. FSA has indicated that it intends to apply greater focus on the outcomes of firms’ actions rather than just the systems and processes.

It has been recognised that FSA supervision needs to be enhanced not only in number (the number of staff is expected to rise by 200), but also qualitatively and FSA intends to roll out a training and competence scheme of its own for its relationship management supervisors as well as implementing a tenure policy to help ensure a greater degree of consistency of supervisor, an area where firms have criticised FSA in the past.

It remains to be seen to what extent firms, management and supervisors have the capacity and appetite for change to embrace the practical implications of the new order envisaged by Turner, as they make preparations for what may now gradually emerge as a significantly different role, environment and culture for financial services in the future.

See also: FSA plans greater liquidity risk oversight