Enabling More Effective Governance of Canadian Financial Institutions - Remarks by Superintendent Jeremy Rudin to the Global Risk Institute, Toronto, Ontario, June 14, 2016

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While OSFI recognizes the progress that boards have made since the crisis, many boards need to make further improvements in their performance. But before we challenge boards to raise their game in this area, OSFI needs to ensure that we have created the conditions for their success.

Introduction

I would like to thank the Global Risk Institute (GRI) for inviting me to speak to you this afternoon. GRI provides valuable support to boards of financial institutions in helping them to address risk issues. So it is a very fitting venue for my topic today.

The financial crisis that erupted in 2008 exposed weaknesses in the risk management and oversight practices of some of the world’s financial institutions, pointing to failures in corporate governance in the global financial sector. Post-crisis, regulators around the world, OSFI included, responded by introducing new regulatory requirements and enhanced supervision of corporate governance, raising the bar for boards of directors. Boards of Canadian financial institutions have responded, becoming more engaged on risk issues and exerting more oversight over senior management.

While OSFI recognizes the progress that boards have made since the crisis, many boards need to make further improvements in their performance. But before we challenge boards to raise their game in this area, OSFI needs to ensure that we have created the conditions for their success.

To enable more effective governance of Canadian financial institutions, OSFI will streamline our expectations of boards, and make them better adapted to the size, complexity and risk profile of the institutions. This will create better opportunities for boards to concentrate on the prudential responsibilities that truly matter. And it will create opportunities for OSFI to set, and achieve, high standards for effective risk governance by boards.

To expand on how OSFI intends to create those conditions for success, today I want to provide you with some background on OSFI and our role in setting out corporate governance principles. Then I will touch on the current state of boards based on our observations and conversations with the industry, and I will wrap up by providing you with some information on the approach OSFI will be taking to ensure that our expectations around board-related requirements are indeed more clear, streamlined and effective.

OSFI and Corporate Governance

OSFI is mandated by Parliament to protect the rights and interests of depositors, policyholders and creditors of financial institutions, having due regard to the need to allow financial institutions to compete effectively and take reasonable risks.

We believe that the best way to pursue this mandate is to use principles-based regulation whenever practicable. This is particularly important in the corporate governance area. Our goal is to set high-level principles and then provide boards with the flexibility to apply those principles in a way that is well suited to their particular financial institution.

Canadian financial institutions vary considerably in their size, complexity, risk profile and business models, and so we have to be open to the possibility that the approaches adopted by effective boards will vary as well.

While a principles-based approach to corporate governance may appear to be aimed at making life easier for boards, it is anything but that. To comply with principles-based regulation boards must put considerable thought into how best to apply the relevant principles, designing a tailored approach that is sewn together by the institutions themselves.

If OSFI were to take a rules-based approach to corporate governance, we would risk offering a safe harbour to boards, allowing them to comply with our regulation through activities designed mainly to qualify for check marks on a generic to-do list.

Effective governance cannot be achieved by ticking boxes.

Just as principles-based regulation of corporate governance is more challenging for boards, it is more challenging for OSFI as regulator and supervisor. But it is also a more effective way to pursue our mandate.

OSFI’s Corporate Governance Guideline

In 2013, OSFI issued an updated Corporate Governance Guideline, revised based on the lessons learned from the global financial crisis. The guideline contains a concise set of principles-based expectations for boards based on what OSFI believes are the essential elements of a board’s prudential responsibilities.

The guideline focuses on the critical role of boards and provides OSFI’s expectations around what an effective board should look like in terms of its skills and competencies, as well as what OSFI expects an effective board to do with those skills and competencies.

It sets out markers about the responsibilities of boards, distinguishing what items boards must “approve” (those are the issues where we expect the board to take full responsibility) and what items the board should “review and discuss” (those are the issues where we expect the board to play an advisory role to senior management).

More specifically, the guideline specifies that the board should approve the institution’s overall strategy, and oversee the institution’s senior management and internal controls. This includes approving the institution’s risk appetite, major acquisitions and divestments, the internal control framework, and the appointment and compensation of the CEO and (often) other senior officers. Senior management, on the other hand, is accountable for implementing these decisions, and is responsible for directing and overseeing the institution’s operations.

We have chosen not to attempt to draw a bright line that separates where the board’s responsibilities end and where senior management’s responsibilities begin. In our view, deciding where to put the dividing line, and moving it when necessary, is one of the most important responsibilities of the board. Moreover, that decision can appropriately vary depending on the nature of the institution, and its specific circumstances.

Board Effectiveness

With that as overview, let us look at the current state of board effectiveness in Canada and start by recognizing some of the very real progress that has been made in recent years.

As I noted earlier, we have seen Canadian boards evolve since the financial crisis and they continue to do so. Of course, the performances of boards differ, sometimes driven by their own renewal, sometimes driven by a rebalancing of the roles and responsibilities between the board and senior management, and sometimes driven by OSFI’s intervention.

We see that many boards are seeking out and obtaining broader skillsets and expertise, and are ensuring that they have enough members with relevant financial industry and risk management expertise. This type of expertise is a key component of an effective board at a financial institution.

From our reviews of material provided to boards, and through discussions with directors and members of senior management, we can also see that many boards have become more engaged on strategy in general and in the development of the Risk Appetite Framework that OSFI now expects.

The Risk Appetite Framework should set boundaries on how the financial institution will operate and the risks it will take, as well as how it will monitor and report on those risks. It is an important tool in an institution’s risk management tool kit and we are encouraged to see the importance it is assigned by many boards of directors.

At the same time, we continue to identify opportunities for enhancement in risk appetite, board self-governance, and oversight of senior management.

While boards may have approved their institution’s Risk Appetite Framework, the ultimate test will be to embed the Risk Appetite Framework in the institution’s decision-making and risk governance processes. When we hear that growth in a business line did not occur or was curtailed because it went beyond the approved risk appetite, that will show that the Framework is starting to be effective. To be fully effective, the Framework has to be reflected in the attitudes and behaviours towards risk that constitute risk culture of an institution. 

Many boards have improved their own self-governance. Yet there is more to be done. We have raised awareness of the importance of financial industry and risk management expertise on boards, and most boards have responded. Better still would be for boards to be more assiduous about assessing how their own requirements for different skills and experience have changed. Boards need to regularly take stock of industry developments and identify if the required expertise and knowledge is available on the board.

One of the board’s most important responsibilities is in the effective oversight and challenging of senior management. A simple indicator that more could be done here can be found in the volume of material that many boards receive prior to their meetings. We know that many directors feel that receiving several hundreds of pages of material ahead of every board meeting does not suit their needs. Yet the practice continues at many institutions.

A board that does not have the requisite expertise, or is unwilling, to task senior management to provide it with suitably focused material is undermining its own effectiveness. There is clearly a risk that a board that allows itself to be immersed in overly detailed or sometimes inconsequential information will lose sight of important prudential risks.

Moreover, if the board cannot successfully assert itself with senior management on an issue as apparent and recurring as the volume of material that senior management provides the board, we have to wonder where else the board may be failing to gain traction with senior management.

The Path Forward

Having set out some goals for boards to become even more engaged on prudential issues, we need to stop to ask ourselves if we will be able to reach those goals. Are the conditions for success in place? I can think of at least two conditions that may not currently be satisfied. 

The first condition that we need to check is the capacity of boards to meet these increased expectations. Certainly, the boards of Canadian financial institutions have become more engaged over time. The skills and experience of board members are now better suited to providing oversight of financial institutions. And board members are devoting more time to their responsibilities.

Similarly, OSFI has deliberately (and I believe, appropriately) chosen to direct an increased share of the board’s overall capacity to prudential matters. Yet the share of board capacity that we commandeer cannot grow continuously without eventually colliding with other essential responsibilities of the board.

In other words, we can think of OSFI as having a certain amount of “bandwidth” with the board. Our “bandwidth” has been rising over time, and perhaps it can increase further, but it cannot grow without limit. Before further raising our expectations for boards, we need to be confident that we do not risk exceeding our “bandwidth”.

The second condition that we need to check is the clarity and consistency of the requirements that we impose on boards. In 2015 we conducted a consultation with representative board members, using a public opinion firm to ensure confidentiality to the participants. You will find a link to the results on our web site. I am glad to report that there were many positive comments.

That said, not all of the participants shared the portrayal of our approach as principles-based and adapted to the particular circumstances of each institution that I gave you earlier. Some of them said that they found our corporate governance expectations to be very prescriptive, that they took a “check the box approach”, and required the board to spend too much time on “minutiae.” Others pointed out that the governance requirements in the Corporate Governance Guideline did not always mesh with other OSFI guidance and recommendations.

In response to this feedback, we have taken stock of everything in our sixty-plus guidelines that set out expectations for boards of directors in some form. We also assessed a large sample of institution-specific recommendations we have made that touch on the responsibilities of the boards of those institutions.

What we have found is a long and in many ways less-than-consistent list of tasks for boards to navigate. Left unchecked, this can have the unintended consequence of creating confusion and impeding board effectiveness. If we overburden boards with inessential responsibilities we will make it difficult for them to identify and accomplish what is essential.

To make sure that the conditions for success are indeed in place, OSFI is  currently in the midst of a review of our approach to corporate governance that will prune away some of the growth in the requirements that we have placed on boards of directors of banks and insurers over the years. We will be streamlining, we will be simplifying, and ultimately, we will be presenting boards with a more focused and effective approach to governance. 

One-Stop Shop

Our revised approach to corporate governance begins, not surprisingly, with our existing Corporate Governance Guideline. Our view is that the current guideline needs only minor changes as it continues to cover what we see as the most important parts of a board’s prudential responsibilities.

However, when it comes to all the other pieces of OSFI guidance, and the specific instructions that we have given to particular institutions, there are some steps we are going to have to take.

Our first step to re-establish the conditions for success will be to gather all our expectations for boards into OSFI’s Corporate Governance Guideline; removing all references to regulatory requirements for boards of directors that appear in other OSFI guidance. This will create what we call a one-stop shop approach.

The one-stop shop approach will minimize confusion and maximize consistency of messaging, making it easier for both boards and senior management to better understand the requirements, and the reasons behind them. 

We will ensure that our approach is tailored to the size, nature and complexity of the various financial institutions as we recognize that there are clear differences between OSFI’s expectations of large, complex institutions and smaller institutions.

For small and medium-sized institutions, the emphasis will be placed exclusively on the principles in the Corporate Governance Guideline itself. The needs of these institutions vary greatly, so they should have flexibility to set up and conduct their governance structures and practices in a manner that is suitable to the size and nature of their operations.

For large, more complex institutions, the same principles will also apply. However, we will add an annex to the Corporate Governance Guideline that will set out some more detailed expectations that should apply to every large and complex institution.

At this stage, we are reviewing the list of items that should be included in this annex. This will involve dropping specific requirements that may have previously existed in other guidance, modifying other requirements and ensuring the resulting list is focused and geared to the “right” prudential issues.

The next step in bringing this about will be for OSFI to consult with industry, outline how we propose to amend the current Corporate Governance Guideline, and set out how we plan to reshape the ensemble of these requirements as well as the necessary amendments to our other guidelines.

We plan to begin consultations in fall 2016, and as the revisions will affect a number of guidelines, we will provide a longer-than-usual time period for stakeholders to prepare their comments and suggestions.

Going forward, we will revise the Corporate Governance Guideline when necessary, and keep it updated on our website. This will remind us to think hard before adding new board-related requirements to any of our guidelines, whether these potential new requirements have their origin in our own work or in some international standard-setting initiative.

We will encourage boards of financial institutions to take advantage of the new flexibility that we envisage in the next iteration of the Corporate Governance Guideline. We recognize that principles-based regulation relies on dialogue between OSFI and the institutions we regulate, and we look forward to ongoing conversations in this area.

Conclusion

At OSFI, it is not in our nature to be satisfied with things as they are, and the dynamic and constant change within the financial services industry requires that we be focused on what matters. So while we recognize the progress that boards of Canadian financial institutions have made in risk governance, we believe that they can and should be more effective.

To enable more effective governance we will streamline our expectations of boards, and make them better adapted to the size, complexity and risk profile of the institutions. This will create better opportunities for boards to concentrate on their prudential responsibilities.

Only when we have presented boards with these opportunities can we hold them accountable if they fail to become fully engaged on the important issues. And we will hold them accountable; you can be sure of that.