Thank you for that introduction Geoff. I’m delighted to be down here in Queenstown.
I’d also like to introduce my colleague Simone Robbers. Simone is our Director of Primary Markets and Investor Resources and has led our recent work with the IoD and directors more generally on corporate governance. We’d both be very happy to take questions or to just chat afterwards.
A few weeks back I read a profile of Ross McEwan, the New Zealander who is CEO of the Royal Bank of Scotland in the UK.
Leading up to 2008, RBS was one of the biggest banks in the world, with interests in Europe, the US, Asia, and Australia … it’s global balance sheet was about the same size as annual British GDP.
So it was, literally as big as the entire UK. Quite an interesting dynamic given the current enthusiasm in Scotland for separating from the rest of the UK, but that’s for another day.
Ross McEwan has one of the toughest jobs in banking, cleaning up a bank that came within hours of going broke during the GFC.
And which was bailed out by the British Government to stop it collapsing and taking down a big part of the UK economy with it.
McEwan’s task is to reduce RBS’s balance sheet – including managing some assets of questionable value – cut staff, and wind-back RBS to a UK-only retail bank.
The press profile of Ross McEwan and the challenges at RBS got me thinking about one of the things I want to talk about tonight, which is quality governance.
RBS overlooked many of the principles of good governance, especially during the boom years in the mid-2000s.
Indeed, it’s a casebook study of what not to do in the boardroom.
So, tonight I’ll talk about quality governance first. And I’ll use RBS to illustrate some of that … because there is so much information on what happened at RBS that we can rely on it as an example.
I know RBS was and still is a very big company – and based in the UK – but what happened there is surprisingly applicable in all boardrooms. Whether you are in London or on Beech Street, and whether you are a big firm or a small one.
And secondly I will talk about some of the new capital-raising opportunities in the new Financial Markets Conduct Act, which is taking effect right now.
I know that capital-raising is high on the agenda of many New Zealand firms, given the economy is improving steadily and firms can see new business prospects again.
The Act has been designed to make capital-raising easier, especially for smaller high-growth firms, and also for firms that already have listed debt or equity.
The FMA’s statutory mandate – as a regulator – is in financial services and capital markets.
We don’t have a general mandate across all New Zealand business. We don’t regulate every boardroom in the country. We do of course regulate offers of securities to the public and it is in that context that we do come into contact with many boards outside of the financial services sphere.
Nonetheless, as we have been refining our strategy as a regulator, we’ve recognised we have an interest in the quality of governance in many New Zealand firms.
That’s because good governance is one of the conditions leading to good investor outcomes.
And good investor outcomes are among the objectives that we have, as a capital markets regulator.
We also have a mandate to deepen New Zealand’s capital pool, in order to grow New Zealand business.
So, again, we have an interest in quality governance where it affects capital-raising.
In line with those interests, a few months ago, led by Simone, we revised and modernised our corporate governance principles and guidelines that were first published in 2004.
The principles amount to a solid working guide as to how a well-run board would organise itself, and how it would organise the key levers of governance, such as auditor practice.
We consulted publicly on the principles before we republished them, and also talked with directors of some of our bigger listed companies along with some of our largest institutional investors.
After all, a lot happened in the decade since the principles were first published.
Some big court cases over directors’ duties here in New Zealand, and also in countries with similar approaches to corporate governance systems … like Australia and the UK.
Melt-downs and government bail-outs at banks all over the world.
And household names – including General Motors, Chrysler, and AIG – on the brink of collapse, often as a result of shortcomings in governance.
Plus a big shift in shareholders’ expectations, as Generation X steadily replaces the baby boomers as the world’s main investors.
However, when we republished the governance principles - just before Christmas last year – it was notable how little has changed when it comes to the basics of sound governance .
In 2004 there were nine principles. And there’s nine principles now – covering largely the same things - in 2014.
Broadly, those nine areas are:
- maintaining ethical standards
- board composition and performance
- the role of committees
- reporting and disclosure
- risk management
- the role of the auditor
- shareholder relations
- and responding to stakeholders’ interests
We considered developments in case law, legislative changes, plus some changes in business practices such as an increased focus globally on all aspects of risk management.
But not much more.
What that tells me is that the principles that underpin a successful board are largely the same now as it was ten years ago.
In other words, the broadly-recognised formula for governance has been adjusted post-GFC … but not transformed.
Times change, good practices remain
Reading Ross McEwan’s profile and recalling what happened at RBS and elsewhere in the big banks, I was reminded of how good governance practices transcend crises like the GFC.
Times change. But the formula for a well-run board stays largely the same.
Over a period of six to seven years, RBS’s board overlooked or subverted several of the principles we advocate, with palpable results.
Some notable examples.
- Our principles say that – generally - the CEO shouldn’t move directly to becoming chairman of the Board.
We think the Chairman must be sufficiently independent to mediate between the board and the management … and a former CEO is unlikely to enjoy that independence.
But Sir George Mathewson did exactly that, shifting directly from CEO to chairman of RBS. Direct from the C-suite to the top seat in one jump.
As a result, Mathewson has indicated that he eased-off pressure on the new CEO, Fred Goodwin to give him room to manage … which, in turn, allowed Goodwin to dictate acquisitions to the board, stretching the balance sheet to breaking point and to drive a culture at the bank where whatever he said, went.
- Our principles advocate independent directors (though of course this will depend on the size and circumstances of the company) and explain the factors that might undermine that independence
Independence of mind . Which often means asking the lateral questions or questioning the underlying motivation of a proposal.
And independent practically, in not being former employees, and without family ties or business ties to a firm.
RBS had independent directors. Indeed, the independent directors were dedicated and highly-capable businesspeople.
But they found themselves in a minority on a board that was overwhelmed by a domineering chief executive. While the directors remained independent in name, they weren’t able to assert themselves as such.
That meant the board accepted acquisitions about which it should have asked more questions.
Including the one which was the proximate cause of RBS’s near-collapse, when it bought the Dutch bank ABN Amro at the very top of the market in a very competitive situation where they were not able to do adequate due diligence on ABN’s loan book.
And the board accommodated a series of vanity projects, which it should have stopped a … mammoth corporate HQ near Edinburgh … a Six Nations’ rugby sponsorship … a Formula One car-racing franchise … and a corporate jet that ferried RBS executives around Europe.
The lesson from RBS is that a board should have independent directors, and – more importantly - it should also allow them to be independent.
It can be especially tough as an independent on a smaller board or a board where the firm is run by a family.
But creating a dynamic where there’s an inner board of informed insiders, and an outer board that struggles to be heard, condemns the independents to irrelevancy … and mutes the views that may need to be heard most.
Carefully-considered diversity policies can add to the independent perspectives around the board table.
The RBS boards were made up mostly of members of the English and Scottish establishments.
And the vast majority of the RBS boards were men. It certainly wasn’t a board that resembled 21st Century Britain.
However, a diversity policy at RBS might not have helped much in the event.
Because even directors who were senior and respected members of the establishment found themselves in a minority when they insisted on asking awkward questions.
Generally, I remain surprised at how many boards avoid receiving bad news about the performance of their own firms.
There’s an instance that illustrates this, and which is one of the most revealing anecdotes about boardroom defensiveness I have heard.
Sir Anthony Salz … an eminent UK lawyer … conducted a review of culture and governance within Barclays – the big UK bank – after the Libor-rigging scandal of 2012. You may recall that the UK regulators insisted on the removal of Bob Diamond the CEO.
Salz reported that he had found an employee survey which had produced a negative score for the willingness of senior management and the CE to hear about poor performance and ethical dilemmas.
In other words, people were frightened to raise these things at the top.
When Barclays HR people presented a summary of the survey to the board, guess which bit they removed … for fear of upsetting the CE.
We can conclude that the bearers of bad tidings never came back at Barclays … and, I imagine, at RBS too.
- We’re advocates of the auditor attending shareholder meetings and answering questions from the shareholders.
The main role of the auditor is to provide reassurance to the board.
But we think the auditor can play a role in ensuring shareholders are informed as to what the auditor is finding.
Shareholders ought to benefit from quality information - like that which auditors have - on the company’s performance.
A couple of other things we recommend, and which I think would have been unpopular in the RBS boardroom, at least with some members, are:
- A published code of ethics that applies to the board and management, and public reporting on serious breaches of the code and what happened as a result. Because a code is at its most useful, for the firm and for shareholders, if you are accountable for action under it.
Of course, codes like this are mandatory for NZX-listed firms.
- And we urge boards to have their performance regularly assessed by someone who is independent. Including boards of smaller firms.
As someone who has sat on boards, I acknowledge it’s one of the toughest things to do.
To receive criticism of your own performance and do so with an open mind.
But - when it is conducted professionally and in an orderly way, with an eye to productive outcomes – a performance review can assist a board.
The biggest immediate improvements from reviews are in a board’s internal dynamics. How board members get along with each other, and with management.
Less often, the improvements are in the quality of governance.
Either way, regular reviews are a form of discipline, ensuring a board has a way-station, where it stops to consider its own effectiveness.
Final observation on governance
A final observation on boards and governance, in the light of RBS.
Among the reports that were written on RBS was one by the FSA, the British financial services regulator at that time.
The FSA’s report says there were no failures of governance procedures at RBS.
On paper, the systems at RBS looked fine.
That seems remarkable given RBS came within days of total collapse. Empirically, we know something serious had gone wrong in the boardroom.
The FSA went on to say that, while the procedures were sound, there were repeated failures of board effectiveness.
That’s another way of saying you can have the best systems and practices available, but they need to be operated effectively and directors have to be willing to observe them diligently.
Indeed, the biggest failures in boardrooms are human ones. Not systems failures.
It’s a reminder that governance isn’t a machine. More a means of continuously organising a group of people so they do the right thing for the right people at the right time.
New era in capital-raising
I wanted to turn now to capital-raising, which has been made easier under the Financial Markets Conduct Act, which took full effect in December last year, and which is being phased in over two years.
The FMA administers the Act. Indeed, it’s the main statue we administer.
The origins of the Act lie partly in the Capital Markets Development Taskforce, which reported back in 2009.
The taskforce made recommendations on how we can deepen the pool of capital available to New Zealand firms, and make it more accessible.
In capital-raising, one of the biggest features of the Act are same-class offers, which allow firms that have publicly-listed debt or equity to make further, similar offers using simplified disclosure. More on that in a minute…
And crowd-funded equity, a type of capital-raising which allows capital-raising – for firms or projects – through licensed online platforms.
Crowd-funding is one of the new fin-tech categories … the newly-emerging financial services products that are built for the Internet.
The disclosure requirements for crowd-funded offers are much lower than, say, those for a listed firm … and subscribers to the offers don’t own tradable equity in the way shareholders on a public exchange do.
Indeed, many of the offers coming through … on crowd-funding platforms … would be high-risk if you applied a conventional investment assessment.
Typically, crowd-funding offers are smaller firms, often with one or two breakthrough products or projects.
Renaissance, a craft brewery based in Blenheim, was among the first. Aeronavics, which designs sophisticated aerial drones, has been another over-subscribed crowd-offer.
The Act also paves the way for the new NXT market, which NZX is expecting to launch soon with its first listing.
NXT is what’s known as a stepping-stone market for firms that want access to public capital-raising without the costs and demands of listing on the main board.
Over the long-run it’s likely to be a source of funding for high-growth, emerging firms, which might otherwise depend on private equity or a small group of private owners.
As I mentioned, the Act also makes same-class offers much easier for firms that already have listed debt or equity.
Put simply, making a further offer of debt or equity which is largely the same as that already on offer, is now much easier.
A same-class offer can now be made in the space of a few weeks, even days, and at much lower cost to the issuer.
Same-class offers effectively put boards – who are confident in their continuous disclosure processes – in the driving seat, allowing capital-raising without a lengthy and expensive due diligence process and without a detailed prospectus.
Precinct Properties has conducted a big same-class offer, a $174 million dollar ($174 m) rights issue. And Fonterra launched one for $250 million dollars in debt in mid-April which has been increased to $350 million.
There’s a big picture objective behind all this, which is that the Government wants to near-double the quantity of capital that is available for New Zealand exporting firms
That’s going to be a big jump, from about $222 billion in 2012 to $422 billion by 2025.
Part of our role is to work on the supply-side, with firms, with their advisors, and with NZX, to make it easier to raise that capital, and to provide more capital-raising platforms.
Our message to firms and directors that are contemplating capital-raising is that you have more choices, and potentially lower costs, than you did say two years ago.
But also for their advisers: now is the time to work with the new framework, not the old.
There are immense cost savings and investor benefits to the new laws and we want both sides of the market to benefit from those.
Indeed, there are probably dozens more New Zealand firms … that are focused on growing their companies, that could consider accessing some form of public capital … than there were just a few months ago.
Thank you for the opportunity to speak to you tonight.
I know that, as directors and finance professionals, you share our desire to improve the quality of governance in New Zealand businesses.
We applaud the efforts of the IoD and its members in this endeavour, including your decision to move to mandatory professional development for your members from this year.
The FMA is committed to working with you, with the aim of improving business outcomes for firms, for investors, and for the economy.