Conformance, competition and culture are the key to good corporate governance, says Jacob Wallenberg.

It has become a truism of this new century that business is under vastly increased public scrutiny. This holds equally for the banking sector, which has been variously affected by the recent corporate governance scandals in companies through credit exposures, greater investor scepticism and increased uncertainty in capital markets; not to mention the ubiquitous questioning of its own corporate governance practices.

It is well known that the regulatory response in the aftermath of these scandals has been swift. And it has never been clearer that appropriately designed prescriptive rules can and should play a vital role in supporting healthy financial systems, both nationally and internationally. Nevertheless, there is a danger that the current overwhelming focus on “rules-based” approaches could overshadow other elements just as essential to good corporate governance, such as open, competitive markets, and at the firm level, an ethical tone that is set at the top.

An excessive emphasis on rigid “box-ticking” may deflect attention from the critical task of improving the competitive environment for financial services in Europe and globally, which will go a long way to improving transparency and accountability. Moreover, within individual firms, this emphasis runs the risk of encouraging a passive attitude towards governance issues that are far better served by conscientious, “judgement-based” approaches, which stress individual responsibility and are grounded in an ethical management culture.

Banking a special case

Corporate governance in the banking sector is both similar to other industry sectors in its underlying principles and unique in a number of important respects. For one thing, banks have always carried a far heavier, more stringent regulatory burden. This is not least because of the large implications that the health of banks has for the wider economy and society – for example, as a source of liquidity in times of crisis; as an integral part of the nation’s payment systems; and more generally, in terms of the need for adequate investor and consumer protection.

For another thing, the significance of the linkages between the board, senior management and associated committees plays a prominent role in the governance of banks. It is crucial to managing risks that board members be extremely well versed in financial and regulatory issues and well-informed of the many details of the bank’s financial status, and that the channels of communication be open with board and senior management. These and other differences in the operation of banks have frequently led to the view that regulatory conformance and effective board oversight are complementary forces. But while regulation and board oversight are indeed inseparable, it is a mistake to take too a narrow view of what good corporate governance involves.

Too prescriptive rules

Traditionally, bank regulatory oversight has been conducted using prescriptive rules but there has been an increasing questioning of the effectiveness of primarily rules-based oversight, in favour of “market-driven” approaches. Part of this has to do with the many unintended consequences of rules and regulations that can create barriers to competition, particularly across borders, and can have the opposite effect to that intended. Regulatory infringements, for example, can take years to resolve if they are subject to a costly and cumbersome court process, leaving many stakeholders exposed in the meantime and, in the end, the rules are not always consistently enforced.

It is precisely more open competition that can serve as a key driver of corporate governance within firms, by increasing market pressures for better transparency and accountability. Freeing up markets gives more leeway to financial actors – including depositors, debt-holders and equity-holders – to provide the signals that lead banks to behave in a manner consistent with their solvency. For example, in a truly competitive market, if excessive risk-taking or a lack of transparency by a bank leads to increased costs and/or greater uncertainty, then depositors can respond by taking their business elsewhere. The bottom line is that regulatory initiatives must be carefully designed so they do not stifle competition but go hand-in-hand with reinforced efforts to make markets more efficient through competition.

Since the 1980s, the financial sector has gradually deregulated, creating a more competitive environment and a more level playing field. As a result, the banking sector is better managed today than it has ever been. Still, in Europe, there is an urgent need to create a fully integrated, liquid financial market, to allow banks, fund-managers and insurers to operate on a EU-wide basis and with sufficient economies of scale. Much inefficiency in the market remains – such as the fact that there is no single European stock exchange. Convergence of the rules relating to company law, including providing equivalent protection for shareholders, ensuring freedom of establishment for companies throughout the EU, and generally resolving clearing problems is necessary. The outstanding measures of the EU’s Financial Services Action Plan must be completed as scheduled in 2005, if the EU is to reduce the productivity gap with the US. The failure to deliver the Lisbon agenda is a problem for all of us.

Moreover, EU directives need to be implemented fully; it’s an area where, despite the legislative progress to date, the record remains dismally poor. At the end of last year, 131 internal market directives (around 8.5% overall) had still not been implemented into national law in every member state. Successfully integrating the EU’s 10 new members is another important challenge.

Recent studies carried out for the European Commission indicate potential benefits of around 1% of GDP and corresponding increases in employment. This suggests that the benefits of a single, truly competitive financial market would accrue to both business and society at large.

Outward-looking

It is equally important that Europe’s banking sector continue to be outward looking. The EU will adopt International Accounting Standards from next year. And it is imperative that a constructive regulatory dialogue with the US continues at a steady pace as I have argued within the framework of the Transatlantic Business Dialogue (TABD). Globally, working through the international bodies, we need to aspire to an environment in which investors and traders can buy and sell financial products around the world as easily as if they were buying or selling them domestically.

Nevertheless, we must also accept that regulatory convergence has its limits. There is no perfect formula for all countries, industries and firms. And convergence of voluntary codes also has its limits – such codes are only as good as their relevance to the specific circumstances of individual firms.

More importantly, corporate governance codes, voluntary or otherwise, are worthless if they are divorced from strong, ethical business leadership. The Enron scandal has demonstrated that in the most regulated market of all, even the best-written governance documents are of little use in the absence of a management culture which embodies real, committed and responsible business ethics. A slavish focus on a rigid set of codes can have the converse effect of encouraging complacency rather than dynamic and proactive management of pressing governance issues.

Ethics-based attitude

Perhaps the most powerful corporate governance mechanism is one that operates at the level of principle; that is, the level at which core values are attentively established at the top, and communicated and enforced clearly throughout an organisation. This ethics-based attitude towards corporate governance is what SEB has sought to articulate through its “One SEB” programme in the past few years. Following a rapid international expansion, SEB recognised the need to develop and cultivate a common culture that embraces the entire organisation.

In sum, it is my view that initiatives aimed at improving corporate governance across the financial sector must strive to promote and balance conformance with competition and an ethical corporate culture. A vigorous regulatory framework is of course essential. However, it needs to be alive – debated, understood and enforced – with a regular dialogue between industry and regulators, employer and employees, and investors and management.

We cannot forget that the need for good corporate governance does not eliminate the need for value-creation, via new products and services and via new markets. Corporate governance should enhance value-creation not detract from it, which is why an improved competitive environment is indispensable.

Finally, the promotion of both rules-based and market-driven corporate governance mechanisms cannot permit us to lose hold of our internal compass.

Fundamentally, good corporate governance is a management question, in terms of having the right ethical attitude at the top; and it is a cultural question, by ensuring that that attitude permeates every aspect of a business’s operations and conduct.

Jacob Wallenberg is chairman of SEB

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