The Bank for International Settlements has defined criteria specific to the Corporate Governance of financial services firms. Directors must work closely with the Internal Auditor to assure that Corporate Governance is functioning properly, but directors must also expect the auditor to review board performance and board composition, so that a Corporate Governance audit affects them directly.
Directors: What the Internal Corporate Governance Audit Means
The UK Corporate Governance Code highlights the critical role of directors in promoting good corporate governance. In particular, boards are charged with ultimate responsibility for the effectiveness of their organisations’ internal control systems. Regulators insist on the key role that internal audit can play in supporting the board in ensuring adequate oversight of internal controls and the effectiveness of corporate governance.
The Bank for International Settlements, responsible for international regulation in the sector, has defined how corporate governance is different for these firms and institutions:
“The presence of an effective corporate governance system, within an individual company or group and across an economy as a whole, helps to provide a degree of confidence that is necessary for the proper functioning of a market economy. For financial institutions in particular, a solid ‘set of relationships’ is crucial given the pervasive role that these institutions play in all facets of an economy and people’s lives. Also to be taken into account is the growing complication of financial transactions in a climate where technology allows for rapid movements of funds, while abrupt changes in market sentiment can lead to large scale deposit runs. Public trust and confidence are therefore essential and good corporate governance helps to set a basis for that assurance”.
The critical role that directors play in overseeing corporate governance in financial services firms is clear. An audit of corporate governance will, however, also take a hard look at board composition, board member skills and board performance, so the directors should be aware that it could affect them directly.
The head of internal audit should work with the board, the audit committee and the executive management team, as appropriate, to determine how governance should be defined for internal audit purposes and the extent and expectations of internal audit assurance and consultancy needed to satisfy the internal audit charter.
Financial Services Require Specific Audit Techniques
According to the UK Chartered Institute of Internal Auditors, the internal audit activity at financial services firms must assess and make appropriate recommendations for improving the governance process in its accomplishment of the following objectives: promoting appropriate ethics and values within the organisation; operating effectiveness of the internal governance structures and processes of the organisation.
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This mandate is implemented differently at financial services firms than at non-financial companies, because of the specific factors that set financial institutions apart from other business firms.
The financial crisis has led to a restatement of the global principles concerning the corporate governance of financial institutions in the belief that governance failures contributed to these institutions’ failures in the crisis. As a result, the Chartered Institute of Internal Auditors now proposes that Internal Audit functions should include a specific type of corporate governance review.
As one regulator notes: “The effectiveness of the economy depends significantly on how well its financial services sector functions. Relative to non-financial businesses, the failure of a financial institution can have a greater impact on members of the public who may have placed a substantial portion of their life savings with the institution and who may be relying on that institution for day-to-day financial needs. There is also potential in some circumstances for system- wide impacts from failures or material impacts in selected markets, given the interconnectedness of the financial system. Safety and soundness concerns are, therefore, of particular importance for financial institutions. These include:
- Financial institutions may have high ratios of debt-to-equity (leverage), making them more vulnerable to unexpected adverse events;
- Financial institutions can experience severe liquidity problems if their customers or counterparties lose confidence in their safety and soundness;
- Financial institutions may accept funds from the public and often deal in long-term financial commitments, which are predicated on a high degree of confidence in the long-term stability and soundness of the institutions making these commitments;
- The value of many financial institutions’ assets and liabilities can be volatile and may be difficult to price accurately. Similarly, financial institutions may issue and trade in complex financial instruments, which can be difficult to evaluate properly and can materially and rapidly affect the risk profile of an institution; and
- Financial institutions can have large mismatches between the term of their assets and liabilities. This can result in material funding or investment risks”.
These characteristics create unique challenges for the governance of financial institutions and underscore the importance of effective risk management systems and rigorous internal controls. They point to the need for knowledgeable, independent oversight exercised by or on behalf of the Board, along with the additional assurance of regulatory oversight, to provide assurance to markets on the reliability of reporting and disclosure. Also, as a consequence of being a regulated industry, the governance processes of financial institutions are subject to review and may be influenced by the views of OSFI and other regulatory bodies.
“Finally, many financial institutions have complex organisational structures with a large number of entities (some of which may not be regulated) used to deliver different financial products. For these organisations, the relationship between the parent company and its subsidiaries merits special consideration and the effective governance of subsidiaries should be a high priority for directors and Senior Management,” the regulator notes.
Corporate Governance Must Effectively Manage Risks
As auditing firm Deloitte points out, the auditor does not have direct corporate governance responsibility but rather provides a check on the information aspects of the governance system. The auditor’s role in Corporate Governance at financial services companies involves a review of decision-making, accountability and monitoring – the auditor must ensure that decisions are made with relevant and reliable information. The auditor is also responsible for ensuring accountability throughout the organisation, and that involves reviewing reporting and transparency. Auditors must monitor systems and feedback as well. And the auditor has a special responsibility to ensure that financial information given to investors is reliable.
It is the responsibility of the board of directors to see that the special risks that challenge financial services firms must be managed correctly. The Audit Committee, working with the Internal Auditor, has a specific responsibility for this role, as does the Risk Committee, if there is one.
Diligent Boards Offers Efficient and Secure Environment
Directors working with auditors on a Corporate Governance Audit need the immediate access to information that a portal provides, especially when that portal is available on a variety of electronic devises. Portals ensure that board members have access to the most up-to-date information and aren’t wasting time juggling paperwork. Staff can update documents via the portal, and board members can take notes there as well.
The Diligent board portal is also secured with the highest grade of encryption and other measures to control threats.
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