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Charlie McCREEVY

European Commissioner for Internal Market and Services

Corporate Governance

Institute Chartered Secretaries and Administrators (ICSA) EU Corporate Governance Summit
Brussels, 8 October 2008


Ladies and Gentlemen,

I am very pleased to be with you today and draw to a close your discussions over the past couple of days on corporate governance.

These are challenging times for corporate governance. We are now more than a year into the current financial turmoil. We do not yet know where it will end. I do not need to step back from the turmoil to say to you now that corporate governance issues are at the very heart of the current situation. It is obvious to me.

I have always been a strong supporter of the "comply-or-explain" principle. And in particular for codes of conduct. I am convinced that this is the approach that best reconciles the objective of promoting good corporate governance practices in the market with the need to ensure the necessary flexibility for companies.

But there is pressure to go further and put more rules in legislation. I believe that corporate governance codes should continue to play an important role. The same is true for the "comply-or-explain" principle. Last week, I adjusted the regulatory framework for banks. The Commission approved my proposals on strengthening the existing prudential framework, in particular, regarding the capital requirements for banks. However, these cannot be, nor should they ever be viewed, as a substitute for proper corporate governance. Whether this pressure can be resisted will depend on whether the current approach has served the markets well and whether it continues to do so in these testing times.

Corporate governance is essentially about the behaviour of firms in both good times and bad. The bad times have clearly demonstrated the weaknesses. However, the systems we have in place must serve us equally well when things get difficult.

It is not too early to draw some conclusions. At the end of the day, the areas that will remain under the spotlight will be risk management, disclosure and transparency.

Risk management

It is clear that poor, indeed, sometimes disastrous, risk management by financial institutions was partly to blame for the current financial turmoil. In the final analysis, such poor risk management is, in part, a result of failing internal governance.

Financial institutions will have to examine their internal governance framework with a view to embracing risk management. Risk management should be part of the strategy of the firm, and indeed the culture of the organisation.

It is the duty of senior management in financial institutions to address this and it is the role of the board to oversee it. In their respective roles, both senior management and the board need to ensure a holistic approach to firm-wide – and group-wide - risk management.

I do not want to go into details how best to integrate a firm's internal risk management strategy. But one area which I think would provide a good early warning of faults in a firm's risk management system is the firm's approach to transparency.

Transparency has to be meaningful for it to mean anything. Disclosures about risk exposures, risk management and accounting policies are crucial. Disclosures in these areas must be targeted and relevant if shareholders are to make sense of them and exercise their role.

This goes to the very heart of the "comply-or-explain" principle. Only if industry delivers on the quality and accessibility of information provided to shareholders and investors alike, can we make this system function in practice.

Then, the ball will be in the court of shareholders and investors.

They should then use this information to ensure the proper management of firms. This would mean applying their judgement to the financial institution’s overall risk management strategy. From the risk exposures of the products that have been sold in the case of investors, to remuneration incentives of employees and executives in the case of shareholders. It would also greatly assist policy makers and regulators who would then have a feel for the exposures of financial institutions.


A word about remuneration since this is an issue which is high on the political agenda in both the US and the EU.

You have been discussing the issue this morning. Up to now, there have been far too many perverse incentives in place. It cannot be either sensible or sane that compensation incentives encourage excessive risk-taking for short term gain. Incentives need to be aligned with shareholder interest and long-term, firm-wide, profitability.

My view is that addressing these perverse incentives is, in the first instance, the responsibility of industry and of the financial institutions themselves. Industry itself is well aware of its duty to address its most pressing problems.

I saw that industry, in the July report by the Institute of International Finance’s Committee on Market Best Practices[1] came to the same conclusion. This, of course, is no surprise. But we should also be aware that by simply changing the remuneration structure of the people who sell the products, we will not solve the problem. After all, where internal control structures work properly, employees should be prevented from taking excessive risks.

An effective internal control system should, in principle, always be capable of preventing what we have witnessed in the last year, no matter what the remuneration structure looks like.

But it is not only remuneration schemes of employees which are at stake. The same is true, if not more so, for the remuneration schemes of board members. The Commission has always defended the position that shareholders, as the owners of the company, should have a strong say on this. This was the starting point of the Recommendation that the Commission adopted in 2004.

However, in evaluating the Recommendation last year, we found that only about a third of Member States had followed the recommendation that shareholders should be able to vote on the remuneration criteria applying to board members.

I think that in the light of recent events, Member States that have not yet done so should reconsider their policy. A say on this issue would go a long way towards increasing and restoring shareholder confidence. It would force boards to do a whole lot more explaining than is currently the case. In particular, shareholders will then be able to understand whether executive pay is linked to performance, whether it should be linked to performance or indeed, to express their disapproval at a compensation package.

What we currently have is a situation where shareholders behave too much like shrinking violets – unwilling, unable, but most of all, unequipped to curb corporate excesses. Shareholders should push their Member States to have a vote on this issue as laid down in the Commission Recommendation.

Risk management and remuneration are the two key areas of corporate governance where existing structures and mechanisms have been tested and found wanting. Over the coming months we need to reflect on the scale and nature of the problems which have arisen. Adjustments may be needed but knee-jerk reactions are not what is required. Your work today will give us useful input in this respect. The Commission's dialogue with experts such as yourselves will continue. This is crucial if we are to get the balance right.

Further action

Earlier I referred to the regulatory framework. To complete the picture, I would like to add one conclusion that I have drawn from recent events - that the EU must take action with regards to the role and responsibilities of credit rating agencies. It is essential to make the industry explain effectively, but investors will only be able to play their role fully if we make sure that they are not misled by the information coming from CRAs. CRAs played a major role in the market turmoil by greatly underestimating the credit risk of structured credit products.

In November I will be proposing a legally binding registration and external oversight regime whereby European regulators will supervise the policies and procedures followed by the CRAs. Reforms to the corporate and internal governance of rating agencies is also part of this package.

Role of regulators and legislators

We also need to look at the role of supervisors in all this. EU supervisors need to cooperate more – it is not sufficient to have a national focus when financial markets are integrated at an EU or global level. EU finance ministers agree with this, and there is a continued call for improvements to be made. That is why the Commission is preparing to revise its decisions establishing the EU supervisory networks.


Ladies and Gentlemen, let me sum up by stressing again that there are important lessons to be learnt for corporate governance from the financial turmoil. But this does not mean we should abandon corporate governance codes applied on the basis of "comply-or-explain". We need to fix the framework and get corporate governance principles right - in particular for the financial industry - to make sure that the system functions effectively. In both good times and in bad.

Thank you for your attention.

[1] July 2008 Report of the IIF sponsored by industry.

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