Good governance is essential to the long-term sustainability of any company. EU banking and insurance prudential standards require regulated institutions to have a rigorous governance framework, founded on the premise that a well-governed institution is essential to the protection of the interests of depositors and policyholders. Thus, the effectiveness of the corporate governance of financial institutions is a central topic for international standard setters in the banking and insurance sector. This goal has been included in the regulatory framework of the guidelines and technical advice issued by the European Supervisory Authorities for all financial institutions. Recent significant risk incidents and corporate scandals caused by misconduct in the banking sector suggest that financial institutions need to further enhance corporate governance measures as well as ethics and culture.
European legislation after the financial crisis clearly shows that the regulation of corporate governance goes beyond the traditional approach of company law, because the governance regime should ensure not only the ‘integrity of the market’ to reduce excessive risk-taking, but also ‘investor protection’ as far as the MiFID II regime is concerned, and ‘policyholder protection’ insofar as insurance is regulated under the Solvency II Directive. Unlike banking regulation, financial stability and fair and stable markets, despite being important objectives of the insurance and reinsurance regulation, should not impair the main objective. Thus, in the insurance sector, the regulation and supervision of internal governance mechanisms are central to the risk management framework because some risks may only be properly addressed through governance requirements. An effective system of governance requires a proactive approach on the part of insurance firms, with a significant impact on the duties and obligations of the members of the board, on the one hand, and on the supervisor’s ability to assess the compliance of the internal governance with these specific requirements, on the other.
In a recent paper, I analysed the insurance sectoral rules on the system of governance, with a special focus on what I consider to be the most relevant provisions to achieve suitable governance. Under the Solvency II directive, corporate governance requirements are a complementary, but essential, element to build a sound regulatory framework for insurance undertakings, and also to address risks not specifically mitigated by the solvency capital requirements. After recalling the provisions of the Second Pillar of the prudential requirements, concerning the system of governance, the paper highlights emerging regulatory trends in the corporate governance of insurance firms in the Guidelines on the system of governance issued by European Insurance and Occupational Pensions Authority.
A first finding is that insurance supervisors are now adopting a more ‘intrusive’ approach which is focused on making forward-looking judgments about firms. This proactive attitude also includes supervision of how the board agrees and oversees the firm’s risk framework. This is a profound change which introduces a ‘four-eyes’ principle to decision-making and the specific role of signing off the strategic plan and monitoring its execution by managers. In a nutshell, good governance increases the probability that good decisions will be made, also because poor governance is a strong lead indicator of more significant problems. Since management is responsible for running firms, and firms fail because of the decisions taken by their board and management, supervisors are interested in enhancing an effective role for the board of directors.
A second finding is related to the specific European Union legal framework in the sense that national prudential authorities operate as supervisors in charge of the application of judgement against a complex and multilevel framework of rules and guidelines which also encompasses the system of governance. Conversely, the regulation of corporate governance should be based on a limited number of standards, with which boards should comply under the ex-post supervision of supervisory authorities. The paper argues that a similar approach is preferable to the extent that it is respectful of the autonomy of insurance undertakings while leaving to supervisors the task to maintain the ‘effectiveness’ of corporate governance from the perspective of the safety and soundness of the institutions concerned. Narrow rule-based approaches to regulations create inflexibility and can easily lead to arbitrage between different legal systems. In the context of the European Union, it will depend on the European Supervisory Framework whether we can expect to continue to have regulations of the highest standards on corporate governance that strike a fair balance between harmonisation and reliability. However, a more principle-based regulation should be built on the results of the best practices developed by national competent authorities. An assessment at the European level by European Insurance and Occupational Pensions Authority could foster a greater convergence of regulatory and supervisory practices in the area of internal governance. A further step for strengthening regulatory frameworks and key regulatory requirements will benefit from high-level cross-sectoral standards on governance in the fields of banking, insurance, securities and UCITS, as well as the field of financial conglomerates.
Among others things, the paper highlights the exceptional extension of the duties and responsibilities assigned to the board of directors, which go far beyond the traditional role of both monitoring the chief executive officer and assessing the overall direction and strategy of the business. However, better risk governance is not necessarily built on narrow rule-based approaches to corporate governance. Risk governance, including risk culture, is a relatively new approach to the corporate governance of both insurance firms and other financial institutions; it implies a crucial role for the board, pushing towards a strategy of effectiveness of risk structures and risk culture within the firm, and opens up new challenges for the supervisor, during the assessment and comparison of the results across the industry. A responsive, yet unintrusive, regulation would be even more helpful in achieving better risk governance.
Michele Siri is Professor of Business Law and holds the Jean Monnet Chair on European Union Insurance and Financial Markets Regulation at the University of Genoa (Italy).