On the 24 October 2022, the FCA issued a "Dear CEO" letter to all UK registered credit rating agencies (“CRAs”). The letter follows on from an earlier one sent in February 2022 in which the FCA underlined its view that "sound governance, both its effectiveness and design, is at the heart of producing high quality ratings". Since then, the FCA has been reviewing the Board structures and documentation for registered CRAs and has conducted more detailed reviews of some firms' Board and wider governance arrangements.
The FCA's conclusion was that CRAs could do more to enhance their Boards and Board effectiveness, and they need to do it now.
What do CRAs need to do?
The FCA's Dear CEO letter was not just issued for informational purposes - it was a call to action. The Regulator makes clear that it will "consider the full range of supervisory responses and enforcement powers" at its disposal, where firms fail to take the necessary action.
So, what do CRAs need to do? They need to consider the thematic findings from the FCA's review (key findings summarised below) and what actions they need to take to address any shortcomings identified. This means conducting and documenting a gap-analysis and action plan; and Board-approved summaries of these must be shared with the Regulator by the 30 January 2023.
For some firms, it may also be appropriate to schedule a more comprehensive Board Effectiveness Review; to ensure that current arrangements are robust enough to meet the Regulator's expectations and from a forward-looking perspective, to help in future-proofing the firm.
What were the key thematic findings from the FCA’s review?
Purpose of the Board:
When it comes to the purpose of the Board, the FCA noted that many UK CRAs are part of larger global organisations, and may consequently have less independence and autonomy than other UK Boards; in some cases, Board meetings only taking place as a "formality".
UK CRA Boards should be sufficiently autonomous from Group, the roles and responsibilities of the Board should be clearly documented and should align to regulatory expectations, and most importantly - the Board should fulfil (and be able to demonstrate that it fulfils) these roles in practice.
Board Composition:
In accordance with the CRA Regulation, at least a third of the Board (or a minimum of two members) should be independent non-executive directors ("NEDs"). The FCA's review found that CRAs were failing to meet these minimum Board composition requirements.
The FCA also raised concerns around wider factors relating to Board composition, including the number of Board directors ( too many and too few being potentially problematic), as well as whether Board members had the right skills and experience (individually and collectively) to be able to fulfil their responsibilities.
Role of the INEDs:
INEDs play an important role on company Boards; being removed from executives and management and consequently providing essential independent oversight and challenge. However, INEDs should be carefully and purposefully selected and should be subject to a robust selection process. It is also crucial that once on the Board, lines are not blurred which could call into question INEDs impartiality and independence. The FCA raised concerns around INED recruitment and induction processes (including how well their skills and experience align to the Firm - and compliment/supplement the existing Board composition), as well as the extent to which INEDs provide robust challenge and how such challenge is received (i.e., whether senior management accept and seek to address requests or challenge provided by INEDs).
How the Board Operates:
The FCA also raised concerns around how CRA Boards operate in practice, including: meeting frequency, length and organisation; the quality and timeliness of management information ("MI") provided to the Board; the extent to which Board discussion can be evidenced (i.e., via detailed and reflective minutes). It also noted differing degrees of Board discussion "ranging from in-depth to superficial" and instances where data, key risk indicators ("KRIs") or MI were not in place or insufficient.
How can BDO help?
CRAs are required to take prompt action in response to the Dear CEO letter.
BDO can support you by reviewing your gap analysis and action plan and providing guidance on these prior to you submitting your documents to the FCA.
BDO has a specialist team which conducts governance and board effectiveness reviews across financial services sectors. You can download our Board Effectiveness Brochure here.
To find out more on how we can help you, please get in touch now with Richard Barnwell.
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