Governance Operating Model: A Tool for More Effective Board Oversight
Renewed pressure from regulators and shareholders in recent years has led boards of directors to examine and strengthen governance roles and responsibilities. The focus on board-level oversight is especially intense in the financial services sector, given the scale and complexity of governance efforts at global financial organizations. “Despite significant recent progress in the area of governance, work remains to be done if the many governance needs of large, complex institutions are to be met,” notes Bob Contri, vice chairman, Deloitte LLP, who leads the U.S. Financial Services industry group and U.S. Banking and Securities sector.
A governance operating model, which defines the mechanisms and interactions through which governance is put into action, can be an important tool for boards to enhance their oversight capabilities while enabling management to implement governance initiatives. “A governance operating model supplies the ‘how’ that board members seek and can reveal gaps or shortcomings in board or management committee charters,” Mr. Contri adds.
The main function of governance operating model is to organize operational, financial, risk management and reporting processes so that the board receives the information it needs to put good governance into practice and business units can conduct their work in compliance with regulations and strategic goals. The governance operating model also extends the organization’s governance framework down to the level of roles, responsibilities, and reporting in order to bridge the gap between the governance framework and operational realities.
The goal of effective governance operating model is not to dictate, but to define decisions and actions in ways that are meaningful from a governance standpoint. “The process of documenting the operating model can create as much value as the resulting documents,” notes Edward Hida, who serves as a global leader for Deloitte Touche Tohmatsu Limited’s Risk & Capital Management practice within the Global Financial Services Industry. “Such an approach can create a feedback loop in which the board and management can identify and respond to new business, operational, competitive and regulatory issues more effectively,” adds Mr. Hida.
From Governance Framework to Operating Model
A starting point for many organizations, and especially those in financial services, is the governance framework. As discussed in the report, Developing an effective governance operating model—A guide for financial services boards and management teams, a framework articulates the various elements of the governance program, such as the governance roles of the board and management, and the relationship between governance, risk management, and organizational culture. Encircling the elements of the framework is the corporate governance infrastructure, a collection of governance operating models—people, processes, and systems—that govern daily organizational activities.
The addition of a governance operating model can enhance and extend the basic principles within an existing governance framework. “A governance operating model is the mechanism used by the board and management to translate the elements of the governance framework and policies into practices, procedures and job responsibilities within the corporate governance infrastructure,” says Scott Baret, partner, Governance, Regulatory and Risk Strategies, Deloitte & Touche LLP, who also serves as global leader, Financial Services Enterprise Risk Service, Deloitte Touche Tohmatsu Limited. “In developing the governance operating model,” he adds, “the board balances competing for goals, such as the pursuit of growth and the preservation of assets, define responsibilities, such as those of a business manager and those of a risk manager, and allocates resources to implementing governance.”
Components of a Governance Operating Model
When properly implemented, a governance operating model defines the mechanisms and interaction points by which governance will be implemented across an enterprise. An effective model enables the board and the executive leadership—as appropriate to their roles and responsibilities—to organize these mechanisms and points of interaction across the organization’s business lines, legal entities, and jurisdictions. Moreover, an enterprise-level model can be adapted to any functional or operating area to promote effective implementation of governance.
A governance operating model consists of four main components:
1. Structure, which includes organization design and reporting structure, committee structures, and charters, and control and support function interdependencies.
2. Oversight responsibilities, which define board oversight responsibilities, committee and management responsibilities, accountability matrices, and management hiring and firing authority.
3. Talent and culture, which enable the behaviors and activities needed for effective governance by establishing compensation policies (particularly regarding incentives), promotion policies, business, and operating principles, performance measurement and management, training, and leadership and talent development programs.
4. Infrastructure, which comprises governance and risk oversight policies and procedures, reports, measures and metrics, management capabilities, and the enabling IT and communications support.
Each of the four components of an effective governance operating model contains a series of role and responsibility issues to be addressed:
Board oversight and responsibilities—The board carries out oversight responsibility across the organization in areas such as business and risk strategy, organization, financial soundness, and regulatory compliance. In this regard, the governance operating model should help the board to:
- Articulate the skills and knowledge it requires to effectively execute its oversight responsibilities and to assess its composition against those needs.
- Engage management in providing the information the board requires to exercise governance and risk oversight.
- Advise management on policies that ultimately influence the manner in which governance is conducted.
- Understand governance activities that occur at various levels within the organization and support management in its efforts to enhance program efficiency and effectiveness.
Committee authorities and responsibilities—Effective board committee and management committee structures can help define the number, terms, and qualifications of members, committee responsibilities, reporting and escalation mechanisms, and ways in which board and management committees will interact. For example, for a management committee, the model could:
- Include committee charters that define the committee’s responsibilities and address linkages connecting the committee, the broader executive team and the board of directors.
- Define the types of decisions, investments, events, risks, and other items that should come to the committee’s attention (and, when applicable, thresholds or amounts).
- Delineate methods of escalating and reporting significant matters to the appropriate person or committee.
Organizational design and reporting structure—A clear, well-thought-out organizational structure normally defines reporting lines for decision-making, risk management, financial and regulatory reporting, public disclosures and crisis preparedness and response. In enterprise governance operating model, the organizational structure could enable executive management to:
- Establish the independence and authority of the control functions of compliance, risk, legal, finance, and audit.
- Define a process of overseeing the spectrum of risks across all regions and businesses, including strategic, operational, market, credit, liquidity, legal, compliance, property, IT, reputational and other risks.
- Maintain a governance structure that is understandable to internal employees and external stakeholders.
Management accountability and authority—Well-understood authority and accountability for key responsibilities are needed at all levels and in all areas of the organization. Sound governance operating model could:
- Balance global and regional strategies by delineating the authority and accountability for key roles and specifying a process for resolving or escalating disagreements.
- Balance the decision-making authority of business units against that of risk managers, such that risk tolerances and exposure limits are set and observed and risk managers have the authority to challenge those who are taking the risks.
- Define clear decision rights such that people understand the authority—and the limits of the authority—associated with their positions.
- Provide direction to control functions to assist overseers in determining that businesses are managed within appropriate limits on both a global and regional basis.
Performance management and incentives—Goals, performance measures, compensation, and incentives should reflect an organization’s overall commitment to governance as well as principles of asset preservation and risk-taking for a reward. In this area, the model should help the board to:
- Establish performance objectives that balance asset preservation and risk-taking in the pursuit of value creation.
- Align incentives to reflect a balance between asset preservation and risk-taking.
- Specify qualifications and performance evaluations that establish and reinforce the desired corporate culture and tone at the top.