Governing on Principle

As a member of the board of directors, do you know what you are supposed to be doing, and why? Do you know what the board as a whole is responsible for, and why? Do you know where the line between governance and management is drawn, and why? If you have questions such as these, do you know where to go internally (at the credit union) to find answers?

In my many years of engaging with boards of directors, I have often seen boards and individual board members struggle with the questions above. In this article we’ll explore a few of the reasons for sound governance and lay out how to substantially improve governance responsibility clarity by implementing a principles-based governance model.

Current Governance Process Risks

All credit unions have governance documentation. Documentation includes bylaws and policies, but at many credit unions the collection of governance documents that should define the “why” and “how” of the credit union’s governance function are fragmented, unclear in their ability to  establish governance structure and standards, and often not even related to the credit union’s current or actual governance practices. This occurs because the board lacks a framework within which to capture and organize its governance activities, which leads, ultimately, to this problematic reality of a broken or non-existent governance structure. 

Absent a structured framework to provide guidance and reference, boards tend to forget about governance documentation and consequently shape their efforts through consultation with non-documented sources. Typically this means individual board members rely on observing what others do and try to mimic the same behaviors: this is akin to passing down traditions via oral storytelling. 

Often this kind of environment is allowed to exist because turnover in the boardroom is so low that observance of known practices and traditions is a relatively effective means to inform the occasional new board member how to behave and what to do. However, this strategy only works so long as:

• Turnover remains low; 

• Key leadership positions are granted only to those that know how practices/traditions actually function, and; 

• New board members are generally aligned with the thought process and practices in place – in other words, they don’t arrive with a desire to disrupt board practices. 

But should such an ad hoc means of governance survive at today’s credit unions, even if it works in certain cases? I don’t think so, for a number of reasons:

1. Governance practices can lag behind evolving governance responsibilities and job demands, meaning the board may not be properly equipped to address emerging governance and operational risks.

2. Boardroom instability is likelier when there is turnover.

3. Preparing potential board members for succession opportunities is nearly impossible -- training specifics will be limited and programming fragmented.

4. New board members are onboarded too slowly; they won’t be able to positively and immediately contribute. They’ll have to “learn by observation,” which introduces a substantial competency gap for the whole board. 

5. Member representation (the voice of the member) diminishes, replaced by boardroom traditions and underlying governance assumptions. This can lead to over-dependence on staff, and/or inadvertent delegation of governance responsibilities to staff.

6. And finally, the board will have a harder time effectively disciplining/removing poorly performing board members.

Establishing a Governance Framework

I used the term “ad hoc” in the prior section. Ad hoc means “when necessary or needed, ” (source: Oxford languages) and I used it to describe governance efforts that are not directly grounded in a formalized governance framework but done when/if the board thinks it should be doing something. If this is not a good way to govern, what is the answer? Establishing a governance framework. 

Glatt Consulting helps boards establish governance frameworks using one of two governance models: Policy Governance or Principles Governance. For the remainder of this article we’ll focus on Principles Governance. 

What is Principles Governance? In short, a governance framework – meaning job responsibilities, tasks, activities, workflows – that sits on a foundation defined by a clear set of principles. Let's explore further. 

A principle is defined as “a fundamental truth or proposition that serves as the foundation for a system of belief or behavior or for a chain of reasoning” (source: Oxford languages).

Governance principles, then, are truths on which the acts of governance are built; the logic behind decision making. 

So where does a board turn to find these “truths” on which to build a more formal, documented governance framework? At Glatt Consulting, we believe the best set of governance principles have been defined by the Organisation for Economic Cooperation and Development (OECD). They call them Principles for Effective Governance, and we’ve adapted them for credit union governance.

Here is a brief summary of each of the six adapted principles:

1. Principle 1: The credit union governance framework should promote transparent and fair markets, and the efficient allocation of resources. It should be consistent with the rule of law and support effective supervision and enforcement.

2. Principle 2: The credit union governance framework should protect and facilitate the exercise of members’ ownership rights and ensure the equitable treatment of all members. All members should have the opportunity to obtain effective redress for violation of their rights. 

3. Principle 3: The credit union governance framework should provide sound incentive throughout the investment chain and provide for markets to function in a way that contributes to good credit union governance.

4. Principle 4: The credit union governance framework should recognise the rights of stakeholders established by law or through mutual agreements and encourage active cooperation between the credit union and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises.

5. Principle 5: The credit union governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the credit union, including the financial situation, performance, ownership, and governance of the credit union.

6. Principle 6: The credit union governance framework should ensure the strategic guidance of the credit union, the effective monitoring of management by the Board, and the Board’s accountability to the credit union and the members (as owners).

Building on the Principles

These six principles act as a foundation for the whole of the governance framework. To be aligned with the principles, a board’s job functions/responsibilities must emanate from the principles. What kinds of job functions and responsibilities emanate from the principles? Again, adapting the OECD principles for credit unions, such functions and responsibilities as:

• Reviewing and guiding credit union strategy, major plans of action, risk management policies and procedures, annual budgets and business plans; setting performance objectives; monitoring implementation and credit union performance; and overseeing major capital expenditures, acquisitions and divestitures.

• Monitoring the effectiveness of the credit union’s governance practices and making changes as needed.

• Selecting, compensating, monitoring and, when necessary, replacing key executives and overseeing succession planning, in particular for the Chief Executive Officer.

• Aligning key executive and (and if relevant, Board) remuneration with the longer term interests of the credit union and its members.

• Ensuring a formal and transparent Board nomination and election process.

• Monitoring and managing potential conflicts of interest of management, Board members and members, including misuse of credit union assets and abuse in related party transactions.

• Ensuring the integrity of the credit union’s accounting and financial reporting systems, including the independent audit, and that appropriate systems of control are in place, in particular, systems for risk management, financial and operational control, and compliance with the law and relevant standards.

• Overseeing the process of disclosure and communications.

At this point, many boards that are comfortably settled into the more ad hoc method of governing may question the scope and depth of the responsibilities outlined above. After all, they reason, they govern well in their estimation, and as evidence they point to what is often a truly successful credit union (strong capital, earnings, growth, etc.). 

My response to such an argument is this: it isn’t that you can’t govern in such a fashion, or that you can’t be successful. It is that you introduce too much governance inefficiency and risk and increase the likelihood of making governance mistakes. And, you become reactionary rather than proactive.

So, how does a board reduce its governance risk and govern on a principled basis?

Creating the Foundation and Framework

For a board that wants to govern on principle, it should first affirm that it will, in fact, govern with a principles-based approach, meaning the board should formally adopt the principles themselves. It should then establish its job responsibilities, in effect claiming (or reclaiming if necessary) ownership of the principles-based responsibilities outlined above.

But the work does not stop there. One of the problems with ad hoc governance is that boards often have nowhere to point new or potential board members to prepare for effective board service. Or, the documentation to which they point is incomplete, missing key responsibilities, or woefully outdated. In other words, there is little or no documentation that describes how to govern. 

To avoid this becoming a problem in a principles system, a board must follow up its affirmation of the foundational principles and job functions with the creation of clear documentation as follows:

1. The approved governance principles (outlined above);

2. The approved Job responsibilities/functions (outlined above);

3. Job procedures and/or workflow (governance work). 

Items one and two should make sense given the preceding text, but what about item 3?

Job responsibilities and functions define governance practices which must be articulated and supported with clear workflows/procedures that the governing body - not staff - owns and executes. 

A different way to say this is: the board, in completing well-defined, principles-based work, fulfills its job responsibilities, which in turn results in the board living up to its own principles. To that end, a board needs to map out how it will actually do its work. 

Every credit union adopting this specific principles-based governance model should have the exact same principles-based job responsibilities/functions we described above; however, as every credit union is different (different owners, locations, value propositions), how and when a given board completes its job responsibilities will be unique to the board itself and the credit union, which means that a given board must establish its own methods for how governance works.

So that you have some perspective on what it takes to document governance job procedures and workflows, let’s consider one of the governance job functions and use it as a simple example.

Here is the job function:

Monitoring the effectiveness of the credit union’s governance practices and making changes as needed.

Creating workflow clarity for this job function requires tackling two tasks:

1. Capturing the Board’s expectations (what and why) for the “Monitoring the effectiveness of the credit union’s governance practices and making changes as needed.” job function. 

2. Defining and documenting how the Board will support its “Monitoring the effectiveness of the credit union’s governance practices and making changes as needed” expectations.

With regard to the first task, the board simply captures a summary statement of activity for the job function. This could look something like:

With regard to the second task, the idea is to clearly define how the board will monitor and evaluate. This could look something like:

• Survey individual board members to obtain opinions regarding whether the board effectively addressed the board’s stated list of job responsibilities and functions. 

• Review, discuss, and act on the results at the December board meeting:

• Review the survey results

• Discuss and determine causes of both positive and negative results

• Identify action items for performance improvement if necessary (to include what to improve, by when, and how.)

In reality this effort will be more complex and time-consuming than the sample suggests, especially for larger credit unions, it is worth it. The outcome creates the clarity lacking in a more ad hoc governance environment and it establishes the source of governance truths and activities needed to properly orient new board members (and long-serving board members) to governing in the credit union’s environment.

Questions?

A principles framework allows a board’s activities and functions to be properly rooted in governance vs operational responsibilities, but boards often have a number of questions about implementing a Principles Governance model. If you are interested in discussing the details schedule a complimentary consultation! We’ll address your questions and help you better understand whether the model is appropriate for your credit union.