Arnold Schilder: Good governance
Speech by Professor Arnold Schilder, Chairman of the BCBS Accounting Task Force and Executive
Director of the Governing Board of the Netherlands Bank, on the occasion of the leave-taking of
Mr Jan Hommen, member of the Executive Board of Philips, Amsterdam, 11 April 2005.
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This speech will highlight the role of public oversight concentrating on recent developments in the field
of governance, accounting and supervision. Some concrete examples will be used from the practice
as prudential supervisors and to show you how at DNB  ́Sense and Simplicity ́ are an objective as
well.
Introduction
Ladies and gentlemen, it is a great pleasure to speak here on Good Governance. I will highlight the
role of public oversight concentrating on recent developments in the field of governance, accounting
and supervision. I will use some concrete examples from our practice as prudential supervisors and to
show you how for us at DNB  ́Sense and Simplicity ́ are an objective as well. I am sure you are familiar
with that slogan.
The main subjects of this speech
In the first part of my speech I will briefly discuss the way DNB has incorporated governance issues in
its supervisory approach and how this compares with views held among the business community. I
would like to emphasise here that as prudential supervisors for the financial sector we highly value
Good Governance, especially such aspects as checks and balances - mainly in risk management
structures - quality of management and accountability.
The second part of my speech is about how public overseers can help establish the rules of the game.
In this capacity DNB uses its influence in the international regulatory environment. There we liaise with
standard-setting bodies to ensure that new regulations and standards advance the public good. I will
illustrate how we have played this role in practice, using recent developments of International Financial
Reporting Standards as an example.
Governance as part of our supervisory approach
The widespread attention Good Governance receives nowadays could give the impression that this
concept has only a brief history. On the contrary - looking back across the history of prudential
financial supervision - we see that governance has been on our agenda for decades. Over time, the
concept has been broadened and deepened, partly, of course due to the eruption of scandals.
Undoubtedly, one of the milestones in the development of Good Governance is the 1997 Report of the
so-called Peters Committee. This Report contained 40 recommendations to promote good
governance. It appeared that these recommendations were not followed up satisfactorily. But the
report set out important principles about a company ́s risk management and necessary checks and
balances. Its recommendations were based on the COSO-framework, an internal control framework of
global standing. The Peters Report was, in fact, the first Dutch Code of Corporate Governance. It gave
an impulse to the development of explicit requirements on good governance for banks. How? Well, in
1999 DNB issued its Regulation on Organisation and Control or ROC. In drafting the ROC, we used
the governance framework of the Peters Report as its backbone. So in addition to risk management
requirements, this Regulation includes checks and balances for the Managing and Supervisory Boards
of banks. For example, the ROC requires all banks to establish an audit committee function involving
knowledgeable and independent Supervisory Board Members. All banks, you may wonder? Yes, we
require such an audit committee function for all, but we allow smaller institutions to meet this
requirement within their limited capabilities. This is an example of a principle-based regulation which
allows congruence with reality. It will come as no surprise that the second Dutch Code on Corporate
Governance, the Tabaksblat Code, contains many of the same aspects as DNB ́s ROC, since both are
based on the same source. The same goes for some papers of the international Basel Committee on
Banking Supervision, in which we were again able to integrate the Peters Committee ́s
recommendations.
Oversight promotes a level playing field
This leads us to an important purpose of public oversight. I refer to the aspect of promoting a level
playing field. Maintaining a level playing field requires not only adequate regulations but also
transparent supervision. You will agree with me that supervising an organisation that applies Good
Governance will differ strongly from supervising an organisation that applies Bad Governance.
Supervisory action towards supervised organisations can have direct or indirect benefits for those who
apply Good Governance. In that sense supervision is in the corporation ́s as well as in the public
interest.
Transparency
I have just mentioned transparency as an important aspect of supervision. It is beneficial for
enforcement purposes. After all, it is important for supervised organisations to know what our
enforcement instruments are and when we will use them. An important new development here results
from the Revised European Directive on banking Capital Requirements. This Directive adopts the new
Basel II capital framework for European legislative purposes. It also requires supervisory disclosures
from all European competent authorities - a development which we support actively. So in future
everybody will be able to compare the supervisory level playing field for banks through the websites of
the European Banking Supervisors.
The view of Jan Hommen
Such supervisory objectives compare well with those of the business community. To illustrate this I will
select some sound bites from a recent speech by Jan Hommen. Speaking before a financial reporting
oversight seminar organised by VNO/NCW and AFM, Jan stressed the importance of oversight in
preventing regulatory arbitrage, and of harmonised accounting standards. Such prevention is
important, according to him, in order to guarantee a level playing field. He also said that public
oversight of financial reporting contributes to the confidence in financial markets. And he went even
further to say that the benefits of this type of public oversight may be diminished if not accompanied by
good governance within the company itself. Indeed, congruence is important both ways. Rules and
regulations should align with internal practices, and internal practices should be in line with formal
governance structures. It is good to see that our views align to such a great extent.
Conclusion on the role of public oversight
In sum, only a balanced mix of sound governance structures and related practices together with
transparent public oversight will give Europe a competitive Internal Market.
Public overseers ́ efforts for  ́Sense and Simplicity ́; an example
I now come to the second part of my speech. The business community, including the financial sector,
also needs legislation, standards, codes and guidance to be able to play the game. The rules of the
game should, however, be conducive to the  ́sense and simplicity ́ in their appliance. As you know
better than anybody, this is an important principle, but far from easy to apply. This is also an important
aspect of the role of the public overseers. Allow me to illustrate this role by taking an example from
recent experience. As you know, the International Accounting Standards Board has issued the revised
Standard on Financial Instruments, IAS 39. The European Community faced the issue of endorsing
this revised accounting standard by the end of last year. A key issue here was the so-called Fair Value
Option. This option allows financial reporting entities to use fair values for the financial instruments in
their accounts. The business community, amongst others banks and insurers, expressed concern
about the revised Standard. Moreover the European Central Bank and the Basel Committee on
Banking Supervision criticized in particular the risk of inappropriate use of the Fair Value Option.
The Fair Value Option
What was the problem? The International Accounting Standards Board, as a matter of policy, issues
standards which can be applied by all relevant organisations, without specifics for individual sectors.
For some sectors, such as the financial sector, these standards appear to be too broad. Regarding the
Fair Value Option, the gap between the parties involved related mainly to the reliability, comparability
and relevance of accounting figures in firms ́ financial statements. There were fears that the
unrestricted use of fair values could open the door to manipulation and the use of inaccurate valuation
methods, which might hurt reliability. Moreover, different institutions could use the Fair Value Option in
very different ways, which might hamper comparability. And finally, the use of fair values might not be
in line with sound risk management practices within institutions, bringing into question the relevance of
reported figures. Now, congruence between sensible standards and sound internal risk management
practice is important. Jan Hommen said as much, in the speech I referred to earlier: for financial
institutions, accounting requirements must align as much as possible with internal risk management
policies.
And with time running short, the question how to bridge the gap became more and more urgent:
between a broad standard on the one hand, and the restriction to a context of good governance and
risk management on the other.
Searching for an acceptable outcome
It is important, in this kind of process, to listen carefully to each other and to search for common
ground. IASB was strongly bent on an unrestricted option for reasons of principle and in order to
maintain simplicity. Banks and insurers disagreed on the proposed restrictions. And regulators were
concerned about the possible abuse of the option. We as banking regulators then engaged in very
informal discussions with banking representatives. We drafted proposals that made sense to both
banks and banking regulators. This was possible because we applied a simple principle: good
governance banks want a level playing field based on sound risk management practices. Four months
later, the now likely outcome is that IASB will have framed the Option within sensible boundaries - and
will require comprehensive disclosures about underlying risk management practices, thereby serving
transparency. Simple, in the end, and sensible - but after much perspiration. This outcome should
strike the right balance between IASB on the one hand, and financial institutions and prudential
regulators on the other. I trust this balance in outcome will receive the support of the European
Commission as well.
Wrap up
Let me now wrap up my speech. I have given you DNB ́s view on some elements of public oversight
and how we contribute to transparency and to solutions that make sense. Both from a business and a
supervisory perspective, one thing is of particular importance, and that is congruence. This means the
congruence of sensible structures and regulations with sound internal practices and vice versa. And
transparency can help achieve this. How gratifying it is, then, that Jan Hommen recently also marked
these terms as overarching principles for the Philips corporate policy. He did so, not only for financial
reporting, but also, if I understand correctly, for the governance structure in general. And as you will
understand from my speech, I would like to congratulate Philips on these outstanding principles and
Jan Hommen on his undoubtedly large contribution to their development. Ladies and gentlemen, thank
you very much.