An understanding thereof warrants general knowledge of the definitions of the two terms themselves, Regulation and Governance, which can then be contextualised as required.
For purposes of this article, we will define regulation as any and all rules and directives devised at a statutory level to support the existence of economic actors. Governance can then be considered as the interactive processes and systems facilitating the decision-making in, as well as the accountability and control of, the stated economic actors. For a basic grasp of their relationship, we will consider firms with fiduciary responsibilities within the financial sector such as pension funds. Financial institutions such as banks will also be referenced for clarity.
Despite the differences in the structures of markets in different economies, as well as the varied regulatory regimes therein, it is generally agreed that there are three basic forms of regulatory supervision: prudential supervision, conduct supervision as well as material supervision.
Prudential supervision entails the oversight of standards relating to aspects such as the financial soundness of institutions and how this financial soundness would proceed to impact the financial stability of the sectors in which these institutions exist, in their entirety. An example in this respect would be the oversight by the reserve or central bank of retail banks. Limits may be set by the central bank on the levels of permissible risk, leading to corollary governance decisions, within the financial institutions, that ensure balances between assets and liabilities thereby promoting alignment with the overarching concept of banking prudence.
Conduct supervision entails insight into the operations of varied firms. For firms with fiduciary responsibilities such as pension funds which have a duty to beneficiaries, conduct supervision would relate to oversight of the particular defined-benefit and/or defined-contribution offerings made available by these institutions. Another instance would be mutual funds where there may be overarching security-type regulations relating to the nature of the financial instruments being offered within the bundles and baskets agreed upon at governance levels in the particular firms. Conduct supervision furthermore includes oversight of the information afforded to investors who have entrusted such asset management firms and pension funds with their monies. Is timely information availed to investors in a clear and intelligible format to avoid information asymmetry? Conduct supervision further addresses issues related to compliance to standards set for the operations of the said organisations. In multiple jurisdictions, the Non-Bank Financial Institutions Regulators have such elements within their purview and their dictates consequently have a significant impact on the governance of firms operating in specific sectors.
Material supervision can be seen as a residual supervisory category where aspects that may not relate specifically to financial soundness, risk levels, prudence, information availability and compliance can be supervised. Despite being ‘residual’, the importance of this category must not be undermined as it entails supervision of aspects material to the existence, operations, and governance of the various organisations, nonetheless. It must be borne in mind that organisations operating within the financial (and other) sector(s) have a plethora of auxiliary regulatory dictates to adhere to as outlined, for instance, in the different Companies’ Acts, Labour and Employment Acts, taxation provisions as well as the environmental, health and safety provisions in the jurisdictions that they operate. Such aspects have a bearing on governance decisions. The varied regulatory bodies responsible for such aspects are continuously required to undertake throughgoing and comprehensive supervision in this regard.
Governance designates have the crucial responsibility of ensuring that their internal governance frameworks have considered the regulatory instruments that exist within their operational territories for streamlined operations, conformance and for sustainability purposes. During the formulation of frameworks, Boards of Directors and Chief Executive Officers must ensure that their agreed systems comport with prevailing legislative frameworks. Overall, an understanding of the relationship between regulation and governance can assist, not only for supervision of the firm by regulators, but also in strengthening of existing governance systems as well as with remedy and realignment of governance systems where indicia of misalignment become evident.
The views and opinions expressed in this article are those of the author, Dumisani F. Ntini – Governance and Strategy Practitioner. Contact Global Governance Group; firstname.lastname@example.org. Visit www.governancegroup.org.
LinkedIn: Dumisani F. Ntini