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Welcome to the brand new HQN governance toolkit. This shorter and updated edition will help you start to ask the right questions about how well your board is doing and think about what you need to do differently. It is certainly a tough time to be a board member. We know there aren’t nearly enough homes. That puts pressure on associations to build. But you can’t do it the old way anymore. Grant levels are down, you need to look at new forms of finance and rents need to be higher to make the whole deal work out. At the same time tenants are losing income due to welfare reform. We will almost certainly see higher rent arrears. What will this do to your association’s finances? Associations are trying to plug the gap by going into new business areas. The Homes and Communities Agency (HCA) wants to make sure that any risks you take do not rebound on social housing. They are coming down hard on associations whose reach exceeds their grasp. We are seeing downgrades for: Botching mergers Losing money on new business like student housing, PFI and management contracts Failing to understand the terms of loans Managing development poorly Making over optimistic assumptions about the returns from sales of new homes. To be fair, you would expect a few casualties as associations grapple with new forms of risk. But it’s not all cutting-edge stuff. It is amazing how often associations lose ratings for failing to stick to their own rules. We would advise you to read your code of governance before the HCA does. Make sure that board members don’t stick around for longer than your rules say they can. One response to the new world is to stick your head in the sand and hope it all goes away. It might well be sensible to proceed with caution just now. But if you just cut to the bone, are you really serving your communities well? What is the difference between you and the fast growing private rented sector? It is not all doom and gloom. Some associations are getting stronger and stronger. Why do they get it right while others flounder? It is not very hard to work out the secret of success. 2 – Governance: the essential tools of the trade

‘Post-merger, insufficient priority was given by the group board in reviewing existing strategies or group decisions’ – HCA regulatory judgement


There are three main explanations: They have good people with lots of experience – they have been over the course before They are in markets where it is possible to be successful – some activities in some areas will never work They spot problems with themselves before anyone else does and take action to sort things out early. Our toolkit asks you questions to help you to work out if you have these ingredients in place – and how to work through any problems.

‘The organisation lacked a sufficiently robust internal control framework during a period of significant change’ – HCA regulatory judgement

Themes from recent regulatory judgements So let’s take a look at what the HCA has been saying recently. Regulatory judgements are now very succinct and cover only governance and finance (viability) issues. Separate ratings from 1 (high) to 4 are given for ‘properly governed’ and ‘viable’. Let's look at some of the problems the HCA spotted that led to downgrades. Taking your eye off the ball Big structural changes, especially mergers, are fertile ground for the kind of mistakes that might not have happened if participants were not dealing with several changes at the same time. Similarly, diversification into new business areas, new types or scale of development and failure to deal with new external pressures in parallel with current ones all lead to problems. Examples include: The board gets distracted by the process of merger and fails to control the future direction of the new organisation Rushing for development without proper examination of risk on cross-subsidy from sales Ambitions for growth not underpinned by proper assessment of wider issues such as the state of the housing market Taking on new contracts and growth commitments without a strong strategic framework and with limited existing capacity.

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Good practice: ‘The business plan includes a significantly increased bad debt provision to offset the potential rent losses following from [welfare] reforms’ – HCA regulatory judgement


Good practice: ‘The regulator’s previous assessment identified four specific risk exposures … the regulator is satisfied that the financial plans are consistent with the financial strategy. Its business plan is fully funded and adequate security is in place. It has been tested to demonstrate that it meets funders’ covenants under a variety of realistic scenarios.’ – HCA Risk Does the HCA want associations to be bold and take on greater risk, or play safe with social housing assets? Delivery of new housing, underpinned by making the most of existing assets, is a government priority, but the commitment of those assets is also an increasing cause for concern. Unregistered subsidiaries and their effects on social housing assets are set to be a continuing regulatory problem. Even if you think you have insulated the social assets because you have not used them as security for the unregistered business, problems in that business can still spill over into the group as a whole. Examples from the judgements: Failure to examine previous decisions and commitments of pre-merger organisations Failure to understand the extent and nature of financial risks faced, especially with unregistered subsidiaries Complexity of loan financing not fully understood Lack of systems to identify and manage financial exposure, particularly combined exposure to, eg, changing cost of financing and RPI; increased cost of derivatives affecting liquidity and requiring additional security Care and support features in several judgements: -

Exposure to the changing external political and economic environment Slowness of reaction to changes in customer demand, and ability to take action to stem losses.

Good practice: ‘The business plan had limited headroom and was therefore susceptible to adverse economic or policy changes…the organisation has increased its loan facilities…this provides additional headroom.’ – HCA

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Functioning of the board This, of course, is where all the problems start. Some of the issues will be politically difficult – what size should the board be? Others are about having the right mix of skills and experience and others are about the quality of board discussions when they do take place. Typical problems include: Poor quality reporting to the board, late alerting to problems, inadequate or broken down financial reporting systems Lack of oversight of the treasury function – of deals being made and of alternative sources of finance Lack of oversight of development function Failure to challenge officers Inadequate internal audit (or none at all), with a lack of board recognition of its value Lack of external input to reviews of board effectiveness and appraisal Not matching skills and expertise to current demands and activities, lack of succession strategy. Especially problematic issues include: Groupthink: failure to follow own code of governance, eg, board members serving too long, case for payment of board members not being substantiated, frequency and quality of appraisal Board being too large to function properly as a team Collective optimism: issues over-simplified, ‘rudimentary sensitivity analysis’, use of complex financial tools without full understanding. And the one most likely to bring the HCA to your door: Failure to provide adequate assurances of competence to the regulator, lack of transparency, late notification of problems.

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‘The development department was allowed to operate almost in isolation’ – HCA regulatory judgement


The snowball effect All of these problems could be dealt with if they occurred in isolation. But in some cases the damage was done by the initial attempt to put things right. In others, it’s the impact of new situations when the organisation is already in difficulties. In one case, the HCA said, problems arose from the ‘combined effect of efforts to stem existing losses and the impact of welfare reform’. In fact, welfare reform emerged as the impending problem for many. Where property has already been sold to balance the books or put up as extra security for loans, the ability to absorb even temporary further losses from welfare benefit changes is reduced.

Governance worksheets Now over to you. The questions below are designed to get you thinking about key governance issues, particularly ones raised by recent regulatory judgments. The most important questions about effective governance cannot easily be reduced to yes or no answers. These are issues you need to reflect on, and then explore further in discussion with others. Identify two or three other board members to share the exercise with. Complete the questions individually and then come together to share your answers and consider what they are telling you. We recommend using separate sheets of paper to fully respond to the questions.

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‘The regulator feels the independence of the board could be compromised by a lack of challenge to long-standing practices and thinking’ – HCA regulatory judgement


1

Setting objectives

Question

Response

What are your organisation’s three most important objectives?

For each of these objectives, how will you know if you are achieving them?

For each of these objectives, how will you know if you are failing to achieve them?

Compare the answers Do you have a clear, shared consensus or is there more work to do before you have an agreed set of priorities? Do you know how you are going to monitor progress? Are the measures specific and objective enough?

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2

Scanning the environment

Question

Response

What sources of information about the sector and your performance do you rely on other than internal briefings and papers?

Can you identify examples of board members using an external perspective to question or challenge officers over the last six months?

Compare the answers How well does the board fulfil its challenge role? It could be that the executive does their job well and has all the answers – how would you know if they lost the plot and what would you do about it? Should you be making more use of any of the following: -

Contact with other board members? Residents’ forums? Tenant contact? Independent advisors? Internal audit? Stakeholder views?

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3

Growth and risk

Question

Response

Identify the main features of your growth strategy (if you have one).

For each of these can you identify the range of potential profit or loss they could create in a) the next 12 months and b) the next five years. If the answer is yes, have a shot at putting the figures down.

How do you know the projections you have are not over optimistic?

Do you know what the impact of welfare reform and other government spending cuts will be on your particular organisation? If you answer yes, put down the figures.

Compare your answers If you don’t know what the impact of any of these will be, how do you find out? If you do know, do you all have the same picture? Is any of it too good to be true? Do you have a clear picture of how your ambition compares to your capacity? What about the other risks – contractual obligations, employment obligations, new partners, people you know less well?

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4

Your meetings

Question

Response

Over the last two meetings, did everyone contribute? Did anyone dominate?

What was the balance between listening to presentations and active questions and discussion?

What was the balance between strategic discussion and discussion about detail?

Do performance reports compare performance to target, trend and sector benchmarks?

Compare your answers How well are your meetings chaired? Are key performance indicators identified for all areas of the business? Do the papers get you to the heart of the issues or is there too much detail, background, context, waffle?

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5

Code of governance

Question

Response

What does your code of governance say about terms of office?

What is your policy on succession and recruitment of board members?

List your particular area of expertise and then list those of your colleagues? Are there any gaps?

What is the board members’ input into your own training and development plan?

What are the appraisal arrangements for: Individual board members? The chief executive? The chair? The board overall?

Compare your answers Do you know what your own rules are? Do you follow them? Is turnover about right or could you do with either more stability or more fresh thinking? What are the skills gaps? Who brings a sense of challenge to the majority view? Is there an element of reality check in the appraisal process or is it just a cosy chat? What are the outcomes of the appraisal process and who are they reported to?

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Find out more HCA regulatory judgements are found at: www.homesandcommunities.co.uk/ourwork/regulatory-judgements Regulatory standards are set out here: www.homesandcommunities.co.uk/ourwork/standards HQN publishes briefings on regulation systems and issues: www.hqnetwork.co.uk/briefings Walker Review of corporate governance of banks (see Annex 4 on psychological and behavioural elements in board performance): http://webarchive.nationalarchives.gov.uk/+/http:/www.hmtreasury.gov.uk/d/walker_review_261109.pdf

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Help from HQN We hope this free toolkit helps you a lot. If you want any more assistance do please contact HQN. We work for lots of boards just like you at associations and ALMOs. Our work includes: Board recruitment and appraisal Executive recruitment (permanent and interim) Governance reviews Board member coaching Training on the responsibilities of board members Training on regulation, health and safety and effective team work Strategic briefings Away days (these can be based on the questions and exercises from this toolkit) Stakeholder surveys Reviews of standing orders Mediation. Please contact Anna Pattison on 01904 557197 or email anna.pattison@hqnetwork.co.uk for more information. Have a look on our website for the latest updates www.hqnetwork.co.uk. Read our magazine for board members and executives – The Governor http://www.hqnetwork.org.uk/governor.

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14 – Governance: the essential tools of the trade

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