Establishing a framework for good governance
Operating on a commercial basis, to the highest investment management standards and operationally independent of SG, the Bank will be in a position to make robust investment decisions without undue influence or control from SG. It is important that the day to day management and operational activities be at arms’ length from SG.
The Bank should maintain its mission-led focus over the long-term, having the confidence to operate in areas which the wider market tends not to consider and accepting a different risk profile to other investors. This should be achieved by the Bank following the governing principles and arrangements described below:
- Scottish Ministers should be able to set, monitor and, where appropriate, amend the overall missions for the Bank and the rules or parameters within which the Bank invests, and to fully understand the risk consequences and contingent liabilities which arise from the various missions undertaken by the Bank. SG should do this by establishing a five year Strategic Framework for the Bank to work within
- The Bank should develop its Investment Strategy and Business Plan in response to the Strategic Framework – establishing its priorities within the framework and retaining discretion about what it invests in, when investments should be made and the nature and value of investments. The Investment Strategy should align with the five year period of the Strategic Framework, whilst the Business Plan will be developed and updated annually
- The Bank’s Board will be fully responsible and accountable for the approach taken to delivering its missions
- The Bank should be operationally and administratively independent of SG
- There should be clear reporting and accountability of performance and outcomes, which is supported by an appropriate remuneration framework which promotes and ensures robust risk conforming and independent behaviour by the management of the Bank
- Given its expected mandate from Scottish Ministers, the potential for the Bank to invest with and on behalf of third parties, and the high level of external scrutiny which the Bank is likely to face, it must operate to very high standards of risk management, regulatory compliance and transparency.
The overall nature of the relationship to SG and the governance arrangements should be made clear through the Bill needed to establish the Bank, which will include how the direction will be set by Ministers. The Bill and its accompanying documents should detail the respective roles of Scottish Ministers, the Board and the Executive Management team, and the formal reporting and accountability arrangements
The appointment of the Chair and Non-Executive Directors will be made by the Scottish Ministers, and the board will likely contain a minimum of two Executive Directors (Chief Executive Officer and Finance Director).
The legal structure proposed in Figure 8 reflects the target model suggested for the Bank, and the broad parameters proposed for its relationship with SG.
To ensure that the Bank remains aligned to SG’s economic strategy, it is envisaged that the Bank should be a limited company with Scottish Ministers being the sole shareholder, for the reasons outlined previously. Some of the capabilities envisaged for the Bank include the setting up of subsidiaries for co-investment activity, which should help ensure State Aid compliance and secure appropriate State Aid and Regulatory approvals to carry out the different functions, such as managing investments or making market investments.
As set out in Figure 8, there should be a ‘Top-co’ structure with subsidiaries underneath the parent institution to carry out specific functions and different types of investment activity. This enables appropriate regulatory and State Aid frameworks to be aligned to the functions which each of the subsidiaries are anticipated they will perform. The precise structure, however, will be subject to the Board’s and Ministers’ views.
Figure 8: Example of ' Top-co ' model with different subsidiaries
The Executive Management Team should manage the day-to-day running of the Bank, with the necessary responsibility and autonomy for implementing the Strategic Framework agreed by the Board with Ministers. This should include determining the relationship between the ‘Top-co’ and other parts of the Bank, such as:
- Risk and Compliance: ensuring operation within the Bank’s regulatory framework and managing risk under the scrutiny of the Audit and Risk Committee and, potentially, Audit Scotland
- Financial Management and Treasury: managing the Bank’s balance sheet and ensuring its on-going liquidity, including the management and direction of its budget allocation
- Investment: responsible for implementing the Bank’s investment strategy, for investment recommendations, for decision-making on lending and investing to the extent delegated by the Investment Committee; and for investment execution
- Asset Management: responsible for managing the Bank’s range of investments and loans.
The Bank’s risk culture should inform effective risk management. This should reflect the Bank’s nature of a ‘promotional bank’ business model for which generating profit is not the primary focus. It should also seek to establish a trading book which is inherently stable (insofar as the strategic investments linked to delivery of missions set for it, and its market making role will allow).
The expected high public profile of the Bank, its role and position within wider Scottish society, its anticipated impact on the economy and its mission-orientated mandate all increase the need for substantial transparency, regularity and probity in the way that the Bank operates. It should expect to make much information routinely public, in recognition of the wider public interest in its activities whilst also protecting commercial confidentiality. This should include, for example, information being made public about investment decisions, investment performance, organisational costs, staffing structures and remuneration levels.
Diversity and inclusiveness
Companies across all sectors with the most women on their Boards of Directors significantly and consistently outperform those with no female representation – by 41% in terms of return on equity and by 56% in terms of operating results  . The Bank should play a clear role in promoting diversity and inclusiveness. Included within this there should be an expectation that the Board and Executive Management Team are gender-balanced.
Different groups also face different constraints with regards to access to finance. For example, the ability to access finance has been highlighted by a quarter of women business owners as a key challenge to them starting their own business, and evidence has shown that women on average start their businesses with a third less capital than that of their male counterparts  . The Bank should consider how it could play a role in addressing this challenge.
To help inform the content of SG’s Strategic Framework, including the nature of the identified missions for the Bank, SG should assess the optimal means of consulting with representatives from stakeholders and wider civic society. This report recommends establishing an advisory group, with membership drawn from a cross section of external stakeholders, to advise SG on setting the Strategic Framework and reviewing the performance of the Bank against this framework. It is also proposed that the chair of this advisory group would have a place on the Bank’s Board as a non-executive director member.
The Bank should be a limited company, wholly owned by SG. The Bank should be accountable to the Scottish Ministers for its performance, and through them to the Scottish Parliament. SG should have the ability to set and monitor the overall mission of the Bank.
The Bank should operate at arm’s length from SG, and it should be independent in determining how to develop and market its products and in making investment decisions.
The governance structure of the Bank should have a clear distinction between the roles of the Board (Executive Directors, Non-Executive Directors and Chair) and the Executive Management Team. The Bank will have subsidiaries that would be responsible for various parts of its activities under the overall umbrella of the Bank. This will facilitate regulatory and State Aid clearance for those activities.
The Bank should adopt a leadership role with regards to diversity and inclusiveness. For example, it should have gender balance across its Non-Executive Director Board members and it should seek to engage with a broad range of external stakeholders.
Recommendation 14: As sole shareholder and sponsor of the Bank, Scottish Ministers will need to set the parameters within which the Bank should work. To do this Ministers should set a five year Strategic Framework for the Bank to respond to in its Investment Strategy and Business Plan. The reporting framework should ensure the highest standards of transparency and accountability.
Recommendation 15: The Bank should be administratively and operationally independent of Scottish Ministers. The Board should include a Chair and non-Executive members appointed by Scottish Ministers, and two Executive Directors in the shape of the Chief Executive Officer and Finance Director. There should be an appropriately experienced and professional Executive Management Team.
Recommendation 16: The Scottish Government should consider how best to consult with wider stakeholders on setting the Strategic Framework for the Bank to ensure that there is broad engagement with civic society on how the Bank is operating. This report recommends that an advisory group should be established whose membership comprises representatives from stakeholders and wider civic society. The group should advise Ministers on the Bank’s Strategic Framework. The Chair of this advisory group could be on the main Bank Board as a Non-Executive Director.
Recommendation 17: The Bank should establish and operate to the highest standards of transparency, accountability and management of risk. This should be reflected in the reporting and accountability arrangements to be put in place, and in the formal governance arrangements of the Bank.