Operational Policy of Bank of England - Case Study Example

Gold Dust Industries (GDI) PLC: Case Analysis SECTION A Operational Policy of Bank of England As in the case of any other central bank, the core purpose of the Bank of England is to promote monetary stability and enhance the stability of the financial system. The Bank maintains a well established monetary policy to ensure the monetary stability of the country believing that stable prices and confidence in the currency are particularly important to achieve monetary stability. In the United Kingdom, the government’s inflation target is the basis for defining stable prices, which the Bank tries to achieve through the decisions taken by the Monetary Policy Committee (MPC) (Bank of England, n.d.). Generally the UK monetary policy operates based on the interest rate. Therefore, the Bank of England regularly makes necessary changes to the interest rate considering the contemporary developments and events in the country’s economic environment as well as the global economy. In times of needs, the Bank together with the MPC deploys the tool of quantitative easing (a practice of injecting more money into the economy by purchasing financial assets) to boost economic activities in the country. Currently the Bank of England maintains a liberal monetary policy to boost the country’s economic growth, which was significantly affected by the ongoing economic slack. Recently the Bank established an independent Financial Policy Committee (FPC) through The Financial Services Act 2012 in an effort to address the drastic effects of the ongoing financial crisis (Ibid). The FPC acts as a subsidiary of the Bank and is specifically responsible for the supervision of financial market infrastructure (Ibid). The FPC significantly contributes to the central bank’s financial stability objective through operating as a prudential regulator. One of the major functions of the FPC is to eliminate or minimise systematic risks so as to safeguard and enhance the resilience of the UK financial system (Ibid). This subsidiary of the Bank also strives to back up the economic policy of the government and improve the stability of the entire finical system. FCA response to the gold fixing scandal A deep analysis of the behaviour of the UK Financial Conduct Authority (FCA) on the gold fixing scandal associated with GDI indicates that FCA has not initiated an investigation into gold fixing; however, the FCA considers it as a part of wider examination of financial benchmarks (Reuters, 2014). This is the same stance taken by FCA in case of other large UK banks too. Referring to the words of an FCA spokesperson, it decided to look at other benchmark rats too, including silver, so as to obtain a clear view of the issue. As the manipulation of the benchmark rates can have notable negative impacts on the foreign exchange market as well as the entire economy, FCA considers this issue seriously. However, gold fixing scandal is not a new issue as it has been practiced by bankers for over a century. In addition, this issue is prevailing in the aluminium and gold commodities market too. Therefore, the FCA thinks a single investigation into the gold price fixing would not eliminate the benchmark manipulation issue existing in the country’s foreign exchange market. This authoritative body believes that a comprehensive investigation over the setting of benchmarks will be more helpful to determine whether the benchmark rates, including gold benchmark rates, are being set properly in the wake of the Libor scandal (Samuel, 2014). Corporate governance failures While analysing the article titled ‘Banks Price Fixing Scandals – A case of ‘Gold Dust Industries (GDI) Plc’, it seems that unfair CEO compensation, poor foreign exchange practices, and unethical business operations are the major corporate governance failures included in the work. CP FUTURES (CPF) maintains a performance based pay system so as to keep the workforce motivated. The CPF’s top management personnel received a substantial portion of cash compensation reflecting their contribution to the firm’s net profitability. It is really suspicious to note that the company’s 94 percent of discretionary bonuses and share-based payment was paid to the CEO. This performance related pay structure of CPF may not necessarily meet the actual intentions of the firm as persons at the helm of affairs – who are authorised to distribute discretionary bonuses and other cash benefits – often try to serve their personal financial gains. Similarly, there is evidence of poor corporate governance with regard to foreign exchange management. To illustrate, CPF suffered huge losses when its share price dropped by 92 percent, falling from HK$43 to HK$3.66, as a result of a foreign exchange scandal. This substantial decline in share price could be attributed to “unauthorised betting on foreign exchange derivative contracts”. “CPF’s cash projections were denominated in USD, but these expenses were paid in Australian dollars and Euros, thus exposing CPF to fluctuations in foreign exchange rates” (GDI Case study). Finally, unethical business practices like Libor fixing reflect corporate governance failures. The GDI admitted that it had manipulated Euribor and Tibor, the equivalent interest rates of Eurozone and Tokyo respectively. Evidently, this unethical business practice had negative impacts on GDI’s corporate reputation. The GDI’s 9 of 12 directors are independent. The company believes that such a structure of board of directors would assist the organisation to obtain a strong independent oversight of its financial performance and senior management. An active senior independent director is responsible for forming independent oversight of crucial areas such as CEO compensation, succession planning, and risk management. Although this approach is beneficial to gain an independent oversight in all key areas, it may lead to great conflicts between the members of board of directors and/or the management team and directors. Organisations like GDI face many challenging when they do business across sectors and countries. Unexpected and huge fluctuations in foreign exchange rates seem to be the greatest challenge because this issue may result in huge financial losses. In addition, absence of a commonly accepted accounting system worldwide also raises potential challenges to firms operating globally. SECTION B Role of GID Board of Directors As discussed in the Section A, the GDI Board of Directors supports independent leadership so as to gain an independent oversight in various key management areas. From the article, it is clear that GDI encourages independent leadership to make sound decision regarding strategy and risk management. The nine independent directors together with the other three discuss various elements concerning the company’s commodities pricing and internal control systems. The GDI Board of Directors also depends on outside agencies to make receive potential suggestions and to make best decisions on certain areas of management. Engaging outside consults will be a better option for GDI because they are more informed of commodities pricing and hence their assistance can benefit the company to gain improved oversight of commodities pricing. The GDI Board of Directors has formed four committees such as audit; compensation; corporate governance, nominating and public responsibilities; and risk committees. Each of the four committees is solely formed of independent directors. The risk committee is responsible for taking decisions regarding internal control systems, the key function of which are to ensure the prevention of fraud and errors. Since the scope of financial fraud is increasing today, internal control systems must be advanced enough to prevent new forms of fraud. Here the concept of independent leadership can better serve the GDI to develop well designed internal control systems. Importance of managing specific risks According to Hirschey (2010, p. 5.2), in finance, a specific risk can be defined as a risk that impacts a particular group of assets. Specific risk is sometimes termed as unsystematic risk. In contrast, generic risk or systematic risk is common to the whole business, and an experienced manager can easily address generic risks. The major difference between generic risk and specific risk is that the former is predictable in nature whereas the latter is unpredictable. To illustrate, news specific to a company, such as loss of patent or occurrence of natural disasters, may represent unsystematic or specific risk. It is particularly important for managers to give first priority to managing specific risks over generic risks for several reasons. As noted already, an experienced manager can effectively address generic risks as they are predictable, but it is not the case of specific risks that are unpredictable. A specific risk can often affect the operational efficiency of the whole business and sometimes that situation would end up in a business failure. As compared to generic risk, it would be difficult to manage the consequences of a specific risk and therefore the organisation will probably take a relatively long time to completely get rid of the impacts of the risk. From the given article, the strong concerns regarding environmental impacts of the plan to build a fourth runway in the Inner City Airport seem to be a specific risk to the GDI. It is clear that the GDI management had not expected such a risk when they planned this construction project. Environmental campaigners and residents argued that the proposed project would increase noise pollution and worsen traffic congestion and thereby reduce the value of surrounding properties. Undoubtedly this specific risk would seriously affect the feasibility of the planned project unless the issue is resolved diplomatically. GDI compensation system While analysing the case study, it is obvious that the compensation system of GDI and its subsidiary CPF has notably influenced the risk appetite of their executives and corporate governance structures. As already identified, the firm follows a pay-for-performance culture so as to promote employee motivation and to foster risk taking. CPF’s top management personnel including CEO received a substantial portion of cash compensation and other discretionary benefits. In addition, the company traders and other managerial persons are compensated accordingly. The CPF’s compensation strategy is similar to that of the GDI group and it has been approved by the board. When there is a performance based pay system in operation, employees and top executives will be highly motivated to achieve their targets and to improve their productivity constantly. Naturally, this increased motivation would persuade management personnel to take excess risk and to increase the level of remuneration. Sometimes managers may even engage in unethical business practices to increase the overall productivity of the organisation. For instance, GDI executives’ increased desire for compensation is the major reason the firm was involved in the issues like Libor scandal, gold price fixing scandal, and aluminium price fixing scandal. Recently media reported that GDI has agreed to pay $1.5 billion to United States and European regulators in an attempt to manipulate the Libor, the London inter-bank offered rate (GDI Case study). GDI has already admitted that they had manipulated Eurozone and Tokyo equivalent interest rates. The organisation engaged in the Libor scandal mainly to inflate its profits and to strengthen its financial position particularly during financial crises. Similarly, the banking giant GDI holds a significant percent of aluminium available in the US market as the recent global recession nearly doubled the quantity being warehoused. The firm was accused of moving aluminium commodities back and forth between warehouses and making money from rent charges. The company’s compensation structure is the major reason GDI executives tried such unfair business practices to maintain profitability. In addition, it was alleged that market making banks including GDI “abused the window between setting the price and the price becoming public and take profits on their accounts” (GDI Case study). Today major banks such as GDI contact on a daily basis to mutually decide the benchmark price of gold. It is evident that GDI takes all these efforts as the firm’s top executives have been extremely motivated by the element of executive compensation. Although the firm’s current compensation system is capable of keeping executives highly motivated, it often results in unintended outcomes. SECTION C Bank stakeholders and the concept of CSR Referring to the stakeholder theory, it can be stated that stakeholders of banks cannot be just limited to shareholders but also include customers, employees, suppliers, creditors, banking and financial institutions, government, and the community. When it comes to GDI, the stakeholder groups include shareholders, customers, suppliers, aluminium and gold industries, US and European regulators, residents near the Inner City Airport, environmental activists, and the society. Corporate Social Responsibility, commonly abbreviated as CSR, is a modern business concept associated with corporate governance. The concept of CSR can be simply defined as a corporate initiative to improve a firm’s operational effects on the environment and the social welfare. According to the United Nations Industrial Development Organisation, CSR is a new management concept whereby business houses increasingly focus on social and environmental concerns while operating their business and interacting with their stakeholders (UNIDO, n.d.). Generally CSR activities mean organisational efforts that go beyond what would be expected by regulators and environmental campaigners. CSR is sometimes referred to as ‘corporate citizenship’ and this concept may cause companies to incur short term costs that do not offer immediate financial gains but deliver long term positive impacts in terms of brand dignity and corporate stature. CSR can be perceived as a way through which an organisation promotes balance of economic, environmental, and social imperatives and meets the expectations of stakeholders (Ibid). It is important to note that there is a clear distinction between charity and CSR. Charity is simply a concept of devoting money and time to meet fundamental human needs like food, water, clothing, and shelter whereas CSR is purely a strategic business management concept. Although concepts like charity, philanthropy, or sponsorship may also assist a company to significantly contribute to social wellbeing and to strengthen its brand image, the concept of CSR is still something beyond such practices. It is a common misperception that CSR focuses only on environmental sustainability but actually it addresses broad areas including worksite conditions, employee relations and welfare, social equity, gender balance, corruption, and human rights. A company that follows a properly implemented CSR strategy can enjoy competitive advantages such as increased access to capital markets, low operational costs, enhanced net profitability, high productivity and quality, potential human resources, improved brand loyalty, and reduced promotional costs (Ibid). Press statement GDI is a company which is always committed to enhance the community living standards and address the growing environmental concerns. The company will not under any circumstance, compromise it’s stated environmental standards for the purpose of achieving improved profitability or market coverage. In order to address the strong environmental concerns of residents and activists, the company will perform a comprehensive environmental audit ensuring active participation of community representatives and campaign leaders. A well planned environmental audit is a good technique to identify environmental compliance and to frame appropriate corrective actions (Nag, 2005, p.10). While describing an environmental audit, it is essential to explain the term ‘protocol’ which indicates the guidelines used by environmental auditors as part of conducting audit activities. Since there are no standard protocols, it is left to companies to design their own protocols to meet particular environmental compliance requirements. The organisation will ensure active stakeholder participation while developing the environment audit protocol with the help of audit firms. Furthermore, the GDI management has planned to complete the environment audit at the possible earliest time and to publish the audit report to communicate the results to the public. Referring to previous corporate experiences, introduction of environmental accounting or reporting can bring great benefits to GDI Group, specifically the Inner City Airport. It is obvious that a well prepared environment report would assist the GDI Group to keep its stakeholders well informed of the potential impacts of the firm’s operations on the environment and the measures taken by the company to eliminate or minimise the impacts. Godschalk (2008, p. 262) says that environmental accounting may also benefit the organisation to show its compliance with the environmental standards in practice and hence to ensure public support. Once the residents and environmental campaigners have realised the firm’s commitment to the growing environmental needs, the organisation can go on with the planned construction project with great public co-operation. An effective environmental reporting can also help the organisation to improve its environmental performance, which in turn would assist the GDI Group to achieve cost savings and to enjoy government assistance. Finally, environmental accounting is also beneficial for the company to deal with employee recruitment and retention successfully because today’s candidates are really conscious about CSR (nibusinessinfo.co.uk, n.d.). In the context of growing environmental concerns regarding construction and transport, a new concept called environmental footprint has been developed. “An environmental footprint is the measure of land and other resources consumed to provide one individual, endeavour, industry, or nation with their needs, wants, and desires” (Patrick, 2007). This technique can be used to measure the land/resources that would be consumed by the GDI Group if it proceeds with the planned construction project at the Inner City Airport. Evidently, the environmental footprint would assist the organisation to keep its stakeholders informed of the possible environmental consequences of the runway construction and to address misleading environmental campaigns against the project. References Bank of England. (n.d.). ‘The Banks Financial Stability Role’. Available http://www.bankofengland.co.uk/financialstability/pages/default.aspx [accessed 9 May 2014]. Godschalk, S. 2008. “Does corporate environmental accounting make business sense?” In Environmental Management Accounting for Cleaner Production. S. Schaltegger (Ed.). US: Springer. GDI Case Study. Hirschey, 2010. Investments : Analysis And Behavious. New Delhi: Tata McGraw-Hill Education. nibusinessinfo.co.uk. “Benefits of producing environmental reports”. http://www.nibusinessinfo.co.uk/content/benefits-producing-environmental-reports [accessed 9 May 2014]. Nag, A. 2005. Environmental Education And Solid Waste Management. UK: New Age International. Patrick, K. 2007. “Plastic Membrane Will Help Filter Toxic Chemicals”. Yahoo Voices, Oct 18. [online] available at: http://voices.yahoo.com/plastic-membrane-will-help-filter-toxic-chemicals-610231.html?cat=15 [accessed 9 May 2014]. Reuters. 2014. “UPDATE 1-London gold-fix banks accused of manipulation in US lawsuit”. [online] available at: http://uk.reuters.com/article/2014/03/05/gold-fix-idUKL6N0M224C20140305 [accessed 9 May 2014]. Samuel, J. 2014. “Whiff of gold price rigging”. The Telegraph, April 28. [online] available at: http://www.telegraphindia.com/1140428/jsp/business/story_18285827.jsp [accessed 9 May 2014]. UNIDO. (n.d.). “What is CSR?” [online] available at: http://www.unido.org/en/what-we-do/trade/csr/what-is-csr.html [accessed 9 May 2014]. Read More