UK Combined Code on Corporate Governance

The CFS Group comprises CFS, Co-operative Insurance Society Limited, CIS General Insurance Limited and The Co-operative Bank p.l.c. The latter is a listed company and its compliance with the Combined Code (the ‘Code’) is detailed in its Financial Statements. The other three are Industrial and Provident Societies. Although compliance with the Code is not mandatory for an Industrial and Provident Society, the CFS Group believes it is appropriate to comply in so far as that the Code is applicable to an Industrial and Provident Society and the purpose of this report is to give an overview of the compliance of the CFS Group as a whole.

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Responsibility of the CFS Board

The Directors are committed to leading and controlling the Society effectively. The Board is responsible for the success of the Society within a framework of controls, which enables risk to be assessed and managed. It is responsible for setting strategy, maintaining the policy and decision making framework in which this strategy is implemented, ensuring that the necessary financial and human resources are in place to meet strategic aims, monitoring performance against key financial and non-financial indicators, overseeing the system of risk management and for setting values and standards in governance matters.

The responsibility of the CFS Board is to direct the business of the Society, and in particular to:

• ensure that the Society’s affairs are conducted and managed in accordance with its Rules and the best interests of its stakeholders within the ethics and values of co-operative principles;
• agree objectives, policies and strategies and monitor executive management;
• determine the vision and strategy of the Society in consultation with the Chief Executive and the Executive;
• approve the annual budget and business plan;
• approve the reported financial statements and dividends;
• monitor, through various Committees, the key significant risks facing the Society;
• establish Board Committees; and
• approve the delegated financial authorities.

The Board manages these matters at its regular Board and strategy meetings and details of attendance are noted. It has met eleven times in 2007. The Board is scheduled to meet for eleven Board meetings and two strategy meetings in 2008.

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Board balance and independence

The Board currently comprises thirteen Non-Executive Directors and three Executive Directors.

The Board has appointed four Independent Professional Non-Executive Directors as defined under the Combined Code: David Davies, Robert Newton, Piers Williamson and Graham Stow. On 23 February 2005, the Board appointed David Davies to be the Senior Independent Director.

The Code requires at least half of the Board, excluding the Chair, to be independent non-executive directors. In accordance with the Code, it is for the Board to consider whether a Director is independent in character and judgement and whether there are any relationships or circumstances which are likely to affect, or could appear to affect, the Director’s judgement. The Board has concluded that, looking across the wider Co-operative Group, Co-operative Group Regional Directors (unless employees within the last five years) should be defined as independent while those representing corporate members of the Co-operative Group could not be so categorised in the Co-operative context. This was because the latter represented significant ‘shareholders’ with material business relationships. Throughout the year the Board at CFS has met the Code requirements on the independence of directors.

With the exception of Graham Bennett and Bob Burlton, who represent corporate members of the Co-operative Group, Martin Beaumont who, until his resignation from the Board on 31 July 2007 was Chief Executive of the Co-operative Group, Martyn Wates, appointed on 13 November 2007 and who holds an executive appointment in the Co-operative Group, and Paul Hewitt who was, until 28 July 2007, Deputy Chief Executive of the Co-operative Group, the Board has determined the remaining five Non-Executive Directors: Simon Butler, Terry Morton, Kathryn Smith, Len Wardle and Stephen Watts, being Regional Directors of the Co-operative Group, to be independent. Together with the Independent Professional Non-Executive Directors, the balance of the Board meets with the Code’s requirements. The Board believes that all the Non-Executive Directors have considerable experience and make valuable contributions to the operation of CFS.

The Board Non-Executive Directors constructively challenge and help develop proposals on strategy and bring strong, independent judgement, knowledge, and experience to the Board’s deliberations. The Non-Executive Directors are of sufficient calibre and number that their views carry significant weight in the Board’s decision making.

The composition of the Boards of CFS, the Bank, CIS and CISGIL (which collectively operate the financial services business of the Co-operative Group) have been organised so that there is common membership of each. CFS does not comply with the Combined Code principle that all directors should be submitted for reelection at regular intervals and that no non-executive director should serve a term of greater than nine years. This is in part due to the method of appointing directors by the Co-operative Group. However, Board composition, and the process for refreshing it, is under review currently

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Board procedures

Board and Committee papers are distributed at least one week in advance of meetings. This provides the opportunity for Directors to prepare fully for meetings. The minutes of all meetings are circulated to all Directors.

There is regular communication between the Directors, the Chair and the Secretary between meetings.

When a Director is unable to attend Board or Committee meetings, issues can be relayed in advance to the relevant Chair. Written questions for management on papers are encouraged from Directors between meetings. A rolling schedule of matters arising from Board and Committee meetings are followed through.

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The Roles of the Chair and Chief Executive

The division of responsibilities between the Chair of the Board and the Chief Executive is clearly defined and has been approved by the CFS Board.

The Chair is a Non-Executive Director. He leads the Board in the determination of its strategy and in the achievement of its objectives. The Chair is responsible for organising the business of the Board, ensuring its effectiveness and setting its agenda. He has no involvement in the running of the day-to-day business of CFS. The Chair facilitates the effective contribution of Directors and constructive relations between the Executive and Non-Executive Directors, ensures Directors receive accurate, timely and clear information and facilitates effective communication with members.

Details of the Chair’s professional commitments are included in the Chair’s biography. The Board is satisfied that these responsibilities do not interfere with the performance of the Chair’s duties for the Society.

The Chief Executive has direct charge of CFS on a day-to-day basis and is accountable to the Board for the financial and operational performance of CFS.

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Board Committees

With the agreement of the Financial Services Authority (FSA), the Board has delegated certain responsibilities to the following Committees, all of which have written terms of reference covering the authority delegated to it by the Board, copies of which are available from the Secretary on request. Each of these Committees has a role in overseeing the Society and its subsidiaries. A provision of the Code is that the terms of reference for the remuneration committee and the audit committee are available on the Society’s website.

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Remuneration and Appointments Committee

The CFS Remuneration and Appointments Committee meets as a joint Committee for CFS, CIS and the Bank. The Committee currently comprises seven members and is chaired by the CFS Chair, Bob Burlton. During the year the Committee also comprised Martin Beaumont (who resigned from the Board on 31 July 2007), Graham Bennett, Simon Butler, Terry Morton, Kathryn Smith, Graham Stow and Len Wardle. The Committee’s role in respect of the Executive and Executive Directors, is to determine remuneration and employment policy, oversee contractual arrangements, review salaries, approve incentive schemes and any payments made under such schemes and recommend appointments to the Board. In respect of Directors, the Committee makes recommendations to members in a General Meeting for decision. The Committee is supported by the Co-operative Group Remuneration and Appointments Committee in ensuring consistency, where appropriate, across the wider Group. The Committee is responsible for overseeing succession planning. It uses external consultants for the appointment of the Executive and Independent Professional Non-Executive Directors. Directors are appointed by the Co-operative Group. The Committee met eight times during 2007, as detailed in the Remuneration report.

The Combined Code provides that all members of the remuneration committee should be independent non-executive directors and that a majority of members of the nomination committee should be independent non-executive directors. The CFS Remuneration and Appointments Committee fulfils the role of both these committees. The Code also provides that the Chair of the Board maybe a member of the remuneration committee but not chair it unless he is considered independent on appointment as Chairman. Bob Burlton is not considered independent. The arrangements for chairing the Remuneration and Appoints Committee are being reviewed in 2008, as part of a wider review of Board effectiveness.

The Committee members are all Non-Executive Directors, one of whom is an Independent Professional Non-Executive Director. They have no personal financial interests in the Committee’s decisions, and they have no involvement in the day-to-day business of CFS or its subsidiaries. Bob Burlton and Graham Bennett are not considered ‘independent’ based on the statement agreed by the Board. Whilst the independence criteria provision, of the Code, for a remuneration committee is not met, a majority of the members of the Remuneration and Appointments Committee are independent and it is felt that the Committee has a sufficient level of independence to discharge its duties.

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Chairs’ Committee

For consideration of urgent business between meetings, a Chairs’ Committee can stand. The Committee meets on an ad hoc basis. The Committee met three times during 2006. The Committee comprises the Chair, the Chief Executive, the Deputy Chairs, and the Senior Independent Director.

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CFS Exposures Committee

The Committee comprises seven members and is chaired by the Bank Chair, Graham Bennett. During the year the Committee comprised of Kathryn Smith, Stephen Watts, Piers Williamson, David Anderson, Kevin Blake (who is not a Board Director), Bryan Portman (who resigned from the Committee on 5 September 2007 and was not a Board Director), and Martyn Wates (who was appointed by the Board on 21 November). Keith Alderson (Director of Corporate Banking) usually attends the meetings by invitation.

The Committee met ten times during the financial year. The main responsibilities of the Committee are to:

• approve all Bank advances in excess of the delegated lending authority of the Chief Executive;
• review all decisions taken within the delegated authority of the Chief Executive or any individual Executive by way of Noting Returns;
• review and approve management actions on excess positions on lending exposures, which exceed the Chief Executive’s discretion;
• review and approve management actions on excess positions on investment exposures, which exceed the Chief Executive’s discretion;
• review and approve management actions on individual counterparty positions on the High Risk Exposures Return, where Credit Committee determines that these should be escalated;
• review and approve management actions on any other positions which the Credit Committee or the Heads of Risk and Capital Management determine should be brought to its attention; and
• review and approve any reports required to be scheduled as part of Board policies.

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CFS Audit & Regulatory Compliance Committee

The CFS Audit & Regulatory Compliance Committee meets as a joint committee for CFS, CIS, CISGIL and the Bank. The Chair of the Committee is Graham Stow, an Independent Non-Executive Director. The other members of the Committee are Tony Lancaster (who retired from the Board on 13 June 2007), Terry Morton, Kathryn Smith, Len Wardle (who retired from the Committee on 7 November 2007), Robert Newton (who was appointed to the Committee on 5 September 2007), and Paul Hewitt. Paul Hewitt brings recent and relevant financial experience.

The Committee met four times during the financial year. The main responsibilities of the Committee are to:

• review and discuss with management and auditors the preliminary results, interim information and annual financial statements of CFS and its subsidiaries before submission to the respective Boards;
• review, prior to its consideration by the Boards of CFS and its subsidiaries, the external auditor’s reports to the Directors and Management's response;
• receive reports on activities and note the minutes of the CFS Risk Management Committee;
• consider any necessary disclosure implications of the process that has been applied by the Boards to deal with material internal control aspects of any significant problems disclosed in the Financial Statements;
• obtain assurance that CFS and its subsidiaries are compliant with relevant regulation;
• review and discuss, with the CFS Director of Compliance, the issues identified as a result of compliance work and how management is addressing these issues;
• monitor regulatory relationships, in particular, with the Financial Services Authority;
• review co-ordination between the internal and external auditors and, where relevant, the risk management functions;
• monitor and assess the role and effectiveness of the Internal Audit function; and
• review the annual statements on internal control of CFS and its subsidiaries and their compliance with the Combined Code or subsequent corporate governance guidance (as applicable) prior to consideration by the Boards; and in particular where requested by the Boards

During the year, the Committee has reviewed its own effectiveness.

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CFS Risk Management Committee

The CFS Risk Management Committee meets as a joint committee for CFS, CIS, CISGIL, and the Bank. The Chair of CIS, Simon Butler, chairs the Committee. The other members of the Committee are David Davies, Mike Fairbairn (who is not a Board Director), Paul Hewitt, John Reizenstein, Piers Williamson, and Craig Shannon (who was appointed to the Committee on 4 March 2007 and resigned from the Board on 20 August 2007). The Committee met seven times during the financial year.

The main responsibilities of the Committee are to:

• review and challenge the impact assessment of the strategic plan on the risk and capital profile of CFS and its constituent elements;
• review and challenge the risk appetite process with a focus on the overall organisational view of risk appetite;
• monitor compliance with board approved risk appetite;
• approve mandates and portfolio limits in line with risk appetite, and monitor and review any breaches thereof;
• assess the robustness of ICAAP/ICAS processes;
• review and challenge the CFS Executive’s recommendations on level of capital held in relation to how adequately it reflects the CFS risk profile;
• review and challenge the adequacy of risk management activities across CFS managed by the CFS Executive, including risk mitigation;
• review and challenge the adequacy of the risk management process and systems in operation;
• set standards for risk management processes and techniques, and benchmark against industry best practice on a regular basis; and
• monitor the credit risk performance of new and existing portfolios, against limits, and ensure any appropriate risk mitigation action or review of risk policies or limits is taken.

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Attendance

The following table sets out the frequency of, and attendance at, the Board and Board Committee meetings for the period under review by Directors.

Directors	Main Board	CFS Remuneration and Appointments Committee	CFS Chairs’ Committee
Number of meetings held	11	8	3
Bob Burlton	10(11)	8(8)	3(3)
Martin Beaumont	7(7)	2(3)	3(3)
Graham Bennett	11(11)	7(8)	3(3)
Simon Butler	11(11)	7(8)	3(3)
David Davies	11(11)	-	3(3)
Paul Hewitt	10(11)	-	-
Tony Lancaster	4(5)	-	-
Terry Morton*	11(11)	7(8)	-
Robert Newton	3(4)	-	-
Kathryn Smith	9 (11)	6(8)	-
Graham Stow*	11(11)	8(8)	-
Len Wardle	10(11)	2(2)	-
Martyn Wates	2(2)	-	0(0)
Stephen Watts	10(11)	-	-
Piers Williamson	10(11)	-	-
David Anderson	11(11)	-	3(3)
Stephan Pater	10(11)	-	-
John Reizenstein	9(11)	-	-
Craig Shannon	7(7)	-	-

Directors	CFS Exposures Committee	CFS Audit & Regulatory Compliance Committee	CFS Risk Management Committee
Number of meetings held	10	4	7
Graham Bennett	10(10)	-	-
Martin Beaumont	-	-	-
Bob Burlton	-	-	-
Simon Butler	-	-	7(7)
David Davies	-	-	5(7)
Paul Hewitt	-	4(4)	6(7)
Tony Lancaster	-	3(4)	-
Terry Morton*	-	4(4)	-
Robert Newton	-	1(1)	-
Kathryn Smith	7 (10)	3(4)	-
Graham Stow*	-	4(4)	-
Len Wardle	-	4(4)	-
Martyn Wates	-	-	0(0)
Stephen Watts	8(10)	-	-
Piers Williamson	9(10)	-	6(7)
David Anderson	10(10)	-	-
Stephan Pater	-	-	-
John Reizenstein	-	-	7(7)
Craig Shannon	-	-	1(2)

* Also members of the Co-operative Group Audit and Risk Committee

The number in brackets indicates the total number of meetings the Director was eligible to attend during the year. In the case of a Director being unable to attend a meeting, the Chair has received a satisfactory reason for their absence.

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Provision of advice to Directors

A number of external consultants provide professional advice to the Boards of the constituent parts of the wider Co-operative Group. There is an agreed procedure by which Directors may take independent professional advice at the Society’s expense in furtherance of their duties.

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Directors and Officers’ Indemnity Insurance

CFS maintains appropriate Directors’ and Officers’ liability insurance cover, through the ultimate parent organisation, in respect of legal action against its Directors and Officers. The arrangements for this were reviewed during the year.

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Professional development

On appointment, Directors undertake an induction programme designed to develop their knowledge and understanding of the Group. The induction is appropriately tailored to their experience and background and includes an overview of CFS and the wider Group, together with the role of the Board and the matters reserved for its decision. Directors also receive information on the principal Board and management committees, and the powers delegated to those committees, CFS’ corporate governance practices and procedures, including the powers reserved to the Executive, and the latest financial information. Briefing sessions on the strategy and performance of CFS’ core business areas are also held with key members of the Executive.

A Board training programme exists which ensures that Directors are regularly updated on CFS’ business, the competitive and regulatory environments in which it operates, corporate social responsibility matters and other changes affecting CFS and the wider Group and the industries in which they operate.

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Performance evaluation

The Combined Code requires the Board to undertake a formal and rigorous annual evaluation of its own performance and that of its Committees and individual Directors. At the present time the Board collectively evaluates its performance, effectiveness, and commitment. The most recent process of annual evaluation started on 21 November and the analysis was reported to the Board in February 2008.

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The Secretary to the Board

The Secretary is professionally qualified and is responsible for advising the Board through the Chair on all governance matters. The Directors have access to the advice and services of the Secretary.The Society’s Rules and the schedule of matters reserved to the Board for decision provide that the appointment and removal of the Secretary is a matter for the full Board.

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The Executive

It is the responsibility of the Executive to implement the strategic objectives as agreed by the Board. The Executive, under the leadership of the Chief Executive is responsible for the day to day management of the Society.

From 15 January 2006, the Executive of the financial services Boards of CFS, CIS, CISGIL and the Bank were organised under a single Executive Management framework.

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Relations with members

CFS is a wholly owned subsidiary of the Co-operative Group. A number of Directors from the Co-operative Group Board sat on the CFS Board ensuring a common understanding of objectives. Members are all invited to the Annual General Meetings.

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Internal control

The Board has overall responsibility for the Society’s system of internal controls which aim to safeguard the Society’s assets, ensure that proper accounting records are maintained and that the financial information used within the business and for publication is accurate, reliable and fairly presents the financial position of CFS and the results of its business operations. The Board is also responsible for reviewing the effectiveness of the system of internal controls. This has been in place for the year under review and up to the date of approval of these financial statements and is regularly reviewed by the Board. The system is designed to provide reasonable assurance of effective operations and compliance with laws and regulations, although any system of internal controls can only provide reasonable, not absolute, assurance against material mis-statement or loss, and can only mitigate rather than eliminate the risk of failure to achieve business objectives.

Since the publication in September 1999 by the Institute of Chartered Accountants in England and Wales of the Turnbull Report, ‘Internal Control: Guidance for Directors on the Combined Code’ (revised by the Financial Reporting Council in October 2005), the Directors have continued to review the effectiveness of CFS’ system of financial and non-financial controls, including operational and compliance controls, risk management and CFS’ high level internal control arrangements. CFS has adopted an internal control framework that contains the following key elements:

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Control environment

CFS’ control environment is designed to create an attitude of taking acceptable business risk within clearly defined limits. The control environment includes:

• an organisational structure with clear lines of responsibility, delegation of authority and reporting requirements;
• clearly defined policies for capital and revenue expenditure. Larger capital and revenue expenditure requires Board authorisation;
• comprehensive systems of financial reporting. The annual budget and long-term plan of CFS and of each division are reviewed and approved by the Board. Results are reported against budget and prior year. The relevant Executives consider any significant changes and variances and remedial action is taken where appropriate;
• a Code of Business Conduct covering relations with customers, members, employees, suppliers, community and competitors;
• a whistleblowing policy and procedure which provides for any employee to report, in confidence, suspected serious malpractice; and
• Internal Audit and Compliance functions that review the system of internal control.

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Risk assessment

The Board and Executive management have the primary responsibility for identifying the key business risks facing the Society. The Board has established Board Committees and Executive Committees to administer a risk management process which identifies the key risks facing the business and reviews reports submitted to those Committees on how those risks are being managed.

Management has responsibility for identifying and evaluating significant risks and for designing and operating suitable controls.

Risks are documented in a risk register. Each risk is assigned to an appropriate manager who is responsible for ensuring that it is managed in accordance with CFS’ risk management process, which is kept under review to ensure that it accords with best practice and the evolving requirements of the FSA. Significant risks are reported to the appropriate Risk Management Committee and CFS Audit & Regulatory Compliance Committee.

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Control procedures

CFS’ control procedures are designed to ensure complete and accurate accounting for financial transactions and to limit the potential exposure to loss of assets or fraud.

In a commitment to the robustness of its internal control environment, in 2007 the Board established Process Managing Operational Rigour to focus on improving processes and controls.

Key accounting policies and procedures are documented. Up to date manuals are maintained that cover CFS’ insurance procedures, employee policies and procedures, Code of Business Conduct and information technology standards. These manuals are issued to appropriate management who are trained in the procedures.

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Information and communication

Communication takes place with all key stakeholders through a variety of media including the CFS Sustainability Report. Employees receive and provide information on strategy and objectives through their reporting lines and a formal performance measurement process. Newsletters, bulletins and electronic media communicate other information.

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Monitoring

The operation of the system of internal control is the responsibility of line management. It is subject to independent review by Internal Audit and, where appropriate, by CFS’ external auditor and external regulators.

During 2007, the solvency of the long-term business fund was monitored regularly by the Head of Actuarial function. The Society has at all times during the year exceeded the required minimum solvency standard.

The CFS Audit & Regulatory Compliance Committee on behalf of the Board reviews the reports of CFS on internal control.

A key part of the work of the Committee is an annual ‘letter of assurance’ process by which responsible managers confirm the adequacy of their systems of internal financial and non-financial controls, their compliance with CFS policies (including those relating to safety, health and the environment), local laws and regulations (including the industry’s regulatory requirements) and report any control improvements required.

The Directors review the system of internal controls and believe it complies with the Turnbull Report guidance.

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External Audit

One of the duties of the CFS Audit & Regulatory Compliance Committee is to make recommendations to the Co-operative Group Audit and Risk Committee in relation to the appointment of the external auditor. In 2003 the Co-operative Group Board approved the re-appointment of KPMG Audit Plc as the external auditor following a competitive tender exercise.

The Committee has put in place safeguards to ensure that the independence of the audit is not compromised including a policy on the conduct of non-audit services from the external auditor. The external auditor is permitted to provide some non-audit services that are not, and are not perceived to be, in conflict with their independence.The Co-operative Group Audit and Risk Committee receives at each meeting a report providing details of assignments and related fees carried out by the external auditor of CFS in addition to their statutory audit work. The pre-approval of the Committee is required for services above certain thresholds determined by the Committee. In addition, the following assignments are prohibited from being performed by the external auditor:

• bookkeeping or other services related to the accounting records or financial statements;
• financial information systems design and implementation;
• actuarial services;
• internal audit outsourcing services;
• management functions or human resources; and
• any other services that the Audit & Regulatory Compliance Committee may determine.

The performance of the external auditor is regularly monitored to ensure it meets the needs of CFS and the results are reported to the Committee.

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Internal Audit

The Internal Audit function is an independent appraisal function, which derives its authority from the Board through the CFS Audit & Regulatory Compliance Committee. Its primary role is to provide reasonable and objective assurance about the adequacy and effectiveness of internal control framework and risk management practices.

Internal Audit seeks to discharge the responsibilities set down in its charter by reviewing the processes which ensure that business risks are effectively managed; reviewing the financial and operational controls which help to ensure that CFS’ assets are properly safeguarded from losses, including fraud; reviewing the controls which help to ensure compliance with corporate objectives, policies and procedures and external legislation and regulation; and on an ad hoc basis, reviewing that value for money is obtained.

Internal Audit also acts as a source of constructive advice and best practice, assisting senior management with its responsibility to improve the processes by which business risks are identified and managed and to report and advise on the proper and effective use of resources.

Internal Audit reports are submitted to the CFS Audit & Regulatory Compliance Committee and significant issues are reported from that Committee to the Co-operative Group Audit and Risk Committee.

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Statement on Going Concern

After making all appropriate enquiries, the Directors have a reasonable expectation that CFS has adequate resources to continue in operational existence for the foreseeable future. For this reason, they continue to adopt the going concern basis in preparing CFS’ financial statements.