Corporate Governance Report
continued

Internal Audit

Group Internal Audit supports the Audit Committee, divisional RCCs and senior executives by reviewing independently and objectively the effectiveness of the controls and risk environment. The Audit Committee reviews and approves the annual Internal Audit Plan (and achievements against it), the Internal Audit Charter, the results of audits and other significant findings, the adequacy of management’s response and the timeliness of resolution of recommendations and the adequacy of staff numbers, qualifications and experience. It seeks to ensure that the activities of the Internal Audit function are co-ordinated with the external auditors. The Audit Committee also approves the appointment, or removal, of the Head of Group Internal Audit. In 2007 a review to assess the independence of the Internal Audit function is planned.

Audit tender

The Company has a policy that an audit tender should be undertaken at appropriate intervals. This supports the Board’s belief that the performance of the incumbent auditors is best evaluated through a thorough comparison with formal proposals from other audit firms. In years when there is no audit tender, an annual in-depth assessment of the external auditors is undertaken.

In 2006, a comprehensive audit tender process, involving the incumbent auditors and other major audit firms, was concluded. The process lasted six months and involved an in-depth assessment of tendering parties’ expertise, industry experience, international resources, audit staff and leadership quality. The outcome of the process was a recommendation from the Audit Committee, approved by the Board, that KPMG Audit Plc (‘KPMG’) be retained. A resolution to re-appoint KPMG as auditors will be put to shareholders at the 2007 AGM.

Auditor independence and remuneration

Both the Board and the external auditors have safeguards in place to protect the independence and objectivity of the external auditors. The Audit Committee has a comprehensive policy to regulate the use of auditors for non-audit services. This policy sets out the nature of work the external auditors may not undertake, which includes work which will ultimately be subject to external audit, internal audit services and secondments to senior management positions in the Group that involve decision-making. It also includes the Group’s policy on hiring former external audit staff. For those services that are deemed appropriate for the auditors to carry out, the policy sets out the approval process that must be followed for each type of assignment. The Chairman of the Audit Committee must be consulted regarding potential instructions in respect of defined non-audit services with a value above defined limits and such services must be subject to a competitive tender process.

Each year the Audit Committee establishes a limit on the fees that can be paid to the external auditors in respect of non-audit services and monitors quarterly the amounts paid to the auditors in this regard. The external auditors also report regularly to the Committee on the actions that they have taken to comply with professional and regulatory requirements and current best practice in order to maintain their independence. This includes the rotation of key members of the audit team. Total auditor remuneration analysed between audit and other services is shown in Note 6 to the Accounts on pages 138 to 139.

Nomination Committee
Membership

Membership of the Nomination Committee is set out in the box below and at all times has a majority of independent Non-executive Directors and includes the Chairman of the Company, the Chief Executive, Deputy Chairman/Senior Independent Director and at least two further Non-executive Directors. The Deputy Chairman/Senior Independent Director chairs the Committee. At the invitation of the Nomination Committee, other persons may attend its meetings to assist in the effective discharge of its duties. The Committee’s responsibilities relate to both the Executive and Non-executive Board roles, as well as oversight of the succession planning process in respect of senior executive positions. It is thus considered appropriate that the Chief Executive is a member of the Nomination Committee. Harry Baines, Company Secretary & Group Counsel, is Secretary to the Nomination Committee.

Membership of Nomination Committee and frequency and attendance at meetings
Number of meetings held in year	4
Number of meetings attended in year:
Sir Ron Garrick (Chairman)	4
Andy Hornby*	-
Sir Brian Ivory*	4
Karen Jones*	1
Coline McConville	4
Dennis Stevenson	4

* No meetings have been held since Andy Hornby joined this Committee and one meeting has been held since Karen Jones’s appointment to it. Sir James Crosby served on this Committee until 31 July 2006 when he stood down from the Board. Sir Brian Ivory will step down from this Committee when he retires from the Board at the 2007 AGM.

Attendance at meetings

The Nomination Committee meets at least twice a year with additional meetings as required, and the actual number of meetings, along with attendance, is shown in the box above. Any Committee member or the Secretary may call for a meeting as necessary.

Committee evaluation

The effectiveness of the Nomination Committee is measured by the effectiveness of appointments made, which are assessed through the Director evaluation process, as well as by ongoing evaluation by the Committee of its role, responsibilities, actions and effectiveness.

Principal duties

The Committee continuously reviews internal, executive ‘talent’ which it benchmarks against appropriate peer group comparisons, as a key input to succession planning decisions by the Chief Executive and other senior executives. From time to time, potential external recruits are also considered. In total, talent and succession data is held in respect of approximately 2,500 colleagues across the Group, including all relevant senior executives. In this way the Chief Executive, senior executives and the Committee (and, through the Committee, the Board) monitor closely the nature, mix and availability of suitably experienced and appropriately qualified management, both within and outwith the Group; create opportunities to challenge and develop individuals at senior executive level (including through inter-divisional moves); and can act with confidence when, expectedly or unexpectedly, senior roles become vacant, or other opportunities to strengthen the senior executive emerge.

With assistance from external search and recruitment consultants, the Committee adopts a similar continuous approach to the identification of potentially suitable candidates to join the Board as Non-executive Directors and to become external RCC members, maintaining a rolling list of potential candidates. When a vacancy occurs, the Committee determines the optimum skills mix required to fill the vacancy, which it then matches to the previously identified candidates. Non-executive Directors are normally appointed to serve a three year term, but this duration is kept under regular review. The Committee is also responsible for ensuring that Directors devote sufficient time to their role and, should concerns emerge, would address these on an exceptional basis.

The Committee, under authority delegated by the Board, also approves the appointment and (where appropriate) the removal of Trustees of the Group’s pension schemes.

The Committee led the process for making appointments to the Board during 2006 in relation to both Executive and Non-executive positions, which included the appointments of Peter Cummings, Karen Jones, Jo Dawson, Benny Higgins and more recently Richard Cousins. The Committee also led the process in relation to Andy Hornby’s appointment as Chief Executive, in succession to Sir James Crosby. Being closely familiar with his skills and experience, the Nomination Committee was able very quickly to confirm Andy as Chief Executive Designate when Sir James Crosby notified the Company of his intention to stand down.

The Committee also ensures that the process for making appointments is formal, rigorous and transparent as is demonstrated in its methodology described above. The Committee also keeps the composition of the Board and its Committees under review through a proper evaluation of the skills, knowledge and experience of Directors and the needs of the Group, the Board and its Committees to ensure best use is made of Non-executive Directors’ skills.

Remuneration Committee
Membership

Membership of the Remuneration Committee in set out in the box overleaf. It must at all times comprise at least three Non-executive Directors. Given their complementary roles, the Board believes that a significant degree of overlap in the memberships of the Remuneration and Nomination Committees is desirable. David Fisher, Director Group HR, is Secretary to the Remuneration Committee.

At the invitation of the Remuneration Committee Chair, the Group’s Chairman and the Chief Executive regularly attend Committee meetings to provide background and context on matters relating to the remuneration of other Executive Directors and other colleagues in the Group, but do not attend when their own remuneration or contractual terms are discussed. No Director is involved in determining his or her own remuneration or contractual terms.

Attendance at meetings

The Remuneration Committee must meet at least four times each year, and the actual number of meetings, along with attendance, is shown below. In addition, any Committee member or the Secretary may call a meeting as necessary. This frequency of meetings enables the Committee regularly to review, for Executive Directors and other senior colleagues, overall reward and the components thereof, in relation to the absolute performance and the relative competitiveness of the Group. The quorum for a meeting of the Committee is any two Committee members.

Membership of Remuneration Committee and frequency and attendance at meetings
Number of meetings held in year	7
Number of meetings attended in year:
Sir Brian Ivory (Chair) *	7
Sir Ron Garrick	7
Coline McConville	7
Karen Jones*	3

* Karen Jones has attended all meetings held since her appointment to the Remuneration Committee on 1 July 2006. Sir Brian Ivory will step down from this Committee when he retires from the Board at the 2007 AGM, and will be succeeded as Committee Chair by Karen Jones.

Principal duties

Below are details of the Committee’s work in 2006 and other key matters reserved to it:

• considering and recommending to the Board the remuneration policy for Executive Directors and other senior executives and determining the specific remuneration arrangements for the Chairman of the Company, Executive Directors and other direct executive reports to the Chief Executive;
• approving the contractual terms for the Chairman and the Executive Directors;
• operating and administering the incentive schemes of the Company for the Chairman, the Executive Directors and other senior executives;
• approving the salary review for Executive Directors and certain senior executives;
• determining contractual and discretionary payments to be made on the retirement, resignation and (where appropriate) dismissal of Executive Directors and other direct executive reports to the Chief Executive;
• providing advice in relation to the fees payable to external parties serving on Risk Control Committees and Non-executive Directors of the Group (but not of the Company) and the fees payable to pension scheme Trustees; and
• considering the policy and monitoring process for all Directors, and senior executives for holding shares in the Company.

Full details of remuneration policy and practice are in the Directors’ Remuneration Report on pages 99 to 119. The Remuneration Committee Chair will be available at the AGM to answer shareholders’ questions in regard to Directors’ remuneration.

Relations with shareholders

Institutional shareholders

The Investor Relations team has primary, day-to-day responsibility for managing communications with institutional shareholders through a combination of briefings to analysts and institutional shareholders (both at the interim and year end results and throughout the year), site visits and individual discussions between institutional shareholders and Board members and key senior executives. Regular dialogue with shareholders helps to ensure that the Company’s strategy is understood and that any queries or other issues are addressed in a constructive way.

There is also an annual audit of investor opinion which is undertaken on behalf of the Board. This takes the form of structured interviews with individual investors and is conducted by an independent external adviser. The 2006 audit was conducted with over 30 major investors in the UK, North America and Europe. Collectively these institutions represent a significant proportion of the institutional ownership of HBOS plc. All interviewees had held meetings with HBOS management over the previous 12 months, the majority of which were with Executive Directors. The audit gathered opinion on strategy, financial and operational results (including comments on individual divisions), management, corporate governance and investor communications. The views of these investors were reported to the HBOS plc Board on a non-attributable basis, giving the Board direct access to investor views on a wide range of performance metrics to help them to develop a balanced understanding of major shareholders. The annual audit of investor opinion complements monthly reports to the Board on market and investor sentiment and opinion.

Private shareholders

The Company Secretary & Group Counsel, primarily through the Shareholder Services team, oversees communications with private shareholders.

Each year shareholders receive the Annual Review & Summary Financial Statement and in addition, if they so choose, the Annual Report and Accounts. Shareholders can receive up-to-date information throughout the year on the Company’s website, www.hbosplc.com. This provides share price information, financial results, copies of presentations to analysts and answers to frequently asked questions. A telephone helpline is available on 0870 702 0102 providing a contact point for shareholders on issues such as dividends and announcements.

As part of our ongoing review of shareholder perceptions a pilot research project was undertaken during the year, in which a sample of shareholders was interviewed about the services available to them. Shareholders’ comments have informed our subsequent communication and, in particular, enhancements have been made to the 2007 AGM documents.

Annual General Meeting (‘AGM’)

The Company’s AGM takes place at different UK locations each year to maximise opportunities for the Company’s shareholders to attend. The AGM provides an opportunity for shareholders to hear about and question the Group’s performance and the Directors’ stewardship of the Company. Shareholders who wish to raise a question can submit it beforehand, or can ask it at the AGM. The Chairmen of the Audit, Remuneration and Nomination Committees are present at the AGM - along with other Directors - to answer shareholders’ questions, through the Chairman of the Board, on the responsibilities and activities of their Committees. In the last three years our AGMs have been held in Birmingham, Edinburgh and Manchester, and the 2007 AGM will be held in Brighton.

2007 AGM - Voting

• Separate resolutions will be proposed on each separate issue, and details of all proposed resolutions will be sent to shareholders at least 20 working days beforehand.
• Voting will be conducted entirely on a poll.
• Shareholders will be able to vote for or against each resolution or to select ‘vote withheld’. (A ‘vote withheld’ is not a vote in law and will not be counted in the proportion of votes cast for or against any resolution).
• The results of voting will be announced to the UK Listing Authority and will appear on our website www.hbosplc.com, on 26 April 2007.
• In order to make the proxy appointment process as easy as possible for shareholders who can’t attend the AGM in person and to encourage shareholder engagement, the Company provides both electronic and written proxy appointment facilities for all shareholders.

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