The Roles and Obligations of NEDs in the Governance Process

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1 The Roles and Obligations of NEDs in the Governance Process Restricted use - Actual and as proposed in CRD (IV) ensuring the best mix of Executives and non- Executive Directors MFSA Seminar on Internal Governance within the Banking Industry: Issues and Developments Malta, 15-16

2 What do you expect from a bank s board? First and foremost that the bank s board understands its fiduciary responsibilities and its role as steward of shareholder value. We expect that the bank s board wants a stable, well regulated, adequately capitalised and profitable enterprise with a prudent risk appetite that is linked to the bank s strategic business model. Decides the strategic direction of the Bank Insist on a competent management team who are accountable for the implementation of the bank s strategy Be an important line of defence 2

3 Corporate governance - A lesson of the crisis The report of the High Level Group on Financial Supervision in the EU chaired by Jacques de Larosière stated that the directors of banks often did not understand neither the nature nor the extent of the risks they faced. The cumulative effect of these failures was an overestimation of the ability of banks as a whole to manage their risks, and a corresponding underestimation of the capital they should hold. 3

4 Governance and NEDs a hot-topic Governance has been high on the regulatory agenda since the financial crisis. The global financial crisis has put significant extra pressure on nonexecutive directors, with the average time spent on an annual basis by a non-executive director of a bank expected to rise significantly. The extra time commitment has been driven by risk and regulatory requirements combined with greater business challenges. The crisis exposed the following significant shortcomings in the governance and risk management of banks: Lack of effective checks against poor decision-making Failures to identify and constrain excessive risk taking Weak controls on remuneration and exercise of ownership rights 4

5 The Governance of Banks Liikanen Report (Report of the European Commission's High-level Expert Group on Bank Structural Reform) highlights that the governance of banks is: more important due to the systematic importance of banks, ability to quickly expand and collapse, higher leverage etc more difficult due to the fact that the shift of the banking activity towards more trading and market related activities resulting in more complex banking activity more difficult to monitor by external parties such as market participants (increase in size reduced incentives to monitor banks) and supervisors (their ability to monitor banks has proven inadequate in certain instances) 5

6 Role of NEDs The financial crisis revealed that NEDs of banks struggled to: provide strong independent oversight of executive management create a boardroom environment of effective challenge before decisions are taken by executives on major risk and strategic issues. (Walker Review of Corporate Governance of UK Banking Industry) One of the five required changes proposed by Michel Barnier (European Commissioner for Internal Market and Services) to remove the roots of the financial crisis an increase in challenge from NEDs and the Board in general 6

7 Challenges for NEDs According to a recent international survey the following are the key factors impacting the role as an NED of a bank: 7

8 NEDs and regulatory developments In an environment characterised by increasing regulatory developments and oversight, various NEDs and the MFSA have voiced their views that proper due diligence is essential prior to taking on a non-executive director appointment. G-SIBs FATCA Basel III/CRD IV Change Agenda EU Banking Union FINREP /COREP NEDs are facing a very challenging environment. FTT/ CCTB AML/ CFT MiFID 8

9 NEDs An evolving role This is what NEDs are saying: Their role has changed and key changes include time commitment, accountability, complexity and reputational risk. They are feeling an increased regulatory burden and associated reputational risk combined with insufficient remuneration given that they expect future time commitment to increase. The role became more attractive over the past few years due to the challenging nature and ability to add value. 9

10 NED s role current requirements Requirements within the Corporate Governance Guidelines for Public Interest Companies: A non-executive director is a director who is not engaged in the daily management of the bank. He has an important role in overseeing executive or managing directors and dealing with situations involving conflicts of interests. Non-executive directors and executive directors have as board members the same duties and responsibilities in terms of law. However, as the non-executive directors are not involved in the dayto-day running of the bank, they can bring fresh perspectives and contribute more objectively in supporting as well as constructively challenging and monitoring the management team of the bank. 10

11 NED s role current requirements The guidelines highlight that each director should apply to his duties the necessary time and attention, and should undertake to limit the number of any directorships held in other companies to such an extent that the proper performance of his duties is assured. Non-executive directors should: constructively challenge and help develop proposals on strategy monitor the reporting of performance scrutinize the performance of management in meeting agreed goals and objectives satisfy themselves on the integrity of financial information and that financial controls and risk management systems are well established. 11

12 Typical terms of reference for NEDs challenge strategy scrutinise performance risk management determination of remuneration of executives take into account the views of shareholders and other stakeholders where appropriate adherence to legal obligations 12

13 Board composition - the right mix for a Bank The right mix Arguably an ED and NED mix with a majority of independent NEDs Directors (particularly NEDs) must exercise their independent judgment and not rubber stamp managements recommendations Diversity in the Bank s board Limiting factors NEDs unable to devote time to develop and refresh their knowledge and skills Limited skills available at times locally to achieve diversity Cost of NEDs 13

14 Outcome of the Salz Report An independent review of Barclays Business Practices Realistically consider the time commitments expected for NEDs, especially those that are a Chairman of a Board Committee Put into action a plan for NEDs to engage with the business to be supplemented with detailed sessions on specialist topics A sufficient number of NEDs should have directly relevant banking expertise (Target 50% of Board members) Address possible unrealistic expectations from NEDs Attract the strongest and best qualified people to non-executive roles Committees allow NEDs to examine issues in more depth and with greater efficiency than at the full Board level. 14

15 CRD IV Implications on governance Proposals on corporate governance with 3 operational objectives: Increase the effectiveness of risk oversight by boards Improve the status of the risk management function Ensure effective monitoring by supervisors of risk governance 15

16 CRD IV recommendations - Where do NEDs fit in? The Board of Directors of a credit institution should at all times be able to understand the bank s business and its main risk exposures. Board members need to possess sufficient skills, knowledge and experience, be of good repute and commit sufficient time to perform their functions. A bank should take into account diversity as one of the criteria for the selection of directors e.g. gender, age and professional attributes. A bank shall provide adequate human and financial resources to the induction and training of its board members. A bank should have a "nomination committee" composed of directors who do not perform any executive function in the institution concerned. 16

17 CRD IV What do we mean by sufficient time? According to CRD IV, a director of a bank shall not combine at the same time either: One executive directorship with two non-executive directorships; or Four non-executive directorships (within the same group, executive or non-executive directorships are treated as a single directorship) The Directive does not specify that directorships be limited to other banks and/or other licensed entities, so the implication of the prohibition is that it relates to all directorships held, whether in licensed or unlicensed entities. This said, there is a discretion provided to competent authorities to authorise more directorships than permitted if this does not prevent the director from committing sufficient time. 17

18 Fee considerations The majority of NED contracts do not include scope for additional fees. Should there be a link between fees paid to NEDs and their performance? There is a need for objective measures and robust evaluation. Performance could be measured by reference to: Knowledge and experience Training Meeting attendance and contribution Company specific objectives 18

19 Way forward EBA will be issuing a number of regulatory technical standards on: the notion of sufficient time commitment of a board member of a bank including the number of permitted directorships; the notion of adequate collective knowledge, skills and experience of the board; the notions of honesty, integrity and independence of mind; the notion of adequate human and financial resources devoted to the induction and training of new board members of banks; and the notion of diversity. 19

20 Board dynamics What works best? The board has the right composition and size Director independence Mix of skills, experience, diversity Committees with proper reporting to the board Right leadership within the board Board meetings are effective and the right frequency Supported by sound agendas and quality materials Chair ensures all directors are engaged Directors get needed education on an ongoing basis Board periodically assesses its effectiveness 20

21 Achieving board effectiveness NEDs of a credit institution should seek to: Devote time to a comprehensive and formal induction Devote time to developing their knowledge and skills Make sufficient time available to fulfil their role Uphold standards of integrity and probity Insist on receiving high quality, timely information Take into account the views of shareholders and others 21

22 A look to the future The role of NEDs continues to be challenging in view of regulatory changes in the banking industry and economic conditions Time commitment perceived to have increased and will continue to increase NEDs are unlikely to hold as many Board positions NEDs may start their career earlier creation of double tier NEDs is quite possible (fosters diversity) More structural support to enable NEDs to discharge their duties Training and development remains a key focus area 22

23 Thank you Data Classification Policy: Restricted use (DC 2) This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it PricewaterhouseCoopers. All rights reserved. In this document, refers to PricewaterhouseCoopers which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity.