Fit and Proper Management of Banks and Other Institutions regulated under the Directives 2013/36/EU and 2014/65/EU
Article 91 (on Management Bodies) of EU Directive 2013/36/EU (Capital Requirements Directive, CRD IV) requires that management bodies of the regulated institutions must meet certain suitability requirements, so as to foster safe and sound banking and financial practices. The Article gave the European Banking Authority (EBA) the competence to specify in detail how the suitability requirements should be.
In addition to the EBA, other European authorities have also been focusing attention to the need for a fit and proper management in the EU financial community. In May 2017, the European Central Bank (ECB) published a Guide to fit and proper assessments, which was addressed to all the institutions under its direct supervision (hereinafter the “ECB Guide”). The ECB Guide is a first step towards a thorough and Europe-wide harmonised regulation on the suitability of the management bodies of the European banks and other financial institutions, as well as the fitness of the individuals serving in them.
Later, on 26 September 2017, the EBA and the European Securities and Markets Authority (ESMA) issued a joint Report laying down Guidelines on the assessment of the suitability of members of the management body and key function holders under Directive 2013/36/EU and Directive 2014/65/EU, i.e., respectively, the CRD IV and the Markets in Financial Instruments Directive (MiFID II) (henceforth referred to as “Joint Guidelines”). The Joint Guidelines adopted a substantive rather than a formalistic approach, ensuring that the provisions also apply to CEOs – even where they are not formally members of the management bodies – and to the key function holders who do not operate within the management body but still “have significant influence over [its] direction”.
The Joint Guidelines will enter into force on 30 June 2018, replacing the guidelines issued by EBA in 2012, and will apply to credit institutions, mixed financial holding companies as defined in Regulation (EU) No 575/2013, and to investment firms as defined in Article 4(1)(1) of MiFID II. In addition, specific provisions will apply to CRD-institutions, defined in Article 4(1)(1) and (2) of the CRD IV, and to significant CRD-institutions as defined in Article 131 of CRD IV or identified, for the purposes of Article 91 of CRD IV, by the competent authorities or national laws.
On the same day in September 2017, the EBA also published its Guidelines on internal governance under the Directive 2013/36/EU. Both documents aim at remedying weaknesses that were identified during the financial crisis regarding the functioning and the composition of the management bodies. However, the guidelines on internal governance and the Joint Guidelines address the issue from different perspectives: while the former regulates the governance arrangements of the institutions, the latter focuses on the management bodies’ working processes.
This note looks at the Joint Guidelines and the ECB Guide, which overlap to a large extent, seeking to remove any possible areas of ambiguity or doubt in relation to them.
In designing the criteria, both guidelines follow the terminology used in CRD IV, whereby management body refers to either the body acting to manage the institution (executive) or the body acting in its role of overseeing and monitoring the management decision-making (non-executive).
The guidelines follow the established principle of proportionality, clarifying that “institutions should take into account their size, internal organization and the nature, scale, and complexity of their activities when developing and implementing policies and processes set out [thereunder]”.
This proportionality principle has a significant influence on the whole EU approach to the internal governance of banks and other financial institutions, backed by the assumption that managing a smaller and less complex institution does not require the higher level of expertise and commitment that is required for managing bigger and more complex entities.
That being said, and prior to describing the criteria themselves, it must be stressed that assessing the initial and ongoing suitability of management bodies is a responsibility of the institution, which must carry out this duty when it applies for authorization to take up business, when material changes to the composition of the management body occur, when a new key function holder is appointed and on an on-going basis to detect any event which may otherwise materially affect the suitability of the individual. It is only at a second stage that the competent authorities have a role to determine – on the basis, inter alia, of the relevant documentation to be provided by the regulated entities – whether the assessments performed by the institutions were, and remain, appropriate or not.
Both the Joint Guidelines and the ECB Guide provide that any appointee should be honest, of good repute, and have integrity. According to the two documents, appointee’s involvement in ongoing prosecutions for criminal offences represents an indication of bad repute: despite the wording of the Joint Guidelines8, it seems in fact problematic to square this approach with the principle of presumption of innocence applicable in all criminal proceedings.
Given that the reputation, honesty and integrity requirements do not refer in any way to the concept of expertise, these criteria are not covered by the principle of proportionality as described above.
All appointees should also have gained, through theoretical and practical experience, skills and knowledge adequately enough to clearly understand the institution’s activities. In this regard, while the ECB Guide sets a threshold at which sufficient experience is presumed (in terms of years spent working in the financial sector), the Joint Guidelines do not.
The time available to the appointee is, of course, a further element to be evaluated and, notably, the expected time to carry out the function has to be calculated having in mind the institution going through the most stressful times 9.
In addition, independence and independence of mind of the appointees should be taken into account when assessing their fitness and propriety.
The Joint Guidelines supply a detailed definition of independence (a key concept due to the fact that “within the overall responsibility of the management body, the independent members should play a key role in enhancing the checks and balances within the CRD-institutions”). Independence pertains to the relationships between the individual exercising a supervisory function within a CRD-institution and the relevant entity, its management or other entities having an interest in it (for example, pursuant to the Joint Guidelines, representing the interest of a controlling shareholder10 triggers the presumption of non-independence). Differently from the Joint Guidelines, the ECB Guide refers to the independence requirement as a lack of conflict of interest: in doing so, it holds that the existence of a material conflict of interest for any appointee (not only for those individuals acting as non-executive managers) shall be verified on a case-by-case basis. Also, and without prejudice for the national law provisions providing for a stricter definition of independent directors, the ECB Guide “does not prevent representatives of shareholders from being members of the management body”.
Unlike independence, “acting with independence of mind is a pattern of behaviour”, which is intended to lead an appointee to make their own sound, objective and independent decisions and judgments when performing their own functions and responsibilities, and especially during discussions within the management body. Given that patterns of behaviour do not always result in objective actions and, even if they do, it still remains extremely difficult to identify the link between the former and the latter, the vagueness of the concept risks diminishing the objective of the provision.
Upon a closer examination, independence of mind makes real sense only where it accompanies the other criteria set out in the two documents. The idea is to promote the skills and knowledge of each individual and avoid ‘group-thinking’. Even more strongly, it preserves the value of diversity. In fact, pursuant to the Joint Guidelines, members of management bodies need to be diverse from each other. It is a curious criterion, which reveals the awareness of the authorities on the influence of gender and culture over the decision-making processes and their outcomes. Thus, by focussing the lens on the appointees’ geographical provenance, age, gender and professional background, the EBA and ESMA seem to admit that technical and financial expertise may not lead, per se, to a safe and sound management of the Institution. Diversity is a cross-cutting aspect, being it used in both individual and collective assessment, and represents the most relevant difference between the Joint Guidelines and the ECB Guide, since the latter does not include diversity within the list of suitability requirements.
With reference to the collective suitability of the bodies, the guidelines provide “that at all times the management bod[ies should] collectively possesses adequate knowledge, skills and experience to understand the institution’s activities, including the main risks”13. On the one hand, executive members of the management body should collectively take appropriate decisions, and, on the other hand, appointees carrying out supervisory functions should collectively be able to effectively challenge and monitor such decisions. Any management body shall verify, through self-assessment, on an ongoing basis or when appointing a new member, whether it collectively meets the suitability requirements.
The Italian regulation on fitness and propriety
With regards to Italy, similar criteria have firstly been listed by the Bank of Italy through the introduction of a new Title IV, Chapter I (Governo societario) within the Supervisory Provisions (Circular No 285 of 17 December 2017, Disposizioni di vigilanza per le banche) as part of the CRD IV implementing process. As a consequence, the appointees of Italian banks and financial intermediaries should possess adequate skills, have integrity, be independence and ensure time commitment. The Italian authority paid particular attention to the independence requirement: in fact, any management body acting in its supervisory function shall include independent members. These rules were introduced in 2014 in anticipation of the EU guidelines.
Also, Article 26 of Legislative Decree 1 September 1993, No 385 (i.e. the Italian Banking Act), which constitutes the primary law regulating the suitability of members of the management bodies of banks and financial intermediaries, employs the same criteria adopted in the CRD IV, after being amended by Legislative Decree 12 May 2015, No 72. The provision, moreover, empowers the Ministry of Economy and Finance to provide, by means of ministerial decree, for specific suitability criteria and requirements which shall act as a driver in the assessment.
On September 2017, a few days prior to the publication of the Joint Guidelines, the deadline to respond to the public consultation on the draft ministerial decree expired. However, despite the fact that the draft came before the publishing of the Joint Guidelines, it created a regulatory structure which is very similar to that required by the EBA and ESMA (as an example, unlike the ECB Guide, the draft maintains the principle of diversity as an element of the suitability assessment).
In light of the above, Italy is on track for a timely implementation of the EU regulation on suitability of the management of banks and financial intermediaries.
In Europe, the idea of preventing unfit and improper individuals from becoming or from continuing in a role within the management bodies of banks and other financial institutions, has given, and is still giving, birth to detailed provisions fixing suitability requirements for professionals to be appointed in such positions.
As skills and reputation of top figures of such entities are some of the most relevant indicators being monitored by market actors, the efforts of the European authorities are to be undoubtedly welcomed.
With regards to the legal framework, the CRD IV, on the one hand, only “succinctly covers”14 suitability requirements, while, on the other, it empowers EBA to provide for a more detailed range of criteria. As a consequence, in the course of 2017, the European Banking Authority, as well as other European authorities have proposed guidelines setting out clearly what these requirements mean, thus providing guidance both for the institutions, which “shall make every effort to comply with [the guidelines]”15, and for the competent authorities, given that fit and proper supervision feeds into their ongoing supervision of governance of the institutions.
However, due to the vagueness of certain provisions, institutions and authorities enjoy a wide margin of discretion in determining who is suitable and who is not. Evidently, the independence of mind requirement is the most difficult to implement: since an objective and reliable method to verify its existence is difficult to find, the implementation of this requirement might swing from widely over time.
For this reason, the impact of the new guidelines on the financial community, which, at least for Italy, has been foreseen by an important Italian think tank17, seems to have been left, to a great extent, to the reasonableness of those implementing them.
This article is for information purposes only and is not intended as a professional opinion.
For further information, please contact Giovanni Leuratti.
1 As regards the listing of the suitability criteria and a more detailed description of the same, Article 9 of the MiFID II only refers to the CRD IV and to the guidelines that “ESMA and EBA shall adopt, jointly”.
2 EBA/GL/2012/06, published on 22 November 2012, Guidelines on the assessment of the suitability of members of the management body and key function holders. Compared to such regulation, the Joint Guidelines include a broader range and a more detailed analysis of suitability requirements.
3 See the Joint Guidelines, Background and rationale (No 3): “Directive 2013/36/EU and Directive 2014/65/EU include requirements to remedy weaknesses that were identified during the financial crisis regarding the functioning and composition of the management body and the qualification of its members”. Similarly, the ECB Guide declares that its “main aim has been to correct institutions’ weak or superficial internal governance practiced, as identified during the financial crisis”.
4 In fact, although the ECB Guide imposes on ECB an undertaking to “compl[y] with the EBA guidelines on suitability” (i.e. the Joint Guideline starting from their entry into force) while carrying out its supervisory activity, the Joint Guidelines essentially list the same criteria laid down by the European Central Bank.
5 See recital No 56 of the CRD IV. The Italian legal system already aligned with the CRD IV in distinguishing management and supervisory function. In particular, the First Amendment to the Bank of Italy Supervisory Measures (Circular No 285 of 17 December 2017), which introduced a new Title IV, Chapter I (Governo Societario, i.e. corporate governance), defines the internal governance of a bank or a financial intermediaries as divided in three functions: management, strategic supervision and control (which is usually a responsibility of a different body).
6 Principle of proportionality has been employed by both the ECB Guide – Principle 4 – Proportionality and case-by-case assessment – and the Joint Guidelines, Guidelines (No 20 and ff.) (Application of proportionality principle).
7 The ECB Guide, Principle 2: “The responsibility of the ECB in this respect is to act as a gatekeeper. It has the task of ensuring that significant supervised entities comply with the requirement to have in place robust governance arrangements, including the fit and proper requirements for the responsible for the management of credit institutions”.
8 See the Joint Guidelines, Guidelines (No 75), “without prejudice to the presumption of innocence applicable to criminal proceedings, […] should be considered in the assessment of reputation, honesty and integrity [certain] ongoing prosecutions for criminal offence”. A similar wording is used in the ECB Guide, whose paragraph 4.2 is entitled “(Pending) legal proceedings”.
9 This criterion needs, of course, to be read in conjunction with the limit on the maximum number of directorships set forth under Article no. 91 of the CRD IV.
10 The Joint Guidelines, Guidelines (No 91).
11 See the Joint Guidelines, Rationale and objective of the Guidelines (No 42): “While the diversity of the management body is not a criterion for the assessment of the members’ individual suitability, diversity should also be taken into account when selecting and assessing members of management bodies”.
12 Pursuant to the ECB Guide, the diversity criteria is employed only for the complementary assessment concerning the experience of the appointee, to be carried out when “the thresholds at which sufficient experience is presumed are not met” (4.1 Experience, Stage 2 – Complementary assessment). Indeed, “the appointee can still be considered suitable of the supervised is able to justify this”, also by, inter alia, “taking into account the need to have sufficient diversity [..] in the management body”.
13 See the Joint Guidelines, Guidelines (No 31, The institutions’ assessment of the collective suitability of the management body).
15 See the Joint Guidelines, Compliance and reporting obligations, Status of these guidelines (No 1).
17 A study of The European House – Ambrosetti, whose outcomes have been disclosed on 6 march 2017 through an article (V. De Molli and A. Brancati, Banche, un consigliere su quattro non è in regola) published on the Corriere Economia, showed that suitability assessment pursuant to the ECB Guide would lead to consider unfit and improper about one fourth of the current members of the management bodies of Italian institutions operating under the ECB supervision.