knowledge | 31 March 2017 |
MiFID II - Corporate Governance
This is the second in our series of briefings on MiFID II, which will significantly overhaul the existing law regulating financial markets when it enters into force on 3 January 2018. This briefing focuses on the relatively detailed principles and minimum standards on corporate governance set out in MiFID II.
MiFID II extends to inscope investment firms the corporate governance requirements set out in the Capital Requirements Directive 2013/36/EU (“CRD IV”), which are currently applicable to banks and certain investment firms. It also includes a number of provisions which set out requirements regarding the composition of the management body and its role.
In a related development, in October 2016, the European Securities and Markets Authority (“ESMA”) and the European Banking Authority (“EBA”) consulted on draft Guidelines on the assessment of the suitability of members of the management body and key function holders under CRD IV and the MiFiD II Directive (the “Draft Suitability Guidelines”). These Guidelines aim at further improving and harmonising the assessment of suitability within the EU’s financial sector and at ensuring sound governance arrangements in institutions.
Composition of the Management Body
When deciding on the composition of its management body, an investment firm within the scope of MiFID II (“Firm”) must ensure that both the body as a whole as well as its individual members (“Members”) meet certain standards. In addition, Members are expected to commit sufficient time to the performance of their functions. The management body must also be provided with induction and training.
The Draft Suitability Guidelines set out common criteria to assess the collective and individual knowledge, skills and experiences of Members as well as their good repute, honesty and integrity and independence of mind. They also specify that the Firm’s management body should adopt and maintain a suitability policy for assessing the suitability of the Members. As part of this policy, the management body should have policies and procedures in place for selecting, monitoring and planning the succession of its Members and for re-appointing existing Members. The proportionality principle applies when developing and implementing these policies and processes.
According to the Draft Suitability Guidelines, the management body should have an adequate number of Members and an appropriate composition, which reflects an adequately broad range of experiences, qualities and competences to be able to understand the Firm’s activities, including the main risks. There should be a sufficient number of members with knowledge in each area to allow a discussion of decisions to be made. Annex 1 of the Draft Suitability Guidelines sets out a template for assessing the Members’ collective competence.
The management body’s overall composition must be “diverse”, a term which the Draft Suitability Guidelines define to mean the situation whereby the characteristics of the Members including their age, gender, geographical provenance and educational and professional backgrounds are different to the extent of allowing for a variety of views. According to the Draft Suitability Guidelines, a Firm must put in place a policy promoting diversity on the management body, which should at least refer to: educational and professional background, gender and age. Firms that are active internationally should include geographical provenance, unless to do so is unlawful. For significant institutions, the diversity policy should include a quantitative target for the representation of the underrepresented gender in the management body. However, a Firm should not recruit Members with the sole purpose of increasing diversity to the detriment of the functioning and suitability of the management body collectively, or at the expense of the suitability of individual Members.
Each Member must possess sufficient knowledge, skills and experience, be of good repute and be able to act with honesty and integrity, and be independent.
Sufficient Knowledge, Skills and Experience - according to the Draft Suitability Guidelines, Members should have an up-to-date understanding of the Firm’s business and its risks and be able to contribute to the implementation of an appropriate corporate culture. Annex II of the Draft Suitability Guidelines sets out the skills that a Firm may take into account. The assessment of adequate knowledge, skills and experience should consider:
- the knowledge and skills attained through education and training;
- the practical and professional experience gained in previous positions;
- the relevant skills required for each position; and
- the knowledge acquired and demonstrated by the Member’s professional conduct.
Reputation, honesty and integrity - the Draft Suitability Guidelines state that a Member should be deemed to be of good repute if there are no objective and demonstrable grounds to suggest otherwise. The Guidelines list a number of factors that should be considered in assessing reputation, honesty and integrity.
Independence – According to the Draft Suitability Guidelines, Members should not have conflicts of interest that cannot be managed that impede their ability to perform their duties independently and objectively. Each Member must be able to effectively assess and challenge the proposed decisions of other Members of the management body, to ask questions and be able to resist “group think”.
A Member must be able to devote sufficient time to performing his or her functions and responsibilities, including any additional time commitments likely to arise in times of increased activity. A Member of a significant institution is limited in the number of directorships that he or she can undertake.
According to the Draft Suitability Guidelines, a Firm must record in writing the functions and responsibilities of different positions within the management body and the expected time commitment required for each position, including time or induction and training. A Firm should monitor to ensure that each Member commits sufficient time to performing his or her functions and keep records of all external professional, political and other functions and relevant activities exercised by the Members.
Induction and Training
A Firm must ensure that it devotes adequate human and financial resources to the induction and training of its Members. According to the Draft Suitability Guidelines, a Member should be provided with induction training within one month of his or her appointment as a Member. The purpose of this training is to facilitate the new Member’s clear understanding of his or her role and the Firm’s structure, business model, risk profile and governance arrangements.
A Firm should also provide its Members with ongoing training as appropriate. According to ESMA and the EBA, ongoing training should aim at improving and keeping the Members’ qualifications up to date so that the management body collectively at all times meets or exceeds the expected level.
A Firm must put in place policies and procedures in place regarding induction and training. The Draft Suitability Guidelines set out what those policies and procedures should include. A Firm must also put in place an evaluation process to review the effectiveness of the induction and training provided and ensure compliance with the induction and training policies and procedures.
The Role of the Management Body
A Firm’s management body is responsible for defining and overseeing its governance arrangements and is accountable for their implementation. It must ensure that the relevant arrangements ensure the Firm’s effective and prudent management, including the segregation of duties in the Firm and the prevention of conflicts of interest. This must be done in a manner that both promotes the integrity of markets and clients’ interest.
In particular, the management body must:
- approve and oversee the implementation of the Firm’s strategic objectives, risk strategy, internal governance and organisation for the provision of investment services and activities and ancillary services;
- approve and oversee a policy as to services, activities, products and operations offered or provided and a remuneration policy of persons involved in the provision of services to clients;
- ensure the integrity of the Firm’s accounting and financial reporting systems, including financial and operational controls and compliance with the law and relevant standards;
- oversee the process of disclosure and communications; and
- be responsible for providing effective oversight of senior management.
The management body must monitor and periodically assesses the effectiveness of the Firm’s governance arrangements and take appropriate steps to address any deficiencies.
All Firms, including those falling within the scope of CRD IV, will need to reassess the composition and role of the management body for the purposes of MiFID II and in accordance with the Draft Suitability Guidelines, once finalised. This means, in particular, that each Firm must:
- design and implement a clear, well documented and transparent Suitability Policy for the assessment of the suitability of its Members;
- put in place a diversity policy and policies and procedures for Members’ induction and training, both of which may be part of the Suitability Policy;
- assess both the collective and individual suitability of the Members both initially and on an on-going basis and document the results of these assessments;
- ensure that any shortcomings identified in suitability assessments are addressed appropriately and document the measures taken to address these shortcomings;
- document the nature and content of training provided to a Member, either individually or as part of the management body;
- ensure that the outcome of suitability assessments for new Members are transmitted to the Central Bank – Annex III of the Draft Suitability Guidelines lists the documentation that must be submitted to the relevant Competent Authority in connection with initial appointments; and
- review the role of its management body to ensure that it complies with the MiFID II requirements.
We expect that ESMA and the EBA will finalise the Draft Suitability Guidelines over the next few months. Once they are finalised, the previous EBA Guidelines on the assessment of the suitability of the management body and key function holders (2012) will be repealed.
Whereas at a practical level we anticipate that Irish authorised MiFID investment firms will satisfy most if not all of the criteria set out in the Draft Suitability Guidelines, (on the basis of the Central Bank of Ireland’s authorisation application process, fitness and probity regime and other similar measures), as mentioned it will be important for each firm to assess its compliance with the specifics of the Draft Suitability Guidelines when ultimately finalised.
This briefing is for general guidance only and should not be regarded as a substitute for professional advice. Such advice should always be taken before acting on any of the matters discussed.