The role of the INED

• United Kingdom

• Financial services disputes and investigations
• Litigation and dispute management

12-04-2021

What are regulators’ expectations of independent non-executive directors (INEDs) of regulated financial services firms? As noted in a recent speech by Elizabeth McCaul, member of the Supervisory Board of the European Central Bank (ECB), some INEDs are concerned that regulators expect INEDs to perform so much oversight of executive management that this veers towards performing executive management functions and the line between executive management and directors gets blurred. She explained that the ECB expects that INEDs serve as a “compass” for the regulated firm:

“providing strong, constant direction in both calm and rough waters by ensuring independent oversight of management proposals and decisions. In times of stress or crisis, effective non-executive directors – especially those in key board positions such as lead independent directors and members of risk and audit committees – are often called upon to provide even more intensive steering of the ship.”

What does this mean in practice? A 21 March 2021 speech by Mary-Elizabeth McMunn, the Director of Credit Institutions at the Central Bank of Ireland (CBI), provides some useful indicators.

She noted that the culture of a firm is of particular importance. An effective INED can help foster a good culture and challenge aspects of the culture in the firm that may not be optimal. She pointed, by way of example, to Risk Mitigation Programmes (RMPs) that are put in place by the regulator:

“Frequently, we see responses to these which do not address the root cause. Where these come to you as board member, I would ask you to consider whether the remediation actions proposed get to the core of the issues and where they do not, to challenge the executive in this regard.”

In other words, the regulators expect that INEDs do not simply take at face value the information they are provided by the executive management in relation to addressing RMPs. INEDs must dig more deeply and ensure that root causes of issues are properly addressed. In this regard, she noted that too often the CBI had seen an optimism bias at senior levels in banks and the regulators expect INEDs to play a role in countering this.

More generally, the CBI expects INEDs to challenge constructively and effectively at board level: “You can and must ask the hard questions and critically evaluate the quality of information or reporting to the board, the strategic direction of the bank, the culture that prevails, the customer relationships, the emerging risks to the business model and much more.” The CBI is keen to see this challenge “exhibited”. The CBI is likely to wish to se evidence of constructive challenge recorded in board minutes.

In order to challenge constructively and effectively, INEDs will need access to adequate relevant information. As noted in the above-mentioned speech by Elizabeth McCaul, this means, amongst other things, that the interaction between the board and the heads of risk, compliance, AML and internal audit should not be filtered through intervening executive management. Also, internal control heads should report regularly to the board and its relevant committees. Board reporting should also be supported by internal systems capable of producing reliable information and board members should have access to independent research, as well as the right to initiate such research, even outside the bank’s regular channels. An important role of INEDs will be to ensure that all of this is in place.

With regard to candidates applying for approval from the CBI under the fitness & probity pre-approval process in Ireland, Ms McMunn noted the role of INEDs on nominations committees to ensure diversity of candidates. Also, INEDs in these positions have a responsibility to ensure that appropriate due diligence is carried out regarding the fitness and probity of the candidate for the role in question: “it remains an issue that candidates being put to the Central Bank for approval under the F&P process are too often unprepared for such engagement and/or do not demonstrate the knowledge or experience necessary… Presentation of such candidates is a not a good reflection on the bank”.

On the issue of diversity, a February 2021 speech by Edouard Fernandez-Bollo, Member of the Supervisory Board of the ECB, noted the importance of addressing diversity. He stated that, according to data available to the EBA, around 55% of banks with a more gender-balanced selection of executive directors have a return on equity (ROE) of 6.42% or higher, while only 41% of banks with executive directors of just one gender reach this level. Also, the average ROE of banks with gender-diverse management functions is around 1.3 percentage points higher than that of banks without such diversity. The EBA data indicated that there is a problem of inadequate gender diversity in European banks: of the 834 credit institutions and investment firms the ECB examined, two-thirds have executive directors of only one gender and over 40% have not yet adopted a diversity policy at all, despite the provisions of the CRD IV. INEDs on nominations committees have an important role in addressing this diversity challenge.

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