This is the second of our series of alerts on MiFID II and MiFIR, the package of reforms and amendments to the Markets in Financial Instruments Directive. It is generally agreed that weaknesses in corporate governance in a number of financial institutions were a significant contributory factor to the ongoing financial crisis and, in this alert, we focus on the changes to the MiFID regime that are intended to enhance corporate governance standards within EU-regulated financial services firms. Although the new requirements will not come into effect until late 2016, or early 2017, it is important that firms are aware of the changes and start acting now to ensure they are ready and to position their businesses to be able to operate effectively in the new regime.
This alert summarises the new corporate governance requirements.
Cross-over with CRD IVArticle 9 of MiFID II requires competent authorities granting authorisation under the Directive to ensure that an investment firm and its management body complies with the governance arrangements and requirements on management bodies as set out in Articles 88 and 91 of Directive 2013/36/EU1.
Under CRD IV, the management body of a firm (i.e. its board of directors or equivalent) is required to define, oversee and be accountable for the implementation of the governance arrangements that ensure the firm’s effective and prudent management, including the segregation of duties in the organisation and the prevention of conflicts of interest. In particular, the management body is responsible for:
- approving and overseeing the implementation of the firm’s strategic objectives, risk strategy and internal governance;
- ensuring the integrity of the accounting and financial reporting systems, including financial and operational controls and compliance with the law and relevant standards;
- overseeing the process of disclosure and communications; and
- providing effective oversight of senior management.
The management body is also required to monitor and periodically assess the effectiveness of the firm’s governance arrangements and take appropriate steps to address any deficiencies2.
Members of the management body are required to be of sufficiently good repute and possess sufficient knowledge, skills and experience to understand the firm’s activities, including the main risks, and perform their duties. The overall composition must reflect an adequately broad range of experiences3.
Members of the management body are required to act with honesty, integrity and independence of mind to effectively assess and challenge the decisions of the senior management where necessary and to effectively oversee and monitor management decision-making4. The chairman of the management body is not permitted to also act as chief executive of the relevant firm.
In addition, firms are required to ensure that members of the management body are adequately trained and that sufficient human and financial resources are devoted to this5.
Members of the management body are required to commit sufficient time to perform their duties6. The number of directorships they may hold must take into account their individual circumstances and the nature, scale and complexity of the firm’s activities. Directors of firms which are significant in terms of their size, internal organisation and the nature, scope and complexity of their activities may not hold more than one of the following combinations of directorships at the same time: (i) one executive directorship with two non-executive directorships; or (ii) four non-executive directorships7. Competent authorities may authorise members of the management body to hold one additional non-executive directorship8.
Firms which member states deem to be “significant in terms of their size, internal organisation and the nature, scope and complexity of their activities” are required to establish a nomination committee9. Such nomination committee must be composed of members of the management body who do not perform any executive function in the firm.
The duties of the nomination committee include:
- identifying and recommending candidates to fill management body vacancies, evaluating the balance of knowledge, skills, diversity and experience of the management body and preparing a description of the roles and capabilities for a particular appointment, and assessing the time commitment expected;
- at least annually, assessing the structure, size, composition and performance of the management body and making recommendations to the management body with regard to any changes;
- at least annually, assessing the knowledge, skills and experience of individual members of the management body and of the management body collectively and reporting to the management body accordingly; and
- periodically reviewing the policy of the management body for selection and appointment of senior management and making recommendations to the management body10.
Firms are required to ensure diversity on their management bodies and to put in place a diversity policy11. In particular, nomination committees are required to decide on a target for representation of the underrepresented gender in the management body and prepare a policy on how to increase the number of the underrepresented gender in the management body in order to meet that target12. It is also the nomination committee’s duty to take account of the need to ensure that the management body’s decision-making is not dominated by any one individual or small group of individuals in a manner that is detrimental to the interests of the firm as a whole.
The European Banking Authority (“EBA”) and European Securities and Markets Authority (“ESMA”) will be issuing guidelines on some of these issues discussed above; for example, the notion of diversity to be taken into account for the selection of members of the management body. We do not expect these guidelines to be published until closer to the deadline given in CRD IV of 31 December 201513. However, we will follow any developments closely and will publish further alerts on this issue in due course.
In the meantime, firms should begin to consider whether and how the enhancements to corporate governance will impact on them and their businesses and plan how they are going to deal with them.
For further information on MiFID II please read the other alerts in this series on the following topics: scope; trading issues, including new venues and pre- and post-sale transparency requirements; position limits and reporting; the European Market Infrastructure Regulation and how it will operate alongside MiFID II; and algorithmic trading requirements.