Hong Kong’s banks are preparing to beef up the independence of their non-executive directors this month following the Hong Kong Monetary Authority’s recent guidelines. Michelle Perry finds out the challenges of finding INEDs who can meet higher expectations
Illustrations by Simone Altamura
Since the global financial crisis a decade ago authorities and regulators around the world have been trying to define the causes and fix the problems which caused the crisis so that no similarly deep and prolonged financial crash will reoccur. One of the areas that has repeatedly been under the spotlight is the weaknesses in governance at financial institutions. Many boards were unable to explain the risks that banks faced and therefore were equally unable to mitigate them or at the very least manage them.
Although Hong Kong and its institutions were not affected by the financial crisis in the same way as the United States and Europe, the Hong Kong Monetary Authority (HKMA) chose to also review corporate governance within banks.
Last December, following an industry consultation carried out in early 2016, the HKMA issued new guidelines that are expected to lead to a higher demand for fittingly skilled and experienced independent non-executive directors (INEDs) by Hong Kong’s banks in future.
The HKMA’s circular – Empowerment of Independent Non-Executive Directors (INEDs) in the Banking Industry in Hong Kong – sets out these guidelines which came into effect on 14 December, and cover the role of INEDs, practices of locally incorporated authorized institutions (AIs) – those banking institutions allowed to take deposits – with regard to INEDs, and proposed measures to be taken by AIs to ensure that there are sufficient suitably qualified people willing to serve as INEDs on the boards of AIs.
The guidance consists of six main areas: Constitution of the board and its committees; the roles, qualities, background and time commitment of INEDs; factors to consider when assessing a director’s independence and tenure; remuneration of INEDs; board practices in relation to INEDs; and training and development requirements.
The HKMA, which approves directors of AIs under section 71 of the Banking Ordinance, has always “assessed an INED candidate’s personal qualities, knowledge and experience, and independence, among other factors”, it says. But what it is aiming to do with the updated guidance on the appointment of INEDs is “to provide some guidance in respect of the roles of INEDs and how to ensure that there are sufficient suitably qualified people willing to serve as INEDs on the boards of AIs, taking into account prevailing industry practices. This is part of the HKMA’s continuing programme to empower INEDs in the local banking industry.”
“By discharging the responsibilities, the INED shall understand the unique culture, business operations, strategic plans, and the associated risks or regulatory concerns of the bank.”
Adams Chan, Partner, PwC’s financial services risk and regulations practice and a Hong Kong Institute of CPAs member, says, “The new rules are part of the HKMA’s regulatory response to mitigate the risk of future crisis in the banking system. In particular, they see corporate governance, and the roles played by INEDs, as a means of enhancing banks’ control environment in a sustainable manner to ensure long-term stability. To achieve this there has been an increasing focus on ensuring that INEDs have the right balance of skills and experience, which are supplemented by ongoing training.”
He adds that a number of the larger local players, including listed banks, already have INEDs on their boards and these new requirements will not have much of an impact on them. “However, this could be a challenge for overseas banks with locally incorporated banking entities and smaller local banks. Having said that, we are talking about 54 locally incorporated authorized institutions in Hong Kong – assuming all of these institutions appoint three INEDs we need around 160 persons. I am quite confident that the number of qualified professionals in Hong Kong is more than that.”
To Jenny Fung, Chief Compliance Officer, Greater China, at ABN AMRO Bank N.V. Hong Kong, the guidelines are necessary. “Banks need a fresh pair of eyes to assess if their operations, practices, and culture, are reasonable or perceived as reasonable,” she says.
Fung, also an Institute member, notes that unlike a locally incorporated bank, her branch does not have a local board or board audit committee. “Even so, our head office has already put in place a similar structure as described in the circular.”
The main challenge of appointing the right INED, she adds, is that individuals who possess in-depth knowledge and experience in the banking industry are limited. “In particular, there are new risks or areas of focus emerging in the banking industry such as cybersecurity, trade-based money laundering, cryptocurrencies, etc. and the regulatory requirements or expectations may change from time to time,” she says. “By discharging the responsibilities, the INED shall understand the unique culture, business operations, strategic plans, and the associated risks or regulatory concerns of the bank. In addition, the independence of an INED is key, while usually individuals who are known or friends to the banks are invited to be an INED. Banks should have sound justification and an assessment process in place before appointing an INED.”
The HKMA, like the United Kingdom, follows a principles-based approach to the supervision of corporate governance and focuses primarily on the overall effectiveness of the boards and senior management of AIs. This is different from the U.S. where a rules-based approach is used by the Federal Reserve.
The updated guidance sets out some key principles and factors to be considered in assessing the fitness and propriety of INEDs and the overall board effectiveness of AIs. “It is not, however, intended to be an evaluation checklist or a ‘pass/fail’ exercise. If there are particular aspects where the corporate governance practice of an AI differs from the HKMA’s guidance, the AI would be expected to take mitigating or enhancement measures within an agreed time frame as necessary,” HKMA says.
Indeed, there is no penalty for those institutions that do not fulfil all the new requirements on INEDs by the deadline for compliance this month. “The HKMA don’t have the power to prosecute, nor do they fine but they do have the power to force banks to remediate,” says Paul McSheaffrey, Head of Banking, Hong Kong and Head of Internal Audit and Risk Compliance Services, Hong Kong, at KPMG China, and an Institute member. “Non-compliance would most likely affect an institution’s CAMELS rating [referring to the six factors of a bank’s condition that are assessed], which could result in the regulator requiring an institution to hold more capital.”
That said, McSheaffrey doesn’t expect any banks to fail to comply. Speaking to A Plus before the regulations came into force he said, “I expect all banks to conclude on 17 December that they are fully compliant with the new rules. No one has come out saying they have a problem with them. It’s all fairly easy to implement even though it might be costly.”
Despite no mandate to penalize institutions that do not fall into line with the new rules, expectations run high that the HKMA will act in some form or another.
Michael Footman, Director of PwC’s Financial Services Risk and Regulations Practice, says: “The HKMA will continue to discuss their expectations on strong corporate governance and risk culture with INEDs, executive directors and senior management for the foreseeable future. These are high on the regulator’s agenda and we expect to see continued enhancement and scrutiny of these areas going forward.”
Higher salary, higher expectations
An emphasis on time commitment is one of the areas that the HKMA has formalized in its updated guidelines. According to the circular, INEDs should be prepared to not only attend all meetings of the board or committees in person, but also devote time to other meetings with the bank’s management, and to training or briefings on the business and developments in the banking sector in general and regulatory requirements.
With the emphasis on time commitment it is therefore only inevitable that a rise in salary would match the increased workload. In 2015, the typical basic compensation of an INED at a large listed bank was around HK$150-200,000. The HKMA now recommends that the minimum basic compensation for an INED should be HK$400,000.
“The HKMA’s steps to introduce minimum director’s remuneration may help attract more individuals into this area. However, a number of institutions that have been slower in starting to identify and screen candidates may find it challenging to appoint the right INEDs,” PwC’s Footman says.
The more attractive compensation of an INED may be a green light to those looking to boost their portfolio careers, however PwC’s Chan sounds a warning, pointing out that one implication of the new requirements is a higher level of individual accountability. “In the past there could be a tendency to make decisions as a collective body as opposed to how individuals have contributed to the decision-making process.
I believe that these more explicit expectations of high attendance rates, evidence of individual challenges and contributions as well as board effectiveness reviews will sharpen the focus on individual accountability. Whilst I do not think any INED would be, or should be, ‘scared’ by these expectations, it is possible that some candidates may wish to re-assess their availability before taking up the INED role.”
“I believe that these more explicit expectations of high attendance rates, evidence of individual challenges and contributions as well as board effectiveness reviews will sharpen the focus on individual accountability.”
Another new requirement states that the boards of all AIs should have at least one INED with a background in accounting, banking or other relevant financial industry. The chair of the audit committee and the chair of the risk committee must also be an INED with this background. “These new rules will result in a greater demand for individuals with the right skills and experience to take on INED roles in the banking industry,” Footman says. “That being said, a number of authorized institutions have made significant progress in identifying individuals through their executive search processes.”
Moreover in its circular, the HKMA stipulated that “INEDs must be persons of integrity with extensive professional or business experience. They need not be from a banking background, but should have skills and knowledge that are relevant to their role, including broad experience of identifying and managing operational, financial, reputational and other risks.
Relevant backgrounds include, but are not limited to, banking, law, accounting or finance, industry, general business, regulatory and government.”
This is good news for accountants in the region. “There is a rising demand for senior-level accounting professionals with HKMA regulatory returns reporting and oversight experience to possess relevant accounting qualifications. Historically, having the right qualifications is not a deal breaker but we are noticing that this is changing,” Kuan-Yu Shen, Team Manager at recruiters Hays, Hong Kong, explains. He adds that increasingly, accountants are seeking experience with locally incorporated banks, not just with foreign banks, to increase their corporate governance knowledge. “This is owing to the additional HKMA guidelines that regulatory accountants based in local banks must follow some rules that foreign banks may not need to adhere to.”
So for those interested in becoming an INED, what skills are in demand? Shen says: “Besides having a minimum of 10 years of HKMA reporting and reviewing experience, employers are increasing placing emphasis on strong stakeholder management and interpersonal skills. It is also important that candidates are up to speed with the latest developments in regulations, thus the appetite and curiosity to stay up-to-date with new trends and regulations is a good must-have.”
Guidance on the Empowerment of Independent Non-Executive Directors (INEDs) in the Banking Industry in Hong Kong was issued on 14 December 2016 by the Hong Kong Monetary Authority. It consists of six main areas: Constitution of the board and its committees; the roles, qualities and background, and time commitment of INEDs; INEDs' independence and tenure; remuneration of INEDs; board practices in relation to INEDs; and training and development requirements for INEDs.