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Warriors of the Board


Oleksandr Vygovskyy, Doctor of law, Attorney at law at Ilyashev & Partners
Source:  The Yurydychna Praktyka

Corporate management reform stipulates for considerable broadening of powers of the supervisory board in management of the bank

The effectiveness of corporate governance of the commercial banks is one of the most important conditions for stable functioning both of individual bank institutions and of the banking system in general. Overcoming the current crisis developments in the banking sector depends not only so much on regular finance loans of the National Bank of Ukraine (NBU) for maintenance of liquidity of Ukrainian banks, but rather on formation at the banks of such system of corporate governance and internal control as to minimize, to the highest possible extent, the possible abuse by the bank’s officials of their powers. Introduction of legislative reforms in this area should be carried out in accordance with best international practices, as summarized in such documents as the OECD Principles of Corporate Governance 2004, the guidelines and recommendations of the Basel Committee on Banking Supervision “Enhancing Corporate Governance for Banking Organizations” in 1999, the recommendations of the Organization for Economic Cooperation and Development (OECD) “Corporate Governance of Banks in Eurasia” in 2008 and so on.

Define the status

In the context of this corporate governance reform of the commercial banks the lawmakers have greatly expanded the powers and increased the management role of the Supervisory Board in the bank. According to the new principles of its formation of the bank’s Board must consist of not only the elected bank’s members (their representatives), as stipulated in the current version of Part 1 of Article 39 of the Law of Ukraine “On Banks and Banking Activities”, but also of so-called “independent members” and, by the way, the latter must constitute not less than a quarter of the total number of the board members. These requirements are consistent with the global corporate governance practices (not only of the banks but also of other companies) having two-level model of the Supervisory Board where it is required to have members not associated with any interest of the company, its officials or shareholders.

The status of an independent member of the Supervisory Board must be determined only in relation to a particular bank and may vary depending on certain events. In addition to the criteria that all the members of the Supervisory Board should meet (in particular, impeccable business reputation) independent members should be independent in their decision-making and display objectiveness in assessing the current situation.

Definition of “independent director” (“an independent member of the supervisory board”) is of paramount importance for the legislative model of corporate governance in the banking sector. As it is noted in the Appendix to the OECD Guidelines “Corporate Governance of Banks in Eurasia” in 2008 (OECD Guidelines 2008) vague definition will unlikely contribute to the effective work of the Board of Directors and overly strict definition, detached from reality, will complicate the selection of suitable candidates. In their practices foreign countries resort to two basic approaches towards formulation of such concept: by defining a list of “negative criteria” (i.e., those qualities presence of which indicates the inability of a certain person to perform the functions of an independent director) or by defining the list of “positive criteria” which the candidates for the position of independent directors must meet. The first approach is more common and was taken as the basic concept of a bank’s independent board member in Ukrainian legislation.

Analysis of Part 4 of Article 39 in the new version of the Law of Ukraine “On Banks and Banking Activities” allows to establish the following “negative” criteria of independence of a board member: such status cannot belong to a person who is an associate of the member of the bank’s management board, representative of the bank’s related or affiliated entities, or the bank’s shareholder or his representative. This list of criteria is much narrower than the list of those established limits to which an independent director must correspond, for example, according to the Appendix to the Recommendation of the OECD 2008 which, in particular, states that an independent director must not be a member of the executive management (including the Board) or a bank’s employee, must not receive any additional compensation, must not have significant business relations with the bank or with any of the bank’s affiliated companies etc.

Even taking into account that criteria listed in the Annex to OECD Recommendations 2008 are offered to be used only as a starting point in the development of relevant definitions in the legislative acts, it is clear that the provision of Part 4 of Article 39 of the Law of Ukraine “On Banks and Banking Activities” (the new version) is not developed well enough and needs to be improved. In particular, in our opinion, at the legislative level it is necessary to secure the notion of “essential business relations” with the bank or its affiliates as an additional criterion of independence of a member of the bank’s board. It is also necessary to use the newly introduced term of “conflict of interest” as an additional criterion of impossibility of a person to be elected to the position of an independent member of the bank’s board.

Establish the procedure

The new version of Article 39 of the Law of Ukraine “On Banks and Banking Activities”, unfortunately, does not provide guarantees of the influence of the independent members onto the decision making process. In particular, the legislator has not formulated the requirement that the decision at the meeting of the bank’s board shall be deemed upheld if a majority of independent members vote in its favor. The law does not also stipulate for the right of the casting vote belonging to an independent member of the board in case of the parity of votes in decision-making process. In addition, the legislator has ignored the actual situation of loss by an independent member of the bank’s board of such status due to the occurrence of circumstances precluding his independence. In particular, the new version of the Law does not impose a duty onto such member to notify the bank’s management and its shareholders about the loss of his independence and/or duty to voluntarily resign from his position of a member of the Supervisory Board.

In this regard, we need to pay attention to the following important point. Amendments introduced to the Law of Ukraine “On Banks and Banking Activities” have not touched the procedure of election and re-election of the members of the bank’s board. Consequently, towards the procedure of election of the bank’s independent members provisions of the Law of Ukraine “On Joint Stock Companies” dated September 17, 2008 shall apply. Thus, the existing procedure for nomination of candidates to the management bodies of the joint stock company suggests the possibility of shareholders to nominate new candidates.

In our opinion, the legislator must stipulate for a special formation procedure of a list of candidates for the position of independent board’s members of the bank, because if such a member of the Board is nominated by a shareholder independence remains out of the question. In addition, amendments should be introduced into the list of information reflected in the ballot for cumulative voting in case of election of independent members of the Board, in particular, by adding questions on eligibility of a candidate to be included into such ballot.

According to paragraph 3 of Article 53 of this Law, election of members of the Supervisory Board of a public joint stock company is carried out exclusively through cumulative voting. This rule also applies to banks existing primarily in the form of public joint stock companies. In accordance with paragraph 2 of Article 57 of the Law of Ukraine “On Joint Stock Companies” if election of the members of the Supervisory Board was carried out by cumulative voting the decision of the General Meeting about premature termination of powers may be taken only in respect of all the members of the Supervisory Board.

Broaden the powers

Thus, hypothetically possible is a situation when a person elected as an independent member of the bank’s board loses such status. In this case the general meeting of shareholders must terminate his powers and appoint a new independent member in fulfillment of requirements put forward by Part 3 of Article 39 of the Law of Ukraine “On Banks and Banking Activities” (new version) towards minimum number of independent members. But it would only be possible to do so by re-electing the entire supervisory board, which is not rational. In our view, Article 39 of this Law should be supplemented by special rules related to the order of termination of powers of the independent members of the bank’s board in order to avoid this situation.

Legislative establishment of the minimum number of the bank’s members of the board should be generally recognized as a positive step (taking into account the small quantities of members of which current boards of many banks consist). However, in our opinion, the boards consisting of five members mean quite an insufficient amount for the effective operation of this official body. If, at the same time, we take into account the fact that the bank’s board must include not less than one quarter of independent members (Part 3 of Article 39 of the Law of Ukraine “On Banks and Banking Activities”, as amended) it turns out that in case of the board of the bank formed in the specified minimum number it will be sufficient to introduce only one independent member. In the absence of any additional powers (possibilities) work of such an independent member in the bank’s board will not be very effective; the most he will be able to do is to announce a point of view different from the views of the majority of board members (the Law does not mention even the possibility to claim introduction of the record about the special opinion of an independent member into the Minutes of the meeting of the bank’s Board) at a meeting of the board, but the outcome of the vote regarding the agenda will unlikely be affected.

Completing an overview of the novelties introduced into the banking legislation in the field of corporate governance it should be noted that the ongoing reform is aimed at increasing the objectivity and transparency of decision-making process within the bank. The reform should make the system of corporate governance and internal control of the bank more effective, encourage further adaptation of Ukrainian legislation to the banking law and practices of the European Union. However, these novelties need to be further developed accounting for the realities of banking practices in Ukraine.

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