3.7.3 A nuanced cross-sectoral approach

Of course, the crux lies in identifying the extent to which the principles are indeed applicable in other, or all, types of financial institutions. In this respect, a nuanced approach is recommended. In the authors’ opinion, the lessons of the financial crisis and the reports mentioned above prove adequate support for application of the five fit and proper criteria laid down in CRD IV not only to banks and investment firms but also to all financial institutions.

However, the proportionality principle should be applied when assessing these criteria. This means that not only may the exact requirements differ, depending on the function and the type of financial institution (for example, the required level and areas of knowledge and experience for board members will differ depending on such factors as the type of institution and its size, risk profile and complexity), but also that how these requirements are to be assessed (by the institution or by the competent authorities, in depth ex ante assessement or assessment of only minimum requirements) may differ too. This will lead to more cross- sectoral harmonization (all five criteria will apply to all institutions), while at the same time preventing a one-size-fits-all approach.

A strong case for a comprehensive, cross-sectoral approach seems to exist in relation to the requirement of good repute. It is hard to find a justification for applying different levels of integrity to members of the management body in different sectors of the financial world, especially since the rebuilding of trust seems to be a cross-sectoral necessity. In the authors’ opinion, all members should adhere to the same high standards of good repute and integrity. Also, these terms should be defined and explained in a consistent way. While all directives and regulations have incorporated the requirement of ‘good repute’ (or an equivalent such as ‘proper’), these are high-level, lax and ambiguous terms that allow for divergent interpretations across the different sectors and among different Member States. In recent years, the ESAs have done much to explain and define the term ‘good repute’ in more detail. It is recommended that the ESAs follow up on this and harmonize the assessment of ‘good repute’ in all financial institutions.

However, this would not prevent the competent financial supervisors from taking a risk-based approach to assessing ‘good repute’, differentiating between the sectors. While members of the management body should at all times be of good repute, ensuring compliance with this requirement is primarily the responsibility of the financial institution itself. Competent financial supervisors may choose to limit the assessment of good repute in the case of certain types of institution, for example to desk research (checking criminal records and evidence of other offences, particularly tax offences), which cannot usually be undertaken by the institutions themselves. This could be followed up by a more in- depth assessment if the outcome of the desk research gives rise to further questions.

In a similar vein, it seems advisable to add ‘independence of mind’ to the suitability test in all financial institutions. All members of the management body, and especially its non-executive members, should be able to form objective and independent judgements and have the capacity, if needed, to challenge management decisions effectively. The existence of conflicts of interests that may impact the independence of mind should be identified and, if possible, mitigated. This can be regarded as one of the most important lessons of the financial crisis.1

In this respect the EBA and ESMA guidelines could be followed. In other words, all members of the management body should have independence of mind, regardless of the institution’s size and internal organisation, the nature, scope and complexity of its activities and the duties and responsibilities of the specific position.2 In keeping with the EBA and ESMA Guidelines, the proportionality principle should therefore not apply when it comes to ‘independence of mind’.

Nevertheless, a risk-based approach might result in differentiation between institutions when this requirement is assessed. For some (low-risk) institutions, the assessment might be left primarily to the institution itself, leaving the competent authorities free to follow up on the findings in the course of ongoing supervision (without carrying out a check in advance).

When it comes to identifying the necessary individual qualifications such as knowledge, skills and experience, much importance should be attached to the proportionality principle. Clearly, individual qualifications are very much connected to the needs of the specific institution, as well as to the specific function of a person within the organisation.

The same risk-based approach suggested before might be used for the assessment of skills. As a rule, supervisors may well feel more comfortable with identifying current, inappropriate behaviour rather than predicting future behaviour. If they come across such behaviour during ongoing supervision, they could consider reassessment since this would shed a different light on the prior fit and proper approval.3

Also, since it is often not feasible for each and every member of the management body to possess all the knowledge and expertise necessary to effectively direct and oversee the institution, the management body should at least have this experience and expertise collectively. This means that individual qualifications may differ within a given institution.

Yet, in the authors' opinion, all members of the management body should have a basic understanding of the major risks faced by the institution and possess a minimum degree of expertise in order to understand and challenge management decisions effectively.4 This might pose a challenge in cases of (mandatory) employee representation in the management body and in (smaller) pension funds.5 In these cases, however, the necessary expertise could be gained by additional training and education or the use of external advisors.6

It is also recommended that ‘time commitment’ be added to the suitability test in all financial institutions.7 Management in all institutions should be able to devote sufficient time to their functions in order to fulfil their duties effectively. Presumably, it would add value to the test if the time commitment were to be specifically addressed. However, what constitutes ‘sufficient’ time is naturally assessed differently from one organisation to another and from one function to another. This provision should therefore be assessed according to the principle of proportionality. Also, the intensity of the test may vary. An extensive assessment of this requirement as laid down in the EBA/ESMA Guidelines of 2017 may not always be necessary and may place an excessively heavy administrative burden on the institution.8 In such cases a simplified method might suffice.

As for the scope of the five criteria, it is recommended that they be applied to all members of the management board, including both executive and non-executive members. As follows from the reports mentioned in this chapter, strengthening the role of non-executive directors and providing for adequate checks and balances on the board can be regarded as one of main lessons of the crisis.

It is also recommended that all members of the senior management and key function holders, who have significant influence over the direction of the institution and the risks taken, fulfil certain fit and proper requirements, including good repute and experience. However, a proportionate approach can be adopted to the assessment of this test. This assessment should be mainly the responsibility of the institutions, leaving the competent financial supervisors to perform fit and proper assessments of members of the senior management and key function holders based on a risk-based analysis only, leaving room for a sector-specific approach.

Other requirements for board composition (diversity and formal independence) may also call for a proportionate and/or a sector-specific approach. However, financial institutions should at least take note of the relevant international recommendations and consider applying them in their organisations (to be laid down in internal policies).9

It is also recommended that the definitions used in the different directives, regulations and guidelines should be aligned and interpreted in a harmonized way. This applies, in particular, to the definitions of ‘non- executive director’, ‘senior management’ and ‘key function holders’ (clarifying the scope of fit and proper testing).

Also, clear definitions and harmonized interpretations of ‘good repute’ and ‘independence of mind’ should be adopted, since the cross-sectoral application of these criteria are advocated. Here lies an important task for the three ESAs, namely enhancing consistent application of these definitions in all financial institutions and all Member States and fostering a level playing field in Europe.

In addition, clear and harmonized interpretations would provide for more legal certainty for institutions and persons subjected to fit and proper testing. Here too lies an important task for the national legislators, ensuring a harmonized implementation of the fit and proper criteria mentioned in the EU directives.10