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Managing Partner, Baker McKenzie
Associate, Baker McKenzie
Corporate Governance in Ukrainian Banks: Great Expectations
This article briefly reviews the recent changes, initiatives and trends in corporate governance rules in the Ukrainian banking sector, which survived the financial meltdown of 2014/2015 and showed the first profitable results in 2018/2019.
The largest banking crisis in Ukraine’s history occurred in 2014 and 2015 with over one hundred commercial banks declared insolvent and transferred to the management of the state-run Deposit Guarantee Fund. Irrespective of the external environment that caused the largest banking crisis in Ukraine, the single biggest reason for such poor performance of Ukrainian banks was the lack of proper internal controls and rules for extending loans to related parties or for taking other unreasonable risks with loans, guarantees and other banking products. Ukrainian commercial banks quite simply lacked the proper corporate governance rules for operating reasonably and for the benefit of their depositors and other creditors.
Once revealed during the banking crisis, the deficiencies of the corporate governance in Ukrainian banks needed to be resolved to ensure stability and economic growth of the banking system. The National Bank of Ukraine took the lead to undertake actions aimed at improving the management of risks and corporate governance in commercial banks. The most significant actions included substantial amendments to the applicable laws, which refreshed existing laws and regulations in the area of corporate governance.
Corporate Governance Novelties
With effect from 6 January 2018, corporate governance rules applicable to Ukrainian joint stock companies, including Ukrainian banks, were substantially amended by Law of Ukraine No. 2210 On Amendments to Certain Laws of Ukraine on Simplification of Doing Business and Attracting Investment by Securities Issuers (Law No. 2210). This Law provides Ukrainian banks with the opportunity to be organized not only in the form of public joint stock companies, but also in the form of private joint stock companies and, among other novelties, introduced a more sophisticated approach to the composition of banks’ supervisory boards, the role of supervisory boards’ committees, the scope and methods of information disclosure and other rules aimed at improving corporate governance.
Although the overall landscape of Ukrainian banks’ corporate governance structure (shareholders’ meeting, supervisory board and management board) remained intact, the composition and powers of the structure-forming bodies as well as the requirements regarding their activity went through substantial alterations. A glimpse of the most significant changes is provided below.
General Shareholders’ Meeting
In contrast to the approach previously used, when the shareholders’ meeting was entitled to decide on all and any matters of the joint stock company’s operation, the shareholders’ meeting shall now decide on all matters except for those falling within the exclusive competence of the supervisory board. The shareholders’ meeting will be empowered to decide on these matters only subject to the supervisory board’s resolution granting the shareholders’ meeting permission to perform accordingly.
In addition to changes related to the powers of the shareholders’ meeting, Law No. 2210 changed the approach taken to the publication of notices about meetings of shareholders in official printed media (joint stock companies, including banks, are now not required to do so but are obliged to publish such notices on their official websites) and information to be contained in them (e.g. the procedure for familiarization with documents for the shareholders’ meeting, submitting proposals to the agenda as well as the procedure for voting through representatives).
Although the shareholders’ meeting continues to play first fiddle in the corporate governance structure of banks, Law No. 2210 enhanced the bank’s supervisory board’s ultimate responsibility for a bank’s business strategy, financial soundness, key personnel decisions, internal organization and governance structure, risk management and compliance obligations, as well as supervision over the bank’s other governing bodies.
Law No. 2210 proposed pivotal requirements to the composition of the supervisory board of a bank and the transparency of its activity. Law No. 2210 required one third of the members of the supervisory board (but at least three) to be independent directors, who are free from any influence from other persons (e.g. such as the board of directors of a bank or bank’s shareholders), both once they are appointed and during the whole term of their office.
In addition to “independence” requirements, the bank’s supervisory board shall now prepare a report annually constituting a separate part of the annual report of a bank submitted to the National Bank of Ukraine. Such report shall assess the activities of the bank’s supervisory board and include an assessment of its composition, structure and activities, information on the matters considered and the decisions made, and an assessment of the competence and effectiveness of each member of the supervisory board (including independent members), as well as of the supervisory board’s fulfilment of the previously declared objectives.
As to the management board, Law No. 2210 mainly covers amendments in respect of the requirements that the members of the bank’s top management shall fulfil (including business reputation, higher education and relevant banking experience).
Soft Law on Corporate Governance in Ukrainian Banks
In furtherance of the objectives declared and introduced by Law No. 2210, the NBU adopted Methodical Recommendations on the Organization of Corporate Governance in Ukrainian Banks, approved by NBU Decision No. 814-рш of 3 December 2018 (“Recommendations”).
When adopting the Recommendations, the regulator intended to increase the level of corporate governance in the Ukrainian banking sector so that it meets the postulates of applicable guidelines of the Basel Committee on Banking Supervision and best international practices. The Recommendations cover, among other issues, requirements for the composition, functions and liability of a bank’s board, rules regarding the activities of a bank’s committees, remuneration policies and disclosure of governance–related information by the bank. Even though these recommendations are not binding in their nature, the most recent practice shows that the NBU takes them into consideration when assessing the corporate governance of each particular bank in the course of its general oversight over Ukrainian banks.
Changes in Risk Management
Alongside corporate governance reforms, the NBU introduced drastic changes to the risk management regulations applicable to Ukrainian banks by adopting Regulation No. 64 On the Organization of Risk Management System in Ukrainian Banks and Bank Groups of 11 June 2018. The Regulation enacted a more thorough approach to establishing and operating the risk management system — subject to the specifics of banking activity and the nature and scope of banking and other financial services. Specifically, it introduced a “three-tier” system of risk management that includes:
— first tier: the bank’s business and support units, which take the risks and are liable for them as well as report on the ongoing management of these risks;
— second tier: especially created risk management and compliance units; and
— third tier: an internal audit unit that runs inspections and assessments of the efficiency of the risk management system’s operation.
Additionally, the Regulation also sets out the following requirements:
— a minimum list of risk management-related internal bank documents (declaration of predisposition to risks, strategy and policy of risk management, methodology for identification of material risks, risk management procedures and code of conduct) and requirements in relation thereto;
— the list of main risks that each bank shall identify, measure, monitor, control and report on (e.g. credit risk, liquidity risk, interest rate risk, market risk, operational risk and compliance risk);
— requirements for risk management during the launch of new products and substantial changes to a bank’s activity.
So far, the Regulation, on the one hand, envisages a wide range of powers given to Ukrainian banks in respect of risk management, and, on the other hand, introduces a high standard of sound risk management accompanied with the respective responsibility for complying with it.
Great Expectations for Corporate Governance
Ukrainian banks are now obliged to stick to the new rules of corporate governance, which, if consistently developed further and properly applied by the relevant state authorities, may lead to a substantial improvement of the situation in the banking sector. In terms of risk management, commercial banks apply a risk-oriented approach to the operations processed by them, and the question is whether commercial banks use this opportunity wisely or again turn it into a “risk management nightmare” for their customers.