Exploring directors’ independence

by Karen Wauters and Yann Merillou

 
The value of independent voices on boards is widely recognised, but there is less agreement on how to define this notion. “Non-Executive Directors in Luxembourg – A focus on NEDs, iNEDs and the concept of independence” is an ILA publication which will add clarity as organisations strive to combat groupthink on their boards. 


 
The ILA board asked the Board Organisation and Effectiveness Committee to provide a framework to help directors better understand the concept of independence. The result is a paper which reviews current rules and guidelines, and offers some definitions and a guide to best practice (See link to paper below). The executive summary of this publication was presented after the ILA AGM held on 15th June at Quintet Private Bank.

Considerable value

“Non-executive directors [NEDs] bring diversity, industry and regulatory expertise, skills and a different background,” said committee chair Karen Wauters, introducing the session. “Independent non-executive directors [iNEDs] bring additional value with higher capacity to challenge the management given their absence of conflicts of interest,” she added. The aim of this publication is to “go beyond legal and regulatory requirements, to help understanding of how to approach the concept of director’s independence,” she said.

“At the genesis of this publication, we conducted a poll, and over half of participants said the definition of independence for Director in Luxembourg was either not good enough or they had no opinion,” said Yann Merillou, the committee member who piloted the writing of this publication. He said an important subset of the Non-Executive Director group has emerged over the last year, with Directors who are not only external, but also free from other material relationships, influences or circumstances which may be perceived as creating a potential conflict of interest : who we call the “Independent Non-Executive Director” or iNEDs.
 
The keys to assessing independence: assessing conflicts of interest

“The starting point to assess the independence of a Director is usually a negative one:  the absence of material conflicts of interest,” he said. If so, independence may be impaired or may be perceived to be impaired. “To be considered as independent, Directors must be free from legal or personal constraints that may impair their objectivity or judgement. Directors who can no longer be considered as an independent will often be able to continue their mandate as a NED – this depends more on the overall Board composition and requirements”, he added.

Conflicts of interest may arise from many different situations and relationships, including for example economic interests, relationships or prior employment, but “Consideration also has to be given to personal relationships, and I think that it is very relevant in a country such Luxembourg, given the proximity of families, business partners and service providers,” he said. 
The report recommends having formal cooling-off periods between leaving an executive role, or a significant business relationship and taking up a directorship mandate as an iNED where there is a risk of conflict of interest. Regarding Board tenure, there is also a suggestion of having a formal process to reconsider the nature of a director’s independence if they have been on the board for several years. 

Thought should also be given to how remuneration could affect the relationship. Performance-related directors fees could affect (of be seen to affect) neutrality, hence a fixed fee might be more appropriate. The report also underlines the importance of the director being able to resign a mandate if they believe this to be necessary, regardless any financial considerations.

In conclusion has been mentioned that there is no “magic number” of NEDs or iNEDs that would be ideal, but one-third of the board total is broadly seen as a healthy benchmark. Having such numbers helps “to ensure sufficient influence on the rest of the group,” said Yann. As regards recruitment, and especially assessing independence of directors, “each board should determine its policies, procedures, processes for board evaluation and board nomination, thus defining some clear criteria,” he said.

Yet throughout, the publication makes clear that there should not be fixed, one-size-fits-all rules about NEDs and iNEDs. “Given the diverse scope of the companies that exist, the Board should set a framework that is appropriate for their company and should review this on a regular basis. Independence in each context should be assessed, policies adopted, and their application monitored, while ensuring consistency and transparency,” Yann said. The publication is available in the link below:

ILA Non-Executive Directors in Luxmebourg - NEDs, iNEDs and the concept of independence


Action for ILA members

“I would encourage ILA members to use the conclusions of this report to help them reconsider how they refer to themselves on their LinkedIn profiles, signatures, business cards and CVs,” Karin added. “The term “independent non-executive director” is specific to a given situation while “non-executive director” applies more widely.