Expertise of independent directors key as regulators overhaul financial governance rules

Financial regulators have launched a governance overhaul at financial holding companies aimed at curbing long-serving chairmen and strengthening board independence, but the industry is raising concerns about potential interference with management autonomy and the practical effectiveness of the new rules. A particular worry is that expanding the authority of independent directors and institutional investors could open the door to greater political or government influence over personnel decisions.

Reaction in the financial sector was mixed Thursday as industry participants weighed the governance reform plan announced by the Financial Services Commission and the Financial Supervisory Service. Although a proposed ban on a third consecutive term for financial holding company chairmen was dropped from the final plan, there is disagreement over how measures to strengthen the powers of independent directors and shareholders will actually work in practice.

The core of the reform plan is to require that the executive candidate recommendation committee — the body that nominates CEO candidates — be composed entirely of independent directors, and to bar sitting CEOs from participating in the nomination of independent directors and audit committee members. The stated aim is to break up the closed personnel structures that have formed around CEOs, but the industry warns that as independent directors take on greater authority and responsibility, securing the expertise and access to information needed to carry out that role will be essential.

A particular concern is whether independent directors, if given an expanded role in selecting subsidiary CEOs, will be able to rigorously vet candidates with sufficient information and expertise. There is an inherent gap in operational knowledge and understanding between internal executives who have spent decades inside a financial institution and outside independent directors. Even if the chairman's influence over appointments is curtailed, independent directors who lack the judgment to fill that role could become vulnerable to improper outside influence.

"Limiting the CEO's personnel authority may improve transparency, but the greater the power given to independent directors, the heavier their responsibility becomes," an official at one financial holding company said. "There is a real possibility that important personnel decisions could be made without a sufficient understanding of the company."

The official added that expanding the authority of independent directors must be accompanied by efforts to strengthen their expertise and independence, as well as appropriate compensation. "It is already difficult to recruit specialists in areas like IT and information security, and if responsibility grows without adequate support, attracting talent to these roles could become even harder," the official said.

Plans to encourage institutional investors such as the national pension fund to recommend independent director candidates are also drawing scrutiny over potential government interference in the financial sector. Regulators intend to broaden their interpretation of relevant laws to make it easier for institutional investors to put forward candidates. Previously, only recommendations made at the board's request were generally not considered an attempt to influence management. Going forward, the same standard will apply when a financial company solicits recommendations through its executive candidate recommendation committee, shareholder meetings or its website — a move designed to reduce the regulatory burden on institutional investors who wish to participate in the nomination process.

The financial industry, however, sees the measure as a potential avenue for major institutional investors, including the national pension fund, to expand their influence over personnel decisions. There is considerable concern that pension funds, which are subject to government policy, could be used as a vehicle for indirect government intervention in financial company management. The expansion of institutional investors' shareholder rights also raises the question of where to draw the line between their role as investors and their involvement in management.

The move is expected to revive debate over so-called "pension socialism," though regulators maintain the arrangement avoids the appearance of government control because institutional investors would be responding to requests from financial companies rather than exercising personnel authority on their own initiative.

Nor would a candidate recommended by an institutional investor automatically become an independent director. Any nominee would still have to pass a qualification review and screening by the executive candidate recommendation committee, and participation by institutional investors in the recommendation process would remain voluntary.

The question of whether tightening the shareholder vote required for a chairman's re-election will actually restrain long tenures is also dividing opinion. Under the reform plan, a banking holding company chairman seeking a first re-election would need the support of at least two-thirds of votes cast at a general shareholders' meeting, rising to three-quarters for a second or subsequent re-election. Critics note, however, that many major financial holding company chairmen have historically won re-election with approval rates of 80 to 90 percent or higher, making it hard to see the new threshold as a meaningful barrier.

Some also question how much the structural changes will alter the status quo. KB, Shinhan, Hana and Woori — the four major financial holding companies — already compose their chairman candidate recommendation committees entirely of outside directors. Legally mandating that executive candidate recommendation committees consist solely of independent directors would therefore change little about how those committees are actually constituted.

Regulators say the reform package should not be judged by the effect of any single measure in isolation. Jeon Yo-seop, director general of the FSC's financial policy bureau, said that of roughly 15 past cases involving the appointment or re-election of major financial holding company chairmen, about three fell short of a 75 percent approval rate. "If the new standard is applied, there will be cases where re-election is blocked," he said. He added that combining tighter voting requirements at the nomination committee stage with independent director evaluations and sanctions against improper CEO interference would significantly strengthen checks on management.

Some within the industry also acknowledge that the tighter voting threshold could become a substantial hurdle over time. "If the oversight functions of shareholders and the board are strengthened, even the 75 percent bar could become difficult to clear in the future," an official at one financial holding company said.

There is also a view that greater shareholder influence need not translate into an erosion of management autonomy. Given the high proportion of foreign shareholders at major financial holding companies, management may in fact become more responsive to investor demands for profitability and improved corporate value.