From Companies to Markets— Global Developments in Corporate Governance IN PARTNERSHIP WITH © Copyright 2016, All rights reserved. International Finance Corporation 2121 Pennsylvania Avenue, NW, Washington, DC 20433 The conclusions and judgments contained in this report should not be attributed to, and do not necessarily represent the views of, IFC or its Board of Directors or the World Bank or its Executive Directors, or the countries they represent. IFC and the World Bank do not guarantee the accuracy of the data in this publication and accept no responsibility for any conse- quences of their use. The material in this work is protected by copyright. Copying and/or transmitting portions or all of this work may be a violation of applicable law. 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Any other copying or use of this work requires the express written per- mission of the International Finance Corporation From Companies to Markets— Global Developments in Corporate Governance From Companies to Markets—Global Developments in Corporate Governance i ii From Companies to Markets—Global Developments in Corporate Governance CONTENTS Contents Foreword............................................................................................................. vii Preface.................................................................................................................. ix Executive Summary............................................................................................ xi Acronymns......................................................................................................... xiv Part A: Recent Developments in Global and Regional Corporate Governance Groups...............................................................................................1 A.1. G20/OECD Principles of Corporate Governance......................................................... 1 A.2. Basel Committee for Banking Supervision Corporate Governance Principles...........2 A.3. A Global Investor View.............................................................................................. 6 A.3.1. ICGN Principles for Investors........................................................................... 6 A.3.2. Stewardship Codes..........................................................................................7 A.4. European Union Developments............................................................................... 9 A.4.1. Enhancing Transparency................................................................................. 9 A.4.2. Ensuring Audit Quality................................................................................... 9 A.4.3. Ensuring Greater Shareholders Engagement.................................................10 A.4.4. Supporting Company Growth and Competitiveness......................................13 A.5. Nordic Corporate Governance Developments........................................................ 14 A.6. Summary of Global Issues...................................................................................... 16 A.7. Trends and Future Developments............................................................................ 16 Part B: Corporate Governance Developments: Practice Issues....................... 17 B.1. Board Effectiveness and Practices............................................................................17 B.1.1. Board Effectiveness: Composition and Diversity—The Right Mix................... 19 B.1.2. Board Effectiveness: Board Committees........................................................ 22 B.1.3. Board Effectiveness: Board Evaluations and Succession................................. 27 B.2. Control Environment and Risk.............................................................................. 30 B.2.1. Risk Governance Developments.................................................................... 30 B.2.2. Board Role in Risk and Risk Culture...............................................................31 B.2.3. Control Environment Developments: IFC Tools.............................................38 B.2.4. Risk and the Control Environment: Other Developments..............................39 B.3. Demands for Transparency and Disclosure—ESG Issues......................................... 43 B.3.1. Sustainability and ESG Reporting.................................................................. 43 B.3.2. Integrated Reporting................................................................................... 49 B.3.3. Periodic Reporting: Is Less More?..................................................................54 B.3.4. Audit Reforms................................................................................................55 B.4. Shareholder Rights: RPTs and Beneficial Ownership.............................................. 57 B.4.1. Related-Party Transactions............................................................................ 57 B.4.2. Beneficial Ownership....................................................................................58 B.5. Commitment to Corporate Governance Developments......................................... 61 B.6. Trends and Future Developments in Practices........................................................63 From Companies to Markets—Global Developments in Corporate Governance iii CONTENTS Part C: Global Developments in Corporate Governance Codes...................... 64 C.1. Stocktaking of Key Issues for Corporate Governance Codes................................... 64 C.2. Regular Reviews of Codes and Frameworks...........................................................65 C.3. Mandating Corporate Governance: An Unfinished Debate.....................................65 C.3.1. Example: Audit Committees..........................................................................67 C.3.2. Jordanian Securities Commission: A Regulator’s View..................................67 C.3.3. Turkey: Use of Scorecards to Encourage Implementation............................ 68 C.3.4. West Bank and Gaza: A Nonmandatory Approach........................................ 69 C.3.5. Kazakhstan: A Sovereign Wealth Fund View of “Comply or Explain”................. 69 C.4. Diverse Approaches: Is “Comply or Explain” Appropriate?...................................... 69 C.5. Code Principles, Practices, and Effectiveness..........................................................71 C.5.1. Kenya: Law and Regulation versus Code under Comply or Explain................. 72 C.5.2. South Africa: Principles versus Practices....................................................... 72 C.5.3. Comply or Explain in the Presence of Controlling Shareholders.................... 72 C.6. Different Types of Codes versus a Standardized Approach...................................... 72 C.7. Code Application Monitoring, Enforcement, and Scorecards.................................. 73 C.7.1. Code Monitoring............................................................................................ 75 C.7.2. Code Reviewing............................................................................................76 C.8. Integration of Sustainable Development/ESG into Codes.....................................76 C.8.1. The Banking Sector........................................................................................76 C.8.2. ESG and the Link to Corporate Governance................................................... 78 C.8.3. Practical Challenges of ESG Inclusion in Codes............................................ 80 C.9. Summary................................................................................................................ 81 C.9.1. Key Findings................................................................................................... 81 C.9.2. Trends and Future Developments in Codes and Scorecards...........................82 Part D: Conclusion.............................................................................................. 83 Appendixes.......................................................................................................... 85 Appendix A: IFC Indicative Independent Director Definition........................................ 86 Appendix B: Board Evaluation Requirements...............................................................87 References........................................................................................................... 88 References for Part A.................................................................................................... 88 References for Part B.................................................................................................... 89 References for Part C.................................................................................................... 92 Boxes Box A.1: BCBS Principle 13: The Role of Supervisors.......................................................... 5 Box A.2: Global Governance Principles Responsibilities..................................................7 Box A.3: Principle 4 of the UK Stewardship Code............................................................ 8 Box A.4: Comments from ICGN Members on ESG Matters.............................................. 8 Box A.5: Disclosures of Proxy Advisers............................................................................12 Box A.6: Example: Renault 2015..................................................................................... 14 Box A.7: Statutory Provisions Backing the Nordic Model............................................... 14 Box A.8: Example: Sweden............................................................................................. 15 Box B.1: FRC Guidance on Board Effectiveness............................................................... 18 Box B.2: From OECD Principle VI ................................................................................... 24 Box B.3: Audit Committee Key Roles in the EU.............................................................. 25 Box B.4: Satyam (India)—Importance of Independence on Board Committees.............26 Box B.5: Global Network of Director Institutes Principle 12........................................... 27 Box B.6: OECD Principle VI.E.4 as Revised in 2015..........................................................28 Box B.7: Excerpt from CII “Best Disclosure: Board Evaluation”........................................29 Box B.8: OECD on Risk Management........................................................................... 30 iv From Companies to Markets—Global Developments in Corporate Governance CONTENTS Box B.9: OECD Principle VI.D.1, as Revised in 2015......................................................... 30 Box B.10: Excerpt from ICGN’s Guidance on Corporate Risk Oversight...........................31 Box B.11: Example: Lack of Clarity about Risk Appetite...................................................36 Box B.12: Risk Terminology: Key Definitions..................................................................36 Box B.13: Risk Appetite Disclosure: Standard Chartered Bank........................................ 37 Box B.14: Risk Framework Disclosure: Commonwealth Bank of Australia..................... 37 Box B.15: IIASB Standard 2110........................................................................................ 40 Box B.16: Chief of Internal Audit..................................................................................... 43 Box B.17: OECD Principle V.A.2....................................................................................... 46 Box B.18: KPMG Corporate Responsibility Reporting Survey......................................... 47 Box B.19: What is IR?..................................................................................................... 49 Box B.20: High-Level Summary of Requirements for an Integrated Report................... 51 Box B.21: Benefits of Changes to the Auditor’s Report...................................................55 Box B.22: The New Audit Report....................................................................................56 Box B.23: Comparison of Uninformative and Informative Statements..........................58 Box B.24: Reporting Example: Indonesia.......................................................................59 Box B.25: Example: Extractive Industries Transparency Initiative.................................. 61 Box C.1: Excerpts from the ecoDa-Mazars Report...........................................................71 Box C.2: Excerpts from the Spanish Corporate Governance Code..................................79 Box C.3: Comply-or-Explain Codes: Benefits and Costs.................................................. 81 Figures Figure A.1: Market Concentration—Share of Market Capitalization of Country Groups . with Different Ownership Structures ..................................................................2 Figure A.2: The Nordic Model as Compared to the One-Tier and Two-Tier Models......... 15 Figure B.1: Time Commitment of Boards........................................................................21 Figure B.2: Prevalence of Women on Boards—By Country............................................. 23 Figure B.3: Board-Level Committee Requirements—By Regulation, Code, or Other..... 25 Figure B.4: Risk Governance Requirements of Listed Companies, by Country.............. 32 Figure B.5: Enterprise Risk Management Framework...................................................34 Figure B.6: COSO View of Risk Appetite........................................................................ 35 Figure B.7: Challenges to Risk Appetite Implementation..............................................36 Figure B.8: Elements of Risk Culture.............................................................................38 Figure B.9: Growth of ERM, 2009–2014..........................................................................39 Figure B.10: COSO Framework...................................................................................... 41 Figure B.11: Mandatory versus Recommended Internal Audit Function in EU Corporate . Governance Codes............................................................................................. 42 Figure B.12: Integrated Reporting Concept................................................................... 50 Figure B.13: RPT Disclosures in Financial Statements.................................................... 57 Tables Table A.1: Key Changes Reflected in G20/OECD Principles...............................................3 Table B.1: Board Effectiveness Initiatives....................................................................... 18 Table B.2: Gender Quotas or Targets...............................................................................21 Table B.3: Examples of Code Provisions Regarding Internal Audit................................. 42 Table B.4: National Initiatives in ESG Transparency.......................................................45 Table B.5: Global Instruments Addressing Sustainability............................................. 48 Table B.6: Regional and National Initiatives to Adopt the Audit Report Changes.........56 Table B.7: Beneficial Ownership Rules...........................................................................56 Table C.1: Code Revisions.............................................................................................. 66 Table C.2: Codes with A Subset Focus............................................................................ 73 Table C.3: ESG and Corporate Governance Codes.......................................................... 77 From Companies to Markets—Global Developments in Corporate Governance v vi From Companies to Markets—Global Developments in Corporate Governance FOREWORD Foreword Good corporate governance is a basic element for healthy more effective application, monitoring, and enforcement of companies and a key to sustainable private sector devel- corporate governance codes. Importantly, the publication opment. Strong governance fundamentals contribute to identifies future directions where more work is needed, better management and more effective boards, leading to such as increased commitment at the national level to pri- enhanced operational efficiency, reduced risk, improved oritize the corporate governance agenda. decision making, and increased valuations, among other IFC has long played a leadership role in the corporate business benefits. governance arena, given the critical link to the World In recent years, we have seen remarkable progress. Com- Bank Group’s twin goals of reducing extreme poverty and panies, regulators, and legislative bodies in markets at promoting shared prosperity. As the corporate governance all stages of development acknowledge the value of good landscape changes, IFC’s work in this area will continue to governance and the role it plays in heightening investor evolve to meet new needs and address emerging issues. interest, improving access to capital, and strengthening This publication makes an important contribution to the markets. global knowledge base on corporate governance and the This publication, From Companies to Markets—Global status of post-financial-crisis governance progress. In addi- Developments in Corporate Governance, represents a tion, the data, information, and analysis provided within unique collaborative effort to assess the state of corporate these pages will help identify future areas of focus for IFC’s governance around the world in the wake of the 2008 corporate governance work. global financial crisis. It draws on the expertise of the IFC Today, the world grapples with instability and uncertainty Corporate Governance Private Sector Advisory Group at many levels. Yet, as we look back on what has been and other practitioners in this important field, providing a accomplished and focus on future goals, we see ever more fascinating and detailed accounting of the range of changes clearly the enduring value of strong corporate governance— that have taken place in the past few years as the corporate for individual companies, regulatory institutions, and governance agenda has been elevated. governments. The report highlights notable improvements in board prac- tices, control environment, shareholder protection, and Darrin Hartzler, Manager transparency and disclosure. It also points to progress on IFC Corporate Governance Group From Companies to Markets—Global Developments in Corporate Governance vii viii From Companies to Markets—Global Developments in Corporate Governance PREFACE Preface In May 2015, the IFC Corporate Governance Group called Project Team: Anne Molyneux, Ralitza Germanova, Kiril together 40 experts in the field and members of the IFC Nejkov, and Charles Canfield. Corporate Governance Private Sector Advisory Group. These participants explored key changes in international Special thanks to Anne Molyneux, the author of this corporate governance standards and codes of best practice publication, and to project team members Ralitza in the wake of the recent global financial crisis and how Germanova, who directed the project and ensured that the these changes have helped draw corporate attention to initial idea came to fruition, and Kiril Nejkov and Charles sustainability issues. The group found that many issues Canfield, who provided invaluable detailed advice. In- that became evident regarding banks in the financial depth comments came from (in alphabetical order) Mi- crisis—and led to changes in the governance of banks— chael Amoako-Atuobi, Atiyah Curmally, Alexander Berg, also have flowed through into broader corporate govern- Winfrid Blaschke, Salamat Kussainova, Per Lekvall, Basak ance developments. Mustu, Chris Pierce, Ansie Ramalho, Sergio Rodriguez, and Roberta Simonetti. Particular thanks to the IFC This publication arises from the issues and informa- Corporate Governance Private Sector Advisory Group tion from these discussions. Specifically, Part A discusses members (in alphabetical order) Bistra Boeva, George developments from global or regional groups involved in Dallas, Peter Montagnon, Christian Strenger, and Patrick corporate governance. Part B addresses developments in Zurstrassen. corporate governance practice, and Part C looks at devel- opments in corporate governance codes and standards. Thanks also to (in alphabetical order) Assylkhan Aitzhanov, Adalyat Abdumanapova, Rosario Carmela G. Readers of this publication are likely to be profession- Austria, Ghita Alderman, Julie Bamford, Stephen Bland, als operating in corporate governance or requiring early Sarah Cuttarree, Hillary Cheruiyot, Visar Dobroshi, information on the issues arising in corporate governance Marina Frolova, Anar Hajizade, Chris Hodge, Yehia El and who know that better governance leads to company Husseiny, Jonathan Labrey, Min Liu, Karen A. Rocha, growth, competitiveness, and more sustainable enterprises. Loty Salazar, Sergii Tryputen, Mazen Wathaifi, Han Yi, and Bashar Abu Zarour. Thanks to Shannon Roe for edit- Acknowledgments ing support and to Wendy Kelly for designing the publication. The project team would like to thank those who attended the May 2015 gathering. We are grateful to everyone who Please note that the comments made during preparatory took the time to participate at the Practice Group meeting meetings or in the quotes that appear in this document on Corporate Governance Codes and Standards and pro- represent personal opinions and are not necessarily those vided us with insights and information. All responses were of the institutions the commentators are affiliated with. instrumental in building the rationale and key thinking points for this publication. From Companies to Markets—Global Developments in Corporate Governance ix x From Companies to Markets—Global Developments in Corporate Governance EXECUTIVE SUMMARY Executive Summary The purpose of this publication is to collect and make performance, remuneration incentives, and share- available in one place a statement and reference for key holder expectations. corporate governance changes, especially those occur- • Recognition of the importance of understanding the ring since the financial crisis, including new directions input, business processes, output, and impact of and other recent developments. The publication does not the business model on the company as well as the seek to reiterate information on all corporate governance context it operates within, balancing the power of regulations and practices but instead focuses only on recent controlling shareholders. changes. It is in four parts. • Demand for increased transparency from companies Part A: Recent Developments in Global and Regional and better information, particularly on governance Corporate Governance Groups—encompasses recent and board effectiveness, related-party transactions, developments from global organizations with the capacity company strategy, risk, performance, and company to widely influence corporate governance standards and culture. practices globally or across a number of countries. These • Recognition of the role of investors in corporate organizations include the Organisation for Economic Co- governance frameworks and the need for shareholder operation and Development (OECD), the Basel Committee engagement in company affairs and company/inves- on Banking Supervision (BCBS), the International Corpo- tor communication. rate Governance Network (ICGN) of the investor commu- • A shift in emphasis in corporate governance regula- nity, and the European Union. Part A also covers some in- tions to consider its role and effects on capital mar- teresting corporate governance developments in the Nordic kets, not just on individual companies. countries—Denmark, Finland, Norway, and Sweden. • Demands by investors for a “say on pay” and in- After the biggest financial crisis since the 1920s, many creased focus by the board on risk and risk culture. changes to corporate governance standards were initiated at the global, regional, and national levels. In general, Part B: Corporate Governance Developments: Practice changes relate to corporate governance as a key compo- Issues—looks at corporate governance developments that nent leading to market confidence and trust, moving the have occurred through company-initiated continuous-im- focus of corporate governance beyond the company level. provement programs that have been more widely applied Changes reflect the following: and recognized as better corporate governance practices. The key corporate governance changes and new directions • The move to increased regulation, as opposed to are reflected in board practices, the control environment, voluntary codes, in some areas of corporate govern- and shareholder protection. An increased focus on board ance, to ensure compliance and to ensure that the and director commitment to corporate governance, on the codes provide for flexibility of application to support culture in a board, and on board behaviors sets a tone for company diversity. better corporate governance. • The need for regulators to monitor disclosure on Boards themselves are structuring and using board corporate governance codes and practices. committees to improve their work, especially in audit, • The need for a long-term view on company affairs remuneration, and risk, as well as for corporate goverance, and the drivers of such a view, especially in strategy, director nominations, and succession planning. This has From Companies to Markets—Global Developments in Corporate Governance xi EXECUTIVE SUMMARY led to the expectation of an expanded role for indepen- (IOSCO) also are focusing on the role of audit committees dent directors and their contribution to board committees. to ensure better audit quality. In some jurisdictions, regula- Most countries have mandated audit committees for listed tors are promulgating AQIs (audit quality indicators) for companies, now requiring appropriate financial skills and regulatory use and for audit committees to assess the qual- increased levels of independence in this committee. Re- ity of their external audits. This publication also looks at garding risks, there is an increasing and emerging need to developments in traditional risk management tools to assist consider other variables in the analysis, adding social and with the management of risk on an enterprise-wide basis. environmental aspects to the economic and financial analy- They include, among others, a model to integrate risk into sis, which requires new expertise and competences among company decision-making processes and a toolkit that IFC the board members. Board evaluations also have become developed to enable its officers to better assess the control accepted practice in most jurisdictions. environment and risk as part of its corporate governance assessments. Control Environment and Risk Given the widespread failure of risk management, it is not Transparency and Disclosure surprising to see the increased focus on risk oversight and Tools and frameworks are emerging that facilitate wider board accountability for risk following the financial crisis— reporting on nonfinancial matters. Integrated reporting to establish a risk culture and robust risk systems and (IR) is one such development, which incorporates and con- processes to enable better risk oversight. Many companies nects sustainability and nonfinancial reporting with finan- have incorporated the “three lines of defense” model, cial reporting. It advocates reporting that gives a concise, initially developed in the banking and financial sector, into holistic picture of company value creation (in the broader their risk management. These companies expect the board sense, beyond mere financial value) and the ability of the to increase its risk expertise, enlarge its understanding of company to maintain the creation of value in a sustainable entity risks and risk tolerance, and set risk appetite limits manner. It is based on a new concept of the six capitals— for the entity—a complex and challenging task, still in its financial, manufactured, intellectual, human, social and infancy. relational, and natural capital—that represents the forms of capital or sources that the company employs, trans- There is a greater focus on the role of internal “gatekeep- forms, and provides. IR tells the story of which capitals the ers” in managing risk. In the banking and financial sector company relies on, how the company uses these capitals, and in response to increased regulatory pressure, the role how it transforms them through its business processes and of a chief risk officer (CRO) has been made clearer, and the activities into products and services, and the impact of links internally between risk officers, compliance officers, these product and services. and internal auditors in supporting and testing internal controls and the overall company control environment The auditors’ findings will also be more transparent on the have been strengthened. external audit as a consequence of a new required external audit report style in which the auditor will disclose key More broadly in all entities, the role of internal audit is matters that arose during the audit and which the auditor growing and the scope of its mandate extended to cover discussed with the audit committee and/or the board. culture—a new role that leads to changes in governance concerning internal audit. It is becoming less common for Shareholder Rights the reporting line of internal audit to be to the chief finan- Shareholder rights have been strengthening in two par- cial officer (CFO) and more common for the chairperson ticular areas: related-party transactions and beneficial of the audit committee to be ultimately responsible. There shareholders. Companies and boards have been improving is an expectation that the internal auditor will lead an policies and practices for related-party transactions and independent, well-resourced function and report directly their approval practices. In good practices, shareholders to the audit committee of the board. There is also an are approving ex ante major related-party transactions, expectation of closer collaboration between the CRO and processes are in place for board review and approval and the board committee overseeing risk. In complex risk of all other related-party transactions. environments, there is a rising expectation of a separate risk committee of the board to which the CRO would In the face of a rise in shareholder engagement with the report. This has been mandated for larger banks in some company on corporate governance matters, there is a need jurisdictions. to be able to identify significant shareholders, especially in the light of the prevalence of controlling shareholders. Regulators and international organizations such as the There is and will continue to be a demand for transparency International Organization of Securities Commissions regarding ultimate beneficial shareholders; the veil might xii From Companies to Markets—Global Developments in Corporate Governance EXECUTIVE SUMMARY be lifted with regard to ownership behind nominees and to make the codes more effective. Other matters remaining intermediaries, trusts, and the like. in codes have been updated to follow international good practices. In these reviews, predominantly undertaken in Commitment to Corporate Governance Europe, the “comply or explain” principle, on which many Above all, companies and directors are demonstrating of the codes are based, has been reconsidered and affirmed, increased commitment to corporate governance and a but in other regions, such as in Africa, there is less support corporate governance tone/culture set from the top of the for the comply-or-explain approach. However, the reviews company. Commitment to corporate governance is ob- note increased assessment of the efficacy of mandatory served by leadership actions in the company, the existence laws, regulations, and codes versus voluntary codes, de- of ethics codes and stronger systems, policies, and practices pending on the legal framework and stage of development regarding board evaluation and succession planning, the of corporate governance in particular jurisdictions. control environment and risk oversight, and increased engagement between shareholders and the board on corpo- In some countries, discussions are ongoing concerning the rate governance issues. relative merits of a single national code versus individual Part C: Global Developments in Corporate Governance codes for listed entities, financial institutions, state-owned Codes—reviews how corporate governance codes and enterprises, and the like. Increased monitoring, enforce- standards have developed in diverse countries and in di- ment, and reporting on corporate governance implementa- verse ways, issues that remain common problems, and how tion is evident in many countries. sustainable development and integrated thinking about the Part D: Conclusion—Since the financial crisis, much has social, environmental, and economic aspects of the busi- changed in the corporate governance environment at the ness are being considered and are becoming integrated into global, regional, and national levels. Meeting the increased corporate governance codes and standards. expectations of stakeholders will require renewed efforts Corporate governance codes of best practice reflect the by companies to improve their corporate governance, by recent changes and new developments in corporate gov- investors to participate in the betterment of corporate gov- ernance standards that look into integrating better board ernance in their investee companies, and by regulators to practices, shareholder protection, value creation to all monitor the level of commitment to corporate governance stakeholders, transparency and disclosure, and environ- in the companies within their jurisdictions. Importantly, ment and social considerations. Recently, many reviews of there is now a realization of the contribution that better corporate governance codes show that some key issues are corporate governance can make to market development, mandated and becoming laws or regulations in an attempt economic growth, and stability. From Companies to Markets—Global Developments in Corporate Governance xiii ACRONYMS Acronyms ACCA: Association of Chartered Certified Accountants IC: internal control AGM: annual general meeting ICAEW: Institute of Chartered Accountants in England and AICPA: American Institute of CPAs Wales ASEAN: Association of Southeast Asian Nations ICGN: International Corporate Governance Network ASX: Australian Securities Exchange ICSA: Institute of Chartered Secretaries and Administrators BCBS: Basel Committee on Banking Supervision IFAC: International Federation of Accountants BICG: Baltic Institute of Corporate Governance IFRS: International Financial Reporting Standards BM&F BOVESPA: Brazilian Stock Exchange IIA: Institute of Internal Auditors CAC: Cotation Assistée en Continu (French stock market IIASB: International Internal Audit Standards Board index) IIRC: International Integrated Reporting Council CEO: chief executive officer IoDSA: Institute of Directors in Southern Africa CFO: chief financial officer IOSCO: International Organization of Securities Commissions CII: Council for Institutional Investors (United States) IR: integrated reporting CII-ITC: Centre of Excellence for Sustainable Development IRM: Institute of Risk Management (India) ISAs: International Standards on Auditing CIIA: Chartered Institute of Internal Auditors ISACA: Information Systems Audit and Control Association CMA: Capital Markets Authority (Kenya) ISO: International Organization for Standardization CMVM: (Portuguese Securities Market Regulator) IT: information technology CNMV: Comissão do Mercado de Valores Mobiliários JSE: Johannesburg Stock Exchange (Portuguese Securities Market Commission) M&A: mergers and acquisitions COBIT: Control Objectives for Information and Related MNE: multinational enterprise Technology NACD: National Association of Corporate Directors CONSOB: Commissione Nazionale per le Società e la Borsa (United States) (Italian Securities and Exchange Commission) NAPF: National Association of Pension Funds COSO: Committee of Sponsoring Organizations of the (United Kingdom) Treadway Commission NGER: National Greenhouse and Energy Reporting CR: corporate responsibility (Act—Australia) CRO: chief risk officer OECD: Organisation for Economic Co-operation and CSR: corporate social responsibility Development EC: European Commission OSC: Ontario Securities Commission ECGI: European Corporate Governance Institute PIE: public-interest entity ECIIA: European Confederation of Institutes of Internal PRA: Prudential Regulation Authority (United Kingdom) Auditors PRI: UN Principles for Responsible Investment ecoDa: European Confederation of Director Associations RAF: Risk Appetite Framework EITI: Extractive Industries Transparency Initiative RMA: Risk Management Association ERM: enterprise risk management ROSC: Report on the Observance of Standards and Codes ESG: environment, social, and governance ROTX: Romanian Traded Index EU: European Union RPT: related-party transaction FCA: Financial Conduct Authority (United Kingdom) SAICA: South African Institute of Chartered Accountants FEE: Fédération des Experts Comptables Européens SASB: Sustainability Accounting Standards Board (Federation of European Accountants) SC: Securities Commission of Malaysia FRC: Financial Reporting Council (United Kingdom) SEBI: Securities and Exchange Board of India FSB: Financial Stability Board SEC: Securities and Exchange Commission ( United States) GGP: Global Governance Principles (issued by ICGN) SK: Samruk-Kazyna (sovereign wealth fund of Kazakhstan) GM: general manager SMEs: small and medium enterprises GNDI: Global Network of Director Institutes SOE: state-owned enterprise GRI: Global Reporting Initiative SOFIX: Bulgarian Stock Exchange stock market index IAASB: International Auditing and Assurance Standards Board UNDP: United Nations Development Programme IBE: Institute of Business Ethics UNHCR: United Nations High Commissioner for Refugees IBGC: Brazilian Institute of Corporate Governance WEF: World Economic Forum xiv From Companies to Markets—Global Developments in Corporate Governance PART A Recent Developments in Global and Regional Corporate Governance Groups Corporate governance changes often follow major crises. Governance and as a reference for reform in After the Asian financial crisis of 1997 and after the major individual countries; collapses arising from the “dot-com bubble” and of Enron • One of the Financial Stability Board’s (FSB) Key and WorldCom in 2002, corporate governance regulations Standards for Sound Financial Systems, serving FSB, were reviewed and amended at a national level. Since the G20, and OECD members; financial crisis of 2008, many reviews have indicated that poor corporate governance practices might have contrib- • Use by the World Bank Group in more than 60 uted to the collapse of the financial system. Reviews were country reviews worldwide (Reports on Observance instigated initially by the Organisation for Economic of Standards and Codes) and IFC to support com- Co-operation and Development, the organization respon- panies in implementing good corporate governance sible for the Principles of Corporate Governance. Since practices; and 2008, key changes in corporate governance regulations • The ASEAN Corporate Governance Scorecard. have continued. The Principles also form the backbone of IFC’s Corporate Governance Methodology, a system for evaluating corpo- The financial crisis revealed severe rate governance risks and opportunities, which IFC uses to shortcomings in corporate governance. support companies working to improve their governance When most needed, existing standards failed practices. It is recognized among development finance to provide the checks and balances that institutions as the most advanced methodology of its kind companies need in order to cultivate sound and is the basis for a coordinated approach to corporate business practices. . . . Failures were closely governance now implemented by 34 development finance linked to. . .remuneration/incentive systems; institutions, including IFC. risk management practices; the performance of boards; and the exercise of shareholder OECD Developments rights. Changes to the Principles arose out of several peer reviews and research undertaken between 2011 and 2014 relating (OECD 2009) to the following: • Board practices, especially remuneration; A.1. G20/OECD Principles of Corporate • The role of institutional investors in promoting good Governance corporate governance; After the financial crisis, OECD revised its Principles of • Related-party transactions and minority Corporate Governance (the Principles) in cooperation shareholder rights; with the G20. The Principles have a proven record as the • Board nominations processes and elections; international reference point for corporate governance and • Supervision and enforcement in corporate serve as the basis for the following: governance; and • OECD Guidelines on Corporate Governance of • Risk management. State-Owned Enterprises; • OECD Guidelines for Multinational Enterprises; The review process, now completed, led to the launch of G20/OECD Principles of Corporate Governance (the Prin- • Guidelines on Corporate Governance of Banks, issued ciples) and related Guidelines in Corporate Governance by the Basel Committee on Banking Supervision; of State-Owned Enterprises (the Guidelines) in September • OECD Guidelines on Insurer and Pension Fund 2015. The inclusion of all G20 countries as signatories to From Companies to Markets—Global Developments in Corporate Governance 1 PART A Recent Developments in Global and Regional Corporate Governance Groups the Principles means their adoption by a wider group of on corporate governance in the presence of controlling countries, not only OECD members. The review also led shareholders and note the importance of transparency to the issuance of the Corporate Governance Factbook. All regarding company ownership. documents share up-to-date information about corporate governance practices in OECD countries and a selection of A.2. Basel Committee for Banking additional jurisdictions. The Factbook is a useful resource Supervision Corporate Governance Principles for national governments looking to compare their own In 2012, the Basel Committee on Banking Supervision frameworks with those of other countries or seeking infor- issued a set of principles to enhance corporate governance mation about practices in specific jurisdictions. The major changes to the Principles are a combination of new material that reflects new thinking on corporate To address fundamental deficiencies in governance issues, a new structure to highlight important bank corporate governance that became issues, and additional explanatory material. (See Table A.1.) apparent during the financial crisis, the Basel The revised Principles1 were issued in September 2015. Committee on Banking Supervision has Because the Principles not only are adopted by the OECD, issued a final set of principles for enhancing G20, and FSB, but also are viewed as a global reference sound corporate governance practices at point for corporate governance, many other laws, regula- banking organisations. . . . The Committee’s tions, codes, and standards globally are under review. guidance assists banking supervisors and provides a reference point for promoting the Over the last several years the shape of share markets has adoption of sound corporate governance changed, as illustrated in Figure A.1. Concentrated own- ership rose from about 22 percent to about 41 percent practices by banking organisations in their from 1998 to 2012, leading to increased recognition of the countries. importance of controlling shareholders on corporate gov- (BCBS 2010) ernance, including family ownership or state ownership. Therefore, the new Principles offer more specific guidance Figure A.1: Market Concentration—Share of Market Capitalization of Country Groups with Different Ownership Structures 5% 6% 9% Others (mostly 4% concentrated ownership) 22% 11% 14% 18% non-OECD G20 countries Mostly 41% (mostly concentrated concentrated 16% owndership) ownership 20% 15% OECD: Concentrated ownership 19% 17% OECD: Mixed ownership OECD: Dispersed ownership Dispersed 57% ownership 47% 41% Note: Figures do not necessarily sum to totals because of rounding. 1998–2002 2003–2007 2008–2012 Source: OECD calculations based on World Bank data. 1 For access to the full text of the Principles see: http://www.oecd.org/daf/ca/principles-corporate-governance.htm 2 From Companies to Markets—Global Developments in Corporate Governance Recent Developments in Global and Regional Corporate Governance Groups PART A Table A.1: Key Changes Reflected in G20/OECD Principles Part Topic Changes I Effective corporate To enhance the effectiveness of supervision and enforcement of governance corporate governance: framework l increased emphasis on the importance of public, independent supervision and enforcement; l more on governance of regulators; l changing role of stock markets, with the goal of profit maximization and its impact on supervision and enforcement in the market; l additional guidance on corporate governance impact of cross-border listed entities. II Rights and equitable To strengthen the rights and protection of shareholders: treatment of l additional guidance on related-party transactions; shareholders and key more on concentrated ownership and its impact on corporate l ownership functions governance; l more transparency of ultimate beneficial ownership. III Institutional To introduce a new chapter in the Principles to emphasize the role of investors, stock institutional investors and stock markets in corporate governance: markets, and other l guidance is included on the role of proxy advisers and asset managers intermediaries in corporate governance—a better approach for global application, including new focus on fee structures, conflicts of interest; l other issues—multiple stock market listings, cross-border impacts, and the application of corporate governance rules. IV Role of stakeholders To update and recognize developments in this area in other OECD in corporate and global instruments (remains largely unchanged): governance l The revision did recognize the need to include in the corporate governance Principles, actions regarding employees and stakeholders, especially to recognize their role in contributing to the long-term success and performance of a company. V Disclosure and To ensure full and proper disclosure of all material matters: transparency l many rules are now covered by IFRS, so material can be revised; l recognition of increased importance of nonfinancial reporting; l disclosure of related-party transactions; l clarity about the responsibilities of chairperson versus CEO; l independent audit regulators, high-quality audits, and audit oversight. VI Responsibilities To clarify board responsibilities in special areas: of the board l oversight of risk management system; roles and responsibilities of board committees, especially audit and risk l committees; l all committees not recommended for all companies, such as risk commitees. Source: Molyneux, 2015. From Companies to Markets—Global Developments in Corporate Governance 3 PART A Recent Developments in Global and Regional Corporate Governance Groups within the banking sector. BCBS states its expectations of Corporate governance of banks in the past focused on banks in corporate governance as a market regulator. The corporate governance structures. Since the financial crisis, BCBS Principles assume the application of OECD Principles, the emphasis has turned more to the achievement of better and then add to them where a need appears for additional corporate governance through increased board effective- and specific focus for banks and bank supervision. The ness. Therefore, greater emphasis is not just on “fit and assumption is that BCBS Corporate Governance Principles proper” people (as individual board directors), but the are equally applicable in emerging markets and developed BCBS also wants to see “fit and proper” applied to the markets, but BCBS recognizes the need for flexibility in entire board to ensure collective competence. BCBS wants application of the Principles, allowing for different markets the board collectively to have the skills and experience for and diverse size and complexity of bank business models. adequate oversight and to have the time and the compe- tence to challenge management and truly hold manage- In 2014, BCBS undertook a revision of the 2012 principles. ment accountable. The focus is on board effectiveness. The drivers for change in corporate governance guidance were the work done in corporate governance development It is important to note that “collective responsibility” of by others, such as OECD, the Group of Thirty, and the the board refers to the board’s duty to the company and Institute of International Finance. Further, the BCBS has to all its shareholders. In its decision making, the board been involved in and is extensively considerate of FSB’s must act in good faith, in the best interests of the company, thematic peer review findings on risk governance, risk and within the company objectives. It should perform its culture, and risk appetite. duties efficiently and effectively and operate in a finan- cially responsible manner. The decisions of the board are BCBS completed development of new guidance on corpo- collective decisions and bind the company. rate governance, issued in 2015. The Basel 2015 Principles (BCBS 2015)2 respond to a need for a holistic approach The board is especially expected to play an effective role in to risk: risk culture, risk appetite, risk competence, and risk governance. For example, board supervision of a bank alignment of compensation with risk. Key revisions is expected to be effective in at least three areas: risk appe- specifically support the following: tite, risk strategy, and risk oversight and culture. The board is therefore expected to “own” the results in these areas. 1. Strengthen the guidance on risk governance, including the risk management roles played by Generally, in the Basel Principles, there is a stronger business units, risk management teams, and inter- emphasis on ownership and accountability of the bank nal audit and control functions (the three lines of board and management for bank corporate governance. defense) and the importance of a sound risk culture The revised text expands on the expectations of a bank to drive risk management within a bank; board regarding board responsibilities for group struc- 2. Expand the guidance on the role of the board of tures, and a key part is to ensure that subsidiary bank directors in overseeing the implementation of effec- boards are responsible for the integrity of the local tive risk management systems; subsidiary and for its activities, such as cross-border activities. Supplementary text has been added to ensure 3. Emphasize the importance of the board’s collective that subsidiary board members will oversee the local competence as well as the obligation on individual subsidiary and take full account of local conditions in that board members to dedicate sufficient time to their oversight, regarding the market and local regulations. mandates and to remain current on developments in banking; 4. Provide guidance for bank supervisors in evaluat- “A healthy banking system is one that not only has ing the processes used by banks to select board a strong relationship between a supervisor and a members and senior management; and bank. . .but there has to be a strong relationship between providers of capital, debt, and equity. We 5. Recognize that compensation systems form a key shouldn’t forget about the role of the creditor, because component of the governance and incentive struc- typically creditors represent around 95 percent of ture through which the board and senior man- bank funding.” agement of a bank convey acceptable risk-taking behavior and reinforce the bank’s operating and – George Dallas, Policy Director, ICGN risk culture. 2 The BCBS “Guidelines: Corporate Governance Principles for Banks” is hereinafter called BCBS Principles or BCBS Guidelines. 4 From Companies to Markets—Global Developments in Corporate Governance Recent Developments in Global and Regional Corporate Governance Groups PART A National authorities have taken measures Box A.1: Principle 13: to improve regulatory and supervisory The Role of Supervisors oversight of corporate and risk governance Supervisors should provide guidance for and supervise at banks. These measures include developing corporate governance at banks, including through or strengthening existing regulation or comprehensive evaluations and regular interaction guidance, raising supervisory expectations with boards and senior management, should require for the risk management function, engaging improvement and remedial action as necessary, and more frequently with the board and should share information on corporate governance management, and assessing the accuracy with other supervisors. and usefulness of the information provided to 158. The board and senior management are primarily the board. responsible for the governance of the bank, and share- holders and supervisors should hold them accountable (BCBS 2015) for this. This section sets forth several principles that can assist supervisors in assessing corporate govern- Other focuses in the revised BCBS Principles relate to ance and fostering good corporate governance in protection not only for equity holders but also for debt banks. holders. It also includes details regarding disclosure of Source: (BCBS 2015). information on creditors. are making reasonable judgments? Supervisors may need to develop specific tools to better assess corporate governance. In discharging these responsibilities, the board should take into account the legitimate Example: United Kingdom interests of depositors, shareholders and Individual banking regulators have undertaken considerable research on how to strengthen their systems against risk. The other relevant stakeholders. It should also regulator in the United Kingdom, the Prudential Regulation ensure that the bank maintains an effective Authority (PRA), issued several papers in 2014 and 2015 for relationship with its supervisors. consideration in these areas, which include alignment of risk (BCBS 2015) and reward, depositor and policyholder protection, board responsibilities in corporate governance, accountability of individuals in banking, and approach of non-executive direc- Finally, expanded materials and a standalone Principle tors in banking—all of which echo the changes reflected in make clear the role of supervisors in ensuring that banks the BCBS Corporate Governance Principles. under their supervision have better corporate governance Experience in the United Kingdom shows that supervisor in place. Supervisors are expected to go beyond looking engagement with a bank board and senior management at the structure of corporate governance in banks. BCBS has a positive effect on corporate governance within the believes they should also look at actual governance be- bank. The U.K. regulator is currently reviewing rules for a haviors, undertake corporate governance assessments, new regulatory framework. and engage the board and senior management of banks in addressing governance failures. Furthermore, supervisors are required to hold the board and senior management We. . .consulted jointly with the. . .PRA. . . accountable for the governance of banks and to share in- on a new regulatory framework for individuals formation on corporate governance with other regulators. working in banking (“Strengthening (See Box A.1.) accountability in banking: a new regulatory The supervisory role is not just to assess corporate gov- framework for individuals”). The proposals ernance but also to take action, while avoiding taking on were intended to encourage accountability for the role of a director or shadow director. Assessment of decision-making in relevant firms, focusing corporate governance practice without reference to any particularly on senior management, while specific tool is difficult. For example, what will be the basis aiming for good conduct at all levels. for a supervisor to conclude that corporate governance in a (FCA 2015) particular bank is good and that directors and management From Companies to Markets—Global Developments in Corporate Governance 5 PART A Recent Developments in Global and Regional Corporate Governance Groups This first consultation paper, quoted above, was followed institutional investors to participate in company affairs and quickly by another, which focuses on the effectiveness of to vote their shareholdings. the board. The effectiveness and credibility of the 1.2 Good governance is critical to delivering a entire corporate governance system and sound and well-run business: and at the centre company oversight depend on institutional of good governance is an effective board. investors that can make informed use of their 1.3 An effective board is one which shareholder rights and effectively exercise understands the business, establishes a clear their ownership functions in their investee strategy, articulates a clear risk appetite to companies. support that strategy, oversees an effective (OECD 2015b) risk control framework, and collectively has the skills, the experience and the confidence to hold executive management rigorously Since the recent crisis, the ICGN is refocusing the attention to account for delivering that strategy and of its members—asset owners and asset managers—not managing within that risk appetite. only on the rights of investors but also on their fiduciary responsibilities to their beneficiaries and clients, and on (PRA 2015) the expectation investors have of companies’ corporate governance. Therefore, the revision of the GGP was quite profound. The GGP incorporates a new chapter on inves- A.3. A Global Investor View tor duties and responsibilities. (See Box A.2.) During the financial crisis, regulators asked, “Where were the investors?” Investors were asked to recognize their role In the revised Global Governance Principles, certain issues in achieving good corporate governance and to step up are underscored and given new prominence. On the inves- engagement with their investee companies. Since then, the tor side, there is new emphasis on the fiduciary duties of global investor community, through such institutions as the investors, their capacity to establish leadership in corporate International Corporate Governance Network, has taken governance, and their ability to influence asset managers and measures and developed tools to aid investors and those investee companies to adopt better practices. This follows in their investment chain to fulfil this oversight role and to on an initiative at ICGN to introduce guidance for members facilitate better engagement with companies as responsible on institutional investor responsibilities (ICGN 2013). investors. Further, diverse national groups have developed “stewardship codes” to formalize for investors, especially In 2012, the ICGN introduced for its members a model institutional investors, expected roles and responsibilities. mandate (ICGN 2012) to be used with asset and fund managers. The mandate requires asset managers to make A.3.1. ICGN Principles for Investors a statement of commitment to what asset owners expect Since the financial crisis, the private sector also has seen of their asset managers. It requires active participation and developments in corporate governance, through global oversight of corporate governance in investee companies entities such as the International Corporate Governance as well as transparency. It has proved a most powerful tool Network.3 The ICGN is an investor-led body with some and has led to increased engagement with companies on 650 members, two-thirds of which come from the global investor community, representing collectively over $26 trillion in assets under management in 45 countries. “If the investor voice is going to be strong here, I think it has to start at the end of the chain with the The ICGN’s mission is to inspire good standards of asset owner establishing expectations that are in corporate governance globally. To this end, it issued the turn passed on to the asset manager. . . . It is not just Global Governance Principles (GGP), revised in 2014, with about picking stocks. . .but also taking some degree the view that good corporate governance helps develop of sense of ownership. . .in terms of monitoring, stronger companies for investors to invest in. The ICGN engagement and intelligent voting.” believes that enhancing the position of specific companies George Dallas, will enhance market efficiency. Many jurisdictions oblige Senior Policy Advisor, ICGN 3 See the ICGN website: www.icgn.org. 6 From Companies to Markets—Global Developments in Corporate Governance Recent Developments in Global and Regional Corporate Governance Groups PART A A.3.2. Stewardship Codes Box A.2: Global Governance Principles Increasingly, codes have been introduced for the investor Responsibilities community, to ensure that they do their part in requiring 10.4 Responsibilities better corporate governance of themselves and their own Asset owners should fully align the interests of their investment operations as well of their investee companies, fund managers with their own obligations to bene- including in the areas of the environment, social, and fi ciaries by setting out their expectations in fund governance (ESG) activities. management contracts (or similar instruments) to Stewardship codes have been introduced globally by the ensure that the responsibilities of ownership are ap- ICGN and in national jurisdictions in Canada, Italy, propriately and fully delivered in their interests. This Japan, Kenya, Malaysia, the Netherlands, South Africa, should include: Switzerland, and Taiwan, China, and are in development a) ensuring that the timescales over which in- in other countries. In some cases, the codes are supported vestment risk and opportunity are considered by requirements in regulation; in others they are not. match those of the client; Individual countries, such as Malaysia, South Africa, b) setting out an appropriate internal risk and the United Kingdom, and individual entities, such as management approach so that material risks Eumedion in the Netherlands, have developed and issued are managed effectively; voluntary stewardship codes to encourage investor engage- c) effectively integrating relevant environmental, ment in corporate governance in investee companies. It social and governance factors into investment is too early to gauge the effect of such initiatives, but the decision making and ongoing management; expectation is clear: investors, too, have a responsibility for d) aligning interests effectively through engagement with companies on corporate governance. appropriate fees and pay structures; e) where engagement is delegated to the fund “There is legislation behind U.K. ESG initiatives. Section manager, ensuring adherence to the highest 175 of the U.K. Companies Act requires investors have standards of stewardship, recognizing a spec- regard effectively for the entity’s environmental and trum of acceptable stewardship approaches; social impact.” f) ensuring commission processes and payments George Dallas, reward relevant and high quality research; Senior Policy Advisor, ICGN g) ensuring that portfolio turnover is appropriate, in line with expectations, and managed effectively; and h) providing appropriate transparency such that The UK introduced a Stewardship Code in dence about all these issues. clients can gain confi 2010, updated in 2012, with the view that stewardship aims to promote the long-term Source: (ICGN 2014). success of companies in such a way that the corporate governance. It places increased emphasis on the ultimate providers of capital also prosper. role of investors, who are encouraged to play an active part Effective stewardship benefits companies, in the corporate governance of their investee companies. The investors and the economy as a whole. In asset owner can delegate some responsibilities to asset and publicly listed companies, responsibility fund managers and other service providers, but it cannot for stewardship is shared. The primary abdicate legal accountability. It is for this reason that the responsibility rests with the board of the mandate for the asset owner to assist in the fulfilment of its company, which oversees the actions of its legal duties is so critical. management. Investors in the company The Global Governance Principles continue the new focus also play an important role in holding the on what investors could do to improve corporate governance board to account for the fulfilment of its and to make demands for increased board effectiveness. They responsibilities. also place more focus on culture and ethics, strategy and opportunities, risk oversight, remuneration, reporting and (FRC 2012) audit—all issues that were highlighted in the financial crisis. From Companies to Markets—Global Developments in Corporate Governance 7 PART A Recent Developments in Global and Regional Corporate Governance Groups Principle 4 in the U.K. Stewardship Code makes it clear that investors who are signatories to the code, currently Box A.4: Comments from ICGN some 300 signatories, are expected to engage with their Members on ESG Matters investee companies on a range of issues, including ESG Eumedion also sends an annual focus letter to all matters. (See Box A.3.) Dutch listed companies in October every year, with specific items institutional investors would like to Box A.3: Principle 4 of the U.K. address at all Dutch listed companies. We also dis- cuss company-specific issues with companies, such Stewardship Code as company strategies, risk management, corporate Principle 4: Institutional investors should governance structure, the quality of financial report- establish clear guidelines on when and how they ing and sustainability policy, and succession planning. will escalate their stewardship activities. Eumedion then facilitates engagement by drafting a Institutional investors should set out the circum- so-called ‘ESG scan’ containing general information stances in which they will actively intervene and regu- about the company’s strategy, its financial policy, the larly assess the outcomes of doing so. Intervention company’s objectives, the corporate governance struc- should be considered regardless of whether an active ture, the remuneration policy, the capital structure, or passive investment policy is followed. In addition, risk management, sustainability policy and where we being underweight is not, of itself, a reason for not identify best practices and areas where the company intervening. Instances when institutional investors concerned can improve its performance. may want to intervene include, but are not limited —Rients Abma, Eumedion, to, when they have concerns about the company’s ICGN Madrid Conference, 2015 strategy, performance, governance, remuneration or Environmental, social and governance (ESG) are the approach to risks, including those that may arise from three key factors for investors considering the sustain- social and environmental matters. ability and ethical impact of investing in a given com- pany. . . . 90 % of NAPF members agree that ESG factors Source: (FRC 2012). can have a material impact upon a fund’s investments Similarly, the global body of the institutional investor com- in the longer term. munity, the ICGN, whose members have some $26 trillion —Will Pomroy, NAPF, collectively under investment, has issued a voluntary U.K. Investor Relations Society, Corporate Governance and Sustainability Conference, 2015 code on the “responsibilities of institutional investors,” which includes proactive engagement with their investee companies. Despite these efforts, two recent studies indicate that the codes established in the United Kingdom under a comply- or-explain regime are honored more in word than in deed. Institutional investors should engage The Financial Reporting Council, in its role of reviewing intelligently and proactively as appropriate corporate governance in the United Kingdom (FRC 2015),4 with investee companies on risks to long-term including the effectiveness of the stewardship code, reported performance in order to advance beneficiary or on its findings of a review undertaken in 2014 and pub- client interests. lished in 2015. (ICGN 2013) The FRC acknowledges that the development of a culture of stewardship may take time. However, the FRC is concerned that not all ICGN members have been active in their own jurisdic- signatories are following through on their tions in engaging with companies on ESG matters, as is evidenced in the comments in Box A.4 from Eumedion, a commitment to the Code. Dutch collaboration of 70 institutional investors, and the (FRC 2015) U.K. National Association of Pension Funds (NAPF). 4 The FRC findings are supported by a survey and report on stewardship from the Investment Association of the United Kingdom, which finds that resources devoted to stewardship in asset managers and asset owners have increased some 19 percent in one year to handle increased company engagement activities. 8 From Companies to Markets—Global Developments in Corporate Governance Recent Developments in Global and Regional Corporate Governance Groups PART A Some jurisdictions have incorporated investor responsi- reporting for large public-interest entities (PIEs). More bilities into the general corporate governance code. guidance, in the form of nonbinding guidelines, is ex- pected to be issued to facilitate the disclosure of nonfi- Example: Kenya Stewardship Code nancial information by companies, taking into account current best practices, international developments, and In 2014, the Code of Corporate Governance for related EU initiatives. Issuers of Securities to the Public was finalized. Given the assessed benefits of better reporting to large One of the principles set out by the Corporate firms, the focus of the directive is on the provision of in- Governance Code is the need for institutional formation relevant to understanding of the development, investors to have transparent, honest and fair business model, performance, position, and impact of practices in their dealings with the companies company activities. Sufficient flexibility has been given to in which they invest so as to promote companies to report in a manner and style they consider sustainable shareholder value and long term most useful and most appropriate for that company. success of such companies.5 Companies may use international, European, or national guidelines, whichever they consider appropriate. The (CMA 2015) directive gives small and medium enterprises (SMEs) some relief to reduce the burden of reporting costs. A.4. European Union Developments Since 2012, after reviews of the financial crisis, the Eu- As regards diversity on company boards, large ropean Commission (EC) has had three major focuses of listed companies will be required to provide initiatives in corporate governance: 1) enhancing transpar- information on their diversity policy, such as, ency, 2) improving audit quality, and 3) ensuring greater for instance: age, gender, educational and shareholder engagement and supporting company growth professional background. and competitiveness.6 (European Council 2014) A.4.1. Enhancing Transparency Transparency was the first initiative to be concluded, resulting in the Accounting Directive being amended and A.4.2. Ensuring Audit Quality changes adopted in April 2014 (effective September 2014). The European Commission also introduced changes to the The directive increases the requirements in corporate Statutory Audit Directive (European Commission 2014c)7 and its associated regulations in 2014. The changes were introduced to strengthen audit quality across the EU and The European Commission welcomes include the following: today’s adoption by the Council of the • Mandatory audit firm rotation for public-interest Directive on disclosure of non-financial and entities; diversity information by large companies and • New requirements for audit committees (or their groups. Companies concerned will disclose equivalent) relating to their oversight of the perfor- information on policies, risks and outcomes mance of the audit; as regards environmental matters, social and • Additional restrictions on the provision of non-audit employee-related aspects, respect for human services by the statutory auditor to its PIE audit rights, anti-corruption and bribery issues, and clients; diversity on boards of directors. • New requirements regarding reporting by the statutory auditor; and (European Council 2014) • Explanation of the definition of public-interest entities.8 5 The subsequent stewardship code was developed, and legislation for it was awaiting official publication in Kenya as of December 2015. 6 For details on developments in the EU, see a Guide to Corporate Governance Practices in the European Union: (IFC and ecoDa 2015). 7 European Commission Directive (2014/56/EU) and Regulation 537/2014 regarding the statutory audits of public-interest entities on statements of annual consolidated accounts are applicable for the first financial year ending after June 17, 2017. 8 The European Commission issued more guidance in February 2016 in the form of an unofficial opinion, “Q&A – Implementation of the New Statutory Audit Framework.” From Companies to Markets—Global Developments in Corporate Governance 9 PART A Recent Developments in Global and Regional Corporate Governance Groups The global drive for improvement to audit quality has led makes it way through the complicated legislative proc- to several initiatives to improve the comparability and esses within the EU. Once the process is completed, transparency between audits and audit firms (IAASB 2015; it would be good for readers to check the final text of FEE 2015), and the European Commission Directive re- the directive. Meanwhile, the key matters raised are flects this. (See also Section B.3.4. Audit Reforms.) discussed in the following sections of this paper. A.4.3. Ensuring Greater Shareholders Engagement A.4.3.1. Improving Identification of Shareholders The European Commission has focused on a number of With the greater focus on having a company engage initiatives to strengthen shareholders’ rights and increase with its shareholders comes the expectation that these shareholder engagement in company affairs, including shareholders will be more active in the oversight of corporate governance. Implementation largely has come their investment. Shareholder engagement best prac- through the revision of the Shareholder Rights Directive, tices involves more than just showing up once a year adopted in July 2015 (European Commission 2014a). to attend and vote at the general meeting. Shareholder Changes affect listed issuers and large companies not listed engagement should include sound and regular dialogue on a regulated market, and they address the following: between shareholders and the company on key mat- • Improving identification of shareholders; ters of long-term impact, such as corporate governance, • Strengthening the transparency rule for institutional strategy, performance, risk, and company funding investors; structure. However, that requires increased transparency of shareholders, especially shareholdings held through • Better shareholder oversight of remuneration; intermediaries. Companies need to know with whom to • Better shareholder oversight of related-party transac- engage. tions; and • Regulating proxy advisers. Current rules subject investors to transparency require- ments when they acquire 5 percent of the voting rights of a company. However, it is not always possible for Without EU norms, rules and their application companies to identify shareholders below this threshold. would be different from Member State to The Shareholder Rights Directive in its draft form Member State, which would be detrimental to includes provisions to facilitate identification of share- the EU level playing field. Without action at EU holdings and shareholders, including that the identity level the problems are likely to persist and only of shareholders should be available to the company and partial and fragmented remedies are likely to its shareholders, and that the company shall provide for be proposed at national level. a reasonable fee, if any, the list of shareholders holding more than 0.5 percent of shares. (European Commission 2014a) [The Shareholder Rights Directive’s provisions] The EU has not yet completed the changes to corporate would significantly improve the exercise governance it seeks. It has announced forthcoming changes, which will focus on the following: of shareholder rights for all shareholders, including retail shareholders. Many • Increasing the long-term focus of investors; problems arise when there is more than one • Improving the relationship between corporate intermediary between the listed company and governance and market development (European the shareholder, especially if these are located Commission 2015), particularly the development in different Member States. The proposal of SMEs, which may lead to application of corporate governance requirements to nonlisted would require intermediaries to transmit companies; the voting information from the shareholder to the company and confirm the vote to the • Strengthening the desired quality and rigor of explanations under “comply or explain”; and shareholder. Shareholders could therefore be certain that their votes have effectively been • More comprehensively involving shareholders in the corporate governance of a company. cast, including across borders. Proposal of the Shareholder Rights Directive has prompted (European Commission 2014b) much discussion as well as amendments as the directive 10 From Companies to Markets—Global Developments in Corporate Governance Recent Developments in Global and Regional Corporate Governance Groups PART A A.4.3.2. Strengthening the Transparency Rule for currently give shareholders a ‘say on pay’. . . . Only 15 Institutional Investors member states require disclosure of the remuneration Institutional investors hold a major portion (in some cases policy” (European Commission 2014b). The proposed more than half) of shares listed on EU markets, and yet directive aims to create a better link between pay and the they were noticeably absent when it came to participation performance of a company. It takes the view that to hold in company oversight and engagement in the lead-up to the management to account for long-term company perfor- financial crisis. European Commission research in 2010 mance, shareholders need information on and the right and 2011 noted the diverse interests and behaviors of asset to challenge pay, particularly when it is not justified by owners and asset managers. The research also noted that performance outcomes. when assets are managed by asset managers there is an in- creased likelihood of a short-term investment perspective. However, much discussion has taken place on this particu- Asset owners (pension funds, insurers, and others) tend to lar topic as the directive makes its way through the Euro- hold a longer-term view more aligned with their beneficiaries’ pean legislative processes, and it continues to be subject to needs and were more likely to engage with a company on amendments at the time of writing this paper. As of mid- its strategies for longer-term returns, which can increase 2015, the directive included the following requirements: stock returns by up to 7 percent. • A remuneration report shall be a part of the corporate governance report of companies, In his keynote speech at an ecoDa conference in 2015, and they shall report to shareholders details of Jeroen Hooijer, acting director of the Directorate-General - how the company determines the remuneration for Justice and Consumers, European Commission, of directors; explained the basis for the drafting of the Shareholder Rights Directive. He also presented its main features. - the role and functioning of the remuneration committee. • Member states shall establish a policy that the “Besides all the consultations conducted by the remuneration policy of a company be submitted to Commission, different studies make it clear that stock a binding vote of the general meeting of sharehold- return can increase by 7 percent with more institu- ers, but that each individual state may make the vote tional investors’ engagement. Engagement means the at the general meeting on the remuneration policy monitoring of companies on matters such as strategy, advisory only. performance, risk, capital structure and corporate • The report shall be put to a vote of the general governance, having a dialogue with companies on meeting at least once every three years. these matters and voting in general meetings.” There was much discussion on the rationale behind mak- Jeroen Hooijer, Acting Director, ing a “say on pay” subject to law, when much of corpo- DG JUST, European Commission rate governance regulation allows flexibility through the comply-or-explain regime. The Commission was of the To encourage this engagement, the directive requires institu- view that in the presence of possible conflicts of interests, a tional investors to disclose how they take the long-term in- stronger stance was required and hence the introduction of terests of their beneficiaries into account in their investment law in this area. strategies and to explain how they incentivize asset man- agers and others in the investment chain to act in the best A.4.3.4. Better Shareholder Oversight of Related-Party long-term interest of the institutional investor. Asset owners Transactions and asset managers are required to explain how they engage The EC directive includes recommendations for strong with investee companies on a comply-or-explain basis. action for related-party transactions. RPTs—transactions between the company and its management, directors, sig- A.4.3.3. Better Shareholder Oversight of nificant or controlling shareholders, or companies within Remuneration the same group—have the potential for abuse against the Recent years have demonstrated repeated mismatches company, its assets, and minority shareholders. between executive pay and company performance. Remu- neration policies and executive pay were not transparent To ensure adequate safeguards for the protection of share- and did not sufficiently incentivize companies to improve holders’ interests, the directive increases transparency of management and performance. A review of EU member RPTs and independent third-party involvement in the ap- states’ practices revealed that “only 13 EU member states proval of such transactions. The directive requires, in part, From Companies to Markets—Global Developments in Corporate Governance 11 PART A Recent Developments in Global and Regional Corporate Governance Groups that member states define specific rules for RPTs, including A.4.3.5. Regulating Proxy Advisers the following: Another focus of the Shareholder Rights Directive is proxy • A clear definition of related parties and related-party advisers, because they advise shareholders how to vote transactions; their shares and so are powerful. Article 3i requires proxy advisers “to guarantee their voting recommendations are • “Related party transactions representing more than accurate and reliable and based on a thorough analysis 5 percent of the companies’ assets or transactions of the information available to them.” Box A.5 lists items which can have a significant impact on profits or that proxy advisers will disclose on their websites in the turnover should be submitted to a vote by the share- preparation of their voting recommendations. holders in a general meeting” (European Commission 2014a); • Where shareholders are involved in RPTs, the con- Box A.5: Disclosures of Proxy Advisers flicted shareholders shall be excluded from the vote; The following are the essential features of the method- • Shareholders votes (as above) shall be taken prior to ologies and models that proxy advisers apply: the conclusion of the transaction; l The main information sources they use; • RPTs that represent more than 1 percent of company assets shall be publicly announced at the conclu- l Whether and, if so, how they take national sion of the transaction. Such announcement shall be market, legal, and regulatory conditions into ac- accompanied by a report from an independent third count; party (a supervisory body of the company, an inde- l Whether they have dialogues with the compa- pendent third party, or a committee of independent nies that are the object of their voting recom- directors) assessing the RPT’s terms and conditions mendations, and, if so, the extent and nature and its fairness and reasonableness. thereof; • Special exclusions/conditions may be available for l The total number of staff involved in the prepara- RPTs with wholy owned subsidiaries and recurrent tion of the voting recommendations; RPTs above 5 percent of company assets and above l The total number of voting recommendations 1 percent of company assets. provided in the last year. The goal is to give minority shareholders an opportunity Source: (European Commission 2014a). to reject material RPTs not in their interest. The meaning of “material” in regard to RPTs is likely to be set by the Such regulations focus on disclosures that proxy advisers national regulator or the company, but the International will make to their clients and will include any disclosure of Internal Audit Standards Board Framework provides the conflicts of interest on the part of the adviser. Again, this following generic definition: “Information is material if its has prompted considerable discussion and diverse views. omission or misstatement could influence the economic deci- France in particular had wanted to see regulation of proxy sions of users taken on the basis of the financial statements.” agencies. These regulations concerning RPTs have been quite contro- The European Commission sees proxies as having an versial. In particular, some member states, such as Germany important role in the engagement of shareholders. The and Finland, oppose a shareholder’s vote on material RPTs. Commission is looking for recommendations of high qual- As a result, the regulations are expected to be weaker and ity that are accurate and reliable. will allow member states the latitude to interpret how they will apply the minority shareholder vote on RPTs. There are diverse interpretations of the rationale behind such regulations. One view is that some regulations included in the Shareholder Rights Directive are less about “I have to say that my sense of where the European making better companies with better corporate governance Union is coming from. . . . It’s been about supporting and more about making companies more trustworthy and the regulatory effort and reducing risk in the corporate accountable—more about an improved regulatory system. sector.” Peter Montagnon, We may be seeing the early stages of a shift in emphasis Institute of Business Ethics and in corporate governance regulations and codes. Previ- IFC Corporate Governance Private Sector Advisory Group ously they were about developing good practices within 12 From Companies to Markets—Global Developments in Corporate Governance Recent Developments in Global and Regional Corporate Governance Groups PART A a company. Now it seems there is a greater emphasis on tion and data protection. It also may require the facilita- development of sound, well-regulated markets as well as tion of electronic voting for shareholders. companies. Companies can no longer have an internal A.4.4.1. Proposal for Additional Benefits to Long-Term focus only. Performance happens in a context—the com- Shareholders pany is an integral part of society. In the proposed European Shareholder Rights Directive, A.4.4. Supporting Company Growth and one issue is how to incentivize a long-term perspective in Competitiveness shareholders. France, under the Florange Law introduced A Green Paper issued in February 2015 by the European in 2014, automatically grants double voting rights from Commission for consultation on the Capital Markets 2016 to shares registered for more than two years, unless Union has flagged for consideration the following issues two-thirds of shareholders vote to overturn it. In the Neth- that may affect corporate governance directly or indirectly erlands, the Supreme Court of the Netherlands established (European Commission 2015): that companies have the right to offer loyalty shares to • Minority protection of shareholders; those holding shares for a certain time, to promote long- • The efficiency of boards; term share ownership, thus also providing shareholder stability in the company. • The digitalization of company law and corporate governance;9 and However, others see this as a market distortion, a trans- • The obstacles in company law or corporate govern- gression of the normally accepted principles of “one share, ance to deeper integration of capital markets, and one vote.” Therefore, many do not see it as the way to go. consideration of how to overcome them. The concept has several unresolved issues: • How to define “long term view”; The Commission issued an action plan for these matters in September 2015 (European Commission 2015). Other • Defining an appropriate long-term holding period; developments in the Commission’s action plan to support • Identifying long-term investors/shareholders in company growth, competitiveness, and the promotion of funds where individual investors/shareowners in jobs through better corporate governance have yet to be the fund come and go, yet the asset managers may fully considered. They include the following: continue; • Improving the framework for more efficient and • Identifying a long-term perspective if shares are lent; and effective financial systems within member states and • Determining appropriate incentives for holding cross-border; shares for the “longer term.” • Promoting a legal form of corporate governance Those who oppose incentivizing a long-term view in this adapted for SMEs (an expert group has been created way argue that it is open to serious abuse from controlling to look into this matter); and shareholders, as is considered to have occurred with • Harmonizing and codifying of EU company law. Renault (see Box A.6, page 14). Therefore, ensuring a Finally, a strategy is in the early stages of development at long-term view as opposed to short-termism does require the European level to establish a digital single market. The clear measures that will achieve the desired outcome and strategy has three pillars: not unintended consequences. For example, ecoDa pro- • Better access for consumers and businesses to digital duced a cautionary note regarding possible issues with goods and services across Europe; the directive’s proposals (ecoDa 2014). Concerns revolve around conflicts arising between the role of the board and • Creating the right conditions and a level playing the role of shareholders. field for digital networks and innovative services to flourish; and A.4.4.2. Need for Balance in All Initiatives Affecting • Maximizing the growth potential of the digital Corporate Governance economy. Initiatives that affect corporate governance and transpar- ency are in a state of flux in the EU. Pan-European regula- This strategy could affect corporate governance by requir- tions may not sufficiently recognize particular and diverse ing greater transparency of companies regarding digitiza- issues in individual member states. A balanced recognition 9 Possible future initiatives for the digitalization of company law and corporate governance could cover a number of areas, such as online registra- tion of companies, electronic submission of documents, electronic voting systems for companies’ stakeholders, digital solutions to allow access to more meaningful and comprehensive information on European companies and their structures (European Commission 2015). From Companies to Markets—Global Developments in Corporate Governance 13 PART A Recent Developments in Global and Regional Corporate Governance Groups Box A.6: Example: Renault 2015 [The Nordic model] allows a shareholder majority to effectively control and take a The French government successfully blocked a share- long-term responsibility for the company. The holder resolution at Renault’s annual meeting on alleged risk of such a system—the potential Thursday that would have prevented it from gaining of a controlling shareholder to abuse this double voting rights in the company under a recently power for her own benefit at the expense of enacted law, tightening its grip on the auto maker and the state’s latest move to assert itself over corporate minority shareholders—is effectively curbed affairs. through a well-developed system of minority protection. The result is a governance model The resolution, which was supported by Mr. Ghosn that encourages strong owners to invest time and opposed by French Economy Minister Emmanuel and money into long-term engagement in the Macron, sought to keep the current one-share, one- governance of the company to promote their vote governance system. It required a two-thirds own interest while at the same time creating majority by Renault shareholders to pass, but the value for the company and all its shareholders. resolution failed, getting 60.5% of the vote. (Lekvall 2014) Source: Excerpt from The Wall Street Journal, April 30, 2015. of the costs of shareholder engagement and of the exercise The Nordic model does seem to work well, even in compa- of shareholders’ rights should be weighed carefully against nies with controlling shareholders, most likely because it is the benefits of more engagement. Overregulation may lead also backed by a strict system of minority protections set to too much shareholder intervention in the company and out in a range of statutory provisions, as described in Box stifle innovation and growth. Caution should be exercised A.7. (See Box A.8 for an example from Sweden). in these areas. Box A.7: Statutory Provisions Backing the “I think corporate governance standards should have a Nordic Model balance. If we put more stringent measures and more The statutory provisions include ones relating to the controls. . .I think we will kill entrepreneurship and in- following: novation of management.” l The principle of equal treatment at all levels, Mazen Wathaifi, Commissioner and Secretary-General, which prohibits any company organ from taking Jordan Securities Commission any action rendering undue favors to certain shareholders at the expense of the company or other shareholders; A.5. Nordic Corporate Governance Developments l Extensive individual shareholder rights to ac- It is not surprising that some of the regulatory develop- tively participate in shareholders’ meetings; ments at the European level are also reflected at the sub- l Majority-vote requirements of up to total regional level in the Nordic countries. However, research unanimity for resolutions by general meeting shows that the four Nordic countries—Denmark, Finland, of particular, potential detriment to minority Norway, and Sweden—have developed a distinctive corpo- shareholder interests; rate governance model that has been successful in ensuring l Minority powers to force certain resolutions at shareholder engagement and a longer-term perspective, the shareholders’ meeting, especially on matters which the European Commission is striving for in the pro- regarding shareholders’ economic rights; posed Shareholder Rights Directive (Lekvall 2014). l Prescriptions for handling related-party transac- tions strictly on market terms; and The Nordic model differs distinctly from the one-tier model, common in Canada, the United Kingdom, and l A generally high degree of transparency toward the United States, where dispersed share ownership is the the shareholders, the capital market, and the norm, as well as from the two-tier model, typically used in surrounding society at large. countries with a German-tradition model. (See Figure A.2.) Source: (Lekvall 2015). 14 From Companies to Markets—Global Developments in Corporate Governance Recent Developments in Global and Regional Corporate Governance Groups PART A Box A.8 Example: Sweden Sweden has a heritage of most public Swedish corpora- Nominating groups are not composed of independent tions being dominated by a few large shareholders. This directors of the board as in other corporate governance has waned a little in recent times but forms the basis of models. Rather, the nominating group typically includes its current corporate governance model. Sweden does a the four largest shareholders. There is no weighting in good job of protecting the rights of minority sharehold- the vote on shareholders’ recommendations. Therefore, ers, and it favors additional rights for shareholders with a any controlling shareholder must get the support of long-term view. the next two on the nominating group for board ap- pointments. These nominating groups tend to have a Shareholders also have a role in selecting board nomi- long-term view of the company and recommend board nees and have a role as the nominating group in Sweden. appointments accordingly. Source: (Dent 2012), which provides an in-depth analysis of the Swedish model. Figure A.2: The Nordic Model as Compared to the One-Tier and Two-Tier Models Two-Tier Model Nordic Model One-Tier Model Ownership GM GM GM level Oversight and Supervisory Board Board Chair control level Board Chair & CEO Executive Management Executive level Board Management The Nordic solution is distinctly different from both of these more widely known models. It is neither a mixture of, nor a compromise between, the two. Instead it differs from both in three fundamental ways: • It allocates virtually all power to the general-meeting majority by placing this body on top of a hierarchical chain of command in which each company organ is strictly subordinate to the gure. next-higher level in the chain. Hence the solid lines in the fi • It vests the board with far-reaching powers to manage the company during its mandate period. Still it may be dismissed by the shareholders at any time and without stated cause, thus ensuring clear subordination to the general meeting and strict accountability to the shareholders. • It makes a clear distinction between the non-executive board and the executive management function, appointed and dismissed at any time at the sole discretion of the board, again entailing a strict hierarchy that ensures accountability. Source: (Lekvall 2015). From Companies to Markets—Global Developments in Corporate Governance 15 PART A Recent Developments in Global and Regional Corporate Governance Groups A.6. Summary of Global Issues company strategy, risk, performance, and company This review of regulatory/global initiatives identified sev- culture; eral common threads that continue throughout. However, • The need for regulators to monitor and enforce many good initiatives have been undertaken in national en- corporate governance codes and practices; vironments and in other global forums that affect the cor- • Recognition of the role of investors in corporate porate governance environment and should not be ignored. governance frameworks and the need for share- Amendments have taken place to address the following: holder engagement in company affairs and compa- • A major shift in emphasis in corporate governance ny-investor communication. codes and regulations to consider its role and effects on capital markets, not only on individual companies; A.7. Trends and Future Developments • The need for a long-term perspective by investors The OECD work on corporate governance development is and management on company affairs, and the drivers ongoing. It is expected to include more peer reviews and of such a view, especially in strategy, performance, amendments to the related corporate governance assess- remuneration incentives, and value creation to all ment methodology used by the World Bank and regional stakeholders; roundtables to promote use of the new Principles and to • The move to increased regulation, as opposed to support corporate governance reform. voluntary codes, in some areas of corporate govern- Regulators and supervisors will increase monitoring ance to ensure application and yet balancing the and review of corporate governance and may need new need for flexibility for company diversity; sanctions or powers to enable demand for remedial • Recognition of the impact of the business model actions in corporate governance. For example, a bank and the presence of controlling shareholders on supervisor may wish to restrict bank activities or apply corporate governance; additional capital or liquidity charges while the bank • Demand for transparency from companies and executes corporate governance changes. better information, particularly on governance There may be more developments arising from a perceived and board effectiveness, related-party transactions, shift in emphasis in corporate governance regulations and codes. At present, there is a greater emphasis on develop- Strong corporate governance standards ment of sound, well-regulated markets, whereas previously, contribute to productivity in two ways. First, corporate governance was focused on the development of they enable shareholders to exert control good practices within the company. (Part C of this publi- over firms, and shareholder value in turn is cation discusses this broader focus in fuller detail.) maximized by raising the firm’s productivity. For the investor community, some issues will continue to Second, by aligning incentives of firms’ exercise the minds of investors. The following are some managers and owners, they limit risks to examples: investors, incentivizing higher levels of • Minority shareholder rights. Investors will con- investment and reducing costs of capital for tinue to be concerned about developments such the firm. Key to corporate governance is the as double-voting rights to long-term shareholders, transparent access of shareholders to timely as these serve to operate against a minority share- and accurate information, accountability holder. of management to strong and independent • The introduction of stewardship codes, investor corporate boards, and auditor independence. stewardship, and the investor role as an active and In addition to formal standards, informal responsible corporate owner. The development of behavioral norms also play a crucial role in the stewardship codes, such as in Kenya, Malaysia, way businesses are run. High ethical standards Taiwan, China, and the United Kingdom, will among business leaders can contribute to continue. building trust, thereby reducing the cost of • The role of culture, risk, and sustainability issues capital and compliance. in the investment decision. (WEF 2015a) • Reporting that investors need and want from companies. 16 From Companies to Markets—Global Developments in Corporate Governance PART B Corporate Governance Developments: Practice Issues The financial crisis highlighted the gap that remains be- culture, risk appetite, and the behavioral elements tween corporate governance principles and corporate gov- related to risk (better risk governance should include ernance as implemented and practiced, despite corporate increased focus on internal control systems and the governance regulations, frameworks, codes, and standards. internal audit function); The OECD concluded that the financial crisis, to an extent, • Demands for increased transparency and disclosure, could be attributed to failures and weaknesses in corporate including 1) environmental, social, and governance governance arrangements (Kirkpatrick 2009). It identified reporting, 2) integrated reporting, 3) periodic report- four areas requiring change: ing, and 4) audit report reform; • Board effectiveness and practices; • The need for stronger shareholder rights in the areas • Control environment and risk oversight and man- of related-party transactions and regarding transpar- agement; ency of beneficial ownership; • Transparency and disclosure; and • The need to demonstrate an overall commitment to • Shareholder rights. corporate governance and an appropriate corporate culture for better governance. Studies by the Basel Committee for Banking Supervision as well as those by David Walker in the United Kingdom B.1. Board Effectiveness and Practices indicated that the practical implementation and effective- Laws, regulations, and codes provide direction for board- ness of corporate governance was inadequate. room conduct. However, ultimately it is up to each indi- Corporate governance codes are often “soft law,” largely vidual director and all directors of a board collectively to because corporate governance requires a degree of flexibility contribute, to function well, and to be effective in fulfilling so good practices can be applied to companies in different their obligations. industries, in different markets, and at different stages of Board structures and procedures to fulfill these obligations development. Typically, companies are allowed to comply vary both within and among countries. There is no single or explain. More recently, several countries are moving to right way to be an effective board, so advice on this subject mandate those corporate governance areas in which com- has been predominantly in the nature of guidance rather pliance is deemed necessary and important, leaving the than prescriptive rules—guidance from regulators and remaining corporate governance matters in a code. This section of the paper will review corporate governance “Critical to strong corporate governance are its imple- developments related to elements in the IFC Corporate menters —the boards of directors. . . . [A]s fiduciaries, Governance Methodology for evaluating corporate gov- all [duties] are clearly aimed at one overarching ernance risks and opportunities in the areas of board of obligation—and that is to faithfully represent the directors, minority shareholders’ rights, control environ- interests of shareholders. . . . To that end, you have ment, disclosure and transparency, and commitment to significant oversight responsibilities with respect to good govern- ance practices (IFC 2016b). The following are executive management and for the overall direction of particular areas where the need for improvement has been the company. As directors, you play a critical role in identified and that have been the subject of recent change: setting the appropriate tone at the top, are expected to be guardians of the company’s assets, and are relied • The need for well-functioning, effective boards, lead- upon by both shareholders and the capital market.” ing to changed demands concerning diversity, board committees, board evaluation, and remuneration; Luis A. Aguilar, (U.S.) SEC Commissioner, • Strengthening risk governance to ensure greater Boardroom Summit, New York, October 14, 2015 clarity of the board role in risk and compliance, risk From Companies to Markets—Global Developments in Corporate Governance 17 PART B Corporate Governance Developments: Practice Issues Box B.1: FRC Guidance on Board Effectiveness An effective board develops and promotes its collective l makes well-informed and high-quality decisions vision of the company’s purpose, its culture, its values based on a clear line of sight into the business; and the behaviours it wishes to promote in conducting l creates the right framework for helping directors its business. In particular, it meet their statutory duties under the Compa- l provides direction for management; nies Act 2006, and/or other relevant statutory l demonstrates ethical leadership, displaying—and and regulatory regimes; promoting throughout the company— l is accountable, particularly to those that provide behaviours consistent with the culture and the company’s capital; and values it has defined for the organisation; l thinks carefully about its governance l creates a performance culture that drives value arrangements and embraces evaluation of creation without exposing the company to their effectiveness. excessive risk of value destruction; Source: (FRC 2011). private sector entities. For example, the Financial Report- In addition to the industry-specific risks of ing Council, charged with oversight of corporate gov- banking, bank directors also need to concern ernance in the United Kingdom, issued guidance on an themselves with the full range of internal and effective board. (See Box B.1.) external risks that any organization faces. Much of the guidance that is available is generally applicable Banks are subject to more intense public to all companies. Other guidance, such as IFC’s Guidance scrutiny than most industries, especially for the Directors of Banks (Westlake 2013), has a particular after the financial crisis, so their directors focus on subsets of corporate governance. (See Table B.1.) carry a higher degree of risk to their personal Corporate governance codes and other documents advocate reputation than do the directors of companies good practices while allowing for flexibility of application. in lower-profile sectors. This paper focuses on recent developments considered to (Westlake 2013) contribute to board effectiveness in four key areas: 1) the composition of the board, including board diversity; 2) the Table B.1: Board Effectiveness Initiatives Country Issuing Institution Effectiveness Instrument Year Issued Global IFC Focus 11: Guidance for Directors of Banks 2013 Australia ASX Corporate Governance Principle 2: Structure the board 2014 to add value Canada Crown Corporations Assessing Board Effectiveness 2008 Estonia BICG Guidance on Board Effectiveness—SOEs 2013 Latvia BICG Guidance on Board Effectiveness—SOEs 2013 Lithuania BICG Guidance on Board Effectiveness—SOEs 2013 United FRC Guidance on Board Effectiveness—SOEs 2011 Kingdom United ABI Report on Board Effectiveness 2012 Kingdom Source: Molyneux, 2015. 18 From Companies to Markets—Global Developments in Corporate Governance Corporate Governance Developments: Practice Issues PART B role of board committees in the effective functioning of a In many jurisdictions high-quality independent decision board; 3) board evaluations; and 4) remuneration. making is underpinned by some well-recognized good practices: • A balance of executive and non-executive directors Corporate governance can never stand in the one-tier board system; still. Our expectations of boards change constantly—especially in our hypercompetitive • A sufficient number or fixed percentage of indepen- and turbulent times. What was acceptable dent directors;10 behaviour a decade ago is often now viewed • Diversity in board composition; very differently. • Competence—ensuring that directors and the board collectively have appropriate knowledge, expertise, (Heidrick & Struggles 2014) and experience, including use of a board-experience- and-skills matrix; and B.1.1. Board Effectiveness: Composition • Separation of roles of CEO and chairperson. and Diversity—The Right Mix The corporate governance reform agenda continues to In my experience I’ve found that the best evolve. The financial crisis reviews found, among other is- boards are also the most diverse boards. sues, that some bank boards were composed mostly of men They can offer a depth and breadth of insight, and were not sufficiently independent or diverse in com- perspective and experience to CEOs that non- position or thinking. A survey by Spencer Stuart indicates an increase of independent directors on boards (Spencer diverse boards simply cannot. When I mention Stuart 2015). For example, independent directors make diversity, I’m addressing more than age, up 88.3 percent of Swiss boards, 62.0 percent of Swedish ethnic and gender diversity, but also diversity boards, and 58.1 percent of South African boards. There is skills, competencies, philosophies and life are lower representations of independent directors on experiences as well. boards in emerging markets, such as Russia (35 percent) and Turkey (33 percent). (Myatt 2013) B.1.1.1. Board Effectiveness: Composition and . . .[I]ndependence and financial sector Commitment expertise alone do not suffice as [what David Board composition is seen as an issue of competence as Walker called] an “important counterweight well as of diversity. Globally, companies looking at board to. . .executive or board ‘groupthink.’” One way appointments and the composition of the board now con- is to identify and test the group’s paradigm, sider the scale and nature of the entity’s activities and look which may be assisted by having directors for an appropriate number of directors who have a range with varied professional disciplines and of relevant and diverse skills, expertise, experience, and perspectives. background. They also seek directors who can understand the issues arising in the organization’s business, provide (Lawton and Nestor 2010) insight, and add value. It is important to carefully consider the types of skills and The lack of people with banking industry experience and experience required on the board in light of the board’s knowledge and risk expertise on bank boards led to a more needs. Backgrounds that are in demand in today’s environ- widespread review of board composition (Ladipo and Nestor ment include the following: 2009). A board’s purpose is to govern and to make decisions, • industry-specific knowledge so its composition should be structured to support the exer- • executive leadership cise of independent, objective judgment. A good board listens, contributes, challenges, and when necessary pushes back. • financial expertise 10 For IFC’s indicative definition of an independent director, see Appendix A. However, different jurisdictions may define “independence” in various ways. An independent director should be capable of independent, objective decision making. From Companies to Markets—Global Developments in Corporate Governance 19 PART B Corporate Governance Developments: Practice Issues survey of board directors indicated that directors surveyed Appointing directors who are able to make think financial expertise (91 percent), industry expertise a positive contribution is one of the key (70 percent), and operational expertise (66 percent) are the elements of board effectiveness. Directors will three most valued skills (PwC 2015a). be more likely to make good decisions and maximise the opportunities for the company’s success in the longer term if the right skill sets An effective board of directors is at the heart of are present in the boardroom. This includes the governance structure of a well-functioning the appropriate range and balance of skills, and well-governed corporation. experience, knowledge and independence. Non-executive directors should possess critical (OECD 2011) skills of value to the board and relevant to the challenges facing the company. Skills and experience are only half the story. Personal (FRC 2011) characteristics are also important and help build the group dynamic. Personal characteristics can be both cre- • global experience and contacts ative and productive, but they also can be destructive in unfavorable circumstances. It is wise for boards to con- • operations/business model sider personal interactions and each individual’s integrity, • governance/committee experience/regulatory courage, strategic perspective, innovative and analytical • strategy development thinking, communication skills, accountability, capacity to influence and mentor, and willingness to be an active • risk management participant on the board and to be a team player. • technology/IT/social media/IT security The Basel Committee on Banking Supervision’s revised • marketing/public relations Corporate Governance Principles (BCBS 2015)11 empha- • corporate social responsibility sizes the importance of the board’s collective competence • government relations as well as the obligation of individual board members to dedicate sufficient time to their mandates and to keep • human resources and compensation abreast of developments in banking. BCBS demands that • mergers and acquisitions the board is “fit and proper” as a group. Other studies have determined that an effective board According to a survey by Deloitte Center for Corporate now spends more time in deliberations than it did previ- Governance and the Society of Corporate Secretaries ously as a way to better understand the company, its (Deloitte 2012), directors identified industry experience industry, and its strategies. A McKinsey study (McKinsey as the skill or experience most important for a director 2013) indicated that high-impact boards and directors to contribute to the board’s success and effectiveness in invest more time per year in total, and especially on strat- the near future. More recently, a PricewaterhouseCoopers egy, performance management, mergers and acquisitions, organizational health, and risk management, than prior It is important that a number of board to the financial crisis. (See Figure B.1.) members bring experience in the company’s B.1.1.2. Board Effectiveness: Diversity industry area to bear, so that they understand Since the financial crisis, the spotlight has also been on the competitive environment in which the the need for diversity in board composition—to achieve company operates and have the ability to ask diversity of thinking as well as diversity of competences, management industry-specific questions. behaviors, and experience. Because most boards in the west have been composed of middle-aged white males, (Watson 2015) the diversity debate has focused on the contribution women can make to boards and, more controversially, 11 See also Part A of this publication, Section A.2. 20 From Companies to Markets—Global Developments in Corporate Governance Corporate Governance Developments: Practice Issues PART B Figure B.1: Time Commitment of Boards Number of days a year board currently spends on issues 40 Overall 19 By issue 12 Strategy 4 Performance 7 management 4 Execution, investments 6 and M&A 3 Organizational health 5 and talent management 2 Business-risk 5 Very high impact,1 n = 224 management 2 Moderate or low impact, n = 205 Core governance 4 and compliance 4 1 Figures do not sum to total, because of rounding. Source: April 2013 McKinsey Global Survey of 772 directors on board practices. the perceived need to establish quotas for the representa- holders are demanding a change to more gender-represen- tion of women on boards. tative boards, and in some countries quotas or targets have been set. (See Table B.2.) Areas of diversity include age, race, gender, cultural experience, and national and international experience. Example: Norway Of the directors surveyed by PricewaterhouseCoopers in Norwegian law requires all companies with more than 5,000 2015, 49 percent view adding diversity to the board as employees to have at least 40 percent of their board members important, and 45 percent believe it leads to enhanced be women. In operation since January 2006, the law imposes board effectiveness (PwC 2015a). Shareholders and stake- sanctions for noncompliance after January 2008. Table B.2: Gender Quotas or Targets Country Quota/ Target % Achievement (expected date) Current Figures % Belgium 33 2017 15 France 40 2017 25 Italy 20 2013 11 Netherlands 30 2015 19 Norway 40 2008 39 Spain 30 2020 13.5 United Kingdom 25 2015 18 Source: (Heidrick & Struggles 2014). From Companies to Markets—Global Developments in Corporate Governance 21 PART B Corporate Governance Developments: Practice Issues Example: Morocco and responses to risk, are more independent, and In Morocco, a directive from the central bank (Bank Al more frequently hold a longer-term view. Maghrib) requires at least one-third of board members to • Women on boards and in senior management build be independent and board composition to demonstrate better workplace relations and make better deci- diversity of expertise as well as gender diversity.12 sions, because they ask more questions and are less • Benefits of Boardroom Diversity likely to nod through decisions. Recent research indicates that diversity of all kinds, including of talent, is associated with diversity of thought • Position of Women on Boards and better business performance. More particularly, a Two key surveys of the incidence of women on boards study for the Conference Board of Canada (Carter and (Credit Suisse 2015; MSCI 2014) indicate that there is Wagner 2011) indicates that diversity, including women, change afoot but that change is slow and considerably on boards is linked to better business performance, such varied. Increases have come predominantly in markets as the following: where regulations have required it or targets have been set for change. According to the MSCI survey (MSCI 2014), • Strong financial performance; women hold 17.3 percent of all directorships globally. • Ability to attract and retain top talent; Yet in Brazil, paradoxically where the Novo Mercado is • Heightened innovation; focused on good corporate governance, women made up • Enhanced client/customer insight; only 6.0 percent of directorships of surveyed companies, below the emerging-markets average of 8.8 percent. • Strong performance on nonfinancial indicators; and • Improved board effectiveness. In a GMI Ratings study (GMI 2013), South Africa ranked fifth in the world in 2013, with 17.9 percent female repre- These findings are supported by another extensive re- sentation on the boards of 59 companies, which has since search piece by Credit Suisse Research Institute, which grown to over 20.0 percent. In South Africa, it has been indicates that companies with women on the board have mandatory for companies to disclose the percentage of consistently higher return on equity over a six-year period female employees in senior management. According to a (Credit Suisse 2012). The arguments for greater numbers European Commission Factsheet (European Commission of women on boards (Bart and McQueen 2013) include 2013), women represent 11.9 percent of board members the following: of the largest companies listed on the Romanian ROTX • Boards make decisions that affect the company, and 11.6 percent of board members of companies on the the community, and the country, half of which are Bulgarian SOFIX. Both of these levels were below the Eu- women. It is important that boards relate to their ropean average representation of women on boards at the customers, clients, and consumers. time. Figure B.2 illustrates the wide range of representation of women on boards. • Diverse age, race, gender, and cultural experience bring diverse perspectives. B.1.2. Board Effectiveness: Board Committees • Diversity on the board gives a company access to a Corporate governance frameworks have used board com- wider pool of board talent with appropriate skills, mittees extensively. So this part of the paper will focus only competences, and experiences. on new, better practices that have emerged recently. • Experts indicate that woman have different approaches In most jurisdictions, law and regulations allow boards to form board committees to more effectively handle the board workload and apply particular expertise to board- “It is important to comment on the lack of female inde- work areas. However, while the board may make use of pendent directors. We have seen progress in this area, committees to assist consideration of particular issues, the but there is clearly considerable room for progress. The board retains the responsibility for the final decisions. best approach would be to professionalise practices and train directors.” In the 2015 revision of the Corporate Governance Principles, Patrick Zurstrassen, IFC Corporate Governance Private Sector Advisory Group the OECD more closely links the role of independent non-exec- and Honorary Chair, ecoDa utive directors and board committees, especially where there is potential for conflict of interest. (See Box B.2, page 24.) 12 Bank Al Maghrib, Directive (D No. 1/W/2014 in Articles 5-10), “On the governance of credit institutions,” October 2014. 22 From Companies to Markets—Global Developments in Corporate Governance Corporate Governance Developments: Practice Issues PART B Figure B.2: Prevalence of Women on Boards—By Country Where Women Are Corporate Directors The United States lags many European countries in women’s representation on corporate boards, including some countries without quotas for directors. Women’s share of board seats at the companies in each country’s major stock index, as of October 2014 Norway 36% Finland 30% France 30% Sweden 29% Belgium 23% Britain 23% Denmark 22% Netherlands 21% Canada 21% Germany 19% United States 19% Australia 19% Spain 18% Switzerland 17% Austria 13% Ireland 10% Hong Kong 10% India 10% Portugal 8% Japan 3% Source: Catalyst Board demands continue to increase as markets globalize, • Enhance the objectivity and independence of the regulation becomes more complex, and companies grow. board’s judgment, insulating it from potential undue The use of board committees can be an effective method of influence of managers and controlling shareowners, dealing with these challenges. The need to delegate over- in such key areas as remuneration, director nomina- sight to specialist board committees is evident. Appropriate tion, and oversight controls. committees should support the board’s ability to accom- B.1.2.1. Good Practices for Board Committees plish the following: The following good practices for board committees have • Handle a greater number of issues more efficiently evolved and are currently in use: by allowing experts to focus on specific areas and • The right to establish board committees to facilitate provide board recommendations; operations of the board can be found in Company • Develop subject-specific expertise on the company’s Law, regulation, codes, or company articles. operations, such as financial reporting, risk manage- • Some committees in some jurisdictions are mandated ment, and internal controls; in law or regulation (for example, an audit committee). From Companies to Markets—Global Developments in Corporate Governance 23 PART B Corporate Governance Developments: Practice Issues & Young 2014). There also is an increase in the Box B.2: From OECD Principle VI prevalence of risk committees, with 22 percent of E.2. Boards should consider setting up specialised companies globally now having a board-level risk committees to support the full board in perform- committee; in Singapore, 42 percent of all compa- ing its functions, particularly in respect to audit, nies have a risk committee of the board, and the and, depending upon the company’s size and risk incidence of board-level risk committees is even profile, also in respect to risk management and higher in financial institutions, with 67 percent remuneration. When committees of the board are having a standalone board risk committee (Deloitte established, their mandate, composition and 2014). working procedures should be well defined and • There is early evidence of the rise of corporate disclosed by the board. social responsibility (CSR)/ethics committees at the board level. For example, 44 percent of CAC 127. Where justified in terms of the size of the 40 companies have an ethics/CSR committee company and its board, the use of committees may (McKinsey 2013). improve the work of the board. In order to evaluate the merits of board committees it is important that • Most committees are prescribed to comprise three the market receives a full and clear picture of their or more members, at least a majority of whom are purpose, duties and composition. Such information independent, non-executive directors. is particularly important in the many jurisdictions • Leadership of board committees is usually an where boards have established independent audit independent, non-executive director. committees with powers to oversee the relationship with the external auditor and to act in many cases • Committee tasks, processes, and performance independently. Audit committees should also be and accountability are outlined in the committee able to oversee the effectiveness and integrity of charter. the internal control system. Other such committees • Committee members should have access to ap- include those dealing with nomination, compensa- propriate support, relevant people, information, tion, and risk. The establishment of additional advice, and professional development to assist their committees can sometimes help avoid audit work. committee overload and to allow more board time • Committee work and the contributions of individ- to be dedicated to those issues. Nevertheless, the ual directors to the committee should be annually accountability of the rest of the board and the board evaluated. as a whole should be clear. Disclosure need not extend to committees set up to deal with, for • Other directors, who are not members of the com- example, confidential commercial transactions. mittee, and management may be invited to attend committee meetings and present or elaborate on Source: (OECD 2015a). issues as a regular pattern or from time to time. These attendees have observer status only and • A board charter is in place for each board commit- should not participate in committee decisions. tee. It is communicated on the company website Caveat: It is important that board committees do not lead and includes discussion of the purpose, duties and to the following: responsibilities, mandate/authority, and composition (including required member expertise) of the com- • Fragmentation of the board; mittees. It will also provide information on com- • Usurping authority and accountability of the board mittee processes (such as for a quorum, on meeting or of management; or notices, and minutes and reporting responsibilities). • Taking on the day-to-day tasks of management. • Areas where board committees are frequently used are audit, board nomination, corporate governance, The board can prevent board committees from falling remuneration, and risk. Board committees are less into these traps by having a clear charter and mandate for evident for strategy and other areas in some jurisdic- each committee, competent committee members who have tions. However, in France, some 60 percent of CAC an understanding of their role and its limits, and regular 40 companies have a strategic committee (Ernst reporting to the board. 24 From Companies to Markets—Global Developments in Corporate Governance Corporate Governance Developments: Practice Issues PART B B.1.2.2. Audit Committee Developments OECD research of developed member countries and “I think most audit committees recognize that they emerging-market countries indicates that most jurisdictions have an increased responsibility for oversight of the now require an independent audit committee. Traditional- financial reporting process and the external audi- ly, audit committees have been a key component of corpo- tors, and they’re taking that responsibility seriously. rate governance regulation, and now more than two-thirds They’re more engaged in their work and in their of jurisdictions require listed companies to establish an in- interactions with auditors. Audit committee agendas dependent audit committee. (See Figure B.3.) However, the have expanded, and we are having deeper conversa- emphasis on the importance of their work has increased. tions with the external auditors and internal auditors (See Box B.3.) and the CFO—and our conversations are very risk- oriented.” A full or majority independence requirement (including Michele Hooper, Audit Committee Chair, PPG Industries, the chairperson) is common, and 100 percent independent President and CEO, The Directors’ Council members of an audit committee is required or recommend- ed in Brazil, Canada, the Czech Republic, Finland, Ireland, Italy, Mexico, Switzerland, Turkey, the United Kingdom, Following a spate of corporate failures between 2002 and the United States. and 2004 and the 2008 financial crisis, the expectations, responsibilities, and workload of the audit committee have expanded considerably in recent years.13 They now include Box B.3: Audit Committee Key Roles in the EU the following: The key roles of the audit committee, as prescribed • Increased oversight of compliance; in the relevant EU Directive (2006/43/EC), include to: • An increased communication role with the external a) monitor the fi nancial reporting process; auditor, especially to discuss the audit report findings and the key audit matters—for example, mandated b) monitor the effectiveness of the company’s in Sarbanes-Oxley Act of 2002 and in the EU Direc- internal control, internal audit where applicable, tive 2006/43/EC, and required by International and risk management systems; Auditing and Assurance Standards Board (IAASB)- c) monitor the statutory audit of the annual and issued new audit standards in ISA 700 series; consolidated accounts; and • Direct role in the appointment, compensation, and d) review and monitor the independence of the retention and oversight of the work of the external rm. statutory auditor or audit fi auditor, including a review of the audit plan (as occurs in Australia, Canada, and the United Source: (EU 2006). Kingdom); Figure B.3: Board-Level Committee Requirements—By Regulation, Code, or Other Number of Jurisdictions in Each Category Audit 37 5 Committee Nomination 7 30 5 Committee Remuneration 10 28 4 Committee Rule/regulation Code No requirement/recommendation Source: (OECD 2015b). A valuable document on the newly expanded role of the audit committee is the KPMG Audit Committee Guide, 2015, and the associated webcast 13 organized with the NACD and the Center for Audit Quality and aired on September 29, 2015. For information, see www.kpmg-institutes.com. From Companies to Markets—Global Developments in Corporate Governance 25 PART B Corporate Governance Developments: Practice Issues • In the absence of a separate risk committee, over- India (SEBI) has made several amendments sight of internal controls, internal audit, and risk to regulation and requirements of audit com- management systems; mittee members, particularly following the • An increased expected or mandated role in the estab- Satyam Computers Case in 2008. It introduced lishment and oversight of policies for related-party Clause 49 into SEBI Listing Rules and intensi- transactions and the review and recommendation fied the details on audit committees regarding for board approval of material related-party transac- independence, its responsibility for indepen- tions;14 dent judgment, and responsibilities in the face of controlling shareholders. Previously, many • Clarity of independence and expertise required by independent directors may not have been con- audit committee members; sidered “independent” according to globally • Demand from investors and regulators for increased accepted definitions. (See Box B.4.) transparency and reporting from audit committees (for example, the new standard on audit reporting According to an annual KPMG survey of some 1,500 au- from IAASB, ISA 700, has been issued); dit committee members in 35 countries, three-quarters of audit committee members said the time required to carry • Increased interfaces with regulators (securities and out their duties has increased moderately (51 percent) or banking), stock exchanges, and independent audit significantly (24 percent); and half said that, given the oversight bodies to improve audit quality; audit committee’s agenda, time, and expertise, their role is • Focus in particular jurisdictions on issues particular becoming “increasingly difficult” (KPMG 2015). to their jurisdiction: Audit committees and their work have become impor- - Japan: The Financial Services Agency introduced tant to the effectiveness of boards and of corporate in 2013 a revised audit standard that facilitates governance. KPMG asked audit committee members in-depth discussion between the auditor and the what they believe they need to be more effective (KPMG audit committee; 2015), and they responded as follows: - United Kingdom: The Financial Reporting Coun- • 43 percent: better understanding of the business cil requires audit committees to provide more (strategy and risks); detailed reports to shareholders, particularly in relation to risks faced by the business; • 38 percent: greater diversity of thinking, back- ground, perspectives, and experiences; - India: The Securities and Exchange Board of • 34 percent: more “white space” time on the agenda for open dialogue; Box B.4: Satyam (India)—Importance • 33 percent: additional expertise—technology; of Independence on Board Committees • 31 percent: greater willingness and ability to An independent director resigned on 25 December challenge management. 2008, stating that she had voiced reservations about the transaction during the board meeting, but had “In many developed markets, especially in the two- failed to cast a dissenting vote to ensure that her tier board system, boards tend to be large and commit- views were put on the record. It transpired that the tees are needed to make board work more effective. In compensation package of one of the independent Germany, for example, big companies have boards of directors was more than seven times that of the other about 20 members. You cannot work with 20 people on independent directors and well above the market rate. audit matters. So I support a strong recommendation It turned out that he was undertaking consulting to have committees for detailed work, especially work for the company, something that should have in audit and risk.” barred him from being an independent director. Christian Strenger, Deputy Chairman, IFC Corporate Governance Private Sector Advisory Group, and Academic Director, Centre for Corporate Governance, HHL Leipzig Source: (OECD 2012). 14 In the one-tier board systems in India, Singapore, the United Kingdom, the United States, and many other jurisdictions, the role of an indepen- dent reviewer of RPTs is undertaken by the audit committee of the board, composed of independent directors. In the two-tier system, such as in Chile and Italy, it is a committee of directors (disinterested parties) that undertakes this role. 26 From Companies to Markets—Global Developments in Corporate Governance Corporate Governance Developments: Practice Issues PART B B.1.3. Board Effectiveness: Board Evaluations • The board chairperson and/or the board members and Succession themselves are responsible for the evaluation. Board evaluation has become a more widespread practice. • 21 percent of entities use external consultants to Nearly three-quarters of European companies participate facilitate the board evaluation.16 in an annual board evaluation (Heidrick & Struggles 2014). Some countries have moved further and mandated The Heidrick & Struggles report indicates that there is an external, independent board evaluation once every three little clarity as to who should lead a board evaluation. years. A key development is that there is the expectation When chairpersons were asked who should lead a board that this evaluation will lead to plans for improvements to evaluation, 41 percent said the board should lead it, and board performance and better planning for board refresh- 30 percent said the CEO should do so. Conversely, when ment and succession. the same question was asked of board members, 53 per- cent said the chairperson should lead the evaluation, and Board evaluation has a number of possible interpretations. 33 percent said it should be the board itself. Other options, It may mean an evaluation of each individual director, an such as an evaluation led by a committee or an external evaluation of the board as a whole and how it operates, consultant, were mentioned much less often. or an evaluation of board committees—or a mix of these. Investors have looked to boards to evaluate their perfor- Evaluations may use diverse tools and may take the form mance with a view to constant improvement in practices of questionnaires, open discussions, one-to-one interviews and board effectiveness. Investors see it as a testament to a of directors, or a combination of these methods. In any board’s commitment to corporate governance. event, directors do believe board and director assessments are helpful. The Global Network of Director Institutes (GNDI), a network of member-based director associations Over time, a board may become complacent from around the world, describes the global perspective for or may need new skills and perspectives to good governance in its guiding principles and believes that respond nimbly to changes in the business board performance evaluations can lead to better boards environment or strategy. Regular and rigorous and better corporate governance. (See Box B.5, page 27.) self-evaluations help a board to assess In the 2004 version of the OECD Principles, there was its performance and identify and address little reference to board evaluations, and only as a volun- potential gaps in the boardroom. tary, recommended practice. In the intervening 11 years to 2015, pressure built for board evaluations to become (CII 2014) the norm. The revised Principles make it clear that board evaluation is a way to ensure continual board develop- When making voting decisions about directors, sharehold- ment, with the goal of achieving an independent board ers attach importance to the detailed disclosure of the capable of objective judgment. Board evaluation is now a board evaluation process.15 Disclosures about how the corporate governance priority. (See Box B.6, page 28.) board evaluates itself, identifies areas for improvement, and addresses them provide a window into how robust the board’s process is for introducing change. Box B.5: Global Network of Director Institutes Principle 12 Heidrick & Struggles published a report (Heidrick & Struggles 2014) that reviewed corporate governance data, GNDI Principle 12 states: including board evaluation practices and reporting, from The board’s performance (including the performance over 400 companies across 15 diverse European jurisdic- of its chair, the individual directors and, where appro- tions. The following are key findings of the report: priate, the board’s committees), needs to be regularly • 70 percent of boards surveyed undergo a perfor- assessed and appropriate actions taken to address any mance evaluation annually. issues identified. • 78 percent of boards were evaluated in the last two years, up from 75 percent in 2009. Source: (GNDI 2015). 15 The Council for Institutional Investors (CII) in the United States undertook a survey of its members in 2013 and 2014. This information on what shareholders value comes from that survey. 16 Another study, on board evaluations in India, by C. Pierce, may be found at http://tinyurl.com/jrqm2gd. From Companies to Markets—Global Developments in Corporate Governance 27 PART B Corporate Governance Developments: Practice Issues Several national codes or regulations require or expect B.1.3.1. Good Practices in Board Evaluations board evaluations and/or related disclosures, and in most Evaluations will vary from company to company and countries it is a recommended practice. However there is within a company at different times in the company’s no one-size-fits-all approach; there are many different ways development. Evaluations should consider the specific for countries and companies to approach evaluations.17 context of the company. Nevertheless, below are some recognized good practices that are emerging: Evaluations may be formal or informal, undertaken inter- nally or facilitated externally, more focused on qualitative • Trust in the credibility and confidentiality of the issues, or more quantitative. Usually an evaluation is a evaluation is a key factor for its success, regard- mix of these styles. It is important to be clear as to what less of who manages the process (IFC 2011). Also, is being evaluated: the board as a whole, board commit- confidentiality and transparency are critical to the tees, individual directors, or all of these. Other focuses of process. evaluation may be board structure, policies and processes, • It is important to have board members’ full under- or the board’s role in the company’s strategy, risk, financial standing of and commitment to quality corporate leadership, shareholder interface, and so on. governance and the evaluation. • The goal of an evaluation is to improve the perfor- mance of the board and the company itself. Box B.6: OECD Principle VI.E.4 • Leadership of the evaluation process is key—usually as Revised in 2015 led by the chairperson. • Evaluations should be a regular feature of board Boards should regularly carry out evaluations practices. Most companies undertaking board to appraise their performance and assess evaluations do so annually; some companies, where whether they possess the right mix of back- they are not mandated otherwise, may undertake an ground and competences. evaluation once every three years. 129. In order to improve board practices and the • Evaluations may be best completed in time for performance of its members, an increasing number discussion at the board strategy session, thus any of jurisdictions now encourage companies to actions may be incorporated into the strategy. engage in board training and voluntary board • Prior to an evaluation, all board members should evaluation that meet the needs of the individual know how they will be assessed (that is, the topics company. Particularly in large companies, board for evaluation), the process, and the way they will evaluation can be supported by external facilitators be measured. to increase objectivity. Unless certain qualifications are required, such as for financial institutions, this • Performance metrics should be developed over time. might include that board members acquire appro- • Questionnaires, open discussion, and one-to-one priate skills upon appointment. Thereafter, board discussions are the most widely used approaches. members may remain abreast of relevant new laws, • Questionnaires should be carefully drafted, prob- regulations, and changing commercial and other ably in collaboration with the chairperson, and risks through in-house training and external courses. reviewed by all those being evaluated, prior to In order to avoid groupthink and bring a diversity finalization. of thought to board discussion, boards should also consider if they collectively possess the right mix of • Evaluations should cover key topics: board com- background and competences. position and structure, dynamics and functioning (including leadership and teamwork), role clarity, 130. Countries may wish to consider measures governance of strategy and risk, board accountabili- such as voluntary targets, disclosure requirements, ty and oversight role, board decision making, board boardroom quotas, and private initiatives that advice role, individual characteristics of directors enhance gender diversity on boards and in senior (vision, contributions, behaviors, time availability, management. preparation, particular skills), chairperson’s role, board functioning (notices, meeting processes, Source: (OECD 2015a). proactivity), and communication. An evaluation of 17 Appendix B provides a list of diverse jurisdictions’ approaches to board evaluations. 28 From Companies to Markets—Global Developments in Corporate Governance Corporate Governance Developments: Practice Issues PART B board committees should cover issues pertinent to available profile of a new board member, should one be that particular committee. required on short notice. The board should continually en- • Evaluation results should remain confidential sure that it has the right set of skills, talents, and attributes and be analyzed, distributed to board members, represented. and discussed in an open and non-confrontational manner. “Board evaluation, if it is conducted in a rigorous man- • Any evaluation should focus on the improvement ner, when it flows on to and is linked with individual of board performance and thus should lead to the director development plans and with board succession development of an action plan to address issues planning and when the results are disclosed, is a valu- arising. able tool. Investors can feel the board has the future of the board safely in hand.” • The process itself should be reviewed for improve- Anne Molyneux, ICGN Board ments. • Disclosure of the evaluation goals and process should be communicated to shareholders in the A well-prepared board will develop a succession plan annual report, included in the company code of that provides guidance on identifying and sourcing po- corporate governance, and placed on the company tential board members who can fulfill key requirements. website. This succession plan helps the organization appoint new directors quickly in a structured manner, allowing the Cautionary notes: board to continue its business without disruption, meet- • Board evaluations can be a sensitive issue to some ing any business challenges that are encountered. people. It is important to be aware of this possibil- ity and to deal with sensitivities. B.1.3.3. Evaluation Disclosure Investors need to know whether a board is effective, and • Evaluations may expose board weaknesses that, good corporate communication can do much to convey if not attended to, may provide information for a the board’s message to investors and other stakeholders later litigation process. on outcomes that arise from evaluation. So important • Safeguards should be built into the system to pro- is it that the Council of Institutional Investors in the tect both the company and individual directors. United States has developed its own guidelines explain- • It is essential for any independent evaluator to be ing its expectations of board evaluation disclosures. experienced in board evaluations, be seen to be in- (See Box B.7.) dependent and fair, and be respected for his or her approach. • The evaluation may destroy board collegiality if it Box B.7: Excerpt from CII is not handled well and if directors’ comments on “Best Disclosure: Board Evaluation” peers are too harsh or ill-considered. c details that explain who Investors value specifi • Careful consideration should take place before does the evaluating of whom, how often each management is included in the evaluation process. evaluation is conducted, who reviews the results The presence of management may constrain and how the board decides to address the results. directors’ comments. ndings This type of disclosure does not discuss the fi B.1.3.2. Succession Planning and Evaluations c evaluations, either in an individual or a of specifi It is most important that boards of directors are prepared holistic way, nor does it explain the takeaways the for resignation and/or retirement of its members. Succes- board has drawn from its recent self-evaluations. sion planning for the board and for board committees Instead, it details the “nuts and bolts” of the self- should follow the board evaluation process. As part of assessment process to show investors how the board evaluation, an evaluation of the skills and com- es and addresses gaps in its skills and board identifi petences within the current board should be measured viewpoints generally. against future expected requirements of the skills and competences within the board. This provides a readily Source: (CII 2014). From Companies to Markets—Global Developments in Corporate Governance 29 PART B Corporate Governance Developments: Practice Issues B.2. Control Environment and Risk The control environment is defined as including internal Box B.9: OECD Principle VI.D.1, control systems, internal audit functions, compliance as Revised in 2015 functions, and risk governance. The board should fulfil certain key functions, B.2.1. Risk Governance Developments including: According to a report by the Financial Stability Board 1. Reviewing and guiding corporate strategy, (FSB 2013a), many boards did not pay sufficient atten- major plans of action, risk management poli- tion to risk management or set up effective structures, cies and procedures, annual budgets and busi- such as a dedicated risk committee, to facilitate meaning- ness plans; setting performance objectives; ful analysis of the firm’s risk exposures and to construc- monitoring implementation and corporate tively challenge management’s proposals and decisions. performance; and overseeing major capital expenditures, acquisitions and divestitures. The financial crisis of 2007–2008 called into question several fundamentals of corporate governance, including 108. An area of increasing importance for boards and which is closely related to corporate strategy is risk governance. One particular focus was the robustness oversight of the company’s risk management. Such and effectiveness of risk oversight processes, which had risk management oversight will involve oversight been an ever increasing issue evidenced by major cor- of the accountabilities and responsibilities for porate collapses (Enron, WorldCom, Ahold, HIH) since managing risks, specifying the types and degree of 2002. The OECD’s fact-finding analysis of the financial risk that a company is willing to accept in pursuit of crisis (OECD 2009a) enhanced the focus on risk. (See its goals, and how it will manage the risks it creates Box B.8.) through its operations and relationships. It is thus a crucial guideline for management that must manage risks to meet the company’s desired risk profile. Box B.8: OECD on Risk Management Source: (OECD 2015a). Perhaps one of the greatest shocks from the financial crisis has been the widespread failure of • 59 percent believe that the volume and complexity risk management. In many cases risk was not of risks have changed “extensively” or “mostly” in managed on an enterprise basis and not adjusted to the last five years. corporate strategy. Risk managers were often kept separate from management and not regarded as • 65 percent were caught off guard by an operational an essential part of implementing the company’s surprise “somewhat” to “extensively” in the last strategy. Most important of all, boards were in a five years. This percentage is even higher for large number of cases ignorant of the risk facing the companies and public companies. company. • 68 percent of boards of directors are asking “some- what” to “extensively” for increased senior execu- Source: (OECD 2009). tive involvement in risk oversight. This is even higher for large companies (86 percent) and for public At the time, corporate governance standards and codes companies (88 percent). typically either did not cover risk governance and over- sight or they did so inadequately. Today that has changed. Even prior to the financial crisis, the Basel Committee on Many codes, such as the G20/OECD Principles, have Banking Supervision viewed banks as having insufficient introduced or strengthened risk-related requirements. (See board oversight of senior management, inadequate risk Box B.9.) management, and unduly complex or opaque bank or- ganizational structures and activities. Since the crisis, the A review undertaken by the American Institute of CPAs BCBS has focused on revising and reissuing its Corporate (AICPA) in 2015 (Beasley et al. 2015), the sixth in its Governance Principles for Banks (BCBS 2015). Risk and series, finds that over the most recent decade there have risk oversight was central to the revision. been escalating demands for organizations to strengthen their enterprise-wide risk oversight processes. Data were In 2015, the International Corporate Governance Network collected in the fall of 2014 from over 1,000 AICPA mem- updated its Corporate Risk Oversight Guidelines to enable bers in CFO roles and in board roles requiring financial the investor community to assess the effectiveness of a expertise. The following are key findings: board in overseeing risk governance. (See Box B.10.) 30 From Companies to Markets—Global Developments in Corporate Governance Corporate Governance Developments: Practice Issues PART B With all these pressures for change, banking and securities [BCBS] expects the board to be responsible and other regulators and parties globally have been review- for overseeing a strong risk governance ing their requirements regarding risk. Changes in attitudes framework. . .an effective risk culture. . .a well toward risk (the new normal) include the following: developed risk appetite. . .and well defined • Increased understanding and expectations of particu- responsibilities for risk management. lar roles in risk governance, especially 1) the board role in setting risk culture, risk framework, and risk (BCBS 2015) appetite; and 2) the chief risk officer and his role in the risk function; • Need for changes to enterprise-wide risk models to Box B.10: Excerpt from ICGN’s Guidance better focus on 1) effective internal controls based on on Corporate Risk Oversight entity risks; 2) a strong, independent internal audit function; and 3) a greater focus on IT risk. l The risk oversight process begins with the board. The unitary or supervisory board has an overarching Risk management must respond to “the responsibility for deciding the company’s strategy and business model and understanding and new normal”—an environment of continual agreeing on the level of risk that goes with it. The regulatory change and ever more demanding board has the task of overseeing management’s expectations. implementation of strategic and operational risk management. (Deloitte 2015) l Corporate management is responsible for developing and executing a company’s strategic and routine operational risk program, in line with Nonfinancial companies are emulating the changes that the strategy set by the board and subject to its financial institutions have seen in attitudes and practices in oversight. risk management. An example is CSR Limited, a building l Shareholders, directly or through designated products company in Australia and New Zealand that is agents, have a responsibility to assess and committed to dealing with business risks and has devel- monitor the effectiveness of boards in overseeing oped a framework for doing so. risk at the companies in which they invest and to determine what level of resources they will dedicate to this task. Investors are not themselves [I]t is CSR’s policy to have a common responsible for risk oversight at corporations. framework across the company to identify, Source: (ICGN 2015). quantify, manage and monitor business risks. CSR is committed to reinforcing effective Further, many other surveys by public sector players and business risk management as a key element private sector groups confirmed the poor risk practices in its strategic planning, decision making and in the lead-up to the financial crisis. A 2011 survey execution of strategies. (McKinsey 2011) revealed that only 14 percent of board CSR Limited website: www.csr.com time was spent on business risk management and that only 14 percent of those surveyed had a complete understand- ing of the risks their company faced. Figure B.4 (on page 32) indicates, across many jurisdictions, the regulations B.2.2. Board Role in Risk and Risk Culture in place relating to risk. It also reveals how few countries Risk management should be a feature of all businesses. clearly explain board responsibilities in risk oversight. Companies take risks to generate returns. All parties in a company—the board, senior management, business units, Responsibility for establishing and overseeing the compa- and employees—have a role in risk. ny’s enterprise-wide risk management system usually rests with the board as a whole and is prescribed in company The board is responsible for ensuring that a framework law and/or listing rules, except in a small number of juris- is in place to adequately deal with the complexities of dictions where this is not clearly stated (OECD 2015b). the business’s risk environment. However, this does not From Companies to Markets—Global Developments in Corporate Governance 31 PART B Corporate Governance Developments: Practice Issues Figure B.4: Risk Governance Requirements of Listed Companies, by Country Jurisdiction Board Implementation Board-Level Committee Chief Responsibilities of the Internal Risk for Risk Control Risk Risk Management Establishment Officers Management Management Role of Audit of Separate Risk System Committee Committee Argentina C C L/R C C Australia C – – C – Austria L/C L La/Ca – – Belgium L L L – – Brazil – – – – – Canada – – – – – Chile – R R R – Czech Republic C C – – – Denmark – – – – – Estonia – – – – – Finland C C Ca – – France – – L – – Germany L/C L/C L/C – – Greece – – C – – Hong Kong C C C – – SAR, China Hungary L/C L/C – – C Iceland – – C – – India L/R L/R L/R R – Indonesia L/C – – C – Ireland C C C – – Israel – R La – Lb Italy C C L C Cb Japan L L – – – Korea, Rep. C – – – – Lithuania – – Ca – – Luxembourg – – C – – Mexico L – L – – Netherlands C C Ca – – New Zealand C C – – – Norway C L/C La – – Poland – L/C La – – Portugal – – – – – Saudi Arabia – – – – – Singapore C C C C C Slovak Republic – – – – – Slovenia C C Ca – – Spain – L/C La/Ca – – Sweden C C – – – Switzerland L C Ca – – Turkey L L – L – United Kingdom C C Ca – – United States R L/R La/Ra – – C = recommendation by codes or principles; L = requirement by law or regulations; R = requirement by the listing rule; – indicates absence of a specific requirement or recommendation. a. Risk management is explicitly included in the role of the audit committee. (In the United States, this is applicable only for NYSE-listed companies.) b. Internal auditors are in charge of risk management. (In Israel, the board of directors of a public company is required to appoint an internal auditor in charge of examining, among other things, the propriety of the company’s actions regarding compliance with the law and proper business management.) Source: Based on (OECD 2015b). 32 From Companies to Markets—Global Developments in Corporate Governance Corporate Governance Developments: Practice Issues PART B indicate that the board role is passive. The board should (usually large companies) for identifying, assessing, re- ensure that all business risks are identified, evaluated, and sponding to, and reporting opportunities and threats that suitably managed. Actual management of many of these affect the achievement of the company’s objectives. There tasks rightly falls to management in the course of day-to- are several ERM frameworks to guide company practices, day operations. In a world of increasing complexity and such as ISO 31000:2009 Risk Management Principles uncertainty, boards must oversee and govern risk more and Guidelines and the COSO (Committee of Sponsoring assiduously than ever before. Organizations of the Treadway Commission)18 2013 ERM Integrated Framework. Enterprise risk management (ERM) is a structured, consis- tent, and continual process across the entire company ERM standards establish a structure for risk management activities within an organization. However, they often focus too much on the role of individuals or groups in the ERM [The] board should retain final responsibility framework. The ISO 31000 model of risk governance is for oversight of the company’s risk underpinned by the view that all entities want to achieve management system and for ensuring the their objectives, but many internal and external factors af- integrity of the reporting systems. Some fect those objectives, causing uncertainty about whether the jurisdictions have provided for the chair of the organization will achieve its objectives, and the effect this board to report on the internal control process. uncertainty has on its objectives is “risk.” ISO 31000 links Companies with large or complex risks key risks and the risk management process to an organiza- (financial and non-financial), not only in the tion’s strategic objectives.19 (See Figure B.5, page 34.) financial sector, should consider introducing B.2.2.1. Current Good Board Practices in Risk similar reporting systems, including direct Management reporting to the board, with regard to risk The board role in risk is one of governance and oversight. management. Companies are also well advised The role of senior management in risk is to operate the to establish and ensure the effectiveness of business within the risk appetite and limits set by the board internal controls, ethics, and compliance and to identify, assess, prioritize, manage, monitor, and programs or measures to comply with report on risk to the board. Each role should be clearly applicable laws, regulations, and standards, defined and distinguished. including statutes criminalizing the bribery of foreign public officials, as required under the OECD Anti-Bribery Convention, and other Deficiencies in risk management point directly forms of bribery and corruption. to deficiencies in board oversight. (OECD 2015a) (IFC and ecoDa 2015) The board has certain obligations regarding risk including 85 percent of respondents reported that their the following: board of directors currently devotes more time • Clearly understand its oversight role in risk and be to oversight of risk than it did two years ago. sufficiently active in fulfilling this mandate, especially The most common board responsibilities are in setting the company tone or attitude toward risk. to approve the enterprise-level statement of risk appetite (89 percent) and review corporate • Determine and ensure the establishment of an strategy for alignment with the risk profile of enterprise-wide risk management framework and the organization (80 percent). ensure its effective operation, including ensuring that the board and company organization and poli- (Deloitte 2015) cies are appropriate and that the company provides adequate resources for addressing risk. 18 COSO is a private sector initiative, jointly sponsored and funded by American Accounting Association (AAA), American Institute of Certified Public Accountants (AICPA), Financial Executives International (FEI), Institute of Management Accountants (IMA), and The Institute of Internal Auditors (IIA). 19 A handy comparison between ISO 31000 and the COSO ERM Framework is available at www.theiia.org. From Companies to Markets—Global Developments in Corporate Governance 33 PART B Corporate Governance Developments: Practice Issues Figure B.5: Enterprise Risk Management Framework L E A D E R S H I P A N D C U LT U R E Corporate Objectives Risk Identification ORGANIZING SYSTEMS Risk Risk Responses Analysis Risk Evaluation Monitor and Review C A PA B I L I T I E S Enterprise-wide risk management is affected by a multitude of structural, organizational, and managerial conditions Source: (IFC 2012). - potential effects and impacts on other companies’ The role of the board of directors in enterprise- stakeholders (including the community and the wide risk oversight has become increasingly environment); challenging as expectations for board - how the company will manage a crisis; engagement are at all time highs. - the importance of stakeholder confidence. (COSO 2009) • Ensure appropriate levels of awareness throughout the company. • Ensure that the board has a collective/shared view • Promote, determine, or define the company’s risk of its responsibilities in risk oversight and its limita- culture, capacity, tolerance, and appetite within the tions and that it tasks a board committee (audit or company. risk committee) to specialize in risk oversight. • Ensure the development, dissemination, and publica- • Ensure that collectively the board’s members have tion of risk management policy and procedures. sufficient knowledge, skills, and experience to assess • Ensure that the risk culture and appetite is commu- the entity’s risks. nicated throughout the company. • Ensure that each director individually understands • Regularly receive, review, and discuss reports on risk the company’s business and has an adequate appreci- performance and management within the company, ation of the nature, types, and sources of risks faced across all risk categories and all business units, to by the company, including better understand risk interconnectivity and com- - identification of the most significant risks; pounding effects. - the possible effects on shareowner value of devia- • Monitor and review management’s risk responses tions to expected performance ranges; and ensure that they are sufficient and appropriate. 34 From Companies to Markets—Global Developments in Corporate Governance Corporate Governance Developments: Practice Issues PART B • Ensure that risk frameworks and systems are regu- larly tested for robustness, resilience, and effective Simply put, risk appetite is defined as the contingency plans. amount of risk (volatility of expected results) • Ensure that senior management and employee re- an organization is willing to accept in pursuit muneration incentivize strong and appropriate risk of a desired financial performance (return). management. The concepts of risk appetite and risk tolerance • Disclose key risks and report on risk management are often used interchangeably, but they have frameworks to investors. distinctly different meanings. Indicative of the change that has occurred in a short (RMA 2013) period, a survey (Heidrick & Struggles 2014) found that 94 percent of directors of European listed companies now believe that the board’s capacity to consider the acceptance senior risk committee member or chief risk officer will of appropriate risks is important. present a draft statement to the board for its discussion, amendment, and approval. Once approved, the risk B.2.2.2. Board Role in Risk Appetite—A Work in appetite framework process cuts in, and the institution’s Progress risk appetite is assigned to the appropriate person(s) or Arising mainly from the financial crisis and from the deter- group(s) and cascaded down through the organization. mination of the Financial Stability Board to improve risk governance, in many jurisdictions a board is expected to COSO’s definition of risk appetite is similar to that of determine the risk appetite for the company. For example, the U.K. Corporate Governance Code, but it does not the U.K. Corporate Governance Code requires a board to locate accountability for determining the risk appetite. be responsible for determining the nature and extent of the It defines it as “the amount of risk, on a broad level, significant risks it is willing to take in achieving its strategic an organisation is willing to accept in pursuit of value. objectives (FRC 2012). Each organisation pursues various objectives to add value and should broadly understand the risk it is will- Further, the FSB, the body doing the most to influence ing to undertake in doing so.” changes in the banking and insurance industry, issued a paper (FSB 2013b) detailing the roles of the board, a risk COSO sees risk appetite in the context of the risk levels management committee, the risk management department, currently prevailing in the organization, and it sees the the chief risk officer, and others (chief financial officer, chief company attitude toward risk as set in the finite bound- executive officer, and chief internal auditor) in risk oversight. aries of estimated risk capacity or the total risks a com- pany could take before risking the viability of entire Typically, the board establishes the risk appetite framework company. Ideally, COSO sees risk appetite as depicted and approves the risk appetite statement. Normally, the in Figure B.6. Figure B.6: COSO View of Risk Appetite Existing The current level and distribution of risks across Risk Profile the entity and across various risk categories Risk The amount of risk that the entity is able to Capacity support in pursuit of its objectives Determination of Risk Risk Acceptable level of variation an entity is willing Appetite Tolerance to accept regarding the pursuit of its objectives Attitudes The attitudes towards growth, Towards Risk risk, and return Source: (Garlick 2015). From Companies to Markets—Global Developments in Corporate Governance 35 PART B Corporate Governance Developments: Practice Issues Box B.11: Example: Lack of Clarity Box B.12: Risk Terminology: Key Definitions about Risk Appetite Risk terminology can be difficult. For clarity, key In February 2008, the board of the French bank terms are defined below: Société Générale learned that one of its traders had lost l Risk capacity—the absolute risk that can be taken $7.2 billion. Jerome Kerviel, the trader in question, had by the company, any risk beyond which would approval to risk up to $183 million. Since 2005, however, lead to the company collapse and would have an Kerviel had apparently ignored his limits and took on impact on the financial structure of the entity and exposures as high as $73 billion—more than the market its key strategies. value of the entire firm. Société Générale’s board, managers, risk management systems, and internal l Risk appetite—acceptable amount of risk taken in controls failed to detect, much less halt, the reckless pursuit of value (a board view). bets. When finally discovered, the failure in risk l Risk tolerance—the variability (maximum or governance and management had cost Société Générale minimum levels) of acceptable risk in a risk type and its shareholders clients, money, and reputation. or in each business unit. Similar failures of risk governance feature in scandals at UBS and Baring, with the latter failing to survive. Source: Based on (COSO 2012). Source: (IFC 2012). B.2.2.3. Risk Appetite Statements by the Board: It is important for all involved with risk to understand the Evolving Good Practices organization’s risk appetite. Box B.11 provides an example Many companies have found it particularly challenging to of a situation where risk appetite was not clear to a bank cascade risk appetite statements into the practical realities operative. Box B.12 defines some key terms. of the organization. In a survey of financial entities with risk appetite statements (PwC 2015a), the top three chal- Although risk appetite is a simple concept, boards are lenges facing surveyed institutions include the following having difficulty setting risk appetite statements for their (also see Figure B.7): entities and distinguishing risk capacity from risk toler- • Effectively allocating risk appetite across the ance. A risk appetite statement should be a qualitative organization; and quantitative statement of the acceptable risk levels of an institution. Apparently it is easier to set a risk appetite • Incorporating risk appetite into decision making; statement when the risks are quantifiable rather than when and the risks are social or affect the environment. • Articulating risk appetite through metrics and limits. Figure B.7: Challenges to Risk Appetite Implementation Most frequently cited challenges 0 20 40 60 80% Mechanism to allocate risk appetite 68 Integration of risk appetite into decion-making process 65 Expression of risk appetite 56 Methodology to integrate risk 15 appetite and stress testing Inadequate 14 information systems Lack of risk 10 culture Supervisory expectations 9 make RAF* bureaucratic Lack of board 5 support Lack of effective 1 communication * RAF = Risk Appetite Framework. Source: (PwC and IACPM 2014). 36 From Companies to Markets—Global Developments in Corporate Governance Corporate Governance Developments: Practice Issues PART B An Oliver Wyman study of the risk appetite statements of 65 financial institutions in 2015 found “a clear con- Box B.13: Risk Appetite Disclosure: Standard vergence towards a common understanding of the critical Chartered Bank role risk appetite should play in the way banks manage We have a clear statement of risk appetite which is earnings volatility, capital and liquidity” (Oliver Wyman aligned to the Group’s strategy; it is approved by the 2015). In the same year, a Towers Watson survey found Board and informs the more granular risk parameters that 84 percent of respondents (from insurance) had a within which our businesses operate. documented risk appetite statement in 2015, compared to 74 percent in 2012 and 59 percent in 2010 (Towers Source: Standard Chartered Bank, Annual Report— Watson 2015). Risk Review (2013). The insurance industry acknowledges that it is trying to apply risk appetite frameworks and statements to its practices, but more work is needed to link its risk appetite Box B.14: Risk Framework Disclosure: to business operations. Many in the industry now have a Commonwealth Bank of Australia firm foundation in place to advance risk appetite frame- works. A key purpose of the [Risk] Committee is to help formulate the Group’s risk appetite for consideration The following describe what a risk appetite statement by the Board, and agreeing and recommending a should be: risk management framework to the Board that is consistent with the approved risk appetite.. • Linked with objectives; • Stated with sufficient precision in qualitative and This framework, which is designed to achieve portfolio outcomes consistent with the Group’s risk quantitative terms; return expectations, includes: • An aid to determining acceptable risk tolerances; l The Group Risk Appetite Statement; • Supported by facilitating alignment (of people, l High-level risk management policies for each of the processes, and infrastructure); risk areas it is responsible for overseeing; and • An enabler for monitoring risk. A set of risk limits to manage exposures and risk l concentrations. Developments evident in financial institutions are also af- The Committee monitors management’s compliance fecting risk frameworks and risk management practices in with the Group risk management framework (in- nonfinancial companies. A study of EU energy companies cluding high-level policies and limits). It also makes (electricity, natural gas) and entities in advanced industries recommendations to the Board on the key policies (high-tech and assembly companies) shows similar devel- relating to capital (that underpin the Internal Capital opments in risk as are taking place in financial institutions Adequacy Assessment Process), liquidity and funding (McKinsey 2012). Boxes B.13 and B.14 provide examples and other material risks. These are overseen and of disclosure of risk appetite and risk framework. reviewed by the Board on at least an annual basis. Such a review took place in the 2014 financial year. B.2.2.4. Risk Culture The Committee also monitors the health of the To move risk governance and risk management to the new Group’s risk culture, and reports any significant and higher levels expected does require strong leadership issues to the Board. within the company. The board should set the “tone from the top.” A company culture of risk awareness and risk Source: Annual Report, Corporate Governance Statement, acceptance is necessary for growth. To achieve a good Commonwealth Bank of Australia (2014). risk culture, this tone from the top has to be supported by many other drivers, such as clarity regarding company be just that—very individual. Therefore, a company must values and ethics, expectations of employee behaviors, work hard to establish and promote its own culture of incentives that are aligned with the appropriate behaviors, ethics, values, and behaviors in how it approaches risk. and enterprise-wide training and development programs. Mindsets and behaviors within the company are critical (See Figure B.8, page 38.) to effective risk governance and risk management and will A risk culture develops from the mindsets and behaviors flavor attitudes toward risk governance, risk ownership, of individuals and groups within the company and it may and the consideration of risk in decision making. From Companies to Markets—Global Developments in Corporate Governance 37 PART B Corporate Governance Developments: Practice Issues is capable of identifying and dealing with risks that may Figure B.8: Elements of Risk Culture prevent the achievement of that strategy. They want to know that the company has in place people, policies, and processes to control the entity and its risks. This is called Risk culture the control environment. Organizational IFC has developed a toolkit to assist its corporate govern- culture ance officers and its investment function in assessing the corporate governance of an entity. One of the five areas Behaviours that the toolkit covers is the control environment, which includes a company’s internal control system, internal Personal ethics audit function, risk governance management system, and compliance function. Personal “[W]hen IFC, as do the other 34 [development finance predisposition institutions] looks at a company, we’re looking at the to risk governance of these functions.” Charles Canfield, Principal Corporate Governance Officer, IFC Source: (IRM 2012). IFC has developed a progression matrix and uses it to establish where a particular company is in its functions and systems for risk and control. From there, the methodology Risk culture is a term describing the helps establish next steps for progressive development of a values, beliefs, knowledge, attitudes and holistic control system. understanding about risk shared by a group of B.2.3.1. IFC’s Control Environment Progression Matrix people with a common purpose, in particular IFC corporate governance assessments focus not only on the employees of an organization. This applies the policies and processes as documented in company liter- to all organizations from private companies, ature but also on the functioning reality of these areas. The public bodies, governments to not-for-profits. financial crisis led to new rules, regulation, and guidance in risk and the control environment, and IFC determined (IRM 2016) It requires great effort to ensure internal compliance “In summary, the approach of the IFC corporate with an established risk culture. Some companies have governance methodology and the tools is on structure introduced initiatives focused on risk conduct, including and functioning of the respective organs that affect better training, tighter internal controls and discipline for corporate governance; therefore, all of the control rogue behavior, greater accountability for individual roles environment tools have been organized to include and responsibilities, remuneration linked to performance 1) progression matrix tools for analyzing commit- metrics reflecting risk, and more frequent risk and controls tees, functions, and systems (audit committee, risk reviews. The development of appropriate risk cultures in management committee, internal audit function, banks is an ongoing focus for banks and bank regulators internal control system, risk management function, at this time and for other entities wanting to upgrade their and compliance function); 2) progression matrix tools risk governance. Deloitte has identified the importance of for analyzing function leaders (chief risk officer, chief an appropriate risk culture in defining its Risk Intelligent internal auditor, and chief compliance officer); 3) IFC Model (Deloitte 2013). model documents (charters/bylaws, terms of reference, and job descriptions); and 4) summary guidance of B.2.3. Control Environment Developments: relevant current best practice.” IFC Tools Charles Canfield, Principal When looking at a particular investment, investors want Corporate Governance Officer, IFC to see that the company has the right strategy in place and 38 From Companies to Markets—Global Developments in Corporate Governance Corporate Governance Developments: Practice Issues PART B Figure B.9: Growth of ERM, 2009–2014 Complete ERM in Place: Full Sample 30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% 2009 2010 2011 2012 2013 2014 Source: (Beasley et al. 2015). it could not look at the control environment as it had B.2.4.1. COSO Developments previously when assessing the corporate governance of Increasingly, companies understand that they do need to be possible investments. IFC updated its methodology and proactive in risk governance and management, and often developed a toolkit to deal with this. to achieve this goal they turn to the prevailing risk frame- works to support their initiatives. An AICPA survey in the Within this matrix methodology, IFC initially deter- United States on the establishment and full use of enter- mines whether the entity meets the minimum level prise risk management shows the remarkable increase in acceptable for IFC to invest (Level 1) or if the entity an ERM application since 2009—since the financial crisis is more advanced and on Level 2, 3, or 4, closer to showed the importance of holistic risk frameworks to an international best practices. Level 4 is international best enterprise. (See Figure B.9.) practices. The tools assisting the corporate governance personnel in the field include matrixes for assessing In 1998, the Committee of Sponsoring Organizations of function leaders, whom they report to, the details of the Treadway Commission—a United States-based organi- their jobs and duties, and their level of independence. For the toolkit—and related to the control environ- ment—IFC developed many model documents, includ- The 2013 revision produced big changes to ing the following: the internal controls framework. The revised • Internal audit department bylaw; Internal Control Integrated Framework (COSO IC Framework), beyond accounting controls • Compliance department bylaw; and financial controls, which had been the • Risk management function bylaw; focus of most regulatory revision in the 2000s, • Terms of reference and job descriptions for the new COSO IC Framework addresses function leaders (chief risk officer, chief of operating and compliance controls. Also, of internal audit, chief compliance officer); and note, the new COSO IC Framework recognizes • Risk management committee matrix. the business case for better controls and ties them to strategy and objective setting. B.2.4. Risk and the Control Environment: Namely that internal controls should allow the Other Developments organization to achieve better operational, Both private sector and public sector initiatives reporting and compliance objectives. emerged following the financial crisis. Below are some of these other developments in the risk and control (IRM 2016) environment. From Companies to Markets—Global Developments in Corporate Governance 39 PART B Corporate Governance Developments: Practice Issues zation comprising individuals from the Institute of Internal standard system of guidance, COBIT 5 (Control Objectives Auditors and various large accounting firms and profes- for Information and Related Technology), which addresses sional organizations—introduced a framework for inter- how to control IT within an entity. It is good guidance on nal controls. In 2004, it introduced the Enterprise Risk the management of the reality of “big data” and helps with Management-Integrated Framework. COSO revised its managing disclosures. ERM Framework in 2013 and released a new Integrated B.2.4.3 Internal Audit Developments Internal Control Framework. Such is the pace of change! Again, the financial crisis has been the impetus for a major Figure B.10 illustrates the COSO framework. The revised change in how boards and entities should view the internal framework included detailed changes in the expectations audit function, the governance and use of internal audit. of board oversight and company management of the The internal audit function is now viewed more as an following: internal corporate governance gatekeeper and less as an • The control environment; entity policeman. • Risk assessment; The International Internal Audit Standards Board in 2013 • Control activities released a revision to the International Standards for the Professional Practice of Internal Auditing (IIA 2016), fol- • Information and communication; and lowing consideration and approval by the International • Monitoring activities. Professional Practice Framework Oversight Council. (See Box B.15.) The new framework on internal controls provides addi- tional advice on key issues: • Internal controls should be risk based (based on the particular prioritized risks facing the entity, deduced Box B.15: IIASB Standard 2110 from a risk assessment). 2110 Governance • Information and communication throughout the entity on risk and internal controls is very important The internal audit activity must assess and make and should start from the top and reach to the bot- appropriate recommendations for improving the tommost rung of employees in the entity. governance process in its accomplishment of the following objectives: • Any internal control system should be actively l Promoting appropriate ethics and values within monitored and regularly tested, and this means the organisation; having a good, independent internal audit function l Ensuring effective organisational performance that can test controls and make recommendations management and accountability; for improvement. l Communicating risk and control information to B.2.4.2. IT Controls Developments appropriate areas of the organisation; and Because of the widespread use of technology and an in- l Coordinating the activities of and communicating creased concern regarding privacy rules and data security, information among the board, external and inter- there is a new emphasis on the governance of technology nal auditors and management. and the internal controls it requires. Information Systems Audit and Control Association (ISACA) has developed a 2110.A1 The internal audit activity must evaluate the design, implementation and effectiveness of the organisa- “Sarbanes-Oxley accepts COBIT 5 as a basis, even the tion’s ethics-related objectives, programmes and King III Report, people who work with King III, have activities. said that COBIT 5 is a good standard to use. . . . It basically sets a system for how one should set IT 2110.A2 controls . . . . That’s very important, because if you The internal audit activity must assess whether the think of what’s the number-one issue companies are information technology governance of the organisa- facing these days, it’s cyber security.” tion supports the organisation’s strategies and objectives. Charles Canfield, Principal Corporate Governance Officer, IFC Source: (CIIA 2016). 40 From Companies to Markets—Global Developments in Corporate Governance Corporate Governance Developments: Practice Issues PART B Figure B.10: COSO Framework COSO Internal Control— ©2013, Committee of Sponsoring Organizations Integrated Framework s g e ion in nc of the Treadway Commission Principles at t ia or pl (COSO). Used by permission. p er ep m O R Co Function Operating Unit Control Environment Division Risk Assessment Entity Level Control Activities Information & Communication Monitoring Activities Control Monitoring Environment Activities 1. The organization 16. The organization demonstrates a selects, develops, commitment to and performs ongoing integrity and ethical Risk Information & and/or separate values. Assessment Communication evaluations to ascertain whether the 2. The board of components of internal directors demonstrates 6. The organization 13. The organization control are present independence from specifi es objectives Control obtains or generates and functioning. management and with suffi cient clarity Activities and uses relevant, exercises oversight of to enable the quality information 17. The organization the development and identifi cation and to support the evaluates and performance of internal assessment of risks 10. The organization functioning of internal communicates control. relating to objectives. selects and develops control. internal control control activities that defi ciencies in a timely 3. Management 7. The organization 14. The organization manner to those contribute to the establishes, with board es risks to the identifi internally communicates parties responsible mitigation of risks to oversight, structures, achievement of its information, including for taking corrective the achievement of reporting lines, and objectives across the objectives and action, including objectives to appropriate authorities entity and analyzes responsibilities for senior management acceptable levels. and responsibilities risks as a basis for internal control, and the board of in the pursuit of determining how 11. The organization necessary to support directors, as objectives. the risks should be selects and develops the functioning of appropriate. managed. general control internal control. 4. The organization activities over demonstrates a 8. The organization 15. The organization technology to support commitment to attract, considers the potential communicates with the achievement develop, and retain for fraud in assessing external parties of objectives. competent individuals risks to the achievement regarding matters in alignment with of objectives. 12. The organization affecting the objectives. deploys control functioning of 9. The organization activities through internal control. 5. The organization identifi es and assesses policies that establish holds individuals changes that could what is expected and accountable for their cantly affect signifi procedures that put internal control the system of internal For more information policies into action. responsibilities in the control. about COSO, visit pursuit of objectives. coso.org. Source: www.coso.org. From Companies to Markets—Global Developments in Corporate Governance 41 PART B Corporate Governance Developments: Practice Issues Individual standards or codes setters are also looking to revise and upgrade the role of the internal auditor, with the Figure B.11: Mandatory versus Recommended aim of improving corporate governance. Research under- Internal Audit Function in EU Corporate taken in 2012 by the European Confederation of Institutes Governance Codes of Internal Auditors (ECIIA 2012) indicates that the inter- nal audit function is considered mandatory in 41 percent 11% of European corporate governance codes. (See Figure B.11 and Table B.3.) 41% 48% At the end of 2015, the Financial Reporting Council in the United Kingdom was working on updating its guidance for audit committees to reflect the new Corporate Governance Code. This guidance is expected to cover the role of inter- l 41% of the codes consider an internal audit function mandatory nal audit in some detail. l 48% of the codes strongly recommend the presence of an internal audit function These codes and activities highlight the key role that l 11% of the codes do not have a specific requirement internal audit can play in supporting the board in ensuring or recommendation about internal audit adequate oversight of internal controls and the effective- ness of corporate governance. The implications for internal Source: (ECIIA 2012). Table B.3: Examples of Code Provisions Regarding Internal Audit Country Name of Code/Document Extract of Comment Finland Finnish Corporate The company must disclose the manner in which the internal audit Governance Code 2010 function of the company is organized. The disclosure must include the organization of the internal audit function and the central principles applied to internal audits, such as the reporting principles, and the organization and working methods of the internal audit function, e.g. the nature and scope of the company operations, the number of personnel and other corresponding factors. France Recommendations on The audit committee is responsible for the following: oversight of Corporate Governance statutory and internal audits, the assessment of the work of internal March 2011 auditors, the selection of statutory auditors, and checking the independence of internal auditors. Italy Corporate Governance The issuer shall establish an internal audit function. The internal Code December 2011 audit function shall report to the board. The internal control and risk management system involves each of the following corporate bodies depending on their related responsibilities: board of directors, that shall provide strategic guidance and evaluation on the overall adequacy of the system...and internal audit, entrusted with the task to verify the functioning and adequacy of the internal control and risk management system. Internal audit function has a central position in the control system, that is charged of the “third level” of control. The internal audit function should be absolutely independent. Latvia Principles of Corporate The board shall perform certain tasks, including timely and Governance and qualitative submission of reports, ensuring also that the internal Recommendations on audits are carried out and the disclosure of information is their Implementation 2010 controlled. Source: (ECIIA 2012). 42 From Companies to Markets—Global Developments in Corporate Governance Corporate Governance Developments: Practice Issues PART B audit are that there will be more interface between the A study by Protiviti (Rossiter 2011), which examined the audit committee of the board and internal audit and be- role of internal auditors as perceived by internal auditors, tween internal audit and the external auditor. Further, the pointed to these skills developments. internal auditor may have an expanded role in supporting the board in challenging strategy, risk management, and B.3. Demands for Transparency and internal controls. Disclosure—ESG Issues Organizations are seeing a continuing demand for disclo- B.2.4.4. Expectations of the Internal Audit Function sure of all matters, financial and nonfinancial, material to In corporate governance good practices, a robust internal the investment decision. Financial reporting is reasonably audit function should have a charter for its activities that well developed, but nonfinancial reporting is still devel- delineates its scope of work and accountabilities. It should oping. In recent times, the investor community has been be an independent function, independent of management asking for changes in corporate reporting to include better structures, and be objective. To undertake its work, it disclosure of the company’s business model, its strategy, should be adequately resourced and have access to, re- performance, and risks. spond to, and report directly to the audit committee of the board or to the board itself. The audit committee should ensure that the internal audit function is well resourced, re- “In a market place where major companies exist where view with it its annual workplan, respond to internal audit up to 80 percent of the market value of the organiza- recommendations, and fulfill the board’s accountability to tion is accounted for by intangible rather than fi- provide assurance about the way the company is managing nancial or physical assets, a new corporate reporting the risks and controls. (See Box. B.16.) framework was needed.” Jonathan Labrey, The transition of the role of an internal auditor—from Chief Strategy Officer, IIRC merely being a checker or tester of internal controls and providing assurance on them, to being a trusted adviser—is not easy. It will require the internal audit profession to Sustainable development reporting is now a new norm develop and broaden the skills of their internal auditors. and has been included in some national corporate governance requirements and codes. South Africa is a case in point. Box B.16: Chief of Internal Audit IFC recognized the best practice of establishing a “[T]he Global Footprint Network shows that we are separate board-level audit committee to help the full using the resources of the earth at one and a half times board govern this area and also a Chief of Internal [faster] than they can be replenished.” Audit. . .to assist management with the implementa- Ansie Ramalho, tion of an internal audit function. One can see that King IV Practice Leader, the ultimate goal is for the board to take adequate Institute of Directors in Southern Africa responsibility in overseeing this important function. Therefore, the IFC tools focus on quality of and the structure and functioning of internal audit functions B.3.1. Sustainability and ESG Reporting in the following respects: As with systems in nature, businesses are resilient when they l purpose, establishment, and scope of work; are able to adapt to new circumstances and to continually create and deliver value to all stakeholders. This involves l cations and competencies of the internal qualifi considering both the risks and the opportunities presented in audit staff; the global context, where environmental and social aspects l resources, responsibilities, and authority; are ultimately what allow and affect the company’s financial l independence and accountability; performance and value creation. To consider the context l reporting; also means understanding that businesses do not exist in a l relationship with management and the risk vacuum but rather are part of their environment, and that management department; and success is measured in the larger context. l quality control and evaluation. The Report of the Brundtland Commission (Brundtland 1987) is the origin of much thinking on business resilience Source: IFC Control Environment Toolkit. and sustainability. From Companies to Markets—Global Developments in Corporate Governance 43 PART B Corporate Governance Developments: Practice Issues document of some national initiatives requiring or advo- “A company which is at odds with the society from cating ESG transparency and reporting. which it derives its franchise is clearly not going to survive in the long run.” There is a broad question as to whether sustainability measures should be included in corporate governance Peter Montagnon, IFC Corporate Governance Private Sector codes. (See Part C of this paper.) Regardless of the regula- Advisory Group and Associate Director, the Institute of Business Ethics, tory requirements, companies should take into account United Kingdom the interests of stakeholders and report on those issues, as required in the OECD Principles. The risks to the company of insufficiently incorporating the stakeholder perspective Sustainable development is the development into governance arrangements could be considerable. that meets the needs of current generations Reports that focus on nonfinancial issues are often called without compromising the ability of future “sustainability reports.” In the last decade, global initia- generations to meet their own needs. tives such as the Global Reporting Initiative (GRI) devel- (Brundtland 1987) oped a set of guidelines that was gradually adopted all over the world. Recently, the effort has been to develop a framework for a unique report that integrates and, it is The financial result of entities is an outcome of something: hoped, connects the whole set of corporate information, it results from the transformation of something, essentially giving investors and all stakeholders a rounded picture of a natural capital (resources) and human capital (labor), through company’s performance. intellectual capital and technology. Therefore, investors are keenly interested in information concerning a company’s Whether in compliance with regulations or through vol- approach to these areas. A recent study (PwC 2015c) untary initiatives, a major shift is taking place in corpo- indicates that 71 percent of investors would decline an rate reporting to include ESG information. In the 1990s, investment based on an ESG assessment and ESG risk. The ESG/sustainability initiatives and reporting was virtually same study found that 97 percent of the major institutional unknown, but by 2000, ESG/sustainability reporting had investors (global large pension funds and asset managers) become commonplace and was focused on corporate ac- expect that demands for responsible investment—with a countability and performance. Between 2000 and 2010, focus on the impact on ESG matters—will increase in the several different standards and codes were developed to next two years. Thus the pressure is for companies to be give form and structure to ESG activities and reporting. By more transparent in their strategy and approach regarding 2013, more than 10,000 corporations and other organiza- environmental, social, and governance matters. tions had issued ESG reports.20 Attempting to build and maintain trust and to better at- The movement is trying to show the importance and con- tract funding, companies have become more transparent tribution of all kinds of capital to corporate value creation and are disclosing far more than previously, particularly and performance. These include financial capital, manu- in the diverse areas of corporate responsibility, sustain- factured capital, intellectual capital, human capital, social ability, and ethics. The disclosure is increasing, in part, as a and relational capital, and natural capital. These “capitals” response to demands coming from regulations and because form the basis of the integrated reporting initiative. To be companies recognize the value of being more transpar- explicit, understanding the companies’ dependencies and ent. Customers, suppliers, employees, governments, and impacts on all these capitals, and how they are connected, investors are all demanding more and better nonfinancial is as important as it is to understand and report financial disclosure from companies, which includes issues related to performance. the environment, social, and governance issues. Sustainability reporting is an intrinsic element of integrated In some countries all or some sustainable development reporting, which is a more recent development that com- matters are enshrined in company law or other related bines the analysis of financial and nonfinancial information laws or regulations. Other jurisdictions have chosen simply and is an attempt to solve the company problem of how to advocate for some ESG inclusion in publicly available to report on ESG matters. (See Section B.3.2. Integrated information. Table B.4 presents a nonexhaustive working Reporting.) 20 See the website Corporate Register.com: http://www.corporateregister.com/ (last accessed October 1, 2013). 44 From Companies to Markets—Global Developments in Corporate Governance Corporate Governance Developments: Practice Issues PART B Table B.4: National Initiatives in ESG Transparency Year Country Requirement/ Comment Recommendation 2007 Australia NGER Act Companies are required to provide data on greenhouse gas emissions and energy consumption and production. 2011 Brazil BM&F BOVESPA Stock Stimulating listed companies to inform Exchange adopted the if they publish a sustainability report initiative “Report or Explain” and, if not, to explain why. 2014 Brazil CVM Instruction 522/2014 Determines information regarding (Brazilian SEC) social and environmental policies and information disclosure. 2014 Brazil Brazilian Central Bank Determines the existence and (Resolution 4.327) implementation of a social and environmental responsibility policy to deal with environmental and social risks. 2010 Canada Environmental Reporting Determines the environmental Guidelines issued by the information to be disclosed. securities regulator 2007 China Environmental Information Requires some mandatory and some Disclosure Act voluntary disclosures and is supported by guidance issued by the Shanghai and Shenzhen exchanges. 2008 and Denmark Amendment to the Danish Requires an evaluation of the ESG 2012 Financial Statements Act achievements in last financial year and a statement of expectations of the future. Updates for mandatory requirements on human rights and climate change. 2014 Europe Directive 2014/95/EU on Requires disclosure in the management disclosure of nonfinancial and report of large businesses of diversity information, updating environmental, social, and employees the Accounting Directive aspects, respect for human rights, 2013/34/EU anti-corruption and bribery issues, and diversity in the board of directors. 2001 France Loi Fabius Investors are required to disclose in their annual reports the extent to which they take SEE information into account. 2010 and France Grenelle Law II, Art. 224, 225 Investment companies and managers 2012 must disclose how they integrate ESG in their investment decisions. (continued on page 46) From Companies to Markets—Global Developments in Corporate Governance 45 PART B Corporate Governance Developments: Practice Issues (continued from page 45) Table B.4: National Initiatives in ESG Transparency Year Country Requirement/ Comment Recommendation 2012 Indonesia Securities Regulation Provides that every company has social 47/2012 and environmental responsibility. 2005 Japan Mandatory Greenhouse Mandatory reporting of greenhouse gas Gas Accounting System emissions for companies. 2008 Malaysia CSR Disclosure Malaysian stock exchange requirement Framework for disclosure of CSR activities. 2014 Malaysia Code for Institutional Guidance on institutional investors’ Investors stewardship to deliver sustainable long-term value to beneficiaries. 2011 Singapore Sustainability Reporting A voluntary guide for listed companies on sustainability reporting issued by the stock exchange. 2009 South King III Code Requires integrated reporting that Africa incorporates sustainability considerations. 2011 United Sustainability Accounting SASB is established to develop States Standards Board (SASB) accounting standards in sustainability for approximately 80 industries in 10 sectors. Source: Molyneux, 2015. Box B.17: OECD Principle V.A.2 The corporate governance framework should other users of information to better evaluate the relation- ensure that timely and accurate disclosure is made ship between companies and the communities in which on all material matters regarding the corporation, they operate and the steps that companies have taken to including the financial situation, performance, implement their objectives. ownership, and governance of the company. 76. In many countries, such disclosures are required for A. Disclosure should include, but not be limited to, large companies, typically as part of their management material information on: reports, or companies disclose non-financial information 2. Company objectives and non-financial voluntarily. This may include disclosure of donations for information. political purposes, particularly where such information is not easily available through other disclosure channels. 75. In addition to their commercial objectives, com- panies are encouraged to disclose policies and perfor- 77. Some countries require additional disclosures for mance relating to business ethics, the environment large companies, for example net turnover figures or and, where material to the company, social issues, payments made to governments broken down by human rights and other public policy commitments. categories of activity and country (country-by-country Such information may be important for investors and reporting). Source: (OECD 2015a.) 46 From Companies to Markets—Global Developments in Corporate Governance Corporate Governance Developments: Practice Issues PART B of corporate professionals on the value to companies of “Long-term financial performance depends on the effi- sustainability reporting—beyond relating to firm financial cient and productive management of resources not cur- risk and the firm licence to operate (Ernst & Young 2014). rently measured by traditional accounting methodolo- The results reveal that companies see ESG/sustainability gies—human, intellectual, social and relationship, and reporting as contributing to their competitive advantage natural capitals. The financial capital market system is by improving company reputation (more than 50 percent), insufficient to guard against the multi-faceted and in- leading to increased employee loyalty, more reliable com- terconnected risks of the future and hence an inclusive pany information, and better refinement of the corporate market system should be adopted.” strategy (more than 30 percent). Other studies (Cheng et Jonathan Labrey, Chief Strategy Officer, IIRC al. 2014) also indicate that firms ranked highly for sustain- ability reporting have improved access to capital. The OECD Principles recognize the need for disclosure and transparency, and the general principle has not changed in “We are looking for greater transparency so that com- the recent revision of the Principles. (See Box B.17.) Nev- panies can be compared, not only on financial terms, ertheless, the trend toward an increased expectation for on the stock price, but also on the contribution that more and better nonfinancial information—to complement the organisation is making to society.” Patrick Zurstrassen, the traditional financial information provided—is reflected IFC Corporate Governance Private Sector Advisory Group in additional specific disclosure recommendations. Honorary Chair, ecoDa A 2013 KPMG survey reviewing a period of 20 years, encompassed some 4,100 companies across 41 countries in B.3.1.2. Sustainability Reporting—Rules and Tools the Asia-Pacific, Americas, Middle East and North Africa, Many of the various guidance tools in the area of sustain- and Europe regions (KPMG 2013). It shows that corporate ability establish principles and standards for company responsibility (CR) reporting, or reporting on sustainability, application. Some instruments focus on application ap- has become standard company practice. (See Box B.18.) proaches by the company committed to sustainability. Some may be used for assessment of company sustainabil- B.3.1.1. The Company Rationale for Sustainability ity activities. Other instruments focus on company report- Reporting ing of sustainability activities. Some are more focused on Each company will approach sustainability differently, the environment or on human rights. The number of tools, as each company’s business model and activities vary. frameworks, and approaches available may lead to confu- In 2013, Ernst & Young collaborated with the Center sion about what and how a company should report on for Corporate Citizenship at Boston College in a survey ESG matters. Many more approaches have been developed at industry and national levels. Nevertheless, the plethora of tools have seen increased use, and many have been re- Box B.18: KPMG Corporate Responsibility vised for new trends and developments. Table B.5 on page Reporting Survey 48 provides a sample of instruments developed for global applicability. In addition, references, such as a publication Over half of reporting companies worldwide (51 percent) now include CR information in their an- from the International Federation of Accountants (IFAC nual fi nancial reports. This is a striking rise since 2016), are available for accounting for sustainability. 2011 (when only 20 percent did so) and 2008 (only 9 B.3.1.3. Trends in Sustainability Reporting percent). Many surveys have been conducted on sustainability To report or not to report? The debate is over. reporting. The following are common findings: Companies should no longer ask whether or not • Sustainability reporting is growing. they should publish a CR report. We believe that debate is over. The high rates of CR reporting in all • Tools to support sustainability reporting are still regions suggest it is now standard business practice growing. worldwide. The leaders of G250 companies that still • The CFO has a key role in reporting on do not publish CR reports should ask themselves sustainability, building on the CFO’s traditional whether it benefi ts them to continue swimming role in reporting. against the tide or whether it puts them at risk. • Employees are emerging as a driver for sustainability Source: (KPMG 2013) Executive Summary. reporting. From Companies to Markets—Global Developments in Corporate Governance 47 PART B Corporate Governance Developments: Practice Issues Table B.5: Global Instruments Addressing Sustainability Instrument Year of Introduction/Revision Development OECD Guidelines for Issued in 1976; revised in 2000 and Provides principles for responsible Multinational 2011 business conduct in employment, Enterprises (MNEs) industrial relations, human rights, environment, information disclosure, anti-bribery, competition, taxation. UN Global Compact Issued in 2000 A set of principles voluntarily used by – 10 Principles many businesses committed to aligning their strategies with UN principles in human rights, labor, the environment, and anti-corruption. UN Principles for Issued in 2006; Principles endorsed by institutional Responsible Investment In 2014, endorsed by 1,250 investors to incorporate sustainability (PRI) institutional investors issues into their investment decision. International Corporate Issued in 2015 Guidance to companies on investor Governance Network expectations of corporate reporting, Guidance on Integrated financial and nonfinancial, including Business Reporting environmental and social issues. Global Reporting Issued in 2013 Guidelines for companies on the Initiative G4 presentation of sustainability Sustainability information, covering economic, Reporting Guidelines environmental, and social aspects of company activities. Equator Principles Issued in 2003 and revised Developed by financial institutions as in 2013; by 2014, adopted by 80 a financial industry benchmark for financial institutions in 34 assessing environmental and social risks countries covering 70% of in projects. international project finance debt in emerging markets UN Guiding Principles Issued in 2011 by UNHCR and focused Developed by the UN, encourages on Business and Human largely on MNEs; in 2015, published a businesses to incorporate in their strategy Rights stock taking of and operations policies and procedures implementation in EU of the to safeguard human rights. Guiding Principles Integrated Reporting Framework issued in 2013 Developed by International Integrated Initiative Reporting Council to facilitate (See detail of Integrated harmonized and holistic financial and Reporting in Section nonfinancial corporate reporting. B.3.2, below) Source: Molyneux, 2015. 48 From Companies to Markets—Global Developments in Corporate Governance Corporate Governance Developments: Practice Issues PART B • Sustainability rankings and ratings matter to com- setters as well as the accountancy profession. The IIRC’s pany executives and are reviewed by investors. mission is to enable IR to be embedded into mainstream • There is a trend to integrate triple-bottom-line business practice in the public and private sectors. Its vi- elements of the economic, environmental, and social sion is to make a lasting contribution to financial stability impacts of business into company reports, as and sustainable development, brought about by the adop- discussed below. tion of IR as the global reporting norm. B.3.2. Integrated Reporting The IIRC assists companies with organizing and rationalizing their ESG disclosures and reports. It also helps them ensure “To achieve a holistic picture of a company’s total that they are linked into the more traditional financial report- strengths and to offer investors a sufficient basis for ing, to give a holistic picture of value creation in a company’s making investment decisions, the following elements business model, strategy, and risks. (See Box B.19.) are vital: • Identification of the most relevant, material aspects of the business model, strategy, and Box B.19: What is IR? governance and how they are interrelated; IR is a process founded on integrated thinking that • Describing the expected impact and measuring results in a periodic integrated report by an organi- and monetizing impacts. zation about value creation over time and related communications regarding aspects of value cre- “Despite the notion that monetization will be quite ation. An integrated report is a concise communica- subjective for certain issues, it is important to describe tion about how an organization’s strategy, gover- the material value drivers and their impacts as pre- nance, performance and prospects, in the context cisely as possible so that investors can appreciate their of its external environment, lead to the creation of value.” value in the short, medium and long term. Christian Strenger, Deputy Chairman, (IIRC 2015) IFC Corporate Governance Private Sector Advisory Group, and IIRC Board While the annual report remains the most impor- tant information source for investors, the reports Views such as those expressed in the quote from Christian ciently in their present form do not provide a suffi Strenger, above, led to the integrated reporting initia- true and fair picture of the company. This is due to the intensive weight factors like ESG, brand values, tive, introduced by the International Integrated Reporting customer and employee loyalty, market position Council in 2010.21 The IIRC is a market-led organization (concept of capitals) that increasingly impact the incorporating the expertise and experience of organizations long-term viability of the business models: for ex- in 25 to 30 countries in corporate reporting. The IIRC is a ample, ‘Intangible Assets’ today account for over 80 coalition of businesses, investors, regulators, and standard per cent of S&P 500’s market value. Investors clearly recognize this and expect compa- nies to explain their business model and the man- Integrated reporting] is a process that results agement concept as well as to state their strategy in communication by an organization, and their execution plans. Investors are much more most visibly a periodic integrated report, interested in how the company generates value rather than only concentrating on the return. about value creation over time. Intellectual capital is organizational, knowledge-based The keen interest of investors in non-fi nancial issues duciary duty to pursue oppor- is explained by their fi intangibles, including intellectual property, tunities for sustainable outperformance. A recent tacit knowledge, systems, procedures, and analysis of the impact of ESG confi rmed that compa- intangibles associated with the brand and nies with higher ESG-standards benefi t from lower reputation. cost of capital [and] higher share price performance. (Strenger 2015) (IIRC 2015) 21 The IIRC website, www.iirc.org, has considerable information on the IR Framework and current applications of integrated reporting. From Companies to Markets—Global Developments in Corporate Governance 49 PART B Corporate Governance Developments: Practice Issues The goal of IR is for the data and information flows from B.3.2.1. The Integrated Reporting Concept businesses operating in complex regulatory and business The idea behind integrated reporting is easy to understand. environments to be allied with efficient capital allocation The IIRC views reporting as complex, and the burden of and to portray—clearly and concisely—the whole posi- corporate reporting has actually lead to an obscuring of a tion of the business and how it creates value. However, true picture of value creation. So it is it is not easy to move from a corporate reporting model, difficult to communicate how an organization creates value based on reporting of historical financial information, to when looking only through the prism of financial report- more forward-looking corporate reporting, which includes ing, even historic financial reporting. More was required. financial as well as nonfinancial information. Example: World Bank Integrated Reporting The World Bank, as a development bank and financial “It should be stressed here that the point goes far institution, is implementing integrated reporting in its own beyond ‘putting the information together,’ but that is right, to test whether the principles of integrated reporting absolutely essential to link it and to make the can be applied to public sector organizations. connection, showing the whole picture of businesses’ IR challenges the silos that have developed historically activities.” in corporate reporting, which separate financial and Roberta Simonetti, Brazilian Institute of Corporate Governance nonfinancial information and allow information to be dis- connected from the strategy of an organization. Such com- partmentalizing of information is a drawback in a world of In 2009, the King Report on Corporate Governance in greater interconnectivity and interdependence. South Africa included a requirement for integrated report- The purpose of integrating reporting is to improve and ing. As a result, the South African Integrated Reporting increase the flow of productive investment, to release Committee issued a guidance document, and the idea was resources to the businesses, leading to future economic taken up more broadly in 2010. It was decided that an growth within a context of respect for sustainable international framework was needed, with the aim of hav- development. ing it become the corporate reporting norm for the private and public sectors. Thus the IIRC was born under the IR is an inclusive concept, and one of the most important chairmanship of Mervyn King, who also chairs the King elements and principles of IR is the idea of six capitals: Committee on Corporate Governance in South Africa. financial, manufactured, intellectual, human, social and Figure B.12: Integrated Reporting Concept Financial Financial Mission and vision Future outlook Manufactured Manufactured Risks and Strategy and opportunities resource allocation Intellectual Intellectual Business model Business Inputs Outputs Outcomes activities Human Human Performance Outlook Social & Relationship Social & Relationship Natural Natural External environment Value creation (preservation, diminution) over time Source: (IIRC 2015). 50 From Companies to Markets—Global Developments in Corporate Governance Corporate Governance Developments: Practice Issues PART B relational, and natural capital. These capitals contribute B.3.2.2. Summary of IR’s Main Elements to value creation in the long term, as shown on the right- The IR Framework demands that an organization be able hand side of Figure B.12. The IR concept is to look at a to articulate its strategy, its value-creation model, and its company from a larger perspective, not just through the uses of various capitals to create value over the medium financial prism that led to the chronic real-world effects on and long term. Box B.20 provides a high-level summary of the economy and the misallocation of capital. the requirements, principles, and main elements of the IR Framework. Box B.20: High-Level Summary of Requirements for an Integrated Report Key Requirements l Reliability and completeness – including all material l An integrated report should be a designated, matters, both positive and negative, in a balanced identifiable communication way and without material error l A communication claiming to be an integrated l Consistency and comparability – ensuring report and referencing the Framework should apply consistency over time and enabling comparisons with all the key requirements (identified using bold italic other organisations to the extent material to the type), unless the unavailability of reliable data, organisation’s own ability to create value specific legal prohibitions or competitive harm Content Elements results in an inability to disclose information that is material (in the case of unavailability of reliable l Organisational overview and external data or specific legal prohibitions, other information environment – What does the organisation do and is provided) what are the circumstances under which it operates? l The integrated report should include a statement l Governance – How does an organisation’s from those charged with governance that meets governance structure support its ability to create particular requirements (e.g., acknowledgement of value in the short, medium and long term? responsibility, opinion on whether the integrated l Business model – What is the organisation’s report is presented in accordance with the business model? Framework)—and if one is not included, disclosures l Risks and opportunities – What are the specific risk about their role and steps taken to include a and opportunities that affect the organisation’s ability statement in future reports (a statement should be to create value over the short, medium and long term, included no later than an entity’s third integrated and how is the organisation dealing with them? report referencing the Framework) l Strategy and resource allocation – Where does the Guiding Principles organisation want to go and how does it intend to get there? l Strategic focus and future orientation – insight into the organisation’s strategy l Performance – To what extent has the organisation achieved its strategic objectives for the period and l Connectivity of information – showing a holistic what are its outcomes in terms of effects on the picture of the combination, inter-relatedness and capitals? dependencies between the factors that affect the organisation’s ability to create value over time l Outlook – What challenges and uncertainties is the organisation likely to encounter in pursuing its l Stakeholder relationships – insight into the nature strategy, and what are the potential implications for and quality of the organisation’s relationships with its business model and future performance? its key stakeholders l Basis of preparation and presentation – How does l Materiality – disclosing information about matters the organisation determine what matters to include that substantively affect the organisation’s ability to in the integrated report and how are such matters create value over the short, medium and long term quantified or evaluated? l Conciseness – sufficient context to understand the organisation’s strategy, governance and prospects without being burdened by less relevant information Source: (IIRC 2015). From Companies to Markets—Global Developments in Corporate Governance 51 PART B Corporate Governance Developments: Practice Issues Research conducted by Nanyang University in Singapore22 “The Framework is a tool for the better articulation found a positive correlation between the application of of strategy, and to engage investors on a long-term IR and share performance. The Nanyang University study journey to attract investment that will be crucial to reviewed 100 South African companies listed on the achieving sustained, and sustainable, prosperity.” Johannesburg Stock Exchange, where integrated reporting Mervyn King, Chairman, IIRC, has been mandated under King III over the most recent and IFC Corporate Governance Private Sector Advisory Group three years, on an apply-or-explain basis. The Nanyang University study used stringent research B.3.2.3. Benefits for the Company methods, and the researchers themselves were surprised Research by corporate reporting communications firm by the findings. They found an observed roughly 9 percent Black Sun Plc indicates that integrated reporting has con- increase in share price as a result of companies’ applying IR.23 siderable benefits to the company (Black Sun 2015). For example: In the pilot stage of development of the IR Framework in • 92 percent of organizations interviewed see an in- 2014, the IIRC closely observed 100 or more companies creased understanding of value creation as a benefit applying the framework, with the result that they appeared of IR. to be much better at understanding and articulating their • 71 percent see a benefit to the board of a better organization’s strategy and business model. According to understanding of how an organization creates value. Jonathan Labrey, IIRC chief strategy officer, pilot study participants reported that IR has been very helpful to them • 87 percent of providers of financial capital have a not only in managing risks internally but also in delivering better understanding of the organization’s strategy. value by explaining to internal stakeholders, particularly • 79 percent of providers of financial capital have employees, how they should fulfill their responsibilities and greater confidence in the long-term viability of the their role in executing the strategy. business model. • 79 percent of management participants report B.3.2.4. IR Country Developments—South Africa improved decisions based on better management Sustainability/triple-context reporting has been mandated information. on an apply-or-explain basis through King II and King III, the South African corporate governance code. Many South African companies were early adopters of IR as a means of “Good practices in integrated reporting are emerging and, reporting in an integrated way on financial and sustainabil- whilst to report in an integrated manner is challenging, ity matters as required by Johannesburg Stock Exchange it allows companies to tell the story of their strategies and risks in a holistic manner which is comprehensible to readers, investors and stakeholders alike.” The survey shows that among those Anne Molyneux, ICGN Board organizations that produce high quality and authentic integrated reports, there Other studies (such as KPMG 2014) show that better is a strong awareness of the concept of business reporting, especially on sustainability issues, is integrated thinking and how it benefits the productive, and integrated reporting is becoming a trend. organization. . . . To date few organizations seem to be using the capitals model outlined “Prior research has established a relationship between in the [IR] Framework to identify and manage disclosure and a firm’s corporate valuation and cost their capitals, but there does seem to be an of capital. Our research shows that firms with better awareness of the six capitals and that these integrated reports do enjoy higher equity valuations.” contribute to the value creation process. Lee Kin Wai, Associate Professor of Accounting, Nanyang Business School, Singapore (SAICA 2015). The study of South African companies by Gillian Yeo, Lee Kin Wai, and Thiruneeran of Nanyang Business School is important to the development 22 of IR in Singapore and has been followed by other initiatives by the Institute of Chartered Accountants of Singapore and ACRA, the Accounting and Corporate Regulatory Authority of Singapore. 23 Statistics provided by J. Labrey in discussions at IFC Codes and Standards Review Group, May 2015. 52 From Companies to Markets—Global Developments in Corporate Governance Corporate Governance Developments: Practice Issues PART B (JSE) Listing Rules in 2010 (on an apply-or-explain Example: India basis). Therefore, South Africa has been watched as a Recently, the Securities and Investment Board of India asked leader in IR development as well as in governance and the Confederation of Indian Industry (CII)—that is, the culture, where South Africa has had a particular focus business community—to develop a roadmap for the imple- on sustainable development. mentation of integrated reporting in the Indian market. The CII established the Centre for Excellence for Sustainable Many studies, such as one by KPMG (Hoffman 2012), Development, which, in partnership with the IIRC, in- have examined the South African story of integrated troduced integrated reporting to India and set up IR Lab reporting. A recent study issued by the South African India, the country-level network, a collective of companies, Institute of Chartered Accountants (SAICA 2015) pro- investors, regulators, accounting firms, and academics, to duced the following findings: practice and advocate in India, and to bridge with IIRC • Several of the top 100 JSE listed companies and and country networks (CII-ITC 2016). leading state-owned entities have recognized the Example: Brazil benefits of integrated thinking. The Brazilian Commission for Monitoring IR is a group • Over 70 percent of entities confirmed that inte- of individuals who seek to discuss and foster the voluntary grated reporting has been a driver for achieving adoption of integrated reporting in Brazil. This initiative, integrated thinking. although it is recognized and encouraged by the IIRC, is completely independent and the responsibility of its mem- • Over 70 percent of executives and non-executive bers. The commission has working groups on five fronts: directors surveyed felt that decision making at knowledge management, communication, pioneer reporters, management and board levels had improved as a investor engagement, and academy. result of integrated thinking. B.3.2.6. IR—A Final Word B.3.2.5. IR Developments—Other Countries The shift from silo reporting to integrated reporting is a Other developments are taking place in integrated journey that is unfolding. However, it is very consistent reporting. Regulators or business organizations have with the work that the World Economic Forum (WEF) does convened laboratories and networks in different markets every year in relation to the key worldwide risks facing the to look at the practical challenges of corporate report- global economy. Last year, the WEF Global Risks Report ing and how integrated reporting can facilitate a better found that no country, industry, or organization can deal dialogue between companies and investors. Integrated with risks on its own or in isolation. It is also not possible reporting is accelerating in some countries and is becom- to isolate financial and nonfinancial risks or country risks, ing a driver of social and economic development. because we live in an interconnected world. Example: Malaysia Klaus Schwab, who chairs the World Economic Forum, said Integrated reporting is part of the capital markets master that these interconnected risks require collective thinking plan of Malaysia. In its Corporate Governance Blueprint and responses as well as new systems and processes for 2011, the Securities Commission of Malaysia includes a understanding them. In the World Economic Forum’s 2015 chapter on disclosure and transparency. The master plan report (WEF 2015b), for the first time it was recognized that it presents recommends that companies promote effective the highest-ranking risks are actually nonfinancial, placing disclosure of nonfinancial information. It states that part further pressure on policymakers, businesses, and investors of the plan will “Establish a taskforce to review develop- to understand, measure, manage, and disclose the impact of ments in integrated reporting and to promote awareness these risks on businesses, their business models, and their and its adoption by companies” (SC 2011). value creation. Example: Japan It is most important to note that the Integrated Reporting In Japan, there are now 180 companies practicing inte- Initiative is but one of a number of initiatives that aim to grated reporting. One of the key accelerators of the shift make company activities more transparent, more accessible, to IR has been the development of the Japanese stew- and more useful to the reader. Such initiatives emphasize the ardship code and most recently a corporate governance real importance of a company’s activities to life and the so- code. Investors in Japan believe they can use integrated cial system it operates within. Some initiatives have focused reporting as the information architecture to underpin on establishing the basis for business activities, such as the high-quality dialogue between the board of the company UN Global Compact’s 10 principles in the areas of human and institutional investors. rights, labor, the environment, and anti-corruption. From Companies to Markets—Global Developments in Corporate Governance 53 PART B Corporate Governance Developments: Practice Issues The OECD has established principles for large multina- investors, and market intermediaries; incentivize earnings tional enterprises (OECD 2014c) to ensure responsible management; and impose unnecessary regulatory burdens business conduct. Some initiatives focus on a particular on companies—without providing useful or meaningful in- group, such as investors, the target of the Principles for formation for investors. Kay considered quarterly earnings Responsible Investment. Others, such as the standards results to be too short a snapshot of performance to prop- developed by the Global Reporting Initiative (GRI 2013), erly inform investors. The key is to achieve a right balance have developed reporting models and focus on reporting of between short-term and long-term perspectives and not to wider company activities. All are worthy of consideration have a reporting cycle drive business decisions. in the transparency and reporting of nonfinancial company In Europe in 2013, post-financial-crisis reviews resulted in performance. amendments to the Transparency Directive (initially passed B.3.3. Periodic Reporting: Is Less More? in 2007) to remove the requirement for listed companies In the aftermath of the financial crisis, many investigations to publish quarterly financial reports, a requirement that into its causes discovered short-termism among banks and many see as a stimulus to short-termism. This amendment public companies as a contributor. Several reviews24 in the was implemented in the United Kingdom in 2014 and United Kingdom and Europe considered quarterly report- is being adopted in various EU member states. National ing of financial information as contributing to a short-term stock exchanges are allowed to impose stricter reporting perspective, to the detriment of a longer-term view. In many requirements than the directive proposed. situations around the world, decisions were made to maxi- However, not all markets have been willing to remove mize financial results in the short term and had severe conse- quarterly reporting. The United States continues to lead on quences in other dimensions, with a rebound effect that ulti- quarterly reporting. Singapore, which introduced manda- mately affects the financial result in the medium or long term. tory quarterly reporting in 2003, continues to require it. The Kay report (Kay 2012) points out that overly frequent Studies from the academic and economic research com- reporting encourages businesses and investors to make munity are mixed in their support for quarterly report- short-term decisions that sacrifice long-term returns and ing. Two recent German studies on mandatory quarterly might increase risks in general and have other impacts reporting suggest the following: on society and the environment. The Kay report included • It does not reduce information asymmetry, but persuasive examples of U.K. companies, including Marks rather causes firms to deviate from their prior invest- & Spencer, BP, Imperial Chemical Industries, Royal Bank ment strategy (Kajuter et al. 2015). of Scotland, Halifax Bank of Scotland, and Glaxo, that steadily moved to and suffered from greater short-termism • It affects firms’ business decisions, and firms with at the expense of long-term investment and the sustainabil- quarterly earnings information show greater ma- ity of the company. nipulation of real activities; it is also associated with decreased levels of long-term operating performance Kay suggests that too rigid reporting requirements can (Ernstberger et al. 2015). promote an excessively short-term focus by companies, In Germany, Porsche resisted issuing quarterly information, even at the expense of being excluded from prestigious Overall we conclude that short-termism is a stock market indexes (Wagenhofer 2014). In 2009, the problem in UK equity markets, and that the Anglo-Dutch consumer goods company, Unilever, moved principal causes are the decline of trust and the away from quarterly reporting in favor of semi-annual reporting. The chief executive officer, Paul Polman, argued misalignment of incentives throughout the that the move would help the firm focus on a longer-term equity investment chain. . . . Recommendation investment perspective. 11 recommended that mandatory quarterly reporting obligations on quoted companies in Conversely, a number of earlier studies (Fu et al. 2012; the form of Interim Management Statements Kanodia and Lee 1998; Gigler et al. 2014) found that . . .should be removed. a higher reporting frequency is associated with lower information asymmetry and a lower cost of capital. These (Kay 2012) studies identified information benefits to the market of quarterly reports, positing that more frequent reporting 24 In 2009, the Walker Review of corporate governance in U.K. banks and other financial institutions investigated the failures of governance, particularly in the Royal Bank of Scotland and the Halifax Bank of Scotland. 54 From Companies to Markets—Global Developments in Corporate Governance Corporate Governance Developments: Practice Issues PART B increases the timeliness of financial information and thus helps improve transparency and monitoring. Box B.21: Benefits of Changes to the Auditor’s Report It is clear that the debate on the benefits or otherwise of quarterly reporting is not concluded. Yet we already see Changes to auditor reporting will also have the regulators and companies moving away from quarterly t of: benefi reporting to limit short-term management decision making l Enhanced communications between investors and behavior. The discussions at the EU confirmed a view and the auditor, as well as the auditor and those that investor protection is already sufficiently guaranteed by charged with governance the requirement for firms to publish market-moving infor- l Increased attention by management and those mation immediately. However, companies themselves may charged with governance to the disclosures in the wish to continue to report quarterly, if they see it as benefi- nancial statements to which reference is made fi cial to investors and to the company position in the market. in the auditor’s report l Renewed focus of the auditor on matters to be B.3.4. Audit Reforms communicated in the auditor’s report, which Reviews of the financial crisis (Hidalgo 2011) have led to could indirectly result in an increase in recent revisions to the International Standards on Auditing professional scepticism. (ISAs) issued by the International Auditing and Assurance Source: (IAASB 2015b). Standards Board (IAASB), the global audit standards setter. The reviews have prompted several jurisdictions to amend will apply the new standards issued by IAASB, adapted to their requirements of auditors and of audit committees to local environments. (See Box B.22, page 56.) ensure increased transparency on external audit findings B.3.4.2. Regional and National Audit Reforms and activities. Thus standard setters and regulators intro- Regional and national initiatives to take up the new audit duced a series of requirements designed to enhance under- report requirements have been and are occurring at the standing of the audit process, including critical judgments time of writing this publication. (See Table B.6, page 56.) made during the audit. Different countries and regions may interpret new au- dit requirements in diverse ways, and some have added “This is a watershed moment in corporate reporting requirements. For example, Dutch law adds restrictions on as it is a long time since the audit report format was the provision of non-audit services by external auditors; amended. The IAASB and other regulators and audit in Spain, the law, which implements Directive 2014/56/EU oversight groups in the EU, the UK and the US and in and Regulation (EU) No 537/2014, includes a mandatory many other countries wished to address the perception rotation period for external auditors of ten years (plus four that the audit report style and content was not useful more in case of joint audit reports), in line with EU audit to investors.” provisions. Anne Molyneux, IAASB Consultative Advisory Group and ICGN Board B.3.4.3. Corporate Governance Changes Resulting from Audit Reforms In the application of audit reforms in the EU and the United Kingdom, some effects have been evident. The new While users of the financial statements have report format provides the key audit matters that the audi- signaled that the auditor’s opinion on the tor considers in the course of the audit, and it provides for financial statements is valued, many have investors points, which facilitate dialogue with boards and called for the auditor’s report to be more audit committees. External auditor oversight has come into informative and relevant. focus, and the role of audit committees is subject to new pressures and demands, including the following: (IAASB 2015a) • Expanded need for “financial expertise” on the audit committee, to include knowledge of audit approaches; B.3.4.1. IAASB Reforms • Increased need for independence of the committee; The IAASB audit report reforms are intended to increase • Demand for increased transparency of the auditor- transparency and enhance the informational value of the appointment process, especially where auditor rota- auditor’s report. (See Box B.21.) Countries that apply ISAs tion has been mandated; From Companies to Markets—Global Developments in Corporate Governance 55 PART B Corporate Governance Developments: Practice Issues Box B.22: The New Audit Report – A separate section when a material uncertainty exists and is adequately disclosed, under the heading “Material Uncertainty What’s New About the IAASB’s Auditor’s Report? Related to Going Concern” Mandatory for audits of financial statements of – New requirement to challenge adequacy of listed entities, voluntarily application allowed for disclosures for “close calls” in view of the entities other than listed entities: applicable financial reporting framework when events or conditions are identified that may l New section to communicate key audit matters cast significant doubt on an entity’s ability to (KAM). KAM are those matters that, in the continue as a going concern auditor’s judgment, were of most significance in the audit of the current period financial l Affirmative statement about the auditor’s statements independence and fulfillment of relevant ethical responsibilities, with disclosure of the Disclosure of the name of the engagement l jurisdiction of origin of those requirements or partner reference to the International Ethics Standards For all audits: Board for Accountants’ Code of Ethics for l Opinion section required to be presented first, Professional Accountants followed by the Basis for Opinion section, unless l Enhanced description of the auditor’s law or regulation prescribe otherwise responsibilities and key features of an audit. Enhanced auditor reporting on going concern, l Certain components of the description of the including: auditor’s responsibilities may be presented in an appendix to the auditor’s report or, where law, – Description of the respective responsibilities regulation or national auditing standards of management and the auditor for going expressly permit, by reference in the auditor’s concern report to a website of an appropriate authority Source:(IAASB 201.5b). 25 Table B.6: Regional and National Audit Reforms Source: (IAASB 2015b).23 Year Organization Initiative 2011– IAASB Review and reissuance of ISA 700 series of standards to require 2014 jurisdictions applying ISAs to introduce new elements to the auditor’s report (termed a “long form report” in the EU and the United Kingdom). 2013 U.K. Financial Changed the requirement to expand the audit report to include an Reporting Council overview of the scope of the audit, showing how this addressed audit risk and materiality considerations. Described the risks that had the greatest effect on: l the overall audit strategy, l the allocation of resources in the audit, l directing the efforts of the engagement team. Provided an explanation of how the FRC applied the concept of materiality in planning and performing the audit. 2014 EU Directive on EU Directive on Statutory Audit (Directive 2014/56/EU) was amended to Statutory Audit incorporate changes as proposed in the IAASB new standards and transposed by 2016 into EU member states’ regulations. 2011– Public Company Development and drafting of new proposals to enhance the content of 2013 Accounting Oversight the auditor’s report. Board (United States) Proposals Source: Molyneux, 2015. 25 More information on audit report changes is available at http://www.iaasb.org/new-auditors-report. 56 From Companies to Markets—Global Developments in Corporate Governance Corporate Governance Developments: Practice Issues PART B Based on a director’s fiduciary duty to the company, “In the Netherlands, the longer form auditor’s reports widespread and diverse actions have strengthened share- have been well received. They give greater insight into holder positioning against abusive related-party transac- the auditor’s work from the investor’s perspective.” tions. Sound definitions of RPTs have been introduced Rients Abma, Managing Director, Eumedion in most jurisdictions. Some specific RPTs are prohibited; more frequently, various companies and jurisdictions have introduced approval requirements for material RPTs and • Demand for increased transparency about audit increased disclosure requirements. committee activities, especially regarding discussions with the auditor and internal auditor; and B.4.1.1. RPT Prohibitions • Increased focus of regulators on audit quality and Usually addressed in corporate law and in regulations, effective audit oversight and supervision. RPTs are recognized as a regular business aspect that may or may not be abusive. However, particular RPTs—such as In the United Kingdom, the corporate governance corp- loans between the company and directors—have been pro- orate governance code requires audit committees to report hibited in several jurisdictions. Some RPT prohibitions are on significant audit matters and how these were addressed. in place in France, India, the Republic of Korea, Turkey, and the United States. A KPMG survey provided valuable discussions of conse- quential developments for audit committees. It found that B.4.1.2. RPT Disclosures three-quarters of audit committee members surveyed said Almost all jurisdictions have introduced International that the time required to carry out their responsibilities has Financial Reporting Standards (IFRS) as issued by the Inter- increased moderately (51 percent) or significantly (24 per- national Accounting Standards Board (IASB), including IAS cent), and half said that their role is becoming increasingly 24 Related Party Transactions Disclosures or a local stan- difficult. According to the report, “Views on audit reforms dard similar to IAS 24, as illustrated in Figure B.13. IAS 24 are mixed. . .there’s still room for auditors to offer more stipulates some information on RPTs to be disclosed. Fur- insight” (KPMG 2015). ther, an interesting IOSCO survey of disclosures to investors (IOSCO 2015) indicates that of 37 IOSCO jurisdictions, some 26 have requirements in place for timely disclosure “Effective audit committee oversight is essential to of material RPTs and usually stipulate a set time frame for investor protection and the functioning of our capital disclosure (from two to seven days is the norm). markets. . . . The way audit committees exercise their oversight of independent auditors has evolved and it is important to evaluate whether investors have the Figure B.13: RPT Disclosures in information they need to make informed decisions.” Financial Statements Mary Jo White, Chair, U.S. Securities and Exchange Commission (SEC 2015) Optional (e.g. IAS or local Others (n.a.), standard), 3, 1, 2% B.4. Shareholder Rights: RPTs and 7% Beneficial Ownership Two of the areas that have undergone review in the process of strengthening shareholder rights are related-party trans- Local standard, 8, actions and beneficial ownership. This section examines 20% changes affecting those two areas as well as current think- ing regarding good practices. IAS, 29 Jursdictions, B.4.1. Related-Party Transactions 71% One of the corporate governance challenges companies must deal with is to ensure that all shareholders are pro- tected in the face of related-party transactions. RPTs can be beneficial, but they are subject to conflicts of interest and The number of jurisdictions in each category are potentially abusive to some shareholders. The OECD and percentage share out of all 41 jurisdictions recognizes the importance of RPTs and has introduced two guidance papers on the topic (OECD 2009b; OECD 2012). Source: (OECD 2015b). From Companies to Markets—Global Developments in Corporate Governance 57 PART B Corporate Governance Developments: Practice Issues Thus, under IAS 24, companies must disclose at least • RPT policy established and publicly available on the annually, in their financial statements (or in the notes to company website; the financial statements), any transaction with directors, • Thresholds set for material RPTs requiring ex ante senior executives, or controlling or significant shareholders board approval and/or shareholder approval; and their related parties, including close family members, associates, and related entities (companies, trusts, private • Abstention of conflicted parties from decision entities, and so on). Apart from annual disclosure, the making regarding RPTs; OECD Corporate Governance Factbook indicates that • Review of RPTs’ terms and conditions by indepen- one-third of all surveyed jurisdictions require immediate dent board members, and recommendation made to public and shareholder disclosure of significant RPTs and the board; the RPTs’ terms and conditions. • Independent formal valuation of RPTs; All disclosure aims to provide shareholders with sufficient • RPTs documented and monitored by the board information to assess the magnitude and impact of RPTs and reviewed by the external auditor; and on the company. The quality of RPT disclosures has been • Specific material RPTs subject to shareholder identified as problematic, and in some countries (such as approval process. Canada, Ireland, Malaysia, Singapore, and the United Kingdom) guidance has been issued to ensure quality RPT Where shareholder approval of specific RPTs is required as disclosures. (See Box B.23.) a complement to board approval processes, it is usually ex ante and only applied to large transactions and/or transac- B.4.1.3. RPT Approvals tions not on market terms and conditions. Some jurisdic- The majority of jurisdictions require all RPTs to be tions specifically prohibit conflicted shareholders from approved by the board in aggregate. However, practices voting on RPT resolutions. regarding board review and approval of specific RPTs vary. Good practices include the following: B.4.2. Beneficial Ownership Investors need to know the parties that own individual stakes in the companies in which they wish to invest. From Box B.23: Comparison of Uninformative 2002 to 2012, concentrated ownership of companies grew and Informative Statements in OECD and non-OECD countries from 22 percent of listed entities to 41 percent of listed entities, making it of For example, a generic and uninformative disclosure particular interest. describing bank management of RPTs follows: The presence of controlling shareholders may dissuade The audit committee reviews and approves all smaller investors from investing in a company. Minority material related party transactions in which the bank shareholders may feel vulnerable if investing alongside a is involved or which the bank proposes to enter into. controlling shareholder. The corporate governance dynamics A more informative statement would be as follows: are likely to change in the presence of controlling sharehold- ers. Therefore, many parties have an interest in establishing The bank’s management team discusses all related the identities of the other parties controlling the entity. party transactions. In considering related party transactions, management will assess the materiality Given the plethora of intermediaries (such as trusts, nomi- of related party transactions on a case-by-case basis with respect to both the qualitative and quantitative aspects of the proposed related party transaction. Investor confidence in financial markets Related party transactions that are in the normal depends in large part on the existence of an course are subject to the same processes and controls accurate disclosure regime that provides as other transactions, that is, they are subject to transparency in the beneficial ownership and standard approval procedures and management oversight, but will also be considered by management control structures of publicly listed companies. for reasonability against fair value. Related party This is particularly true for corporate transactions that are found to be material are subject governance systems that are characterised by to review and approval by the bank’s audit committee concentrated ownership. which is comprised of independent directors. (OECD 2013b) Source: Examples taken from (OSC 2015). 58 From Companies to Markets—Global Developments in Corporate Governance Corporate Governance Developments: Practice Issues PART B nee companies/accounts, chains of corporate vehicles) that positions. There is evidence that institutional investors may be interposed, it is often difficult to distinguish ulti- keep their positions just below the 2 percent level to hide mate beneficial owners and thus company control. Also, ownership, and the regulator, CONSOB (Commissione the issue may be purposefully opaque. Nazionale per le Società e la Borsa), is reviewing the regu- lation in the light of such actions, recognizing that the In all markets—especially emerging markets where state global norm of 5 percent is higher and more flexible. and family controls of businesses and perhaps pyrami- dal control structures are prevalent, and because such Also, emerging markets with a prevalence of controlling- structures in the past have been used to the detriment of shareholder structures and the use of control-enhancing minority shareholders—a strong regulatory environment structures, such as China, Indonesia, and Malaysia, have is important. Information on ownership is also important also introduced regulation on disclosure of beneficial and should be adequate, accurate, and current. As com- ownership.27 Since the G-8 Summit in June 2013, G-8 panies are expected to engage more with shareholders and countries have introduced stricter measures to improve shareholders and institutional investors are encouraged to transparency of beneficial owners to build trust and take a regular interest in the affairs of their investee com- transparency in companies, to facilitate cross-border panies, both company and shareholders need to know the investment, and to prevent fraud, money laundering, identity of significant shareholders. Therefore, regulators and tax evasion. Other countries have followed. (See Box have been introducing enhanced disclosure and enforce- B.24, below, and Table B.7, page 60.) ment regimes to ensure that the ownership structure of the entity is transparent, even in market environments where Now brokers, dealers, banks, insurance companies, there is dispersed share ownership. (See also Section A.4.3. investment companies, parent holding companies, and Ensuring Greater Shareholder Engagement.) others have stronger obligations to report ultimate beneficial ownership. Even particular industries have B.4.2.1 Disclosure of Beneficial Ownership established initiatives to ensure transparency of beneficial Controls to prevent opportunistic behavior by controlling owners of companies. The Extractive Industries Trans- shareholders or large block holders are generally in place parency Initiative is an example, and it has developed a in company law or listing rules. In an environment char- model beneficial ownership form for members’ use. (See acterized by control and insider coalitions in companies, Box B.25, page 61.) the EU has long recognized the importance of mandatory disclosure of significant shareholdings.26 Box B.24: Reporting Example: Indonesia Article 9 [of the Directive] provides that [Bapepam-LK is the Indonesian Capital Market investors will be required to disclose the Supervisory Agency.] acquisition or disposal of shareholdings According to Bapepam-LK Rule No. X.K.6 regarding in listed companies whose securities are the obligation to submit an annual report, listed admitted to trading on a regulated market, companies are required to annually disclose and based on thresholds starting at 5% continuing report information regarding significant direct at intervals of 5% until 30% of the voting rights. shareholders who own 5% or more of the company’s shares. (European Commission 2014a) This information becomes also available on the website of the Indonesia Stock Exchange (www.idx. co.id). Bapepam-LK Rule No. X.M.1 requires all Notifications are required within four trading days. How- significant direct shareholders who own 5% or ever, stricter reporting and disclosure rules were intro- more of the outstanding shares to send a report duced recently to uncover ultimate beneficial owners of containing information about the shareholding companies. Italy requires detailed ownership and control to the Indonesian Capital Market Supervisory information of significant shareholders and requires the Agency...within ten days from the transaction date. ultimate controlling shareholder to make shareholding notifications above 2 percent, including long and short Source: (OECD 2013b). See Directive 88/627/EEC. The rules regarding beneficial owners were amended in 2004 and implemented in 2007. 26 Other examples may be found in regulatory developments in China and Malaysia and other emerging markets. Indeed, Malaysia’s disclosure 27 system is extensive and detailed. From Companies to Markets—Global Developments in Corporate Governance 59 PART B Corporate Governance Developments: Practice Issues B.4.2.2. Beneficial Ownership Rules and Enforcement Most jurisdictions devote considerable resources to en- Disclosure rules themselves do not necessarily imply ac- forcement in this area. Public enforcement may be both curate and compliant disclosure practices. Rules should be formal and informal, and in Italy it can involve imposition supported by proper oversight, monitoring, and enforce- of fines, suspension of voting rights, or more informally ment, and the effectiveness of the rules depends largely a request for updating of information or a reprimand. In on the enforcement capabilities of regulators. However, the United States, the SEC may remind delinquent filers of enforcement regimes and mechanisms vary significantly their obligations and suggest that they provide information when it comes to beneficial ownership rules. voluntarily forthwith. In Malaysia, formal public enforce- ment mechanisms are used and are typically made up of Table B.7: Beneficial Ownership Rules Country Source Amendment to Beneficial Ownership Rules Canada G-8 Action l In 2014, determined an Action Plan to implement the measures as have Plan 2.0 the United Kingdom and the United States (see below). Denmark and FATF response l By 2013, Denmark and Norway committed to a public registry of Norway beneficial ownership information. United Department l Implement a central registry of company beneficial ownership Kingdom of Business information accessible to the public under Disclosure and (also expected Innovation Transparency Rules of Part 22 of the Companies Act 2006. to affect Isle of and Skills— l Companies will be required to maintain a register of beneficial owners. Man, Guernsey, Transparency l Information on the beneficial owners’ full name, date of birth, Jersey, Bermuda, and Trust nationality, country or state of usual residence, residential address, and the Cayman Project and service address, date on which they acquired the beneficial interest in and British draft Bill the company, and details of that beneficial interest and how it is held. Virgin Islands) l Beneficial owners will be required to inform the company of any changes to the information recorded in the register of beneficial owners. l Issuance of new bearer shares is prohibited as is also the use of corporate directors prohibited. United Securities l Require filing with the SEC under Schedule 13 D pursuant to the States and Exchange Securities and Exchange Act of 1934; filings with the SEC will be Commission provided to the company and the issuer’s exchange. l When a person or group of persons acquires beneficial ownership of more than 5% of a voting class of a company’s equity securities registered under Section 12 of the Securities Exchange Act of 1934, they are required to file a Schedule 13D with the SEC within 10 days of achieving the 5% level. l Information required is similar to that required in the United Kingdom (see above). l Since the introduction of the new regulations, the SEC has reviewed companies on compliance with the regulations—34 companies had been charged with noncompliance as of September 2014. Other G-8 Action Other G-8 implementing countries are France, Germany, Italy, Japan, Plan and Russia. In May 2015, the EU required its member states to establish a beneficial ownership registry by 2016. Source: Molyneux, 2016. 60 From Companies to Markets—Global Developments in Corporate Governance Corporate Governance Developments: Practice Issues PART B policies and practices, beyond the minimum required in Box B.25: Example: Extractive law or regulations. The levels of commitment to corporate Industries Transparency Initiative governance in a company may vary from the most basic to rather advanced levels incorporating best practices. In many cases, the identity of the real owners—the “beneficial owners”—of the companies that have In looking at and assessing the commitment of a company to acquired rights to extract oil, gas and minerals is corporate governance, it is not only about where the com- unknown, often hidden behind a chain of corporate pany is but also about the ways in which the company and its entities. This opacity can contribute to corruption, leadership may foster good corporate governance in company money laundering and tax evasion in the extractive attitudes, practices, and personnel. This is a program to move sector. corporate governance practices to a higher, better place. Eleven EITI countries, Burkina Faso, the Democratic According to the IFC Corporate Governance Progression Republic of Congo, Honduras, Kyrgyz Republic, Matrix (IFC 2016b),28 commitment is normally demon- Liberia, Niger, Nigeria, Tajikistan, Tanzania, Togo strated if particular policies and procedures are in place and Zambia, are now taking part in the pilot and will disclose the identity of the real owners behind the and operating in the company. These include the following: extractive companies operating in their countries. • A comprehensive company charter or articles of as- Mongolia, Myanmar, Norway, the Philippines, sociation will include strong shareholder protection Sierra Leone, and the United Kingdom have also provisions and statements referring to the equitable expressed an interest and are undertaking work on treatment of shareholders. The charter will also beneficial ownership. make a clear distinction between the powers and authorities of the shareholders (especially at the Source: (EITI 2016). AGM), the directors, and management or executive groups. The charter will also make a commitment to fines and imprisonment, or the matter may be brought transparency of company governance and activities before the High Court, depending on the breach. and to disclosure of information on these. Private enforcement by one or more shareholders through • The company has in place a written and published derivative suits is less likely, as such suits have high litiga- code of ethics or conduct approved by the board tion costs, involve great uncertainty, and are based on and also applicable to the board and all manage- minority shareholders’ access to beneficial ownership ment. information. • There is a designated company officer responsible Increasingly, IOSCO, as the global securities market for ensuring compliance with all laws and regula- regulator, calls for national securities regulators and other tions and company corporate governance policies. enforcement bodies to cooperate in this area. IOSCO has • The company will have a written and published established memorandums of understanding for exchange code of corporate governance and an annual calen- of information and support. dar of corporate events and will periodically check The challenge, not yet fully resolved by disclosure require- company compliance with its own corporate gov- ments, is to find the right mix of national and internation- ernance code and report this to shareholders. al, public and private, formal and informal enforcement In global best practices, commitment to corporate govern- mechanisms in this area. This is a work in progress in the ance includes incorporating changing corporate govern- corporate governance spectrum. ance best practices into the company code of corporate governance, ensuring quality financial reporting, account- B.5. Commitment to Corporate Governance ing and auditing (internal audit and external audit), and Developments comprehensive shareholder information and broad engage- One of the key tenets of the IFC Corporate Governance ment practices. Methodology Framework is that companies and sharehold- ers demonstrate their commitment to corporate governance The new interest in corporate governance commitment and and to implementing high-quality corporate governance culture stems from the realization that a flawed culture is 28 The matrix is a part of the IFC Corporate Governance Methodology, adhered to by IFC itself for its investments and by many other development institutions. From Companies to Markets—Global Developments in Corporate Governance 61 PART B Corporate Governance Developments: Practice Issues a common factor in corporate disasters. The challenge is the U.K. Code since 2012 and will continue to do so. It is how to adapt board mandates and traditional corporate expecting to continue to develop guidance in several areas to governance approaches to enable boards to articulate and ensure that best practices—such as guidance on succession embed strong values that shape behaviors throughout the planning and the role of the nomination committee—are company. Boards need to assure themselves that the values embedded in a company’s corporate governance system. they want are the ones they actually have. Traditional governance does not address culture and is very process Others too have expressed the desire to see corporate culture driven. change to improve corporate governance and address better behavior and more targeted performance incentives for com- A new approach to corporate governance is required, one pany individuals. The revised G20/OECD Principles provides that recognizes the importance of values and culture in guidance for stock exchanges, investors, and regulators in de- creating and preserving value. The actions of the board to veloping commitment to good corporate governance. Further, ensure recognition of the value of corporate governance the ICGN, the Institute of Business Ethics, and the Institute of throughout the company—and the ways the board fosters Chartered Secretaries developed a report on identifying indi- and mobilizes corporate governance through tools, initia- cators of corporate culture and for identifying warning signs tives, and training—are becoming subject to scrutiny. Com- of poor behavior (ICGN, IBE, ICSA 2015). mitment to corporate governance is demonstrated through policies, processes, and actions to embed corporate gov- ernance in company activities and values—in its culture. Strengthening corporate culture is increasingly seen as a means of reducing risk, especially by Culture is intangible, hard to measure, and different from regulators whose primary focus is to protect country to country and from company to company. Yet it the market and the public from corporate remains a foundation of good corporate governance and “disasters.” involves the board and management team in building and demonstrating it. A corporate governance culture includes (ICGN, IBE, ICSA 2015) norms, mores, traditions, rules, values, and standards of behavior—written and unwritten—for how a company and the individuals within it do business. A good corporate governance culture will have companies following good The European Commission’s recommendation on the qual- governance practices, not just to the letter but also in spirit. ity of corporate governance reporting indicates that report- According to Grant Thornton, nine in ten business leaders ing on corporate governance should improve, especially believe culture is important to a robust governance frame- when there is noncompliance with the relevant code under work, and directors generally agree that it is the board that a comply-or-explain regime. Explanations should describe needs to foster this culture (Grant Thornton 2015). the manner of and reasons for departure, how the decision to depart from the code was taken, when the company envisages compliance with the code, and how it took other actions to meet compliance with the spirit of the code. The governance of individual companies depends crucially on culture. Unfortunately, Increasingly, commitment to corporate governance de- we still see examples of governance failings. velopment and a good corporate governance culture is Boards have responsibility for shaping the observed and measured by a company’s actions in setting culture, both within the boardroom and across the organisation as a whole, and that requires constant vigilance. This is not an easy task. The quality of explanations provided by (FRC 2015) companies when departing from corporate governance codes [is deficient]. In this respect, a large majority of respondents to the Green Paper were in favour of requiring companies to The U.K. Financial Reporting Council pledged to work in provide better quality explanations in case of 2015 to develop best practices in corporate culture, be- havior, values, and ethics and to provide assurance of that departures. culture in the boardroom and throughout companies. The (European Commission 2014b) FRC has been monitoring explanations of deviations from 62 From Companies to Markets—Global Developments in Corporate Governance Corporate Governance Developments: Practice Issues PART B high standards, actively promoting awareness of the im- recognized as valuable and is a focus for the future. portance to the company of good practices, openly assess- Note that diversity includes gender but goes beyond ing those practices (praising good practices and rooting it to include different approaches and perspectives, out poor practices), and exhibiting strong leadership and which together contribute to a robust board and courage in supporting best practices. This can be achieved a resilient company, capable of dealing with an in a variety of ways: increasingly complex environment. • Leadership efforts to set values and principles to • Expectations of increased performance and respon- underpin a corporate governance-aware culture. sibilities will further challenge audit committees to Leadership establishes the tone at the top, acts ac- devote more time to committee activities and cordingly, and fosters a culture of responsibility, to communicating with the internal auditor and accountability, transparency, and fairness. external auditor. • Good corporate governance culture in an entity is • A global trend is to require some board evaluation, set through ethical codes, policies, and practices, with the objective of leading to better practices and creating sound upward-feedback channels, applied board succession planning. Some jurisdictions are consistently even through challenging times. expected to mandate board evaluation and/or report- ing of board evaluations. • Comprehensive and regular communication of expected values and behaviors. • Companies are expected to increase board knowl- edge, time and attention to effective risk oversight • Periodic reviews of practices and the internal culture on an enterprise-wide basis, risk appetite, and the of the organization, including, but not limited to, the development of risk culture. internal auditor. • The role of the internal auditor is changing from that • Regular corporate governance and board evalua- of an internal reviewer/checker of the effectiveness of tion to ensure efficiency and effectiveness of board internal controls to that of a trusted adviser; internal nomination and succession plans and corporate auditors will increase their skills and experience to governance policies, leading to a program of related meet the demands of the new environment. development initiatives, including an assessment of the robustness of discussion, debate, and delibera- • Activities to support an increased focus on company tion in the boardroom. sustainability will continue. That means the board needs a more holistic view that takes into account • Ensuring that a complete corporate governance environmental, social, and economic issues in strate- system is in place in the entity and operating in a gic ways. holistic and linked manner. • Demand for reporting on material nonfinancial • Ensuring and observing cohesion between the three company matters will continue to increase, and key players in corporate governance—the sharehold- models for how to successfully report on these wider ers, the board, and the executive—within an entity, company matters will continue to develop and be including that shareholder engagement is constructive applied. and productive and based on ongoing relationships. • The new audit report style should lead to increased • At a minimum, compliance with the applicable communication between the audit committee and the corporate governance code and stepping beyond external auditor and should encourage better share- this in corporate governance best-practice areas that holder engagement with the board on audit matters. are not regulated by code, such as increased board diversity, quality audit and risk oversight practices, • The effects of auditor rotation and of tendering of comprehensive disclosures, and transparent remu- audits as now required are too new to show an neration practices. impact. • Regulations and practices regarding related-party B.6. Trends and Future Developments transactions and transparency of beneficial owners in Practices are expected to develop further. Observers of corporate governance practices have identi- • There is an increasing focus on corporate culture fied the following trends and future developments: and on development of indicators of good culture • Increased boardroom diversity—including age, and warning signs of a poor culture that may lead to gender, ethnic, background, and experience—is aberrant behavior. From Companies to Markets—Global Developments in Corporate Governance 63 PART C Global Developments in Corporate Governance Codes Corporate governance codes became commonplace in developed and emerging economies from 1992 to 2010, Corporate governance codes of best practice following publication of the Cadbury Report in 1992 are sets of nonbinding recommendations and finalization of the first Combined Code on Corporate aimed at improving and guiding the Governance for the United Kingdom in 1998. In 1999, the governance practices of corporations within OECD issued a set of principles for OECD country appli- a country’s specific legal environment and cation, which also have been more widely adopted. business context. These codes are typically based on principles and focus on country- During this time, several codes were issued and revised, sometimes more than once. The OECD Principles were specific issues. They can differ in their focus or revised in 2004 and again in 2015. The U.K. Combined scope and be more or less detailed. Whether Code was revised and reissued in 2003, 2010, and 2014. intended to restore investor confidence or to South Africa introduced its first corporate governance support a better investment climate, codes of code, King I, and is now looking to introduce a fourth ver- best practice have now been adopted in many sion of the code, King IV. Other countries in the developed countries as a way to introduce international markets and in the emerging economies have adopted and standards and adapt them to the local revised codes of corporate governance. There is much to environment. learn from the experiences of countries as they strive for (IFC/GCGF 2005) better corporate governance though codes. C.1. Stocktaking of Key Issues for Corporate Governance Codes “As a rule, compliance with. . .codes is not mandated by law, but they are important tools for encouraging Originally, corporate governance codes were developed private sector commitment to good corporate govern- as complementary to laws and regulations in the area of ance. . . . To be effective, codes must reflect the level corporate governance. Codes were established and allowed of best practices that can be handled and implemented to be applied in a flexible manner so as not to constrain by a country’s companies, along with a certain level companies in their freedom to realize strategies and create of measured aspirations toward high standards.” value. This flexibility, which became known as a comply- Ralitza Germanova, Corporate Governance Officer, IFC or-explain regime, allowed companies to comply with the code requirements in various ways, and if not, to explain why they had not applied the particular requirement—the backgrounds, and assumptions that countries, companies, most common approach.29 and individuals bring to corporate governance codes. Understanding of and approaches to codes differ accord- In a recent analysis (Berg 2015) of corporate governance ing to the legal traditions and frameworks in which they codes applicable in all countries and a review of all types are set. They also vary according to the perspectives, legal of companies, the World Bank found some 112 codes The comply-or-explain approach allows companies to comply with the corporate governance code or robustly explain why they have not 29 complied and how they have met the goals of the principle. South Africa, on the other hand, requires the apply-and-explain approach, whereby companies must apply the code of corporate governance and explain how they do so—a major difference in approaches. In some countries, such as the United Kingdom and Malaysia, “stewardship codes” have been introduced, which aim to enhance the quality of engagement between asset owners, asset managers, and companies to help improve long-term risk-adjusted returns to shareholders. In the United Kingdom, the code sets out a number of areas of good practice to which the FRC believes institutional investors should aspire. It also describes steps that asset owners can take to protect and enhance the value that accrues to the ultimate benefi ciary. 64 From Companies to Markets—Global Developments in Corporate Governance Global Developments in Corporate Governance Codes PART C applying to listed companies. The analysis of these codes • Addressing perceived shortcomings of the comply- set out to ascertain the various approaches prior to consid- or-explain regime in some environments; ering the question: What does it mean for a code to work? • Identification in local and in other jurisdictions of An initial challenge was to determine what could be new and better practices that countries wish to considered a code. Could it be only those that called introduce; themselves a code, or should other instruments, which are • Changes in laws and regulations affecting corporate not called codes but operate as a code, be included? For governance code provisions, such as changes in EU example, Clause 49 in India is the equivalent of a corpo- laws and regulations requiring changes in member rate governance code even though it is not termed a code, states’ codes; and it is included in the database. • Local issues arising from particular company Of the 112 codes, some 27 were purely voluntary with no problems or local demands; link to regulatory frameworks, 8 were fully mandatory, • Necessity to address shortcomings observed in and 7 countries appeared to have some level of mandatory company responses to code provisions. provisions. All other codes in the database are variations on the comply-or-explain theme that companies and coun- C.3. Mandating Corporate Governance: tries are trying to make work. An Unfinished Debate As the development of corporate governance codes has matured, much time has been devoted to discussion “In our experience, [some ‘comply or explain’ codes] do about distinguishing what should be placed in law or work in different settings, in Latin America with con- regulation and what should be in codes, which have more centrated ownership, with family ownership. . . . What flexible options in application. the paper is trying to do. . .is to look at some of the ways that securities regulators are working to make Many countries have recently revised company, securities, their ‘comply or explain’ codes work better.” and banking laws and securities listing rules to address Alexander Berg, Senior Financial Sector Specialist, issues that had arisen in the particular jurisdiction. Their World Bank rationale for moving an item from a code to law or regu- lation is that it is a matter of importance that cannot be C.2. Regular Reviews of Codes and left to choice or interpretation and so should be man- Frameworks datory. These issues are then removed from corporate Since the financial crisis in 2008, a spate of code revisions governance codes. In general, new and higher standards has emerged to address perceived shortcomings in corpo- have been set. rate governance. Codes have been and are being revised According to Stephen Bland of the BCBS Corporate more regularly, following research, discussion, public con- Governance Task Force, Bank of England, new guidance sultations, and roundtables. Then changes are introduced on corporate governance from the Basel Committee aims after clearly delineating the issues. The website of the at effectively dividing areas between where the BCBS European Corporate Governance Institute (ECGI)30 cites thinks the board of directors needs to ensure things and 14 code revisions since January 1, 2015. Table C.1 on page other areas where it needs to oversee and be satisfied with. 66 provides examples of recent code development. “Oversee and be satisfied with is a slightly higher test than These code developments and the discussions about their oversee, which can imply just to look at,” says Bland. “But development have informed our understanding of the oversee and be satisfied with is our minimum test.” place of corporate governance codes in encouraging better Some jurisdictions have observed that the local environ- corporate governance practices. From the revisions, we can ment is such that companies are not applying the prin- observe issues in code reviews. Consultation documents ciples established in codes, and legislators and regulators and field experience indicate that the revisions have been believe they will do so only if the matter is legislated or prompted by the following: regulated. However, finding the balance and appropriate • Adjustments made to better balance the corporate mix of law and regulation and “soft law” or code appli- governance requirements in law, regulation, and codes; cation is challenging. 30 c nonprofi The ECGI, an international scientifi t association, provides a forum for debate and dialogue between academics, legislators, and prac- titioners, focusing on major corporate governance issues and thereby promoting best practice. Its primary role is to undertake, commission, and disseminate research on corporate governance. Information on ECGI work may be found at www.ecgi.org. From Companies to Markets—Global Developments in Corporate Governance 65 PART C Global Developments in Corporate Governance Codes requirement to have accounts audited or that an auditor Codes are typically ‘soft law’—companies are must be appointed or that notices for the AGM must go not required to implement the rules, but are out by a certain number of days prior to the AGM are required to disclose to the market when they issues almost always placed in law or regulation. These do not do so (the so-called ‘comply or explain’ matters have to be complied with in all circumstances. approach). This approach has a number of benefits in terms of flexibility for listed However, that the roles of chairperson and CEO should companies, in that it allows and encourages be separated is likely to be in a code, because there may an appropriate balance for different types of be circumstances where separation is not possible or not desirable, such as when a CEO departs or there is a crisis. companies. There are other similar issues. For example, whether—and (Berg 2015) the conditions under which—boards should establish board-level risk committees needs to be flexible. Similarly, It is difficult to distinguish what should be in a code from the principle that a chief executive should not go on to what should be in law. There are some areas where the mat- become chairperson of the same company is a good one, ter clearly should be in law or regulation. For example, the but it may not always be right in practice. Table C.1: Code Revisions Country / Economy / Organization Date Nature of Activity OECD – CG Principles Sept. 2015 Revised and reissued OECD – SOE Guidelines Sept. 2015 Revised and reissued ICGN – CG Principles Oct. 2014 Revised and reissued Australia Mar. 2014 Recommendations revised Brazil Nov. 2015 IBGC Brazilian Code revised (5th edition) Bulgaria Feb. 2012 Revised and reissued Canada Jan. 2013 Guideline reissued Denmark Nov. 2014 Recommendations revised France June 2013 Listed entities code reissued Germany June 2014 Code amended Hong Kong SAR, China Dec. 2014 Revised code Italy July 2014 Code revised and reissued Japan June 2015 First code introduced Kenya May 2016 Code revised and gazetted Netherlands May 2015 Revision announced Norway Oct. 2014 Code revised and reissued Singapore May 2012 Code revised and reissued South Africa Jan. 2016 Code revision ongoing Spain Feb. 2015 Code revised and reissued Sri Lanka Sept. 2013 Code revised and reissued Sweden Sept. 2015 Draft revised code issued Switzerland Sept. 2014 Code revised and reissued Turkey Jan. 2014 Code revised and reissued United Kingdom Sept. 2014 Code revised and reissued Source: Based on information available at www.ecgi.org. 66 From Companies to Markets—Global Developments in Corporate Governance Global Developments in Corporate Governance Codes PART C principal/agent problem is different. In particular, it is “I think what is suitable for a code is behaviour where an issue when family groups or governments spin off sub- you are looking for a gradual change over time, an sidiaries to avoid transparency and to avoid relinquishing innovation. I will give an example. Board evaluation ultimate control. The corporate governance community came into the UK CG Code gradually and the result is aware of these issues, which are reflected in the fol- was that over time we have seen the beginnings of an lowing discussion, yet it remains without comprehensive industry that is able to evaluate boards. . . . It is not solutions. possible to suddenly say all boards should be evaluated by an external evaluator because there may be nobody C.3.2. Jordanian Securities Commission: to do it. Through the code process you can guide and A Regulator’s View steer practices.” For many years, Jordan has been on a program of capital market reforms, heightened in recent times, especially Peter Montagnon, IFC Corporate Governance Private Sector since 1997, under a restructuring process. The corporate Advisory Group and Associate Director, Institute of Business Ethics, United Kingdom governance changes commenced with the issuance of a 2004 corporate governance Report on the Observance of Standards and Codes (ROSC) based on the OECD C.3.1. Example: Audit Committees Principles. In response to the ROSC recommendations, the Various commissions and inquiries (such as the 1999 Blue Amman Stock Exchange introduced a code of corporate Ribbon Commission and the Sarbanes-Oxley Act of 2002 governance that contained both mandatory and voluntary in the United States and the 2004 Higgs review in the provisions. Mandatory provisions were based on laws United Kingdom)—often held after fraud cases such as and regulations. The voluntary provisions were based on Polly Peck, Enron, Royal Ahold, and Parmalat—expanded international practices and international standards. The the expectations of the audit committee. Now having an voluntary implementation used the comply-or-explain audit committee is a widespread and accepted practice. approach to allow flexibility and to familiarize companies Audit committees are mandated through laws and regula- and their management with the new rules of corporate tions in many jurisdictions. According to the OECD, more governance and create a culture of corporate governance than two-thirds of jurisdictions require listed companies in the market, since this concept was new. to establish an independent audit committee, and a full or Lessons learned from implementation demonstrated to majority independence requirement is common (OECD capital market regulators the reluctance of companies 2015b). to apply better practices. The regulators concluded that change to a mandatory approach was necessary, because “The notion of audit committees is not new and was the Jordanian corporate governance culture is still emerg- introduced into a code first and then into several other ing. Resistance came from family-dominated companies, national codes until audit committees became a com- particularly with regard to cumulative voting rights, monplace mechanism of corporate governance, now related-party transactions, the separation of the chair and often required in law. Especially in the last quarter of CEO roles, and board committees. Jordanian companies the 20th century, audit committees came to an under- do not want outsiders on the board or mechanisms that standing of their role and developed expertise for that may touch benefits from the company. role.” Anne Molyneux, ICGN Board The Jordanian Securities Commission has tried many ways to build understanding of the value of corporate governance, including in family-owned companies. For Increasingly, the relevance of a code-based, comply-or- instance, the JSC held educational workshops and semi- explain approach to markets where there is a high level nars on the benefits of corporate governance and to build of family ownership will be reviewed. Codes are relevant awareness of the code and its provisions. These initiatives and useful in dispersed-ownership markets, but experience met with resistance. The JSC instituted a scorecard system shows they do not work so well elsewhere (see the discus- especially for banks to increase awareness of corporate sion below on the Jordan and Turkey experiences). Code governance provisions, rules, and practices and to assess content needs to be adapted to suit the ownership circum- the level of corporate governance implementation in the stances and to include more focus on the risk that share- banking sector, but family-dominated banks still resist. holders will be expropriated by the controlling shareholder In 2014, the Central Bank of Jordan issued a mandatory rather than being expropriated by the management. The code of corporate governance. From Companies to Markets—Global Developments in Corporate Governance 67 PART C Global Developments in Corporate Governance Codes The JSC established an independent unit to follow up com- panies’ implementation of and compliance with corporate “Currently in Turkey, we’re debating the effectiveness governance provisions. One of the main challenges the of that because it [mandatory regulation] doesn’t Jordan Securities Commission faced concerned voluntary talk much about the effectiveness of executive rela- rules. The commission does not have the power of law to tionships, such as the quality of the board meetings enforce compliance or sanction noncompliance. The JSC and the independent board members. The regulation dealt with this by making amendments to the law. Even doesn’t say anything about those, so we were thinking so, some companies resisting the introduction of corporate the scorecard can be the solution. Of course, this only governance code provisions argue that they contradict applies to the publicly traded companies where we can Company Law. These alleged contradictions are currently demand more information for the interests of share- under review, with a recommendation to enhance the holders.” powers of the JSC for corporate governance development, Basak Mustu, Corporate Governance Association, Turkey monitoring, and enforcement. The goal is to make applica- tion of corporate governance codes provisions mandatory. Turkey has a similar problem as Jordan with resistance of The experience in Jordan indicates that guidance, encour- family-owned companies to implementing good corporate agement toward good practices, and a voluntary code is governance practices. Recent research on corporate gov- sometimes insufficient. It does appear that there is more ernance in family businesses found that about 80 percent work to be done to develop awareness of the benefits of understand the advantages of corporate governance but corporate governance and implementation of corporate believe that it is not mandatory for them, or does not con- governance codes in Jordan. stitute an urgency for the company in the short term. They do understand the use of corporate governance and that “Our mechanism will move to mandatory [code ap- it is good for the company and improves decision mak- plication]. We realized that companies will not com- ing. However, half did not comply with the requirement ply unless you have mandatory power and you have to have an independent director. Generally, they remain to oblige these companies and impose sanctions on reluctant to share power, have no family constitution, and noncompliance. Less than 50% actually of companies have not considered how the company will pass to the next complied with the [voluntary] provisions of the code.” generation. Mazen Wathaifi, Commissioner, A United Kingdom View Jordanian Securities Commission Some jurisdictions have the luxury to assume deep knowl- edge of and commitment to corporate governance by both companies and regulators. They also operate in a market C.3.3. Turkey: Use of Scorecards to Encourage that has dispersed shareholders and is structured different- Implementation ly from many emerging markets. The United Kingdom is In Turkey, many elements of good corporate governance one with a diversified share ownership and with a longev- have been made mandatory, but Turkey is finding that ity in the benefits of corporate governance. However, the even this is not enough, as implementation of the non- mandatory principles is still an issue. Most of the time, the substance of a company’s disclosure—on how to address these principles that the company has failed to “We had the same example in Germany [as in Turkey implement—is unsatisfactory and repetitive. A scorecard and Jordan] where we had items that were very impor- may be required to encourage better corporate govern- tant. We tried to solve them via the code, via comply ance culture for the publicly traded companies. or explain. Companies just didn’t comply satisfactorily and the issues were legislated. That’s a missed oppor- The code in Turkey has both mandatory and nonmanda- tunity for many important governance items where, in tory rules. Most mandatory rules in Turkey are about most countries, to get a law passed takes a long time. board disclosure requirements and general assemblies. So legislating isn’t the preferred way but if companies The code states the minimum number of independent don’t want to listen, that’s what they get.” board members, the number of committees, and which Christian Strenger, Deputy Chairman, committees are mandatory. Also in the code is Turkey’s IFC Corporate Governance Private Sector Advisory Group and definition of an independent director, which must be Academic Director, Centre for Corporate Governance, HHL Leipzig applied. 68 From Companies to Markets—Global Developments in Corporate Governance Global Developments in Corporate Governance Codes PART C situation with Jordan and Turkey suggests that in corpo- corporate governance code recommends up to 50 percent) rate governance one size does not fit all, especially in the and representatives of shareholders. The changes in corpo- presence of family-owned companies and/or where there rate governance approaches in SK are a part of a national are controlling shareholders. program to become one of the top 30 developed nations of the world by 2050, an ambitious transformation program A View from Germany of SK, launched by the president of the country on October Not all developed economies have a favorable environment 6, 2014. for a comply-or-explain approach to codes. If elements of the market such as family companies do not want to listen, In 2014, SK, with assistance from the OECD, developed then maybe a mandatory approach is the way, at least for a corporate governance code that applies to SK and to the important items. companies where SK has more than 50 percent interest, di- rectly or indirectly. The code consists of seven chapters and C.3.4. West Bank and Gaza: A Nonmandatory two parts: Main Principles and Annotations—rules and Approach provisions that will force implementation of the code. The The corporate governance code of West Bank and Gaza code includes chapters devoted to 1) interaction between was introduced in 2009 and is a hybrid code composed of SK and the government as shareholder of SK; 2) clarifi- both mandatory and voluntary rules. The mandatory rules cation of the relationships between SK and its portfolio in the code are already stated in other laws and regula- companies; 3) sustainable development; 4) shareholders’ tions. Local regulators believe it is very difficult to move rights; 5) board and executive management effectiveness; to a fully mandatory code, as there is concern regarding 6) risk management, internal control, and audit; and 7) how the application of the code should be monitored and transparency. Since government is the sole shareholder of by whom. Corporate governance is seen as a competitive SK, the code made clear the relationships with the govern- advantage to companies that apply the code well. If the ment, between the government and the board, and between code is made mandatory, this capacity for a competitive the board and Samruk-Kazyna. It also clarified the direc- edge is removed. tor nomination process for the board of directors and for CEOs of portfolio companies. “As a regulator, there is the reputational risk of monitoring many corporate governance issues, “We had discussions about comply or explain. Our some mandatory and some voluntary, and there is normal practice is to put compulsory items in legisla- the practical problem of enforcement. I think it’s tion. We decided to use the comply or explain approach better to leave room for competition between in the code. The code was approved by the government companies to develop best practices in corporate in April 2015.” governance in their companies.” Salamat Kussainova, Director, Bashar Abu Zarour, Director, Research and Development, Corporate Governance, SWF Samruk-Kazyna Palestine Capital Markets Authority SK is a member of the International Forum of Sovereign C.3.5. Kazakhstan: A Sovereign Wealth Fund View Wealth Funds, which has agreed that its members will ap- of “Comply or Explain” ply the Santiago Principals of governance, issued in 2008, Samruk-Kazyna (SK), the sovereign wealth fund of Ka- in the way they operate as an institutional investor. There- zakhstan, was created in 2006 to improve the efficiency fore, when drafting a corporate governance code, Samruk- and effectiveness of industrial state-owned companies, Kazyna had to ensure the code’s alignment and compliance mostly oil and gas companies, and companies in transpor- with the Santiago Principles. tation, communications, electricity production and distri- bution, mining, and chemicals. The SK group included 593 companies in 2014, according to the annual report for that C.4. Diverse Approaches: Is “Comply or year. SK has its own law, “On National Wealth Fund,” ap- Explain” Appropriate? plicable to it and its group (KazTransGas Aimak 2015). Discussion on the effectiveness of the comply-or-explain model for corporate governance codes commenced in The prime minister chairs the board of SK, and 40 percent 2008, and in 2009, Riskmetrics published a report indicat- of its members are independent. The boards of SK port- ing its appropriateness. Yet the debate continues. In the folio companies comprise independent directors (the new discussions for the development of the Shareholder Rights From Companies to Markets—Global Developments in Corporate Governance 69 PART C Global Developments in Corporate Governance Codes Directive in the EU, the effectiveness or otherwise of the For example, Portugal revised the mandatory Corporate comply-or-explain model for corporate governance appli- Governance Code in 2013, and the new regulation em- cation within Europe received much attention (EU 2014).31 phasized the importance of comply-or-explain provisions. However, the CMVM32 reports that in 2011 only “53% of Companies often do not provide adequate the non-compliance with the ‘comply or explain’ rules is explanations. This makes it difficult for explained by the company and accepted by the CMVM” investors to make informed investment (Glass Lewis 2013). The new regulation brings the comply- decisions. or-explain provision to the forefront, outlining an accept- able explanation and level of compliance. (European Commission 2014d) The Netherlands has established a corporate governance Despite gradual improvement in the way companies in code monitoring committee and in 2013 for the first time EU member states apply corporate governance codes, reported on compliance with the Dutch corporate govern- perceived shortcomings persist in the application of the ance code and on the quality of explanations for deviations comply-or-explain principle. Some observers see it as inef- from the code where given. fective because of the poor quality of explanations and because it provides a rather soft option, which proved in In February 2012, the Financial Reporting Council in the the financial crisis that it could not be trusted. United Kingdom issued a guidance paper, “What Consti- tutes an Explanation Under ‘Comply or Explain,’” which One result of this ineffectiveness was a demand for more is the subject of monitoring in 2015. prescriptive regulation. Directive 2013/34, the Accounting Directive, included such regulation. It prescribes the for- mat for disclosure for big companies, listed or nonlisted. “I would like to remind both companies and investors However, the debate also led to an expectation that the that simply complying without giving due consider- comply-or-explain regime will be the subject of guidance to ation to what is appropriate and relevant reduces the improve the quality of explanations, especially ones related flexibility that this approach aims to achieve. To this to deviations. It is expected that explanations will be suffi- end, further work will be conducted during the rest of ciently informative and clear and should do the following: this year to monitor companies’ explanations when • Explain the manner in which the company deviates; they are not compliant with the Code.” • Describe the reasons; Win Bischoff, FRC UK Chairman (at the Grant Thornton Governance Dinner, May 1, 2015) • Describe the decision process; • Specify the timing; and • Describe the measure taken instead of compliance. The message is that explanations need to be more robust and will be subject to scrutiny in the future. Despite all the In Europe, member states must define their corporate discussion on the comply-or-explain regime, it will contin- governance monitoring systems to ensure adequate code ue in its current state. While most countries have adopted adherence and explanations. Several EU member states the comply-or-explain approach to corporate governance have revised their corporate governance codes and/or codes, its true meaning has been diversely interpreted. issued guidance on how to apply a comply-or-explain Which is the “right” or most effective approach? Practice regime well and are monitoring code application. suggests there is no one right way to implement or apply codes of corporate governance. “The comply or explain practice accommodates the Countries and companies may have been under a misap- wide diversity of business models operating across the prehension regarding comply or explain. It really means to many legal jurisdictions that make up the European comply with a code and apply its principles or to explain Union.” why the principle has not been applied. Yet the debate over Patrick Zurstrassen, IFC Corporate Governance Private Sector the right approach to comply or explain has persisted. Advisory Group and Honorary Chair, ecoDa The Dutch in the Tabaksblat Report moved on to an 31 nancial statements and related reports include a corporate governance statement that refers to the Directive 2013/34/EU requires that annual fi corporate governance code applied and provides an explanation of which parts of the code the entity departs from and the reason for doing so. 32 The CMVM is the Portuguese Securities Market Regulator. For more information, see www.cmvm.pt. 70 From Companies to Markets—Global Developments in Corporate Governance Global Developments in Corporate Governance Codes PART C apply-or-explain approach, and King III in South Africa monitoring and enforcement of code application is varied. followed the Dutch tradition to ensure clarity on the need Further, explanations when provided have been of a range to apply the principles of the codes. The United States has of quality, depending on the level of company commitment gone rather further into a comply-or-else approach by to corporate governance transparency. introducing legislation and regulation for key corporate governance areas; the Sarbanes-Oxley Act of 2002 and the Recent diagnostic work and discussions with Dodd-Frank Wall Street Reform and Consumer Protection client country counterparts indicate that Act of 2010 have regulated many corporate governance there is considerable dissatisfaction with practices and disclosures. In Germany, company law re- the practical implementation of corporate quires an annual statement of compliance with the German corporate governance code. governance codes in many countries, and significant experimentation by securities Throughout the United Kingdom and Europe, there has regulators around the world who are been intense debate on the effectiveness of the widely working to improve the quality of code used comply-or-explain regime for code application.33 In implementation. particular, the EU wants a set of regulations that uniformly (Berg 2015). regulates company law and corporate governance at the supranational level, a goal at odds with a code allowing flex- ibility of application. ecoDa (the European Confederation of C.5. Code Principles, Practices, and Director Associations) recognizes the importance of corpo- Effectiveness rate governance and of the comply-or-explain mechanism to The debate on how to achieve an outcome of better and promote good governance and published in 2015 its report more effective corporate governance continues. Some on practices in the EU under comply or explain (ecoDa/Ma- recommend that codes not become too detailed or com- zars 2015). Box C.1 provides excerpts from the report. plex and remain at the principle level, allowing for diverse company and country approaches. Others suggest that more code provisions should be included in regulations to Box C.1: Excerpts from the ecoDa/Mazars ensure application and that more guidance to support ap- Report plication is required. Still others question the validity of a comply-or-explain-style code in the presence of controlling Although adaptations to code requirements might shareholders. have taken longer than anticipated to occur, there seems to be a clear trend throughout Europe that compliance is increasing, be it at a different degree “The principles should almost be motherhood and from one Member State to another, with overall a apple pie statements. . . . The principle is so obvious cant difference between the larger companies signifi and must be followed. . . . Then. . .an organization that lead the pack and the small and mid cap listed [must] explain how you are applying the principle.” companies. Chris Pierce, Global Governance Services We fully agree with the statement of the EC that more attention should be given to the promotion of high A principle might be that the responsibilities and account- quality explanations as a critical success factor for an abilities within the organization should be disclosed. If effective self-regulatory regime. then this is the nature of the principle, the guidance will mention documents referring to it, such as the articles and Source: (ecoDa/Mazars 2015). memorandum of association and the board charter, and these documents should be disclosed. An organization Applying the comply-or-explain principle poses some ques- chart would also be required. tions and presents some difficulties in achieving harmoni- zation, as there may be diverse code provisions at a nation- In developed markets, it is often acceptable to apply princi- al level, application may be voluntary, and provisions may ples, as opposed to more detailed rules in codes. However, not be explicit as to how to apply the provisions. Also, some practitioners with emerging-market experience report 33 This has been the subject of several papers, including EU research into how EU member states apply the comply-or-explain concept, resulting in the EU recommendation on the quality of corporate governance reporting, Recommendation 2014/208/EU, FRC UK, Comply or Explain. Also, an essay for the 20th anniversary of the U.K. Combined Code, 2012, and an ICAEW article ask, “When is comply or explain the right approach?” From Companies to Markets—Global Developments in Corporate Governance 71 PART C Global Developments in Corporate Governance Codes that using principles instead of detailed rules is not always to the stated practice in King III regarding independent a successful approach. directors may result in a majority of independent direc- tors who are not able to challenge management effectively. “Emerging markets need guidelines for applying the Industry knowledge is sometimes sacrificed in the name principles. . . . I think to update them and to make of independence; therefore, independent directors may them really future proof, you need guidance.” not have sufficient knowledge of the business. This is not a desirable outcome, but it would fulfill the code require- Christian Strenger, Deputy Chairman, ments—a box-ticking exercise. South Africa in drafting IFC Corporate Governance Private Sector Advisory Group King IV wishes to move on to a code based on principles and outcomes and less focused on practices. Below are some examples of different experiences with the comply-or-explain concept in practice. “Differentiating very clearly between what is a prin- C.5.1. Kenya: Law and Regulation versus Code ciple and what is a practice can actually help us be rid under Comply or Explain of the mind-set of box ticking in corporate governance. It is helpful to learn from the experience of Kenya in its At the moment we implement the practices and say we comply-or-explain debate. The Capital Markets Authority, have good corporate governance. If you have principles established in 1989, had led many corporate governance that are setting out objectives to achieve sound cor- initiatives, one of which included the introduction in 2002 porate governance in place, then it is not about input of corporate governance guidelines similar to a code. Re- (practices implemented). It is rather about whether the cent activities show that Kenya is distinguishing between objective and desired outcome has been achieved.” elements that should be in law or regulations and other Ansie Ramalho, matters to be placed in a code. King IV Project Lead, Institute of Directors in Southern Africa Between 2012 and 2014, Kenya moved toward putting in place a corporate governance code with World Bank and C.5.3. Comply or Explain in the Presence IFC support. The code was finalized in April 2016. In the of Controlling Shareholders process, Kenya realized that it did not want to put all the It also is useful to think of the practicality of comply or explain corporate governance requirements on an apply-or-explain where you have controlling shareholders. Its effectiveness in basis. Code provisions of high importance were put into markets where controlling shareholders prevail is limited by the corporate governance regulations. The code will be on an very power of controlling shareholders in the company. apply-or-explain basis, and essential provisions will be in the public offers and listing regulations on a mandatory basis. Kenya wishes to move corporate governance from C.6. Different Types of Codes versus box-ticking to effectiveness. a Standardized Approach As codes have come into wider use, diverse code types have blossomed. There are now codes for listed entities, for “One of the recommendations in the corporate gov- banks and financial institutions, for family-owned com- ernance code is the need for institutional investors to panies (listed and unlisted), for small businesses, and for actively participate in management. The code calls for state-owned enterprises. Each of the codes in Table C.2 has the establishment of a stewardship code for institu- a particular subset focus. tional investors—that is work in progress.” Given the breadth of entities that corporate governance Hillary Cheruiyot, Legal Officer, Capital Markets Authority, Kenya codes may apply to, it is not surprising that there would be interest in achieving some uniformity or standardization of codes. Recently, a few countries have looked into develop- C.5.2. South Africa: Principles versus Practices ing one code that is applicable to a variety of companies The South African King III Code current principles include (listed, unlisted, banks and financial institutions, small, that the board should consist of a majority of non-execu- family-owned, or state-owned). For example, Mauritius tive directors, a majority of whom are independent. This and Nigeria have been attempting to bring some standard- is not really a higher-level principle but rather a detailed ization to codes and corporate governance application practice. The real goal is to achieve a balanced and effec- across diverse types of companies and sectors. Such an tive board—the higher-level principle. In reality, adherence approach presents challenges, as discussed below. 72 From Companies to Markets—Global Developments in Corporate Governance Global Developments in Corporate Governance Codes PART C Table C.2: Codes with a Subset Focus Country / Organization Date Nature of Code OECD 2015 SOE Guidelines Basel Committee 2015 Corporate Governance Guidance for Banks and Financial Institutions Global organization 2012 nance Institutions Practice of Corporate Governance in Microfi Australia 2013 Corporate Governance Guidance for Charities Brazil 2014 Good Practices for Closed Societies Brazil 2015 Corporate Governance Guide for Cooperatives Baltic States 2010 Corporate Governance Guidance for Government-Owned Enterprises Colombia 2009 Corporate Governance Guide for Closed Societies and Family Companies France 2009 Corporate Governance Code for SMEs Ireland 2013 Corporate Governance Code for Credit Institutions and Insurance Undertakings Nigeria 2014 Corporate Governance Code for Banks and Discount Houses United Arab Emirates 2011 Corporate Governance Code for SMEs Source: Molyneux, 2016. large public companies, state-owned enterprises, and large “Principles are regarded as being of a higher order private companies. All other companies should give due than practices. All public interest enterprises (PIEs) in consideration to the principles of the code and disclose in Mauritius will be required to apply all of the principles their annual reports the extent to which they have applied contained in the Code and to explain in their annual the principles. reports how these principles have been applied.” Chris Pierce, The benefits of this approach are that it is believed to be Global Governance Services easier to understand and simpler in style. The apply-and- explain approach allows for flexibility of application in diverse company circumstances. By focusing on principles, Example: Mauritius Experience the code can be more concise and succinct.34 However, for The Code of Corporate Governance of Mauritius, pro- those entities requiring some guidance or support for code posed in 2015, is believed to be the first code that takes a explanation or implementation, this may yet prove new approach to corporate governance. It has an emphasis challenging. on corporate governance principles that can be applied by a wide variety of entities and clearly distinguishes C.7. Code Application Monitoring, principles from practices. Enforcement, and Scorecards In general, some monitoring of corporate governance In short, this is an apply-and-explain approach to a corpo- codes has emerged. Recent OECD research (OECD 2013a; rate governance code, which has standardized the corpo- OECD 2014a) into monitoring and enforcement arrange- rate governance principles to be applied to several catego- ments for corporate governance—especially in listed ries of companies in Mauritius. The principles of the code entities, across 27 jurisdictions participating in the OECD must be applied by all entities that come under the follow- corporate governance committee—illustrates this point. ing definitions: companies listed on the Stock Exchange of Mauritius, banks and nonbank financial institutions, It is important to note that those issuers of national 34 The draft Mauritian Code is available at http://tinyurl.com/nhw3c42. From Companies to Markets—Global Developments in Corporate Governance 73 PART C Global Developments in Corporate Governance Codes are several steps to successful monitoring and enforcement. At least 29 institutions in 24 jurisdictions Below are some examples of “a start.” issue a national report reviewing adherence Example: Latin America to the corporate governance code by listed In Latin America, the use of questionnaires provides a basis companies in the domestic market. National for monitoring and enforcement. Requiring companies to regulators review and publish such reports complete a questionnaire—rather than making a single in 10 jurisdictions, 8 of which review and statement—about compliance encourages companies to publish the report regularly, at least annually think; it encourages them to take note of specific provisions or once in two years. Approximately half of the where they may not be in compliance. In Colombia, compa- jurisdictions adopting the ‘comply or explain’ nies produce a report based on their code disclosure state- system have established a formal mechanism ments. It shows what’s working and what’s not working and under which national authorities regularly provides good and useful information for regulators. analyse and report regarding listed companies’ disclosures on adherence to the code. “IFC has been successfully instrumental in incentivising (OECD 2015b) corporate governance change through the development and application of national scorecard assessments of corporate governance code application.” corporate governance reports may be public institu- Ralitza Germanova, Corporate Governance Officer, IFC tions, including regulators, or other private institu- tions. Nineteen jurisdictions have national regulators IFC has delivered several programs related to implemen- that monitor and report on their activities with regard tation of corporate governance codes and scorecards to to corporate governance. France, Hong Kong SAR, assess implementation. Scorecards are a way to encourage China, Italy, the Netherlands, Singapore, Sweden, and compliance, assessing companies’ governance practices and the United Kingdom are some of the countries and providing opportunities for systematic improvement. In economies that regularly review and report on corporate 2005, IFC published a toolkit that sets out a step-by-step governance code adherence. approach to develop, implement, and review a corporate However, the coverage and frequency of monitoring governance code. A supplement on building scorecards was reports varies significantly across jurisdictions. Experi- published in 2014.35 IFC has undertaken 15 scorecards ence of the World Bank in emerging markets, especially since 2008 and supported 45 code development projects through its ROSC program, finds that monitoring and out of 95 codes, laws, and regulations developed with IFC enforcement of corporate governance and corporate gov- support in 30 countries. ernance disclosures is less than in the developed countries. “In Vietnam, IFC provided technical support to three Some countries and regions are trying to enforce codes corporate governance scorecards between 2009 to and code requirements through the use of question- 2012, which assessed corporate governance in listed naires, scorecards, awards, and other mechanisms. There companies. The scorecard reports led to reviews of legislation and regulations related to corporate govern- “Many regulators, especially low capacity regulators, ance, amendments in 2012 to the corporate governance don’t really enforce corporate governance code require- code, and to disclosure rules. Scorecards are a most ments and because it’s not enforced, attempts by com- effective tool to promote change.” panies to understand and be aware of good practices Anne Molyneux, ICGN Board are diminished. Requirements to comply or explain will encourage companies to at least make the initial disclosure, even if that disclosure is not very good, even Example: The ASEAN Regional Corporate if the comply or explain statement is not very appropri- Governance Scorecard ate. It’s a start.” The ASEAN corporate governance scorecard is a joint Kiril Nejkov, Corporate Governance Officer, IFC initiative of the ASEAN Capital Markets Forum and the Asian Development Bank. It covers the five areas of the 35 IFC work on Corporate Governance Scorecards, including a toolkit and a supplement is available at: http://tinyurl.com/zmffzw5. 74 From Companies to Markets—Global Developments in Corporate Governance Global Developments in Corporate Governance Codes PART C OECD 2004 Principles. Six countries—Indonesia, Malay- “Many countries find it difficult for a securities regula- sia, the Philippines, Singapore, Thailand, and Vietnam— tor, both legally and culturally, to intervene in a com- participate in this initiative. The corporate governance pany, to interview them on CG matters. In Indonesia scorecard provides a common benchmark on the corpo- for example, the securities regulator inspects compa- rate governance practices within the ASEAN region and nies—approximately one-third of the listed companies allows country-to-country comparability. Most countries every year. Most countries’ regulators do not have that have shown improvement in corporate governance prac- power, intention or level of resources to undertake that tices over the period. kind of active investigation.” To date, there has been healthy transparency and a Alexander Berg, Senior Financial Sector Specialist, little international competition in corporate governance World Bank improvement. As of 2015, the plan was to publish the 50 ASEAN listed companies with the best corporate governance scores. Scorecards throughout Asia have In general, monitoring and enforcing corporate governance been a positive impetus for corporate governance change. is difficult (OECD 2013a)36 and is likely to remain so, be- National scorecards, the forerunners of the ASEAN score- cause so many corporate governance practices are internal card, were successful in achieving change in the corporate to the company and are therefore unobservable externally governance regulatory frameworks and in getting cor- or verifiable from disclosure regimes. Many of those who porate governance on the companies’ agendas. However, monitor corporate governance do not have the capacity, the reaction to the scorecard system in ASEAN is not all time, or resources—and sometimes the right, as exists for positive. banking regulators—to go into a company, develop rela- tionships with company directors, observe board workings, and inspect the actual working of corporate governance “Some companies complain that the requirements of within that company. To verify the application of comply- the ACGS [ASEAN scorecard] are more than what is or-explain codes remains a problem. Lack of priority for currently required by the rules, laws, or regulations of monitoring and enforcement of corporate governance is the Philippines. So they say they have difficulty com- explained thus: plying and sometimes they feel that it is impossible for them to comply with the best practices espoused • Some countries do not have a designated public author- by the scorecard. The most challenging philosophy for ity for corporate governance oversight as exists in the companies to understand is that corporate governance Financial Reporting Council in the United Kingdom. requirements really would go beyond the requirements • In emerging markets, there appear to be challenges in of national legislation.” funding corporate governance monitoring and enforce- ment, either by public or private institutions. It is an R. C. Austria, Securities Counsel, Corporate Governance Division, expensive business to produce a report. Not all coun- Securities Commission, the Philippines tries can afford to do so. • In monitoring and enforcing corporate governance C.7.1. Code Monitoring code practices, regulators may face reputational risks It is important to take into consideration the possible as well as resource constraints. negative aspects of reporting on the outcomes of cor- On the positive side, monitoring and enforcement—as seen porate governance monitoring and enforcement activi- through the use of scorecards—have led to the following: ties. For instance, regulators may report that corporate governance in a particular company is “good,” and then • Heightened awareness and greater visibility of provi- that company rated with “good corporate governance” sions and better practices; may have a major and public corporate governance • Greater investor insight into corporate governance in failure. This then could lead to considerable reputational potential investees and investee countries; risk for the assessing institution, particularly if it is a • A systematic way to review corporate governance regulator. developments within companies and countries and across regions; 36 nds that a lack of independence and/or resources constrains the ability of many securities regulators to supervise and The OECD review fi enforce corporate governance standards. From Companies to Markets—Global Developments in Corporate Governance 75 PART C Global Developments in Corporate Governance Codes • More integration and harmonization of laws, regu- This subject has been increasingly included in corporate lations, and codes for better corporate governance governance codes. implementation; • Companies motivated to enhance their corporate gov- The corporate governance framework ernance practices beyond the minimal requirements of should recognise the rights of stakeholders laws and regulations; established by law or through mutual agreements and encourage active co- • Engagement of shareholders and stakeholders in the corporate governance debate through roundtables and operation between corporations and discussions on the results; and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises. • Assessment of corporate governance progress year to year. (OECD 2015a, Principle IV) C.7.2. Code Reviewing Behind this high-level Principle (G20/OECD Principle In the absence of consensus on how to effectively monitor IV) stands an increasing awareness of the importance of and enforce corporate governance code application, some sustainability, and sustainability thinking, to the long-term countries are reviewing what should be mandated in law success of companies, as it also relates to the success of the or regulation. Important elements are being moved to law whole civilization. or regulation. Some countries are moving away from the comply-or-explain regime completely. Others are moving Some codes addressed the need for greater nonfinancial the other way. information for investors and are now incorporating Example: Mexico sustainability/ESG issues—a set of issues that have a mate- Mexico is one of a few countries that actually completely rial impact on the long-term success of the company and, got rid of its comply-or-explain code, because it moved so potentially, investment returns. Companies are including many provisions into a Company Law in 2008 and consid- consideration of ESG issues in their business model, par- ered the code in its old form as no longer necessary. This ticularly in their thinking on strategy and risk. may be a false choice, as codes exist because you cannot always mandate all corporate governance provisions. C.8.1. The Banking Sector As recently as 2007, ESG or sustainability was still dealt Example: The Philippines with separately from corporate governance, even if the two The Philippines is set to come out with a new code of had become progressively more overlapping. Since then corporate governance by 2016 wherein it will shift to the law and regulations and national corporate governance comply-or-explain approach entirely. At present the code codes have referred increasingly to sustainable develop- is composed of both mandatory provisions and voluntary, ment matters, moving to an integrated corporate govern- advisory, or directory provisions. ance view. No one approach is deemed appropriate for all environ- ments, and debates still continue on the efficacy of the “There are three areas where we do regard banks’ direc- comply-or-explain regime. Whatever the approach, the key tors as being responsible individually to ensure delivery is that it be monitored and publicly reported to encour- of corporate governance elements. Those three areas age corporate governance development and to ensure that are bank strategy, agreement of the bank’s risk expo- the philosophy of the corporate governance framework is sure and the tone from the top of the Board of Directors adhered to. on risk culture and sustainable development.” C.8. Integration of Sustainable Stephen Bland, Development/ESG into Codes BCBS Corporate Governance Task Force, Bank of England As the global commitment to sustainable development continues to trend upward on the agendas of governments and private enterprise, the requirements also escalate for The British Companies Act 2006 requires directors “to act transparency on ESG37 or responsible investment issues. in the interests of shareholders, but in doing so, have to 37 Many terms are used to describe sustainable development. Each is slightly different from the others and alone could be the subject of another whole paper. Terms such as ESG, CSR, and CR are not directly interchangeable or identical. For simplicity, this part of the report uses “ESG” or ect all components of these terms. “sustainability” to refl 76 From Companies to Markets—Global Developments in Corporate Governance Global Developments in Corporate Governance Codes PART C pay regard to the longer term, the interests of employees, style of these disclosures, and companies may use interna- suppliers, consumers, and the environment” (UK 2006). tional, European, or national guidelines in fulfilling these responsibilities. Table C.3 provides examples of various The EU in its 2014 directive on nonfinancial and diversity regulatory and code approaches to ESG and corporate information requires large public interest companies with governance. more than 500 employees, about some 6,000 companies, to disclose information in their annual reports on policies, The investor community, driven largely by the interests of risks, and outcomes on environmental and social issues. their clients and beneficiaries, particularly pension funds These issues shall include employee information, informa- with a long-term horizon, also have been at the forefront tion on respect for human rights, on anti-corruption and of demanding information on ESG matters and integrating bribery issues, and the diversity in their board members. ESG into their investment decisions. However, the integra- The directive itself allows for flexibility in the manner and tion of ESG matters into corporate governance codes is still Table C.3: ESG and Corporate Governance Codes Country Instrument Requirements Australia Corporate Governance: Stewardship guidance for determining an approach to corporate A guide for fund governance, voting, and other issues, including national greenhouse managers and gas, energy consumption, and other ESG disclosures. corporations Brazil SEC Regulation Securities rules requiring information related to the social, and Brazil Stock environmental, and corporate governance dimension of a company. Exchange rules The Code of Best Practices issued by the Brazil Institute of Corporate Governance has multiple references to ESG matters. Bulgaria Bulgarian Code for Under the comply-or-explain approach, companies should take into Corporate Governance consideration the interests of stakeholders in accordance with principles of transparency, accountability, and business ethics. Companies are encouraged to balance development of the company with economic, social, and ecological development. Denmark Amendment to the Mandatory ESG disclosure for companies and investors on corporate Danish Financial social responsibility, CSR implementation methods, and an Statements Act evaluation on what has been achieved in CSR in the past year. The rules apply to both companies and institutional investors. India CSR Voluntary Encourages businesses to formulate a CSR policy and provide a roadmap Guidelines for CSR initiatives, aligned with their business goals. Indonesia Securities Regulation Requires every company to have social and environmental 47/2012 responsibility policy. Jamaica Code of Corporate Encourages all company management to act ethically and responsibly Governance – Best and charges all boards to ensure that the company is a good corporate Practice citizen. It encourages listed companies to report against the code provisions in their annual reports. Malaysia Stewardship Code for Gives guidance on the effective exercise of stewardship Institutional Investors responsibilities to ensure delivery of sustainable long-term value to their beneficiaries. Source: Based on information from the Principles for Responsible Investment website: http://www.unpri.org/. From Companies to Markets—Global Developments in Corporate Governance 77 PART C Global Developments in Corporate Governance Codes a growing phenomenon. Countries exemplifying integra- “In South Africa we see the function of corporate tion of sustainable development and corporate governance governance codes quite widely. In fact, we define into codes are Brazil, South Africa, and Spain. corporate governance as effective leadership on an C.8.2. ESG and the Link to Corporate Governance ethical foundation. Ethics in turn is defined broadly Sustainability relates to corporate governance in that it is a as including corporate citizenship and sustainability duty of directors to be aware of the opportunities and risks considerations. The South African view is that there is of the environment to the company, including the natural, a symbiotic relationship between society and busi- economic, and social environments. This responsibility will ness—an interdependency and therefore for business to then affect the composition of boards, as they should incor- succeed, society should prosper. Business and society porate individuals who have some knowledge and experience should co-exist by finding the place where value for in ESG areas, so the board can better determine the company business and value for society intersect.” position and deal with sustainability issues as they arise. Ansie Ramalho, King IV Project Lead, Institute of Directors in Southern Africa Sustainability issues will affect business relations with stakeholders, the entity’s products and services, and the outcomes of the company being in business. Sustainability notion of inclusivity and is not necessarily aligned with issues should be incorporated in risk management assess- the notion of shareholder primacy. There is a reliance on ments, and internal audit should check the effectiveness of capitals other than financial capital, and you cannot say management of sustainability issues. that the provider of financial capital is the most impor- tant stakeholder. For several years, sustainability issues have been the focus of separate codes, such as the global UN-backed Principles “It is aspirational but if you agree there is an interde- for Responsible Investment, the UN Global Compact, the pendency between society and business and if in theory OECD Guidelines for Multinational Enterprises, the Global it makes sense that these two things need to meet and Reporting Initiative, the German Sustainability Code, and move along together, then we need to find a way to others. Disparate initiatives are increasingly coalescing to do it. It is critical that all corporate governance codes integrate sustainability thinking into corporate governance move in this direction.” codes, into law and regulation, and into company responsi- Ansie Ramalho, King IV Project Lead, bilities and reporting. Institute of Directors in Southern Africa In recognizing this change in corporate accountability for ESG issues globally, a mix of regulation and voluntarism is The forthcoming King IV code, currently in development, evident. As noted, countries such as Brazil, South Africa, incorporates the idea that, through principles, companies and Spain are incorporating ESG issues into their codes. will be required to disclose how they have integrated Investor groups are incorporating ESG into their steward- sustainability considerations into their strategy and into ship codes as a consideration of the investor’s fiduciary the ways they have mitigated their impact on the environ- duty. Regulators too are encouraging consideration of ESG ment and society. The premise of this approach is that issues from a company stewardship perspective. sustainable development is a source of both risk and op- C.8.2.1. South Africa portunity for companies. Influenced by African value systems, such as ubuntu (a concept that we are all connected in our humanity), King The South African corporate governance framework is III set the tone for integrating sustainability into the corpo- supported by another code for investors, the Code for rate governance code. Mervyn King has pointed out that, Responsible Investing in South Africa, to ensure better for an investor to make an informed assessment, the old incorporation of environmental, social, and governance format of the annual report that mainly focused on finan- issues in decision making and ownership practices. It is cial information and the short-term horizon is no longer also supported by Regulation 28 to the Pension Funds adequate. Therefore, King III recommended integrated Act, which requires trustees of pension funds to consider reporting to enable investors to make an informed assess- a responsible investment approach and to take into ac- ment of the company’s long-term sustainability. count material ESG factors in all asset classes, not just equity. Thus the South African approach to the incorpo- In South Africa, corporate governance takes the view that ration of sustainability is a mix of code and regulatory companies contribute to sustainable development. It is a approaches. 78 From Companies to Markets—Global Developments in Corporate Governance Global Developments in Corporate Governance Codes PART C C.8.2.2. Spain the corporate strategy with regard to sustainability, the Since 2015, Spain has been reviewing its company law and environment, and social issues of the company; and the its corporate governance code. In the revisions to company mechanism for supervising nonfinancial risk, ethics, and law, the following amendments strengthen corporate gov- business conduct. Thus Spain has introduced ESG issues ernance issues: into corporate governance. • New powers to encourage shareholder participation in Key to the success of Spanish initiatives is that the com- company affairs, especially the AGM; pany law includes the duty of directors to have a corporate • Increased transparency of remuneration policies; and responsibility policy, which previously had been in the corporate governance code but was moved to the law. The • Required board involvement in sustainability issues. corporate governance code now requires transparency on Company law established a non-delegable power of this legal duty. This provides a combination of pressures the board to approve the corporate social responsibility for ESG initiatives. The Spanish experience shows us that policy. there are several steps that a country could follow to im- The Corporate Governance Code was revised in parallel with prove sustainability initiatives: the company law amendments and is a voluntary code based • Identify sustainability or ESG as an important issue for on the comply-or-explain principle. Principle 12 encourages companies for long-term growth. a wider view of corporate governance, incorporating consid- • Identify which institutions are responsible for sustain- eration of stakeholders, the environment, and the broader ability policies, if it is to be set in law or regulations or community. Corporate responsibility issues, absent in the codes, and involve them in the sustainability debate. previous code, is now the object of express recommendations in the code, with the aim of defining minimum content of the • Ask companies to apply disclosure and transparency policy of the company regarding sustainability (targets, com- measures in line with the company’s professed ESG mitments, practices, and so on), as well as its evaluation and policies and practices, including disclosing the commu- dissemination. (See Box C.2.) nication channels on their practices to stakeholders. • Perhaps consider seeking assurance on sustainability The directors of a company should now report (or ex- activities so as to build confidence in the market in plain why they do not do so) on ESG developments in its sustainability information. directors’ report and specify the goals of the ESG policy; • Be aware that there are several platforms for address- ing the sustainability topic. Each country may have Box C.2: Excerpts from the Spanish Corporate different mechanisms for sustainability improvement. Governance Code Report • Institutional investors, civil society, corporate govern- The Board of Directors should perform its duties with ance codes, and regulation can combine to demand unity of purpose and independent judgement, ac- information from companies on environmental, social, cording the same treatment to all shareholders in the and governance policies and initiatives. same position. It should be guided at all times by the C.8.2.3. Brazil company’s best interest, understood as the creation The 5th edition of the Corporate Governance Best Practices of a profitable business that promotes its sustainable Code issued by the Brazilian Institute of Corporate Gov- success over time, while maximising its economic ernance brings new perspectives. Besides the full review of value. established practices, the new code 1) is more principle based In pursuing the corporate interest, it should not only than prescriptive, as the previous version was; 2) stimulates abide by laws and regulations and conduct itself ac- reflection before its effective application; 3) emphasizes ethics cording to principles of good faith, ethics and respect and ethical behavior; and 4) valorizes and uses the capital for commonly accepted customs and good practices, language, as in the integrated reporting initiative. but also strive to reconcile its own interests with the legitimate interests of its employees, suppliers, clients A new section introducing the code deserves to be read and other stakeholders, as well as with the impact upfront. It states the premises of the code and highlights of its activities on the broader community and the the responsibility of the corporate governance agents in a natural environment. new context, with themes such as sustainability, complexity, different stakeholders’ perspectives and interests, and long- Source: (CNMV 2015). term value creation. It brings a thoughtful approach to the From Companies to Markets—Global Developments in Corporate Governance 79 PART C Global Developments in Corporate Governance Codes decision-making process, the organization’s identity (purpose, need to move from generalities to more specific issues mission, vision, values, and principles) and ethical delibera- and include specifics such as supplier and supply chain tion, the role of corporate governance agents, and how to use relationships: the code. - ESG issues perhaps should be specifically included in required disclosures mentioned in the corporate The corporate governance framework governance code; should recognise the rights of stakeholders - Some consideration would be required regarding established by law or through mutual who would write the ESG disclosures, what skills agreements and encourage active co- and competences the writer(s) should possess, and operation between corporations and what standards should be applied in writing the stakeholders in creating wealth, jobs, and the disclosures; sustainability of financially sound enterprises. - Some consideration may be given to including (OECD 2015a, Principle IV) statements regarding board responsibilities for ESG initiatives and disclosures, which may include responsibilities for ESG strategies and for systems C.8.3. Practical Challenges of ESG Inclusion to measure and report on ESG activities. in Codes Several standards are available as possibilities for applying A debate during an IFC Practice Group meeting on codes and sustainability disclosures. The Global Reporting Initiative standards brought out differing opinions on whether sustain- has issued its standards, with particular standards for certain able development matters should be included in corporate industries. The United States is developing sustainability governance codes. One view was that business has to be reporting standards through the Sustainability Accounting cognizant of sustainability issues, and yet it is also charged Standards Board; SASB’s mission is to develop and dissemi- with being profitable—two goals that are not the same but nate sustainability accounting standards that help public are connected. Another view was that reporting sustainability corporations disclose material and information that is useful is a challenge! to investors for decision making. There are industry stan- Nevertheless, the trend is evident. Countries and companies dards for sustainability issues such as the UNDP Strategy for are including ESG issues in corporate governance laws and Supporting Sustainable and Equitable Management of the regulations, corporate governance codes, separately into stew- Extractive Industries. Countries requiring such disclosures ardship codes for investors, and even in individual investor might consider which, if any, of these standards its constitu- statements on the company’s approach to ESG. However, it is ents should report against. clear there is not one approach but rather a number of diverse A member of the IFC Corporate Governance Private Sector approaches to bringing corporate governance and ESG issues Advisory Group, Bistra Boeva, conducted research in Bulgar- closer together. ia, prompted by the 2016 applicability of the EU directive on Despite a general acceptance of sustainability as a core issue nonfinancial information. Her research raises several issues, for the future in corporate governance, there remain issues and she believes consideration should be given to the follow- and conflicts yet to be resolved. Investors have a fiduciary ing matters: duty to look after the beneficiaries for whom they are in- • Corporate governance codes should incorporate ESG vesting. Some of them see their fiduciary duty as including requirements. sustainable development. Others do not. • Clarification is likely to be required as to who are an entity’s stakeholders, as sustainability is usually consid- “The investor community would be uncomfortable with ered in terms of the entity’s stakeholders. sustainability if it infers that the company’s purpose • Discussions at the IFC and OECD levels indicate there was not necessarily commercial success. If we start is little cohesion on definitions of stakeholders. to intermingle sustainability with corporate purpose, • Better understanding of the current corporate gov- then I think many investors are going to get a bit ernance requirements and ESG practices and links nervous, even if they embrace, as I think most investors between corporate governance and sustainability is do, the core ideologies of sustainability.” necessary. George Dallas, Senior Policy Advisor, ICGN • If ESG issues are included in a code, the code may 80 From Companies to Markets—Global Developments in Corporate Governance Global Developments in Corporate Governance Codes PART C C.9. Summary To address the concerns outlined in Box C.3, a paper (Berg We are seeing evidence that the development and applica- 2015) inspired by recent World Bank diagnostic work and tion of corporate governance codes and of scorecards discussions with client country counterparts proposes several are having an effect in improving corporate governance steps that securities regulators can take to revitalize their practices. However, recent reviews and analyses of the corporate governance codes: existing codes are bringing forth several lessons, such as the • Clarify the comply-or-explain requirement. following: • Enforce corporate governance disclosures. • Distinguish carefully between matters that should • Improve how companies comply or explain. be mandated in law or regulation and matters that are better placed in codes. Place in codes issues and • Report on code compliance. behaviors that may take time to change and in which • Consider active enforcement of the quality of disclo- a degree of flexibility is required or which are aspira- sure statements. tional in nature. • Move from a comply-or-explain requirement to a man- • Develop an understanding of the variations, ef- datory regulation. fectiveness, and nuances of the different comply-or- • Adopt a stewardship code. explain approaches. Consider the local environment and ascertain which code style is appropriate for it. C.9.1. Key Findings Consider also the environment in which comply or The following points capture some of the key findings of the explain is set, before determining whether to use high- research for this publication: level principles (with additional separate guidance) • Codes exist because not all corporate governance good or principles with a greater degree of detail. Avoid practices can be mandated. confusion. • Many codes have been supplemented by guidance on • Consider the likely effectiveness of comply or explain specific matters in local jurisdictions. where there are controlling shareholders or where the • Code application should be regularly monitored, re- rule of law is weak. viewed, and reported on to encourage code implemen- • Challenges to the use of comply or explain in cor- tation. Increased monitoring is evident. porate governance codes are likely to remain in the • Codes may continue to be high-level principles. How- future. (See Box C.3.) ever, if this is so, many companies and markets may need the support of increased guidance on how to ap- Box C.3: Comply-or-Explain Codes: proach each corporate governance principle in practice Benefits and Costs and in diverse types of enterprises. • Codes should be reviewed, with the aim of developing Comply or explain codes present a number of well better practices and making better adjustments to local known potential benefits. Relative to a fully mandatory market issues. system, they are flexible; by allowing companies to opt out of the code provisions, the comply or explain • The concept of sustainable development and its place approach reduces the regulatory burden, and ‘one size in corporate governance needs to be better understood fits all’ is avoided. However, many studies of the impact by companies, investors, and regulators globally, and of corporate governance codes mention a variety of sustainable development should be included in require- potential challenges. These include: ments in corporate governance codes. l Lack of influence/awareness of codes (especially • There is an increasing consensus that boards should voluntary codes) have a responsibility for setting values that determine l Lack of adoption of code provisions how the company interacts with and affects the society l Poor quality of code disclosure statements it operates in, but some investors with fiduciary duties l Lack of attention paid to code compliance by to beneficiaries are nervous about this issue. shareholders • Scorecards, awards, and other mechanisms should be l Lack of monitoring, supervision, and enforcement encouraged, to provide an incentive for companies to by securities regulators and stock exchanges target better corporate governance. Source: (Berg 2015). From Companies to Markets—Global Developments in Corporate Governance 81 PART C Corporate Governance Developments: Practice Issues C.9.2. Trends and Future Developments in Codes • A closer review of the comply-or-explain model for ap- and Scorecards plication of corporate governance principles, including The global community interested in corporate governance greater variation in its use than previously practiced; should expect the following future developments: • More monitoring, enforcement, and reporting activi- • Pressure for more effective application of corporate ties regarding corporate governance code application, governance principles and practices, requiring more including increased use of scorecards; and better guidance to assist with implementation and • More codes being amended to incorporate ESG activi- a focus on corporate governance outcomes; ties and reporting; and • A wider debate concerning what should be mandated • Increased monitoring of the success of steps to stan- in laws and regulations as opposed to being included in dardize corporate governance codes so they are appli- codes, traditionally a “softer” approach; cable across diverse sectors. 82 From Companies to Markets—Global Developments in Corporate Governance PART D Conclusion Research for this publication included an examination of of corporate governance. They will be required to continu- recent developments of such corporate governance groups ally monitor their corporate governance and its effectiveness, as OECD, BCBS, and ICGN as well as the EU, with particu- to be prepared to change and adapt to new regulations and lar notice of developments in corporate governance in the adopt better practices, and to respond to increased scrutiny Nordic countries and in emerging markets. One result of the and investor engagement. research was confirmation that significant and widespread changes have occurred in the wake of the financial crisis of Overall, these developments in corporate governance improve 2008. Areas of corporate governance practice that have seen the quality of information available to the board, boost the noteworthy changes are the control environment and risk, performance of management, and enhance the company’s transparency and disclosure, shareholder rights, increased awareness of and attention to risk—all of which should ben- commitment to good corporate governance, and the examina- efit the company and support the achievement of its objectives tion and strengthening of corporate governance codes. in the long term. From the magnitude and breadth of change in corporate It is highly likely that such developments will continue as governance depicted in this publication, it is evident that market regulators notice the benefit of corporate governance companies and boards of directors are, or soon will be, to market development and to economic growth and stability. expected to respond to new or greatly enhanced standards This is the new normal in corporate governance. From Companies to Markets—Global Developments in Corporate Governance 83 84 From Companies to Markets—Global Developments in Corporate Governance APPENDIXES Appendixes Appendix A: IFC Indicative Independent Director Definition Appendix B: Board Evaluation Requirements From Companies to Markets—Global Developments in Corporate Governance 85 APPENDIXES Appendix A: IFC Indicative Independent Director Definition “Independent Director” means a Director who has no (f) is not employed as an executive officer of another direct or indirect material relationship with the Company company where any of the Company’s executives other than membership on the Board and who:1 serve on that company’s board of directors; (a) is not, and has not been in the past five (5) years, (g) is not, nor has been at any time during the past employed by the Company or its Affiliates; five (5) years, affiliated with or employed by a present or former auditor of the Company or any (b) does not have, and has not had in the past five (5) of its Affiliates; years, a business relationship with the Company or its Affiliates (either directly or as a partner, (h) does not hold a material interest in the Company shareholder (other than to the extent to which or its Affiliates (either directly or as a partner, shares are held by such Director pursuant to a shareholder, director, officer or senior employee of requirement of Applicable Law in the Country a Person that holds such an interest); relating to directors generally), and is not a direc- (i) is not a member of the immediate family (and is tor, officer or senior employee of a Person that has not the executor, administrator or personal rep or had such a relationship); resentative of any such Person who is deceased or legally incompetent) of any individual who would (c) is not affiliated with any non-profit organization not meet any of the tests set out in (a) to (h) (were that receives significant funding from the he or she a director of the Company); Company or its Affiliates; (j) is identified in the annual report of the Company (d) does not receive and has not received in the past distributed to the shareholders of the Company as five (5) years, any additional remuneration from an independent director; and the Company or its Affiliates other than his or her director’s fee and such director’s fee does not (k) has not served on the Board for more than [ten constitute a significant portion of his or her annual (10)] years.2 income; For purposes of this definition, “material interest” shall (e) does not participate in any share option [scheme]/ mean a direct or indirect ownership or voting shares repre- [plan] or pension [scheme]/[plan] of the Company senting at least [two percent (2%)]3 the outstanding voting or any of its Affiliates; power or equity of the Company or any of its Affiliates. 1 Some jurisdictions have legal definitions for independent directors which may or may not be as stringent as IFC’s definition. If such a definition exists, consult with the Corporate Governance Group as to whether such definition would be appropriate. If, for a particular reason, the Investment Department intends that the IFC Nominee Director be deemed to be an Independent Director, consult with the Corporate Governance Group (www.ifc.org/corporategovernance). 2 Depending on the availability of qualified independent directors in a particular country, the term could be shortened to seven (7) years. Consult with the Corporate Governance Group if this is an issue. 3 Consult with local counsel as to the relevant percentage, if any, specified by local law (which may apply to publicly listed or unlisted companies, or both). For example, in the United Kingdom, a shareholder is treated as having a material (disclosable) interest in a publicly listed company if it holds 3% of the shares; in the United States, the equivalent threshold is 5%. 86 From Companies to Markets—Global Developments in Corporate Governance APPENDIXES Appendix B: Board Evaluation Requirements Source Companies Country Instrument Affected Requirements Requiring Evalution Australia ASX Corporate Gover- Listed companies It is the role of the board nominating commit- nance Principles and SEC Regulation tee to ensure the development and implemen- Recommendations and and Brazil Stock tation of a process for evaluating the perfor- ASX Listing Rules Exchange rules mance of the board, its committees, and directors. Companies should report in annual report or corporate governance statement against this Principle. Brazil IBGC Code of Best Recommended for An annual formal evaluation of the board, Practices all companies and individual directors, and the CEO. Disclosure organizations to shareholders of the process and results. India Companies Act 2013 Report on the annual evaluation of the board, Large listed public board committees, and individual directors. Equity Listing c0mpanies Monitor and review the board evaluation Agreement (2014) Listed companies framework. Singapore Corporate Governance Principle 5 recommends that there should Code All companies – all be a formal assessment of the effectiveness listed companies must of the board of directors as a whole and the disclose how each contribution by each director to the effective- principle of the code is ness of the board. South Africa King III Code of Corpo- applied. The evaluation of the board, its committees, rate Governance 2009 All entities in South and the individual directors should be per- Africa on an apply- formed every year. or-explain basis Annual evaluations of the board, its commit- tees, and directors (including evaluations of the chairperson, CEO, and other executive directors) should be performed by the chair- person or an independent service provider. The overview of the process should be disclosed in the integrated report. United Code of Corporate The board should undertake a formal and rigor- Kingdom Governance Listed companies ous annual evaluation of its own performance, its committees, and individual directors. Performance evaluation to be undertaken by Large companies an external independent evaluator at least every three years. 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From Companies to Markets—Global Developments in Corporate Governance 93 NOTES Notes 94 From Companies to Markets—Global Developments in Corporate Governance NOTES Notes From Companies to Markets—Global Developments in Corporate Governance 95 NOTES Notes 96 From Companies to Markets—Global Developments in Corporate Governance NOTES Notes From Companies to Markets—Global Developments in Corporate Governance 97 NOTES Notes 98 From Companies to Markets—Global Developments in Corporate Governance 2121 Pennsylvania Avenue, NW Washington, DC 20433 USA Tel: +1 (202) 458-8097 cgsecretariat@ifc.org www.ifc.org/corporategovernance APRIL 2016