78552 Assessing and Raising Unlocking the the Bar Value on Corporate Governance: of Emerging Markets A Study of Eight Stock Exchange Indices Sustainability Indices Assessing and Unlocking the Value of Emerging Markets Sustainability Indices Andreas D. Grimminger Pasquale Di Benedetta June 2013 ©2013 The International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org All rights reserved A copublication of The World Bank and the International Finance Corporation. The findings, interpretations, and conclusions expressed in this volume do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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For permission to photocopy or reprint any part of this work, please send a request with complete information to the Copyright Clearance Center Inc., 222 Rosewood Drive, Danvers, MA 01923, USA; telephone: 978-750-8400; fax: 978-750-4470; Internet: www.copyright.com. All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2422; e-mail: pubrights@worldbank.org. About the World Bank Group The World Bank Group is one of the world’s largest sources of funding and knowledge for developing countries. It comprises five closely associated institutions: the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA), the International Finance Corporation (IFC); the Multilateral Investment Guarantee Agency (MIGA); and the International Centre for Settlement of Investment Disputes (ICSID). Each institution plays a distinct role in the mission to fight poverty and improve living standards for people in the developing world. For more information, please visit www.worldbank.org, www.miga.org, and www.ifc.org. Foreword There are three possible reasons for introducing an index based on the quality of governance. Indices can supplement the regulatory framework around governance by providing companies with an incentive to adopt better practices. They give companies an opportunity to differentiate themselves in the market, as well as the possibility of tapping into a pool of money committed to good governance and sustainability. All these reasons appear good on the surface, but we need to know more about how such indices actually operate. This study provides some useful evidence based on the experience of indices in eight different markets. It points out not only the strengths of such indices but also their limitations. Not all indices are constructed in the same way: some focus more on governance and some on issues of corporate responsibility. There is not always evidence of superior performance by companies that are part of an index, perhaps because most companies in the relevant market are included. The standards applied to indices vary from market to market, so membership in an index gives no absolute guarantee of governance standards. That said, there is a general acceptance that governance indices can be a useful tool for raising both standards in companies and awareness among investors. The use of indices is growing, and it is important to have analysis from which those planning an index can learn. For companies to reap the full benefits of membership, the criteria for inclusion in an index must be clear and transparent, so that investors can understand what the index delivers. Arguably, where an index is available, all companies should be assessed for inclusion automatically, rather than being allowed to decide for themselves whether to join. For those wondering what indices can and do deliver, this study provides a good starting point. Governance indices are one tool among many, but they have a potentially important role to play. Peter Montagnon Senior Investment Adviser Financial Reporting Council United Kingdom iii Bosphorus Bridge, Istanbul, Turkey, connects Asia to Europe This study reviews the different approaches used by stock exchanges to build indices incorporating corporate governance. Table of Contents Acknowledgements vi Executive Summary vii I. Introduction 1 II. Objectives and Types of Indices 2 A. Objectives 2 B. Types of Indices 4 III. The Building Blocks of Governance Indices 7 A. Index Criteria 7 B. Company evaluation 10 C. Disclosure 13 D. Index Supervision 15 IV. Growth, Performance, and Product Development 17 A. Growth 17 B. Performance 17 C. Investment Products 20 V. Main Findings 21 VI. Eight Steps in Building a Successful Corporate Governance Index 24 VII. Selected Bibliography 26 VIII. Appendices 27 Appendix I: Index Profiles 27 Appendix II: Corporate Governance Framework in Indices’ Jurisdictions 37 Appendix III: Indices’ Governance Criteria 38 Appendix IV: Independence Definitions 41 Acknowledgements The authors of this report would like to specifically thank the following organizations and individuals for their time, input, and insights in contributing to this study. Organization Contact BM&FBOVESPA Rogerio Marques, Patrícia Pellini Chinese Index Securities Co., Ltd. Zheng Hua Liu Borsa Italiana Paola Fico Bolsa Mexicana de Valores Catalina Clave Universidad Anáhuac Jorge Fabre, Marta Vaca Bolsa de Valores Lima Liliana Casafranca Johannesburg Stock Exchange Corli LeRoux Korea Stock Exchange Yoon Bosung Korea Corporate Governance Services Kim Myong Seo Istanbul Stock Exchange Osman Parlak. Levent Bilgin Capital Market Board Turkey Ayça Sandikcioğlu, Bekir Safak MSCI Hewson Baltzell In addition, the authors would like to thank Catherine Hickey for her assistance with the capital markets section of this study and Honglin Li for her help in analyzing the Chinese corporate governance index. The authors would also like to thank Caroline Bright and Alison Harwood for supporting the study since inception, and Berit Lindholdt Lauridsen, Roman Zyla, and Alexander Berg for their invaluable inputs during the review process. Last but not least, a thank you to Loty Salazar and Uloaku Oyewole for their guidance on the publication’s internal processes. vi Executive Summary Since 2001, eight stock exchanges around the world have launched corporate governance indices (CGIs), sometimes as part of a broader environment, social, and governance (ESG) initiative. The comprehensive analysis of these indices presented in this study is the first of its kind, and it reveals that CGIs have a positive impact, enhancing legal and regulatory frameworks by extending governance criteria to develop objective and measurable benchmarks. The study also shows that CGIs present companies with an opportunity to differentiate themselves in the market and, ultimately, offer companies an incentive to adopt better governance practices. Nevertheless, as the process for vetting and evaluation of companies for inclusion in the indices continues to evolve, access to underlying methodologies, disclosure of the ratings and self-assessments of individual companies, and of overall monitoring processes and procedures can still be enhanced. CGIs offer a market solution to address shortcomings in corporate governance. Common weaknesses in governance frameworks, such as lack of shareholder protection, poor corporate disclosure, and weak requirements for independent directors, are some of the main reasons behind the creation of CGI and ESG indices. CGIs have proven that they can elevate the legal and regulatory “ceiling� for governance, can allow companies to differentiate themselves in the market, and can increase their access to capital. CGIs also enhance voluntary national codes of corporate governance. Across all the indices studied, stock exchanges tend to pick and choose from the national codes of governance those provisions that are objective and measurable. This approach is critical in elevating the stature of the codes and in supporting the evaluation and monitoring of companies, as well as in boosting the overall credibility of the index. In addition, most indices employ market-based criteria such as minimum free float and liquidity. These factors are important for the marketability of the index, but they can also be detrimental in illiquid markets, since the number of companies eligible for inclusion in an index can be severely reduced. The commitment of companies to governance differs across types of indices. There are two types of indices: listing tiers and those in which companies meet a rating threshold. Since adherence of companies to mandatory rules in listing tiers is binding, the “tier� option requires a higher level of commitment from the constituent companies. Evaluation and monitoring of the constituent companies and transparency of the index are critical for the index’s credibility. Stock exchanges that have not set up a listing tier tend to outsource the evaluation process to mitigate conflicts of interest with client companies. In most cases, stock exchanges pay for the evaluation to ensure an independent rating process. Most of the stock exchanges disclose index criteria and methodology, but in most cases, access to this information is a challenge. Rating results are rarely disclosed, mainly because of the companies’ reluctance to have their rating reports published. Exclusion from indices occurs primarily during annual reviews and is rarely due to a failure to meet governance criteria. This pattern suggests that stock exchanges are reluctant to exclude companies for governance considerations because of the associated reputational risks. Indices are growing in numbers but struggle to beat the market. Most of the indices studied have shown strong growth often in only a few years, underlining their attractiveness and their potential to influence corporate behavior. The performance of most indices, however, mirrors that of the broader market. This often reflects the overlap of constituent companies or a lack of depth in the capital markets. The lack of differentiation in performance also explains the slow development of investment products tailored to the indices. vii seoul, south korea. skyiline at night. This study reviews the different approaches used by stock exchanges to build indices incorporating corporate governance. I. Introduction Many countries are making reforms to corporate governance (CG) a priority as a way to improve business performance and help companies attract outside investment. As a result, stock exchanges in these countries are looking for ways to promote better governance practices in companies. Corporate governance indices (CGIs) can raise a country’s overall corporate governance standards and can offer companies possible financial and investment benefits from making governance improvements. With these goals in mind, an increasing number of stock exchanges have set up CGIs in the past decade, sometimes as part of a broader environmental, social, and governance (ESG) initiative. Each stock exchange has its own set of motives for launching an index, however, and each has employed different criteria for vetting company governance. They have also developed distinct evaluation processes, as well as diverging approaches to the disclosure of results. This study reviews the different approaches used by stock exchanges to build indices incorporating corporate governance. In the case of ESG indices, the focus is on the governance component of these indices. The study also draws lessons from the stock exchange’s experiences and highlights success factors and shortcomings. In particular it addresses the following key questions: 1. What are the key drivers for stock exchanges to launch CGIs? 2. What are the critical building blocks in the construction of a CGI? 3. What are the risks faced by those investing in CGIs? Eight stock exchanges that have their own CGI or ESG index form the basis of the study. Detailed index profiles are provided in Appendix I. Country Stock Exchange Index Name Brazil BM&FBOVESPA Special Corporate Governance Stock Index (IGC) China Shanghai Stock Exchange (SSE) Corporate Governance Index Italy Borsa Italiana FTSE Italia STAR Mexico Mexican Stock Exchange (BMV) Indice IPC Sustentable Peru Lima Stock Exchange (BVL) Good Corporate Governance Index South Africa Johannesburg Stock Exchange (JSE) Socially Responsible Investment (SRI) Index South Korea Korea Stock Exchange (KRX) Korean Corporate Governance Index (KOGI) Turkey Istanbul Stock Exchange (ISE) Corporate Governance Index Information for this study was collected in three phases: �� Publicly available information on the indices and their host jurisdictions was gathered and analyzed. �� A survey was designed and circulated among the responsible parties for the CGIs at the eight stock exchanges. �� Analysis of the survey responses was followed by phone interviews with the respondents to close knowledge gaps and record their experience. 1 II. Objectives and Types of Indices A. Objectives Three objectives motivate stock exchanges to launch CG or ESG indices: 1. To supplement the legal and regulatory corporate governance framework and thus raise the country’s overall corporate governance environment 2. To give companies an opportunity to differentiate themselves in the market 3. To tap into a growing pool of money committed to good governance and sustainability 1. Raise the “governance ceiling� Creating incentives for corporations to apply higher standards of corporate governance is an effective policy tool for improving a country’s overall corporate governance environment. For example: �� China: In 2007, the Chinese Securities Regulatory Commission (CSRC) started an initiative to improve the corporate governance of listed companies. At the end of 2007, to support this push for reform, the Shanghai Stock Exchange (SSE) launched the SSE Creating incentives CG Board, the basis of the SSE CG Index. Criteria for admission to the CG Board for corporations directly address issues related to controlling shareholders—a prevalent concern in Chinese companies. Seven of the 20 questions in the self-evaluation that a company must provide to apply higher in its application for the SSE CG Board address the ownership dimension. Questions standards address topics related to conflicts of interest, related-party transactions involving the controlling shareholder—common occurrences among Chinese companies—the of corporate controlling owner’s influence on dividend distribution in the three preceding years and on governance is an board appointments. effective policy �� Brazil: In Brazil, corporate governance and investor protection have been shareholder concerns for many years. However, reformers found it difficult to attack the problem tool for improving through changes to the legal and regulatory framework. In December 2000, the Brazilian a country’s Stock Exchange BOVESPA launched a new listing segment, the Novo Mercado, and its sister segments, Level 1 and Level 2. These listing segments have corporate-governance overall corporate requirements that go far beyond Brazil’s legal and regulatory framework. Crucially, Novo governance Mercado, the most demanding of the three levels, has eliminated non-voting shares and requires a company’s capital stock to be exclusively represented by common shares. In environment. addition, to ensure that minority shareholders get equal treatment in case of a control change at the company, constituent companies of Novo Mercado or Level 2 must extend full tag-along rights 1to all shareholders. Tag-along rights for all shareholders are commonly missing in the traditional stock market, as Brazilian corporate law requires tag- along rights only for voting shareholders. �� Mexico: In Mexico, regulators have been working to improve corporate governance standards. Since 2005, Mexican Securities Law has required 25 percent of the board to be independent. However, many practitioners have questioned the true independence of some Mexican board members. In 2011, the Mexican Stock Exchange (Bolsa de Valores Mexico, BMV) introduced the IPC Sustentable, in part, to improve CG practices in the country. 1 Tag-along rights oblige a major shareholder to include the holdings of minority shareholders in any negotiations and to ensure the same terms and conditions apply. 2 A Study of Eight Stock Exchange Indices 3 Crucially, one of the two organizations providing markets. Many investment managers Mercer interviewed evaluations for the Mexican Index, Universidad tend to actively investigate governance standards in their Anáhuac, has adopted a tougher set of criteria to better meetings with, and appraisals of, investee companies, and assess independence requirements. One example lies considered it material at a stock selection stage. 2 with the definition of significant clients and suppliers, since Mexican Securities Law does not allow a candidate In Italy, the STAR segment for small and medium-sized to be considered independent if he/she represents a enterprises (SMEs) was launched in 2001.3 By creating a label client/supplier that accounts for more than 10 percent of governance quality and transparency for these companies, of the total sales or purchases of the listed company STAR has generated higher liquidity and improved access to within the 12-month period immediately preceding the capital among member companies. According to data released appointment. Universidad Anáhuac, in its evaluation for for STAR’s 10-year anniversary, companies belonging to the the IPC Sustentable, lowers this threshold to 5 percent STAR segment consistently show higher liquidity than other and plans to lower this number further in coming years. listed SMEs. From 2001 to 2010, their average turnover velocity was 83 percent compared with 66 percent for other SMEs. Even Some stock exchanges use corporate governance indices to more impressive is the growth in foreign investment. Whereas in improve compliance with a code of corporate governance. As 2001 foreign investors represented 54 percent of investment in such, standards that were adopted only sporadically can become STAR companies, in 2011 that number had risen to 88 percent. widespread practice through the index. This is the case in Turkey and Peru. In South Africa, the launch of the Johannesburg Stock Exchange (JSE) SRI Index in 2004 was sparked by the 2002 Earth Summit �� Peru: The track record of compliance with the in Johannesburg and by the desire of South African companies country’s Corporate Governance Code issued in to showcase their commitment in the area of governance and 2002 had not been positive. To spur the adoption of sustainability. Today, the SRI Index has become a base universe norms, the Lima Stock Exchange (Bolsa de Valores for active management and stock picking, with investors paying Lima, BVL) launched the Good CG Index in 2008, a premium for companies with good ESG practices. encouraging companies to perform self-evaluations against the principles of the code. The BVL also The example of Brazil underlines the attraction of a means created an annual Corporate Governance Award (the through which companies can distinguish themselves in a Key Award) for the best performer. Today, the self- legal environment that is perceived to be weak. Since 2004, 94 evaluation forms the basis of a company’s application percent of all new listings have occurred on one of the three to the index. specialized corporate governance segments, the Novo Mercado �� Turkey: The Capital Market Board (CMB) encouraged (74 percent), Level 2 (14 percent), and Level 1 (6 percent).4 better application of the Turkish Corporate Governance Principles issued by CMB in 2003. 3. Access the money committed to governance and sustainability 2. Give companies an opportunity to Many studies show that CG factors, whether alone or as differentiate themselves part of ESG analysis, play an increasingly important role in Helping companies to distinguish themselves with a label guiding investment decisions, particularly in emerging markets. of governance excellence is another key reason for creating a Therefore, creating a CG or ESG market index in the local CGI. Companies in the index or market segment can expect stock market to draw investor capital has serious potential. to increase their access to capital, particularly that of foreign The above-cited 2009 survey of fund managers by Mercer for investors. These investors value information on company IFC showed that ESG considerations factor into the decision- governance, especially for emerging-market companies. A quote from a 2009 global survey of fund managers by Mercer 2 IFC and Mercer, “Gaining Ground – Integrating environmental, for the International Finance Corporation (IFC) underlines the social and governance factors into investment processes in problem: emerging markets� (International Finance Corporation, 2009), 4. 3 Companies with a market capitalization between €40 million and While corporate governance is regarded as important €1 billion by investment managers, they may struggle to obtain 4 P. Pellini, “Stock exchanges as an engine for corporate governance clarity on companies’ governance structures in emerging improvements: Reaching out to non-listed companies� (Presentation at OECD Roundtable in Lima, Peru, 2011). 4 Raising the Bar on Corporate Governance Table 1: Index Type Index Type Commitment Cap CG or ESG Brazil BM&FBOVESPA CG Index Listing Tier Binding Rules All qualifying CG China SSE CG Index Index Voluntary application All qualifying CG Italy FTSE STAR Listing Tier Binding Rules All qualifying CG Mexico BMV IPC Sustentable Index Automatic evaluation All qualifying ESG Peru BVL Good CG Index Index Voluntary application Maximum 10 CG South Africa JSE SRI Index Index Automatic evaluation All qualifying ESG South Korea KRX KOGI Index Automatic evaluation Maximum 50 CG Turkey ISE CG Index Index Voluntary application All qualifying CG Source: Stock exchange websites and responses to questionnaires making process behind about US$300 billion of investment in Reflecting this growing importance, the Mexican stock exchange emerging markets. In fact, according to survey responses: BMV explicitly launched the IPC Sustentable in November 2011 to allow the Mexican market to share in the growing ESG issues are taken into account in almost half (47 market for ESG investment. percent) of the Emerging Market Equities ((EME) products offered by the managers. (This compares to around a quarter of all managers across all asset classes B. Types of Indices and outside of EME on Mercer’s database). Managers of two-thirds of these strategies saw ESG factors as a means CGIs can be categorized in a number of ways: of identifying investment opportunities, with many of the �� Degree of commitment of listed companies to being remainder seeing it as a risk-management tool.5 part of the index A number of more recent studies show that incorporating ESG �� Whether the company’s evaluation occurs factors into investment decisions has grown in importance: automatically or voluntarily �� The “Global Sustainable Investment Review 2012� �� Whether there is a cap that limits entry found that globally, US$13.6 trillion of professionally �� Whether only governance or broader ESG criteria are managed assets incorporate ESG concerns into their evaluated investment selection and management. This represents 21.8 percent of the total assets under management in How an index is constructed has important consequences for the regions covered by the report.6 the level of company commitment, as well as the credibility and perception associated with the index (Table 1): �� In December 2012, Aviva Investors published a survey of global equity and fixed income managers with 1. Listing tiers have mandatory special listing rules and, combined assets under management of about US$ 6 ultimately, require a higher degree of commitment. trillion. The survey shows that 84 percent consider ESG factors as part of their investment process and 2. Indices based on automatic evaluation appear more credible actively vote on holdings. Of the managers polled, 79 than those based on voluntary application, since companies percent believe that ESG factors will be incorporated are not free to choose whether they want their CG practices into all mainstream funds in the future, and 72 percent analyzed. believe there is a link between a company’s ESG 3. Capping the maximum number of companies in an index may performance and total returns for investors.7 suggest to investors that it is difficult to be part of the index. 5 IFC and Mercer, 14. 4. Whether to establish a CG or ESG index depends to a 6 Global Sustainable Investment Alliance (GSIA), “Global large degree on whether the primary goal is to improve the Sustainable Investment Review 2012� (GSIA, 2013). 7 Aviva Investors, “Global Equity and Fixed Income Manager ESG corporate governance culture or to draw investment for Survey� (Aviva Investors, 2012). well-governed and sustainable companies. A Study of Eight Stock Exchange Indices 5 1. Listing tier Index of the BVL, a company must contract a rating agency to Two indices in this study are based on listing tiers: verify its self-evaluation. A side effect of voluntary application BM&FBOVESPA’s Corporate Governance Index and the FTSE is often that only companies that can be assured of qualifying Italia STAR. While joining the listing segment is voluntary, will apply. Meanwhile, companies with poor CG practices adherence to all listing rules of the segment is contractually can simply claim not to be interested and will not suffer the required. This approach differs from that of the other indices embarrassment of a bad CG evaluation. where companies must reach a predetermined threshold of An automatic assessment of all companies in the main index, compliance to join but are never required to score 100 percent compliance with the index criteria. such as occurs in Mexico, South Africa, and South Korea, carries a stronger message, since evaluation is not voluntary In listing segments, violation of the listing governance criteria and is therefore a potentially more effective tool for improving (Table 2) triggers defined consequences (review, fines, and governance. non-monetary sanctions that include eventual delisting), and compliance is monitored continuously. All companies included in the special listing tiers of BM&FBOVESPA’s Novo Mercado, 3. Capping the number of companies Level 1, and Level 2 automatically constitute the Corporate If an index is not based simply on strict adherence to specialized Governance Index, just as all companies in the STAR tier are rules, it must create a qualifying threshold for companies to meet. part of the Italy FTSE STAR. In four of the six indices that have not established a listing tier, any company that meets the threshold qualifies for the index. The 2. The base universe of the index: exceptions are Peru and South Korea. The BVL Good Corporate Voluntary application vs. automatic Governance Index in Peru has a maximum size of 10 companies. If evaluation more than 10 companies were to qualify, which has not occurred A critical decision for a stock exchange when setting up an to date, the companies with the higher scores would be accepted. index is how to define its base universe. Two basic options exist. The Korea Stock Exchange (KRX) Corporate Governance Index All listed companies (or a defined subset such as the main index (KOGI) is limited to 50 companies, selected based on their constituents) can be automatically assessed for inclusion in the rating (and on market capitalization for companies with the same index, or companies can voluntarily apply to be evaluated. rating). In theory, if the rating scores were disclosed (which they The indices in China, Peru, and Turkey rely on the voluntary are not, see below), capping the number of companies gives an application of companies to be subject to a corporate governance index the characteristics of a ranking and makes qualification evaluation. In Peru, for example, in order to join the Good CG appear more competitive. Table 2: Mandatory Governance Criteria for Listing Segment Italy STAR Brazil Novo Mercado Appointment of investor relations officer Annual public meeting with analysts Disclose Quarterly Interim Management Report, Semi- Common shares only Annual and Annual Report on company website Publish all reports and financial statements in English Company bylaws may not limit voting rights for minority shareholders Composition of board according to Art.2 CG Code Full tag-along rights Min. 2 independent directors Tender offers at least at economic value of company Establish internal committees English financial statements Remuneration of directors Disclosure of Code of Conduct and Securities Trading Policy 20 percent independent directors Establish Internal Control Committee Separation of CEO/chairman Arbitration for dispute resolution Source: Listing rules of STAR and Novo Mercado 6 Raising the Bar on Corporate Governance 4. G or ESG? This apparent investor preference is supported by the fact The decision to establish a pure CGI or an ESG index depends that commercial index providers, such as FTSE,9 MSCI,10 largely on the principal purpose of the index. Listing segments and Standard & Poor’s,11 offer a number of ESG indices but with enforceable rules are perhaps better based only on no pure CGIs. Even so, governance criteria can generally be straightforward governance requirements than on additional viewed as the foundation of ESG indices and are arguably social and environmental considerations, which tend to be the most important factors from an investor’s perspective. broader in scope and less easily quantified. A 2012 survey of more than 1,000 investment professionals by the consultancy SustainAbility supports this view. Of the From the perspective of creating a market, investors seem to professionals using ESG factors in their decisions, 59 percent prefer ESG indices, since they factor in a larger range of issues of respondents often or always consider governance issues in and often go beyond a narrow definition of governance, even their investment decision, followed by social issues (40 percent) though governance criteria do form the backbone of company and the environment (34 percent).12 It would certainly be ESG evaluations. A 2009 study by the Economist Intelligence shortsighted, especially in emerging markets, to underestimate Unit for IFC underlines the business case for incorporating the importance of governance factors such as shareholder rights ESG factors into investment decisions in emerging markets: and conflict-of-interest provisions. The exchanges with ESG indices in this study—Mexico and South Africa—are clearly The investment case in emerging markets rests most heavily aware of the importance of governance factors. South Africa’s JSE on the concept of inefficient markets, where not all the SRI Index, for example, employs a triple-bottom-line approach, available information is incorporated in the current stock with environmental, social, and economic sustainability as the price. There is a lack of comprehensive research coverage three pillars, and good corporate governance underpinning each in emerging markets in general and a dearth of ESG- of the pillars. related analysis in particular. Given the higher levels of both risk and return in emerging markets, investors who make an effort to understand the impact of ESG have 9 FTSE has developed a whole series of ESG indices for developed a better chance of reducing risk and boosting returns. markets, called FTSE4Good, which employ six ESG criteria: Because information is scarcer in emerging markets, fund environmental management, climate change, supply chain labor standards, human & labor rights, corporate governance, and managers see sustainability criteria as a way to make countering bribery. It also entirely excludes two industries from superior investment decisions. 8 consideration: tobacco and weapons. 10 MSCI offers ESG indices for developed Asia Pacific, Europe and the Middle East, Canada and the United States. 11 Standard &Poor’s has three ESG indices for Egypt, India, and the Middle East and North Africa region. 8 Economist Intelligence Unit, “Sustainable Investing in Emerging 12 M. Sadowski, “Rate the Raters Phase Five – The Investor View� Markets: Unscathed by the Financial Crisis� (IFC, 2009). (SustainAbility, 2012). III. The Building Blocks of Governance Indices Four areas have been selected as most critical in the analysis of a CGI or ESG Index: A. What criteria is the index is based on? B. How is the information compiled; i.e., what type of information is used and what is the rating methodology? C. What kind of information about the index and about the results is disclosed? D. How is the index supervised and compliance with its criteria monitored? A. Index Criteria Two types of criteria are used in CG indices: governance and market-based (e.g., free float and liquidity requirements). Turkey’s ISE CGI and China’s SSE CGI are the only two that rely solely on governance criteria as benchmarks. All other indices add market-based benchmark criteria. The Mexican and South African indices, as ESG indices, also add environmental and social criteria, Criteria used in which are not addressed in this study. the indices stem predominantly 1. Governance criteria: Sources, commonalities and differences Criteria used in the indices stem predominantly from voluntary national codes of corporate from voluntary governance. However, if the index criteria are based solely on the corporate governance code, they national codes can be only as strong as the code’s underlying principles. Therefore, in some instances, the index criteria go beyond the national corporate governance framework and incorporate additional criteria of corporate derived from international best practices, such as the OECD Principles of Corporate Governance. governance. Figure 1: Sources of Governance Criteria Code & Additional Criteria: Brazil, China, Italy, Mexico, South Africa, CG Code: South Korea Peru, Turkey Source: Analysis of listing requirements and index evaluation criteria 7 8 Raising the Bar on Corporate Governance Figure 1 illustrates the distribution in the survey sample. and chairman, which is not covered in the Mexican Examples include: framework, and the nomination of individual directors, which stands in direct contrast to the general �� Turkey: The country’s Capital Market Board Mexican practice of nominating slates of directors for encouraged the development of an index based on election. Turkish Corporate Governance Principles to promote the voluntary comply-or-explain code. Rating agencies �� Brazil: To join BM&FBOVESPA’s listing tier, the evaluating Turkish companies apply the Principles in Special Corporate Governance Stock Index, requires the adoption of corporate governance rules that go their entirety when assessing companies. beyond the local legal and regulatory framework. �� Italy: The governance criteria in the STAR segment Independent directors are not required by law in of the Borsa Italiana are based on compliance with Brazil, but Novo Mercado companies must have selected articles from the Italian Corporate Governance a board of directors that is at least 20 percent Code. These criteria are supplemented with conditions independent. designed to make the SMEs in the index more investor With respect to governance criteria, issues addressing the role friendly, such as hiring an investor relations officer, of the board of directors overwhelmingly dominate the criteria disclosing management reports with greater frequency, of all the indices. This reflects the fact that—with notable and providing English translations of all company exceptions—shareholder rights are addressed mainly in law reports. and regulation, while disclosure requirements are usually �� Mexico: The IPC Sustentable in Mexico uses a covered in mandatory listing requirements and accounting mix of criteria based on the Mexican Corporate standards. By contrast, the composition and role of the board is Governance Code and criteria going beyond the often addressed only in the voluntary framework of corporate Mexican framework altogether, thus allowing governance codes. Board composition and qualification is thus member companies to move beyond national an effective target with which to differentiate companies from practices. Examples include the separation of CEO the rest of the market. Figure 2: Most Common Governance Criteria13 9 8 7 6 Number of Indexes 5 4 3 2 1 0 Evaluation of Board Independent Director Separation of Audit Committee CEO/Chairman Source: Analysis of listing requirements and index evaluation criteria 13 For a list of all governance criteria evaluated by the indices in the study see Appendix III: Indices’ Governance Criteria. A Study of Eight Stock Exchange Indices 9 Table 3: Liquidity and Market Capitalization Criteria Index Market-based Criteria Brazil BM&FBOVESPA CGI 25 percent free float China SSE CGI None Italy FTSE STAR �� 35 percent free float entry requirement, cannot fall below 20 percent �� Market cap between €40 million and €1 billion Mexico BMV IPC Sustentable More than 30 percent free float and/or more than US$1 billion market cap requirement Peru BVL Good CGI Free-float-weighted index: companies need to be in top 80 percent of stocks in terms of liquidity South Africa JSE SRI Index Free-float-weighted index: companies must turn over of at least 0.5 percent of their liquid shares per month South Korea KRX KOGI Average transaction volume for past 3 months within top 40 percent bracket of listed companies Turkey ISE CGI None Source: Stock exchange websites and responses to questionnaires While all the indices studied include criteria that require independent directors, made mandatory in the STAR listing independent directors, they vary greatly on what constitutes rules, is for companies to have an adequate number of, and at independence (see Appendix IV). Definitions in the Peruvian least two, independent directors. and South African codes are brief, and the South African code reflects its principle-driven approach.14 More-detailed Even though board criteria dominate, shareholder rights definitions in Brazil, Mexico, Italy, and Turkey cover the are also addressed, particularly in the Brazilian and Chinese typical conditions that a director cannot meet in order to be indices. In these countries, shareholder rights are considered to considered independent: (i) be a controlling shareholder; (ii) be rather weak. Consequently, both BM&FBOVESPA’s Novo receive remuneration from the company other than director Mercado segment and the SSE’s Corporate Governance Board fees; (iii) have a significant business relationship (client, (companies apply to be admitted to the Board, which in turn provider, debtor, etc.) with the company; and (iv) be related to a forms the basis of the index) have a number of listing rules person meeting any of the conditions above. However, only the and evaluation criteria that address issues of shareholder rights. Mexican Securities Market Law defines a threshold above which These include rules on the mandatory issuance of common a business relationship, or influence over a business group, is shares with tag-along rights, self-evaluation criteria in China considered “significant.� The other codes and rules underpinning that focus on conflicts of interest and related-party transactions the criteria leave such thresholds open to interpretation. (RPTs), and whether 50 percent of the board is nominated by non-controlling shareholders. The Peruvian Code, underpinning the criteria of the BVL CG Index, requires only a “sufficient� number of directors to be independent. The ISE CGI, based on Turkish Principles, requires 2. Market-based criteria: Free float, at least one-third of the board to be independent. The Novo liquidity, and market capitalization Mercado requires 20 percent of directors to be independent, and When setting up a CGI, particularly in markets with the Mexican index has a 25 percent independence requirement. concentrated ownership structures, ensuring the availability South Africa’s King Code III, used as the basis for the JSE of a sufficient number of shares for trading is critical for SRI Index, recommends that a majority of the board be non- an index’s marketability. All indices in the study, with the executive directors and that a majority of those be independent. exception of China’s SSE CGI and Turkey’s ISE CGI, have free The Italian Corporate Governance Code’s recommendation for float or liquidity requirements (Table 3). These requirements significantly reduce the number of eligible companies in the 14 According to South Africa’s King Code III: “Independence is the absence of undue influence and bias which can be affected case of some stock exchanges. Market capitalization is of less by the intensity of the relationship between the director and the importance and is used primarily in the Italian STAR, since it company.� targets a specific market segment, the SME sector. 10 Raising the Bar on Corporate Governance Free float and liquidity Market Capitalization The free float of shares is commonly defined as shares of a public Market capitalization has less significance when attempting to company freely available for trading. It thus excludes locked-in determine the availability of a company’s shares for trading, but shares held by controlling shareholders, the stock’s promoter, it can be a good indicator of the importance of a company in and long-term investors, such as governments and institutional the market. investors, as well as the company’s board, senior management, Only the Mexican IPC Sustentable and the Italian STAR and employees. Differences in the definition of free float can segment apply restrictions regarding market capitalization. In have significant effects on the number of companies eligible for the case of STAR, a company must have a market capitalization an index.15 Higher free float is commonly an indicator of better between €40 million and €1 billion, thereby targeting the index shareholder protection, since dispersed ownership necessitates stronger rights for minority shareholders. constituency of SMEs. In addition, a company must have at least a 35 percent free float to enter the index, and that figure A certain free float is the precondition for a stock’s liquidity, cannot subsequently fall below 20 percent. This may stem from but does not guarantee liquidity since even free-float shares long-term investors locking up a percentage of the stock in the might not turn over sufficiently. Applying a liquidity screen segment. can therefore be an additional requirement for companies in an index. For example, this could measure the average transaction volume of a company’s stock. Applying requirements for free B. Company Evaluation float and liquidity, in addition to governance criteria, severely The information selected to assess companies and the affects the number of companies eligible for some of the indices methodologies employed are critical factors for the integrity of surveyed. Two examples illustrate this effect: any index, particularly for corporate governance indices that �� Mexico: The Mexican IPC Sustentable adopts a dual- are, at times, based on qualitative considerations. This section screen approach where companies must have more examines the type of information collected for the evaluation, than a 30 percent free float and/or US$1 billion market the use of outside evaluators, the rating methodology, and the capitalization. In 2009, the first year of evaluation for vetting process for the information used in the evaluation, as the index that launched in 2011, all 134 listed Mexican well as the evaluation results. companies were assessed. In 2010, only 70 companies Assessment of companies in the eight indices studied is based that passed the dual screen were evaluated, and in predominantly on publicly available information. In a few cases, 2011 this number fell further to 54. The free float of this is supplemented by proprietary research and company the 16 companies excluded had fallen owing to the feedback (Table 4). The evaluation of governance is outsourced repurchasing of stocks by the company and/or equity to external providers in all cases but China’s SSE CGI. The SSE swaps entered into by the controlling shareholder(s). puts together a team of outside experts from inside the SSE. �� Peru: The BVL employs a liquidity screen for the Rating methodologies for the indices differ in how much they Peruvian Good CGI. A company must be in the top are predetermined by the stock exchange. At times, they are 80 percent of stocks in terms of liquidity to qualify. left entirely to the external evaluators. Rating agencies, when This requirement excludes a number of companies paid by the companies, get accredited by the securities market that would qualify if only governance criteria were regulator or stock exchange. applied. In 2011, 9 companies constituted the Good CGI, while an additional 8 companies were recognized for their good governance practices but failed to meet 1. Evaluation process liquidity requirements. The information used to evaluate companies is almost exclusively public and includes annual reports, company bylaws, security 15 A change in how the BMV in Mexico calculates free float filings, and corporate governance reports based on comply- illustrates this point. As of September 2012, new definitions of free float prevent shares that are tied up in a company’s derivative or-explain disclosure with the respective corporate governance transactions from being included when calculating a company’s codes. Evaluations also include: free float. In a striking example, this change in rules reduces Grupo Elektra SA’s free float from 29 percent to 6 percent, �� In Brazil and Italy, the stock exchanges evaluate making them ineligible for inclusion into the BMV’s main index companies against the segment’s listing requirements IPC, which requires a free float of 12 percent. and make the results public. A Study of Eight Stock Exchange Indices 11 Table 4: Evaluators, Evaluation Process, and Evaluator Compensation Index Evaluator Evaluation Process Evaluator Compensation Brazil BM&FBOVESPA BM&FBOVESPA Evaluation of listing criteria N/A Special CGI by stock exchange China SSE CGI SSE and China Securities Index Co., Public self-evaluation and SSE Ltd. SSE research Italy FTSE STAR Borsa Italiana Evaluation of listing criteria N/A by stock exchange Mexico BMV IPC �� Universidad Anáhuac Publicly available BMV Sustentable �� Ecovalores (EIRIS) information and company feedback Peru BVL Good CGI Accredited rating agencies Public self-evaluation and Company proprietary research South Africa JSE SRI EIRIS and University of Stellenbosch Publicly available JSE Index Business School’s Unit for Corporate information and company Governance in Africa feedback South Korea KRX KOGI Korea Corporate Governance Publicly available KCGS is not-for-profit, Services (KCGS) information and proprietary partially funded by KRX research Turkey ISE CGI Accredited rating agencies Publicly available Company information and proprietary research Source: Stock exchange websites and responses to questionnaires �� In China and Peru, the SSE CGI and the BVL Good in the evaluation design. Each year, the SSE sets up a Selection CGI rely on companies’ self-evaluations of governance. Unit to review each application. The Unit consists of rating In both cases, these self-evaluations are publicly agencies, fund managers, securities firms, and insurance disclosed, and China solicits public feedback. companies. Based on this review and on feedback from public disclosure, an SSE Expert Consultation Committee (external �� In Peru, Turkey, and South Korea the analysis also experts nominated for two years) makes the final decision on includes proprietary research, which can include company selection. interviews with company executives, the board, as well as investors. Most of the stock exchanges (four out of six) pay the evaluators �� Company feedback regarding the initial evaluation is to avoid potential conflicts of interest. In Peru, companies have incorporated into the evaluation process in all indices to hire one of the accredited rating agencies to verify their self- assessment. In Turkey, companies pay one of the rating agencies that are not based on a listing tier. South Africa’s JSE registered with the CMB. As an incentive, the cost of the rating SRI Index, in existence since 2004, now achieves an 80 is partially offset, as new companies joining the CGI pay only percent response rate to the initial evaluation it sends half of the annual listing fee for the first two years, 75 percent to the companies that it automatically assesses. for the next two years, and 90 percent thereafter. 2. Governance evaluators 3. Methodology One of the most common concerns in the evaluation process is the conflict of interest that may arise between company and All indices studied rely on publicly available information, and evaluator. To avoid such conflicts, evaluation against governance almost all outsource their research to external providers (Table 5). However, the index methodologies differ substantially in two or ESG criteria is outsourced in five of the six indices surveyed aspects: (i) Whether the benchmark criteria are determined that are not listing tiers, with the exception of China’s SSE GGI. by the stock exchange, and (ii) How much of the rating Even in the case of the Chinese SSE CGI, which relies mainly methodology is set by the stock exchanges. Stock exchanges on in-house research, conflict of interest is taken into account set the rating benchmark criteria in all cases except Mexico and 12 Raising the Bar on Corporate Governance Table 5: Index Benchmark Criteria and Qualifying Threshold Index Benchmark Criteria Qualifying Threshold Brazil BM&FBOVESPA Special CGI Novo Mercado, Level 1 and Level Compliance with listing rules 2 listing rules China SSE CGI 20 self-evaluation questions Not disclosed Italy FTSE STAR STAR listing rules Compliance with listing rules Mexico BMV IPC Sustentable 100 ESG criteria Higher than global EIRIS ESG average Peru BVL Good CGI 26 governance criteria 60 percent of max score of 312 South Africa JSE SRI Index 90 ESG Indicators 50 percent of all indicators, 1/3 of core indicators South Korea KRX KOGI 95 governance criteria Rating above B+ Turkey ISE CGI 4 chapters of CG Code Rating of at least 7 out of 10 Sources: Stock exchange websites and responses to questionnaires South Korea. On the other hand, in Mexico, South Korea, and shareholder principles 25 percent, stakeholders 15 Turkey rating methods are left entirely to the evaluators. percent, disclosure 35 percent and board 25 percent. �� South Africa: For the JSE SRI Index, the JSE sets �� South Korea: For the KRX KOGI, Korea Corporate environmental, social, and governance criteria, Governance Services (KCGS) sets the benchmark separated into core and desirable indicators. The governance criteria and the rating methodology. methodology is set so that in order to qualify, a Companies must score a minimum rating of B+ to be company must meet a majority of indicators, at least eligible for the index. Since the number of constituent one-third of which must be core indicators. EIRIS and companies is limited to 50, companies with higher the Stellenbosch Business School’s Unit for Corporate scores qualify should more than 50 companies be Governance in Africa automatically evaluate the JSE’s eligible. Top 40, FTSE/JSE Mid Cap, and current SRI Index �� Mexico: The Mexican Stock Exchange, the BMV, constituents using this methodology. on the other hand, disengages entirely from the �� Peru: The BVL Good CGI is based on 26 criteria ESG rating process to avoid any potential conflict derived from the Peruvian Corporate Governance of interest with its clients, the listed companies. The Principles. In the evaluation methodology, the methodology, including the ESG benchmarking criteria, is set by the Universidad Anáhuac and principles are categorized into essential, important, Ecovalores (a subsidiary of EIRIS), and both convenient, and desirable, with scores from 54 to organizations apply their own methodology. After 1 assigned to the four categories. One of the rating obtaining its overall score from the ratings of both agencies accredited by the BVL then reviews the evaluators, a company must be above the global self-evaluation of the company against each principle average of EIRIS’ ESG rating (based on a universe and assigns a level of compliance ranging from of 3,500 companies) to be included in the IPC not complying (0 percent of the point scale) to Sustentable. full compliance (100 percent of the point scale). A company must score a total of at least 60 percent of �� By definition, CG listing segments do not need a the possible points to qualify for the index. methodology for evaluating governance criteria since membership is automatically determined by adherence �� Turkey: The Turkish CG Principles in their entirety to the listing rules. form the basis of the ISE CGI. Companies are assessed against the four chapters of the Principles that address shareholder rights, stakeholders, transparency and 4. Vetting of information disclosure, and board of directors. However, the rating Both the information used in the evaluation and the company agencies engaged by the companies set the actual rating can be verified. In practice, the indices that are not rating methodology. The CMB determines only the based on listing tiers do not run additional verification on the weights for the calculation of the overall company score: information feeding into the evaluation. The exceptions are A Study of Eight Stock Exchange Indices 13 the indices based on company self-evaluations. Similarly, the mentioned previously, these rating agencies must be accredited company evaluations are not formally verified by a third party by both the stock exchange and the securities regulator. or by the stock exchanges. Information underlying evaluation: Public information, such C. Disclosure as financial statements, annual and governance reports, are taken Effective communication and transparency about the criteria at face value, based on the assumption that such information has and methods used in assessing companies for inclusion in been verified by independent external auditors and approved by the index are essential building blocks for an index’s market the securities commissions and the stock exchanges. credibility. The disclosure of evaluation results is equally Self-evaluations: The indices in China and Peru, which are desirable and important for securing an index’s credibility. based on initial company self-evaluations, employ a verification However, companies are reluctant to have the detailed results of process, since the information provided by the companies is not their evaluations published. necessarily public. The application by a company for the SSE While criteria and methodology are disclosed almost everywhere Corporate Governance Board gets posted for public comment (China’s SSE does not publish a qualifying threshold or details and afterwards is evaluated by the SSE CG Selection Team. In of a methodology), ease of accessibility differs substantially. Peru, an accredited rating agency verifies the company’s self- With respect to the disclosure of the ratings, only South Korea’s evaluation. KOGI (rating score) and Turkey’s ISE CGI (full rating report) Vetting of ratings: The ratings provided by the governance go beyond disclosing the bare minimum, i.e., the constituents and ESG evaluators do not undergo additional verification of the index (Table 6). by the stock exchanges. In Peru and Turkey, companies are free to choose their evaluator from a list of rating agencies. As Table 6: Disclosure of Index Criteria, Methods, and Results Index Index Criteria Methodology Rating Disclosure Brazil BM&FBOVESPA Special CGI Novo Mercado. Level 1 N/A Segment constituents and Level 2 listing rules in English China SSE CGI Self-evaluation questions No details disclosed Only index constituents available in Chinese Italy FTSE STAR STAR listing rules in English N/A Segment constituents Mexico BMV IPC Sustentable In Spanish on Universidad In Spanish on Only index constituents Anáhuac website Universidad Anáhuac website Peru BVL Good CGI In Spanish In Spanish Index constituents, including best performer South Africa JSE SRI Index In English In English Index constituents including best performers South Korea KRX KOGI In Korean on Korea In Korean on KCGS Index constituents; Corporate Governance website Services (KCGS) website rating score in Korean on KCGS website Turkey ISE CGI Turkish CG Code, available in In Turkish on the rating Full rating report of English agencies’ websites constituents on website of Turkish Corporate Governance Association, mostly in Turkish Source: Stock exchange websites and responses to questionnaires 14 Raising the Bar on Corporate Governance 1. Disclosure of index criteria and 2. Disclosure of ratings methodology The disclosure of detailed results, ideally including the rating All stock exchanges in the study offer dedicated pages for CG report, is important for an index’s credibility. It is also critical or ESG indices on their websites. This does not always include for investors to know whether the unmet criteria are those access to the index criteria and methodology, however, which important for their investment decisions. This does not apply are often posted only on the evaluators’ websites. English to governance listing tiers, where the adequate presentation of translations of criteria and methodologies are available only the special listing rules and company disclosure is sufficient to in Brazil, Italy, and South Africa. Other observations about ensure that a company complies with all governance-related disclosure and accessibility: listing requirements. �� BM&FBOVESPA’s presentation of the corporate Despite a strong case for the disclosure of results, four of the six governance tiers in Brazil (Novo Mercado, Level indices studied that are not based on listing segments disclose 1, and Level2) is exemplary. On a dedicated page, only the companies that constitute the index. The exceptions governance provisions are well laid out and easily are Turkey and Korea: accessible, and with the recent introduction of the �� In Turkey, the detailed rating reports underlying Reference Form (an online annual report that is Turkey’s ISE GCI are provided for all constituent updated in real time), companies disclose all sorts of companies of the index by order of overall score, governance information. including historical reports. The majority of the reports �� In South Africa, the JSE SRI Index site offers are in Turkish only, however, and they are disclosed not thorough information on the development of the on the ISE website but on the website of the Turkish index, clear presentation of and access to the criteria Corporate Governance Association. and methodology used in the evaluation, together �� In Korea, companies with rating scores better than B+ with other useful links, such as historical data on index are disclosed, but there are no details on how the score constituents and press releases. was obtained. Like Turkey, the score is disclosed only �� In Mexico, Turkey, and South Korea, the disclosure on the website of KCGS, not by the stock exchange. of the detailed rating methodologies, and in the case of The major obstacle to increased disclosure cited by most stock Mexico and South Korea of the rating criteria, is left to exchanges is the reluctance of companies to have detailed the evaluators and rating agencies. The stock exchanges reports and scores published, since it would effectively rank do not even provide a link. them against other companies. There are, however, a number of �� The only indices offering comprehensive information ways to work around this obstacle: in English are Brazil’s BM&FBOVESPA Special CGI and the South African JSE SRI Index. In the case of �� In the annual presentation of the companies that China’s SSE CGI, the Korean KRX KOGI, and the make up South Africa’s SRI Index, the JSE presents Turkish ISE CGI, basic information is available in “Best Performers,� or companies that meet additional English, but the governance evaluation methodologies levels of performance, such as fulfilling all social and and/or criteria are disclosed only in Chinese, Korean, governance core requirements. and Turkish, respectively. In addition, the governance �� The BVL in Peru annually awards a “Key to the BVL� criteria and evaluation methods in Turkey and to the best-performing company. Korea are available only on the websites of the rating �� Having launched the IPC Sustentable index only agencies. All information made available by the parties recently, in 2011, the BVM in Mexico plans to responsible for the Mexican BMV IPC Sustentable gradually increase disclosure once the index is more and the Peruvian BVL Good CGI is in Spanish only. established. �� The Mexican IPC Sustentable was launched only in December of 2011. It is, however, the only index that has a dedicated website, which offers presentations and profiles (but no evaluations) of the constituent companies. A Study of Eight Stock Exchange Indices 15 D. Index Supervision 1. Monitoring of index composition and criteria compliance A CG or ESG stock exchange index has to be monitored for two distinct reasons. First, the index composition must Index calculation and rebalancing follow the technical guidelines of the stock exchange. Second, The calculation of the index is carried out by the stock exchanges compliance with governance criteria must be monitored. This in all eight cases, with the exception of China’s SSE CGI, for is of utmost importance to avoid potential reputational damage which China Securities Index Co. Ltd. calculates the index. for all companies in the index as a result of one constituent’s Index maintenance and rebalancing takes place two, three, or corporate scandal. Equally important is a credible procedure for four times a year. the immediate exclusion of companies that gravely violate index criteria. Monitoring and review of compliance with governance/ ESG criteria For the indices in this study, monitoring, rebalancing, and calculation of market weights occurs on a quarterly, thrice With the exception of BM&FBOVESPA’s corporate governance listing tiers in Brazil, where compliance with the segment’s yearly, or semi-annual basis (Table 7). Compliance with CG listing rules is continuously monitored, all formal evaluations criteria is formally evaluated annually in all indices with the take place on an annual basis. The following observations can exception of the Brazilian CG Index, , which is monitored also be made: continuously. All, with the exception of the BVL’s Good GCI, have procedures in place for immediate exclusion of a company, �� In Mexico, in addition to the formal annual although in practice this has occurred only once. evaluation, the research providers for the BMV’s IPC Table 7: Monitoring of Index and Governance Criteria, Monitoring of Compliance Index Compliance Monitoring Index composition with CG Criteria Frequency Exclusion Procedure Brazil BM&FBOVESPA BM&FBOVESPA Continuous Immediate in case of delisting due to BM&FBOVESPA violation of listing rules or voluntary Special CGI decision of the company China SSE CGI China Securities SSE Expert Annual Annual review and immediate for Index Co. Consultation grave criteria violation Committee Italy FTSE STAR Borsa Italiana and Borsa Italiana Annual Annual review and immediate for FTSE listing rule violation or voluntary decision of company Mexico BMV BMV Universidad �� Annual evaluation Annual review and immediate for IPC Sustentable Anáhuac and �� Semi-annual grave criteria violation Ecovalores monitoring Peru BVL Good BVL Accredited rating Annual During annual review CGI agencies South Africa JSE JSE JSE and EIRIS �� Continuousfor JSE Annual review and immediate SRI Index ground rule criteria for unsatisfactory handling of �� Annual evaluation controversial issue for all criteria South Korea KRX KCGS Annual Annual review and immediate for KRX KOGI grave criteria violation Turkey ISE CGI ISE Accredited rating Annual Annual review and immediate for agencies grave criteria violation Sources: Stock exchange websites and responses to questionnaires 16 Raising the Bar on Corporate Governance Sustentable monitor the index’s constituent companies company to remedy weaknesses and remain semi-annually. At this time, ESG issues raised during in the index. In Mexico, the company has the the previous evaluation are discussed and progress, or period until the following year’s evaluation to lack thereof, is noted. improve the practice(s) in question. The South �� While there is a formal annual evaluation of the African index identifies so-called Borderline companies in South Africa’s JSE SRI Index, the Companies that, during the annual review, criteria of the index that are based on the JSE’s Ground meet most criteria but marginally fail in one. Listing Rules are continuously monitored. They have three working days to respond to the issue, after which a decision is made on �� For most indices, the annual review takes place at the whether they qualify for the index. same time for all companies. The exception is the ISE CGI in Turkey. Turkish companies wishing to join �� Extraordinary exclusions for a grave violation the index can get their evaluation at any time and are of governance criteria—extremely important eligible to join once they pass the rating threshold of 7 for the reputation of the index—can take place out of 10. Constituent companies must be re-evaluated at any time. All stock exchanges surveyed, with at least once a year. the exception of the Lima Stock Exchange, have the option for such exclusions. �� The JSE’s SRI Index in South Africa is also a good example of the engagement of civil society for the purpose of monitoring compliance with index 3. Exclusions in practice criteria. On numerous occasions, the JSE has In practice, virtually all removals from CGI and ESG indices received comments from individual and institutional are for the first two reasons listed above. Companies are delisted shareholders on the practices of companies in its index, because of mergers, acquisitions, or bankruptcy, or because they the majority on environmental issues, but some on fail to meet market-based criteria. For example: governance topics. �� In Italy, 45 companies have been removed from the STAR tier since 2002, all for either delisting (mergers, 2. Exclusion from the index acquisitions, or bankruptcy) or exceeding the market Companies can be removed from CG or ESG indices for three cap limit of €1 billion. reasons: �� In Peru, one company, La Cima, has been excluded 1. Violating general listing rules or delisting. from the BVL CGI since 2008. It no longer met the Companies can be removed from the index for liquidity requirements of the index. violating general listing rules or because of delisting. �� In China, 17 companies have been removed from the These removals occur immediately in all indices. SSE CGI since 2009. Sixteen of these removals were 2. Failure to meet market-based criteria. Most due to mergers and acquisitions. indices specify market-based criteria, such as market The SSE CGI in China featured the only case in the study where capitalization, free float, or liquidity thresholds, in the a company was removed because of violating CG criteria. In index rules. Removal of companies falling below these February 2009, Chongqing Bridge and Road Company was thresholds can take place during the annual review, but removed from the index after it was fined by the SSE for illegal can also occur during the quarterly, thrice yearly, or transactions. The removal took place immediately. semi-annual rebalancing of the index. This case underlines the dilemma of removing companies from 3. Failure to comply with CG/ESG criteria. Two types an index and protecting the integrity of the index as a whole. of governance-criteria-related exclusions from an index While knowledge of corporate wrongdoing might exist early, in can occur: ordinary and extraordinary. order to exclude a company from the index a stock exchange �� Ordinary exclusions occur in all indices has to wait until a case has been resolved to take action. At this when a company does not meet the specified point it could be too late to avoid reputational damage for the benchmark threshold during the annual index. review. The Mexican and South African indices have procedures in place that allow a IV. Growth, Performance, and Product Development A. Growth In several countries, the number of companies listed in corporate governance indices has grown enormously in a short time. Table 8 illustrates this growth. In the indices that are not capped (Brazil, China, Mexico, Italy, Turkey, and South Africa), listings have grown markedly since index inception. For instance, Turkey’s index has grown steadily, by six companies in 2008, eleven in, in 2009, seven in 2010, and 2011, and six in 2012. Table 8: Number of Companies Original Index Launch Date Constituents February 2013 Brazil BM&FBOVESPA CGI 2001 (*) 12 174 China SSE CGI 2008 199 266 Italy FTSE STAR 2001 20 66 The performance Mexico BMV IPC Sustentable 2011 23 29 of the eight indices Peru BVL Good CGI 2008 9 9 in this study, in South Africa JSE SRI Index 2004 49 79 comparison to South Korea KRX KOGI 2003 50 50 Turkey ISE CGI 2007 7 45 their respective Source: Stock exchange websites and responses to questionnaires benchmark (*) The segments were launched in 2000, but the first companies joined the segments only in 2001. indices, ranges from those Some of the listing increases in the CGI come in markets that have not seen strong growth of new listings (Figure 3). For instance, Italy, South Africa, and Turkey have not seen a significant number closely tracking of new listings in the recent past, but their CG indices have thrived. the benchmark to those clearly B. Performance outperforming it. The performance of the eight indices in this study, in comparison to their respective benchmark indices, ranges from those closely tracking the benchmark to those clearly outperforming it. This study cannot control for variables other than governance that may affect the performance of the companies in the CGIs. For example, general economic circumstances may affect companies in the CGI differently than companies in the benchmark index, depending on factors such as the sectorial mix of companies in the indices. Nevertheless, outperforming the benchmark over a longer period, as is the case in Brazil, can probably be attributed to the positive impact of governance factors. The majority of the eight CGIs, summarized in Figure 4, have closely tracked the country’s broader market index. The principal reason is the high level of overlap between the portfolios of both the broader index and the CGI in many countries. For instance, South Africa’s JSE All Share Index (ALSI) consists of 164 companies. All 79 companies in the JSE SRI Index are also part of the ALSI. Those 79 companies, however, capture nearly 80 percent of the market capitalization of the ALSI. 17 18 Raising the Bar on Corporate Governance Figure 3: Number of New Listings 120 100 Number of new listings 80 60 40 20 0 zil i ly ico u a a y ha ric re e r Ita rk Pe a Ko ex ng Br Af Tu M a th Sh th u u a– So So in Ch n 2007 n 2008 n 2009 n 2010 n 2011 Source: World Federation of Stock Exchanges Underlining the fact that the main market drivers are part of the SRI Index is that 36 of the companies in the Top 40 Index—the largest companies by market capitalization—are part of the JSE SRI Index. Outperforming the benchmark over a China offers a similar example of the main drivers in the longer period, as is the case in Brazil, country’s stock market dominating both the benchmark and the CGI. China’s CGI and the main market index, the SSE 180, can probably be attributed to the had virtually identical (negative) performance over the past few years. The only explanation for such similar performance positive impact of governance factors. is that the 100 companies in the SSE 180 Index are also almost exclusively driving the performance of the broader 266-company SSE CGI. The other 166 companies appear to be too thinly traded to make an impact on performance. A Study of Eight Stock Exchange Indices 19 Figure 4: Performance of CGI and ESG Indices against Market Benchmark Brazil – IGC vs IBOVESPA China – CG Index vs SSE 180 Italy – STAR vs Mid Cap Mexico – IPC Sustentable vs IPC Peru – IBGC vs IGBL South Africa – JSE SRI vs All Share South Korea – KOGI vs KOSPI Turkey – ISSE CG vs IMKB 100 Source: Stock exchanges 20 Raising the Bar on Corporate Governance cape town, south africa There are, however, three examples of CGIs outperforming possible even if there is significant overlap between the CGI their respective market benchmarks, Brazil, Italy, and Mexico. and the benchmark index. 24 of the 29 constituent companies of the IPC Sustentable are also among the 35 companies listed In Brazil, the corporate governance index, IGC, has dramatically on the IPC. But these 24 clearly outperform their 11 peers in outperformed the broader IBOVESPA index since 2001. The the IPC who are not part of the IPC Sustentable. IGC has steadily made bigger gains in strong markets, such as 2007, and has been less volatile than the broader market. The As more companies are added to the CGIs over time, strong performance of Brazil’s IGC may come from the strong performance should diverge from the broader market in relative performance of better-governed companies. The IGC the medium to long term. Brazil and Mexico, albeit with a weights companies by multiplying their market values by a shorter time span, demonstrate how well-governed companies governance factor. This factor is 2 for companies on the Novo can outperform the market as a whole. Brazil’s distinctive Mercado, 1.5 for Level 2, and 1 for Level 1. Thus, companies weighting of its corporate-governance levels also offers a way to with the best governance practices (i.e., on the Novo Mercado) differentiate CGIs meaningfully. get the biggest weightings relative to market value, followed by those on Levels 2 and 1, respectively. If these companies outperform others in the market, the IGC index’s superior C. Investment Products performance becomes even more accentuated. Only two exchange-traded funds (ETFs) have been built from The STAR index in Italy has mirrored the comparable Mid the indices surveyed—in Brazil and China. It is worth noting, Cap index for the better part of its existence since 2003. however, that trading volume among these products is fairly However, since 2009, the STAR governance segment has clearly strong. China’s BOCOM SSE 180 Corporate Governance outperformed the Mid Cap index, as well as the broader FTSE Index ETF generated a volume of more than 2 million shares Italia All-Share Index. Over the ten-years since 2003, FTSE on days in 2012. Brazil’s It Now IGCT Fundo de Indice ETF Italia STAR has gained 40 percent, while the FTSE Italia Mid has recently posted a trading volume of about 180,000 shares, Cap lost 7 percent over the same period, and the FTSE Italia and over the past year volume has climbed as high as 400,000 All-Share lost 28 percent. shares. Also of note: two ETFs in Korea are based on KOGI’s sister index, the KRX SRI index. Both have limited trading The Mexican IPC Sustentable has outperformed the broader volumes, however. IPC index by almost 20 percent between its November 2011 inception and February 2013. Backdating the two indices Product development based on CGIs is currently limited. to 2009 shows that the IPC Sustentable would also have However, if stock exchanges can find ways to better differentiate outperformed the broader index prior to its launch. The Mexican CGIs from the broader market, they may attract more interest example also shows that superior performance by the CGI is from investors and can lead to more fund and ETF development. V. Main Findings A review of the experience of the eight CGIs studied shows that they are having a strong impact in a number of areas: Indices are growing and attracting companies across index types. All indices in the study that are not capped have shown strong growth, often in only a few years. This is particularly true for the listing tiers in Brazil and Italy, but also for the ISE CGI in Turkey and the SSE CGI in China. This shows that companies see the value in adopting more stringent governance requirements than are required in the regular market. The growth of the JSE SRI Index in South Africa, based on the automatic evaluation of the main index at the JSE, indicates that companies are improving their practices to be part of the index. CGIs offer tangible benefits as research and policy tools. In markets where information on the governance practices of companies is scarce, companies selected to be in an index can be a useful starting point for investors choosing stocks. More importantly, raising the governance bar via the introduction of new market-driven index requirements can have an immediate effect on companies’ governance practices and can offer alternative avenues to attract foreign capital. Some indices outperform, while most indices mirror, the broader market. Almost all indices studied closely track the main benchmark index of their markets. This mainly reflects the large overlap in constituents between the main index and the CG and ESG indices. It also shows the lack of depth in capital markets in most of the countries in the study, where a few blue chip companies move the market. These blue chips are also the natural constituents of CGIs since they usually have good governance practices. Brazil’s BM&FBOVESPA CGI is the only CGI that has significantly outperformed the market over time. This shows both the success of the index in differentiating itself from the main market and the greater depth of capital markets in Brazil. Besides these observations on the impact of CGIs, this study attempts to address three key questions: In markets where 1. What are the key drivers for stock exchanges to launch CGIs? 2. What are the critical building blocks in the construction of a CGI? information on 3. What risks do investors face when investing in CGIs? the governance Based on the review of experience and performance of the eight CG and ESG stock exchange indices studied, a number of conclusions can be reached: practices of companies is 1. Key drivers for launching CGIs Indices can elevate a country’s overall corporate governance environment. Weaknesses in scarce, companies a country’s CG framework, such as lack of shareholder protection and weak requirements for independent directors, are some of the main reasons behind the creation of CG and ESG indices. selected to be in Evaluation criteria often address the most salient issues facing a country in this area. an index can be Indices can offer companies an opportunity to differentiate themselves and can increase their access to capital. Creating an index or listing tier of excellence in corporate governance a useful starting allows companies to differentiate themselves from other companies in the market. At its 10-year anniversary, the Italian STAR showed that SMEs in the index were able to increase their liquidity point for investors and access to foreign capital. Brazil’s Novo Mercado not only attracts the bulk of new listings in the Brazilian market but also significantly outperforms the broader market index. This is also true for choosing stocks. 21 22 Raising the Bar on Corporate Governance indices incorporating broader ESG issues, as the premium paid indices contribute to better application of codes. If the index for companies in South Africa’s JSE SRI Index demonstrates. criteria are based solely on the corporate governance code, however, they can be only as strong as the underlying principles Indices based on listing tiers offer a higher degree of of the code. This can present a challenge, as in the case of Peru, commitment to governance issues than indices with a rating where the Code’s independence definition for directors is weak. threshold. Since adherence to all of the tier’s listing rules becomes a binding contractual obligation, listing tiers offer a Market-based criteria are important for the marketability higher level of commitment than indices based on meeting a of the index but may hurt its policy impact. Ensuring the rating threshold, where a company is never required to score 100 availability of a sufficient number of shares for trading is of percent compliance with the index criteria. The attractiveness of critical importance for a CGI to be marketable, especially in the listing-tier approach is highlighted by the strong growth of markets with concentrated ownership structures. Applying Brazil’s Novo Mercado and Italy’s STAR. free float and/or liquidity criteria in the index can achieve this goal. However, in markets where liquidity is concentrated in a The success of Italy’s STAR underlines that CGIs are also few stocks and free float is limited, the number of companies an option for segments in markets where overall corporate eligible for inclusion in an index can be severely reduced, as governance is already considered strong. By focusing on the is the case in Mexico. It thus diminishes the potential of an particular governance challenges of SMEs, the Borsa Italiana index to broadly influence corporate behavior, if companies created a listing tier that offers clear benefits for both companies not meeting free float and liquidity criteria are not part of the and investors as is evident from the performance of STAR. governance evaluation. On the other hand, it can motivate When indices are based on a rating threshold, automatic tightly controlled companies to make more shares available for evaluations have a stronger potential impact on CG practices trading. Market-based criteria can also skew the evaluation, than voluntary applications. Corporate governance indices since highly traded companies tend to be the blue chips of can be an efficient policy tool for improving CG practices. In the index and are likely to have higher governance standards. this context, automatically evaluating listed companies has a Definitions of free float can also be problematic, since little stronger reputational effect than letting companies voluntarily changes can trigger big consequences, as can be seen from the apply. Experience with voluntary application in Peru and Turkey recent changes in Mexico. shows that only companies assured of qualifying for the index Stock exchanges outsource the evaluation process for will apply, while companies with bad CG practices can pretend indices based on a rating threshold to avoid conflicts of not to be interested in joining the index. Automatic evaluations, interests with client companies. For indices based on a rating on the other hand, offer no such option. If a company in the threshold instead of compliance with special listing rules, the evaluation sample is not part of the index, it is because the evaluation of companies by the stock exchange can present a company’s practices were not good enough to meet the index potential conflict of interest, since the companies are also the threshold. This offers a stronger incentive for companies to clients of the exchange. All exchanges, with the exception of improve their practices. China’s SSE, consequently outsource the evaluation to external providers. Nevertheless, with the exception of Peru and Turkey, the evaluation is paid for by the stock exchanges to ensure an 2. Critical building blocks independent evaluation process. of an index Most of the stock exchanges disclose index criteria and Stock exchanges tend to select governance criteria that are methodology. Transparency about index evaluation criteria and objective and measurable, and are often based on national methodology is an essential building block for a CGI, and all corporate governance codes. The governance criteria used indices, with the exception of China’s SSE index, disclose both. for listing-tier rules and index evaluation tend to be concrete However, effective communication goes further than mere and measurable, which is critical for supporting the evaluation disclosure and includes easy accessibility of information. Only process, the supervision of companies, the potential exclusion the exchanges in Brazil, Peru, and South Africa link directly to of companies that do not meet the criteria, and the overall criteria and methodology from the index pages on the stock credibility of the index. A majority of criteria focus on the exchange websites, and only Brazil and South Africa offer the role of the board of directors, such as number of independent information in English. directors, existence of committees, and separation of CEO and chairman. National corporate governance codes play an Disclosure of rating results is rare. The disclosure of rating important role as source for the criteria used in the indices, and scores and evaluation reports is important for investors, and A Study of Eight Stock Exchange Indices 23 it also adds to the index’s credibility. Nevertheless, of the six 3. Risks for Investors threshold-based indices, only the Korean and Turkish exchanges CGIs offer a unique challenge for investors’ expectations, disclose the rating grades. Turkey discloses the full evaluation as the underlying governance criteria do not always follow report. international standards. For example, while all indices Exclusion of companies from indices occurs mainly during require the presence of independent directors on the board, annual reviews and rarely occurs because of a failure to the definition of independence and the required number of meet governance criteria. Evaluation of companies against independent members differ substantially among the indices index criteria is an annual affair in all indices and listing tiers and vis à vis international practices. with the exception of Brazil, where compliance is monitored Asymmetry of information can create false expectations. continuously, and exclusion for a violation of listing rules Investors may believe that they understand the CG criteria of an may occur immediately. To protect the index from the risk of index based on notions from markets that they are familiar with, reputational damage, stemming from a scandal at a constituent but the criteria employed in the indices can be very different. company between the evaluation cycles, all indices with the Equally important is the process of company evaluation and exception of Peru have an option for immediate exclusion of supervision of the index employed by the stock exchange. a company. Such an exclusion outside of the review cycle has Investors need to make an effort to fully understand the occurred only once in the eight indices. Even during the annual intricacies of each index to ensure that their initial expectations review, virtually all exclusions are due to failure to meet market- are met. based criteria or because companies have simply delisted. SHANGHAI PUDONG LUJIAZUI AT NIGHT This pattern could suggest reluctance by stock exchanges and The more transparent the index, the lower the information evaluators to exclude constituent companies for governance asymmetry investors face. Transparency about the set-up of the reasons. It could, however, also indicate the success of the index, including its rating criteria, methodology, and disclosure indices in permanently elevating the governance practices of its of evaluation results, is critical in allowing investors to ensure constituent companies. that the index meets their expectations. San Isidro, lima, peru VI. Eight Steps in Building a Successful Corporate Governance Index 1. Use a Wide Initial Consultation Process Whether the initiative for the index originates from the stock exchange, the regulator, companies, or even investors, a thorough initial consultation process is critical to gauge interest from all stakeholders, anticipate obstacles, and prepare companies for the launch of the index. 2. Define the Objective(s) of the Index A CGI’s objectives can be to function as a policy tool with which to improve CG practices, to offer companies a platform for differentiation, and to tap into the pool of investments committed to good governance and sustainability. An index can pursue any combination of these three objectives, Indices based depending on circumstances in the home market. Defining the objectives is critical for selecting the index type. When attracting investment is a key objective, the introduction of market-based criteria on adherence is essential to ensure sufficient availability of shares for trading. to listing rules represent the 3. Select the Index Approach highest level of Indices based on adherence to listing rules represent the highest level of commitment by constituent companies and are best suited to improving CG practices, differentiating companies and attracting commitment investment. If building a listing tier is not a feasible option, an index based on a rating threshold by constituent can achieve the same objectives, if the following observations are kept in mind: An index based on automatic selection offers more credibility and has better potential to improve CG practices. companies and Indices based on broader ESG issues are more likely to attract investment. are best suited to improving 4. Differentiate Criteria from Standard Governance CG practices, Practices differentiating The criteria for the index should be measurable and should address issues that are of particular concern in that country. The national corporate governance code serves as a good basis for the companies development of evaluation criteria. However, additional criteria offer companies a greater and attracting opportunity for differentiation and can address potential weaknesses in the code. investment. 5. Build a Transparent and Credible Evaluation Process The evaluation methodology should be straightforward and easily accessible to all parties involved. Development of the methodology may be outsourced to avoid conflicts of interest between the stock exchange and its clients, the companies. The evaluation of companies should be outsourced for the same reason. To guarantee the objectivity of the external evaluators, the stock exchange should cover the rating costs. 24 A Study of Eight Stock Exchange Indices 25 6. Achieve Maximum Possible company. Dealing with such a crisis credibly includes excluding client companies from the index for the violation of governance Disclosure criteria. Stock exchanges should also encourage stakeholders Information on the index, including its rating criteria and and the general public to participate in monitoring constituent methodology, should be easily accessible on the stock exchange’s companies, something the Johannesburg Stock Exchange has website and preferably available in English as well. Evaluation started for its environmental index criteria. results, including rating scores and detailed reports, are ideally fully disclosed on the same central webpage, but stock exchanges need to take into account that client companies are reluctant 8. Develop the Index to allow disclosure of their ratings and reports. Encouraging Once an index is established, it should become more demanding companies to disclose evaluation reports as best practice, or over time. While companies should not be presented with gradually increasing the level of disclosure every year, may help ever-changing criteria, it is important to build a progressive improve overall disclosure. and adaptable model that develops with the evolution of governance. This can include introducing new criteria, as the BM&FBOVESPA did in 2009 when the separation of CEO and 7. Effectively Monitor Index Criteria chairman was added to the Novo Mercado listing requirements, While the annual review of compliance with governance criteria or gradually increasing the disclosure of index results as the is generally sufficient and cost efficient, a stock exchange should BMV plans in Mexico in the years to come. Making index employ some form of continuous monitoring to avoid the criteria harder to meet can also help differentiate the index more reputational damage that can result from a scandal at a constituent meaningfully from the market’s main blue chip index. ciudad de mexico, mexico VII. Selected Bibliography Aviva Investors. 2012. “Global Equity and Fixed Income Manager ESG Survey.� CFA Institute Centre for Financial Market Integrity. 2010. “Shareowners Rights across the Markets: A Manual for Investors.� Economist Intelligence Unit. 2009. “Sustainable Investing in Emerging Markets: Unscathed by the Financial Crisis.� International Finance Corporation (IFC). Global Sustainable Investment Alliance. 2013. “Global Sustainable Investment Review 2012.� IFC and Esty Environmental Partners. 2011. “Assessing and Unlocking the Value of Emerging Markets Sustainability Indices.� IFC and Mercer. 2009. “Gaining Ground – Integrating environmental, social and governance factors into investment processes in emerging markets.� Institute of International Finance. 2007. “Corporate Governance in South Africa-- An Investor Perspective.� International Monetary Fund. 2007. “Turkey: Financial System Stability Assessment.� Organisation for Economic Co-operation and Development. 2010. “The Role of Stock Exchanges in Corporate Governance.� Pasquini, R. 2010. “Securities Markets Regulations and Evaluations on the Degree of Implementation: Argentina, Brazil, Chile and Peru.� Center for Financial Stability Working Paper No. 32. Pellini, P. 2011. “Stock exchanges as an engine for corporate governance improvements: Reaching out to non-listed companies.� Presentation at OECD Roundtable in Lima, Peru. Price, R., F. Román, and B. Rountree. 2009. “The Impact of Governance Reform on Performance and Transparency.� Journal of Financial Economics 99 (1): 76–96. Sadowski, M. 2012. “Rate the Raters Phase Five – The Investor View.� London: SustainAbility. World Bank. 2003. “Report on the Observance of Standards and Codes (ROSC) Corporate Governance Country Assessment, Mexico.� ———. 2003. “Report on the Observance of Standards and Codes (ROSC) Corporate Governance Country Assessment, Republic of Korea:.� ———. 2004. “Report on the Observance of Standards and Codes (ROSC) Corporate Governance Country Assessment, Republic of Peru.� ———. 2005. “Report on the Observance of Standards and Codes (ROSC) Corporate Governance Country Assessment, Brazil.� 26 VIII. Appendices Appendix I: Index Profiles Brazil CORPORATE GOVERNANCE INDEX (IGC) Name CORPORATE GOVERNANCE TRADE INDEX (ICGT) June 2001 IGC Launch date January 3, 2011 IGCT Geographic market Brazil Ownership structure BM&FBOVESPA Scope of Index Pure CG Index. The IGC - Special Corporate Governance Stock Index, consists of all companies participating in BM&FBOVESPA Listing Tiers Novo Mercado (NM), Level 1, Components, weighting and Level 2. Value of shares is weighted with factor 2 for companies on the Novo Mercado, 1.5 for Level 2, and 1 for Level 1 Companies participating in Level 1, 2, or Novo Mercado of BM&FBOVESPA are obliged to fulfill Governance criteria/ increasingly stringent corporate governance requirements going beyond the regular Brazilian factors, origin corporate governance framework Selection of companies Automatic if member of Level 1, 2, or Novo Mercado If company leaves one of the special segments. If a NM, L1 or L2-listed company fails to comply with listing regulations, BM&FBOVESPA will notify the company in writing, stipulating Exclusion of companies a deadline for rectification of the irregularities. The company may also be subject to the following consequences: fines, suspension of shares from trading, and, in more serious cases, cancellation of its NM, L1 or L2 registration. NM, L1, or L2: 25 percent free float. Additionally, IGCT companies must comply with the following criteria: Market-based criteria a) Those included in a group of stocks whose combined negotiability indices represent 99 percent of the total value of all individual indices b) Those with trading session participation that is equal to or greater than 95 percent in the period Methodology & Data Collection Type of information Documentation of compliance with rules of listing tier Evaluator BM&FBOVESPA Evaluation methodology N/A Index calculation BM&FBOVESPA At the end of April, August, and December, the theoretical IGC portfolio is re-evaluated Monitoring/Updates to check that none of the companies surpassed the maximum participation limit. On this occasion, shares that do not meet the minimum liquidity requirements may also be excluded. Supervision BM&FBOVESPA Companies in the 3 segments must meet their contractual obligations (such as 20 percent Verification/Audit of independent directors). BM&FBOVESPA verifies the companies’ compliance with the listing information and third- rules mainly by monitoring the disclosure of information required by the Brazilian Securities party providers and Exchange Commission. 27 28 Raising the Bar on Corporate Governance BRAZIL (cont.) Disclosure & Transparency of Index Level of detail of Companies listed on NM, L1, and L2 have additional disclosure requirements towards disclosure BM&FBOVESPA who will in turn make them public. Methodology http://www.bmfbovespa.com.br/Indices/download/IGC_ing.pdf Dedicated, easy-to-find page on BM&FBOVESPA site for Index offering introduction, Accessibility of methodology, composition, and historical statistics. information http://www.bmfbovespa.com.br/Indices/ResumoIndice.aspx?Indice=IGC&Idioma=en-us Performance Number of companies 174 as of February 2013 Additions/Exclusions N/A Performance IGC has gained over 640 percent since 2001, outperforming BOVESPA by 300 percent Financial products ETF: It Now IGCT Fundo de Indice (GOVE11) MILAN, italy A Study of Eight Stock Exchange Indices 29 China SSE Corporate Governance Index Name SSE 180 Corporate Governance Index Launch date January 2008 Geographic market China, People’s Republic Ownership structure Shanghai Stock Exchange (SSE) Scope of Index Components, weighting Pure CG Index Governance criteria are based mainly on Chinese Corporate Governance Code and take into Governance criteria/ account specific Chinese issues. As part of the application process, a company conducts self- factors, origin evaluation against 20 governance questions. Companies apply to be part of the SSE Corporate Governance Board. All companies selected Selection of companies; form the SSE Corporate Governance Index. The SSE 180 CG Index is constructed of the first benchmark 100 companies in the intersection between the CG segment and the SSE 180 Index Companies commonly removed during annual review but can be removed immediately for Exclusion of companies grave violations of index criteria. Market-based criteria None Methodology & Data Collection Type of information Self-evaluation of company and other publicly available information Joint effort between SSE and China Securities Index Co., Ltd. Evaluators A company’s application is reviewed by SSE CG Board Selection Working Team and posted for public comment. A Selection Unit is formed annually to review each application. It is Evaluation methodology composed of rating agencies, fund managers, and insurance companies. Based on this review and on feedback from public disclosure, an Expert Consultation Committee (nominated for 2 years) makes the final decision on company selection. Index calculation China Securities Index Co., Ltd. Monitoring/Updates The CG segment is evaluated annually between May and June. SSE Corporate Governance Board Rating Expert Consultation Committee and China Securities Supervision Index Co., Ltd. Verification/Audit of The SSE CG Segment Selection Working Team verifies the information provided by the information and third- companies, which includes posting the self-evaluation for public comment. party providers Disclosure & Transparency of Index Level of detail of Index constituents; self-evaluation of companies for public comment disclosure The evaluation process and self-evaluation questions for companies are disclosed in Chinese Methodology http://www.sse.com.cn/cs/zhs/xxfw/flgz/temp/temp20071008a.pdf Accessibility of Detailed evaluation methodology and qualifying thresholds not disclosed. \ Only the information calculation methodology of index is available in English. Performance SS CG Index: 266 Number of companies SSE 180 CG Index: 100 Over 4 review cycles, 17 companies have been excluded from SSE CG Index owing to failure to Additions/Exclusions meet CG Board requirements. Very similar to main index SSE 180 because of overlap in constituents and lack of liquidity of Performance majority of index constituents. Financial products ETF: BOCOM SSE 180 Corporate Governance Index 30 Raising the Bar on Corporate Governance Italy Name FTSE Italia STAR Launch date April 2001 Geographic market Italy Ownership structure FTSE, Borsa Italiana Scope of Index Components, weighting Based on the STAR segment of Borsa Italiana Governance criteria/ STAR segment market rules require companies to comply with certain normally voluntary rules factors, origin of the Italian Corporate Governance Code (see Appendix III). Selection of companies All constituents of STAR Exclusion of companies At any time for violation of listing tier rules Market capitalization between €40 million and €1 billion Market-based criteria STAR requires entry requirement 35 percent free float, which cannot fall below 20 percent Methodology & Data Collection Type of information Documentation of compliance with rules of listing tier Evaluator Borsa Italiana Annual verification process by Borsa Italiana. Company submits annual self-assessment and Evaluation methodology declaration of compliance with tier rules. Borsa reviews information and assigns internal rating, determining continuous membership of company. Index calculation FTSE Index is reviewed on a quarterly basis in March, June, September, and December. Governance Monitoring/Updates of companies is reviewed annually. Supervision Borsa Italiana Verification/Audit of Governance is annually verified by Borsa Italiana to confirm Star status. information and third- party providers Disclosure & Transparency of Index Level of detail of STAR segment companies publish governance reports showing their compliance with disclosure governance criteria. Methodology STAR segment listing rules Ease of disclosure Basic tenets of STAR segment are laid out on stock exchange website. Performance Number of companies 66 as of February 2013 STAR launched with 20 companies in 2001 Additions/Exclusions 45 exclusions from STAR segment since 2002, mainly because of mergers and delistings Grew by only 40 percent since December 2002, but did outperform both FTSE All-Share and Performance FTSE Mid Cap indices. Financial products None A Study of Eight Stock Exchange Indices 31 Mexico Name IPC (índice de precios y cotizaciones) Sustentable Launch date December 2011 Geographic market Mexico Ownership structure Bolsa Mexicana de Valores – Mexican Stock Exchange (BMV) Scope of Index E, S, and G Components, weighting Corporate Governance 34 percent; Social Responsibility 33 percent; Environment 33 percent Framework of Index is based on 6 OECD Principles, factors derive from OECD Principles, Governance criteria/factors, national law and code, and investor demand. Criteria go beyond mandatory and voluntary origin Mexican framework. Initially from all listed companies with a score better than the global average of EIRIS’ Selection of companies; ESG rating of a universe of 3,500 companies. Subsequently from all companies who meet benchmark market-based criteria. If company falls below benchmark in annual evaluation, it has a grace period until next Exclusion of companies year’s evaluation to improve score. Market-based criteria More than 30 percent of free float liquidity and/or US$1 billion of market capitalization Methodology & Data Collection Type of information Analysis of publicly available information Two providers: Universidad Anáhuac del Sur and EIRIS (through a Mexican representative: Evaluators Ecovalores) Anáhuac and Ecovalores evaluate publicly available information and rate companies on ESG Evaluation methodology data. Results are integrated between the results of both providers Index calculation Mexican Stock Exchange Monitoring/Updates Monitoring every 6 months, formal evaluation annually by evaluators Supervision Mexican Stock Exchange Verification/Audit of Companies audited reports are considered verified information; analysis of third-party information and third-party providers is exclusively based on such information providers Disclosure & Transparency of Index Level of detail of disclosure Index constituents Basic methodology (overall ESG criteria weight and index calculation) on Mexican Stock Exchange website. http://www.bmv.com.mx/wb3/wb/BMV/BMV_repositorio/_rid/223/_mto/3/ Methodology NotaMetodologicaIPCSustDic2011.pdf Universidad Anáhuac evaluation methodology at: http://ols.uas.mx/cegc/doctos/ CALIFICADORA_DE_SUSTENTABILIDAD_CORPORATIVA_METODOLOGIA.pdf Dedicated site: http://www.ipcsustentable.com/ offering background information on index. Ease of disclosure All information in Spanish Performance Number of companies 29 Additions/Exclusions Six companies were added in the first review cycle in 2012. In 2012, the first year of the IPC Sustentable, it outperformed the benchmark IPC by almost Performance 20 percent. Financial products ETFs planned, but not launched yet 32 Raising the Bar on Corporate Governance Peru Name �ndice de Buen Gobierno Corporativo (IBGC) Good Corporate Governance Index Launch date July 2008 Geographic market Peru Ownership structure Bolsa de Valores de Lima (BVL) – Lima Stock Exchange Scope of Index Components, weighting Pure CG Index. Governance criteria/ 26 governance criteria derived from Peruvian Corporate Governance Code. factors, origin Companies need to be part of general index to ensure liquidity. Voluntary participation of Selection of companies; companies; information provided gets verified by accredited auditors. Companies qualify if benchmark scoring at least 60 percent of maximum score of 312. Exclusion of companies During annual review if failing to meet benchmark or liquidity threshold Market-based criteria Constituents need to be in the top 80 percent liquid stocks at the BVL. Methodology & Data Collection Type of information Self-evaluation of companies Evaluators 6 auditing firms accredited by BVL to verify self-evaluation of companies The criteria are derived from Corporate Governance Code and receive different weights based Evaluation methodology on importance (essential, important, convenient, desirable). Index calculation BVL Monitoring/Updates Annual update of index by rating providers Supervision BVL Verification/Audit of The self-evaluation of companies is verified by third-party providers; providers have to be information and third- accredited by the BVL. party providers Disclosure & Transparency of Index Level of detail of The highest-scoring company gets publicized annual award “Key to the BVL� disclosure Methodology http://www.bvl.com.pe/ipgc/MetodologiadeSelecciondeValores.pdf Dedicated page for index offering all relevant information in Spanish http://www.bvl.com.pe/ Ease of disclosure acercabuengobierno.html Performance Number of companies 9 companies, another 8 recognized for practices but fail to meet liquidity criteria Since 2008, 2 companies have been added and one excluded owing to failure to meet liquidity Additions/Exclusions threshold Performance Slightly better but very similar to main index Financial products None A Study of Eight Stock Exchange Indices 33 South Africa Name SRI Index Launch date May 2004 Geographic market South Africa Ownership structure Johannesburg Stock Exchange (JSE) Scope of Index Components, weighting E, S, and G Companies are assessed based on policy/strategy, management/performance and reporting Governance criteria/ against more than 90 indicators across each of Environment, Society, Economy, and factors, origin Governance. Governance criteria taken from international best practice standards and South African Code King III. Any company in the FTSE/JSE All Share Index is eligible. The Top 40, FTSE/JSE Mid Cap and current SRI Index constituents are automatically evaluated; others can volunteer to be Selection of companies; assessed. benchmark Criteria are separated into core and desirable. Company must meet the majority of all indicators, at least one-third of which must be core indicators. So-called controversial issues can trigger investigation during annual review and lead to Exclusion of companies exclusion of company if issue not satisfactorily addressed. All Share Ground Rules apply: turnover of at least 0.5 percent of shares in issue, after the Market-based criteria application of any free float restrictions, per month in at least ten of the twelve months Methodology & Data Collection Type of information Analysis of publicly available information followed by feedback where necessary EIRIS assisted by University of Stellenbosch Business School’s Unit for Corporate Governance in Evaluator Africa Two-fold approach: 1st phase: Data provider reviews all publicly available information regarding the company to compile a profile indicating how information compares to the criteria; Evaluation methodology 2nd phase: Following the review, companies are invited to respond to the profile by commenting on, supplementing, or clarifying information contained in the profile within three weeks from receiving the preliminary profile. Index calculation FTSE on behalf of JSE Criteria, which are part of listing requirements, are continuously monitored, others as part of Monitoring/Updates Annual Review published in November. Index reviewed quarterly to determine if still complying with the Ground Rules of the JSE All Share Index. Supervision JSE Verification/Audit of JSE conducts informal quality assurance of the analysis done by EIRIS and USB. information and third- party providers Disclosure & Transparency of Index Level of detail of Index constituents and Best Performers (companies meeting all social and governance core disclosure requirements) Methodology http://www.jse.co.za/About-Us/SRI/Criteria.aspx Ease of disclosure Very comprehensive and informative site in English http://www.jse.co.za/About-Us/SRI.aspx Performance Number of companies 79 (2012) Original Constituents 2004: 51; exclusions have occurred owing to violation of unlawful Additions/Exclusions competition and human rights violations. Performance Very similar to JSE All Share Index because of overlap in constituents. Financial products A few funds actively track the SRI Index. Index is set out to become more demanding; i.e., aligning more closely with global Impact/Outlook benchmarks, converting desirable indicators into core indicators, and automatically assessing the whole core universe of companies. 34 Raising the Bar on Corporate Governance South Korea Name Korea Corporate Governance Stock Price Index (KOGI) Launch date February 2003 Geographic market South Korea Ownership structure Korean Stock Exchange (KRX) Scope of Index Components, weighting Pure CG Index Governance criteria/ 95 assessment criteria, representing a blend of OECD Principles and Korean characteristics factors, origin All companies on main Index KOSPI and top 100 companies on tech index KOSDAQ get Selection of companies; automatically evaluated. Selection according to rating and market capitalization if ESG rating benchmark same. The company score has to be above B+. Exclusion of companies During annual review Value traded: average transaction volume for past 3 months within top 40 percent bracket of Market-based criteria listed companies Methodology & Data Collection Type of information Evaluation based mainly on publicly disclosed information. Evaluator Korea Corporate Governance Service (KCGS) 5 ratings (A+, A, B+, B, C) are assigned, top 50 companies with minimum rating of B+ are Evaluation methodology selected Index calculation KRX Monitoring/Updates Annual regular realignment in September based on evaluation of KCGS Supervision KRX Index Committee Verification/Audit of Corporate governance committee and corporate governance research committee with outside information and third- experts to audit evaluation results. party providers Disclosure & Transparency of Index Level of detail of Index constituents on KRX website, Company grades B+ and better on KCGS website disclosure Methodology In Korean on KCGS website Ease of disclosure Information dispersed between KRX and KCGS website. Performance Number of companies 50 Additions/Exclusions On average 18 percent turnover of index constituents since 2007. Performance Slightly worse than main index KOSPI but similar because of overlap of constituents. Financial products None on KOGI A Study of Eight Stock Exchange Indices 35 Turkey Name ISE Corporate Governance Index Launch date August 2007 Geographic market Turkey Ownership structure Istanbul Stock Exchange (ISE) Scope of Index Components, weighting Pure CG index Based on the Corporate Governance Principles issued by Capital Markets Board of Turkey (CMB), which, in turn, are modeled after the OECD Principles. Companies are assessed against Governance criteria/ the four Chapters of the Principles addressing Shareholder Rights, Stakeholders, Transparency factors, origin and Disclosure, and Board of Directors. For the calculation of the overall company score, the following weights are applied: Shareholder principles 25 percent, Stakeholders 15 percent, Disclosure 35 percent, and Board 25 percent. Companies have to engage rating companies to be assessed. Any company on the Istanbul Selection of companies; Stock Exchange (ISE) is eligible. Companies with a corporate-governance rating of a minimum benchmark of 7 out of 10 are selected for index. Company is excluded when its rating falls below 7 or when it stops contracting rating Exclusion of companies companies to be assessed. Market-based criteria No additional free float or market capitalization requirements Methodology & Data Collection Rating agencies base rating on public information supplemented by additional information Type of information provided by companies upon request, as well as interviews. Evaluator Rating institutions incorporated by CMB in its list of rating agencies Each rating agency has its own rating methodology within parameters (factor weighting) set Evaluation methodology by the CMB. Index calculation Istanbul Stock Exchange Monitoring/Updates Companies are required to get rated at least once a year. Supervision Istanbul Stock Exchange Verification/Audit of No verification beyond accreditation of rating agencies by CMB. information and third- party providers Disclosure & Transparency of Index Level of detail of Full rating reports of companies included in Corporate Governance Index are posted on the disclosure website of the Turkish Corporate Governance Association. Methodology The rating agencies disclose their rating methodologies on their websites in Turkish. Companies announce their CG ratings on Public Disclosure Platform (www.kap.gov.tr) in Ease of disclosure Turkish and link to their websites for the full report. All reports are also available on the website of the Turkish Corporate Governance Association. Performance Number of companies 45 as of February 2013 No exclusions so far. Index started with 7 companies in 2007. Additions/Exclusions Additions: 2008 (6); 2009 (11); 2010 (7); 2011 (7); 2012 (7) Performance Practically identical to main market index IMKB Financial products Currently none shanghai, China Appendix II: Corporate Governance Framework in Indices’ Jurisdictions Country Type Name Applies to Law Corporation Law, 1976 Joint Stock Companies Brazil CVM Rules 480, 481, 2009 Listed companies Reg Novo Mercado Rules, 2011 Listing Tier Law China Code Code of corporate Governance for Listed Companies in China, 2001 Listed companies Law on Savings No. 262 of 2005 Law Listed companies Italy Consolidated Law on Financial Intermediation, 1998 Code Codice de Audodisciplina -Corporate Governance Code, 2011 Listed companies Companies Law, 1996 All companies Law Mexico Securities Market Law, 2005 Listed companies Code Best Practice Code, 2nd edition, 2010 Listed companies Companies Law, 1997 All companies Law Peru Securities Market Law, 1996, amended 2002 Listed companies Code Principles of Good Governance for Peruvian Companies, 2002 Listed companies Law Companies Act, 2009 All companies South Africa Code King Code of Corporate Governance, 2010 (King III) All companies Law Financial Investment Services and Capital Markets Act, 2009 Listed companies South Korea Code Code of Best Practices for Corporate Governance, 2003 Listed companies Commercial Code, 1956 Listed companies Listed Law Commercial Code, 2011 (effective July 2012) companies Turkey Corporate Governance Principles, Capital Markets Board of Turkey, Code Listed companies 2005 37 38 Raising the Bar on Corporate Governance Appendix III: Indices’ Governance Criteria Legend: Shareholder rights Stakeholder Rights Disclosure Board Other Brazil BM&FBOVESPA CG Index Italy - FTSE Italia STAR Mexico BMV IPC Sustentable Source �� NovoMercado Listing �� Borsa Italiana Star Listing Rules �� CGEvaluation criteria of Regulation �� Italian CG Code Universidad de Anahuac Quart. Interim �� Disclose �� Only common shares 1 �� Only common shares Management, Semi-Annual & Annual Report on website all reports and financial �� Publish �� Disclosure of RPTs 2 �� No voting limitations statements in English �� Composition of Board according �� Sep. CEO/Chairman 3 �� Full tag-along rights to Art.2 CG Code �� Min 2. Ind Directors �� Ind. Nomination of Directors �� Tenderoffers at least at economic 4 value of company �� Establish Internal Committees �� 25 percent Independent Directors �� Disclosure of Code of Conduct & 5 Securities Trading Policy �� Remuneration of Directors �� Independent Audit Committee 6 �� English Financial Statements Internal Control �� Establish �� Board evaluation 7 �� 20 percent Independent Directors Committee �� Englishspeaking Investor �� At least 4 meetings a year 8 �� Separation of CEO/Chairman Relations Officer and Board �� Executive 9 �� Arbitration for dispute resolution compensation policies �� Board’s Interest in ESG Practices �� Annual public meeting with 10 analysts A Study of Eight Stock Exchange Indices 39 Peru BVL Good CG Index Turkey ISE CG Index Source �� BVLCG Index Methodology – Questionnaire on CG �� Turkish CG Principles, 2005 Principles �� Facilitating the Exercise of Shareholders’ Statutory 1 �� Agenda topics should facilitate discussion Rights 2 �� Location of AGM facilitates shareholder’s participation �� Shareholders Right to Obtain and Evaluate Information Right to Participate in the General Shareholders’ �� The 3 �� Shareholder’s ability to include topics on the agenda Meeting 4 �� Shareholders’ ability to be represented by others �� Voting Rights �� Opportunity to exchange non-voting shares for voting 5 �� Minority Rights shares 6 �� Sufficient number of independent directors �� Dividend Rights 7 �� Disclosure of external audits �� Transfer of Shares 8 �� Designated information channels �� Equal Treatment of Shareholders 9 �� Confidentiality of information clearly defined �� Principles and Means for Public Disclosure �� Public Disclosure of Relations between the Company 10 �� Ind. internal audit and Its Shareholders, the Board and Executives �� Periodical Financial Statement and Reports in Public 11 �� Board fulfills key functions (strategy, risk, etc.) Disclosure 12 �� Transparent nomination and election process �� Functions of External Audit 13 �� Remuneration of board and executives �� The Concept of Trade Secret and Insider Trading Events and Developments That Must Be �� Significant 14 �� Monitoring of conflicts of interest Disclosed to the Public 15 �� Existence of Audit committee �� Company Policy Regarding Stakeholders �� Stakeholders’ Participation in the Company 16 �� Supervise CG policies Management 17 �� Supervise disclosure policies �� Protection of Company Assets 18 �� Special bodies to deal with conflicts of interest �� Company Policy on Human Resources 19 �� Board is representative of all shareholders �� Relations with Customers and Suppliers �� Appropriate information for directors to perform their 20 �� Ethical Rules duties 21 �� Defined policies to contract external experts �� Social Responsibility 22 �� Introductory policies for new board members �� Fundamental Functions of the Board of Directors �� Principles of Activity and Duties and 23 �� Procedures to elect alternate board members �� Responsibilities of the Board of Directors 24 �� Avoid duplicity of functions btw CEO and Chairman �� Formation and Election of the Board of Directors �� Structure of corporation should avoid concentration of 25 �� Remuneration of the Board of Directors power Structure and Independence of the �� Number, 26 �� Management compensation should be tied to results Committees �� Established by the Board of Directors 27 �� Executives 40 Raising the Bar on Corporate Governance China South Africa South Korea Source �� SSE Corporate Governance �� Excerpted CG criteria from �� KoreaCorporate Governance Segment Selection JSE SRI Index Background and Services Rating Criteria Methodology Brief, company Selection Criteria 2011 self-evaluation questions, unofficial translation �� Controlling shareholder’s property �� Protectionof Shareholder Rights 1 titles have been transferred to �� Sep. CEO/Chairman (27 evaluation criteria) company �� Conflictof interest involving 2 �� Independent Chairman �� Disclosure (27 evaluation criteria) controlling shareholder �� RPTsinvolving controlling non-executive & majority �� Majority �� Auditing System (13 evaluation 3 shareholder independent criteria) �� Cont. shareholder vetoed dividend and Remuneration �� Audit �� Board of Directors (25 evaluation 4 distribution in past 3 years Committee criteria) �� Procedures to review external of Profits (3 �� Distribution 5 �� Cumulative voting allowed audit findings evaluation criteria 6 �� Online voting allowed �� Board Charter 7 �� CSR disclosed in annual report �� Ind. Chairs of committees (D) �� Nomination and Risk Committees 8 �� Self-evaluation of board disclosed (D) 9 �� Audit Report disclosed �� Annual Evaluation of Board (D) �� Chairman and General Director 10 �� Internal Audit Function (D) are selected with due process �� Chairman nominated by �� Code of Ethics covering core 11 controlling or related shareholder issues of Index �� 50percent of board nominated responsibility for ethics �� Senior 12 by non-controlling shareholder management �� Board/Chairmanvoices 13 independent opinion �� 1/3or more of board vote 14 cast through long-distance communication �� Long-termincentive plans for 15 senior management management violated law �� Sr. 16 during duties in the past 3 years �� Financialreports have received 17 reservation or negative feedback from audit in past 3 years Appendix IV: Independence Definitions *Indices in China and South Korea do not have clearly defined independence criteria as part of their evaluation criteria Definitions of Independence Brazil Mexico Peru Italy Turkey South Africa Novo Mercado Listing Securities Market Law Corporate Governance Corporate Governance Corporate Governance King Report on Regulation Principles Code Principles Corporate Governance “Independent Director� Independent directors II.B. Independent 3.C.1. (…) a director 3.3.5. A member of Independence is the means a member of the are directors appointed directors are those usually does not appear the board who fulfill absence of undue board of directors that: based on their selected for their independent in the the below mentioned influence and bias (i) has no ties to the experience, capacity and professional prestige and following events, to be requirements may which can be affected Company, other than an professional prestige, who are not connected considered merely as an be qualified as an by the intensity of the equity interest; (ii) is not and that at the time of to the company example and not limited “independent member�: relationship between the a Controlling Shareholder, their appointment are management, nor to to: director and the company spouse or close family not: (i) relevant officers7, the control group of the a. Not to have any direct member (to the second employees or statutory same. a) if he/she controls, or indirect relationship degree) of a Controlling examiners of the PHC or directly or indirectly, of interest in terms of Shareholder, and neither of any of the entities that the issuer also through employment, capital or has, nor has had in the integrates its corporate subsidiaries, trustees or trade and commerce three (3) previous years, group8 or group9, (ii) third parties, or is able to between the company, its any ties to any company individuals with decision exercise over the issuer subsidiaries, affiliates or or entity related to a making authority10 or dominant influence, any other group company Controlling Shareholder significant influence11 or participates in a and himself/herself, his/ (excluding persons with over the corporation or shareholders’ agreement her spouse and his/her ties to public education any of the entities that (…); blood or affinity relatives or government research integrates its corporate by up to the third degree entities); (iii) in the group or group, (iii) b) if he/she is, or has been within the last two years, three (3) previous shareholders that are part in the preceding three years has not been an of the group of persons fiscal years, a significant b. Not to be previously employee or officer of that controls the PHC, representative of the elected to the board the Company, or of the (iv) clients, providers, issuer, of a subsidiary of directors as a Controlling Shareholder debtors, creditors, having strategic relevance representative of a certain or of a subsidiary of partners, directors or (…); group of shareholders, the Company; (iv) is employees of a company not a direct or indirect that is a significant c) if he/she has, or had in c. Not to be employed in provider, supplier or client, provider, debtor or the preceding fiscal year, a company, primarily for buyer of goods and/ creditor12, and (v) spouse directly or indirectly (… ) the audit and consultant or services, to an extent or family members of an a significant commercial, firm, which undertakes that would imply loss of individual mentioned in financial or professional full or partial activity independence; (v) is not (i) through (v) herein. relationship: or organization of an employee or senior the company under a manager ofany company - with the issuer, one contract and not to be or entity that of its subsidiaries, or have a managing position any of its significant therein within the last representatives (…) two years,d. Not to be A Study of Eight Stock Exchange Indices previously employed by the external auditor of 41 42 Appendix IV: Independence Definitions (cont.) Definitions of Independence Brazil Mexico Peru Italy Turkey South Africa Novo Mercado Listing Securities Market Law Corporate Governance Corporate Governance Corporate Governance King Report on Regulation Principles Code Principles Corporate Governance is offering or requesting or is, or has been in the the company or not to services and/or products preceding three fiscal have been included in to and from the years, an employee of the external audit process Company to an extent the above-mentioned within the last two years, that would imply loss of subjects; d) if he/she independence; (vi) is not receives, or has received e. Not to be previously a spouse or close family in the preceding three employed by a firm member (to the second fiscal years, from the providing significant degree) of any senior issuer or a subsidiary amounts of services manager of the Company; or holding company of and products to the and (vii) is not entitled the issuer, a significant company and not to have to any payment by the additional remuneration a managing position Company other than the (…) therein within the last Raising the Bar on Corporate Governance consideration earned as two years, director (excluding cash e) if he/she was a director distributions received in of the issuer for more f. For his/her spouse or the capacity of an equity than nine years in the last any of his/her relatives by holder) twelve years; blood and affinity up to the third degree, not to f) if he/she is vested have a managing position with the executive or be a shareholder director office in another holding more than 5 company in which an percent of the total executive director of the capital or the controlling issuer holds the office of shareholder by all director; means, or not to hold a managerial position or g) if he/she is shareholder not to be effective in the or quotaholder or control of the company, director of a legal entity belonging to the same g. not to receive any network as the company compensation other than appointed for the the board membership auditing of the issuer; compensation and attendance fee; to hold h) if he/she is a close shares of less than 1 relative of a person who percent if he/she is a is in any of the positions shareholder due to his/ listed in the above her duty, provided that paragraphs. such shares are not preferred shares. A Study of Eight Stock Exchange Indices 43 SAO PAULO, brazil Assessing and Unlocking the Value of Emerging Markets Sustainability Indices Contact information The World Bank International Finance Corporation 1818 H Street, N.W. 2121 Pennsylvania Avenue, N.W. Washington, DC 20433, USA Washington, DC 20433, USA Telephone: +1 202 473 1000 Telephone: +1 202 473 1000 Facsimile: +1 202 477 6391 Facsimile: +1 202 974 7384 Internet: www.worldbank.org Internet: www.ifc.org June 2013