Policy Brief on Corporate Governance of Banks in Eurasia Outline of the Preliminary First Draft

1
Policy Brief on Corporate Governance of Banks in
EurasiaOutline of the Preliminary First Draft

• Motoyuki YUFU
• Principal Administrator, OECD
• Tbilisi, Georgia
• 17 May 2007

2
Before we start The Eurasian Corporate
Governance Roundtable

• The OECD and the World Bank Group promote five
  regional roundtables on corporate governance in
  the world.
• The Eurasian Roundtable (Roundtable) was
  established in 2000.
• The Roundtable comprises policy-makers,
  regulators, academics, stock exchanges,
  non-governmental institutions and private-sector
  bodies from 9 Eurasian countries.
• Armenia, Azerbaijan, Georgia, Kazakhstan,
  Kyrgyzstan, Moldova, Mongolia, Ukraine and
  Uzbekistan
• The Roundtable agreed on a report (2004)
• Corporate Governance in Eurasia - A
  Comparative Overview

3
Before we start The Task Force on CG of Banks in
Eurasia

• One of the six priorities of the Comparative
  Report
• Governments should intensify their efforts to
  improve the regulation and corporate governance
  of banks.
• The Roundtable decided to launch a task force on
  bank governance
• Experts in banking or capital market
• Experts from Eurasia, OECD countries and
  international organisations
• To develop a policy recommendations/options paper

4
Before we start Some notes for discussion

• We would appreciate your understanding on the
  followings.
• Simultaneous interpreters at work. Please be
  advised to speak slowly and clearly.
• There are many chapters. Please make sure your
  comments best suit for the chapter being
  discussed.
• Any additional comments are welcomed even after
  the meeting (by email).
  Motoyuki.yufu_at_oecd.org
• We would most welcome informal, lively discussion
  in your private capacities.

5
Table of contents of the first draft

• Background
• Introduction
• Recommendations section
• Chapter 1 Boards, board members committees
• Chapter 2 Strategic objectives, professional
  conduct, etc.
• Chapter 3 Clear lines of responsibilities
• Chapter 4 Internal controls
• Chapter 5 Internal/external audit
• Chapter 6 Compensation
• Chapter 7 Disclosure
• Chapter 8 State owned/controlled commercial
  banks
• Chapter 9 Banks monitoring function on CG
• Chapter10 Supervisory roles next steps

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Background chapter of the Draft

• Introduction to the Roundtable
• Task Force who are we?
• Personal views do not reflect the views of the
  organisations they serve.
• Nature of the Policy Brief
• Non-binding
• Serves as a source of reference
• Not an exhaustive textbook
• OECD Principles, SOE Guidelines, Roundtables
  Comparative Report
• Harmonisation with the Basel Committees work
• Would assist wide range of people
• Banks, banking industry associations, institute
  of directors, stock exchanges, capital market
  authorities, and banking supervisors

7
Introduction chapter of the Draft

• Why is bank governance so important?
• It is essential to sound proper banking sector
  
• In Eurasia, banking is the most advanced
  industry Banks can be role models to others in
  improving corporate governance (CG)
• Some definitions
• board and senior management (functional
  definitions)
• Revision Commissions
• Statutory bodies different from boards
• Responsibilities in relation to internal audit
  and supervision
• Appointed at general shareholder meetings
• Mostly report directly to general shareholder
  meetings
• Named/translated in various ways

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Possible Discussion Points for Background
Introduction

• Paragraph 7 (Why is bank governance so
  important?)
• May also refer to the point that
• Poor governance can lead to a bank failure which
  may undermine a core element of market economy,
  peoples confidence in banks, which was once lost
  during the period of economic dislocation.
• May need more stress on depositors, which
  differentiates bank governance discussion from
  that of general CG. While minority shareholder
  protection is a focal point for CG in general,
  depositors should be highlighted more in the
  discussion of bank governance.
• Paragraph 9 (Definition of boards, etc.)
• Instead of using upper/lower boards, use
  supervisory board and management board
• Paragraph 10 (Definition of Revision
  Commissions)
• Let us discuss later (Chapter 5)

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Chapter 1. Boards, board members and committees
(1/4)

• Chapter 1 deals with four subjects.
• Importance of boards (paragraph 12)
• Boards independence (paragraph 13-16)
• Boards competence/knowledge and trainings
  (paragraph 17)
• Boards specialised committees (paragraph 18-20)

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Chapter 1. Boards, board members and committees
(2/4)

• 1. Boards are crucially important
• 2. Boards independence
• (A) Independence from senior management
• Former employment
• Material business relationship
• Additional remuneration
• Close family ties
• Cross directorship
• AND
• Former members of lower boards
• (B) Independence from controlling shareholders

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Chapter 1. Boards, board members and committees
(3/4)

• 2. Boards independence (Cont.)
• How many independent directors?
• a sufficient number of independent
  directors
• How to enforce/implement it?
• CG Codes with comply or explain basis, but
• Laws/regulations with binding force can be
  another option

12
Chapter 1. Boards, board members and committees
(4/4)

• 3. Boards competence/knowledge and trainings
• Collective knowledge as an entire board
• Trainings including CG awareness-raising program
• 4. Boards specialised committees
• Boards audit committees vs. Revision
  Commissions
• Other committees
• They would normally belong to upper boards, not
  lower boards
• Nomination committees
• Not common in Eurasia, but strongly recommended

13
Possible Discussion Points for Chapter 1
(1/2)Board, board members committees

• Paragraph 13 14 (Independent directors)
• May stipulate more detailed definitions of
  independent directors.
• May stipulate positive definition in addition to
  (OR instead of?) the negative list definition of
  the draft.
• For instance, the ability to exercise objective
  judgement and provide informed opinion
  independent of self-interest, management or major
  shareholders
• May stipulate that chairperson must be
  independent.
• Paragraph 15 (How many independent
  directors, etc)
• May stipulate that the upper limit of the numbers
  of boards on which one person can concurrently
  sits is NOT necessarily appropriate.
• Paragraph 16 (How to enforce/implement it)
• Which is better for the requirements of
  independent directors
• Hard Law (laws/regulations with binding force),
  and
• Soft Law (codes with comply or explain basis)

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Possible Discussion Points for Chapter 1
(2/2)Board, board members committees

• Paragraph 17 (Knowledge training)
• May stipulate that individual board members (all
  of them?) must have competence in banking on
  their appointment, not just general business
  experiences.
• Paragraph 19 (Boards audit committees)
• May stipulate competence of audit committee
  members
• All members be financially literate and at least
  one member should posses financial expertise
• Paragraph 20 (Boards specialised
  committees)
• Should they be committees of upper boards or
  lower boards?

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Chapter 2. Strategic objectives and professional
conduct, etc. (1/2)

• Cooperation between upper lower boards in
  setting objectives, etc.
• Implement the objectives, etc. bank culture
• Boards are responsible for nurturing sound bank
  cultures
• Whistleblowers
• Employees should be encouraged to communicate
  their concerns
• Procedures (including contact point) should be
  specified
• Protection/confidentiality should be secured

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Chapter 2. Strategic objectives and professional
conduct, etc. (2/2)

• Related Party Transactions (RPTs)
• Core set of regulations exist in many Eurasian
  countries
• Definition, ban on favourable transactions,
  lending limits
• How to secure effective observance to them
• Make bank boards fully accountable/responsible
• Prior approval of materially important
  RPTs
• But there is a risk of Rubber Stamping
• Burden of proof (Never approve it unless
  management successfully proves it)
• Boards specialised committees
• Public disclosure
• Outright banning of certain, limited types of RPTs

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Possible Discussion Points for Chapter 2
(1/2) Strategic objectives, professional conduct,
etc.

• Paragraph 21 (Co-operation in developing
  strategies, etc.)
• In Uzbekistan, banking law requires different
  boards to draft policies according to the nature
  of policies some polices (e.g. ALM) to upper
  boards, and others (e.g. credit) to lower boards.
• Paragraph 22 (Nurturing sound bank
  cultures)
• May elaborate more on board members as role
  models.
• Paragraph 23 (Whistleblowers)
• May stipulate boards obligation to (i) properly
  address such (bona fide) information and (ii)
  report back to shareholders on remedies taken.

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Possible Discussion Points for Chapter 2
(2/2) Related party transactions

• Paragraph 25 (Boards responsibility on
  RPTs)
• May refer to regulatory/supervisory measures
  addressing RPTs stipulated in Basel Core
  Principle 11.
• Principle 11 In order to prevent abuses
  arising from exposures to related parties and to
  address conflicts of interest, supervisors must
  have in place requirements that
• - banks extend exposures to related parties on
  an arms length basis
• - these exposures are effectively monitored
• - appropriate steps are taken to control or
  mitigate the risks and
• - write-offs of such exposures are made
  according to standard policies and processes.
• May stipulate (as banks internal rules)
  indemnification requirements on managers who
  breach relevant rules to get involved in RPTs.

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Chapter 3. Clear lines of responsibilities and
accountability

• Clear, not multiple, lines
• Boards (upper boards) should occupy superior
  position over senior management (lower boards)
• Upper boards ought to have power in relation to
  appointment removal of lower boards
• If not, revision of laws recommended
• In the meantime, at least, encourage upper boards
  to nominate candidates for lower boards

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Possible Discussion Points for Chapter 3 Clear
Lines of responsibilities

• As a New Paragraph
• May refer to possible problems arising from dual
  reporting lines of banks that are subsidiaries of
  others such as foreign financial institutions.

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Chapter 4 Oversight by senior management and
internal control functions

• Internal control serves for
• Performance objectives
• Information objectives
• Compliance objectives
• Who should do, and what to do?
• In varying degrees, everyones responsibility in
  banks
• Senior management should establish, monitor and
  improve it
• Boards should ensure that senior management does
  so

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Possible Discussion Points for Chapter 4
Oversight by senior management internal
control functions

• As a New Paragraph
• May refer to the four eyes principle, values of
  which are not widely understood.
• Four eyes principle includes segregation of
  duties, cross-checking, dual control of assets,
  double signatures.

23
Chapter 5 Internal audit and external auditors
(1/3)

• Revision Commissions
• Statutory bodies other than boards
• Responsibilities in relation to internal audit
  and supervision
• Appointed at general shareholder meetings, not by
  boards
• Mostly report directly to general shareholder
  meetings
• What to do with the Revision Commissions?
• (Tentatively) suggests two options
• Either empower/activate them, OR
  replace them

24
Chapter 5 Internal audit and external auditors
(2/3)

• If they are to be empowered/activated
• Include independent members
• Include full-time members
• Include accounting experts
• Involve in their own nomination process
• Financial resource
• Investigatory power
• Coordination with boards
• Fiduciary duties (legal liability)
• Or, replace them
• Make it optional for banks to replace them by
  creating boards audit committees

25
Chapter 5 Internal audit and external auditors
(3/3)

• Banks external auditors
• Boards and banking supervisors exchange views
  with them
• legal basis for banking supervisors to hear their
  views without consent of banks
• Legal obligation to report material breach of
  laws to banking supervisors
• Legal protection when they report
• Availability of external auditors with expertise
  at a reasonable cost
• (No magic formula but..) Get together for
  nurturing such experts.
  

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Possible Discussion Points for Chapter 5
(1/2) Revision Commissions

• Paragraph 32 (Recent reforms in other
  countries)
• Any recent fundamental reforms in Eurasia or
  others in terms of Revision Commissions?.
• Revision Commissions in several countries do
  not have much to do with internal audit functions
• Paragraph 33 (Policy options)
• Should Revision Commissions be replaced or
  empowered?
• Should we push the replacement option a little
  harder?
• Banks establish boards audit committees while
  maintaining the Revision Commissions. Should
  it be encouraged or discouraged ?
• Any comments on the draft in terms of the options
  to empower Revision Commissions?

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Possible Discussion Points for Chapter 5
(2/2) Internal audit external auditors

• New Paragraph
• May stipulate internal auditors competency,
  impartiality and independence as well as their
  reporting line.
• Paragraph 34 (Relationship with external
  auditors)
• May refer to rotation principle and quality
  assessment.
• May stipulate legal liability of external
  auditors for the loss caused by their negligence.
• May refer to the fact that banking supervision
  needs competence in accounting standards.
  Invest more on supervisors trainings in relation
  to this.
• What are the prerequisites for making it
  mandatory for external auditors to report
  material breaches to banking supervisors?

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Chapter 6. Compensation

• Extraordinary low remuneration for bank boards
  (and Revision Commissions) is not desirable
• Banking supervisors and others may want to
  provide guidance on compensation
• Remuneration for senior management and unitary
  boards executive members
• Long-term incentive scheme link to long-term
  performances of the bank, not short-term ones

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Possible Discussion Points for Chapter 6
Compensation

• Any suggestions?

30
Chapter 7. Transparency and disclosure in terms
of CG

• Ensuring appropriate bank public disclosure is
  important
• Market oversight and discipline do work
• Harmonisation to internationally recognised
  accounting standards
• In addition to the items listed on the Basel CG
  Guidance
• Information about Revision Commissions
  should be disclosed, too
• Encourage co-operation between banking
  supervisors capital market authorities

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Possible Discussion Points for Chapter 7
Transparency and disclosure

• Paragraph 39 (Securing appropriate bank
  disclosure)
• Should we specifically refer to the harmonisation
  with IFRS (IASB), not just saying
  internationally recognised accounting
  standards?
• May also refer to auditing standards ISA (IFAC)
• May also refer to CEBS Guidelines on Supervisory
  Disclosure (Committee of European Banking
  Supervisors).
• Paragraph 41 (Co-operation between banking
  securities regulators)
• May refer to the experiences of countries who
  have an integrated financial supervisor. Do we
  recommend it?

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Chapter 8. Corporate Governance of SOCBs
(1/2)

• State-Owned/Controlled Commercial Banks (SOCBs)
• States significant control, either full,
  majority or significant minority ownership
• Either direct or indirect ownership
• Either listed or non-listed
• Commercial banks
• Core concept of the OECDs SOE Guidelines
• The state should
• Make SOCBs have professional, effective and
  independent boards
• Utilise the boards to effectively supervise
  management while reflecting from day-to-day
  intervention

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Chapter 8. Corporate Governance of SOCBs
(2/2)

• The state ownership policy
• Prioritised, clear objectives
• The states role in CG of the SOCB
• How to implement the ownership policy
• Utilising boards in supervising management
• The states should NOT intervene into day-to-day
  management
• Instead, fully utilise/activate SOCB boards
• Professional and independent directors
• SOCBs should subject to external auditing
• The states special audit not a substitute for
  an independent external audit
• States should exchange views with external
  auditors
• SOCBs should/can be role models in improving CG

34
Possible Discussion Points for Chapter 8
Corporate Governance of SOCBs

• Paragraph 42 (CG of banks and SOCBs)
• May lay emphasis on the fact that challenges of
  CG of SOCBs are different from that of
  private-sector banks.
• May refer to Basel Core Principles para. 14.
• To summarise,
• Market signals/discipline can be distorted if
  governments influence banks commercial decisions
  (e.g. lending) in order to achieve public policy
  goals.
• In such cases, if guarantees are provided for
  such lending, they should be disclosed and
  arrangements be made to compensate the banks when
  the policy loans cease to perform.

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Chapter 9. Banks monitoring of the CG practices
of their corporate borrowers

• Two different arguments
• Assess and monitor, ex-ante and ex-post, CG
  standards of corporate borrowers
• Intervene into CG of corporate borrowers
• Assessment and monitoring (ex-ante and ex-post)
  should be further encouraged
• Will benefit banking industry
• One of the essential parts of risk management
• Will benefit sustainable national economic growth
• Policy tool to improve CG in a country through
  bank-finance incentives
• Banks direct intervention is not encouraged
• To prevent banks arbitrary decision, criteria on
  corporate borrowers CG standards should be
  specified in covenants
• Banks themselves ought to improve their CG

36
Possible Discussion Points for Chapter 9 Banks
monitoring of corporate borrowers CG

• Paragraph 48 (Assessment monitoring)
• May refer to the preconditions for effective
  banking supervision (Basel Core Principles para.
  11-13)
• Preconditions Effective business law,
  independent audit based on accounting principles,
  auditors are held accountable.
• Where shortcomings exist, banking supervisors
  should make the government aware of these.
• May suggest that banks encourage their large
  customers to obtain independent credit ratings.
• Paragraph 49 (Banks intervention)
• Some expressions may be a bit too restrictive for
  banks.
• May also refer to banks acquiring holdings in
  non-financial companies.
• Clear definition of banks permissible businesses
  
• Conflicts of interest being managed

37
Chapter 10. The role of supervisors and the next
steps

• Banking supervisors should promote structures in
  which banks naturally follow sound banking
• Effective banking supervision is important, but
  it is not a panacea.
• More emphasis on promoting good CG of banks
• Monitor whether banks really implement sound CG
  policies or not
• Banking supervisors, in cooperation with capital
  market authorities and others, should develop a
  national CG code for banks
• Appropriate combination between laws/regulations
  and voluntary rules (codes)
• Developing a template based on which banks would
  develop their own CG codes, respectively

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Possible Discussion Points for Chapter 10 The
role of supervisors next steps

• Paragraph 53 (CG codes for banks)
• Why do we need codes (soft law) in addition to
  laws regulations (hard law)? What is an
  appropriate balance/combination of them?
• Do we need national CG codes for banks in
  addition to general CG codes?
• Any suggestions for others chapters?

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• Thank you very much.