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Key Points

Opening Remarks

Role of the Forum globally

No doubt we have probably encountered one of the worst crises since the great depression

Yet again….This crisis demonstrates that regulations alone do not guarantee ethical behavior and good governance

A corporate governance framework is a set of market mechanisms that are closely linked

Where were the directors? The importance of board members’ skills is yet again reinforced

Some expectations in regulatory shifts

So, Where to from Here?

Concluding observations

Opening Remarks

  • Thank youfor the kind invitation to address this annual conference on occasion of the Chartered Secretaries Southern African centenary, and I extend my heartfelt congratulations to the Institute and all its members on this significant milestone.
  • I am particularly grateful to the Institute for the opportunities the CIS qualification has afforded me, and is a body to which I remain very dedicated and deeply indebted.
  • In this era of corporate governance, the role of the company secretary in my opinion remains as important as ever, if not more so! What frustrates me, however, is the demand for access to training in this important skill coming from parts of the world where, hitherto, the concept of company secretary was until recently unknown.
  • The challenge I pose to all of you here today, leading your respective Institute’s in your various countries, is how do we harness our collective capacity to support this growing demand in a way that we can take advantage of the opportunities for the benefit of the Chartered Secretary profession.
  • And, importantly, to ensure that the appropriate level of professionalism is introduced into the boardrooms of some very challenging environments out there.
  • I have about 30 or so minutes to outline my thoughts on the financial crisis and corporate governance. All I can really do in this time is, perhaps, highlight some of the underlying symptoms and then perhaps question whether we have really confronted the issues satisfactorily, or is it pretty much back to business as usual.
  • Much has happened since I took up my current position with the Global Corporate Governance Forum nearly four years ago – South Africa has a new President, indeed, new Cabinet, numerous CEOs seemed to have called it a day and a new echelon of business leaders are emerging, King III has been launched, and, the world is at various stages of a recession led in large measure by the implosion of the US banking system and housing market.
  • It would be inappropriate for me to opine on corporate governance in South Africa, although I do try to follow some of the developments with interest. Instead, I would rather share with you somepersonal observations drawn from my work with the Global Corporate Governance Forum, and perhaps share a few thoughts on how any of this might be relevant to South Africa.

Role of the Forum globally

  • The Forum, as we are known, was established by the World Bank and the OECD at the time of the East Asian Crisis in the late 90s. Its primary role at the time was to facilitate the articulation of the newly promulgated OECD CG Principles in non-member OECD countries; read “developing countries”!
  • It is 10 years henceand we are looking at another major crisis – with one significant and compelling difference.
  • This one was started in the very countries responsible for insisting on those standards, which makes for some interesting dilemmas right now. I will come back to this later.
  • The Forum has since been located in the private sector arm of the World Bank Group, the International Finance Corporation, which is our anchor donor. The Forum is also funded by a number of European governments, Canada and Japan.
  • The Forum in its current phase of work, for which I am responsible, is now almost fully focused on building the necessary capacity around the world to facilitate the necessary expertise and technical resources to help countries initiate or sustain corporate governance reforms but ensuring always, that the process is owned and led by the local stakeholders.
  • This work is directed at both developing countries and emerging markets, hence my having just arrived from China where we are building partnerships in both the private and public sectors. The Forum is currently engaged in over 50 countries worldwide, operating with a small team of seven plus a number of consultants and experts.
  • Our work not only centres on assisting with the development of codes and standards, where we have been working extensively in North Africa and the Middle East, but also working extensively with institutions seeking to enhance their board leadership trainingcapacity e.g. Brazil, Ecuador, East Europe, parts of Africa, SE Asia;the training of financial journalists globally; and, assisting with the implementation ofdispute resolution mechanisms for business in the Balkans and Ukraine, among numerous targeted initiatives in India, China, Bulgaria, Panama, Egypt, Vietnam, Mongolia, The Philippines and also elsewhere.
  • We depend a great deal on the advice and guidance of our private sector advisors, who represent over 75 business leaders, investors, professionals and corporate governance experts from around the world, to bring a practical and well seasoned perspective to our work with countries – some of whom I have just mentioned.
  • Peter Dey, former head of Morgan Stanley in Canada heads this group which includes Mervyn King and Reuel Khoza. Others you may have heard of include Mark Mobius, Ira Millstein, Patrick Chisanga from Zambia, Eddy Wymeersch who is one of the senior advisors to the EU on banking regulation, Paul Coombes from the UK who previously headed the well known McKinsey studies along with Simon Wong, and Christian Strenger of Germany for example.

No doubt we have probably encountered one of the worst crises since the great depression

  • Virtually every thoughtful analysis of the crisis has cited macroeconomic imbalances, regulatory failure and various flaws in the intersection between economic and regulatory policies – this, as we have observed, has been particularly severe in the banking sector.
  • The IMF has projected negative global growth for 2009, with sharp declines predicted for advanced countries, and nominal GDP growth for emerging markets and developing countries but I would caution that this will be lumpy and probably will be mostly in the Asian region led by China and India for the most part.
  • The World Bank estimatesthat for every one percentage point decline in global GDP growth, 20 million more people fall into poverty. In China alone, 20 million migrant workers were laid off in 2008.
  • The sharp decline in remittances from migrant workers back home to Africa is likely to be significant, as just one severe example of the crisis. This currently is estimated at USD15 billion annually. The effect this will have on underlying socio-economic conditions in Africa is quite threatening in its potential consequences. In Kenya alone, this has fallen from an estimated USD61 million in October 2008 to USD39 million in early 2009.
  • Some 100 000 workers are estimated to have lost their jobs in the DRC and some 80 000 in the Zambian Copperbelt.
  • Contrary to earlier speculation that the crisis was largely the problem of the so-called developed countries, developing countries have discovered they arenot immune. The crisis is hitting hard through trade and financial market channels.
  • And, it is my understanding that you are experiencing some of this in South Africa currently. The contraction in South Africa’s GDP by 3 percent for the 2nd quarter of 2009 indicates the economy is still in recession, although this is nominally an improvement on the 6.4 percent contraction in the 1st quarter.Job losses this year are expected to be considerable too, and I needn’t dwell on the consequences of this.

Yet again….This crisis demonstrates that regulations alone do not guarantee ethical behavior and good governance

  • Probably most disturbing is that the causes of this crisis are not novel: we’ve seen it in 1990’s (Asian crisis) and repeated far too often in the 2000’s (Dotcom Bubble, and numerous corporate scandals mostly in the US – first Enron and now the banking sector).
  • Despite various regulatory responses, notably the requirements of Sarbanes-Oxley in the US,all it seems to have led to has been a focus on formal compliance rather than substantive controls and risk management.
  • While, on the other hand, in Europe the notion of the so-called “comply or explain” approach is being questioned as the opposite side of draconian legislation, being soft rules in which various market intermediaries support the regulatory process, doesn’t seem to have worked terribly well either if one looks at the UK banking sector.
  • What is increasingly apparent is that the current financial crisis is a result of inefficient market operation and weak supervisory rules and systems in some so-called developed countries.
  • This has been aggravated by the increased complexity of globalised financial systems, which regulators simply did not have to the capacity to keep pace with; much less regulators in developing countries.
  • This is going to present some interesting challenges for international standard setters, and national regulators, in seeking to find the “right” balance.
  • However I think it is equally germane to note that this crisis (in my opinion) was not born out of corporate malfeasance and fraud as with a number of the earlier episodes that gave rise to the Cadbury Code in the UK in the early 90’s and Sarbanes-Oxley in the United States more recently for example.
  • As the OECD has observed: “the financial crisis can be attributed in part to failures and weaknesses in corporate governance arrangements.”
  • But as one financier has also questioned: “The speed and severity of the current economic downturn has caused observers to question the role of corporate governance regimes in failing to identify excessive risk-taking at a number of financial institutions. A prevailing question is whether the financial crisis would have occurred had corporate governance standards been higher across the board.”
  • The point here is, that I am not entirely persuaded that the commonly accepted standards of good corporate governance practices failed but rather their application was distorted for a number of reasons ranging from an unhealthy obsession of companies to simply comply without taking seriously the underlying substantive basis of recommended practices to weak or incompetent enforcement by regulators and the absence of sound, thoughtful engagement by institutional shareholders.
  • In the recently issued Walker Review in the UK, this point was noted, and there seems to be a strong view that a lot of the difficulties encountered in the financial sector were more behavioural rather than failure to comply with existing corporate governance standards and rules.

A corporate governance framework is a set of market mechanisms that are closely linked

  • This is amply illustrated in South Africa’s approach to corporate governance, but I question whether it has the necessary infrastructure to ensure that the various intersecting intermediaries critical to an effective “apply or explain” process are sufficient to ensure its complete adherence.
  • Not least, the role of enforcement and relatively inactive institutional shareholdersalthough I am interested in how the Investors’ Code will work in practice.
  • Having said that, South Africa remains a benchmark in many ways, especially with the way it integrates core financial aspects of corporate governance with the wider elements of sustainable reporting on so-called non-financial matters.
  • BUT, other concerns about South Africa are perhaps diminishing its relevance!

Where were the directors? The importance of board members’ skills is yet again reinforced

  • In the time available, I would like to focus on the role of boards and directors in light of observations from the current crisis. As this to my mind, remains a challenging area clearly notwithstanding all the standards, guidelines and recommendations that are now in place the world over!!
  • What has come through, once more, as we have seen too often in previous crises, is the lack of engaged and effective oversight by boards, especially in the banking sector.
  • Poor functioning of board committees, which are an important underpinning of any effective board governance process, specifically the audit committee and their inability to deal with complex financial matters and risk.
  • This has, in effect, manifested itself in weak internal controls and risk management practices.
  • And, of course, in the US particularly but also in a number of other advanced economies, flawed incentives built around executive and senior management compensation.
  • Jack Welch, the former head of General Electric, makes a somewhat caustic observation on these issues: “[T]he real fallacy of CG in this crisis is not what boards did and didn’t do. It’s what was expected of them…….The list of guilty parties in bringing on the current economic situation is long, and boards do belong on it. Just don’t put them near the top. That would give them too much credit for a job they couldn’t do.”
  • Which really begs the question, are we expecting too much of directors, and particularly non-executive directors?

  • According to a KPMG study – “Never Again? Risk Management in Banking Beyond the Crisis”.Carried out by the Economist Intelligence Unit with 500 Respondents.

Some expectations in regulatory shifts

  • No doubt there is huge political pressure in the advanced markets for regulators to intervene further. The question is how much, and in what way?
  • A concern I have is how much of this will translate into further revisions to international standards, and the impact this will have on the developing countries already heavily burdened with requirements to adhere to the existing standards.
  • While this is not the time to simply look at what’s going on in the developed countries with smug indifference, I think there are lessons to be learnt but to carefully consider how this relates to your own circumstances, e.g. South Africa has done well in this regard!
  • It seems clear that, at least at this early stage because I think we are still some way from really understanding the full impact of what’s currently going on, while the crisis in the developed economies will place a lot of focus on the financial sector in those countries – in the developing countries, the consequences will be felt more in the wider business sector as demand for products and services decline through tighter credit in advanced economies among other things.
  • For this reason, we are likely to see new mandatory rules particularly focused on the financial sector and then need to carefully consider how any of this might translate into responses in the wider business sector generally.
  • The focus, for the moment, seems to have two main trajectories – (1) how to tighten regulation of the financial sector and how to address some of the public indignation at the seemingly excessive levels of remuneration of bank executives, which will be a strong focus of the upcoming G20 meeting later this month, and (2) how some governments are going to have to manage their new found ownership of some of the world’s major banks and insurance companies, e.g. US.
  • Peripheral issues will likely centre on concerns with conflicts of interest prevalent in the credit ratings sector – who seem to have become convenient scapegoats; regulating,further, processes related to board structures and operation; rules that will advance shareholder access to corporate decisions (especially in the US where shareholder rights are weak); and, impose obligations on shareholders to exercise more effective oversight of their ownership responsibilities (a criticism in the UK and The Netherlands).
  • The point being, not all these issues have the same significance in developing countries and emerging markets.Therein lies the challenge in the way ahead, and I haven’t even begun to dwell on some of the structural issues that are clearly apparent in all this!

So, Where to from Here?

  • As mentioned at the outset, in the time I have available, there is not enough scope to cover all the issues warranting consideration. However, I will endeavor to highlight, briefly, some!
  • These are some practical thoughtsborne from an extensive observation of boards around the world, and the processes that govern and regulate companies.
  • The role of the Board Chairman is going to become ever more critical, especially in the financial sector where independence alone is not sufficient – he or she has to know something about the business.
  • While perhaps not an issue in South Africa, the separationof the roles of Chairman and CEO remains a hotly debated issue in the US; although my proposition is that if Chairmen take on the role they should, it will simply become impossible to manage the two combined functions effectively in sheer practical terms.
  • Notional independence to accommodate corporate governance rules is no longer sufficient; Boards must think intelligently about the competencies that they require to competently supervise the business. This to my mind, remains a bewildering shortcoming in so many boards.
  • This will have particular consequences for the selection of individuals that can competently fill critical positions on board committees – an area I believe has been found seriously wanting in this crisis! In the financial sector, I would expect some measure of regulatory intervention in this area, e.g. prescribed skills and perhaps greater regulatory intervention in the “fit and proper” test process.
  • Non-executive directors are going to have to have to spend much, much more time on their responsibilities and therein rest a whole lot of issues I don’t have time to cover. This not only has implications for more frequent meetings of boards and committees, but also the time for preparation plus getting out and looking at the business operations and meeting management, e.g. “kicking the tyres”- even in banks!
  • This will, or should, impact fees paid to NEDsif we are going to expect them to do all this work, a thorny issue at the best of times! Remember the adage, “you get what you pay for!”
  • Executive compensation, itself, is ahuge issue– at least in the advanced economies, and seems to be emerging as a potential issue in some emerging markets given some of the discussions last weekend in China. While I think we are rightly offended by the excesses we have seen, the question of what to do about it and how to regulate it is being driven more by political expediency than common sense to my mind. I fear that some of the current recommendations have the potential for unseen consequences, but then again, the behaviour of some banks recently is not helping matters frankly.
  • More time is going to need to be devoted to the training and development of directors during the term of their office and their induction at the time of their appointment, particularly in complex sectors like banks. This, again, remains a shortcoming the world over and I am sure some of you here today will share this frustration. This also calls for a more intuitive approach to board development – directors don’t like going to “training”!!!
  • The regular evaluation of the performance of the board, each director individually and the board’s committees is going to have to become an important component of continuous quality improvement for the good governance of boards. What is not clear to investors and regulators is quite how to engage this process in a way that usefully informs discussions around board and director effectiveness – as this is not yet entirely obvious given the proliferation of approaches.
  • As part of improving the effective functioning of board committees, I think we are reaching a point where board committees will require their own budget (independent of management) to hire experts to advise them independently on highly complex decisions.
  • Risk management has been highlighted as a major failing, and will require considerable deliberation and, possibly, may lead to mandatory requirements specifically in the financial sector.Some suggestions include an independently ‘audited’ report to shareholders, separate from the statutory auditor’s report which really provides little cover for shareholders.
  • I strongly agree with KPMG’s recent study advocating that risk management be mainstreamed within the operational DNA of management and their operational responsibilities, this is not simply a perfunctory role performed from time to time or annually. I think South Africa has very much been a leader in this area, but it is remarkable that this idea should come as something of a revelation in many other markets.
  • This brings attention to a lot of structural and operational issues, which in the banking sector are likely to be prescribed, around the intersection of the separate priorities of therisk management and internal audit functions. If you think this is challenging here in South Africa, consider how much more so in weaker markets.
  • An important element of this all, is that Boards will need to focus much more on risk identification rather than risk measurement– this requires a much more intuitive approach, as opposed to a perfunctory one. Some European banks have an obsession with terrorist strikes, and not what happens if the housing market fails!
  • Something we are not hearing nearly enough about, is the question of building strong value systems founded on clear ethical guidelines and practices. This very often defines the quality of decision making and business judgment. And, therein lies the very essence of many of the elements of the current global crisis!

Concluding observations