Corporate Governance, current state, challenges and way forward

2012 & Beyond

Syed Asad Ali Shah

Managing Partner

Deloitte Pakistan

Purpose of Corporate Governance & Board’s Role Key changes / features of 2012 Code Independent Directors Board Evaluation Sustainability and governance Extent of compliance with the Code Outcomes of 2007 IFC survey What is missing Some provisions of King III Enforcement of the Code Approach to governance : Beyond compliance

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Company’s objectives relate to performance

conduct its business so as to enhance corporate profit and long-term shareholder value.

Public interest : Accountability & reporting to shareholders & market participants to ensure market confidence

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What is the biggest reason for Corporate Failure?

Inactive Boards.

Most CCG are an effort to define the responsibilities of the BODs so that they understand and perform their responsibilities effectively.

Key to good governance is Board’s Role & effectiveness

In pursuing the company’s objective, board’s role is to assume accountability for the success of the company, by taking responsibility for both failure and success.

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Composition of the Board

• Board encouraged to have a balance of

executive and non-executive directors,

including independent directors and

those representing minority interests

with the requisite skills, competence,

knowledge and experience so that the

board as a group includes core

competencies and diversity, including

gender, considered relevant in the

context of the company’s operations.

• Board shall have at least one and

preferably one third of the total

members of the board as independent

directors. The board shall state in the

annual report the names of the non-

executive, executive and independent

director(s).

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Comments / Changes

No guidance on recommended size of

the board.

May have included:

“The board shall periodically review

its own size, and determine its size

for efficient performance and

attainment of its objectives”

One independent director made

mandatory.

Criteria for assessment of

independence substantially

expanded.

No disclosure required on the

board’s confirmation about

independence of some of its

directors.

Effective date : next election

Who is independent director?• Explanation: "independent director" means a director who is

not connected or does not have any other relationship, whether pecuniary or otherwise, with the listed company, its associated companies, subsidiaries, holding company or directors. The test of independence principally emanates from the fact whether such person can be reasonably perceived as being able to exercise independent business judgment without being subservient to any form of conflict of interest.

• No director shall be considered independent if one or more of the following circumstances exist :

• He/she has been an employee of the company, any of its subsidiaries or holding company within the last three years;

• He/she is or has been the CEO of subsidiaries, associated company, associated undertaking or holding company in the last three years; 8

Who is independent director?• No director shall be considered independent if one or more of

the following circumstances exist :

• He/she has, or has had within the last three years, a material business

relationship with the company either directly, or indirectly as a partner, major shareholder or director of a body that has such a relationship with the company:

– Explanation: The major shareholder means a person who, individually or in concert with his family or as part of a group, holds 10% or more shares having voting rights in the paid-up capital of the company;

• He/she has received remuneration in the three years preceding his/her appointment as a director or receives additional remuneration, excluding retirement benefits from the company apart from a director’s fee or has participated in the company’s share option or a performance-related pay scheme;

• He/she is a close relative of the company’s promoters, directors or major

shareholders:

Explanation: close relative means spouse(s), lineal ascendants and descendants and siblings;

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Who is independent director?• No director shall be considered independent if one or more of

the following circumstances exist :

• He/she holds cross-directorships or has significant links with other

directors through involvement in other companies or bodies;

• He/she has served on the board for more than three consecutive terms from the date of his first appointment provided that such person shall be deemed “independent director” after a lapse of one term.

Any person nominated as a director under Sections 182 and 183 of the Ordinance, shall not be taken to be an "independent director" for the above-mentioned purposes.

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Independent directors on the board

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Number Percentage

None* 13.33%

One 50%

More than 1/3rd 16.67%

Majority independent 6.67%

* It includes Bank Alfalah Limited which has availed exemption from SECP for

appointment of independent director, and Pakistan state Oil Company Limited

whose BOM has been suspended.

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Composition of the Board (Contd..)

(c) professional indemnity insurance

cover in respect of independent

directors shall be encouraged.

(d) executive directors, i.e., paid

executives of the company from

among management, shall not be

more than one third of the elected

directors, including the Chief

Executive.

Comments /

Changes

Prof indemnity

encouraged.

In Code 2002, number of

executive directors was

restricted 75% , now

further reduced to 33%

(including CEO).

Effective date : Next

election of directors.

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Responsibilities, powers and

functions of board

iv. Exercise its powers and carry out its fiduciary

duties with a sense of objective judgment and

independence in the best interest of the company.

v. Ensure that professional standards and

corporate values are put in place that promote

integrity for the board, senior management and

other employees in the form of a Code of

Conduct and take appropriate steps to

disseminate Code of Conduct throughout the

company along with supporting policies and

procedures and these shall be put on the

company’s website;

iv. Ensure that adequate systems and controls are in

place for identification and redress of grievances

arising from unethical practices.

Comments

• Directors fiduciary

responsibility / working

in the interest of the

company often not

properly understood.

• Statement of ethics &

business practices no

more required.

• Some form of

confirmation should

still be desirable.

• Code of Conduct to be

placed on the website.

• Some fundamental

aspects of Board’s role

in governance not

properly elaborated.

Governance structures and practices should be designed by the board to position the board to fulfill its duties effectively and efficiently.

The board of directors, as the central mechanism for oversight and accountability in the corporate governance system, is charged with the direction of the corporation, including responsibility for deciding how the board itself should be organized, how it should function, and how it should order its priorities.

For this purpose, the Board should develop its own charter / mandate, as distinct from the powers and functions delegated to other forums / CEO / senior management.

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The board’s fiduciary objective is long-term value creation for the company.

Board’s primary duties are to select and oversee well-qualified and ethical chief executive officer who, with other management, runs the company, and to monitor management’s performance and adherence to corporate and ethical standards.

Effective corporate directors are diligent monitors, but not managers, of business operations.

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The art of governance in Pakistan is postponing decisions until they are no longer relevant.

Information available for the board’s decisions is insufficient.

But the board members some time desire more & irrelevant information than required for decision

Independent board members are some times more focused on compliance & accountability than performance.

Independent members do not contribute to the business, and are more in the mode of avoiding risk than managing risk.

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Board Evaluation

Within two years of

coming into force of

this Code, a

mechanism is put in

place for an annual

evaluation of the

board’s own

performance.

Materiality Board shall define the

materiality, keeping in

view the specific

circumstances of the

company

Comments

New requirement in 2012 Code.

Guidance on “how” missing.

Nominating / Governance committee is not

required.

No evaluation of Board Committees required.

No evaluation of individual directors required

It is not clear what is the deadline for

completion of board’s evaluation?

Effective date: April 2014.

Intent appears to be that the Board should

define what is the level of issues that are

brought to the board’s attention or decision,

and what should be handled at management

level.

There would be both qualitative &

quantitative aspects, that need to be defined.

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Evaluation of Board Performance mechanism implemented up to June 30, 2014

Evaluation mechanism Percentage

Implemented 16.67%

Not implemented 76.67%

In process 6.67%

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Chairman & CEO

• The Chairman and the Chief

Executive Officer (CEO),

shall not be the same person

except where provided for

under any other law.

• The Chairman shall be

elected from among the non-

executive directors of the

listed company. The

Chairman shall be

responsible for leadership of

the board and shall ensure

that the board plays an

effective role in fulfilling all

its responsibilities.

• The Board shall clearly

define the respective roles

and responsibilities of the

Chairman and CEO.

Comments

Separation of these roles now a mandatory

requirement.

Effective date (Reconstitution of the Board

after Dec 31, 2015)

Best practice through out the world.

Need for further elaboration of roles of

Chairman & CEO.

For instance, Chairman’s responsibilities

should include:

• Providing leadership to ensure effective

functioning of the board.

• CPD of the board

• Evaluation of the board and committees

• External communication & shareholder

rights

• Setting agenda, ensuring participation of all

board members & efficiency & effectiveness

of board meetings.

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Significant issues to be placed for

decision of Board

The significant issues for this purpose may

include:

• the CEO shall immediately bring before the

board, that the company will not be in a

position of meeting its obligations on any

loans (including penalties on late payments

and other dues, to a creditor, bank or

financial institution or default in payment of

public deposit), TFCs, Sukuks or any other

debt instrument.

• Full details of the company’s failure to meet

obligations shall be provided in the

company’s quarterly and annual financial

statements.

Comments

New requirement & rightly

included in view of

prevailing default

culture.

Disclosure in the

financial statement

should be in 4rth

schedule rather than the

code.

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Significant issues to be

placed for decision of Board

• management letter

• report on governance, risk

management and compliance

issues. Risks considered shall

include reputational risk and

shall address risk analysis, risk

management and risk

communication;

• whistleblower protection

mechanism;

• report on CSR activities

Comments / Changes

Some new requirements

Only whistleblower protection is

not enough.

Fraud Reporting framework to

ensure violations of Ethics / frauds

/ irregularities are reported and

addressed not required.

Focus on sustainability (CSR+

Environment) required on the

pattern of King III governance

code of South Africa.

At present, no reporting required

on environment / company’s

carbon foot prints.

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The old Governance Model

200 year Old Model

• Based on two false assumptions :

– Since 17th century Industrial Revolution

– That there were limitless resources in nature

– Nature had an infinite capacity to absorb waste

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200 Years model

Take, Make and Waste

Natural capital at no cost

As a result, natural resources depleted, water polluted and greenhouse gasses (GHG) into sewer in the sky

Business cannot be conducted as usual

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Fresh Water Crisis

• No water – no existence

• Fresh water: 1% of world’s waters

• Contain 40% of aquatic biodiversity

• Sea occupies 75% of the earth’s surface

• Only 60% of fish species

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The New Governance Model

New model

• Business as unusual

• Making more with less

• Profit, People and Planet

• Governance, strategy and sustainability are

inseparable!

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Integrated Governance, strategy & Reporting

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Sustainability Reporting in Pakistan

A growing number of Pakistani companies are beginning to

recognize sustainability and/or social responsibility, and have

commenced reporting the same, either via their annual reports

or by issuing dedicated sustainability reports.

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Sustainability Reporting in Pakistan

Sustainable business initiatives are now becoming a business

imperative; KSE 100 currently has 19 companies that are

reporting on sustainability, of which 10 companies have issued

dedicated sustainability reports.

Of the 10 issuing separate sustainability reports, include ICI

Pakistan, Siemens Pakistan, Unilever Pakistan, Security Papers,

Lucky Cement, Attock Refinery, Fauji Fertilizers, Engro

Corporation, Engro Polymer & Chemicals Limited and Al Ghazi

Tractors.

Few banks (MCB, Askari ) are making limited disclosures on sustainability, while JS reports on their CSR initiatives.

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Directors’ Training Program (DTP)

Basically two requirements:

1) Companies to make appropriate

arrangements to carry out orientation

courses for directors to acquaint them with

this code, applicable laws, their duties and

responsibilities to enable them to effectively

manage the affairs of the company.

2) Mandatory certification under any

directors training program that meet

SECP criteria, whereby:

• Minimum one director obtains

certification year from June 12.

• All directors compliant by June, 2016.

Exemption: Individuals with 14 yrs

education & 15 yrs board experience on a

listed company(local or foreign) exempted

from DTP.

Comments

Compliance statement will

require an annual

confirmation on the courses

arranged during the year,

which indicates that each

year, some orientation

program is required to be

organized.

The Code is however, not

specific in terms of number

& frequency of orientation

courses

Certification under DTP

required from any

Institution, which meets the

criteria specified by the

SECP.

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CFO, Company Secretary and

Head of Internal Audit

• Appointment, remuneration and terms

and conditions of employment shall be

determined by the board of directors.

• The removal of the CFO and Company

Secretary of listed companies shall be

made with the approval of the board of

directors.

• The removal of Head of Internal Audit

shall be made with the approval of the

board only upon recommendation of the

Chairman of the Audit Committee.

Comments

Under 2002 code, CEO had

the power with the approval

of the board.

Removal of CAE:

Require Approval of Board

on the recommendation of

Chairman Audit Committee.

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Requirement to attend board

meetings

• The CFO and Company Secretary

shall attend all meetings of the

Board, except such part of the

meeting which involves

consideration of an agenda item

relating to the CFO and Company

Secretary respectively.

Comments / Changes

This is a unique

requirement for CFO to

attend all board

meetings in Pakistan

code, retained from 2002

code.

There is no empirical

evidence that this

improves governance?

Corporate & Financial Reporting Framework

Board required to report that:

The system of Internal Control is sound in design and has been effectively implemented and monitored.

Comments

• No change

• An inappropriate requirement , which is similar to Sox 404 : still continued from 2002.

• The statement is generally given without any review / assessment of internal control.

• Proper course would be UK model : Combined Code & Turnbull Report.

• Give descriptive disclosure

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Directors’ remuneration

• A formal and transparent procedure

for fixing remuneration packages of

individual directors. No director shall

be involved in deciding his/her own

remuneration.

• Directors remuneration shall

encourage value creation, and shall be

subject to prior approval of

shareholder / board as required by the

company’s Articles.

• Levels of Remuneration shall be

appropriate to attract and retain the

directors needed to govern the

company successfully.

• Details of aggregate remuneration to

be disclosed separately for executive

and non-executive in annual report.

Comments / Changes

Requirements on remuneration

were missing in the 2002 code, but

need further elaboration.

Most important issue in

Governance in developed world.

Principle based requirements on

remuneration introduced, but

following are missing:

• Should be approved by

shareholders only.

• Individual director

remuneration should be

disclosed.

• Require more guidance/

amendments.

Effective date: Immediate

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Initialed Accounts

• For six months and annual

financial statements, the

requirement for the CEO and

CFO is to present the financial

statements, endorsed by

themselves and initialed by

external auditors.

• In FAQs attached with the Code,

under question 52, it is stated:

“In terms of the requirements of Code

2012, the audit committee or the board

of directors can only approve duly

reviewed or audited accounts

respectively.”

Comments / Changes

These requirements (FAQ 52 and

46) are seriously flawed, and

rather illegal and in violation of

the Companies Ordinance.

The initialed financial statements

are not audited financial

statements. In fact, the auditors

initial the financial statements

only for identification.

The audit of financial statements

is only completed, after the

accounts are approved by the

board, and external auditors issue

their audit report duly signed by

them.

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Audit Committees

• The chairman of the Audit

Committee shall be preferably

an independent director, who

shall not be the chairman of the

board. The board shall satisfy

itself such that at least one

member of the audit committee

has relevant financial

skills/expertise and experience.

• Secretary of Audit Committee :

Either Company Secretary or

Head of Internal Audit but not

the CFO

Comments

2002 Code only required Chairman of the

audit committee to be a non-executive

director. Now, an Independent director can

be Chairman of AC.

Also, Chairman of the Board can not be the

Chairman of AC.

Board required to ensure that at least one

audit committee member has financial skills,

expertise and experience.

Head of IA allowed to be Secretary of AC :

inconsistent with best practice and need to

be modified.

Primary job of the secretary is to assist the

AC, whereas job of HIA is to serve as key

resource to AC on internal control

monitoring and functionally reporting to the

AC.

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Chairman Audit

Committee & AGM.

• Chairman of the Audit

Committee & Engagement

Partner of the external

audit firm are required to

be present in the AGM.

Comments

The requirements should not be

confined to Chairman of the

Audit Committee only.

The Chairman of the Board and

all Chairs of Board Committees

should be required to attend

AGM and be available to

respond to shareholders

questions.

This is essential to make AGMs

more effective.

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Board Committees

• Human Resource and Remuneration

(HR&R) Committee with at least

three members comprising a

majority of non-executive directors,

including preferably an independent

director.

• The CEO may be included as a

member of the committee but not as

the chairman of committee. The

CEO if member of HR&R

Committee shall not participate in

the proceedings of the committee on

matters that directly relate to his

performance and compensation.

Comments / Changes

HR&R is a new requirement.

• A key requirement, missing

in the Code, is the

Nominating Committee /

Governance Committee,

which is considered critical

for good governance.

• Another critical aspect

missing / not properly

elaborated is the “Board’s

Role in annual evaluation of

CEO’s performance”,

although it is included in HR

committee’s TOR.

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Internal audit - outsourcing

The internal audit function may be

outsourced to a professional services firm or

be performed by the internal audit staff of

holding company. However, due care shall be

exercised to ensure that suitably qualified

and experienced persons, who are conversant

with the company's policies and procedures,

are engaged in the internal audit.

In the event of outsourcing the internal audit

function, company shall appoint or designate

a fulltime employee other than CFO, as Head

of Internal Audit, to act as coordinator

between firm providing internal audit

services and the board:

Comments / Changes

There was no guidance on

outsourcing of internal audit

in 2002 code.

Appointing or designating a

fulltime employee as head of

internal audit may not be

feasible, and therefore,

burdensome for small

companies.

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External auditors

• Requirement of Management letter

now required in 45 days of the date

of audit report:

Any matter deemed significant by

the external auditor required to be

communicated in writing to the

board prior to the approval of the

audited accounts by the board.

Comments /

Changes

Previously, the time period

for ML was 30 days.

Requirement to

communicate significant

matters specified.

Effective date: For accounting

period ending on or after June

30, 2012.

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Status of Compliance with the Code

Status Percentage

Clean report 75%

Non Compliances reported 25%

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Nature of Non Compliances reported

Nature of Non CompliancesNumber of instances

Percentage

Qualification criteria for Head of internal Audit not met

2 3.33%

Board Performance not evaluated 8 13.33%

Requirement of Director’s training program not complied with

7 11.67%

Certain Policies required by Code not documented

4 6.67%

Different committees not formed as required by CCG

2 3.33%

IFC survey 2007- chairman of a local listed company

• Not corp. governance but the Code of Corp. Governance is important: I have to follow each and every word of the Code. I do not understand why independent directors, audit committees, internal audit and company secretaries are important but the Code wants them and I need to have them. For me the profitability of the company is important. I think the Code has not increased the profitability of my company even though we do have four meetings of the board, we have non-executive directors, we follow the Code but having all this has decreased my profits, not increased my profits. When I should be concentrating on business matters, I am concentrating on internal audit reports. So why do I follow the Code? Because I am the owner of a listed company and have to follow the Code because the SECP wants us to follow the Code.

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IFC survey – Company Sectry of local listed company

• Corporate governance is important because we have to follow the Code of Corporate Governance… benefits like the ones outlined by you relating to access to foreign capital, institutional investors, increased reputation of the business, all this does not matter to my company. What matters to the company is the survival of the business and we need money for that. We can take a loan from the bank at any time and they are not worried about our corporate governance practices so why do we need to think of foreign capital or increased reputation or better governance?

• I only consider corporate governance important because the SECP wants me to consider it important.

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IFC survey – Benefits of Corporate Governance

• For an overwhelming majority (82%) of the respondents, the most important benefit of adoption of corporate governance practices was compliance with legal and regulatory requirements.

• There was no sufficient evidence of appreciation or comprehension of other significant benefits, such as protecting shareholders’ rights; building/enhancing the company’s/bank’s reputation; improving strategic decision making; gaining better access to external capital …….

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IFC survey – Board Practices (CFO of a listed company)

• We follow the Code of Corp. Governance in terms of board composition and our board of directors do all that the Code requires…we have to do this. We have board meetings, we have a separate CEO and chairman. We have non-executive directors who may be considered independent but there is no compulsion to have non-executive directors who are independent. …The Code wants the board to approve annual reports, remuneration, strategy, etc. Thus most of the board’s time is spent in approvals. The board hardly gets any time to think of vision, succession planning, long-term strategy, new business opportunities, going global.

• The board has human beings not robots who can comply with the Code and also think of succession planning and vision. The Code is more important than anything else.

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IFC survey – Role of Institutional shareholders

• It was observed from the interviews that key executives of responding companies were unhappy with the duties and functions performed by institutional investors as members of the board of directors.

• They asserted that representatives of institutional investors are overworked because each one is on more than ten different boards and they do not generally come prepared for board meetings.

• The SECP should incorporate in the Code a section on a revised role for institutional investors. This is essential to make the institutional investors aware of their duties and responsibilities. It may also be helpful in ensuring that the institutional investors and their nominee directors play a pivotal role in effective implementation of corporate governance practices.

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Elaboration of board’s role to achieve enhanced performance needs, including requirement to define the board’s charter.

Guidance on Board and Committee evaluations. Emphasis & guidance on Board’s own annual

evaluation, evaluation of CEO’s performance & holding the CEO accountable.

Lack of requirement on Nominating / Governance Committee to ensure right appointments on the board

Incorporating sustainability in governance, strategy & reporting

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Reporting on Internal Control effectiveness by the board should be based on review of int. contrl system.

Confirmation of directors, which the board considers to be independent.

Elaboration of responsibilities of Chairman of the Board and the CEO.

Requirement to have executive sessions of the Board (without the presence of management / CEO)

Role of Institutional Investors in the Corporate Governance Guidance / requirements on shareholder communications,

holding effective general meetings and robust disclosure.

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Confirms the role of the Board as the focal point for corporate governance. The directors have to ensure that the company:

• operates ethically with integrity as a responsible corporate citizen

• considers the interests of the community within which it operates

• integrates governance, strategy, risk, performance and sustainability

• employs structures and processes to ensure the integrity of its integrated reporting.

• should ensure that prudent and reasonable steps have been taken in regard to IT governance.

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• Strategic alignment with performance and sustainability objectives;

• development and implementation of an IT governance framework;

• value delivery: concentrating on optimisingexpenditure and proving the value of IT;

• risk management: addressing the safeguarding of IT assets, disaster recovery and continuity of operations; and

• the protection and management of information.

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Corporate governance should not be confined to requirements of the Code, rather it should be “beyond compliance” aimed at enhancing long-term viability of the company.

Code requirements should be considered as minimum.

Demand based Corp. Governance, mainly driven by institutional investors / lenders rather than regulators.

“Comply or Explain” , or “Apply or Explain” model should be considered

More pro-active approach by front line regulator.51

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Thank You