©2005 YRK Reddy 1

CORPORATE GOVERNANCE FRAMEWORK

byProf. YRK Reddy

www.yagaconsulting.comwww.academyofcg.org

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The Globalisation of StandardsThe Globalisation of Standards

• The rationale & the broad strategy

• IMF,World Bank,OECD,Commonwealth, BCBS,IAIS

• The moves fro generic to specific – the early arguments of ACG

• All assume market economy benefits and mostly the “outsider model”

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A Good SituationA Good Situation

Research Analysis/Media/

Ratings/ markets for

control

Activisim/Transparency/Accountability/ equitable rights

Shareholder Meetings & Vote

Board, supervision, meetings & Vote

Management Reportings

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1Reputational agents refer to private sector agents, self-regulating bodies, the media, and civic society that reduce information asymmetry, improve the monitoring of firms, and shed light on opportunistic behaviour

External

Private

Reputational agents1

AccountsLawyersCredit RatingInvestment BankersFinancial mediaInvestment advisorsResearchCorporate Governance Analysis

MarketsCompetitive factor and product marketsForeign direct investmentCorporate control

Standards(for example, accounting and auditing)Laws and regulations

Regulatory

Financial SectorDebtEquity

Shareholders

Board of Directors

Management

Core functions

Reports to

Appoints and

monitors

Operates

Internal

Stakeholders

Modern corporations are disciplined by Modern corporations are disciplined by internal and external factorsinternal and external factors

(Source: Corporate Governance Framework, Nadereh Chamlou, Magdi Iskande, World Bank)

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““The Irresistible Case for CG”The Irresistible Case for CG”

• Korea-US Research: 160% premuim• ABN/AMRO: Best CG Rated companies had P/E

ratios 20% higher• Russian study: 70,000% increase in firm value of

21 companies• Deutsche Bank: S&P 500: 19% out-performance.• Harvard / Wharton: abnormal returns of 8.5%• Cheaper debt: Romania`s BCR• Operations too: better ROE; EVA

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The Country Analysis in Scorecard – The Country Analysis in Scorecard – Four Critical FactorsFour Critical Factors

• Legal InfrastructureLegal Infrastructure

• RegulationRegulation

• Information InfrastructureInformation Infrastructure

• Market InfrastructureMarket Infrastructure

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The Special Case of Insurance Industry

• Opacity of financial institutions due to nature of some contracts; deferred exchange; swift changes in risk profiles

• Illiquidity & risk of Asset liability mismatch• Informational asymmetries between policy holders

& insurers• Complex structure of principle-agent issues and

coordination problems

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• The need for strong regulation and active supervision. ( fixes the informational asymmetries, market failures, systemic risks).

• Supplemented by self-regulatory initiatives by Boards and shareholders; market discipline, legal infrastructure etc.

• A complex construct of listing agreements; company laws; insurance laws; regulatory norms; supervisory expectations – the great need for alignment / harmonisation.

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The IAIS Guidance

• ICP 9 is mainly the role, responsibility of Boards and senior management.

• Integrates with other Core Principles that relate to CG: – Suitability of Persons– Changes in control & Portfolio Transfers.– Internal Controls– On-site inspections– Risk Assessment & Risk Management– Information, disclosure and Transparency towards the

market

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Insurance Core Principles on Corporate Governance

Essential criteriaA) The supervisory authority requires and verifies that the

insurer complies with applicable corporate governance principles

B) Board of Directors:1. Sets out its responsibilities in accepting and committing to the specific corporate governance principles for its undertaking. Regulations on corporate governance should be covered in general company law and/or insurance law. These regulations should take account of the size, nature and complexity of the insurer.

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2. Establishes policies and strategies, the means of attaining them, and procedures for monitoring and evaluating the progress toward them. Adherence to the policies and strategies are reviewed regularly, and at least annually.

3. Satisfies itself that the insurer is organised in a way that promotes the effective and prudent management of the institution and the board’s oversight of that management. The board of directors has in place and monitors independent risk management functions that monitor the risks related to the type of business undertaken. The board of directors establishes audit functions, actuarial functions, strong internal controls and applicable checks and balances.

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4. Distinguishes between the responsibilities, decision-making, interaction and cooperation of the board of directors, chairman, chief executive and senior management. The board of directors delegates its responsibilities and establishes decision-making processes. The insurer establishes a division of responsibilities that will ensure a balance of power and authority, so that no one individual has unfettered powers of decision.

5. Establishes standards of business conduct and ethical behaviour for directors, senior management and other personnel. These include policies on private transactions, self-dealing, preferential treatment of favoured internal and external entities, covering trading losses and other inordinate trade practices of a non-arm’s length nature. The insurer has an on-going, appropriate and effective process of ensuring adherence to those standards.

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6. Appoints and dismisses senior management. It establishes a remuneration policy that is reviewed periodically. This policy is made available to the supervisory authority.

7. Collectively ensures that the insurer complies with all relevant laws, regulations and any established codes of conduct (refer to EC f)

8. Has thorough knowledge, skills, experience and commitment to oversee the insurer effectively (refer to ICP 7).

9. Is not subject to undue influence from management or other parties. The board of directors has access to information about the insurer, and asks and receives additional information and analyses that the board sees fit.

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10. Communicates with the supervisory authority as required and meets with the supervisory authority when requested.

11. Sets out policies that address conflicts of interest, fair treatment of customers and information sharing with stakeholders, and reviews these policies regularly (refer to ICP 25).

C) Senior Management is responsible for:

1. Overseeing the operations of the insurer and providing direction to it on a day-to-day basis, subject to the objectives and policies set out by the board of directors, as well as to legislation.

2. Providing the board of directors with recommendations, for its review and approval, on objectives, strategy, business plans and major policies that govern the operation of the insurer.

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3.Providing the board with comprehensive, relevant and timely information that will enable it to review business objectives, business strategy and policies, and to hold senior management accountable for its performance.

Advanced criteria

1. The board of directors may establish committees with specific responsibilities like a compensation committee, audit committee or risk management committee.

2. The remuneration policy for directors and senior management has regard to the performance of the person as well as that of the insurer. The remuneration policy should not include incentives that would encourage imprudent behaviour.

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3. The board of directors identifies an officer or officers with responsibility for ensuring compliance with relevant legislation and required standards of business conduct and who reports to the board of directors at regular intervals (refer to EC b).

4. When a “responsible actuary” is part of the supervisory process, the actuary has direct access to the board of directors or a committee of the board. The actuary reports relevant matters to the board of directors on a timely basis.

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OECD Guidelines for Insurers Governance

• Recommendations for Insurance and Private Pensions Committee, adopted by OECD Council on April 2005.

• Note the absence of “corporate” – and the overall emphasis on the stakeholder system.

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“Regulation alone cannot achieve the good practice necessary for integrity and effectiveness. Companies themselves must develop internal rules and systems in order to reach these goals, but governments and international bodies can provide guidance on these rules and systems.”

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Main Objectives

“To provide complementary guidance that would help the sector to enhance the protection of policyholders and/or shareholders beyond the protection already by existing regulation and supervision; and “To develop complementary guidance specifically directed to the insurance sector that would supplement corporate governance rules generally applicable to corporations”

Covers: Governance structure,Internal governance mechanisms andStakeholders protection

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Guidelines for Insurer’s Governance

1. Governance Structure: The governance structure must establish an appropriate division of administrative and oversight responsibilities, stipulate and delineate the qualifications and duties of persons bearing responsibilities, and protect the right of policyholders and shareholders or “participating policyholders”

Guidelines I. Identification of responsibilities Guidelines II. Board's structure

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Guideline III. Functions and responsibilities

Reviewing and guiding the strategy of the insurance entity, including insurance strategies,; approving the pricing strategy, setting performance objectives, overseeing auditing and actuarial functions, and other oversight structures and monitoring the administration of the insurance entity in order to ensure that the objectives set out in the fund by-laws, statutes or contracts, or in documents associated with any of these, are attained (e.g. diversified asset allocation, cost effectiveness of administration et.);

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Guideline IV. Composition and suitability

Guideline V. Accountability

Guideline VI. Actuary

Guidelines VII. External Auditors

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2. Internal Governance Mechanisms: Insurance entities should have appropriate control, communication and incentive mechanisms that encourage good decision – making power and timely execution, transparency, disclosure and ensure regular review and assessment, having regard to the branches of business operated. These mechanisms should be tailored to the protection of policyholders, beneficiaries and shareholders (or participating policyholders).

Guideline VIII. Internal controls Guideline IX. Reporting

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3. Stakeholders’ protection: The governance framework of insurance entities should ensure an appropriate protection of the rights of stakeholders through disclosure and redress mechanisms and the compliance with the basic rights of shareholders or participating policyholders in the case of mutual insurers.

Guideline X. Protection of participating policyholders in the case of mutual insurers.

Guideline XI. DisclosureGuideline XII. Redress