GOOD CORPORATE GOVERNANCE: INTEGRITY, ANTI-CORRUPTION AND RISK MANAGEMENT IN STATE-OWNED ENTERPRISES PRESENTATION BY HANS CHRISTIANSEN, OECD SEMINAR ON BUSINESS INTEGRITY AND CORPORATE GOVERNANCE IN STATE-OWNED ENTERPRISES, TUESDAY, 25 APRIL 2017, MOSCOW

Overview of presentation

• What is integrity? • Why worry about it? • Key integrity risks and challenges for SOEs

• What can be done about it? • OECD Guidelines on Corporate Governance of State-

owned Enterprises (2015) • Risk management in SOEs. • Anti-corruption and integrity guidance for SOE owners

What is integrity?

Integrity refers to upholding ethical standards and moral values of honesty and professionalism, and it is a cornerstone for ensuring fairness, non-discrimination and compliance. It is an inherent part of good corporate governance. Ethics and integrity policies include internal company programmes, functions, people, processes or controls that seek to prevent, detect or address risks of waste, abuse and corporate misconduct.

Responsible Business Conduct

Measured and robust ethics and integrity

policies, integrated into

strategy and management

Efficient anti-

corruption mechanisms (prevention,

detection, response)

Addressing specific

corruption risks

(Bribery, fraud, etc.)

Integrity: important for economies and society

• Corruption raises more concern (69%) and fear (40%) than other challenging policy issues including globalisation and immigration (2017 Edelman trust barometer)

• Perceptions of corruption are negatively correlated with confidence in government, which in turn is needed for well functioning economies and societies

• The OECD estimates that 10-30% of the investment in a publicly funded construction project may be lost due to mismanagement and corruption.

• 50% of surveyed CEO’s of state-backed companies reported being concerned about bribery and corruption (PWC, 2015)

• Breaches of integrity can weaken the entity, make it vulnerable to waste and corruption, and detract from achievement of broader goals.

OECD Foreign Bribery Report: An analysis of the crime of bribery of foreign public officials

Analysis of 427 enforcement actions or “cases” of foreign bribery that were concluded since the entering into force of the OECD Anti-Bribery Convention (1999) until mid-2014.

Key results show that:

• Foreign bribery is concentrated in key sectors: extractive, construction, transportation and storage, and information and communication

• In the majority of cases, bribes were paid to obtain public procurement contracts (57%), followed by clearance of customs procedures (12%)

• Bribes equalled 11% of the total transaction value and 34.5% of the profits.

• Sanctions ranged from 100 to 200% of the proceeds of the bribe in 41% of cases.

SOE officials receiving foreign bribes: at all levels of the SOE

7%

17%

31%

45%

Level of SOE Official Involved

Agent/Consultant

President/CEO

Working-level Employee

Management

(Adapted analysis from the OECD’s Foreign Bribery report (2014)

0% 0% 0% 1% 1%

4%

31%

63%

Percentage of total bribes recieved by SOE officials, by sector

Transportation and storage

Professional, scientific andtechnical activitiesFinancial and insuranceactivitiesManufacturing

Electricity, gas, steam and airconditioning supplyInformation andcommunicationExtractive

Construction

SOE officials receiving foreign bribes:

in the largest amounts

$2,502,383,897

(Adapted analysis from the OECD’s Foreign Bribery report (2014)

SOE officials receiving bribes: namely for public procurement

1% 2% 2%

7%

11%

77%

Purposes of bribes promised, offered or given to SOE officials

Customs clearance

License / Authorisation

Favorable tax treatment

Confidential information (access to)

Other preferential treatment

Public procurement

(Adapted analysis from the OECD’s Foreign Bribery report (2014)

SOE officials receiving bribes: detected through whistleblowing and due-diligence

• Self-reporting has been key: When SOE officials were involved in bribery cases, they were more likely to be brought to attention through self-reporting (53% of cases), and by media, than when SOE officials were not involved. For those cases that were self reported, it was mainly thanks to whistleblowing and due diligence around mergers and acquisitions. (see figure).

• There’s a time-lag: Since the first conviction of bribery involving an SOE official in 2004, it’s taken an average of 4 years for final enforcement action to be made in cases involving SOE officials.

0.0 20.0 40.0 60.0

Civil action

Criminal investigation

Internal Audit

M&A DD

Oil-for-food

Pre-listing DD

Training

Unknown

Whistleblower

Source of self-reporting whereSOE involved

Source of self-reporting wherenon-SOE involved

(Adapted analysis from the OECD’s Foreign Bribery report (2014)

Why are there specific risks for SOEs?

• SOEs operate with close proximity to government: risk of undue influence and conflict of interest

– In a survey of state backed and non-state backed CEOs 69% said government has a high or very high impact on their business strategy (PWC, 2016)

– Companies were feeling more negative in 2015 about the implications of government ownership than before (PWC, 2015)

• SOEs operate in high-risk areas: – Between 2014 and 2016, there was a 16% increase in the incidence of bribery and corruption

in aerospace and defence (PWC, 2016)

– The cases of foreign bribery were at least one SOE official was involved took place most often in the extractive sector, the construction sector and information and communication sectors, which are ranked as high-risk by Transparency International’s Bribe Payer’s Index.

• SOEs engage in high-risk activities, like public procurement – On average, 57% of all bribes paid were paid to win procurement contracts (OECD, 2014).

This number rises to 77% when looking just at cases involving SOE officials.

Integrity risks and challenges: what do we know?

• SOEs may be susceptible to behavioural elements of corruption and integrity:

– Overreliance on “someone else”? • A study asked: “how does your organisation ensure that your business ethics and

compliance programme is effective?”. – 76% : internal audit

– 54% management reporting

– 42% monitoring whistleblowing hotline reports (PWC, 2016).

• However, while internal audit played a prominent role in detecting cases of foreign bribery, it accounted for detection of less than 10% of all cases (OECD, 2014).

– Fear of retaliation? • A survey of 13,046 private and public sector representatives would report misconduct

(59%), but at least one third (36%) experienced retaliation for reporting (private sector 33% and public 41%) (ECI, 2016).

– Pressure? • A 2016 survey showed that one in five respondents in both the public and private sector

felt pressure to compromise standards (22% in private sector and 25% in the public sector) (ECI, 2016)

• Another survey showed of senior company executives showed that one third would be willing to justify misconduct , while almost half would justify misconduct to meet financial targets (E&Y, 2016)

The OECD Guidelines on Corporate Governance of State-Owned Enterprises

• A vision for ownership. The state should clarify why it owns enterprises and how it exercises its ownership rights.

• A rules-based environment. SOEs should be subject to the same rules and regulations as other enterprises. They should compete on a level playing field with private enterprises and not distort competition.

• Reinforcing the ownership function. The state administration should exercise SOE ownership on a whole-of-government basis. The state ownership function should be separate from the regulatory function to avoid conflicts of interest.

• Equitable treatment of shareholders. The state should not have any undue advantages over other investors in SOEs.

• Transparency and disclosure. SOEs’ objectives and performance should be disclosed and reviewed.

• Stakeholder relationship. SOEs and their owners should treat employees, creditors and affected communities fairly and equitably.

• Boards of directors. The boards are the highest decision-making bodies within the SOEs. They should exercise their powers free of political interference.

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Main priorities in the Guidelines:

The OECD Guidelines on Corporate Governance of State-Owned Enterprises

Government

• Sets ownership policy • Coordinates at cabinet level

Ownership function • Defines objectives for individual SOEs • Monitors performance

SOE board

• Approves strategy • Monitors management

Management

• Runs the company

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Independent regulation

The “OECD model” implies: • The ownership of SOEs is separated from regulation • Each ownership decision should be taken at the appropriate level

Recommendations of particular relevance (part 1)

• (II.F.2): Establishing well-structured, merit-based and transparent board nomination processes in fully- or majority-owned SOEs, actively participating in the nomination of all SOEs’ boards and contributing to board diversity;

• V.C. The boards of SOEs should develop, implement, monitor and communicate internal controls, ethics and compliance programmes or measures, including those which contribute to preventing fraud and corruption. They should be based on country norms, in conformity with international commitments and apply to the SOE and its subsidiaries.

• VII.D. Independent board members, where applicable, should be free of any material interests or relationships with the enterprise, its management, other major shareholders and the ownership entity that could jeopardise their exercise of objective judgement.

Recommendations of particular relevance (part 2)

• III.G. When SOEs engage in public procurement, as bidder or procurer, the procedures involved should be competitive, non-discriminatory and safeguarded by appropriate standards of transparency.

• VII.B. The boards of SOEs should have the power to appoint and

remove the CEO. They should set executive remuneration levels that are in the long-term interest of the enterprise.

• VII.H. SOE boards should consider setting up specialised committees… to support the full board in performing its functions, particularly in respect to audit, risk management and remuneration.

Recommendations of particular relevance (part 3)

• III.F.1. SOEs’ relations with all financial institutions, as well as non-financial SOEs, should be based on purely commercial grounds.

• V.D. SOEs should observe high standards of responsible business conduct. Expectations established by the government in this regard should be publicly disclosed and mechanisms for their implementation be clearly established

• V.E. SOEs should not be used as vehicles for financing political activities. SOEs themselves should not make political campaign contributions.

Corporate Governance and Business Integrity (2015)

• OECD Survey on Business Integrity and Corporate Governance: 88 responses, 40 in-depth interviews with private sector representatives

• Results show that companies are:

• increasingly recognisng the importance of preventing misconduct through effective corporate governance;

• developing an integrity policy; • creating a business integrity

function.

www.oecd.org/daf/ca/trust-business.htm

Organisation of the integrity function

Source: TNB Survey 2015 (47 respondents)

0

4

9

11

21

32

45

64

0 10 20 30 40 50 60 70

Separate Legal Entity or Special Purpose Vehicle

Other

External Professional Service Provider or Consultant

Internal Controls Department

Internal Human Resources Department

Internal Audit Department

In-House Legal Department

Independent business integrity department within thecompany

% of Respondents who selected one or more options from this question

Mandate of the integrity function

Source: TNB Survey 2015 (48 respondents)

35.4%

31.3%

25.0%

6.3%

2.1% The business integrity function(s) has veto powerin relation to certain decisions

The business integrity function(s) makesrecommendations

The business integrity function(s) is integratedacross corporate operations (e.g. administrative,commercial, financial)

The business integrity function(s) does not playany role in the company's decision-makingprocess

Don’t know

Scope of business integrity policy

Source: TNB Survey 2015 (56 respondents)

1.8%

1.8% 3.6%

41.1% 51.8%

Separated by level of business (e.g. governmentrelations, supplier relations, customer level(KYC))

Separated by line of business (e.g. sales,distribution)

Separated by region (e.g. Europe, MENA, LatinAmerica)

Separated by risk category (e.g. bribery, anti-trust, sanctions)

It is integrated across business and regionaloperations

• Silos approach towards risk management

• Insufficient support for risk management

• Excessive focus on compliance

• Lack of alignment of remuneration policies with risk strategies

Challenges for business integrity

• Legal and regulatory framework: Almost all countries have similar expectations as private firms. Around half impose added requirements

• At the level of the SOEs: – 52% of governments require SOEs to establish risk management systems – 42% require (large) SOEs to establish specialised board committees to deal with

risk – 18% require (large) SOEs to employ risk specialists

• At the state level: – Only 15% formally set risk tolerance levels for SOEs – 34% factor risk into rate-of-return requirements – 79% review their SOEs’ risk management practices

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Risk Management by SOEs and their Ownership (overview of a recent OECD study)

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Rules on SOE risk management

The establishment of risk management systems

Specialised committees to oversee risk management

Toward OECD anti-corruption and integrity guidelines for SOEs?

2017 - Stock-taking report on corruption and breaches of integrity: • The problem:

– What is happening? Active and passive corruption and breaches of integrity – Who is involved, actively or passively? – Where and when it’s happening: geographically, sectorally, and in what

processes (operations or strategy)

• Corporate practices: – Who within the SOE are responsible for countering corruption? – Subject to what reporting channels and incentives? – How does the state oversee this? – Protection of whistleblowers and other exposed individuals.

Toward OECD anti-corruption and integrity guidelines for SOEs? (continued)

2018 – Anti-corruption and Integrity Guidelines • Based on the OECD Guidelines on Corporate Governance of State-

Owned Enterprises

• Addressed to the state ownership function – hence respecting the autonomy of SOEs and their management.

• Consistent with ongoing efforts to develop guidance for the SOEs themselves (e.g. Transparency International)

• Intended for a wider audience than OECD’s membership (e.g. the G7; G20)

Resources and contacts

For more information on OECD work on state-owned enterprises, please visit:

http://www.oecd.org/daf/ca/soemarket.htm

Questions can be addressed to:

StateOwnedEnterprises@oecd.org

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