Corporate Governance in Mongolia: Key Insights and Recommendations

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This presentation by Sebastian Molineus from the World Bank's Corporate Governance Group in Mongolia highlights the importance of good corporate governance. It defines corporate governance, explores the roles of various stakeholders, and discusses key themes such as enforcement regime, control structures, and shareholder rights. Recommendations are provided to enhance corporate governance practices in Mongolia.

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Corporate Governance in Mongolia: Results from the 2009 Corporate Governance ROSC Assessment A presentation by Sebastian Molineus World Bank Corporate Governance Group In Ulaanbataar on May 27, 2010

1. The Definition of and Business Case for Corporate Governance (CG) 2. The World Bank s CG ROSC Program 3. Key Findings of the CG ROSC for Mongolia 4. Policy Recommendations 2 out of 26

To begin with, it is important that we are all on the same page as to what good corporate governance means Simplified definition The OECD defines corporate governance as: A system by which companies are directed and controlled which involves a set of relationships between: a company s management board of directors its shareholders and other stakeholders and which provides the structure through which company objectives are set, attained and monitored. 3 out of 26

A simple enough definition. But reality is more complex: Illustration Internal Corporate Perspective External Stakeholder Perspective Shareholders - The general assembly - Intermediaries Stakeholders Elect & dismiss Are accountable to Ext. Audit Law- & rule makers Company, Banking, Securities Laws Regulations, Listing rules National CG Codes Reputation Agents Provide capital to Act in interest of Directors Accounting firms - The board of directors - Law firms Audit Cttee Rem Cttee Risk Nom Cttee Cttee Investment banks Capital & Financial Markets Debt & equity markets Competitive forces Market for corporate control Credit rating agencies Report & answer to Guide & control Financial analysts Financial media Research institutes Managers / Executives - CEO / mgt. team / ExCom - Educational institutions Civil society CSR HSE Corporate governance institutes CIA CRO CCO Institutes of directors 4 out of 26

The following illustration offers a look & feel of the key themes CG touches upon Illustration Strong enforcement regime Robust control structures Protection of (minority) Good board practices Strong disclosure & transparency regime shareholder rights Robust legal & regulatory environment 5 out of 26

The good news: much research and analysis by renown international experts demonstrates that CG adds to the corporate bottom line Optimizes Operational and Financial Efficiency Streamlines business processes, leading to better operating performance & lower capital expenditures Gompers, Ishii and Metrick, Corporate Governance and Equity Prices, August 2001 Improves the company s ROCE, with firms in the top cg quartile avg. 33% & in bottom quartile 15% Credit Lyonnais SA, 2001 Better share price performance, higher profitability, larger dividend payouts & lower risk levels than peers Lawrence Brown, Georgia State University, Sept. 2003 Improves Access to Outside Capital Global Institutional Investors managing more than 1 trillion of assets state that they will pay a premium for well governed companies. Premiums avg. 30% in Eastern Europe & Africa and 22% in Asia and Latin America McKinsey Global Investor Opinion Survey on Corporate Governance, 2002 Improves Valuation and Lowers the Cost of Capital Over 10 years, well-governed companies across a wide range of sectors have seen superior valuation multiples of more than 8% over their badly governed peers. Metrick, Ishi and Gompers, Corporate Governance and Equity Prices, August 2001 One standard-deviation improvement in governance brings an improvement in valuation multiples that ranges from 18% for companies in major OECD markets to 33% in emerging markets. Clapper and Love, World Bank, 2002 Builds/Improves the Company s Reputation CG can make/break reputations by creating confidence &goodwill andbuilding/restoring investor trust 6 out of 26

And, at the same time, CG can bring important benefits to the government , markets, and economy as a whole For regulators and supervisors: A first line of prudential defense Increased financial stability & reduction to crisis For markets: Higher market capitalization and liquidity Increase in investor confidence and trust Ability to attract, allocate & monitor investment For economies: More champion companies that can compete and grow internationally Higher economic growth 7 out of 26

1. The Definition of and Business Case for Corporate Governance (CG) 2. The World Bank s CG ROSC Program 3. Key Findings of the CG ROSC for Mongolia 4. Policy Recommendations 8 out of 26

The CG was identified by G-8 Financial Stability Forum as one of 12 standards of the global financial architecture A ROSC consists of a gap-analysis, policy recommendations, and action plan, and aims to help our client countries improve upon their CG frameworks 1 2 3 4 Implementation by country Invitation to conduct ROSC Benchmarking and drafting Feedback and dissemination 1 month May - July 4 6 months 1 3 months Aug. Sep. Several years Oct. May 10 CG ROSC is voluntary, and is not published w/o client approval Step 1: Upon receipt of invitation, team compiled Step 2: Local consultants hired to assess CG framework Country to carry-out recommendations. WBG may be of assistance Step 1: Separate request to WBG, incl. IFC and IBRD Step 2: WBG assesses need and resources Step 3: In follow-up to implementation, a 2nd ROSC may be commissioned to asses progress Benchmarking vis- -vis the OECD Principles Step 1: Desk review of all laws & regulations Step 2: Survey of listed companies Step 3: Fact- finding mission to qualify data Step 4: Drafting of ROSC report Final draft report sent to client for comments Step 1: Internal peer review process organized Step 2: Final draft report sent to client for feedback Step 3: Feedback discussed and incorporated Step 4: Final report issued in The term ROSC is short for a Report on the Observance of Standards and Codes 9 out of 26

The CG ROSC has a global reach, and since 2001, 71 CG ROSC Assessments have been carried-out in 61 countries In addition, the World Bank s CG Group has also developed country-level CG Reviews specifically targeting the SOE and banking sectors 10 out of 26

1. The Definition of and Business Case for Corporate Governance (CG) 2. The World Bank s CG ROSC Program 3. Key Findings of the CG ROSC for Mongolia 4. Policy Recommendations 11 out of 26

A quick prelude to the presentation of key findings However, the CG ROSC carries many important lessons for all company types, incl. large non-listed banks, LLCs, and SOEs. Focus of the CG ROSC: Publicly listed companies Laws and regulations date up to June 2009 Recent amendments to laws and regulations may since have been made. Note that the data is based on a 2007 FRC survey and WB fact-finding mission in early 2009 Practice data dates from mid-2007 to early 2009 Wide discrepancies in practice, in particular between banks vs. SOEs and companies! Carried-out in close cooperation with relevant stakeholders In particular the local World Bank and IFC offices, WB Accounting & Auditing ROSC team, and USAID 12 out of 26

CG needs to be seen within the context of the economic, political, and legal environment, some of which are still in development Limited number of companies for which CG is a priority - 384 listed COs. (early 2008); however, trading is limited to MSE-20 - 16 banks, 137 NBFI plus some large SOEs operating in Mongolia - Most companies are SMEs, in which a tailored approach is called for N.B.: Ownership highly concentrated, largely in the hands of company insiders and/or the state Enforcement institutions (BoM, FRC, courts) present, but often do not appear have resources, authority, and/or independence Capital market presents opportunities & challenges - Low free-float: Associated with insider trading; discourages shareholder involvement - Few institutional investors: Little CG engagement - Levels of disclosure remain low 13 out of 26

Much has already been achieved! However, the CG ROSC shows that a number of important challenges remain, in particular in practice vs theory Today s Achievements Tomorrow s Challenges CG Codes/Regs launched for listed companies, banks, SOEs To close remaining gaps in the legal and regulatory framework, e.g.: Legal & regulatory reforms -Ability of shareholders to approve dividends, issue new share issues Key laws in place & recently amended; new reforms launched A&A, CG ROSCs commissioned Modernize framework FRC created in 2006 Build enforcement capacity/ regulatory bite , with real fines Enforcement capacity MoU between the BoM, FRC and SPC to ensure for financial market stability Independence of regulators should be strengthened Launch of CG reform projects by USAID and IFC Boards need to fulfill their primary role of oversight/guidance Actual practices Launch of CG Centers and training programs to build capacity among directors Disclosure must be improved Nascent internal control frameworks are built 14 out of 26

This inability of companies to follow good corporate governance at the company level has impacted Mongolia s CG ROSC Assessment Implementation of the OECD Principles in Mongolia Fully implemented, 2 Broadly implemented, 4 Not implemented, 7 Partially implemented, 19 The great majority of high-level OECD Principles are either Partially or Not Implemented Only 18% are Fully or Broadly Implemented Source: World Bank analysis 15 out of 26

Diving down a bit further, we find that Mongolian companies have particular difficulties in terms of implementing good board practices Implementation of Principle VI on Board Practices VI.F. Access to information VI.E. Exercise objective judgment VI.D. The board should fulfill certain key functions VI.B. Treat all shareholders fairly VI.A. Acts with due diligence, care VI.C. Applies high ethical standards Source: World Bank analysis 16 out of 26

Most boards are not fulfilling their role: that of providing managerial oversight and strategic guidance on behalf of all shareholders Boards involved in day-to-day management; no succession plans Duties (of loyalty and care) defined, but not understood Role In practice, most companies have not formed board committees Position of CEO and chairman legally separated, yet insiders continue to dominate board Structure MCGC calls on 1/3 of boards to be independent, but definition fails to cover directors who are shareholders In practice, few directors thought to be truly independent Composition Except for the largest companies, NEDs receive low pay Executive pay not based on formal evaluation or LT incentives Remuneration Cultural stigma against training Board self evaluations virtually non-existent Training & evaluation 17 out of 26

Moreover, many boards have failed to implement robust control structures Little practical guidance offered for companies outside of banking sector, Risk governance structures nascent, underfunded Risk management Internal control structures organized around a unit and not spread to all staff Management letters cite gaps in internal control structures Internal controls MCGC calls for the IA to be independent; yet, IA often reports to the CEO and not board/audit cttee Internal audit Conflicts of interest due to the provision of non-audit work Quality of peer review process questioned External audit 18 out of 26

And while Mongolia has taken an important step in adapting IFRS and ISA, the level of transparency remains below international standards Implementation of Principle V on Disclosure and Transparency V.B, Standards of accounting & audit V.C. Independent audit annually V.A. Disclosure standards V.F. Research conflicts of interests V.E. Fair & timely dissemination V.D. External auditors should be accountable Source: World Bank analysis 19 out of 26

Financial and non-financial disclosure in particular remains weak, despite the adoption of IFRS and ISA IFRS mandatory for all companies; however, challenges expected in transition process (adapt vs. adopt) 2008 A&A ROSC: critical gaps in financial reporting in terms of quality and timeliness Financial reporting standards 2007 FRC report: 78.9% failed to submit their financials to the authorities Even fewer are thought to publicly disclose their financial statements, e.g. in their annual report or www Financial disclosure Only 4 5 companies prepare and disclose annual reports; most do not have CG sections Little to no information on CG, ownership structures, information on board members, remuneration, etc. Non-financial disclosure Conflicts of interest due to the provision of non-audit work Quality of peer review process questioned External audit 20 out of 26

And while the legal frameworks contains many good practice provisions protecting minority shareholders, these are often not followed in practice Implementation of Principle II and III on Shareholder Rights III.A. All shareholders should be treated equally II.G. Shareholders allowed to consult each other II.E. Control arrangements allowed to function III.C. Board/Mgrs. disclose interests III.B. Prohibit insider trading II.D. Disproportionate control disclosure II.C. Shareholders GSM rights II.B. Rights to part in fundamental decisions II.A. Basic shareholder rights I.IF. Exercise of ownership rights facilitated Source: World Bank analysis 21 out of 26

With a few exceptions, key shareholder rights are in place While a number of basic shareholder rights are in place Participate and vote in the GMS Art. 35 CL Basic information rights in place Art. 96 CL Ability to nominate & elect directors Art. 63 CL Allowed to vote on non-executive compensation Art. 63, 77 CL One share, one vote exists for common shares Art. 64.2 CL A few remaining gaps need to be address. The board and not shareholders approves a rise in authorized capital or issuance of new shares (potential for dilution) Whistle-blower procedures absent The board and not shareholders approve dividends 22 out of 26

The real story: a number of companies fail to respect basic shareholder rights Companies conducting a GMS and paying dividends 450 400 350 300 Total no. of listed companies 250 200 No. of companies holding a GMS 150 100 No of companies paying declared dividends 50 0 Source: FRS 2007 Survey 23 out of 26

1. The Definition of and Business Case for Corporate Governance (CG) 2. The World Bank s CG ROSC Program 3. Key Findings of the CG ROSC for Mongolia 4. Policy Recommendations 24 out of 26

Policy Recommendations. The Government of Mongolia might consider to: 1. Make regulatory bodies responsible and hold them accountable for enforcing laws and regulations 2. Restore trust in the capital market by developing a fair process that allows companies to de-listing when they are inactive or fail to comply with the law, and also protects minority shareholders fairly 3. Develop a strategy to improve upon the corporate governance of Mongolia s SOEs. 4. Modernize the corporate governance framework by amending the company, banking, accounting and auditing, and securities laws, relevant regulations, in particular the listing rules, as well as the MCGC! 5. Build a qualified cadre of directors by supporting the Mongolia Corporate Governance Center and other nascent corporate governance institutions 25 out of 26