Financial Sector Governance: The Role of the Private Sector

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Financial Sector Governance The Role of the
Private Sector

• Michael Pomerleano
• Financial Sector Development Dept.
• The World BankJune 4, 2003

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Strengthening Financial Sector Governance in
Emerging Markets Overview by V. Sundararajan and
Michael Pomerleano
http//www.worldbank.org/wbi/banking/finsecpolicy/
pillars/
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A clinical approach to each specialized industry
in the financial sector

• Banks and in particular State Banksblurred
  distinction between private and public FS
• Asset-Management Companies blurred distinction
  between private and public FS
• Public Pension Fund Management blurred
  distinction between private and public FS
• Mutual Funds / Collective Investment Vehicles
• Capital markets Effective measures in capital
  markets to exert governance over corporates

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Why does corporate governance in banks warrant
special attention?

• Banks are funded by depositors their failure
  may have systemic impact
• Operating in an increasingly competitive,
  volatile global environment
• Facing major strategic crossroads (e.g., new
  technology, consolidation, globalization,
  deregulation)
• Cases during the Asian financial crisis of boards
  of directors under-performing

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Bank Governance The Basle Guidelines Issued in
1999

• Intended complement The OECDs Corporate
  Governance Principles
• Focused on the unique issues related to corporate
  governance of banks and set out the key elements
  of corporate governance in banks
• Objectives
• To encourage practices which can strengthen
  corporate governance under diverse structures
  -e.g. as regards the relative role of the board
  of directors management. Document does not
  promote a particular governance structure (e.g.,
  Anglo-Saxon vs. German models)
• To assist supervisors in promoting the adoption
  of sound corporate governance practices by
  banking organizations in their countries

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The Basle Guidelines

• 1 Strategic objectives corporate values should
  be established
• 2 Clear lines of responsibility accountability
  should be set enforced
• 3 Board members should be qualified, understand
  clearly their role not be subject to undue
  influence from management or outside concerns
• 4 There should be appropriate oversight by
  senior management
• 5 Work conducted by internal external auditors
  should be effectively utilized
• 6 Compensation approaches should be consistent
  with the banks ethical values, objectives,
  strategy control environment
• 7 Corporate governance should be conducted in a
  transparent manner

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Issues in State Banking Corporate Governance of
Banks Concepts and International
Observations(Jerry Caprio and Ross Levine)

• The situation. More than 40 of the worlds
  population live in countries in which most bank
  assets are held by state-owned banks
• What are the implications? Government ownership
  thwarts competitive forces, limits effectiveness
  of government supervision banking market suffers
  from opacity, need to improve accounting,
  auditing, credit information
• Illustrative solutions
• Contestability of markets lessens reliance on
  family or conglomerate relationships
• Incentives matter legal and bankruptcy
  frameworks

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Issues in State Banking (Cont.)Corporate
Governance of Banks Concepts and International
Observations (Jerry Caprio and Ross Levine)

• Select countries solutions
• U.S. has published a book with guidelines for the
  Board of Directors (The OCC guide for bank
  directors). Thailand, Oman, and East Africa
  reported that they have recently released guides.
  
• Education/ training for corporate directors re
  their obligations by a local institute of
  corporate directors. Switzerland reported that
  there is a local institute of corporate directors
  that offers training. Thailand, Philippines and
  Fiji advised that they recently established local
  institutes of directors
• HKMA issued a guideline on corporate governance
  in locally incorporated authorized institutions
  in May 2000. HKMA recommendation 5 The board of
  each bank should establish an audit committee
  with written terms of reference specifying its
  authorities and duties the audit committee
  should be made up of non-executive directors, the
  majority of whom should be independent
• MAS requires banks to separate financial and
  non-financial businesses to change their audit
  firms every five years

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Asset-Management Companies THE GOVERNANCE OF
ASSET MANAGEMENT COMPANIES SELECTED
OBSERVATIONS (David C. Cooke, Managing Director,
Barents Group, KPMG)

• The situation.
• Following the East Asia crisis, IBRA in Indonesia
  controlled 70 of financial sector assets in
  Indonesia. Similarly Danaharta in Malaysia, Kamco
  in Korea.
• Often mission statement has conflicting
  objectives restore financial stability, minimize
  taxpayer losses, etc.
• Governance of AMCs impacts pace of problem
  resolution responsibilities poorly defined
  oversight committees not sufficiently separated
  from management.
• Solutions Provide for independent and informed
  oversight committee to articulate policy
  objectives, review performance.
• Areas of Oversight authority typically include
  approval of Operating policies, Budget and
  funding proposals, Operating board members,
  Outside auditor, may also include approval of
  significant NPL transactions.
• Provide an independent operating board with
  authority to manage AMC activities
• Transparent reporting
• Encourage stakeholders participation in corporate
  governance

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Public Pension Fund Management and Governance
(Governance Issues In Public Pension Fund
Management Gregorio Impavido)

• The situation. 81 of world labor force covered
  by partially funded or PAYG public schemes
  Pension spending can reach 15 of GDP Implicit
  pension debt up to 200 of GDP (Transition
  economies) Publicly managed pension reserves up
  to 55 of GDP (Malaysia).
• In numerous countries multiple objectives
  governance structure is murky, and performance of
  PPFM is poor
• What are the implications? Identify good
  governance practices and distill into governance
  guidelines aimed at reducing the political
  influence risks that are associated with central,
  public pension fund management.

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Public Pension Fund Management and Governance
(Cont.)(Governance Issues In Public Pension Fund
Management Gregorio Impavido)

• Solutions
• Only one objective portfolio investing and
  maximizing returns for retirees.
• Development of a satisfactory set of governance
  guidelines tailored to public pension funds
• Governors independent and fit and proper
  Governors' responsibility defined by fiduciary
  law accountable for fund performance (e.g.,-
  Ireland, Canada)
• Independent performance evaluations should be
  conducted by external and independent entities on
  a regular basis.
• Internal controls should be established to avoid
  conflict of interests.

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Mutual Funds(Mark St. Giles and Sally Buxton,
Cadogan Financial)

• The situation.
• In the US investment fund assets represent 50 of
  GDP, whereas in Europe 25. In the transitional
  economies funds have been used for privatization.
  Collective investment schemes can become
  increasingly important financial institutions in
  developed countries
• Types of CIS governance structures
• Corporate style mutual funds are found mostly in
  the U.S. and a few emerging markets, and dominate
  in terms of value of assets. Directors have a
  fiduciary responsibility to look after the
  interests of investors.
• 75 of collective investment schemes by number
  are held in the trust or the contractual form,
  and are found mostly in developing countries.
• The trust made by trust deed between a
  management company and a trustee.The trustee has
  the fiduciary responsibility
• The contractual fund where investors contract
  with the management company. Protected by a
  combination of contract law, regulation and the
  actions of the depositary, which plays a quasi
  trustee role.

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Mutual Funds II

• No evidence that any one fund legal structure
  provides improved fund governance
• Tentative solutions.
• Ability to exit a fund creates competitive
  commercial pressure
• Transparency is critical to leveling the playing
  field, pressure funds to perform
• Regulation for fair competition
• But. probably
• Better governance structure when fund management
  is separate from oversight with independent
  corporate directors
• Regulation and enforcement are needed

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How Effective are Capital Markets in Exerting
Governance on CorporatesLessons of Recent
Experience with Private and Public, Legal Rules
Cally Jordan, The World Bank and Mike Lubrano, IFC

• Pressures of Capital Markets will Improve
  Governance of Corporates and Improvements in
  Corporate Governance will Promote Development of
  Capital Markets. How?
• Changes designed to facilitate better governance
  are not a "silver bullet" . Solutions are
  inextricably linked to a constellation of legal
  practices, institutions, and corporate governance
  structures.
• Legal Families Matter legal families appear
  to shape legal rules, which in turn influence
  financial markets (La Porta, et al)
• Hostile takeovers are a strong disciplinary force
  in U.S. markets. They relied on a rather well
  developed high-yield bond market, that was been a
  source of funding for acquiring firms. However
  takeovers are not prevalent in emerging markets.
• Importance of private rules for governance.
  Adopted ex ante by contract, often underpinned by
  voluntary codes of conduct, or through ex post
  enforcement through contractual dispute
  resolution, including arbitration, or through
  market discipline.

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Next Steps

• The program is a a start
• We do not have readily available answers
• Considerable work is needed to develop specific
  measures geared to the individual industries
  while recognizing the unique circumstances of
  developing countries.
• Ideally, a follow up collaborative research
  effort of the WB/IMF/Brookings
• Financial Sector Governance Assessments?