Transcript Financial Sector Governance

Financial Sector Governance:
The Role of the Private Sector
Michael Pomerleano
Financial Sector Development Dept.
The World Bank
June 4, 2003
Strengthening Financial Sector Governance in Emerging Markets
Overview by V. Sundararajan and Michael Pomerleano
http://www.worldbank.org/wbi/banking/finsecpolicy/pillars/
A clinical approach to each specialized
industry in the financial sector
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Banks and in particular State Banks…blurred
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
Why does corporate governance in banks
warrant special attention?
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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
Bank Governance:
The Basle Guidelines Issued in 1999
Intended complement The OECD’s 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 bank’s
ethical values, objectives, strategy & control environment
7: Corporate governance should be conducted in a transparent
manner
Issues in State Banking
Corporate Governance of Banks: Concepts and International Observations
(Jerry Caprio and Ross Levine)
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The situation. More than 40% of the world’s population live
in countries in which most bank assets are held by stateowned 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
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
Asset-Management Companies
THE GOVERNANCE OF ASSET MANAGEMENT COMPANIES: SELECTED
OBSERVATIONS (David C. Cooke, Managing Director, Barents Group, KPMG)
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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)
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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.
Public Pension Fund Management
and Governance (Cont.)
(Governance Issues In Public Pension Fund Management Gregorio Impavido)
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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.
Mutual Funds
(Mark St. Giles and Sally Buxton, Cadogan Financial)
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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.
Mutual Funds II
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No evidence that any one fund legal structure provides
improved fund governance
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Tentative solutions.
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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
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But…. probably
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Better governance structure when fund management is
separate from oversight with independent corporate directors
Regulation and enforcement are needed
How Effective are Capital Markets in
Exerting Governance on Corporates
Lessons of Recent Experience with Private and Public, Legal Rules Cally
Jordan, The World Bank and Mike Lubrano, IFC
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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.
Next Steps
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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?