SASAC Lecture SOEs Reform and Governance Andrew Sheng Chairman Securities and Futures Commission 23 June 2005
Contents of Lecture • Objectives of State Ownership Governance. • How to monitor SOE performance through better governance. • How SFC, as a HKSARG statutory body, accounts for its performance through transparency, benchmarking and accountability 2
Example: Sweden Government Ownership • The Swedish state is Sweden’s largest company owner. • The Swedish Government Offices administer 57 companies/groups or public enterprises, of which 43 companies are wholly owned and 14 partly owned by the state. • A total of approximately 200,000 people are employed in these companies. • The state is also the largest owner of the Stockholm stock exchange. 3
Sweden: Active Ownership Policy Objective • SOE must create shareholder value for the State and, where relevant, serving specific societal interests in an economically efficient manner. • Each SOE therefore must have clear benchmarks for efficiency, profitability, development capacity and environmental and social responsibility. • Such performance and conformance must be transparent to shareholders and public 4
Sweden Active Ownership Policy • Sell off smaller none-core stake in publicly-held companies [ 抓大,放小] . • “Privatization” through transferring public entities into limited companies. • Retain full control in “natural monopoly” companies, such as the main utilities and transport. Deregulation at the same time to enhance competition. • The three principal tools for implementing the ownership policy: Transparency Capital structure Board nominations 5
Active Ownership Policy: Transparency • Agree on clear performance objectives and targets for each SOE. • Nominations to the boards of directors of the companies shall be transparent. • High quality reporting structure comparable to that of publicly listed companies. • Open annual shareholders’ meetings to participation from politicians, the media and general public. • Evaluation by independent analysts. • Organize seminars where companies present themselves and challenged by financial analysts on strategy, performance etc. 6
Active Ownership Policy: Capital Structure • Creating value through optimizing individual SOEs’ capital structures. • After restructuring capital, investment managers set financial targets, including operating margins and capital and asset ratios. • SOEs are expected to pay regular dividends, taking surplus capital and transferring the money back to the shareholders. • SOEs are also expected to borrow in market at own credit risk, not with guarantee from State. They will borrow on the basis of own financial condition which forces them to improve their earnings potential. 7
Active Ownership Policy: Board Nominations • State exercises control mostly through Board nominations. • SOE Boards should have high professional expertise, adjusted to each company’s operations, situation and future challenges. • SOE Board members should have a high level of integrity and comply with the requirements for good judgment expected of representatives of the state. • Use “outside” expertise from the private sector to streamline the Board. • Board nominations in listed companies where the state is a participant are to take place in consultation with other main owners in a nomination committee. • The composition of the Board must change in step with the development of the company and changes in the outside world. 8
Active Ownership Policy: How the Board Works • The Board shall annually adopt a written formal work plan. • The Chairman of the Board is to be elected by the annual general meeting. • All Board members set aside sufficient time to prepare and take part actively in board meetings. • The Board should annually carry out a structured assessment of its work. • All Board members receive remuneration for the work performed and the responsibility that rests on them. • Committees can be formed when there is a special need or to improve the efficiency of the work of the board. • The Board should adopt an ethical policy to make sure the company operates within the framework set by legislation. 9
Governance is about Conformance and Performance • Conformance and Performance are based on standards: standards of conduct (eg ethics) and standards of measurement (eg IAS), but increasingly, process quality standards (eg ISO9001) are now available to measure corporate or governmental standards of efficiency • Standard setting requires consultation and acceptance by all stakeholders • Once standards are set, there are winners and losers • Must give time to implement change • Must have incentives to persuade losers that in public interest to change • Success of reform depends on timing ( 天時) , geography/resources ( 地利) and unity of purpose ( 人和) – in other words, its all about the politics of reform • Trust in change management process key to success. 10
Information & Markets • Markets need real time, reliable information to make correct decisions, especially for risk management in highly volatile environment • Quality information needs: Good accounting standards Reliable, timely statistical data & reporting processes Capacity to process, analyze and decide on information critical to competitive success 11
Misinformation causes Market Volatility • In the absence of comprehensive, timely and accurate disclosure, market participants will: – find it difficult to compare financial performance of different companies – tend to speculate on unavailable information and make their investment decisions accordingly – tend to dispose of or withdraw extra investments or credit • True information ultimately emerges and market volatility is bound to follow 12
Lessons from Asian Financial Crisis and Enron Crisis • Bad Accounting = • Bad Statistics = • Bad Decision-making = • Bad Risk Management = • Wrong Policies = • Financial Crisis 13
Corporate Governance = 3 Disciplines • Self Discipline – Code of Conduct for Managers – Non-statutory codes such as Listing Rules and Takeovers Code etc – Self-regulation of professionals • Regulatory Discipline – Licensing and entry requirements – Securities Law and Company Law – Use of administrative sanctions and the criminal court to deal with corporate misconduct • Market Discipline – Anti-trust Laws – Class Actions – Investor activism 14
Greater Public Supervision • After the Enron incident, self-regulatory framework is gradually being transcended – Statutory backing for enforcement of codes, eg, FSA in UK may impose fines for code breaches • Regulatory discipline – SRO required to set up public supervisory committees comprising mainly independent members and to consider public interests – Analysts now subject to more supervision – Heavier penalties for breaches involving corporate misconduct • Market discipline – Encourage investor activism to safeguard their own interests – Certain regions considering to demand institutional investors to take heed of public interests; some others request them to disclose how they exercise their voting rights 15
Four Levels of Checks and Balances • Step up the board’s supervision of Management • Ensure compliance of professional codes of conduct, ethics and disciplines by second-line staff (professionals) • Regulatory discipline must be enforced effectively - appropriate incentive structure – High transparency and clear delineation of duties – Swift enforcement actions to ensure the punishment of fraudsters and market manipulators • Shareholders can resort to the court to safeguard their own interests 16
More stringent rules on integrity of information and disclosure Sarbanes- Oxley mandates :- • More clear and personal responsibilities so conflicts are identified and addressed • CEO/CFO to certify financial statements, and statements on internal controls • Sanctions for failure results in disgorging compensation following restatement of financial statements • Similar rules imposed in other jurisdictions 17
Appropriate sanctions • Post-Enron, more and heavier sanctions against breaches; • Increasing trend for civil action and civil fines • Need for graduated and targeted approach to regulatory discipline i.e. sanctions proportionate to seriousness of the offence • Hong Kong SFO introduced Market Misconduct Tribunal, with judge + 2 lay professionals to hear cases 18
Experience on Implementation of Sarbanes-Oxley Act s. 404 • Compliance with Section 404 is producing benefits, including a heightened focus on internal controls at the top levels of public companies. • Implementation resulted in significant costs. Some non-trivial costs may have been unnecessary, due to excessive, duplicative or misfocused efforts. • A number of companies have reported material weaknesses in their internal control over financial reporting in the first year of implementation. 19
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