September
Keynote Address to the Annual Conference of Chartered
Secretaries Southern Africa on the Occasion of its
Centenary
Phil Armstrong, Head: Global Corporate Governance
Forum, International Finance Corporation
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Key Points
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Opening Remarks ......................................................................................................... 2
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Role of the Forum globally ............................................................................................ 3
 No doubt we have probably encountered one of the worst crises since the great
depression ........................................................................................................................... 4
 Yet again….This crisis demonstrates that regulations alone do not guarantee ethical
behavior and good governance ............................................................................................ 6
 A corporate governance framework is a set of market mechanisms that are closely
linked .................................................................................................................................. 7
 Where were the directors? The importance of board members’ skills is yet again
reinforced ............................................................................................................................ 8
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Some expectations in regulatory shifts ....................................................................... 10
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So, Where to from Here? ............................................................................................ 11
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Concluding observations............................................................................................. 13
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Opening Remarks
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Thank you for the kind invitation to address this annual conference on occasion of
the Chartered Secretaries Southern African centenary, and I extend my heartfelt
congratulations to the Institute and all its members on this significant milestone.
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I am particularly grateful to the Institute for the opportunities the CIS qualification
has afforded me, and is a body to which I remain very dedicated and deeply indebted.
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In this era of corporate governance, the role of the company secretary in my
opinion remains as important as ever, if not more so! What frustrates me, however, is the
demand for access to training in this important skill coming from parts of the world
where, hitherto, the concept of company secretary was until recently unknown.
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The challenge I pose to all of you here today, leading your respective Institute’s in
your various countries, is how do we harness our collective capacity to support this
growing demand in a way that we can take advantage of the opportunities for the benefit
of the Chartered Secretary profession.
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And, importantly, to ensure that the appropriate level of professionalism is
introduced into the boardrooms of some very challenging environments out there.
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I have about 30 or so minutes to outline my thoughts on the financial crisis and
corporate governance. All I can really do in this time is, perhaps, highlight some of the
underlying symptoms and then perhaps question whether we have really confronted the
issues satisfactorily, or is it pretty much back to business as usual.
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Much has happened since I took up my current position with the Global Corporate
Governance Forum nearly four years ago – South Africa has a new President, indeed, new
Cabinet, numerous CEOs seemed to have called it a day and a new echelon of business
leaders are emerging, King III has been launched, and, the world is at various stages of a
recession led in large measure by the implosion of the US banking system and housing
market.
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It would be inappropriate for me to opine on corporate governance in South Africa,
although I do try to follow some of the developments with interest. Instead, I would rather
share with you some personal observations drawn from my work with the Global
Corporate Governance Forum, and perhaps share a few thoughts on how any of this might
be relevant to South Africa.
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Role of the Forum globally
The Forum, as we are known, was established by the World Bank and the OECD at
the time of the East Asian Crisis in the late 90s. Its primary role at the time was to
facilitate the articulation of the newly promulgated OECD CG Principles in nonmember OECD countries; read “developing countries”!
It is 10 years hence and we are looking at another major crisis – with one
significant and compelling difference.
This one was started in the very countries responsible for insisting on those
standards, which makes for some interesting dilemmas right now. I will come back
to this later.
The Forum has since been located in the private sector arm of the World Bank
Group, the International Finance Corporation, which is our anchor donor. The
Forum is also funded by a number of European governments, Canada and Japan.
The Forum in its current phase of work, for which I am responsible, is now almost
fully focused on building the necessary capacity around the world to facilitate the
necessary expertise and technical resources to help countries initiate or sustain
corporate governance reforms but ensuring always, that the process is owned and
led by the local stakeholders.
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This work is directed at both developing countries and emerging markets, hence
my having just arrived from China where we are building partnerships in both the
private and public sectors. The Forum is currently engaged in over 50 countries
worldwide, operating with a small team of seven plus a number of consultants and
experts.
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Our work not only centres on assisting with the development of codes and
standards, where we have been working extensively in North Africa and the Middle
East, but also working extensively with institutions seeking to enhance their board
leadership training capacity e.g. Brazil, Ecuador, East Europe, parts of Africa, SE
Asia; the training of financial journalists globally; and, assisting with the
implementation of dispute resolution mechanisms for business in the Balkans and
Ukraine, among numerous targeted initiatives in India, China, Bulgaria, Panama,
Egypt, Vietnam, Mongolia, The Philippines and also elsewhere.
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We depend a great deal on the advice and guidance of our private sector advisors,
who represent over 75 business leaders, investors, professionals and corporate
governance experts from around the world, to bring a practical and well seasoned
perspective to our work with countries – some of whom I have just mentioned.
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Peter Dey, former head of Morgan Stanley in Canada heads this group which
includes Mervyn King and Reuel Khoza. Others you may have heard of include Mark
Mobius, Ira Millstein, Patrick Chisanga from Zambia, Eddy Wymeersch who is one
of the senior advisors to the EU on banking regulation, Paul Coombes from the UK
who previously headed the well known McKinsey studies along with Simon Wong,
and Christian Strenger of Germany for example.
No doubt we have probably encountered one of
the worst crises since the great depression
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Virtually every thoughtful analysis of the crisis has cited macroeconomic
imbalances, regulatory failure and various flaws in the intersection between economic and
regulatory policies – this, as we have observed, has been particularly severe in the banking
sector.
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The IMF has projected negative global growth for 2009, with sharp declines
predicted for advanced countries, and nominal GDP growth for emerging markets and
developing countries but I would caution that this will be lumpy and probably will be
mostly in the Asian region led by China and India for the most part.
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The World Bank estimates that for every one percentage point decline in global
GDP growth, 20 million more people fall into poverty. In China alone, 20 million migrant
workers were laid off in 2008.
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The sharp decline in remittances from migrant workers back home to Africa is
likely to be significant, as just one severe example of the crisis. This currently is estimated
at USD15 billion annually. The effect this will have on underlying socio-economic
conditions in Africa is quite threatening in its potential consequences. In Kenya alone, this
has fallen from an estimated USD61 million in October 2008 to USD39 million in early
2009.
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Some 100 000 workers are estimated to have lost their jobs in the DRC and some
80 000 in the Zambian Copperbelt.
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Contrary to earlier speculation that the crisis was largely the problem of the socalled developed countries, developing countries have discovered they are not immune.
The crisis is hitting hard through trade and financial market channels.
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And, it is my understanding that you are experiencing some of this in South Africa
currently. The contraction in South Africa’s GDP by 3 percent for the 2nd quarter of 2009
indicates the economy is still in recession, although this is nominally an improvement on
the 6.4 percent contraction in the 1st quarter. Job losses this year are expected to be
considerable too, and I needn’t dwell on the consequences of this.
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Yet again….This crisis demonstrates that
regulations alone do not guarantee ethical behavior
and good governance
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Probably most disturbing is that the causes of this crisis are not novel: we’ve seen it
in 1990’s (Asian crisis) and repeated far too often in the 2000’s (Dotcom Bubble, and
numerous corporate scandals mostly in the US – first Enron and now the banking sector).
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Despite various regulatory responses, notably the requirements of Sarbanes-Oxley
in the US, all it seems to have led to has been a focus on formal compliance rather than
substantive controls and risk management.
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While, on the other hand, in Europe the notion of the so-called “comply or explain”
approach is being questioned as the opposite side of draconian legislation, being soft rules
in which various market intermediaries support the regulatory process, doesn’t seem to
have worked terribly well either if one looks at the UK banking sector.
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What is increasingly apparent is that the current financial crisis is a result of
inefficient market operation and weak supervisory rules and systems in some so-called
developed countries.
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This has been aggravated by the increased complexity of globalised financial
systems, which regulators simply did not have to the capacity to keep pace with; much less
regulators in developing countries.
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This is going to present some interesting challenges for international standard
setters, and national regulators, in seeking to find the “right” balance.
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However I think it is equally germane to note that this crisis (in my opinion) was
not born out of corporate malfeasance and fraud as with a number of the earlier episodes
that gave rise to the Cadbury Code in the UK in the early 90’s and Sarbanes-Oxley in the
United States more recently for example.
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As the OECD has observed: “the financial crisis can be attributed in part to failures
and weaknesses in corporate governance arrangements.”
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But as one financier has also questioned: “The speed and severity of the current
economic downturn has caused observers to question the role of corporate governance
regimes in failing to identify excessive risk-taking at a number of financial institutions. A
prevailing question is whether the financial crisis would have occurred had corporate
governance standards been higher across the board.”
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The point here is, that I am not entirely persuaded that the commonly accepted
standards of good corporate governance practices failed but rather their application was
distorted for a number of reasons ranging from an unhealthy obsession of companies to
simply comply without taking seriously the underlying substantive basis of recommended
practices to weak or incompetent enforcement by regulators and the absence of sound,
thoughtful engagement by institutional shareholders.
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In the recently issued Walker Review in the UK, this point was noted, and there
seems to be a strong view that a lot of the difficulties encountered in the financial sector
were more behavioural rather than failure to comply with existing corporate governance
standards and rules.
A corporate governance framework is a set of
market mechanisms that are closely linked
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o This is amply illustrated in South Africa’s approach to corporate governance, but I
question whether it has the necessary infrastructure to ensure that the various
intersecting intermediaries critical to an effective “apply or explain” process are
sufficient to ensure its complete adherence.
o Not least, the role of enforcement and relatively inactive institutional shareholders
although I am interested in how the Investors’ Code will work in practice.
o Having said that, South Africa remains a benchmark in many ways, especially with
the way it integrates core financial aspects of corporate governance with the wider
elements of sustainable reporting on so-called non-financial matters.
o BUT, other concerns about South Africa are perhaps diminishing its relevance!
Where were the directors? The importance of
board members’ skills is yet again reinforced
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In the time available, I would like to focus on the role of boards and directors in
light of observations from the current crisis. As this to my mind, remains a challenging
area clearly notwithstanding all the standards, guidelines and recommendations that are
now in place the world over!!
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What has come through, once more, as we have seen too often in previous crises, is
the lack of engaged and effective oversight by boards, especially in the banking sector.
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Poor functioning of board committees, which are an important underpinning of any
effective board governance process, specifically the audit committee and their inability to
deal with complex financial matters and risk.
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This has, in effect, manifested itself in weak internal controls and risk management
practices.
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And, of course, in the US particularly but also in a number of other advanced
economies, flawed incentives built around executive and senior management
compensation.
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Jack Welch, the former head of General Electric, makes a somewhat caustic
observation on these issues: “[T]he real fallacy of CG in this crisis is not what boards did and
didn’t do. It’s what was expected of them…….The list of guilty parties in bringing on the
current economic situation is long, and boards do belong on it. Just don’t put them near the
top. That would give them too much credit for a job they couldn’t do.”
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Which really begs the question, are we expecting too much of directors, and
particularly non-executive directors?
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The Lehman Brothers’ Board Example:
»Nine of them are retired. Four of them are over 75 years old. One is a theater
producer, another a former Navy admiral.
»Until the 2008 arrival of former US Bancorp chief Jerry Grundhofer, the group was
lacking any financial knowledge.
»The board’s members include John Macomber, 80 years old, a former McKinsey &
Co. consultant and chief executive of chemical-maker Celanese Corp; John Akers, 74,
former IBM chief; Thomas A. Cruikshank, 77, chief executive of Halliburton Co. prior
to Vice President Dick Cheney; and Henry Kaufman, 81.
»Other members include: Sir Christopher Gent, 60, the one-time chief of mobilephone company Vodafone PLC; theatre producer Roger S. Berlind, 75; former
Telemundo Chief Executive Roland Hernandez, 50; Michael Ainslie, 64, former chief
executive of Sotheby’s Holdings; Marsha Johnson Evans, 61, one-time head of the Red
Cross and a former Navy rear admiral.
»Until 2006, Lehman’s board included Dina Merrill, the 83-year-old actress once
featured in movie “Desk Set,” as well as “Caddyshack II.”
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According to a KPMG study – “Never Again? Risk Management in Banking Beyond
the Crisis”. Carried out by the Economist Intelligence Unit with 500 Respondents.
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Some expectations in regulatory shifts
No doubt there is huge political pressure in the advanced markets for regulators to
intervene further. The question is how much, and in what way?
A concern I have is how much of this will translate into further revisions to
international standards, and the impact this will have on the developing countries
already heavily burdened with requirements to adhere to the existing standards.
While this is not the time to simply look at what’s going on in the developed
countries with smug indifference, I think there are lessons to be learnt but to
carefully consider how this relates to your own circumstances, e.g. South Africa has
done well in this regard!
It seems clear that, at least at this early stage because I think we are still some way
from really understanding the full impact of what’s currently going on, while the
crisis in the developed economies will place a lot of focus on the financial sector in
those countries – in the developing countries, the consequences will be felt more in
the wider business sector as demand for products and services decline through
tighter credit in advanced economies among other things.
For this reason, we are likely to see new mandatory rules particularly focused on
the financial sector and then need to carefully consider how any of this might
translate into responses in the wider business sector generally.
The focus, for the moment, seems to have two main trajectories – (1) how to
tighten regulation of the financial sector and how to address some of the public
indignation at the seemingly excessive levels of remuneration of bank executives,
which will be a strong focus of the upcoming G20 meeting later this month, and (2)
how some governments are going to have to manage their new found ownership of
some of the world’s major banks and insurance companies, e.g. US.
Peripheral issues will likely centre on concerns with conflicts of interest prevalent
in the credit ratings sector – who seem to have become convenient scapegoats;
regulating, further, processes related to board structures and operation; rules that
will advance shareholder access to corporate decisions (especially in the US where
shareholder rights are weak); and, impose obligations on shareholders to exercise
more effective oversight of their ownership responsibilities (a criticism in the UK
and The Netherlands).
The point being, not all these issues have the same significance in developing
countries and emerging markets. Therein lies the challenge in the way ahead, and I
haven’t even begun to dwell on some of the structural issues that are clearly
apparent in all this!
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So, Where to from Here?
As mentioned at the outset, in the time I have available, there is not enough scope
to cover all the issues warranting consideration. However, I will endeavor to
highlight, briefly, some!
These are some practical thoughts borne from an extensive observation of boards
around the world, and the processes that govern and regulate companies.
The role of the Board Chairman is going to become ever more critical, especially in
the financial sector where independence alone is not sufficient – he or she has to
know something about the business.
While perhaps not an issue in South Africa, the separation of the roles of Chairman
and CEO remains a hotly debated issue in the US; although my proposition is that if
Chairmen take on the role they should, it will simply become impossible to manage
the two combined functions effectively in sheer practical terms.
Notional independence to accommodate corporate governance rules is no longer
sufficient; Boards must think intelligently about the competencies that they require
to competently supervise the business. This to my mind, remains a bewildering
shortcoming in so many boards.
This will have particular consequences for the selection of individuals that can
competently fill critical positions on board committees – an area I believe has been
found seriously wanting in this crisis! In the financial sector, I would expect some
measure of regulatory intervention in this area, e.g. prescribed skills and perhaps
greater regulatory intervention in the “fit and proper” test process.
Non-executive directors are going to have to have to spend much, much more time
on their responsibilities and therein rest a whole lot of issues I don’t have time to
cover. This not only has implications for more frequent meetings of boards and
committees, but also the time for preparation plus getting out and looking at the
business operations and meeting management, e.g. “kicking the tyres”- even in
banks!
This will, or should, impact fees paid to NEDs if we are going to expect them to do
all this work, a thorny issue at the best of times! Remember the adage, “you get
what you pay for!”
Executive compensation, itself, is a huge issue – at least in the advanced economies,
and seems to be emerging as a potential issue in some emerging markets given
some of the discussions last weekend in China. While I think we are rightly
offended by the excesses we have seen, the question of what to do about it and how
to regulate it is being driven more by political expediency than common sense to
my mind. I fear that some of the current recommendations have the potential for
unseen consequences, but then again, the behaviour of some banks recently is not
helping matters frankly.
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More time is going to need to be devoted to the training and development of
directors during the term of their office and their induction at the time of their
appointment, particularly in complex sectors like banks. This, again, remains a
shortcoming the world over and I am sure some of you here today will share this
frustration. This also calls for a more intuitive approach to board development –
directors don’t like going to “training”!!!
The regular evaluation of the performance of the board, each director individually
and the board’s committees is going to have to become an important component of
continuous quality improvement for the good governance of boards. What is not
clear to investors and regulators is quite how to engage this process in a way that
usefully informs discussions around board and director effectiveness – as this is
not yet entirely obvious given the proliferation of approaches.
As part of improving the effective functioning of board committees, I think we are
reaching a point where board committees will require their own budget
(independent of management) to hire experts to advise them independently on
highly complex decisions.
Risk management has been highlighted as a major failing, and will require
considerable deliberation and, possibly, may lead to mandatory requirements
specifically in the financial sector. Some suggestions include an independently
‘audited’ report to shareholders, separate from the statutory auditor’s report which
really provides little cover for shareholders.
I strongly agree with KPMG’s recent study advocating that risk management be
mainstreamed within the operational DNA of management and their operational
responsibilities, this is not simply a perfunctory role performed from time to time
or annually. I think South Africa has very much been a leader in this area, but it is
remarkable that this idea should come as something of a revelation in many other
markets.
This brings attention to a lot of structural and operational issues, which in the
banking sector are likely to be prescribed, around the intersection of the separate
priorities of the risk management and internal audit functions. If you think this is
challenging here in South Africa, consider how much more so in weaker markets.
An important element of this all, is that Boards will need to focus much more on
risk identification rather than risk measurement – this requires a much more
intuitive approach, as opposed to a perfunctory one. Some European banks have
an obsession with terrorist strikes, and not what happens if the housing market
fails!
Something we are not hearing nearly enough about, is the question of building
strong value systems founded on clear ethical guidelines and practices. This very
often defines the quality of decision making and business judgment. And, therein
lies the very essence of many of the elements of the current global crisis!
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Concluding observations
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In concluding, I’ve tried to focus on some, but certainly not all, issues that might
warrant careful re-evaluation in this crisis.
There are a host of systemic issues that need to or should be addressed, and I fear
that with the political pressure in some western countries to quickly “fix” the
problems, that we may be missing the opportunity to remedy some serious flaws in
the way our markets are currently structured.
Fixing the governance of boards and companies yet again will not rescue us from
the next crisis, unless we address some of the more fundamental systemic issues
and perverse market incentives!!
Areas I haven’t even dwelt on include: the question of ‘moral hazard’ that now
strongly resides in some leading markets accompanied by concerns over the issue
of ‘too big to fail’ (now already prevailing the auditing sector); how to re-align
perverse ‘incentives’ that continue to pervade the financial markets for short term
gains as companies will always “have” to respond to these; how to get institutional
shareholders more engaged given their own conflicts; the implications on new
found government ownership in markets not familiar with the complexities of this
issue, specifically the US; potential consequences for CSR at this time, and
numerous others.
The disturbing fact, as I highlighted at the beginning of my talk, is that it is
somewhat a case of déjà vu – we seem to have seen it all before.
In closing I would like to emphasis the point made by former US banker and PSAG
member, George Vojta: “Boards must re-establish and enforce the standard that risks
are to be undertaken for the benefit of their constituents, not for the personal gain of
management.”
Thank you for your attention and I will be happy to answer any questions or
provide any points of clarity during the course of the conference, as I feel I have
only touched the surface.