SOEs Reform and Governance Andrew Sheng Chairman Securities and - - PowerPoint PPT Presentation

SASAC Lecture

SOEs Reform and Governance

Andrew Sheng Chairman Securities and Futures Commission 23 June 2005

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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

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Example: Sweden Government Ownership

• The Swedish state is Sweden’s largest

company owner.

• The Swedish Government Offices administer

57 companies/groups or public enterprises,

• f 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.

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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

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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
• wnership policy:

 Transparency  Capital structure  Board nominations

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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

• n strategy, performance etc.

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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.

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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.

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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.

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Governance is about Conformance and

Performance

• Conformance and Performance are based on standards: standards
• f 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.

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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

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Misinformation causes Market Volatility

• In the absence of comprehensive, timely and

accurate disclosure, market participants will:

– find it difficult to compare financial performance

• f different companies

– tend to speculate on unavailable information

and make their investment decisions accordingly

– tend to dispose of or withdraw extra investments

• r credit
• True information ultimately emerges and market

volatility is bound to follow

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Lessons from Asian Financial Crisis and Enron Crisis

• Bad Accounting =
• Bad Statistics =
• Bad Decision-making =
• Bad Risk Management =
• Wrong Policies =
• Financial Crisis

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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

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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

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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

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More stringent rules on integrity

• f 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

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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

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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.

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SFC Regulatory Objectives

• To maintain and promote the fairness, efficiency,

competitiveness, transparency and orderliness of the securities and futures industry;

• To promote understanding by the public of the operation

and functioning of the securities and futures industry;

• To provide protection for members of the public investing

in or holding financial products;

• To minimise crime and misconduct in the securities and

futures industry;

• To reduce systemic risks in the securities and futures

industry; and

• To assist the Financial Secretary in maintaining the

financial stability of Hong Kong by taking appropriate steps in relation to the securities and futures industry.

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Checks and Balances

• 7 independent non-executive directors vs 5 EDs
• Independent Process Review Panel
• Securities & Futures Appeal Panel/Tribunal
• Ombudsman
• ICAC reviews
• Accounts audited by KPMG
• Internal control review by PwC
• Budget approved by Financial Secretary
• Judicial review

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Be Financially Responsible

+19.6% $27.2 $9.3 Depreciation

• 10.5%

$37.0 $71.9 Other +3.6% $425.7 $344.4 Total Expenditure

• 5.4%

$691.0 $964.9 Reserves (end period)

• 14.0%

$125.4 $311.8 Surplus

• 4.7%

$32.7 $43.8 Premises +7.0% $328.8 $219.4 Staff Expenditure

• 2.9%

$551.1 $656.2 Revenue CAGR% 2003/04 1997/98 Actual (in million HK$)

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Increase in SFC Staff Relative to Market Growth (1994/95 – 2004/05)

81.8% SFC staff increased by 129% Brokers average turnover increased by 64% Brokers capital base increased by 245%

Prosecutions

183%

New investigations

Enforcement workload increased in terms of: 132%

Licenses

875%

Net assets of mutual funds

221%

Market capitalization

Market growth in terms of:

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Benchmark Against Overseas Regulators

Staff costs over the period from 2000/01 to 2004/05:

14.8%+ Monetary Authority of Singapore 42.7%+ Financial Services Authority, UK 38.1% Australian Securities & Investment Commission 74.6%# US Securities & Exchanges Commission 8.5% SFC Increased by Regulators

# % change 04/05 over 01/02 + % change 03/04 over 00/01

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Conclusions

• Three principal tools for SOEs reform: transparency,

capital structure and board nominations

• Must have Clear Corporate Governance Objectives,

Benchmarks and Performance Evaluation

• Must use Self-discipline, Regulatory Discipline and Market

Discipline

• Pick Important Problems, Fix Them and Tell Everyone
• Delivery of Good Shareholder Return, subject to social
• bjectives, key to good SOE Management and Fiscal

Responsibility.