the hawkamah · 2016-11-25 · the hawkamah journal issue02/2014 issue 02/2014 a journal on...

thehawkamahjournal

issue02/2014

issue 02/2014 a journal on corporate governance & leadership

Sir Michael RakeInterview with the Chairman ofBT & Majid Al Futtaim Holdingspages 05-10

pages 33-40

pages 20-24

Investor Perspectives on theRole of BoardsAn inside view into the investor expectations

Corporate Governance and Nominee DirectorsThree articles exploring the role and responsibilities of Nominee Directors

published by hawkamah, the institute for corporate governance.

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FOREWORD

The board of directors forms the backbone of corporate governance within companies, and the effectiveness of a company’s corporate governance practices is highly dependent on the effectiveness of the company’s board of directors. Following the financial crisis and corporate scandals of recent years, stakeholder expectations for directors and their boards have never been higher. Boards across the world need to think how they can strengthen their contribution, by providing insight and foresight as well as oversight.

This issue of the Hawkamah Journal focuses on boards and explores board effectiveness in various settings. We are privileged to feature an interview with Sir Michael Rake who discusses the differences between chairing a large listed company with dispersed ownership in the UK and chairing a family-controlled company in the UAE. Other contributors explore the challenges faced by boards of state-owned enterprises, banks, subsidiary boards and nominee directors. This issue also provides an inside look into what shareowners expect from the boards of their portfolio companies.

The aim of the Hawkamah Journal is to provide insights for business practitioners and I hope you will find this issue informative, interesting, and stimulating.

H.E. Hamad BuamimChairman

Hawkamah, The Institute for Corporate Governance

Hawkamah issue0214.indd 1 11/3/14 12:30 PM

EDITORIAL TEAMAlec Aaltonen

Saeed Bin Shabib

EDITORIAL BOARDPeter Montagnon

Hanan AhmedStephen Davis, Ph.D.

Alec AaltonenGrant Kirkpatrick, Ph.D.

Saeed Bin Shabib

HAWKAMAHTHE INSTITUTE FOR CORPORATE GOVERNANCE

LEVEL 14, THE GATE BUILDINGDUBAI INTERNATIONAL FINANCIAL CENTRE

P.O. BOX 506767DUBAI, UNITED ARAB EMIRATES

TEL: +971 4 362 2551FAX: +971 4 362 2475

EMAIL: [email protected]


TABLE OF CONTENTSINTERVIEW WITH SIR MICHAEL RAKE

INTERVIEW WITH THE CHAIRMAN OF MAJID AL FUTTAIM HOLDINGSPAGES 05 - 10

BOARDS OF STATE OWNED ENTERPRISESARTICLE BY DR. ASHRAF GAMAL EL DIN

PAGES 12 - 14

GETTING THE COMPOSITION OF THE BOARD RIGHTARTICLE BY DR. GRANT KIRKPATRICK

PAGES 16 - 19

“INDEPENDENT” NOMINEE DIRECTORS IN INTERNATIONAL GROUPSARTICLE BY FRANK DANGEARD

PAGES 20-21

NOMINEE DIRECTOR FRAMEWORKARTICLE BY SHARON DITCHBURN

PAGES 22-24

THE “NEW NORMAL” IN BANK GOVERNANCEARTICLE BY STILPON NESTOR

PAGES 26-32

EVOLVING THE ROLE OF THE COMPANY DIRECTORARTICLE BY AMRA BALIC

PAGES 33-36

THE IMPORTANCE OF DIRECTOR DEVELOPMENT IN GROUP COMPANIESARTICLE BY MUBADALA

PAGES 38-40

WHAT THE MARKET EXPECTS OF CONTROLLING SHAREHOLDERSARTICLE BY PETER MONTAGNON

PAGES 42-44

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InTERvIEW WITH SIR MICHAEl RAKE

As Chairman of both BT in the UK and Majid al Futtaim Holdings in Dubai, Sir Michael Rake is uniquely placed to assess the different governance challenges facing a large public-listed corporation with a very broad shareholder base and those of a company with one single shareholder. He brings to these roles a wealth of experience from his time as a leading representative of the accountancy profession, his role on other boards, including previously as Chairman of EasyJet, and his current position as president of the UK Confederation of British Industry. In conversation with Peter Montagnon he explains what an independent board can bring to a family-controlled company both in terms of strategic advice and sound financial reporting.

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What is the difference between chairing a large listed company with dispersed ownership in the UK and chairing a family-controlled company in the UAE?

Quite obviously a large public company like BT with one million shareholders is totally different from a family owned company. In BT, the whole question of investor communications is a big challenge. It means spending time with your major shareholders, and communicating with other shareholders in an equivalent way whilst running a board who are effectively reporting to all of the shareholders. You as a chairman have to take the responsibility for balancing the experience, diversity, length of service and relative skill base of the directors. This something you as the chairman have to do on account of the shareholders and you have to take responsibility for that. You also have to deal in a large company like BT with a huge amount of press, which is very open, direct and sometimes exotic and sensational.

All of these things are facets of a British public company whereas in a Middle-East company like Majid al Futtaim you’re talking

to case just one shareholder. You are running a board in loco parentis for that shareholder with a fundamental objective of looking after his interests through the operations of that company, applying good, globally rated corporate governance techniques in order to ensure the company is properly and efficiently run. Also where you’re in the public debt markets you have to ensure that translates into a financial reporting dynamic that is appropriate. The primary responsibility of directors is to look after the shareholder but they also have a responsibility to the public markets when the company has raised debt. This is different from the obligations that arise when the company has raised equity in public markets, as opposed to a shareholder situation.

Similarly the press is less involved. It’s a private company that has public debt, that presents financial statements, that has an open website that espouses proper corporate governance techniques which are applied in principle, but at the end of the day obviously the responsibility is to be in the shoes of the owner and to protect his interests or that of the

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INTERVIEW WITH SIR MICHAEL RAKE


family if it is family-owned. You have to engage with them to make sure they understand and support the strategy of the operating companies, that they feel adequately informed of progress, that they’re adequately aware of the risk, so the principle is the same, but the style is different. Sometimes london seems quite a hostile environment by contrast.

How do you apply the UK governance code in these circumstances?

This is where corporate governance works in a different way, because Majid al Futtaim has always been committed to having well run companies with good systems, good people and good corporate governance and standing. We work very hard to make sure the reputation of the brand is protected through proper governance, influence over behaviour and compliance with rules and laws around the world, to keep the brand out of the press in a negative way, to ensure that the audit committee, the internal audit, the external audit work in a way that protects the underlying assets of the company and that the financial reporting is correct both for the owner and, where you’ve got debt, for the debt markets.

So actually I think it’s a very substantive thing. Sometimes people say that this is just box-ticking, but the Middle East proves the point that, when done properly and if you look at the progress of the Majid al Futtaim group it’s been stunning. During the five or six difficult years of financial crisis and the Arab spring, the balance sheet has been strengthened. That’s been a tribute to the principles of good governance in a substantive economic way as opposed to just a public accountability sense. You could take different positions as a family owned company.

What elements of governance matter when you have a controlling shareholder. You have emphasized the reporting parts, but what about other aspects like succession planning and remuneration?

We review the content of all the boards every year from the holding company and make recommendations. We look at all the things as you would in a public company. We listen to and make recommendations to the shareholder. We look to have succession planning in place in the operating companies to make sure that the executives we have are the right ones. And of course, while the owner doesn’t take part in management, he has a big influence on strategy. As owner he has views, which you have to take account of.

On remuneration, we have independent remuneration committees. On the bonus element - the element which is variable as opposed to fixed under contract - the board looks at that very closely as to the application of the principles, the reasonableness test on the totality of the bonus pool which is also obviously a very sensitive issue in the UK. Then we also stand back from that and look at whether the package is reasonable and appropriate for the individual. The owner signs off on the result. He wants to be assured that it’s been looked at, that we think it’s fair and appropriate, that it’s done in an objective way, the same way a public company would. He doesn’t want to know about everything, as no shareholder does, but the big things matter: the basic direction, the overall results, the distribution of the remaining profits after salaries and fixed costs have been paid.

What does it feel like to be an outside independent director in these circumstances?

If you take the holdings company, we have on it myself, we have Dr Khalifa Sulaiman, ex head of the private office of the ruler and ex-ambassador to the UK, we have Ian Davis,

07INTERVIEW WITH SIR MICHAEL RAKE


08

ex head of McKinsey and Chairman of Rolls Royce, we have viswanathan Shankar, main board director and head of Americas and the Middle East for Standard Chartered. We have Tariq al Futtaim, the son of the founder on the board. Then we have Iyad Malas who’s the chief executive, and that’s the current board. So it’s got a very strong independent component.

What would be your advice to someone who was invited to become an independent director in a family-owned company?

My advice would be exactly the same as somebody coming to any board here in the UK. Stand back and do your due diligence about the board, the company, its position and where you think you can add value and how you think you are going to be able and allowed to add value. Those are the key questions. You wouldn’t want to be on every board here in the UK. Most people would tell you you’ve got to be quite fussy around that. On the positive side, I’ve worked and lived in the Middle East for a while. It’s a fascinating part of the world. Dubai is a kind of epicentre of a lot of activity, financial and otherwise in the Middle East and it’s an extraordinary place to be where there is a huge amount happening. It is the Middle East, it’s not Europe, it’s not the US, it’s not China, it’s different.

What do you in the event of a disagreement with the shareholder?

It’s very simple. Even in a situation like EasyJet (which Sir Michael formerly chaired) where you have 38 per cent in a block, you had to act in the interest of all the shareholders. The position of the EasyJet board was always to do what was in the interest of all the shareholders, and where we disagreed with what one shareholder’s viewpoint was, who was a minority shareholder, we would stand out for what we thought was right and seek to get the majority vote. If we failed

to get the majority vote, there would have of course been repercussions on us as directors. However, we did get those majority votes, we did execute the strategy and all the shareholders did benefit.

When you’ve got a very large shareholder, what you do is engagement by constructive agreement. Ultimately a shareholder in that situation makes the final big strategic decisions. And obviously an outside director in that situation makes up their minds to what extent that puts them in a position where they can no longer provide advice and support. It’s the art of persuasion and engagement and trust. And it’s knowing where the red lines are. You have to know where the red lines are for the shareholder and the things he absolutely doesn’t want and what he does want and the red line for the directors in terms of whether things are moving in a direction that they feel so uncomfortable with that it’s better for others to take on the task. But I think it’s basically a question of trust, and engagement, openness and frankness that’s the most important thing. But like any other civilised society, you do have disagreements.

You have to hope that doesn’t happen because if there is a disagreement that could be reconciled, you just have to give up?

Any non-executive director of any company has to have in the back of his mind – not to give up too early because you’re doing the right thing for the shareholders. For example it would have been very easy for me to walk away from EasyJet with the amount of hassle – you must first of all try to do the right thing and then leave at the right moment, but I think any non-executive director or chairman has to be willing in certain circumstances to resign where they’re not content with the way things are going, with the leadership of the board, not content with their ability to add value, with the strategy or the way that they’re not adding value any more. These are all questions you



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have to ask in any public company and then make up your mind if it’s time to go.

In your case related party transactions don’t worry you do they?

For the directors they all do. We watch it but in essence the issue of related parties doesn’t apply in so far as the owner is concerned. The issue of full disclosure of directors’ interests in each of the other companies is the same as in the UK. They get monitored and declared in exactly the same way.

You began by talking about the audit committee

It creates this throughput and discipline from a management information and an external reporting and around it you’ve got the internal

audit. We have full independent valuation of assets. It’s better than some public companies.

Would you have been doing this if you weren’t on the public debt markets?

We were obviously borrowing from banks. When you have debt and things go wrong, banks always pretend that they’ve looked at the audited accounts, but often they have not. We decided to go to the public debt markets because of the deals we could do on bonds and sukuks, which also promoted Dubai. We were one of the first companies in the Middle East that went out and got a credit rating so we could do it because we wanted to take advantage of the opportunities while keeping a strong balance sheet. So we’ve kept very liquid but we’ve had this debt capability available to us because during



the Arab Spring we realized that banks can be here today and gone tomorrow in terms of lines and commitments. If it hadn’t been because of the very strong reporting and auditing and governance that’s part of the credit rating assessment we wouldn’t have got a credit rating that allowed us to go to the debt markets. It was there and the owner’s view is that you’ve got to keep the opportunity for future flexibility of structure. So here it’s worked quite well for us to be able to access the debt markets at very reasonable prices.

So governance helps with your creditworthiness even if you don’t see any other purpose?

You can sleep better at night about the security of your assets and your earnings. Secondly you’ve got flexibility to do things and flexibility in financing. There are dark times when all the banks as we know in 2008 were withdrawing all their lines as fast as they could all the way round the world. If you put on top of that an Arab Spring, and you put on top of that a worry about what’s happening in the Middle East and Iran and so on and so forth. Then you can imagine if you said I am a Dubai property company and I’d like to borrow money, the answer was “get lost!”

What are the weakness in the Western system that you don’t want to draw on?

There are some areas where it’s easier to deal with substance over form. Take for example, some of the arbitrary rules the UK has about what constitutes independence. Some people are independent for five minutes, some people are independent for 20 years. There is a big differences with the UK, where generally you’re talking six to nine years for a non-executive and the US where it’s probably double that. In the Middle East where the mandate can sometimes change more rapidly depending on the individual and sometimes mean longer, depending on the contribution.

That’s quite a big difference. That’s one of the things where we have substance over form.

It’s easier to spend more of your time in the board on the relativity between the pure governance aspects and helping the business. You get to spend a bit more time on the strategic aspects rather than the pure governance. This is particularly the case – I’m probably not comparing like with like – but I look at my experience in highly regulated companies like financial institutions. The amount of time you actually spend on compliance is massive.

So it must be more interesting?

Yes, it is. That’s why we have people like Ian Davis in. We can really challenge and talk. We have three operating companies. We’re protecting the owner and that takes a certain amount of time. We’re trying to make sure the business is run well in accordance with the strategy. We want to test and challenge the strategy to make sure we’re getting the best out of the assets. And over the top we’re managing the financing of quite a big group now. In the meantime we’re taking input from very much on high from the owner whose got a position he never dreamed to have. This group has been going for only 18 years from scratch and it’s worth billions.

10 INTERVIEW WITH SIR MICHAEL RAKE


BOARDS OFSTATE OWnED EnTERPRISES

Why and how do boards of SOEs differ from other boards?

Boards are chosen by shareholders so that they supervise companies and make sure that strategic objectives of company owners are met. They also have to make sure of the integrity of information coming out of the company and that the company is paying enough attention to all of its stakeholders. Boards hence lie in the heart of corporate governance. This is evident when we look at codes of corporate governance as we see that boards take a big share of provisions covering aspects such as board composition, responsibilities, committees, remuneration, etc.

While the role that boards play and the way in which they function may be somehow straightforward in privately owned companies, it is quite different when the owner is the state. Then the whole system of how the board is chosen, how it functions, and even how it is assessed, is very different.

The Impact of Goal Difference

Boards serve to achieve the overall objective(s) of the company. Private sector companies are usually measured against the achievement of one ultimate goal: profits. This means that the main criteria the board uses in such companies to assess policies and courses of action is how such policies or actions will help the company to achieve sustainable profit. To ensure the sustainability of profits, boards in private companies do have to take non-financial considerations, such as reputation and stakeholder management, into account to maintain their license to operate, but usually these non-financial considerations serve to purpose of profit.

State Owned Enterprises, on the other hand, have multiple social, political, economic, and financial objectives. These objectives rarely carry the same weight. Priorities will differ from

12 ARTICLE BY DR. ASHRAF GAMAL EL DINCHIEF EXECUTIVE OFFICER

HAWKAMAH INSTITUTE FOR CORPORATE GOVERNANCE


time to time based on so many factors that we cannot cover here. What complicates things further is that in many cases these objectives conflict with one another. Focusing on social objectives will normally be at the expense of financial objectives and so on. Even when governments establish companies to achieve profits, political and social pressures usually make it impossible to focus on profits as the main objective. SOEs are sometimes used to create jobs for the unemployed, and sometimes for the unemployable, they are used to provide low price goods and services to the poor, or to prevent monopolies of some national resources or strategic goods, etc.

Oversight Challenge

The multiple conflicting objectives phenomenon has a direct impact on boards of SOEs. It makes their oversight role somehow ambiguous. On what basis can board members then assess strategic policies? Which objectives carry more weight than others now? Will there be changes in such weights in the near future?

Some of these companies will fall under political pressure to take certain decisions or to adopt certain policies that boards may not be able to refuse or even to examine freely or thoroughly. Examples include making certain investment or entering into joint ventures. less strategic examples include introducing certain new products or services, using certain inputs or specific suppliers, serving certain markets, or using specific pricing structures. In an ideal world, such decisions are proposed by the management and discussed by the board. While the board should hold the management accountable for the outcome of their policies, in the examples given above, this cannot happen. The question then becomes “to what extent can the financial performance, or even the overall performance, of the company be attributed to the management or to the board itself”?

Therefore, one of the recommendations of the SOE guidelines on CG released by the Organization for Economic Cooperation and Development, the OECD, is that the government must have a clear vision for its ownership. In other words each government must ask itself “why do we own this company”? The answer to that question will then be reflected on how the board can assess the policies and management of that specific company. The ownership objective is also used to evaluate the success or failure of the board. The OECD guidelines state that if the government is to use an SOE to achieve social or political objectives, this can happen with two conditions; it must be disclosed properly and the cost of doing so must be calculated and paid for by the government not by the company itself.

Director Independence & Fiduciary Responsibility

Another dilemma for SOE boards is independence and integrity. When shareholders elect the board, they make sure that the board understands the mandate of the company. The board is then left to do its job and is evaluated annually. In SOE boards, the board is usually appointed by politicians or by Ministers or by senior government officials. Many appointed directors are in fact themselves public servants coming from different government bodies. This exercise raises some concerns about board independence and whether SOE directors are loyal to the companies that they serve or to the executives and officials who appointed them there. If appointed directors are not qualified enough or if they lack the experience needed to be effective board members, then there is a possibility that they become “shadow directors”. In other words, if directors are not qualified enough or they do not have free decision making powers, it is actually the politicians and Ministers who are influencing board decisions. From the legal stand point,

13ARTICLE BY DR. ASHRAF GAMAL EL DINCHIEF EXECUTIVE OFFICERHAWKAMAH INSTITUTE FOR CORPORATE GOVERNANCE


however, it is the board that is liable for whatever decisions it makes.

It is therefore strongly recommended that there is a transparent way to nominate and choose directors of SOEs. This reduces chances of poor selection of board members. Qualified directors will understand their fiduciary responsibility and legal consequences of their decisions and could be more reluctant just to act as “shadow directors” of politicians and high ranking government officials.

SOE Boards and the Free Market MechanismsOne of the key challenges facing boards of SOEs is to oversee the company’s “Market Distortion” effects or to what extent are company policies compatible with the free market mechanisms. Such mechanisms aim to create market conditions that promote fair competition among companies operating in the same market. In many countries, depending on the laws f each country, SOEs can seriously damage the way in which markets function. This can take various forms. Sometimes SOEs have preferential treatment from banks, this may cause crowding-out effect for other companies in the market. Sometimes SOEs are immune against bankruptcy, so they can afford pricing levels that their competitors cannot afford. Another example of market distortion is when SOEs have a preferential treatment as suppliers to the government or to other SOEs. Therefore, SOE boards have to be careful in assessing the impact of their companies’ policies on the market as a whole and whether such policies will benefit the customers and will create a healthy environment for current and new comers or will it ruin the market.

Conclusion

The above are just examples of the key differences between being a director in a joint stock or a privately held company and an SOE. SOE board members often find

themselves on boards of companies that have many of the above long-existing problems and that have various explanations of why they existed and why they still exist. Once appointed as a board member, directors are expected to deal with all problems, even for chronic and long lived ones that existed long before you joined. long gone are the days during which SOE directorship was an honorary position or a prize for senior public servants. Political pressures accompanied by fiduciary responsibility should make one think carefully before agreeing to serve as a board member in an SOE.

14 ARTICLE BY DR. ASHRAF GAMAL EL DINCHIEF EXECUTIVE OFFICER

HAWKAMAH INSTITUTE FOR CORPORATE GOVERNANCE


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GETTInG THE COMPOSITIOn OF THE BOARD RIGHT

The case of nominee directors

A key issue in applied corporate governance concerns the composition and the duties of a board of directors in the presence of controlling shareholders and or powerful blockholders. The debate about independent directors, how to define them and what should they do, must be seen in this context. Much less has it seems been written about another class of director which are contractually or otherwise bound (de facto or de jure) to particular shareholders: “nominee directors” which are permitted in a number of jurisdictions. While there is a demand by some investors for nominee directors to secure their interests operational or otherwise, in a company, they sit uncomfortably with company law and corporate governance approaches and can therefore be problematic. This paper aims to address these issues.

Definition and role of nominee directors

A nominee director is one who is an agent of a principal and therefore follows their instructions. This may be established by a contract or by other means such as being an employee of the principal. A director appointed by a major shareholder and with close relations with the same might, in many jurisdictions, be regarded as a nominee director. A nominee director might also be established by a shareholders agreement that specifies the number of board positions that each shareholder may appoint. In some cases, it may arise from an agreement with a creditor or even with the labour force. In other cases, the role of the principal is not just to nominate a director for approval by the general meeting of shareholders, but actually the right to appoint someone directly to the board.

For example see Ferrarini and Filippelli, “Independent directors and controlling shareholders around the world”, ECGI law Working Paper,258/2014, 2014

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16 ARTICLE BY DR. GRANT KIRKPATRICKEDITORIAL BOARD MEMBERTHE HAWKAMAH JOURNAL


nominee directors serve the practical interests of investors in a number of different ways. venture capitalists might have an agreement allowing them to place their employees on the board of an investment to make sure that sight is not lost of an exit strategy. A subsidiary of a company group or joint venture will often involve directors being appointed by the partners or the parent company which is also their employer. Their interests might therefore range from major commercial decisions to operational issues such as dividing markets, use of technology and transfer pricing (i.e. intra firm prices). These are all legitimate commercial demands to guarantee an investor’s interests and the exercise of group control.

However, and more controversially, nominee directors are also used to ensure anonymity of the beneficial owner: the nominee director is usually not obliged to report whose interests they represent. Using nominee directors is also useful when establishing a company in a foreign jurisdiction which requires residents on the board, even from the moment of initial registration. But anonymity has a big role to play in hiding tax liabilities, facilitating money laundering and securing terrorist financing. This article focuses on the corporate governance aspects including corporate law.

How do they help or hinder corporate governance?

It is axiomatic for corporate governance arrangements that the board of a company has a key oversight and control role to play and this is mostly reflected in company law and jurisprudence. Thus company law often specifies fiduciary duties of board members towards the company, and especially a duty

of loyalty. Most important of all, boards are treated as a collective body with a duty to the company as a whole and not just one stakeholder such as a major shareholder or even a labour union. The duty of loyalty is here crucial for it requires directors to avoid conflicts of interest and to make independent judgements.

Nominee directors are clearly in a difficult position and have been described as being between the “devil and the deep blue sea” or “between a rock and a hard place”. A nominee director following the instructions or interests of their principal may not be taking decisions in favour of the company as a whole. Being in breach of their fiduciary (or director) duties might make them liable for damages. An obvious solution might be for the director to recuse themselves from any decisions involving a conflict of interest. It might well be asked in this case, what is the purpose of having a nominee director and how long they might be so employed if they avoided the needs of their principal?

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The issue is often not nominee directors per se but the ability to conceal beneficial ownership through shell companies. The abuse of corporate vehicles is a major concern of the OECD and the G20. See The Abuse of Corporate vehicles, OECD, 2001Historically this was often not the case, as in the US up till around 1980 and in Germany with the supervisory board having limited powers up till the last 20 years. The new UK company law goes further specifying the duty to promote the success of a company.

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Nominee directors are clearly in a difficult position and have been described as being between the “devil and the deep blue sea” or “between a rock and a hard place”.

17ARTICLE BY DR. GRANT KIRKPATRICKEDITORIAL BOARD MEMBERTHE HAWKAMAH JOURNAL


Proposed solutions

Most accept the legitimate need for nominee directors, but there are arguments by some that the contradiction with the law and jurisprudence needs to be settled more formally. One author analyses the issues in common law jurisdictions by proposing a working taxonomy for categorisation of disparate judicial approaches on nominee directors in the common law world: an absolutist approach, a corporate primacy approach and an attenuated duty approach. However, once one starts by attenuating the law, it is a slippery slope.

She concludes that “ while courts have acknowledged the reality of nominee directors giving some consideration to the interests of their appointers, in the absence of specific legislative intervention the preponderance of judicial opinion lies in favour of this only being possible where any action taken does not impinge on the interests of the company” (page 145).

A pragmatic solution might be to balance nominee directors with further “independent” directors. But this solution does entail loosening the duty of the board as a whole and will split the boards. Moreover, it still begs the question how the principal will achieve their objectives.

Some jurisdictions have dealt with the issue by establishing a fiduciary duty of major shareholders (i.e. those normally using nominee directors) towards other shareholders

(i.e. Germany, Israel) in subsidiary companies. Thus instructions to nominee directors to take measures not in the interest of the company, would involve potential compensation to injured shareholders and perhaps to other stakeholders.

Some jurisdictions take a slightly different approach by providing courts and investors with the concept of “shadow directors” which would be liable for decisions not in the interest of the company. They thus lift the veil of the nominee director to hold the principle liable. Fine legal interpretations are necessary to enforce and interpret such a concept.

One approach more in the civil law tradition addresses the issue of corporate control in company groups and is particularly important in dealing with the control of related party transactions, an important area for conflicts of interest. It involves a controlled company documenting the losses suffered as a result of its relations with another controlling company. The board of the investee company accepts responsibility for net loses arising from the relationship (Italy, Germany, Portugal, and Turkey). In France and Belgium, a company can take decisions in the interests of another company if there is a close economic relationship between them (the so called Rozenblum doctrine) . This would appear to give cover to nominee directors working for the interests of another company, albeit shifting liability toward the board of that company.

D. Ahern, 2011, “ nominee directors duty to promote the success of the company: Commercial pragmatism and legal orthodoxy”, Law Quarterly Review, 127For a discussion see nominee Directors in Australia: Guidelines, and Duties of Employees who are appointed or nominated as a Director of a Company in Australia, Baker McKenzieSee Kirkpatrick et al, Related party transactions and minority shareholder rights, OECD, 2012 However, there must be close economic relations between the companies and the courts have established demanding criteria to prove the case. See op cit for discussion of Belgium and France.Germany goes further than most others in defining two types of company group. The implicit group can result from contracts of one company with the management board of another, which results in operational control. Under German law, management boards have quite a deal of independence from the supervisory board that is excluded from day to day operational decisions.

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18 ARTICLE BY DR. GRANT KIRKPATRICKEDITORIAL BOARD MEMBERTHE HAWKAMAH JOURNAL


One solution that is proposed especially in the US is to modify company law along contractarian lines. Company law is seen as setting broad principles that are applicable as default rules that can be overridden by the constitution of a company. Thus two or more shareholders could agree in the articles of association to appoint their own nominee directors to the board. There would thus be no conflict with corporate law. However, Prof Ahern argues persuasively that the contractarian approach is not suitable where there are many stakeholders. There is thus a case for company law not just establishing minimum default settings, which can be easily set aside, but something more mandatory.

Conclusions

The debate over independent directors to manage conflicts of interests on a board and to ensure board objectivity has raised a number of questions about the role of major shareholders. Outside of the US and the UK, most companies around the world have a

major or controlling shareholder. However, attention also needs to be given to those cases where a director is bound either legally, or by way of employment status: nominee directors. There appears to be strong demand by investors for such directors both in civil law and common law jurisdictions.

Some methods that might be considered subject to the prevailing corporate law system include explicit consideration of company groups and introducing the concept of shadow directors into company law. Another route would be to establish more clearly a fiduciary duty of major shareholders towards other investors in group companies.

19ARTICLE BY DR. GRANT KIRKPATRICKEDITORIAL BOARD MEMBERTHE HAWKAMAH JOURNAL


20 ARTICLE BY FRANK E. DANGEARDMANAGING PARTNER

HARCOURT

“InDEPEnDEnT” nOMInEEDIRECTORS In

InTERnATIOnAl GROUPS

Most international groups have subsidiaries or affiliates with local partners or shareholders. This may be as a consequence of regulations prohibiting majority ownership by a foreign company, or because the local business was bought from local entrepreneurs who have kept an interest, or because raising capital locally makes financial sense.

The governance of these subsidiaries or affiliates raises serious issues, which wholly owned activities do not have to the same extent.

First the international group must deal with the presence of outside directors on the local board, either representatives of the local partner(s) or, if the business is listed on a local exchange, independent directors from

the region. Second, the local business will often have to publish accounts, or at least provide full transparency on numbers to the local partners. This translates into a set of accounts and disclosure that wholly owned activities do not generally need to provide. Third, and this is particularly true if listed on an exchange, the board of the local business will have to act in the interest of the business itself, rather than simply on behalf of the main shareholder.

In the event of tension between the local interests and those of the international group, good governance becomes essential in order to find ways forward that preserve the interests of all parties. It is also in these situations that weak governance reveals itself, with compromise solutions being


negotiated outside the forum provided by board meetings, or the situation breaking into outright conflict.

One of the reasons why the boards of these businesses fail to play their role is that their composition is flawed.

The international group rarely sends as directors the group CEO himself or herself, or a member of the Executive Committee, simply because these people do not have the time. The job is often delegated to lower-level employees, for example those responsible for the country or the business area. They are competent, know the local market and business environment, and work hard to deal with the issues arising between partners or those that are brought up to the board.

But they seldom have real board experience, and are not really considered as worthy interlocutors by the local directors or the shareholders they represent, who themselves are often highly successful and wealthy business people. In addition, it is difficult for the directors representing the international group to put the issue in the broader perspective of the group’s overall interests in the region and worldwide, or the sector and industry, rather than the local country or the narrower business area. It is also difficult for them to argue internally that the position they are asked to defend is neither realistic nor fair – they are, after all, subordinates.

As a result of this “disconnect”, I have seen – both as CEO and as board member of large international groups with multiple local businesses – conflict situations spiral out of control. In some cases, the group CEO was brought in on time to put things back on track, in others the conflict was beyond repair.

I have experienced successfully with one partial solution to this governance problem: the appointment of “independent” directors

on the contingent of board seats reserved for the international group. These people must be independent, trusted by the group in question, and have self-standing authority and gravitas - for example ex-senior employees or independent business people the group has had contacts with, and who have a number of board positions elsewhere.

Of course, people who accept such a position need to recognize that they are representatives of the international group on the local board, and act as such. But they are experienced directors, used to dealing with conflicts at board level. They will put forward the group’s position with authority and empathy. Whilst clearly representing the international group, and bound to argue in its interest, they are not subordinates and will not hesitate to discuss internally with group executives a position they find too extreme or unlikely to succeed locally.

Probably even more important, they will be seen by local board members as both representing the international group and also “independent” directors in their own right. The local directors will open up more easily to them, and will often channel through them constructive compromise position. In other words, good directors in that position end up being trusted, or at least taken seriously, by all sides.

Obviously not every conflict can be resolved in such a way that the business can carry on without a fundamental restructuring of the shareholding positions. But I have found the appointment of independent directors on the contingent of board seats allotted to my own groups very useful in maintaining good governance and helping solve crisis situations in local subsidiaries and affiliates.

21ARTICLE BY FRANK E. DANGEARDMANAGING PARTNERHARCOURT


nOMInEE DIRECTORFRAMEWORK

Conflicts of interest faced by Nominee Directors continues to be a topic of much discussion in many Boards. Most Boards tend to believe that the conflicts arise due to the potential for biased decision making, the sharing of information between parent and subsidiary in an uncontrolled manner, a high degree of government ownership which impacts on strategy and funding, and where shareholders own multiple competing interests. Conversely, nominee Directors are becoming more vigilant as to how they should actually, and be seen to, balance the competing interests between their duty of loyalty to the company on whose Board they sit, and the nature of their appointment and expectations of the appointing shareholder. These concerns are being highlighted during annual Board evaluations in addition to ad hoc situations which arise during normal Board discourse.

To date there has been fragmented guidance by regulators and standard setters on a complete set of documents which efficiently lay out the protocol of behavior and responsibilities. However, in practice much the same framework can be adopted regardless as to whether the nominee Director is a group executives being nominated to subsidiary/operational companies, a private equity nominee, or a nominee from major shareholders such as governments or family holdings.

Whilst most Corporate Governance Codes tend to focus on the establishment of policies and the disclosure and/or avoidance of conflicts (including the new Basel Committee Proposals released 14 October 2014), the entire nominee Director relationship is best served using a set of documents agreed

by various parties, primarily because the nominees lie within a small web of relationships that do not fully interconnect.

The most critical documents are the Nomination/Consent letter between the Appointor/Appointee, the Service Contract issued by the Company, and the Nominee Director policy approved by the Board. These may be supplemented by formal Investor Policies (as recommended by the OECD for State Owned Enterprises, or Private Equity/Institutional Investors as per their Stewardship or industry Codes) and reserved powers in the Articles and Shareholders Agreements. In practice, nominee Director protocol is rarely captured or committed to formally in writing, despite nominee Directors being extremely common in the Middle East. Each situation tends to be unique and require its own format and protocol.

It is necessary to consider nominee Director issues from a range of perspectives. (note: For this article, we do not consider wholly owned subsidiaries who may, in some jurisdictions, adopt legal provisions in their Articles which allow protection against sub-optimal decision making in favour of the whole group.)

Director duties at law

It is well established in law that all Directors owe a fiduciary duty, a duty of loyalty and a duty to avoid conflicts. Courts in common law jurisdictions tend to apply a strict liability to act for the benefit of the company, regardless of the Appointor’s interests or the fairness of the outcome to the overall group. The UK case of Hawkes v Cuddy (2007 and 2009 on appeal) noted that a nominee director is permitted to have regard to the interests of

22 ARTICLE BY SHARON DITCHBURNMANAGING PARTNERCAPITAL ADVANTAGE


his appointer, but only to the extent that those interests are not incompatible with his duty to act in the best interests of the company. Peoples Department Stores v Wise (2004, Canada) held that nominee directors are not strictly agents of their nominators. The recent Australian case Allco Funds Management (2014) again confirmed that director’s conflicts of interest must be dealt with strictly, and decisions need to be bona fide, in the best interests of the company and for a proper purpose. It is extremely rare to hear of breach of Director duty cases in the GCC, but we would expect that it is likely that a similar approach would be adopted.

Nominee Director Appointment

Appointment generally falls into two categories – (a) “arms length” nomination of a person with little or no connection to the Appointor and usually made on the basis of skill and experience, or (b) a “close associate” or employee of the Appointor with or without consideration of adding value to the Board. Regardless of the type of nominee, they should formally consent to their appointment, although general advance consent to nomination may be included in employment contract. Consent lies between the nominee, the Appointor, and in some cases, the regulator. nomination/Consent letters confirm the degree of communication and the nominee’s ability to apply independent judgment, but should avoid contractually obligating their nominee into an agency relationship (where the Appointor would have a right to sue under contract if the nominee fails to follow directions). The risk of including agency provisions could also inadvertently involve the Appointor as a shadow director, which in some countries such as the UK, applies the same duties of care and liability to the Appointor and removes their general right to act in their own interests no matter how unfair they may be to the Company.

All nominees should sign a Director Appointment letter issued by the Company, ideally signed by the Board Chairman, which sets out the duties, appointment term, location for performance, remuneration, appraisal and reporting lines. It is usually a template document signed by all non-executive Directors and the Company. It is rare that specific nominee director issues are included in this, except for binding Directors to have regard to applicable policies. The Appointor is not normally a party to this agreement.

The arms length nominee usually has a lower loyalty level to the Appointor and in some cases rarely interacts or communicates with their Appointor. As a small degree of bias remains, a relatively simple nomination/Consent letter can confirm the manner of communication and their ability to apply independent judgment, but should avoid contractually obligating their nominee into an agency relationship (where the Appointor would have a right to sue under contract if the nominee fails to follow directions). A light to moderate nominee Company Policy could suffice where only arms length nominees are appointed.

The close associate has the greater degree of conflict, particularly when they also have an employment contract with their Appointor or Group entity. A more comprehensive set of documents would apply:

• A shareholders’ agreement between the Appointor and the Company provides consensus on the process and criteria for appointment, dealing with information sharing and certain decision making protocols, although it would not normally define the conflicts.

• A corporate Appointor adopting good stewardship practices may have developed an Investor Policy which sets out its selection, expectations and treatment of nominees,

23ARTICLE BY SHARON DITCHBURNMANAGING PARTNERCAPITAL ADVANTAGE


although this is generally a unilateral document with little room for negotiation by the Company.

• A very comprehensive nominee policy approved by the Company Board (see below).

• Standard employment contracts with a right to nominate, avoiding agency provisions, and additional appraisal terms.

• The Appointment Letter may have different remuneration clauses (usually nil for Group employees).

• Group nominee director policy.

Nominee Director Policy

This Policy is most comprehensive document, describing the full process of nomination, appointment, duties, disclosure of instructions and conflicts, behavior and decision making, lines of enquiry, acceptable reporting, appraisal and rotation/removal of nominees. They often incorporate a mirror statement to the Investor Policies of Appointors or Group policies using aligned language.

It is logical to break the policy into parts dealing with appointment/removal, communication with Appointors (whether formally or through the nominee), behavior and decision making within the Company (including treatment of conflicts), and communication within Group entities. The proposed Basel Committee Guidelines provide useful guidance on the elements to be included.

Policy approval by the Board of the Company ensures that nominees and management have input into practical considerations, which should be balanced by the views of independent directors. In addition to providing input to the nomination process, the nomination Committee at Group and/or Company level should have responsibility

for monitoring conflicts, appraising behavior and outcomes, and reviewing the policy and associated documents.

Where the nominee is simultaneously performing functional Group roles, the policy should cover decision making and reporting lines which account for their functional area responsibilities. The Group policy is usually developed at Appointor level and mandated throughout closely held groups, with a degree of adoption by the subsidiary Company. In particular, Group nominees should restrain their reporting to functional information on a consolidated or segment basis, i.e., for the benefit of the Group decision making, and should leave governance reporting responsibility to the Appointor to the Chairman or CEO of the Company.

Typologies of common conflict situations and tables clearly indicating responsibility for a range of matters are extremely useful in practice, such as when nominees believe that important information is not being escalated appropriately or timely.

As with most corporate governance good practices, nominees and the Company should aim for a principle led and risk based approach, exercising a degree of compliance with agreed standards and protocols, but retaining a constant vigilance and flexibility for new or evolving situations which give rise to conflicts.

24 ARTICLE BY SHARON DITCHBURNMANAGING PARTNERCAPITAL ADVANTAGE


IMAGINE A BANK

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Imagine a bank without risky sovereign debt or toxic assets on its balance sheet.

Imagine a bank whose owners have steered a course through over 40 financial crises.

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Welcome to Lombard Odier.

Geneva · Amsterdam · Bermuda · Brussels · Dubai · Frankfurt · Fribourg · Gibraltar · Hong Kong · Lausanne · London Lugano · Luxembourg · Madrid · Milan · Montreal · Moscow · Nassau · Panama · Paris · Singapore · Tokyo · Vevey · ZurichBank Lombard Odier & Co Ltd - Representative Office Dubai Dubai Representative Office supervised by the UAE Central Bank The Fairmont, 25th Floor · Sheikh Zayed Road · P.O. Box 212240 · Dubai, UAE Telephone +971 4 509 0111 · Facsimile +971 4 509 0222 · [email protected]

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LO_BankMidEast_ImgEN_210x270.indd 1 20.03.14 15:21bleed guide.indd 1 10/13/14 2:08 PM

THE “nEW nORMAl” In BAnK GOvERnAnCE

The 2007-8 international banking crisis uncovered long-simmering weaknesses in the structure, strategy and governance of global banks. Far from a solitary annus horribilis, the subprime crisis proved to be the beginning of a series, with the Greek/Euro crisis of 2010-12 and the on-going scandals of rate manipulation and compliance failures following close on its heels.

The eye of the cyclone being the western financial system, MENA banks were mostly--but not completely-- spared. Their conservative balance sheets and “old school”, Basel I regulatory rules proved to be a lifesaver against the global tsunami. nevertheless, MEnA banks will suffer a lot of the consequences of the upheaval. This is a global industry with active international counterparties, investors

and clients. Regulators are sophisticated and well organised in international fora and networks, facilitating the development and implementation of global standards. MEnA banks are therefore sooner or later bound to become part of the emerging “new normal” in conducting their business and organising their governance. new regulation at international (Basel Committee on Banking Supervision-BCBS) and national level has already brought forth key changes that directly address the causes of the crisis: capital requirements have been significantly raised, a leverage “backstop” was introduced to stop banks from manipulating their risk weighted assets (RWAs) and liquidity considerations came into the Basel picture. More onerous requirements in

...and some thoughts on its impact on MENA banks

26 ARTICLE BY STILPON NESTORMANAGING DIRECTOR

NESTOR ADVISORS


these areas were imposed on “systemically important financial institutions” (SIFIs). Regulators on both sides of the Atlantic require banks to develop detailed, realistic recovery and resolution plans; and they are being quite tough with their implementation: US supervisors have sent the majority of SIFI “living wills” back to the drawing board while some US banks have created special resolution plan committees at board level.

Overall, these requirements make it less attractive for institutions to keep growing their balance sheets in ways that put the whole banking system at risk. Of course, one of the key goals of all this effort is to banish “too big to fail”. In other words, smaller institutions (and balance sheets) constitute a key aspirational element of the “new normal”. Some of the largest OECD economies have witnessed important regulatory efforts to keep banks from engaging in certain activities or, alternatively, to “ring fence” activities that are “systemic” (e.g. retail banking).

Another important aspect of the “new normal” is the way regulators view governance arrangements within individual banks. A radical shift occurred in this area. Past approaches ranged from completely indifferent to “light touch”. A supervisory “heavy hand” is currently replacing these approaches, spearheaded by G20 jurisdictions and the BCBS which significantly include KSA. Within the revamped Basel Pillar 2 mandate, supervisors have placed governance at the centre of both on-site and off-site supervision of the banks. In more active supervisors, substantive norms on governance have been developed, of a detail and scope unimaginable five years ago. let us take a quick look at the most important areas:

a. Remuneration: Compensation was never perceived to be a very important issue for MEnA banks-- probably rightly so. Close involvement of private or government shareholders ensured that agency problems were never acute in this part of the world. But in the west, the principal-agent relationship between shareholders and management is intermediated by share price and “independent” boards. If one believes that the alignment of these “abstract” shareholders with management in the relentless pursuit of shareholder value is good corporate governance, the banking crisis might be seen as too much of a good thing.

Big failures in the remuneration area became systemic risks and, eventually, important drivers of the global crisis, making remuneration a key focus of global regulators. The enormous remuneration packages, averaging an annual total of EUR 5,617,944 for a European top-25 bank CEO in 2007 (and much higher for their US counterparts), were largely composed of variable remuneration. Return on equity (ROE) was by far the most popular metric used. ROE is an indicator highly sensitive to leverage. It should therefore come as no surprise that ROEs of more than 20% observed in the noughties were, to a large extent, the result of excessively levering the balance sheet.

Within the same European bank group, variable remuneration packages also had relatively short term vesting horizons. Bankers could make risky bets today and watch their institutions fail “from afar”, having already pocketed the gains.

All of this is now changing. The “new normal”, mandated by major regulators on the basis of FSB guidelines, wants a significant proportion

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Sorkin, Andrew. Too big to fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System--and Themselves new York: viking Press 2009ladipo D. & nestor, S, Bank Boards and the Financial Crisis: A corporate governance study of the 25 largest European banks. london: nestor Advisors, May 2009

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of variable remuneration (at least 40% in the EU ) to be deferred and paid out over a period of three to five years in the future. Current proposals in the UK would take this period to an astonishing seven years for senior managers. Regulators want variable remuneration to be “at risk” and be “clawed back” if pay-outs were based on false assumptions. And board remuneration committees, now mandatory for all large banks, are responsible for setting the quantum of the remuneration for a significant number of “risk takers” within the organisation.

Interestingly, our research at nestor Advisors suggests that the CEOs of some of the best-performing large European banks received little variable remuneration. Among the three Swedish banks that come at the top of our three-year performance ranking none has a bonus scheme . Moreover, the Swedish bank boards that approve variable pay would typically tie it not to individual but collective performance, and pay it out to bank employees in a fairly egalitarian way, deferred well into the future.

b. Risk governance, controls (and culture): The absence of risk management “ownership” by bank boards was identified as another proximate cause of the crisis and of various conduct failures. Regulators on both sides of the Atlantic now require bank boards to constitute stand-alone risk committees

(BRCs) made up exclusively of non-executive directors. In Europe, this is the case in 13 of the top-25 banks compared to 5 in 2007. In the US, SIFIs are now required to have risk committees with extensive responsibilities. Some of the largest banks that failed during the crisis did not have risk committees (Bear Stearns); or, in the banks that did have them, the committees met only rarely (lehman Brothers).

Rules have also been established to ensure the seniority, competence and authority of the risk management function, and its head, the Chief Risk Officer (CRO) – what we at Nestor Advisors call CRO “gravitas” , and to place the responsibility for maintaining the adequacy of the function squarely on the board and its risk committee . As a result, all CROs are today members of executive committees, while in 2007 only 20 were sitting in ExComs in the top-25 European banks.

Most importantly, bank boards and their risk committees now have the responsibility for setting the risk appetite, i.e. the amount of risk the bank is willing to take in order to fulfil its business objectives. In most banks, boards were the active setter and “owner” of high-level quantitative boundaries on risk taking . They were not used to such a rigorous, top–down process. In the best of cases, they perceived their responsibility to

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Directive 2010/76/EU Annex I - note also that the CRD Iv limits the amount of annual variable remuneration to a maximum of two times fixed pay following explicit shareholder approval (Directive 2013/36/EU (CRD IV), Article 94), European Union, http://eur-lex.europa.eu/legal-content/En/TxT/?uri=CElEx:32010l0076PRA CP15/14/FCA CP14/14, Strengthening the alignment of risk and reward: the new remuneration rules Prudential Regulation Authority, Bank of England, July 2014, http://www.bankofengland.co.uk/pra/Pages/publications/cp/2014/cp1514.aspx nestor Advisors, Cultural revolution: culture and corporate governance in the largest 25 European banks london: nestor Advisors, (forthcoming December 2014)Directive 2013/36/EU (CRD Iv), Article 76, http://ec.europa.eu/internal_market/bank/regcapital/legislation-in-force/index_en.htm & US Federal Reserve System, Enhanced Prudential Standards for Bank Holding Companies and Foreign Banking Organizations; Final Rule, March 2014, http://www.gpo.gov/fdsys/pkg/FR-2014-03-27/pdf/2014-05699.pdfLawton C. & Nestor S., Bank boards after the flood: The changing governance of the 25 largest European banks, london: nestor Advisors, October 2010 & IIF, Governance for strengthened risk management, Washington, DC: Institute of International Finance, October 2012See for example Directive 2013/36/EU (CRD Iv), Article 76.FSB, “Principles for an effective risk appetite framework”, Basel: Financial Stability Board, november 2013

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be limited to the oversight of the bank’s risk profile as it developed from the bottom up. now, in addition to setting the risk appetite, regulators also want boards to own and approve the internal capital and liquidity adequacy assessment processes (ICAAP, IlAAP). These are highly technical exercises requiring an advanced understanding of the business of banking.

In these areas, many MEnA regulators have been quite active in adopting norms similar to global standards. For example, the Saudi Arabian Monetary Authority requires boards in SIFIs to approve a risk appetite statement as well as ICAAP, to form risk committees and to have independent risk functions.

And then there is risk culture…

Banking (and risk) culture: In a recent interview, Archbishop Welby, a member of the UK Parliament’s Commission on Banking Standards, quoted Peter Drucker to remind us that “when it comes to banking, culture eats regulation for breakfast every morning”. Welby is referring to an astonishing number of conduct failures among global banks which has led to a barrage of sanctions by regulators. BnP Paribas settled for USD 8.9 billion to federal and state government agencies while agreed to pay USD 16.6 million in the context of a settlement with OFAC. Irrespective of the sometimes legally dubious reasoning behind these sanctions, most banks have not dared challenge them--and for good reason. The trust of their clients and the public at large is at such a low point that self-righteousness would only make matters worse.

Welby is also alluding to the misguided view that regulation alone can fix all that. It cannot…but it is certainly trying! The draft guidance of the European Banking Authority (EBA) on the new Supervisory Review Process (SREP) requires supervisors to “encompass the assessment of banking and risk culture” in their already quite extensive on-site assessment of banks’ “internal governance” . The Institute of International Finance (IIF), the industry’s global think tank/lobby, asks banks to regularly self-assess their “risk culture” , the key “indicators” of which are : tone at the top, accountability, effective communication and challenge; and incentives.

At nestor Advisors, we view culture as “process over time”, i.e. the main accepted paths that the members of an organisation follow in order to accomplish their tasks—crucially including conducts and behaviours. Such similarities in behaviour can emerge only over time—it is not enough to mandate change, you have to live it. “Process over time” can only reflect the (real, as opposed to website) values that members of an organisation hold dear. It also encompasses views (and expectations as to other members’ views) on the firm’s identity, continuity and relationship with clients.

The subject of culture is too complex to be further discussed within the scope of this brief paper. Suffice it here to make two key points:

i. While culture is “real” and important, it can only be changed by targeting specific incentives, policies and conducts which impact on “the way we do things”. This targeting must be sustained and consistent over a period of time. Thus, while boards

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Financial Times 11/10/2014, http://www.ft.com/cms/s/0/6b91b4fc-506b-11e4-8645-00144feab7de.html?siteedition=uk#axzz3GOmx4Pm7EBA/CP/2014/14, July 2014, https://www.eba.europa.eu/documents/10180/748829/EBA-CP-2014-14+(CP+on+draft+SREP+Guidelines).pdfIIF, Risk Culture, “Reform in the financial services industry: Strengthening practices for a more stable system”, December 2009FSB, “Guidance on supervisory interaction with financial institutions on risk culture: A framework for assessing risk culture”, April 2014, http://www.financialstabilityboard.org/publications/140407.htm

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need to regularly review the banking and risk culture of the organisation, cultural change as such can only be achieved by setting specific policy, incentive or conduct change objectives.

ii. There is such a thing as a “bad” culture which is more or less what regulators are trying to target. However, the opposite is not true. It is counterproductive for boards to aim for a universally “good” culture. Each institution has its own history of developing its business and dealing with its environment. Some are more individualistic than others; in some, the way people and products evolve is slower and more “embedded”, while in others constant change is “part of the DnA”. Finding the language to recognise these differences is important but targeting an “ideal” culture might risk “throwing the baby with the bathwater”.

c. Board composition and effectiveness: Other areas claiming supervisory attention in the “new normal” are board nomination, composition and effectiveness. Previously these were subject to “softer” capital markets regulation, such as CG Codes. But this is rapidly changing via mandatory banking regulation.

Contrary to the spirit of most European company laws and continental traditions, the board of a bank is now expected to be responsible for its own composition and has a central, explicit role in the nomination process. large banks are required to have nomination committees who are expected to maintain an active interest in the board’s composition needs and actively plan nED and executive

succession. There is a minimum content of independent directors required in order to populate audit, nomination and remuneration committees while non-executives are required not to sit on too many other boards so that they may effectively discharge their ever increasing responsibilities, as discussed above .

Boards are also required to maintain a watchful eye on their own collective effectiveness and engage in annual evaluations whose adequacy will be checked by supervisors. Most importantly, supervisors are taking an active stance as regards the individual suitability of board directors and of other key function holders. In contrast to a fairly perfunctory “Cv” approach on classic fit and proper elements (reputation, criminal record, absence of bankruptcy etc.), supervisors are now directly interviewing and authorising board members. Also, they are ready to hold boards (and their nomination committees) accountable for not having done their homework in vetting individual fit-and-proper and competence. Board members’ contribution of knowledge, skills and experience is expected to become an integral part of annual board reviews. In the UK, supervisors are proposing a double track regime: approval for the board members and most senior managers heading key functions (e.g. CEO, CFO, CRO etc.); and a self-administered certification regime for lower level managers, a system whose robustness is subject to supervisory review .

Currently, MEnA bank boards are essentially composed of shareholder representatives with limited banking experience and way too many other engagements. This might

Power M., Ashby S., Palermo T., Risk culture in financial organisations, London: London School of Economics, 2012, http://www.lse.ac.uk/researchandexpertise/units/carr/pdf/final-risk-culture-report.pdfEBA, Guidelines on Internal Governance (Gl44), September 2011, http://www.eba.europa.eu/documents/10180/103861/EBA-BS-2011-116-final-EBA-Guidelines-on-Internal-Governance-(2)_1.pdfDirective 2013/36/EU (CRD Iv), Article 91Idem at Article 88FCA CP14/13/PRA CP14/14, Strengthening accountability in banking: a new regulatory framework for individuals, July 2014, http://www.fca.org.uk/static/documents/consultation-papers/cp14-13.pdf

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sit awkwardly with the “new normal” emphasis on board expertise and increasing responsibilities. Moreover, shareholder dominated “constituency” boards will have trouble meeting the emerging requirement of board responsibility for nominations, discussed above.

What does all this mean for the future of banking institutions and their boards? How will they look a few years from now?

On the composition front, the emphasis is moving from “idle” independence (based on historic, general corporate governance standards) towards competence. As a result, bank boards are becoming more and more “professional” and hands-on. The need for expertise combined with the increasing legal liability of bank directors result in the significant limitation of the pool of available board members.

Significantly more hands-on boards might mean less “independent” boards, at least in the traditional sense of completely disinterested

outsiders sitting as non-executive directors (nEDs). The example of Santander, one of the most successful European banks during and after the crisis, is interesting in this respect. The Santander board asks its nEDs to work quite hard: in 2013 its BRC met 97 times while its AC met 12 times. The board is quite large because it has a significant number of executives. But these “additional” executive directors (i.e. in addition to the CEO and CFO who are “standard” members in many unitary bank boards) are not the traditional heads of businesses who usually sit on other boards with significant executive presence. They are rather “roaming” executives with very broad portfolios and oversight responsibilities. For example, the “CRO” is not the head of the risk function but its overseer, and also the overseer of liquidity management. The executive chairman can sit in most executive committees but does not run the bank; idem for the director who heads strategy. In effect, the distinction between nEDs and executive directors is quite blurred.

All of the above might result in bank boards becoming smaller and more hard working—neither of which is a bad thing. Our own findings suggest that this has already started happening: from a median board size of 15 in 2007 bank boards have steadily, albeit modestly, come down to 14 in 2013 . In MEnA, boards are already quite small: our in-house research indicates that median board size in MEnA is 11. Ironically, they might need to become larger as a result of a “double whammy”: (a) outside pressure for more expertise, more diversity and a heavier workload (b) internal opposition in removing non-expert shareholder representatives from the board.

Regulatory pressure is also resulting in the significant centralisation of control functions. In the “new normal”, risk management, finance, compliance and internal audit are

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“In the “new normal”, risk management, finance, compliance and internal audit are increasingly independent from management. They report directly to the board and are slowly being transformed into quasi-agents of the supervisor. Perversely, this might result in worse, not better, controls: it might significantly weaken the authority of top management to effectively run the bank and to get timely, adequate information. It is likely that, in the “new normal”, management might need to build parallel control channels.”



increasingly independent from management. They report directly to the board and are slowly being transformed into quasi-agents of the supervisor. Perversely, this might result in worse, not better, controls: it might significantly weaken the authority of top management to effectively run the bank and to get timely, adequate information. It is likely that, in the “new normal”, management might need to build parallel control channels. As nassim Taleb points out , such redundancy and duplication in the control systems might actually be beneficial. But it is expensive at a time where profit generation is key, both in terms of increasing the appeal of banks to equity investors and in maintaining adequate capital adequacy.

In fact, it is quite worrying that compliance costs (including control centralisation) and exponentially increasing regulatory complexity set the bar for banks quite high in terms of size and scale. Only large institutions will be in a position to effectively respond to regulatory requirements. While regulators struggle to banish too-big-to fail, they are also pushing banks to become bigger. Moreover, Haldane and others point out that the mind-boggling levels of complexity in bank regulation might have unintended consequences. Rigid, detailed regulatory templates might “blind” boards and executives to big emerging risks, especially of the “fat tail” variety. A highly prescriptive and monolithic approach in identifying, reporting and managing risk might crowd out alternative views and dampen challenge, this much sought after cultural “good”. One could be forgiven in viewing Basel as a “Stalinist” regime of sorts.

Whether problematic or not, MEnA banks will have to move closer to emerging “new normal” governance standards. If they are found to significantly diverge they might face

non-trivial costs, especially as they seek capital and funding through the wholesale markets. Rating agencies, the gatekeepers of these markets, are becoming more and more vigilant on governance issues. Here are three important challenges that MEnA boards might face and some potential solutions:

i. The need for fewer “outside” engagements of individual directors might be met by the appointment of more independent outsiders, trusted but not directly accountable to shareholders. Potentially, more executives might also need to populate boards—maybe of the Santander variety.

ii. The need for more effective, knowledgeable boards should translate into more in-depth, regular board evaluations and on-going director development programmes. It might also drive more engagement in planning board and top management succession through tailored nomination policies and procedures;

iii. The need for a more effective control environment and top-down governance by the board might be met through regular outside revues of corporate and risk governance. In their turn, these might drive the explicit “ownership” of values by the board.

One thing is sure: the pre-crisis days of unbridled bank expansion and “black box” corporate governance are not coming back in the foreseeable future. The “new normal” is here to stay.

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Taleb, nassim. Antifragile: Things that gain from disorder. new York: Random House, november 2012Haldane G. Andrew. The dog and the Frisbee, Speech, Bank of England, August 2012, http://www.bankofengland.co.uk/publications/Documents/speeches/2012/speech596.pdf

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EvOlvInG THE ROlE OF THE COMPAnY DIRECTOR

More than ever, investors value the role that directors play in ensuring companies are well governed and act in the long-term interests of their shareholders. However, today’s rapidly changing environment means both shareholders and directors have to adapt continually. Building strong relationships between the two parties is an essential prerequisite for success, argues Amra Balic, head of corporate governance and responsible investing for Europe, the Middle East and Africa at BlackRock. This article provides an inside view on a global investor’s expectations on boards.

An evolving role

The role of board director is a key position from the shareholder’s perspective. Shareholders rely on directors to represent their interests and the right to nominate directors is a crucial element in the protection of shareholders’ interests. Over the last decade, the importance of the role has continued to increase. The financial crisis and the rise of real time and social media mean that shareholders now require more regular engagement with board members. This presents a notable change as, traditionally, many boards of directors tended to communicate with shareholders only

33ARTICLE BY AMRA BALICHEAD OF CORPORATE GOVERNANCE AND RESPONSIBLE INVESTING FOR EMEABLACKROCK

FOR PROFESSIONAL INVESTORS ONLY


annually at shareholder meetings. While this requirement for greater accountability and pro-active engagement with shareholders may vary from market to market, it is only a matter of degree. Globally, the direction of travel is clear: shareholders are looking to establish better understanding and constructive relationships with individual directors and the wider board.

We view the changing and growing role of directors as a highly positive development. However, we recognise that it further increases the already substantial commitment required from the board directors in terms of time and intellectual focus. From a shareholder point of view, it requires a supportive approach and an appreciation that there are different ways to run a company well. After all, good corporate governance is a complex matter that requires thoughtful execution in line with local practices. It is important that investors understand the local market’s culture and regulatory environment as well as the specific ownership structures. The board structure of companies with strong majority ownership will necessarily be different from that of a company with a highly dispersed shareholder base, but both may be as effective in protecting shareholders. likewise no single governance model works best universally, and even when comparing major markets, such as Japan, the US and the UK, we find significant differences. In all instances, however, we expect boards to add meaningful value in a number of key governance areas as well as to engage pro-actively with shareholders.

Adding value

In our view directors add value in the following areas:

• establishing an appropriate corporate governance structure; • setting the tone for the culture of the

company;• providing counsel/guidance to the management in the setting of the strategy and overseeing the execution of the agreed strategy; • ensuring the integrity of financial statements and audit process; • establishing a sound process regarding mergers, acquisitions and disposals; • creating appropriate executive compensation structures that align interests of executives with shareholders; and • addressing business critical issues – including social, ethical and environmental matters – that could affect corporate reputation and performance.

Establishing a clear and transparent governance structureAs a global investor, we respect regional differences and believe that governance structures need to reflect the markets in which a company operates. nevertheless, we believe that it is important to have robust checks and balances as they significantly reduce the risk of negative financial consequences. This usually involves clearly defining the different roles of the board and management such that the responsibilities of each are well understood and accepted. It may also include the use of ad-hoc or more permanent sub-committees for areas where the board needs to consider certain aspects more closely (e.g. audit process, nominations etc.) or where certain board members face a potential conflict of interest.

In order for boards to act as an effective counsel to management they also need to represent a sufficient diversity of views and experience. In our view, companies that can muster a wide range of perspectives and experience at the most senior level are better placed to respond to changing risk and opportunities.

34 ARTICLE BY AMRA BALICHEAD OF CORPORATE GOVERNANCE AND RESPONSIBLE INVESTING FOR EMEA

BLACKROCK


Directors also have to communicate their corporate governance approach to shareholders and other stakeholders. This involves explaining the underlying rationale and why the chosen approach is in the interest of shareholders, particularly where it differs from standard market practice.

Supporting management in setting the culture of the company ‘The tone from the top’ is critically important in embedding corporate culture. Management has a primary role in establishing the corporate culture. However, the role of the board is to ensure that management’s view and application of the company’s culture is firmly rooted in clearly articulated ethical principles that a broad range of stakeholders can subscribe to.

Providing strategic direction and oversightCompany boards have a role to play in setting the strategic goals of the company, by providing management with insights and counsel to steer the development of a coherent and robust strategy that they can endorse. It is also incumbent on the board to oversee and monitor the successful implementation of the approved strategy and, where/if necessary, undertake corrective steps.

Integrity of financial statements and oversight of audit processFinancial statements should provide a complete and accurate picture of a company’s financial condition. Directors play a vital role in ensuring that goal is met through appropriate oversight of the management of the audit function. We believe it is important that auditors are independent both in practice and perception. This involves putting in place appropriate procedures. These should include disclosure of any potential conflict of interest faced by the auditors that could affect the integrity of financial statements and, ultimately, the company’s reputation.

Making decisions regarding mergers, acquisitions and disposalsMergers, asset sales or other special transactions can have a material impact on the long-term economic interests of shareholders and other stakeholders. Boards therefore need to put in place a transparent decision making process, which takes into account the views and inputs from the entire board. We also believe it is important to have processes for managing any potential conflict of interest.

CORPORATE GOvERnAnCE AT BlACKROCKAs an independent fiduciary of our clients, BlackRock devotes significant resources to corporate governance as we believe well-governed companies deliver better long-term outcomes for both shareholders and the companies in which we invest on behalf of our clients.

We are a member of more than 40 corporate governance, shareholder, and responsible investment-related organisations. We vote in more than 85 markets and engage with over 1500 public companies worldwide every year.

We believe good governance is about leadership. We focus our efforts on the board of directors because without board and executive leadership, companies may not have sound governance practices. These cover a range of critical business issues, including the environmental and social impact of companies.

35ARTICLE BY AMRA BALICHEAD OF CORPORATE GOVERNANCE AND RESPONSIBLE INVESTING FOR EMEABLACKROCK


Establishing an appropriate executive compensation structureExecutive compensation has become a hot topic in most markets with much greater scrutiny around the potential misalignment of executive compensation with the long-term interests of shareholders and other stakeholders. While the way companies respond will differ from market to market, we believe that directors are best placed to put in place an appropriate compensation structure. This necessarily needs to take into account the specific circumstances of the company and the key individuals the board is trying to incentivise. As a rule, boards have to ensure that their compensation packages incorporate appropriate and challenging performance conditions consistent with corporate strategy and market practice.

Addressing business critical issues, including social, ethical and environmentalWe see social, ethical and environmental (‘SEE’) matters as corporate governance issues that are integral to the successful management of companies. We believe companies that have robust governance structures and practices in place are much better positioned to identify and manage the risks and opportunities – including those

relating to SEE issues – that are material to their company. This also extends to providing the necessary transparency to shareholders and other stakeholders on the adopted approach and how it compares to global and industry standards.

A constructive dialogue

Our starting position is to be supportive of boards in their oversight efforts on behalf of our clients. As a shareholder, we do not seek to micromanage companies but rather present our views as long-term shareholders and listen to companies’ responses. Directors, along with shareholders, are critical in ensuring this dialogue is fruitful for both parties. While this dialogue has always been at the heart of good governance, a rapidly changing environment and greater scrutiny by regulators, media and broader stakeholders has added a new urgency. Directors and shareholders now need to be able to respond pro-actively to an ever wider range of issues. A crucial element in meeting this challenge is the strength of the relationship between shareholders and directors.

This material is for distribution to Professional Clients (as defined by the FCA Rules) and should not be relied upon by any other persons. The opinions expressed are as of 1 September 2014 and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all inclusive and are not guaranteed as to accuracy. There is no guarantee that any forecasts made will come to pass. Any investments named within this material may not necessarily be held in any accounts managed by BlackRock. Reliance upon information in this material is at the sole discretion of the reader. Past performance is no guarantee of future results. The content is provided for information only. It is purely observation-based and does not present a forecast or a view of what may or may not happen, nor is BlackRock giving any indication about whether and how this information is used on behalf of its clients. In the EU issued by BlackRock Investment Management (UK) Limited (authorised and regulated by the Financial Conduct Authority). Registered office: 12 Throgmorton Avenue, london, EC2n 2Dl. Registered in England no. 2020394. Tel: 020 7743 3000. For your protection, telephone calls are usually recorded. BlackRock is a trading name of BlackRock Investment Management (UK) limited. Issued in Switzerland by BlackRock Asset Management Schweiz AG, Bahnhofstrasse 39, Postfach 2118 CH-8022 Zürich. This is for use by Qualified Investors only as defined in the Swiss Collective Investment Schemes Act of 23 June 2006, as amended (“CISA”) and its implementing ordinance. In Hong Kong, the information provided is issued by BlackRock (Hong Kong) Limited and is only for distribution to “professional investors” (as defined in the Securities and Futures Ordinances (Cap. 571 of the laws of Hong Kong)) and should not be relied upon by any other persons. In Singapore, this is issued by BlackRock (Singapore) limited (company registration number: 200010143n) for institutional investors only. For distribution in Korea for Professional Investors only (or “professional clients”, as such term may apply in local jurisdictions). For distribution in EMEA and Korea, for Professional Investors only (or “professional clients”, as such term may apply in relevant jurisdictions). This material has not been approved for distribution in Taiwan. In Japan, not for use with individual investors. In Canada, this material is intended for accredited investors only. This material is being distributed/issued in Australia and new Zealand by BlackRock Financial Management, Inc. (“BFM”), which is a United States domiciled entity and is exempted under ASIC CO 03/1100 from the requirement to hold an Australian Financial Services license and is regulated by the Securities and Exchange Commission under US laws which differ from Australian laws. In Australia this document is only distributed to “wholesale” and “professional” investors within the meaning of the Corporations Act 2001. In new Zealand, this document is not to be distributed to retail clients. BFM believes that the information in this document is correct at the time of compilation, but no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BFM, its officers, employees or agents. In latin America, for Institutional and Professional Investors only. This material is solely for educational purposes and does not constitute investment advice, or an offer or a solicitation to sell or a solicitation of an offer to buy any shares of any funds (nor shall any such shares be offered or sold to any person) in any jurisdiction within latin America in which such an offer, solicitation, purchase or sale would be unlawful under the securities laws of that jurisdiction. If any funds are mentioned or inferred to in this material, it is possible that some or all of the funds have not been registered with the securities regulator of Brazil, Chile, Colombia, Mexico, Peru or any other securities regulator in any Latin American country, and thus, might not be publicly offered within any such country. The securities regulators of such countries have not confirmed the accuracy of any information contained herein. no information discussed herein can be provided to the general public in latin America. © 2014 BlackRock, Inc. All Rights reserved. BlACKROCK, BlACKROCK SOlUTIOnS, AlADDIn, iSHARES, lIFEPATH, SO WHAT DO I DO WITH MY MOnEY, InvESTInG FOR A nEW WORlD, and BUIlT FOR THESE TIMES are registered and unregistered trademarks of BlackRock, Inc. or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners.

The Business Year is also available on tablet, giving you an insider track into the country’s most dynamic sectors—in the palm of your hand.

Bumper years, growth years, record-breaking years, challenging years. The key players and their stories are all in The Business Year.

www.thebusinessyear.com36 ARTICLE BY AMRA BALIC

HEAD OF CORPORATE GOVERNANCE AND RESPONSIBLE INVESTING FOR EMEABLACKROCK


The Business Year is also available on tablet, giving you an insider track into the country’s most dynamic sectors—in the palm of your hand.

Bumper years, growth years, record-breaking years, challenging years. The key players and their stories are all in The Business Year.

www.thebusinessyear.com


THE IMPORTAnCE OFDIRECTOR DEvElOPMEnT In

GROUP COMPAnIES

Mubadala has grown at a rigorous pace over the past decade, with interests now spanning the globe, across a number of key sectors. As Mubadala continues to grow, so does the need for effective governance across the portfolio, which consists of over one hundred key projects and investments across four diverse business platforms: Technology & Industry, Aerospace & Engineering Services, Energy and Emerging Sectors, which are currently collectively valued at around USD 60 billion. The underlying assets in each of these platforms cover a range of fields such as information and communications technology, healthcare, defense services, financial services, utilities, renewable energy, oil and gas, mining, and real estate. The complexity of these platforms, combined with the fact that they do business in over twenty jurisdictions and include twenty-seven joint

ventures, creates unique challenges for the approximately 100 Mubadala-appointed directors that serve on the boards of these assets. It is therefore critical to the Group’s success to have the right board composition for such assets.

not only does each Mubadala-appointed Director need to be an expert in the business of their asset and champion good governance, risk management and compliance, they also need to ensure that the asset actively implements Mubadala’s unique mandate of balancing economic and social returns. Since its inception, Mubadala has generated significant social returns for Abu Dhabi, including the establishment of important healthcare facilities such as the Imperial College of london Diabetes Center and Healthpoint, as well as the master planning

38 ARTICLE BY MUBADALA


of Al Maryah Island, a 114 hectare mixed-use development in the heart of Abu Dhabi, and Masdar City, a green urban development that is designed to provide a high quality of life with the lowest environmental footprint. Other facilities, such as Cleveland Clinic Abu Dhabi, will soon add to that contribution.

This unique mandate makes it critical to ensure optimal composition of asset boards, which are the primary drivers of sustained growth. Thus, a comprehensive training program for asset Directors and asset managers has been established and implemented. The training program brings together existing and prospective Directors and an expert faculty and allows them to have open discussions on best practices and proven methods to enhance their effectiveness. Current training modules include Director Effectiveness, Joint venture Governance, Audit, Risk and Compliance Committee Training, Corporate Secretary Training and Chairman Coaching, each of which provides the participants with a unique and complimentary skillset required to succeed as an effective Director.

Training Programs

The Director Effectiveness module takes participants through board structuring, optimizing meeting agendas and increasing the effectiveness of both the board and its individual directors. Members of Mubadala’s senior leadership attend all training sessions and share their experiences by responding to practical questions from participants. Many of the participants leave the training with key takeaways that they implement in the performance of their duties, including preparing annual board calendars and simplified board packs.

Another bespoke training module offered is the Joint venture Workshop, which was developed because Mubadala’s growth can be largely attributed to the ability to structure

successful joint ventures with world class companies such as GE, Occidental Petroleum and lockheed Martin. The Joint venture training workshop uses Mubadala-specific examples to promote optimal structuring, board and shareholder alignment, improved management performance, and building long-lasting joint ventures. Participants are taken through the case study of a successful joint venture restructuring within the Group, as well as various participatory exercises in complex areas such as conflicts of interest. This training has highlighted the importance of Mubadala’s joint ventures, and has provided participants with important tools to enhance their ability to ensure their continued success.

Given the large number of boards that oversee Mubadala’s assets, it is paramount for there to be consistency in the way corporate secretaries are trained and also in how board minutes are prepared. Mubadala trains all corporate secretaries on the art of taking and producing well-written minutes in the Corporate Secretary Workshop. Participants observe a mock board meeting and minute it, then have an open discussion of how certain matters are to be minuted. The training also provides tips on how to best manage governance responsibilities, internal and external communications as well as board meetings.

Emphasized throughout each of the training modules is the importance of transparency. To implement this, and ensure that assets properly manage their financial profile, key risk and compliance matters, Mubadala requires its assets to have effective Audit, Risk and Compliance Committees (ARC). The members of these committees, along with internal audit professionals, CFOs and senior managers of Mubadala Group assets, are required to attend ARC Training. This training provides an interactive forum for discussion regarding important topics such as risk management frameworks, systematic

39ARTICLE BY MUBADALA


internal controls, accounting policies and statutory reporting, effective ARC charters and managing internal, external and governmental audits – as well as governance and internal controls, ethics and compliance.

We recognize that an effective Chairman can contribute significantly to the well-running of a board, as well as setting the tone at the top. This led to the creation of the annual Mubadala Chairman Roundtable form, which is the pinnacle of the Corporate Governance training program and is attended by the Chairmen of all Group company boards as well as senior executive management. Participants engage in discussions that are moderated by internationally renowned guests, which are designed to examine leadership qualities, discuss best practices and explore strategies to deal with commonly faced challenges. The event has received great feedback and has ensured that the tone at the top is consistent across the Mubadala Group.

In addition to the wide range of training programs prepared and delivered in-house, Mubadala has also formulated a detailed Corporate Governance Handbook that sets out the roles and duties of boards and committees, and provides guidance on board operating procedures and directors’ fiduciary duties. The Handbook is circulated to all Mubadala employees, as well as board and committee members and senior managers of all assets. There are also weekly mailers circulated to all Mubadala Group directors setting out key developments in corporate governance and compliance, as well as related topical news and studies.

Board and Director Assessments

Another important element of Mubadala’s holistic governance approach is the implementation of board assessments, which aim to ensure that boards are functioning optimally. Directors are primarily responsible

for the direction of a company, thus it is important to remind them of their duties, responsibilities and shareholder expectations through these evaluations. Evaluations are sent out in the form of surveys that are completed by board members online. The survey results are then reviewed, with the top issues for improvement identified and discussed with the Chairman. An action plan is then developed and implemented to ensure that these issues are addressed.

Although board evaluations are necessary, there may sometimes be sensitivity by board members who are not clear on the intention behind the exercise. In order to alleviate concerns that the evaluation process is a forum for criticism, Mubadala’s senior leadership vets the process and directly sponsors the exercise. As a result, Directors view the evaluations as a means for improvement rather than criticism. The tangible impact of this exercise is evident through the increased number of directors that align themselves with Mubadala’s vision and mission. It also ensures that the right mix of people sits on each asset’s board and emphasizes that continuous individual and collective improvement is of paramount importance to Mubadala.

Conclusion

In order to ensure its sustained growth, which can only continue with best-in-class corporate governance, Mubadala has developed a comprehensive plan to ensure that all of the Directors appointed to its asset boards are properly trained, empowered and evaluated. These efforts have had a tremendous impact on Mubadala’s performance, and will continue to evolve in line with best practice.

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WHAT THE MARKET EXPECTS OF CONTROLLING

SHAREHOLDERSFor all the excitement and razzamatazz, the flotation of Alibaba in New York in September was a controversial event. Although Hong Kong might have appeared a more natural venue for a big Chinese company, Alibaba chose New York because the American market was prepared to go along with arrangements that give a key group of top managers a controlling interest well out of proportion to their financial stake.

Alibaba is thus one of a growing line of flotations in the US – Google, Facebook and Apple are similar – which do not respect the principle, often known as one share one vote, in which control rights are shared in proportion to the financial stake in the company held by investors.

Hong Kong’s reservations about Alibaba reflect a view that there is a basic fairness in the one-share-one-vote. Because the financial risk is shared by all investors, it ought to be the case that the control rights, which enable investors to protect themselves against that risk, are also equally and proportionally shared. The high demand for the Alibaba shares and the growing prevalence of these kinds of arrangements in the US and other markets suggest, however, that the market view is more nuanced. It is thus worth taking a look at the pros and cons.

Supporters of extra control rights for founders or other key shareholders usually make the following arguments.

They say that founding shareholders may be reluctant to list their shares if they lose control

over the company they have built up. This could damage the firm’s prospects because it may not have access to the capital it needs to expand. At the same time investors would lose out on the opportunity to profit from the efforts of the founder. Since the founder is the one whose talent and energy built the company – and by implication did all the work - it is perfectly reasonable to allow him or her to keep control.

Besides, a well-entrenched controlling shareholder can take a coherent long term view of strategy rather being pushed around by the vagaries of a short term stock market. Too often the corporate strategy of big listed companies is driven by the short term expectations of investors who want returns now rather than in the distant future, even if this comes at the expense of long term opportunities. Enhanced control rights are seen as an antidote to the short termism that plagues many Western markets.

There is also a legal argument. If both the founding shareholders and those that are buying the shares are content with the restrictions on minority control rights, then they

42 ARTICLE BY PETER MONTAGNONEDITORIAL BOARD CHAIRMAN

THE HAWKAMAH JOURNAL

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should be entitled to agree to this. To prevent them doing so amounts to an infringement of their freedom of contract, which is a basic right.

With the excitement around big flotations like Alibaba, even though the aftermarket can sometimes bring disappointments, it is easy to assume that these arguments should hold sway, but there are some strong arguments on the other side as well, which explain the refusal of Hong Kong to authorise the listing. Enhanced control rights are usually all right as long as the minority shareholders are doing well. When this is no longer the case, either because the company has hit a difficult patch or because the controlling shareholder is extracting benefits at the expense of the minorities, things start to look a little different. Over the last couple of years some overseas mining companies listed in the UK market, notably Bumi plc and Eurasian natural Resources(EnRC), gave very big problems because of the behaviour of dominant shareholders which caused the minorities serious financial losses. As a result the UK listing Authority has revised its rules to

allow, among other things, some safeguards over the election of directors when there is a controlling shareholder.

Since their fingers have been burned, large international investors are generally wary of arrangements which unduly protect and enhance the control rights of block holders. Their concern is that the controlling shareholder may use his or her power to divert entitlements to him or herself at the expense of the minorities. The risks are especially large when the controlling shareholder also owns companies that are not listed and is moving assets between them.

Enhanced control rights reinforce these concerns. They can also mean that management becomes entrenched and cannot be dismissed even if it is running a completely flawed strategy. Nor can the company be taken over, if things have reached the stage where it is better under a different owner. This is not to say that takeovers are always a good idea, but a properly functioning market in corporate control does provide a good discipline on management.

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This is why many international investors, including large asset managers and sovereign wealth funds such as the norwegian Bank Investment Management, which is one of the largest international investors in equities in the world, prefer companies to adopt the one share one vote principle. The question facing companies planning to list is how far to acknowledge this, especially since the international investors who are most worried are also the ones most likely to be called on to put up new capital if needed.

Even in normal times, the price of insisting on extra control rights is likely to be a higher cost of capital, since the minority shareholders will want compensation for the extra risk they are running. This can, however, be mitigated by measures to protect the minority shareholders. One idea that was suggested in the European Union in the early part of the last decade was that extra control rights should cease to operate when shareholders were voting on a takeover. In the event this proposal was rejected by the European Parliament and never implemented.

In contrast Sweden has a long established system for addressing the problem. Many Swedish companies have a controlling shareholder who enjoys extra voting rights, and the country is proud that this has given their companies the ability to take a long term strategic view of their business, but they also acknowledge the need to reach out to minorities and ensure that there is a consensus around the election of directors to the board.

For this reason Swedish companies have developed a particular approach to nominations Committees, which normally consist of a representative of each of the four largest shareholders. Within the nominations Committee, each member has a single vote, so that the controlling shareholder cannot force through the election of a new

director who does not enjoy the support of at least two other top shareholders. When the formal election of the board happens at the general meeting, voting is on the basis of the previously allocated voting rights. The controlling shareholder will enjoy his or her extra voting rights but, because of the nominations Committee process, cannot use them to force through directors to whom the minorities would object.

The Swedish system suits a relatively small country which values consensus but may be too cumbersome for other markets. nonetheless, it is an example of a compromise which works and provides food for thought for companies considering flotation with extra voting rights for founding shareholders.

Two principles should operate when this is the case. First there has to be full transparency so that minority shareholders know exactly what sort of deal they are buying into. Second controlling shareholders do need to recognise the need to treat minority shareholders fairly. If they do not, their cost of capital will rise and they may fund it hard to raise additional funds from the market should they need them.

Whatever the excitement around a big new flotation, the original shareholders cannot escape the fact that the basic situation has changed. By tapping into other people’s money, they have created a new set of obligations. If they do not honour these, at some point the market will exact a price.

44 ARTICLE BY PETER MONTAGNONEDITORIAL BOARD CHAIRMAN

THE HAWKAMAH JOURNAL


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thehawkamahjournal

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issue 02/2014 a journal on corporate governance & leadership

Sir Michael RakeInterview with the Chairman ofBT & Majid Al Futtaim Holdingspages 05-10

pages 33-40

pages 20-24

Investor Perspectives on theRole of BoardsAn inside view into the investor expectations

Corporate Governance and Nominee DirectorsThree articles exploring the role and responsibilities of Nominee Directors

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