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Bank for International Settlements (Financial Stability Institute) - Committee of Banking Supervisors of West

and Central Africa

Khartoum, Sudan, 11 April 2002

SUPERVISORY RESPONSIBILITIES RELATIVE TO CORPORATE

GOVERNANCE

Errol Kruger

Deputy Head - Bank Supervision South African Reserve Bank

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Agenda• SURVEILANCE

– BANKS ACT

– REGULATIONS

• PROCESS OF CORPORATE GOVERNANCE

• GUIDELINES RELATING TO CONDUCT OF DIRECTORS

• COMPOSITION OF THE BOARD OF DIRECTORS OF A BANK

• COMPOSITION OF THE BOARD OF DIRECTORS OF A CONTROLLING COMPANY

• STATEMENT RELATING TO ATTRIBUTES OF SERVING OR PROSPECTIVE DIRECTORS OR EXECUTIVE OFFICERS

• REPORTABLE OFFENCES

• COMPLIANCE FUNCTION

– REGULATIONS (Cont.)

• MARKET ABUSE AND FINANCIAL FRAUD

• PUBLIC DISCLOSURE

• ANNUAL FINANCIAL STATEMENTS

• CONSOLIDATED FINANCIAL STATEMENTS

• AUDIT REPORTS

• THE EXAMINATION PROCESS

– COMPLIANCE CHECKLISTS

– SELF-ASSESSMENT OF THE EFFECTIVENESS OF THE BOARD OF DIRECTORS

– HIGH LEVEL GOVERNANCE MEETINGS

• DISCIPLINARY ACTIONS AND SANCTIONS

• SOME GLOBAL TRENDS IN CORPORATE GOVERNANCE

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SURVEILLANCE

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Banks Act

• Registrar empowered to issue regulations• Directors of bank or controlling company• Appointment of auditor by Registrar• Special functions of auditor in relation to Registrar• Audit committee

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Banks Act - cont.

• Directors of bank or controlling company

– fiduciary relationship spelt out

– majority of board to be non-executives

– of no legal force if fit and proper test failed

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Banks Act - cont.

• Appointment of auditor by Registrar

– questionnaire to be completed by:

• Audit firm

• Lead partner

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Banks Act - cont.

• Special functions of auditor in relation to Registrar

– duty to report any fact which may impair going concern, protection of depositors’ funds, or contrary to sound management and internal controls

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Banks Act - cont.

• Audit committee

– functions outlined

– three members - majority non-executive

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Regulations

• Process of corporate governance• Guidelines relating to conduct of directors• Composition of the board of directors of a bank or of a

controlling company• Statement relating to attributes of serving or prospective

directors or executive officers (fit and proper test)• Reportable offences• Compliance function• Market abuse and financial fraud• Public disclosure• Annual financial statements• Consolidated financial statements • Audit reports

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Process of corporate governance

• Board of directors ultimately responsible

• Includes maintenance of effective risk management

• Risks include any risk regarded as material by bank

• Conduct of the business of a bank entails the management of risks

• Overall effectiveness of process monitored by board of directors

• Once a year assess and document whether process successfully achieves the objectives

• External audit review of process followed by board of directors

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Guidelines relating to conduct of directors

• Must acquire basic knowledge and understanding of:

– the business, laws and customs of a bank

– commensurable with the nature and scale of the business conducted

• Perform functions with diligence and care

• Duty to ensure risks managed in prudent manner - deposits from general public

• Annual report to Registrar on:

– internal controls (material malfunction)

– going concern

– external auditors report if they concur

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Composition of the board of directors of a bank

• Chairperson of bank not an employee of :

– bank

– any subsidiaries

– controlling company

– subsidiary of controlling company

• Chairperson of bank not a member of the audit committee of:

– bank

– controlling company

• At least two members of board must be employees

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Composition of the board of directors of a controlling company

• Chairperson of controlling company not an employee of:

– controlling company

– any bank of which that company is registered as a controlling company.

• Chairperson of controlling company not a member of the audit committee of:

– controlling company

– any bank of which that company is registered as a controlling company.

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Statement relating to attributes of serving or prospective directors or executive

officers

• Bank and controlling company

• Declaration submitted by the chairperson i.r.o. prospective candidates:

– 30 days prior to appointment

– first time accepts an appointment as director or executive officer

– resigned and reappointed as director or executive officer

– declaration by candidate

• At Registrar’s request

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Reportable offences

• Reportable offence includes

– breach of fiduciary duties by directors/ senior management

– market abuse or financial fraud that would result in the bank losing an amount in excess of 1 per cent of capital

– Actions by directors/ senior management resulting in reputation of the bank being affected adversely

– Actions by directors/ senior management resulting in the contravention of the code of conduct or ethical code of any institution of which the bank is a member or with which the bank is associated

– any money-laundering activity not identified timeously and reported, as required by law

– any activity declared as such by Registrar

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Compliance function

• Independent compliance function must be part of risk-management framework

• Headed by a compliance officer with adequate stature and resources

• Compliance officer duties:

– Effectiveness

– Monitoring

– Reporting

– Resources

– Manual

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Market abuse and financial fraud

• Implement and maintain policies and procedures to guard against the bank being used for purposes of market abuse and financial fraud including:

– insider trading

– market manipulation

– money laundering

• Policies and procedures should be adequate to:

– ensure compliance with legislation

– facilitate co-operation with law-enforcement agencies

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Market abuse and financial fraud - cont.

• Policies and procedures should be adequate to: (cont.)

– identify customers and, in particular, recognise suspicious customers and transactions (KYC)

– maintain high ethical standards in all business transactions

– provide adequate training and guidance to relevant staff

– maintain internal records of transactions

– report suspicious customers and transactions

– provide a clear audit trail

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Public disclosure

• Reliable and timely information that enables users to make an accurate assessment of:

– financial condition

– performance business activities

– risk profile

– risk-management practices

• Compliance with Generally Accepted Accounting Practice - minimum disclosure

• If not sufficient to give a true and fair presentation, additional disclosure should be made

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Public disclosure - cont.

• Disclose each material item separately - material if omission or misstatement could change or influence judgement or decision of user

• Shall hold copies of annual financial statements/ disclosures and shall provide copies to public on request

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Annual financial statements

• Annual financial statements shall be compiled in accordance with Statements of Generally Accepted Accounting Practice and International Accounting Standards

• Departures authorised by Banks Act or Registrar - onus on bank to inform external auditors

• Interim reports prepared in accordance with Statements of Generally Accepted Accounting Practice

– Submitted to Registrar as soon as available

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Consolidated financial statements

• Furnish the Registrar with consolidated annual financial statements

• Shall present the state of affairs of business activities conducted by:

– Reporting bank and subsidiaries

– Associates of bank and subsidiaries

• Prepared in accordance with Statements of Generally Accepted Accounting Practice and International Accounting Standards

• Equity method of accounting shall be applied

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Audit reports

• Audit reports

– Preparation

• Annual bilateral discussion with Registrar

• Obtain copies of statutory returns direct from Registrar

– Report whether statutory returns

• Reasonably reflects management accounts

• Are complete

• Are accurate

• Are prepared using same accounting policies

• Accord with Banks Act and Regulations

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Audit reports - cont.

• Audit reports (cont.)

– Significant weaknesses in the system of internal controls i.r.o

• financial regulatory reports

• compliance with Banks Act and Regulations

• granting of loans

• making of investments

• ongoing management of loan and investment portfolios

• loan loss provisions and reserves

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THE EXAMINATION PROCESS

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Process

• Compliance checklists

• Self-assessments

• High level governance meetings

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BANKS/BRANCHES OF FOREIGN BANKS

FORM NO DESCRIPTION

• DI 800 Corporate governance» Directors/management

• DI 805 Compliance» Shareholding

• DI 810 Compliance» Provisions relating to aspects of the conduct of the business of a bank

• DI 815 Compliance» Functioning of banks and controlling companies, with reference to the Companies

Act, 1973 (Act No. 61 of 1973)

• DI 820 Compliance» Prudential/statutory requirements

• DI 825 Reporting» Returns relating to banks and controlling companies

• DI 830 Reporting» Requirements in terms of statutory returns

Compliance checklists

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OFFSHORE BANKING SUBSIDIARIES /BRANCHES

FORM NO DESCRIPTION

• DI 835 Corporate governance

• DI 840 Compliance

• DI 845 Reporting

Certification of DI 800 series by:

• Compliance Officer

• Chief Executive Officer

Compliance checklists - cont.

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Self-assessment of the effectiveness of the board of directors

Assessing the effectiveness of the board ofdirectors questionnaire

Boardrating

Follow-upactions

Strategy and planning Risk management Tone at the top Measuring and monitoring performance Transactions relating to mergers, acquisitions

and investments Management evaluation, compensation and

succession planning Telling the world Board dynamics

Attendance at board meetings

Schedule of board memberships

1 = Strongly Disagree 5= Strongly Agree

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What do we do with the self-assessment?

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XYZ Bank LimitedManagement evaluation, composition and

succession

0

1

2

3

4

5

Bank Peer Group Total Banks

1 = Strongly Disagree and 5= Strongly Agree

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XYZ Bank Limited Board meeting attendance

70

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0

10

20

30

40

50

60

70

80

90

100

Average Attendance Number of Meetings

%

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High level governance meetings

• Board of directors

• Trilateral discussions

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DISCIPLINARY ACTIONS AND SANCTIONS

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• Inspection/ investigation in terms of Banking Act

• Remedial plan of action required from board of directors

• Increased capital and other prudential requirements

• Only limited and controlled growth allowed

However,

The best disciplinary actions and sanctions is that of the market

• Recent global studies have shown that those companies with proper corporate governance:

> Demand a premium

> Attract global investors

> Have reduced cost of capital and enhanced capital efficiency

> Are more resilient in times of distress

Disciplinary actions and sanctions

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• Awareness is being raised about corporate governance issues– Investors and analysts

– Corporates and lenders

– Governments and stock exchanges

• Institutional investors are paying increasing attention to the issue, particularly large institutions and pension funds

• Institutional investors are starting to set-up corporate governance screens and use it as an investment decision making tool

• Governments are encouraging improved corporate governance in order to boost their equity markets

• Governments are also concerned about reducing country risk and consequently cost of capital for their companies

Some global trends in corporate governance

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Annexure A - useful websites on Corporate Governance

www.amnesty.org.uk – Amnesty International, UK

www.asx.com.au – Australian Stock Exchange

www.boardgovernance.com/home.htm – Policy Governance

www.brtable.org – The Business Roundtable

www.calpers.org or www.calpers.com - CalPERS

www.cbc.to/ - Commonwealth Business Council

www.cii.org – Council of Institutional Investors - USA

www.ciionline.org – Confederation of Indian Industry

www.conferenceboard.org – The Conference Board

www.corpgov.net/links/links.html – Corporate Governance Portal

www.coso.org – COSO Fraudulent financial reporting

www.davisglobal.com – Davis Global Advisors

www.directorship.com – The Directorship Search Group

www.dti.gov.uk – The Department of Trade & Industry - UK

www.dvfa.com – German Society of Capital Market Experts

www.feicanada.org – Financial Executives International Canada

www.fsa.uk.gov – Financial Services Authority

www.fsb.co.za – Financial Services Board

www.gccg.de – German Code of Corporate Governance

www.globalreporting.org – Global Reporting Initiative

www.gm.com – General Motors Board of Directors

www.governance.co.uk – Governance

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www.hermes.co.uk – Hermes

www.hkex.hk – Stock Exchange of Hong Kong

www.icgn.org – International Corporate Governance Network

www.irrc.org – Investor Responsibility Research Centre

www.issaustralia.com – Independent Shareholder Services

www.jse.co.za – JSE Securities Exchange South Africa

www.klse.com.my/website – Kuala Lumpur Stock Exchange

www.londonstockexchange.com – London Stock Exchange

www.nacdonline.org – National Association of Corporate Directors - USA

www.napf.co.uk – National Association of Pensions Funds - UK

www.nyse.com – New York Stock Exchange

www.oecd.org/daf/governance/principles.htm – OECD

www.pirc.co.uk – Pensions Investment Research Consultants

www.sc.com.my – Malaysian Securities Commission

www.sec.gov – U.S. Securities and Exchange Commission

www.tse.com – Toronto Stock Exchange

www.wbcsd.ch – World Business Council for Sustainable Development

www.worldbank.org/html/fpd/privatesector/cg/index.htm – World Bank

www.tiaa-cref.org – Teachers Insurance and Annuity Association

www.ses.com.sg – Stock Exchange of Singapore

www.standardandpoors.com – Standard and Poor’s

www.stockex.co.uk – London Stock Exchange