Saturday, November 28, 2009

New Zealand Corporate Governance Regulations: Running on International tides of change?

New Zealand Corporate Governance Regulations: Running on International tides of change?
Due to the core fundamentals of Corporate Governance, it is something that cannot be ruled and regulated easily. The fact that not only does it tie investors to operations to accounting – it does so while trying to negotiate a “General set of ideas” for all individuals involved.
With that in mind, the world has split 2 ways on how Corporate Governance should be enforced. In the America’s – a set of rules are laid out, should you exceed the boundary of the rule, you are found to be using incorrect Corporate Governance. The black and white are set by the rules – the grey, unknown, unexploited area is something that the rules do not cover.
New Zealand (and other European countries), operate under a set of Corporate Governance Principals (SEC, 2004). These principals are broken down under the following headings:
a) Ethics of Directors
b) Balance of the Board
c) Effectiveness of the Board
d) Integrity and Timeliness of Disclosures to the Board
e) Fair, Transparent and Reasonable pay to Directors
f) Checking of Processors to Manage Risk
g) Quality and Independence of Auditing
h) Boards relationship to shareholders
i) Boards relationship to stakeholders
These are broken down to a more refined set of Guidelines. The reason why the principals fit well with Business is due to the fact that the same countries that use principal based accounting, also use principal based Corporate Governance. This however also means that the accountants are also heavily involved in the Corporate Governance.
So if we have different ways of conforming to Corporate Governance, how was it that a series of crashes overseas? Well apart from the obvious that they are linked markets with shared investments – when the US market had large players display poor corporate governance, all corporate entities were then considered “evil”.
When the books of a few of these entities were researched, some less than pleasing results occurred. While in the US, companies were getting away with it due to being outside the rules; in New Zealand (and other European countries) it was where the line was not drawn where exceptions were made.
If you look at the New Zealand Principals of Corporate Governance (SEC, 2004), you will notice that the 9 principals are actually quite specific. The board must be balanced, well informed and able to maintain a relationship with the board. The Directors must have a relationship with the board, and make ethical decisions. But it is because of this – which large voids appear.
What happens if the board are not well informed, who’s disclose is it at?
Where are the Directors business related decisions? Are they purely based on ethics and board?
Are the employees stakeholders? If so how is their relationship to the board? Is it only through the director?
Why don’t the Risk Management Audits have independent?
What are good ethics? What cultural backgrounds are they based?
Who is monitoring whom? Are they biased?
How quickly can the board react if they find something out of place?
Does the old boy’s club of Boards still exist? (Gaynor, B, 2009)
By not setting a clearly defined rule, the principals can be interpreted in different ways. Even the Handbook for Directors, Executives, and Advisers (SEC, 2004) states that it is:

“It is intended as a reference for directors, executives and advisers, as they decide how best to apply the Principles to their particular entity. The nine Principles and their accompanying guidelines are included together with the Commission’s view on the particular area of corporate governance.”

So how to you enforce principals, when you state they are up for miss-interpretation? Well the system is not set in place to “go out and get people” – It’s actually set in place so that individuals exceed the recommendations. Reading the individual guidelines show evidence of this, with words such as “should” rather than “required”. It is the diligence of the board and directors that “should” changes to “must” and “required”.

However one could argue, how do you punish someone that “should” have done something, but failed to recognize it? If a formal charter is not established – can you really hold the board accountable?

The Principals rely heavily on Due Diligence, and Common Sense (PWC, 2003) – which are no longer punishable by the law (corporate or civilian). So while there are “winners” who will exceed the S.E.C.’s recommendations, there will also be losers who may choose to ignore them.

So why are there still holes in Corporate Governance? Can this be fixed?
As stated earlier, Corporate Governance is not an easy thing to regulate. Whenever an issue arises – this hole in the theory is either covered up or a “safety net” is placed underneath to try and catch it next time.
Most acts amendments or “safety net” acts are based on the accounting side of Corporate Governance. This does not identify with the core fundamental flaw that is the moral obligation of the direction of the company. Even the famed reform act, the Sarbanes–Oxley Act (see “Other Resources” in rear) – which was written up to protect investors, can only protect them from an accounting perspective. Which, given the current financial situation is obviously not sufficient.
The reason for this being, that most situational issues regarding poor Corporate Governance are only formally recorded as accounting errors. Emails, notes, conversations and other recordings of poor governance are very difficult to follow and monitor.

While the accounting processors can monitor the outbreak of a Corporate Governance failure, in most situations when it has reached that stage, the problem is already deep rooted. Meaning the only acts that can be made are that of Retribution by holding the Directors (and on occasion the board) responsible. It has only fallen on the moral obligations on the directors and the board during recent times, to decide whether to declare issues before they become problems. However, in most of these situations – doing this also does not put you in a good light with the stakeholders or shareholders, as it usually means the company will require entering a form of receivership.

The current proposed solutions out there involve reform and compliance to new policy. Two strong contenders are Basel II (a review of Basel I – Risk Reserve) and Solvency II (a review of Solvency I – Company operations vs. Solvency)

The problem with Basel II is very simple; how do you measure risk? Currently the only way this is done – is purely on a financial basis. If I do this, and it goes wrong, I stand to lose “X” dollars....

This then is covered by a banking operation and reserve accounts. However is this not just another safety net which protects the stupid? What happens to those that fail to use good operational risk management? Well this is covered by Solvency II – which (from an insurance firm’s perspective) checks to see if the safety nets can actually be paid in full.

But wasn’t this already in place before? Yes, yes it was. Remember principals 6 and 7? To calculate, manage and audit risk. This has been a corporate governance principal in NZ for many years.
It also in the US rules based system. But it also relied on the principal of “disclosure”. If you did not disclose the problem – you did not have to address. This is where the rules failed.

So have we solved any problems by introducing Basel II and Solvency II? Well actually all we have done is put more specifics, and made the topic a bit less broad. But it does not solve the issue of disclosing the true figures of risk.

The USA is also tightening policy outside of business. With investors’ acts, they hope to prevent people from making unwise investment. Taking the supply of bad investment away from Poor Corporate Governance. (Willkie, Farr, Gallagher, 2009)

How will this reform process in the USA and Europe feed down to New Zealand?

Due to New Zealand being tucked away from the world, policies usually are not enforced here immediately. However they will be put in place overseas – so international trading companies will have to comply, along with multinational companies with branches in New Zealand.

This in turn will slowly dictate how the market will operate. As a large percentage of the big companies in New Zealand fall into the 2 categories described below. First people will be “exceeding” the “advice” of the current principals by apply to the new system (to continue business), and then we may have our own reform to change the standards to what we are already doing in New Zealand.

This however still will not fix all the problems, unless the individuals are continuously driven to exceed the recommendations of the Corporate Governance Principals. Likewise can be said about the USA and applying above the required for the rules based system.

References:
Willkie, Farr, Gallagher, (2009),. IMPLICATIONS OF PROPOSED U.S. FINANCIAL REGULATORY REFORM FOR NON-U.S. FUND MANAGERS
www.willkie.com

SEC, (2004),.CORPORATE GOVERNANCE IN NEW ZEALAND, PRINCIPLES AND GUIDELINES - A Handbook for Directors, Executives, and Advisers
Securities Commission (New Zealand)

Gaynor, B (2009),. Old Boys Club remains closed to new entrants
http://www.briangaynor.co.nz/blog/2009/11/4/old-boys-club-remains-closed-to-new-entrants.html
(last viewed 4/11/2009)

PWC (2003),. Audit Committees - Good practices for meeting market expectations (2nd ed)
PWC

Other Resources (read but not quoted or paraphrased):
http://en.wikipedia.org/wiki/Sarbanes-Oxley_Act
http://en.wikipedia.org/wiki/Corporate_governance
http://www.kpmg.com/aci/gov.asp
http://www.questia.com/googleScholar.qst;jsessionid=KxhCd7rf0ltYlNwTrVFGz95L0QQLgVGvNkFp3wpZpxK10QTpvPhL!-950397748!568259201?docId=5008765482
http://en.wikipedia.org/wiki/Basel_II
http://en.wikipedia.org/wiki/Operational_risk_management
http://en.wikipedia.org/wiki/Solvency_II
http://en.wikipedia.org/wiki/Data_governance
http://shareinvestornz.blogspot.com/
http://www.iod.org.nz/
http://www.briangaynor.co.nz/
http://www.stuff.co.nz/business/blogs/stirring-the-pot/
http://www.economist.com/businessfinance/displaystory.cfm?story_id=14738392
http://www.economist.com/businessfinance/displaystory.cfm?story_id=14756903
http://search.ft.com/search?queryText=corporate+governance&ftsearchType=type_news
http://books.google.co.nz/books?id=Vrm4b4sLzz8C&pg=PA170&lpg=PA170&dq=regulatory+review+of+US+corporate+governance&source=bl&ots=o5IBshaYLK&sig=wYHOlbRwjWtfnv2LFsy5bk2Z0UI&hl=en&ei=s6TxSo-vBo_ssQOUxbX4AQ&sa=X&oi=book_result&ct=result&resnum=3&ved=0CBQQ6AEwAjgU#v=onepage&q=regulatory%20review%20of%20US%20corporate%20governance&f=false


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