REPORT OF THE WORKING GROUP

ON CORPORATE GOVERNANCE

 

 

SET UP BY THE MALTA STOCK EXCHANGE

 

 

 

 

Introduction

The Working Group (WG) was set up to make recommendations to the Malta Stock Exchange with respect to the establishment of a basic framework for appropriate guidelines to public listed companies on corporate governance.

The WG consisted of:

·          Mr Paul J Spiteri (Chairman), Ms Eileen Muscat and Dr Robert Vella Baldacchino, members of the executive   of the Malta Stock Exchange;

·          Dr Andre Camilleri, Company Secretary Simonds Farsons Cisk p.l.c.;

·          Mr Charles Borg, General Manager Valletta Fund Management Limited;

·          Mr Wilfred Mallia,  Stockbroker of Curmi & Mallia (Stockbrokers) Ltd; and

·          Dr Louis de Gabriele – Partner Camilleri Preziosi – Advocates. 

The WG submitted a draft Report to the Council of the MSE on the 18 June 2001 together with a draft of a ‘Code of Principles of Good Corporate Governance’ for consideration by the Council.  In that Report the WG also recommended to the Council that before the Council determines the recommendations of the WG the Malta Stock Exchange undertake a more comprehensive consultative process.

This recommendation was taken on board by the Council and in the latter part of June 2001 the MSE circulated, with listed companies and other interested parties, extracts from the report of the WG and a copy of the draft ‘Code’ for comments.  Following receipt of comments the MSE requested the WG to consider the several contributions received before submitting a final Report to the Council.

Accordingly this Report and the attached Code builds on the draft Report originally submitted to the Council and takes into account the contributions received from several sources.

Comments were received from the following entities/persons:

§          Bank of Valletta p.l.c.

§          Central Bank of Malta

§          Mr Gavin Fryer

§          Mr Louis E Galea

§          HSBC Bank Malta p.l.c.

§          The Institute of Directors

§          International Hotel Investments p.l.c.

§          KPMG

§          Lombard Bank Malta p.l.c.

§          Malta Chamber of Commerce

§          Malta Government Privatisation p.l.c.

§          Malta Labour Party

§          Malta Shareholders’ Association

§          Maltacom p.l.c.

§          Nobel Mantrich Limited

§          Prof. J.M. Ganado & Associates

§          PriceWaterhouseCoopers

§          Simonds Farsons Cisk plc

§          Mr George Wells

Corporate Governance.

The significance of corporate governance stems from the conception of the economic function of the corporation and its acknowledgement at law.  The WG believes that corporate structures and mechanisms are the result of the cultural context within which companies exist and operate.  Accordingly, there is no particular structure or arrangement that can guarantee success, nor any arrangement that has been adopted in other jurisdictions that can be imported wholesale in the local scenario without the appropriate modifications dictated by the demands of the Maltese economic and social reality.

The classical paradigm of corporate law is not a new phenomenon.  Indeed academics and practioners alike have all had their own say on the matter and discussion on the subject has been extensive.  The basic paradigm, however, remains– Directors manage the corporation whilst the shareholders own it.  Hence whenever there is public ownership there may be a failure by the Directors in protecting the public shareholders.

Different systems have adopted a variety of rules to deal with the issue and any analysis must take into account a host of factors and influences that are central in addressing the matter.  Corporate governance, when applied in this context, can be used to bring under one head the different kinds of rules which determine how power is exercised within the corporation– Corporate Governance therefore deals with the issue of accountability and focuses on the relationship among the participants in the corporation.  The rules become pertinent to corporate governance when they have a material impact on the various players within the institution.  Accordingly these rules have several sources including company law, banking law, securities legislation and insolvency and bankruptcy law.

It is submitted that the issue of corporate governance in the advent of the 21st Century needs to be addressed as the product of two fundamental drivers:

·          the ownership structure of corporations and the financial system within which they operate; and

·          the determination of the various corporate interests– namely the determination of which groups ought to participate in corporate governance.

The WG, in reaching its conclusions and making its recommendations has taken a fresh look at the matter of corporate governance and has commenced its work by posing the question: What is Corporate Governance? 

This could well be a matter of debate and left to academics there would be no end to the discussion.  The WG however had to find a pragmatic working definition and common understanding of the term.  To this end we have accepted the definition adopted by the UK’s Cadbury report namely that:  

Corporate Governance is the system by which companies are directed and controlled. 

In the opinion of the WG this is a concise but sufficiently wide definition to incorporate the various ramifications of the term.  Moreover, it puts the Directors of the company, those responsible for the direction and management, at the core of the debate

We have had the benefit of learning from the way that other systems have addressed the same subject.  Notwithstanding that the underlying principles of management accountability are the same everywhere the focus and emphasis may change in different jurisdictions in line with the dictates of the local economic and social context.  We have been sensitive to the current state of development of the Maltese capital markets and of listed companies.  Accordingly, we have attempted through our recommendations to ensure a suitable framework for Corporate Governance of Maltese listed companies without however rendering that framework too draconian for compliance by Maltese companies.

The WG has used as its platform the basic tenets of Corporate Governance contained in Maltese legislation as the basic standard of conduct.  Our remit was:

·          to analyse those requirements in the context of the development of Maltese companies today and in the future; and

·          to provide those companies with principles which will on the one hand ensure compliance with the basic statutory requirements, and on the other go beyond those basic requirements by providing companies with a thorough understanding of what is expected of them as a matter of good corporate conduct.

The WG also focused on the targets of these recommendations. The need for enhanced Corporate Governance structures is, of course, paramount in public companies where the distinction between ownership and control is more pronounced then in privately owned corporations where the manager is usually the owner or where at least the dichotomy between ownership and management is more of a legal fiction than it is fact. 

The Approach 

It is submitted that Corporate Governance rules and practices are also cultural and historical practices. The company is a human response to the economic and social pressures in the generation of wealth and the relationship between the owners of capital and the managers of that capital. The central feature of Corporate Governance is a part of that response.  It would serve little purpose, to attempt to find a complete global solution to Corporate Governance, which does not take into account the significant cultural and conceptual differences, expressed in the rules and practices on Corporate Governance in several jurisdictions. 

Any Corporate Governance solution must reflect the cultural, social and economic background in which companies are to operate.  However, globalisation of industry and cross-border transactions, are creating the need for a level of convergence of rules and practices, which establish certain basic parameters for good Corporate Governance.  Accordingly, the WG has attempted, in its recommendations, to reflect the generally accepted standards of Corporate Governance internationally whilst at the same time ensuring that their application and implementation is coherent with the local economic and social contexts. 

It is not  the recommendation of the WG to prescribe any particular corporate structures, nor to advocate compliance with any hard and fast rules. 

The state of development of the Maltese company, particularly those making the culture leap from private to listed companies, requires flexibility and a gradual, but steady, evolution of standards that should, in the medium term contribute, to a higher level of awareness of the importance of good Corporate Governance and the improvement of current corporate structures leading towards greater accountability.

Another significant factor that the WG has considered in devising its approach is to determine the various interests at stake. The new dimension for Corporate Governance of public companies brings to the fore the issue of determining the different components that have an interest to participate in Corporate Governance.

The traditional paradigm has always had as a focus of proper Corporate Governance the shareholder and investor as the owner and how the ownership interests are to be protected against the actions of the managers.  More recent proponents on Corporate Governance have extended this traditional concept into the constituency model, which extends the responsibility of corporate directors to other interests including the interests of labour, creditors, consumers and the community at large.

Although there may be merit in the constituency model, it may not be appropriate for all the interests that are mentioned to become a matter for corporate law and good corporate practice.  Indeed a re-statement of the classical shareholder model might be more conducive to attaining the proper balance within the parameters of corporate law and practice.  A re-statement of that model would extend the responsibility of corporate directors to take into account all other interests in the decision making process, with the principal focus however remaining the shareholder. 

The issue that arises is that even here cultural and historical approaches differ from one jurisdiction to the other.  Whereas jurisdictions that have traditionally had a market oriented financial system have typically adopted a shareholder model approach, jurisdictions whose financial systems have traditionally been dominated by banking institutions have typically been more amenable to the constituency model.

In this context Malta seems to have a unique combination.  On the one hand it is a jurisdiction whose financial system has been and still is principally dominated by the banks, but on the other hand has a corporate law system and culture that views directors’ responsibilities as being owed to the company and its shareholders.

This, of course, does not mean that all other interests are not addressed by other legislation, measures or mechanisms – but they are not matters of corporate law and practice. 

·          Labour interests have always been regulated by industrial legislation and collective bargaining characterized by a strong Trade Union presence.

·          Creditors’ interests are protected by the general law and the laws of bankruptcy and insolvency (even if the latter in effect forms part of the Companies Act). 

·          Consumers’ interests are the subject of general consumer protection legislation. 

·          In the case of depositors’ of banks banking law and regulation.

The responsibility of directors as a matter of Maltese law and practice remains one embedded exclusively in the shareholder model – and the directors prime responsibility is owed to the company and directors must properly act in the best interests of the Company.

It is against this social and cultural backdrop that the WG makes its recommendation that the fundamental focus of corporate law and practice should be the regulation of the relationship between the shareholders and directors.

Modifications

Following the review of comments received the WG is proposing some modifications to the final text of the code.  Most of the issues that have been raised are not matters of principle and do not have a material impact on the thrust of the code.  However, in view of certain clarifications requested, such as for instance giving guidance on what constitutes  “Independence”,  the WG has considered it useful to include a broad definition of what would constitute independence. 

Recommendations

After due consideration the Working Group makes the following recommendations to the Council:

General

î     In view of the fact that the working group has been working under the auspices of the Malta Stock Exchange, the Working Group is of the view that the Principles to be adopted should be restricted to companies whose securities are listed either on the Official List or the Alternative Companies List of the Malta Stock Exchange.  No inference should be made from this recommendation that the Working Group does not consider it appropriate that other companies, particularly public companies, should not also adopt these principles.  Indeed, the Working Group believes that the principles being suggested should also constitute guidance to directors of all public companies and that their adoption should lead to breeding the right basis for the proper conduct of corporate directors.  In addition, the WG is of the view that greater awareness of good Corporate Governance principles, even at other levels of family-run companies and private companies is desirable and should be encouraged as it tends to contribute towards building the right corporate culture.  The WG, however is also aware that the Principles being recommended may require companies to make certain material changes in their corporate structures, which may impose cost burdens on smaller unlisted companies where the absence of the dichotomy between ownership and control does not warrant them.  In addition, it is the view of the WG that the introduction of change in this sector should be gradual, and that the companies whose securities are listed on the Exchange are the ones that should set the example.

î     The set of Principles attached to this report are the basic principles which in the opinion of the WG are the most significant in the attainment of a better corporate environment.  The way that these are thought out is through the enunciation of ‘The Basic Principle’, which we have tried to retain as concise as possible, followed by an explanation and recommendations on the measures that companies should adopt with a view to complying with the Principle.

î     It is also the view of the WG that after approval of the Code transitory provisions should be promulgated to regulate the dates by when Companies will be expected to comply with the Code and when Auditors will be required to report on that compliance.  In addition, it is also recommended that discussions are held with firms of accountants/auditors with a view to issuing ‘guidance notes’ in connection with how auditors would be expected to report and possibly to agree on a pro forma report.

Finally, it is our view that these Principles should remain in the realm of recommendations and as the benchmark of best practice.  Indeed it is the view of the WG that these Principles ought to be adopted as the benchmark by the Exchange and that companies whose securities are listed on the MSE ought to be encouraged to adopt them.  However, it is also recommended that each company should, at least once in every year report to the market on whether it has adopted these Principles and the extent to which these Principles have been adopted and the mechanisms put in place to implement them.  The WG thought that it would be convenient for such a statement to be made in the Company’s Annual Report.  This disclosure to the market will enable investors and market players to understand better the mechanisms of each company for appropriate governance and would be able to distinguish between companies that adopt the principles and those that do not and make their own inferences about those that do not.  In this context, the WG is also of the view that in order to give this disclosure more weight with the market, the auditors or legal counsel of the company should themselves report on the disclosure made by the company in the annual report. 

It is also recommended that:

·          The Code will apply to listed companies but should not apply to listed Collective Investment Schemes since the nature of those Schemes is certainly different to mainstream listed companies.  At any rate the regulation of Collective Investment Schemes is the subject of a different regime.

Specific

There are three areas which we have considered need to be addressed, and within the parameters of which the several Principles fall. 

The areas are:

1.         The Board and the Directors;

2.         Remuneration of the Directors;

3.         Relations with Shareholders and with the Market.

Accordingly, the structure of the Code of Principles for Good Corporate Governance will follow the above division.  At this stage of development, the view taken by the WG was that the first subject matter merited special focus and attention.  The code of Principles is designed to provide all those involved in Corporate Governance with a concise guide on the obligations of Directors and how they may be performed.

The WG is aware that over the last few years the Maltese capital markets have also experienced the significant growth of a new player in the market – the institutional investor.  The WG therefore feels that in the context of the Maltese market, which has hitherto been predominantly a small shareholders’ market, institutional investors should have the requisite knowledge, expertise and resources which can add value to corporate governance in the interest of all shareholders. Indeed their actions or inactions with respect to companies in which they invest can influence smaller shareholders attitudes, and therefore the attitude of the market, towards those companies.  The WG sees institutional investors as a very important market check on listed companies and their share values.  In this context  the WG  considers the prudent use of voting by institutional investors in listed companies as a positive factor.  However, to avoid creating a situation of addressing a specific class of shareholders the WG is recommending that the issue is not dealt with as a Principle but rather as part of Principle twelve.

 

The Working Group

1 October 2001