We thought it would be interesting to share the common approach to integrating corporate governance (CG)  into investment decisions that 34 DFIs have adopted. DFIs cover emerging markets around the world, including Africa, Latin America, the Caribbean, Asia, Middle East, North Africa, Europe and Central Asia, with total assets of more than $850 billion. DFIs investin equity, debt and mezzanine deals.

What does it provide?

The corporate governance framework establishes a common approach for evaluating governance practices in the due diligence phase of a deal and subsequently improving the corporate governance of investee companies.

While not designed as a one-size fits all approach that can easily result in undesired tick-the-boxes behavior, a unified approach makes it more predictable for investee companies what to anticipate in terms of corporate governance expectations by investors. By signing on to the framework, the DFIs hold themselves accountable to actively implement the common approach. In addition, the framework initiative provides a set of corporate governance tools such as corporate governance assessment methodology and guidebooks that are ready to be used. It also establishes incentives for investee companies to embark on governance reforms.

The signatories of the framework undertake to:

1. Integrate Corporate Governance (“CG”) in its investment operation

a. Adopt CG procedures and tools in line with the Framework’s methodology;

b. Where considered appropriate, conduct CG assessments of investee companies and develop CG action plans;

c. Monitor progress of the implementation of CG action plans.

2. Ensure internal responsibility

Identify and assign an internal function that is responsible for the implementation of the Framework.

3. Provide or procure training

Ensure capacity building and knowledge transfer to staff for the implementation and further development of the Framework.

4. Collaborate with other signatories

a. Share experience and resources in training and implementation

b. Contribute to developing case studies and progress reports on the above.

5. Report on implementation

Report annually to the other signatories on the internal implementation of the Framework.

What can private investors in emerging markets learn?

The take-away for private investors is at least two-fold.

1. Coordination of efforts can be effective.

We don’t expect private investors to share their evaluation methodologies any time soon, but the increasing focus big private investors such as Black Rock put on governance and sustainability issues can ha e a significant impact on company behavior and efforts. Coordination efforts by pension funds in some emerging markets such as Chile, where the Administradoras de Fondos de Pensiones (AFP), the country’s private pension funds, operate a shared data base for independent directors show that cooperation can take many different and fruitful forms.

2. Emerging market companies want to improve their governance.

The DFI experience over the last decade shows that there is appetite by emerging market companies to implement corporate governance reforms. If investors provide additional incentives to their investee companies, governance reforms are even more likely to be initiated.

The investors’ guide to corporate governance in Latin America published by BNamericas looks at the ownership concentration and a lack of minority shareholders’ rights that have defined the landscape for many years.

This week BNamericas spoke with the report’s author, Andreas Grimminger, founder and managing director of PGS Advisors international, a policy and corporate governance consultancy, to take a pragmatic look at the level of corporate governance standards in the region and gain a better understanding as to the role of capital market development in encouraging better standards.

The full report can be found here.

BNamericas: How do corporate governance standards compare between Latin America and other emerging markets?

Grimminger: Most emerging markets face very similar corporate governance issues, as concentrated ownership is a prevalent feature across markets. Asian markets, as well as some Latin American markets, are further characterized by significant cross-shareholdings and sometimes pyramid structures, which make related-party transactions an issue of particular importance.

Corporate governance practice standards and their integration into law and regulation have improved significantly in both developed and emerging markets over the last decade, but the distinguishing factor lies in their implementation and enforcement and in developing a culture of good corporate governance that is part of the business fabric.

For sound corporate governance practices to become truly engrained in the business culture, I believe a balanced mix between regulatory and private initiatives is essential. Latin American markets, especially Brazil, compare fairly well to other emerging markets in this respect.

Corporate governance reforms in Brazil have been to a large degree driven by private actors, such as the Brazilian institute for corporate governance (IBGC) and self-regulatory initiatives such as the Novo Mercado segment on BM&F BOVESPA.

On the other hand, initiatives in Malaysia, which can be considered a regional corporate governance leader in Asia, have been top-down, driven by the Malaysian Security Commission.

In contrast, investor groups like the Brazilian association of capital market investors (AMEC) are private investor initiatives. This is not to say that the Brazilian securities regulator CVM is not playing an increasingly important role in corporate governance reforms, but many initiatives have come from the private sector.

Other Latin American markets like Colombia and Peru and especially Chile, on the other hand, are predominantly driven by regulatory initiatives in their corporate governance reforms. So there is room for more private sector initiative, even though Chile can already count on three corporate governance institutes.

BNamericas: Can you differentiate the role of foreign investors from local investors when it comes to pressuring companies to follow certain standards?

Grimminger: Given the low liquidity of most equity markets in the region and the AFPs’ preference to invest locally, AFPs are clearly the dominant institutional investors and minority shareholders in the region. For minority investors, whether they are AFPs or foreign investors, securing representation on the board and obtaining the disclosure of relevant company information to protect their rights are the most important issues.

AFPs certainly have a leg up on foreign investors as they usually fill the few seats for independent directors, but there are already many successful examples of cooperation between AFPs and foreign investors and, ultimately, the growing influence of AFPs is beneficial to all minority investors.

This increased influence can, to a degree, be tracked to the introduction of regulatory requirements forcing AFPs in Colombia, Chile and Peru to vote their shares, nominate directors, actively consider corporate governance and report on all these issues.

BNamericas: What is required for the pace of improvement in corporate governance practices to speed up?

Grimminger: Good corporate governance practices are important for companies for two principal reasons. First, to assure outside investors that their investor rights are respected. Second, sound corporate governance structures, such as diverse and independent boards of directors, benefit any company regardless of its capital structure as they improve decision-making and risk management.

In order for reforms to continue or even accelerate in the region, two developments are necessary. First, liquidity needs to increase so outside investors become more relevant and companies more likely to listen to their governance demands. And second, companies’ awareness needs to be further raised with respect to the many economic benefits of good corporate governance.

We see both occurring, albeit at a slow pace. However, improved corporate governance practices, in particular when it comes to the disclosure of company information in the region, are critical for the continuous development of the regional economies and capital markets.

BNamericas: With the rise in cross-border consolidation within the region, do you foresee new issues arising with regards to standards of corporate governance and regulations?

Grimminger: Regional integration initiatives such as MILA and the rise of the multilatinas will not lead to the rise of new issues, but – in my opinion – to the intensification of already existing ones.

A larger and more diverse investor base will demand better governance standards, such as increased disclosure of company information ahead of the annual general meeting and more say on board nominations.

The current practice that board nominees are not disclosed until the AGM (with the exception of Brazil) will certainly come under increased pressure. We already see the disclosure of at least the names and background of nominees ahead of the board elections at companies needing the votes of outside investors to reach a quorum.

At PGS Advisors we believe that companies across the region will increasingly follow best practices, not only in the case of multilatinas and other blue chip companies, but also more and more in the case of medium-sized and even family-owned companies.

It is important in this context to demonstrate the economic and reputational benefits of good corporate governance and good sustainability practices for all kind of companies. The growing regional importance of ESG (Environmental, Social and Governance) standards for corporations and investors in the region will be an important trend to watch.

Emerging markets have been lagging in the development of ESG investment and investment products though. However, it seems that the time has come for the systematic incorporation of ESG risk assessments into emerging market investment decisions.  Three major trends are responsible for bringing emerging markets and ESG investing together, until recently separate investment specialty areas, although two of the fastest growing:

1. Emerging markets growth is diversifying and is not predominantly based on infrastructure investments anymore. In addition, a rising middle class represents a new class of consumers increasingly paying attention to sustainability concerns. Both developments lead to an increasing role for sustainability considerations in emerging markets.

2. Many emerging market companies are entering their mature growth phase, consolidating and affording the ability to focus more on management quality and corporate responsibility. These companies also are also facing increasing challenges such as resource constraints, demand for more corporate accountability and compliance with global best practices such as labor standards and reporting guidelines. Companies that embrace the challenge can truly differentiate themselves from companies that do not and offer attractive investment opportunities.

3. Information on ESG practices of emerging markets companies was very difficult to obtain only a few years back. This has changed significantly in a short time span. An increasing number of emerging market companies today publish sustainability reports, a growing number of them in compliance with the guidelines of the Global Reporting Initiative. In addition, for investors willing to purchase rating reports, GMIRatings has increased its ESG rating service for emerging market companies from 688 in June 2012 to 998 as of April 2013.

Indeed, underlining these developments, two commercial emerging market ESG indices have been launched in the past two months.

In February, RobecoSAM, a sustainable investment specialist and S&P Dow Jones Indices launched the Dow Jones Sustainability Emerging Markets Index with 69 companies. The companies are selected based on RobecoSAM’s annual corporate sustainability assessment, which evaluates companies’ sustainability performance based on economic, environmental and social criteria.

In March, asset manager Northern Trust announced the first emerging markets custom index based on MSCI ESG Research and Institutional Shareholder Services’ (ISS) governance screens. The design of the fund applies three screens to the MSCI Emerging Market (EM) Index universe, followed by a sequence of checks on governance and executive independence. The first screen eliminates constituent companies of the MSCI EM Index that have been found to be in breach of the UN Global Compact’s ten principles. The second screen removes manufacturers of controversial weapons ant he third tobacco manufacturers. Following these exclusions a filter is applied targeting companies lacking sufficient independence across ownership, board representation, key corporate committees and audit and remuneration committees.

In addition to these indices representing select companies from a variety of emerging markets, stock exchanges in a number of emerging markets had already launched ESG indices over the past decade. Prominent examples are the Johannesburg Stock Exchange Socially Responsible Investment Index and Sao Paulo’s BM&FBOVESPA’s Corporate Sustainability Index, launched in 2004 and 2005 respectively.

While these are encouraging signs, much work still needs to be done. Two reports published late last year, EIRIS’ “Evolving markets: what’s driving ESG in emerging economies?”, and the Forum for Sustainable and Responsible Investment “Lessons Learned: The Emerging Markets Disclosure Project, 2008 – 2012” found that poor corporate environmental and social governance disclosure remains the number one challenge to investing in emerging markets. The reports also highlighted that knowledge of sustainability reporting practices and international norms varied widely between markets.

As investors are integrating ESG risk factors into their investment decisions in emerging markets, it is clearly time for emerging market companies to take the sustainability challenge serious.

On Monday, the IIC announced that it would launch a new US$80 million initiative for direct lending to SMEs in Latin America and the Caribbean. The initiative will provide loans and technical assistance packages to help primarily export-oriented SMEs meet emerging international best practices in corporate governance. According to the press release, the new loan initiative is part of a larger effort to target SMEs more directly and raise lending standards by integrating corporate governance improvements into IIC operations. It is also part of the IIC’s commitment to the Corporate Governance Development Framework. The Corporate Governance Development Framework was established in 2011 by development finance institutions to promote corporate governance at companies in which they invest. It currently has 31 development finance institutions as signatories.

For the first time, Rule No. 341requires all listed companies to provide on an annual basis (no later than March 31) to the SVS information on a catalog of corporate governance questions regarding the immediately preceding fiscal year. In essence, companies are requested to perform a kind of self-evaluation against a set of best practices. According to the rule, companies are requested to indicate whether they have or have not adopted the corporate governance practices laid out in the regulation. In addition, they have to explain how, if adopted or – if not adopted – why not and what steps are being taken towards adopting.  Since 2013 is the first year the norm has been put in place, companies have until June 30 to submit their answers.

The catalog of 19 questions is divided into four areas. In addition, companies can add practices they have adopted that are not covered by the questions of the rule.

The four areas addressed by the questionnaire are:

1. The functioning of the board with 7 practices;
2. Shareholder and public relations with 6 practices;
3. Executive compensation and succession planning with 2 practices; and
4. Internal control and risk management with 4 practices.

While the initial reaction of Chilean companies to the new Norm is predictably negative, it will be interesting to see the degree and quality of information companies will disclose when the self-evaluations against the new rule becomes public upon filing at the end of June.

The main findings of the Companies Circle 2012 report are:

1. Board evaluations have been increasingly recognized in the region as a useful tool to improve the performance of the Board.
2. Trust in the credibility and confidentiality of the evaluation process is a key factor for its success.
3. In the path to build an effective Board, evaluations require the commitment of directors to undergo a thorough review to identify the strengths and areas for improvement.
4. The main results of the evaluation should be inputs to an action plan, followed up by the Board.

The report can be downloaded here.