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.

Corporations must be prepared for the introduction of tax and other policy tools and should be aware of the benefits and implications they represent. This post highlights three challenges corporations face regarding the implementation of green policies: 1) identifying relevant policies, 2) understanding their scope and 3) integrating them into the company’s operations.

Identifying relevant policies

The first challenge companies face is identifying and understanding the tools in place and their relevance for their operations. In most cases, companies are aware of relevant penalties but lack information on other instruments’ potential usefulness. Given that the green policies are increasingly focusing on incentives and other tools such as low-interest loans and grants, companies should take advantage of these incentives by reviewing strategies and operations, and evaluating the incorporation of incentives into new or existing projects.

Understanding policies’ scope

Companies often misinterpret the scope of green policy tools. In some cases, corporations believe these instruments are only relevant to companies offering green products or services or to companies who have a long-term sustainability strategy. Fortunately, green policies are addressing multiple topics and can result in the transformation of core strategies, the modification of everyday operations and the increase of the feasibility of projects in the pipeline. For example, the Japanese government is providing subsidies to acquire eco-friendly vehicles and fleets, which will reduce a company’s transportation costs considerably; Australian farmers are selling carbon credits to companies looking to offset emissions and are contributing to more sustainable farming practices in the country; and energy-efficient buildings deductions in the U.S. are representing millions of dollars in potential savings to corporations.

Integrating policies into everyday operations

The adoption of new policies into everyday operations can represent challenges that require leadership and collaboration. In this process, company leaders have to make sure that policies are considered an opportunity and not a threat. As reported in E&Y’s Six Growing Trends in Corporate Sustainability, setting the tone from the top is key to ensure the adoption of sustainable practices. The same approach should be adopted when aiming for the adaptation of green policies by companies.

At the same time, the introduction of new policies will require alignment across areas in both strategy and processes. In order to successfully adopt these, collaboration among areas is essential: the translation of sustainability issues into costs and benefits by financial teams, into project planning tasks by operations departments and so forth. Lastly, the communication of potential benefits and clarity in goals will be key to engage all areas of a company into making the necessary changes to adopt new policies.

Governments have taken steps – however timid – towards addressing environmental challenges. Corporations contribute to these challenges and should play a central role in addressing them too. As companies  incorporate green policy tools and become examples of successful adaption, the private sector’s perspective and experience will be an invaluable source of information for the future design and evaluation of green tax systems. It could be win – win for everybody…

In order to address the challenges of environmental changes, governments are designing and implementing green policy tools ranging from tax incentives to specific subsidies and grants. KPMG International’s Green Tax Index Report analyzes green tax systems from 21 countries. The Index provides information on “which countries are most active in using green tax incentives and penalties to drive sustainability”. It identifies over 200 individual tax incentives and penalties to achieve green policy objectives and categorizes countries into four quartiles according to the degree of tax use (see table below). The ranking of China in the first quartile and Finland and Germany in the third are certainly surprises.

Source: KPMG Green Tax Index Report 2013

The United States tops the ranking with a strong bias towards tax incentives due to its extensive program of federal taxes promoting energy efficiency, renewable energy and green building. Japan comes in second place, ranking higher on green tax penalties than the U.S, with a specific focus on the use and adoption of green vehicles. In third place, the United Kingdom leads on carbon and climate change and presents a more balanced approach between incentives and penalties.

Australia, Germany and Finland, associated with strong environmental policies, are surprisingly constituents of the third quartile. However, this is mainly explained by the wide range of green policies they have implemented, few of which are of the tax variety. Australia (18^th) has focused on non-tax tools such as grants, loans and direct investment to promote green innovation and energy efficiency. Similarly, Germany (17^th) favors low-interest loans and capital subsidies, and Finland (21^st) focuses on grant funding for green innovation.

The emerging economies Brazil, Mexico, Russia and Argentina are located in the fourth quartile. Policy tools in these countries are mainly applied as incentives: Russia leading in promoting energy efficiency and Brazil in green innovation.  However, overall, there are few instruments in place in these countries regarding the achievement of green goals.

Since January 2011, more than 30 green taxes have been introduced around the globe. This trend will continue to drive consumer and business behavior towards more sustainable practices. These policies will certainly contribute to already changing customers’ perceptions on greener businesses and products. Corporations must be prepared to benefit from these policies and to adopt them into their everyday operations. In another post we will discuss some of the implications these policies represent for corporations and their sustainability goals.

Every two years, Aon asks risk leaders across industries to identify the main risks their companies are facing in their operations. More than 1,400 practitioners responded to the 2013 survey. The 2013 survey ranked the top 50 risks companies face, focusing on the top 10 risks in 2013 and how they may change in 2016, displayed in the table below. Overall, the survey found that most respondents found their organizations less risk-ready than in the previous survey in 2011, which might in part be attributed to the prolonged economic recession, which has strained many organizations resources.

Source: Aon Risk Solutions – Global Risk Management Survey 2013

We have three main observations about this ranking:

1. It is certainly interesting to see that damage to reputation/brand is perceived to be diminishing in risk, according to the survey. From our perspective, this seems to be an optimistic scenario. With social media – both a valuable marketing and communication tool as well as potent potential reputation killer –– being only ranked as risk factor number 40, it certainly appears as if companies seem to underestimate reputational and social media risks.
2. Political risks and uncertainties are ranked 10th and are expected to be more relevant going forward. Weather/natural disasters, while not far off the radar at the current ranking of number 16, are also projected to jump into the top 10 risk list at number nine. Both rankings make sense. Somehow though, the connection is not made between environmental risk, climate change and severe and erratic emerging weather patterns. Environmental risk is ranked only 28th and climate change 38th. This seems to be an underestimation of these factors – especially moving forward – and in particular in the light of recent weather events in the United States.  These numbers also imply that companies that take the development of sustainable strategies serious should be able to gain an edge over companies that do not.
3. What’s more, and we will be focusing on this issue in a subsequent blog post, these are all external risks. One might argue that the most relevant risks a company faces are internal, of the organizational nature, ranging from inadequate board oversight to lack of monitoring capabilities to insufficient risk strategies. It can be argued that it is quite essential to get these issues right before one sets out to worry about global external risks.

The main problem with this multitude of codes, according to the Nigerian corporate governance website The Corporate Prof, is that while the industry specific codes are mandatory, the SEC code is voluntary. In addition, in cases of conflicting provisions, the stricter provision are supposed to prevail, but as the website points out, it is not always easy to determine which is the stricter one in case of conflicts.

However, change is coming, as the corporate governance landscape of Nigeria has been evolving quite a bit over the last few years. The Financial Reporting Council of Nigeria was established in 2011 and given wide reaching powers for the regulation of companies. It also got explicit authority to regulate corporate governance. And just last week, on January 17, 2013, a Steering Committee on the development of a National Code of Corporate Governance for Nigeria was launched under the auspices of the Financial Reporting Council. The 16-member Committee is charged with the responsibility of developing a unified Code of Corporate Governance. Apart from unifying the disparate codes, the new code is envisioned to enable the Financial Reporting Council to promote the highest standards of corporate governance, increase public awareness about corporate governance principles and practices and act as the national coordinating body responsible for all matters pertaining to corporate governance in Nigeria.  The Committee is supposed to complete a first draft within six months.  Stay tuned in July 2013!

Sergei Sinkevich, Primary Market Department and Globalisation Managing Director of the Moscow Exchange formulated the motivation for the launch in an interview with FTSE Global markets:

“We are introducing this segment for two reasons: on the one hand we are planning to attract long-term investors who are ready to invest in “high-quality’’ issuers. On the other, we want to attract issuers that want to establish reputational capital and who expect to enjoy market premia, added to the price of their shares, which clearly demonstrate their exemplary practice of corporate governance and transparency.”

In essence, the rationale is the same that led to the launch of the “Novo Mercado” in Brazil 12 years ago: the stock exchange introduces a set of special listing rules, in particular concerning shareholder rights, that go beyond the host jurisdiction’s rather weak protection offered to investors. The Novo Mercado, consisting of three different tiers with increasingly stringent corporate governance requirements, has been a resounding success: virtually all new listings in Brazil occur in the special corporate governance segment and the index based on the segments has soundly outperformed the BOVESPA benchmark since its inception. Given this success story, the “Novy Rynok” is directly modeled after the Novo Mercado.

A November 2012 presentation by the Moscow Stock Exchange, available on the Russian Investor Protection Association website, lays out the details of the planned segment. The basic principles and some of the specific criteria addressing these principles are:

1. Procedures and obligations associated with public offerings to protect new shareholders. Provisions targeting this principle include the obligation that public placements must target dispersion and a 6-month lock-up period following an IPO.

2. Additional provisions for the protection of existing shareholders: Tag-along rights, a minimum of 3 independent directors on the board and a majority independent Audit Committee.

3. Transparency and disclosure: IFRS based quarterly statements in Russian and English; ongoing disclosure in English; detailed disclosure of related-party transactions and of the ultimate controlling shareholder, annual shareholder meeting material to be published in English and Russian 20 days in advance.

According to the presentation, internal approval procedures within the Moscow Stock Exchange for Novy Rynok are supposed to be finalized in the first and second quarter of 2013. The project is to be launched in the third quarter, with the first issuers joining the segment. The stated goal is to have at least 5 companies listed in the new market in 3 years. This seems overly modest. Brazil’s Novo Mercado started out with 18 back in 2001.

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.