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©2005 YRK Reddy 1 CORPORATE GOVERNANCE FRAMEWORK by Prof. YRK Reddy
©2005 YRK Reddy 2 The Globalisation of Standards The rationale & the broad strategy IMF,World Bank,OECD,Commonwealth, BCBS,IAIS The moves fro generic to specific – the early arguments of ACG All assume market economy benefits and mostly the outsider model
©2005 YRK Reddy 3 A Good Situation Research Analysis/ Media/ Ratings/ markets for control Activisim/ Transparency/ Accountability/ equitable rights Shareholder Meetings & Vote Board, supervision, meetings & Vote Management Reportings
©2005 YRK Reddy 4 1 Reputational agents refer to private sector agents, self-regulating bodies, the media, and civic society that reduce information asymmetry, improve the monitoring of firms, and shed light on opportunistic behaviour External Private Reputational agents 1 Accounts Lawyers Credit Rating Investment Bankers Financial media Investment advisors Research Corporate Governance Analysis Markets Competitive factor and product markets Foreign direct investment Corporate control Standards (for example, accounting and auditing) Laws and regulations Regulatory Financial Sector Debt Equity Shareholders Board of Directors Management Core functions Reports to Appoints and monitors Operates Internal Stakeholders Modern corporations are disciplined by internal and external factors (Source: Corporate Governance Framework, Nadereh Chamlou, Magdi Iskande, World Bank)
©2005 YRK Reddy 5 The Irresistible Case for CG Korea-US Research: 160% premuim ABN/AMRO: Best CG Rated companies had P/E ratios 20% higher Russian study: 70,000% increase in firm value of 21 companies Deutsche Bank: S&P 500: 19% out-performance. Harvard / Wharton: abnormal returns of 8.5% Cheaper debt: Romania`s BCR Operations too: better ROE; EVA
©2005 YRK Reddy 6
7 The Country Analysis in Scorecard – Four Critical Factors Legal InfrastructureLegal Infrastructure RegulationRegulation Information InfrastructureInformation Infrastructure Market InfrastructureMarket Infrastructure
©2005 YRK Reddy 8 The Special Case of Insurance Industry Opacity of financial institutions due to nature of some contracts; deferred exchange; swift changes in risk profiles Illiquidity & risk of Asset liability mismatch Informational asymmetries between policy holders & insurers Complex structure of principle-agent issues and coordination problems
©2005 YRK Reddy 9 The need for strong regulation and active supervision. ( fixes the informational asymmetries, market failures, systemic risks). Supplemented by self-regulatory initiatives by Boards and shareholders; market discipline, legal infrastructure etc. A complex construct of listing agreements; company laws; insurance laws; regulatory norms; supervisory expectations – the great need for alignment / harmonisation.
©2005 YRK Reddy 10 The IAIS Guidance ICP 9 is mainly the role, responsibility of Boards and senior management. Integrates with other Core Principles that relate to CG: –Suitability of Persons –Changes in control & Portfolio Transfers. –Internal Controls –On-site inspections –Risk Assessment & Risk Management –Information, disclosure and Transparency towards the market
©2005 YRK Reddy 11 Insurance Core Principles on Corporate Governance Essential criteria A) The supervisory authority requires and verifies that the insurer complies with applicable corporate governance principles B) Board of Directors: 1. Sets out its responsibilities in accepting and committing to the specific corporate governance principles for its undertaking. Regulations on corporate governance should be covered in general company law and/or insurance law. These regulations should take account of the size, nature and complexity of the insurer.
©2005 YRK Reddy 12 2.Establishes policies and strategies, the means of attaining them, and procedures for monitoring and evaluating the progress toward them. Adherence to the policies and strategies are reviewed regularly, and at least annually. 3.S atisfies itself that the insurer is organised in a way that promotes the effective and prudent management of the institution and the boards oversight of that management. The board of directors has in place and monitors independent risk management functions that monitor the risks related to the type of business undertaken. The board of directors establishes audit functions, actuarial functions, strong internal controls and applicable checks and balances.
©2005 YRK Reddy D istinguishes between the responsibilities, decision-making, interaction and cooperation of the board of directors, chairman, chief executive and senior management. The board of directors delegates its responsibilities and establishes decision-making processes. The insurer establishes a division of responsibilities that will ensure a balance of power and authority, so that no one individual has unfettered powers of decision. 5. E stablishes standards of business conduct and ethical behaviour for directors, senior management and other personnel. These include policies on private transactions, self- dealing, preferential treatment of favoured internal and external entities, covering trading losses and other inordinate trade practices of a non-arms length nature. The insurer has an on-going, appropriate and effective process of ensuring adherence to those standards.
©2005 YRK Reddy Appoints and dismisses senior management. It establishes a remuneration policy that is reviewed periodically. This policy is made available to the supervisory authority. 7. Collectively ensures that the insurer complies with all relevant laws, regulations and any established codes of conduct (refer to EC f) 8. Has thorough knowledge, skills, experience and commitment to oversee the insurer effectively (refer to ICP 7). 9. Is not subject to undue influence from management or other parties. The board of directors has access to information about the insurer, and asks and receives additional information and analyses that the board sees fit.
©2005 YRK Reddy Communicates with the supervisory authority as required and meets with the supervisory authority when requested. 11. Sets out policies that address conflicts of interest, fair treatment of customers and information sharing with stakeholders, and reviews these policies regularly (refer to ICP 25). C) Senior Management is responsible for: 1. Overseeing the operations of the insurer and providing direction to it on a day-to-day basis, subject to the objectives and policies set out by the board of directors, as well as to legislation. 2. Providing the board of directors with recommendations, for its review and approval, on objectives, strategy, business plans and major policies that govern the operation of the insurer.
©2005 YRK Reddy 16 3.Providing the board with comprehensive, relevant and timely information that will enable it to review business objectives, business strategy and policies, and to hold senior management accountable for its performance. Advanced criteria 1. The board of directors may establish committees with specific responsibilities like a compensation committee, audit committee or risk management committee. 2. The remuneration policy for directors and senior management has regard to the performance of the person as well as that of the insurer. The remuneration policy should not include incentives that would encourage imprudent behaviour.
©2005 YRK Reddy The board of directors identifies an officer or officers with responsibility for ensuring compliance with relevant legislation and required standards of business conduct and who reports to the board of directors at regular intervals (refer to EC b). 4. When a responsible actuary is part of the supervisory process, the actuary has direct access to the board of directors or a committee of the board. The actuary reports relevant matters to the board of directors on a timely basis.
©2005 YRK Reddy 18 OECD Guidelines for Insurers Governance Recommendations for Insurance and Private Pensions Committee, adopted by OECD Council on April Note the absence of corporate – and the overall emphasis on the stakeholder system.
©2005 YRK Reddy 19 Regulation alone cannot achieve the good practice necessary for integrity and effectiveness. Companies themselves must develop internal rules and systems in order to reach these goals, but governments and international bodies can provide guidance on these rules and systems.
©2005 YRK Reddy 20 Main Objectives To provide complementary guidance that would help the sector to enhance the protection of policyholders and/or shareholders beyond the protection already by existing regulation and supervision; and To develop complementary guidance specifically directed to the insurance sector that would supplement corporate governance rules generally applicable to corporations Covers: Governance structure, Internal governance mechanisms and Stakeholders protection
©2005 YRK Reddy 21 Guidelines for Insurers Governance 1. Governance Structure: The governance structure must establish an appropriate division of administrative and oversight responsibilities, stipulate and delineate the qualifications and duties of persons bearing responsibilities, and protect the right of policyholders and shareholders or participating policyholders Guidelines I. Identification of responsibilities Guidelines II. Board's structure
©2005 YRK Reddy 22 Guideline III. Functions and responsibilities Reviewing and guiding the strategy of the insurance entity, including insurance strategies,; approving the pricing strategy, setting performance objectives, overseeing auditing and actuarial functions, and other oversight structures and monitoring the administration of the insurance entity in order to ensure that the objectives set out in the fund by-laws, statutes or contracts, or in documents associated with any of these, are attained (e.g. diversified asset allocation, cost effectiveness of administration et.);
©2005 YRK Reddy 23 Guideline IV. Composition and suitability Guideline V. Accountability Guideline VI. Actuary Guidelines VII. External Auditors
©2005 YRK Reddy Internal Governance Mechanisms: Insurance entities should have appropriate control, communication and incentive mechanisms that encourage good decision – making power and timely execution, transparency, disclosure and ensure regular review and assessment, having regard to the branches of business operated. These mechanisms should be tailored to the protection of policyholders, beneficiaries and shareholders (or participating policyholders). Guideline VIII. Internal controls Guideline IX. Reporting
©2005 YRK Reddy Stakeholders protection: The governance framework of insurance entities should ensure an appropriate protection of the rights of stakeholders through disclosure and redress mechanisms and the compliance with the basic rights of shareholders or participating policyholders in the case of mutual insurers. Guideline X. Protection of participating policyholders in the case of mutual insurers. Guideline XI. Disclosure Guideline XII. Redress
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