New Zealand Governance Centre - Inaugural Conference Auckland,
15-16 August, 2008
Jane Diplock AO
Chairman
Executive Committee, IOSCO
New Zealand Securities Commission
"Corporate Governance and Securities Law"
It is a special pleasure to be participating in this inaugural conference on corporate governance. Corporate governance is important because it goes to the heart of investor confidence in our capital markets. Investors are likely to have more confidence in markets when companies have high standards of corporate governance. As New Zealand's securities regulator our purpose is to strengthen confidence in New Zealand's markets as a basis for greater capital investment in this country, by local and offshore investors. The Commission does this by promoting and safeguarding market integrity and efficiency, and also by striving for securities regulation that is cost effective. In considering market integrity and efficiency, issues of corporate governance are never far away.
It is particularly timely that the University of Auckland Business School has established the New Zealand Governance Centre. Now more than ever, following disruption across part of our financial services sector, and around the world's financial markets for that matter, it is pertinent to review and discuss matters that impact the protection of investors. It is also vital in today's globalizing capital markets to keep a global perspective on issues and developments. I commend the initiative to establish this centre which promotes and undertakes research on governance. One of the key messages we should take away from periods of turmoil, past and present, is that the most effective way to minimize damage from market turmoil is to set in place a world-class financial sector and responsible corporate governance.
I should note that it is important that jurisdictions strike a balance between under-regulation, which carries the risk of fraud, abuse and a loss of investor confidence, and overregulation, which saps the economic vitality of otherwise vibrant markets. The aim is to promote healthy corporate governance as a means of securing the many potential benefits of global markets for investors and issuers alike, while continuing to provide the strong investor protections that our capital markets ultimately depend upon. These and many related issues confront us as globalization of markets intensifies.
Today I will share with you some international perspectives on the topic of corporate governance and other challenges confronting international securities regulators. Recent events have shown that financial markets are now truly global. We have seen a decade of tremendous growth in emerging markets, constant and impressive modernization, re-organization of market infrastructures and product innovation, and rapid growth of cross-border activities and capital flows. Some established stock markets have merged, to produce multinational markets. Investors are seeking out the best investment opportunities regardless of their physical location across the globe. The aftermath of the sub-prime mortgage market crisis in the United States which reverberates around the world leaving the financial markets struggling with the most severe turmoil we have seen in many years is a poignant reminder of this. Globalization of capital markets makes it vital we understand the diverse treatment of corporate governance in jurisdictions around the world and challenge ourselves on whether differences matter.
Keeping a global perspective, today I will focus on three themes:
Firstly, I believe what we are seeing around the world in corporate governance is conceptual convergence, but with implementation differences.
Secondly, effective benchmarks around the world exist and can be used to measure equivalence in corporate governance between jurisdictions, while respecting those differences.
Thirdly, benchmarking and recognizing equivalence in corporate governance frameworks will facilitate mutual recognition of regulation between jurisdictions globally.
Starting with my first premise:
Globally today we see increasing evidence of what one might call a conceptual convergence of corporate governance. While we may not expect to see harmonization of corporate governance, there is increasing scope for jurisdictions to recognize equivalence in the effectiveness of another jurisdiction's corporate governance benchmarks or principles, and in the effectiveness of their enforcement regime. At the same time there are and always will be implementation differences.
Whether in the UK, US, Australia or New Zealand the elements of good corporate governance are obvious to all. They rest initially on elements of integrity, understanding roles and responsibilities, honesty and fairness, and transparency. All these issues are essential for fundamental trust and confidence in commercial dealing. As I noted above, from a securities markets point of view this is an important aspect of maintaining investor confidence in our capital markets. The fundamental aspects of corporate governance play a key role in corporate performance. It goes to the core of being able to attract investment both from local and international sources.
These elements are manifest in various ways in various jurisdictions. In some jurisdictions their history, jurisprudential background, commercial experiences, market structures and conditions and legal frameworks lead to an appetite for certainty which is referenced in a more rules-based approach to implementing corporate governance.
In other jurisdictions the power of the principles themselves, or a principles-based approach encourages drivers of good behaviours. Often there's a combination of rules- based and principles- based approaches. But all approaches are to the one end. That is, to drive and reward appropriate behaviour in the corporate sphere. Implicit in any system of good corporate governance is an understanding of the expectation of good behaviour, what that actually means, and the discipline of enforcement against those who fall short of the standards.
The different approaches to corporate governance are often reflected in different legislative provisions and structures. The Companies Act in New Zealand and the Corporations Act in Australia set out certain behaviours which are considered so invidious to good corporate governance and to the protection of investors that they are contrary to the law. The legislation is not identical but the general outcomes of behaviour are similar. The legislative provisions are bolstered in each jurisdiction by sets of principles or guidance which are developed by regulators to enable the directors of companies to deliver best practices and outcomes.
In my view these differences in the legislative provisions are not sufficient to undermine the confidence in the regulatory regime of the other jurisdiction.
The development of legislation or other regulatory approaches to corporate governance is often a product of the particular history or market conditions of the jurisdiction. Corporate failures, significant investor losses, egregious corporate misbehaviour, can all focus the legislative mind to a response which is directed to this domestic concern. The Sarbanes- Oxley legislation in the US is a clear example of this.
There was seen to be a need to shore up confidence in the US market in the aftermath of the Enron and World Com excesses and the response was predicable. When considering such a response the domestic legislature needs to be cognizant of the compliance costs imposed by such a response, the comparison with international norms, and the possible consequent choice of venue for issuers and investors when there are competing exchanges. The competition between the New York Stock Exchange or NYSE Euronext as it is now called, and the London Stock Exchange has many features, but regulatory differences between them have been cited as one element in this competition for listings.
The aggregation of various stock exchanges and the regulatory challenges this aggregation can elicit, may relate to differential listing and corporate governance requirements of issuers and other market participants, and to the appetite for issuers and investors for those requirements.
Take the example of the differing approaches from the US and the EU. The regulators of these economies are in close dialogue right now about increased regulatory cooperation and in particular about adopting a mutual recognition regime. I will come back to the topic of mutual recognition shortly.
As they explore mechanisms for closer regulatory co-operation, there is recognition that their legal systems and regulatory approaches are different. The other important aspect here is that there is an understanding of the histories and circumstances that lead to this divergent approach. As Christopher Cox, Chairman of the US SEC said at a US-EU Corporate Governance Conference late last year:
"The important point is that when it comes to securities regulation, differences in market structure will necessarily give rise to different problems, and it's up to the national regulator to diagnose and treat them.
For example, in markets with large blockholders, or markets where retail investment isn't common, regulators will naturally focus first on protecting minority shareholders from possible abuses by controlling shareholders. In other respects, they're more likely to take a ‘caveat emptor' approach to oversight. On the other hand, in markets with diffuse share ownership and heavy retail participation, regulators tend to focus on areas such as adjusting standards and internal controls, to help these shareholders guard their interests against possible managerial abuses. "
It is clear then, that due to the many histories and differences of jurisdictions around the world we cannot expect to see the evolution of a completely harmonized set of corporate governance principles or benchmarks.
But I do believe there is an increasing momentum and desire on the part of regulators around the world to be able to recognize and accept equivalence in the effectiveness of others' corporate governance frameworks as globalization of markets hastens.
My second premise is that the fundamental building blocks enabling this recognition of equivalence in corporate governance to occur do indeed exist around the world.
Benchmarks for good corporate governance exist around the world. These have been developed in many jurisdictions. Some are statute based, some are code based, others rely on a set of principles. The important point is that the various benchmarks of corporate governance enable practitioners, market participants, and regulators around the world to measure equivalence in corporate governance between jurisdictions.
One excellent example is the set of OECD Principles of Corporate Governance originally developed and agreed in 1999 and subsequently reviewed and amended in 2004. Theoriginal principles, one of the12 key standards for international financial stability of the Financial Stability Forum (FSF), were released in response to the growing awareness of the importance of good corporate governance for investor confidence and national economic performance.
They also form the basis for the corporate governance component of the Report on the Observance of Standards and Codes conducted by the World Bank. These Principles are intended to assist OECD and non-OECD governments in their efforts to evaluate and improve the legal, institutional and regulatory framework for corporate governance in their countries, and to provide guidance and suggestions for stock exchanges, investors, corporations, and other parties that have a role in the process of developing good corporate governance.
In New Zealand, the Securities Commission published a set of principles to give guidance to the market in February 2004, entitled Corporate Governance in New Zealand-Principles and Guidelines. The intention was to contribute to high standards of corporate governance in New Zealand, to be achieved when directors and boards implement the Principles through their structures, processes, and actions, and demonstrate this in their public reporting and disclosure. The Principles were developed taking into account the views expressed during an extensive process of public consultation. The Commission was assisted by other work done in New Zealand, in particular by NZX Limited, the Institute of Directors in New Zealand, and the New Zealand Institute of Chartered Accountants. It also drew upon international developments, particularly from the OECD, and in Australia, the United Kingdom, and the United States. The Principles are consistent with international practice and reflect the views of most people who took part in the project.
The Commission's corporate governance principles are intended to apply to entities of all types not merely issuers or listed entities.
They are not part of the law. Extensive consultation indicated to the Commission a definite lack of appetite in New Zealand for law based rules of corporate governance.
International research shows that fundamental aspects of corporate governance can play a key role in corporate performance. At the Securities Commission we have seen many examples which support this theory. Most cases of corporate failure and breaches of securities law are in the Commission's view at least partly attributable to a failure of governance at some point. Certainly in the work we have been doing recently in relation to failed finance companies we have seen many examples of what we consider to be poor governance issues:
These have included
My third proposition is that benchmarking and recognizing equivalence in corporate governance frameworks enables mutual recognition by international securities regulators. And that mutual recognition is emerging as a compelling solution for enhancing cooperation between regulators. This proposition will take me a little longer to explain!
I have talked already about differences between nations, which in turn lead to differing regulatory regimes and different approaches with corporate governance.
Again quoting Christopher Cox on the issue, he said:
"I am absolutely certain we can accommodate differences as we seek to increase regulatory cooperation around the world. But unless we keep in mind the reasons that legitimate differences can exist - and it's easy for us to forget that, in our increasingly globalized world - then the job of mutual cooperation will be made needlessly more difficult. Just because capital now flows across borders more easily, and businesses routinely operate on a worldwide basis, doesn't mean that a one-size-fits-all approach to securities regulation is wise. We've got to respect our differences as we build on common ground.
Recognizing that there are differences doesn't require us to give up on the idea that convergence can be achieved in many important areas, or on the idea that mutual recognition is possible after a degree of convergence has been achieved. "
He went on to note that in some cases, convergence and harmonization are the right approach; and in other cases, an intentionally different national approach is best; and sometimes simply offering investors a choice after full disclosure is the way to go.
Thus there are a number of ways for increasing regulatory cooperation globally, and I will elaborate on a couple of these shortly.
At this point I should mention the leading global body which promotes cooperation between regulators around the world. The International Organization of Securities Commissions known as IOSCO, is the global standards setter for securities regulation and the leading institution to foster international cooperation among securities regulators and affiliate organizations. I have the privilege to chair the Executive Committee, the governing body. IOSCO aims for regulators cooperating and exchanging information across borders, and aspires to seeing markets which operate across the world on sound and explicit principles and standards. It has a vision for globally operating markets that are fair, efficient and transparent, markets where investors are protected, and where systemic risk is reduced. It's members regulate some 95% of the world's securities markets and comprise regulators from 109 jurisdictions.
Operationally IOSCO has developed 30 broad Principles for securities regulation, and it actively promotes and facilitates the full implementation of these Principles in the regulatory framework of every member jurisdiction. To explain, the Principles do not constitute rules and regulations which if implemented would achieve convergence between regulators. They are rather a set of benchmark standards against which any jurisdiction is able to measure and align their own laws in a manner consistent with their own priorities, traditions, market developments and conditions and legal frameworks. They have been accepted as an international benchmark for securities and derivatives regulation.
To facilitate a mechanism for regulators to share information and co-operate to engage in effective enforcement across borders, IOSCO has also developed a Multilateral Memorandum of Understanding (IOSCO MMOU) to which members can sign up. The IOSCO MMOU is very specific about the types of information, such as banking and client records, that must be made available, and about the types of purposes for which the information must be made available. As signatories the securities regulators can gather information from their counterparts overseas on cases of insider trading or other securities law violations that they are investigating. There are currently more than 63 jurisdictions from around the world who have either signed on to the IOSCO MMOU or committed to making the changes necessary to do so, and IOSCO has set the bold objective of having all member jurisdictions signed up or committed to do so by 2010. More than half of those 63 jurisdictions are from emerging markets.
I mention IOSCO here because it is pivotal in bringing together securities regulators from around the world, and it's Principles and MMOU are fundamental building blocks to the achievement of cooperation among securities regulators in the global financial architecture. These provide the foundation for mutual recognition to occur, and I will come back to that shortly.
Returning to the different approaches for achieving regulatory cooperation, I noted that in some cases convergence is an appropriate mechanism and I'd like to share a concrete example with you.
That is, the work being done by the International Accounting Standards Board (IASB) towards a truly global set of high quality accounting standards. It has opened up a pathway in many respects for greater levels of convergence or co-operation across jurisdictions. The work towards the goal of a single set of global accounting standards, known as the International Financial Reporting Standards (IFRS) regime has been an ambitious and laudable undertaking, which has now gained global momentum, international recognition, and increasing commitment from around the world. The vision behind this is that a single worldwide set of standards will permit investors around the world to benefit from a high level of comparability and consistently high level of quality in financial reporting.
The engagement by the US in this harmonization project and the removal of the reconciliation requirement of US GAAP has greatly accelerated this project.
There remain ongoing challenges, for example with off-balance sheet entities such as Special Purpose Entities (SPEs) and with mark-to -market valuation issues in the context of illiquid markets, and these are all being addressed by the IASB.
As I noted not all standards and norms lend themselves readily to harmonization or convergence however. We might need to review other mechanisms and approaches for achieving the desired goals for the global financial system.
One thing, however, remains constant and that is that cooperation between regulators remains at the core of any solution.
An alternative system which is gaining increasing acceptance and building momentum is that of mutual recognition of securities regulation. There is increasing international acknowledgement of mutual recognition as a solution for effective regulation in the world of cross border trade.
To explain mutual recognition: Rather than envisaging standardized model frameworks across jurisdictions, mutual recognition allows domestic laws and regulations to reflect national imperatives while providing the capacity for cross-border cooperation and enforcement.
To work effectively, mutual recognition requires coordinated responses and consistent approaches to regulating cross border transactions. As a first step for achieving mutual recognition, one must agree on a common basis of principles on which to assess the effectiveness of foreign regulations and the work of the foreign regulator. I have already mentioned the IOSCO Principles and the MMOU in this regard.
A worldwide application of mutual recognition is still some way off. There have, however, been some exciting developments.
The US SEC announced in late March a series of actions to further the implementation of mutual recognition with a number of other countries. It has entered formal discussions for mutual recognition with the Australian Securities and Investments Commission, and has commenced processes aimed ultimately towards achieving mutual recognition regimes with Canada and also with the EU. From an industry perspective the EU-US Coalition (the Coalition) on Financial Regulation (a group of global financial industry associations) has noted mutual recognition as among the requirements necessary to form the basis for regulatory modernization.
In our own part of the world, New Zealand and Australia have just introduced mutual recognition of securities offerings. This regime allows our businesses to raise capital in Australia using NewZealand offer documents - and vice versa. Investors will also benefit from having a wider choice of investment opportunities.
The decisions of Australia and New Zealand to enter into this historic agreement on mutual recognition of securities offerings required the two jurisdictions, the Australian Securities and Investments Commission (ASIC) and the New Zealand Securities Commission and Companies Office to thoroughly canvass each others regulatory frameworks and to have confidence in the level of regulation and enforcement in each others jurisdictions. The role of corporate governance norms, the legislative framework and principles espoused in each jurisdiction were assessed. The stock exchange rules and other corporate governance frameworks were required to have equivalence before the agreement was entered into. While they are not identical the effect was considered generally equivalent for the purposes of mutual recognition.
Not only in the developed markets however are we seeing the application of this mutual recognition solution. A number of emerging markets are embracing the approach. One example is a voluntary opt-in scheme for mutual recognition of general/non-specialised collective investment schemes offered to non-retail investors developed through a working group of the IOSCO Regional Committee for the Asia-Pacific Region which was endorsed at that Committee's meeting in Seoul last November. This arrangement is currently open to IOSCO members from the Asia-Pacific region, which comprise a majority of emerging market economies, provided that specific requirements, including implementation or relevant IOSCO Principles, are met.
All these arrangements recognize the importance of local regulation applying to local markets and create mechanisms for consultation and cooperation between regulators.
What will be core to the effectiveness of arrangements based on mutual recognition is the level of trust in the capacity and willingness of the other regulators to enforce and cooperate. It requires a mutually acceptable legal framework, and a similar appetite to take action. Domestic regulators who wish to participate in mutual recognition arrangements will be compelled to look at their own regulatory arrangements and ensure that they have regulatory frameworks and enforcement capabilities in place that others would wish to mutually recognize. Under mutual recognition there would be true confidence in the regulatory frameworks of both jurisdictions. This framework can be extended to multiple jurisdictions.
A fundamental underpinning of any of those frameworks is adherence to the relevant IOSCO Principles and signing onto the IOSCO MMOU. Another important point to note is that the IOSCO benchmarks are very tangible: There are very clear and objective ways that such benchmarks can be measured. For example if a country was exploring mutual recognition of mutual funds in another jurisdiction, a pre-condition should be complete implementation of the IOSCO Principles relating to mutual funds and signature of the regulator onto the IOSCO MMOU. Equally important would be a calibration of the corporate governance framework of that jurisdiction and the satisfaction of the recognizing jurisdiction of its efficacy.
This leads me to outline a vision that some of us regulators have for the world's capital markets. My vision would see a mutually recognized network of multilateral and bilateral frameworks around the world, providing a regulatory net globally.
There is much work to be done to get there, but the process is well and truly on the way. However the point of this in respect of our topic today, is that I believe there is a core underlying foundation for achieving this vision, or for that matter for achieving progress towards such a vision.
Just as the IOSCO Principles and the MMOU provide a core building block to achievement of mutual recognition in providing standards against which equivalence in securities regulation can be measured, fundamental to the operation of any such system is the existence of good corporate governance within companies. In adopting mutual recognition with another jurisdiction it will be essential to be able to recognize equivalence in the effect of such jurisdiction's corporate governance rules, and the structures or elements within its systems that make corporate players within that jurisdiction behave properly.
Globally we cannot reach our aim unless the companies that are the players in the mutual recognition arena are governed by a good corporate governance framework. For instance New Zealand was comfortable embarking on a mutual recognition scheme in relation to securities offerings with Australia because we both had confidence in each others corporate governance framework.
I have discussed the OECD benchmarks, and they provide a very viable starting point or set of benchmarks for the recognition of equivalence in corporate governance systems around the world.
In any mutual recognition regime there will be the need to very carefully assess the appetite for enforcement of the corporate governance benchmarks in any jurisdiction. The mutual recognizing jurisdiction will want to be sure that the corporate governance regime is in place, working and in force. This all points towards ensuring one has trust in the corporate governance framework in the other jurisdiction.
In concluding I reiterate the very important place that the principles and practice of good corporate governance play in the global financial architecture. Healthy corporate governance around the world supports the delivery of the many benefits of global markets while continuing to provide strong investor protection.
A fully harmonized global set of corporate governance rules is a utopia which to my mind will remain out of reach. However, as the worlds markets continue to grow and integrate it is more important than ever that we find ways to recognize and trust in the efficacy of others' regulatory frameworks around the world. In the case of corporate governance principles while full convergence is not within our reach, we might quite realistically expect to see conceptual convergence albeit with implementation differences.
Just as with other parts of the regulatory architecture surrounding capital market activity around the world I remain very optimistic that a good many steps are being taken to further this. We know there are established benchmarks for good corporate governance. We now have formal mechanisms for increased co-operation and information exchange among regulators around the world through IOSCO, and its Principles and MMOU. We are seeing excellent examples of convergence where practicable, notably the introduction of IFRS. More and more momentum is building for mutual recognition of securities regulation.
I believe that regimes promoting good corporate governance around the world which are based on globally accepted benchmarks, and which are effectively enforced, coupled with a practice of recognizing equivalence between jurisdictions play a fundamental role in the growth and development of the world's capital markets. In this arena we therefore have a role to play in enhancing global prosperity and peace.
You can feel very proud of the contribution that this New Zealand Corporate Governance Centre will make to these global developments.