EBRD The Mongolian Cooperation Fund Improving Corporate Governance Legal Framework and Practice in Mongolia

Transcription

1 GBRW GBRW Limited 27 Throgmorton Street London EC2N 2AQ Telephone : Facsimile : mail@gbrw.com Website : pjlr/dt 12 th March 2004 Mr Hsianmin Chen Counsel, Legal Transition Team European Bank for Reconstruction and Development One Exchange Square London, EC2N 2JN By only Dear Hsianmin EBRD The Mongolian Cooperation Fund Improving Corporate Governance Legal Framework and Practice in Mongolia I have pleasure in enclosing the English version of the Action Plan as set out in the Terms of Reference for the above assignment. The Mongolian version is in translation and I will forward a copy to you as soon as I receive it. Copies in both languages will be delivered to Mr Bailykhuu for distribution to the SGH Working Group on Corporate Governance. Yours sincerely Paul J L Rex Managing Director Copies: Ms O Gerel, EBRD The Mongolian Cooperation Fund Mr N Ganbyamba, Member of the State Great Hural, Head of Working Group on Corporate Governance Mr D Bailykhuu, Secretary, SGH Economic Standing Committee Registered in England No Registered Office: IET House, Chestnut Close, Potten End, Berkhamsted, Herts HP4 2RN

2 GBRW LYNCH & MAHONEY This Project has been funded by EBRD The Mongolian Cooperation Fund Action Plan Improving Corporate Governance Legal Framework and Practice in Mongolia 10 th March 2004 GBRW Limited 27 Throgmorton Street London EC2N 2AQ Tel: Fax: GBRW was awarded GoodCorporation accreditation in A "GoodCorporation" is an organisation that has committed to good corporate behaviour and has passed an independent verification against the GoodCorporation principles. The verification process covers fairness to employees and associates; dealings with customers, suppliers and providers of finance; environmental protection issues; and contribution to the communities in which we operate.

3 CONTENTS A. INTRODUCTION... 4 B. EXECUTIVE SUMMARY... 6 An overview of good corporate governance... 6 Legislative and non-legislative issues... 7 C. REVISIONS TO THE CURRENT LEGAL FRAMEWORK AND OTHER LEGISLATIVE ISSUES... 9 Revisions to the Company Law of Mongolia... 9 Revisions to the State and Local Property Law Revisions to Tax Laws Adoption of Comprehensive Regulations Issues of Enforcement Training for Judges D. DEVELOPMENT OF A CODE OF CORPORATE GOVERNANCE E. ESTABLISHMENT OF A CORPORATE GOVERNANCE INSTITUTE Examples of institutes in other countries Other Corporate Governance awareness initiatives Education...19 Public awareness...20 F. THE ROLE OF THE BOARD OF DIRECTORS The Supervisory Board Minimum number of members of the Board of Directors Balance between Executives and Non-Executives How to define an Independent Director Board Committees Frequency of meetings The role of state as owner G. APPROACHES TO HELP REVITALIZE THE MSE Mandatory de-listing Conversion of JSCs to LLCs Consolidation of shares Other mechanisms for share consolidation Redemption price Representation of small shareholders The Foundation and the Corporate Governance Institute H. DONORS AND OTHER ASSISTING AGENCIES Assistance proposals from other donors or assisting agencies The roles that donors can play in facilitating the Action Plan I. WORK PLAN UPDATE Time line Action Plan Page 1

4 APPENDICES Appendix 1: Elements of Terms of Reference and where addressed in report Appendix 2: Description of previous studies Appendix 3: Work Guidelines of the SGHWG Appendix 4: Extracts from British Companies Act 1985 regarding auditors' duties Appendix 5: Examples of drafting to cover the concept of acting in concert Appendix 6: OECD Principles of Corporate Governance (January 2004 draft) Appendix 7: Closely held JSCs Appendix 8: Analysis of JSC shareholdings Appendix 9: Revised timeline Action Plan Page 2

5 Abbreviations used in this report BEOITL BOD BOM CCM CCP CLM DWS EBRD GBRW IFI JSC L&M LLC LRLE MOFE MOJHA MSE MSEC or Securities Committee NCLJR ROSC SGH SGHWG SLPL SML SPC Business Entity and Organization Income Tax Law Board of Directors Bank of Mongolia Civil Code of Mongolia Code of Civil Procedure Company Law of Mongolia Denton Wilde Sapte, London and Moscow European Bank for Reconstruction and Development GBRW Limited International Financial Institutions Joint Stock Company Lynch & Mahoney, Ulaanbaatar Limited Liability Company Law on Registration of Legal Entities Ministry of Finance and Economy Ministry of Justice and Home Affairs Mongolian Stock Exchange Securities Commission of Mongolia National Center for Legal and Judicial Research, Training and Information Review of Standards & Codes State Great Hural State Great Hural Working Group on Corporate Governance State and Local Property Law Securities Market Law of Mongolia Government of Mongolia State Property Committee Action Plan Page 3

6 A. INTRODUCTION 1. This Action Plan is the fourth Report prepared by GBRW Limited (GBRW), as lead firm for a consortium which includes Denton Wilde Sapte, London & Moscow (DWS) and Lynch & Mahoney, Ulaanbaatar (L&M). 2. We have previously delivered an Inception Report and an Assessment Report (see below). The Terms of Reference for this part of the assignment require us to draft an Action Plan to assist the SGH Working Group with its work for improving the corporate governance legal framework and practice in Mongolia. The specific tasks involved are: After the Assessment Report has been reviewed and commented by the SGH Working Group and the EBRD, the Consultant shall prepare an Action Plan to assist the SGH Working Group for improving the corporate governance legal framework and practice in Mongolia In preparing the Action Plan, the Consultant shall work with the SGH Working Group to: Analyse all corporate governance reports and reviews previously conducted about Mongolia; Identify and prioritise specific needs of the Mongolian Government: Review and discuss the objectives and goals of the Mongolian Government; and Review and discuss assistance proposals from other donors or assisting agencies concerning Mongolia The Action Plan shall, at the minimum, contain the following components: Briefing description of the analysis work conducted as required by Section above. Brief description of the issues and problems identified in various assessments; The Consultant s recommendations on specific revisions of the current legal framework to improve the conditions for corporate governance practice in the country; A reform agenda setting forth the concrete steps in priority order that should be taken by the Mongolian Government in order to improve corporate governance practice in the country; and The roles that donors and assisting agencies can play in facilitating the implementation of the Action Plan. 3. Appendix 1 sets out these elements and where they are addressed in this report. Action Plan Page 4

7 4. The assignment started during the inception visit in the week of 6 th October 2003, during which meetings were held with the State Great Hural Working Group (SGHWG), the Mongolian Stock Exchange (MSE), the Securities Commission of Mongolia (MSEC), the State Property Committee (SPC) and other interested parties, including Ministries, International Financial Institutions (IFIs) and other donor agencies. 5. Following the inception visit, the MSE and the SPC provided data on the Joint Stock Companies (JSCs) and State-Owned Enterprises (SOEs) which would form the target universe for our study of corporate governance practice. This information was analysed and summarised in the Inception Report dated 24 th October A second visit took place in the week beginning 17 th November, when two teams of consultants interviewed ten candidate companies. Seven of these were from the list suggested in the Inception Report and three new companies were substituted for the original suggestions, partly because of logistical difficulties (the original names were situated well outside Ulaanbaatar) and partly because of non-availability of management. 7. Analysis of the structured questionnaires used in the company interviews was contained in the Assessment Report dated 19 th December 2003 (although the finalised Mongolian version was only released on 15 th January 2004). 8. A draft Action Plan was delivered in the week beginning 26 th January A third visit took place in the week beginning 2 nd February The draft Action Plan was discussed with the SGHWG, the MSE, the MSEC and the SGH Secretariat. Meetings were also held with donors, including USAID (both the Economic Policy Reform and Competitiveness (EPRC) and Judicial Reform projects), the World Bank, the ADB, GTZ, JICA and EC Tacis. 9. This final Action Plan reflects feedback received in meetings held during the week beginning 2 nd February. Three of the main requests were that the Action Plan should focus on specific measures to be taken; that it should contain detailed recommendations; and that it should provide examples from other countries experience. For this reason, we have deleted some parts of the draft Action Plan and re-ordered others in order to provide a focused set of recommendations. 10. Sub-paragraph of the Terms of Reference requires us to provide an analysis of previous corporate governance reports and reviews. This analysis is contained in Appendix Sub-paragraph of the Terms of Reference also requires us to identify and prioritise specific needs and review and discuss the objectives and goals of the Mongolian Government. This discussion is contained in Appendix 3. Action Plan Page 5

8 B. EXECUTIVE SUMMARY An overview of good corporate governance 12. Before discussing specific corporate governance issues, we believe it is important to take a step back and look at the concept of good corporate governance from its broadest perspective. As indicated on the diagram overleaf, the adoption of good governance practices is one factor that contributes to the building of investor confidence in a company. Confidence is the key factor in all business relationships. However, confidence is not something that can be legislated - no law or regulation can dictate that an individual must have confidence in a particular company. A solid legal environment, characterized by rational law and regulation, coupled with their fair and transparent implementation are key factors that will help to build confidence. Confidence derives from a basket of factors that will be analyzed by each individual investor. An investor who has enough confidence in a company will be willing to invest; investors who lack such confidence will not. The higher the level of confidence in a company, the greater the price an investor will pay for an ownership stake, and the lower the rate of interest a lender will require when lending to such company. 13. The diagram also demonstrates how good corporate governance practices intersect with regulation under the securities laws and with the listing of a company on a stock exchange. A recurring point made in our action plan concerns the "carrot" versus the "stick" approaches 1 that could be utilized to promote good corporate governance practices in Mongolia. By the carrot we mean the benefits that can accrue to a company that implements good corporate governance practices, being primarily the boost which this gives to investor confidence, which in turn leads to easier access to cheaper capital. While the Mongolian Stock Exchange may not be a viable source of capital at the present time, the development of investor confidence will assist companies to raise capital privately from foreign and domestic banks and equity investors. 14. Simply put, it should not be forgotten when analyzing the issues covered by our series of reports that the adoption of good corporate governance practices is in the best interest of companies and company managements should therefore be strongly motivated to adopt them. Companies that do so should survive and grow, while companies that do not should over time wither and die. Having said this, there still remains a necessity for the establishment of minimum legal requirements concerning issues of corporate governance together with enforcement mechanisms that can force companies to meet these requirements (in other words, the stick). 15. Our recommendations contained in this Action Plan reflect this philosophy. There must be minimum standards which, in the case of those who fail to comply, will be enforced. But the goal is to develop a culture that recognizes the virtues of the voluntary adoption of good corporate governance practices which exceed the 1 The terms derive from the two methods used to motivate a horse or donkey a carrot held in front will pull the animal forward while a stick applied from behind will push it. Conventional wisdom is that the carrot is more effective and requires less effort than the stick! Action Plan Page 6

9 Action Plan Page 6A

10 minimum legal requirements. Development of this culture will be most effectively promoted through private initiatives utilizing carrot approaches. Legislative and non-legislative issues 16. Our Assessment Report identified two categories of issue to be addressed: The first of these involves specific revisions of the current Mongolian legal framework in order to improve the conditions for corporate governance practice in the country The second area consists of a series of concrete recommendations for steps to be taken by the Mongolian Government in order to improve corporate governance practice. 17. In this Action Plan we propose seven initiatives: A small number of changes to existing legislation; Creation of a Code of Good Corporate Governance adapted to Mongolia s situation and needs; Development of an Institute of Corporate Governance; Development of corporate governance education and training programmes; Launch of a corporate governance public awareness programme; Promotion of the role of independent directors; Steps to deal with the some of the issues which currently hamper the MSE, which does not function as an effective securities market at present. 18. Of these seven initiatives, only one relates to changes in legislation. We have discussed at length in a number of our meetings whether new legislation or nonstatutory measures are the most effective means of changing the behaviour of the parties involved in corporate governance, especially company directors. We believe that the non-statutory measures which we recommend are likely to prove most effective and have set out the reasons why we believe so in the relevant sections of this Report. 19. The Action Plan deals with problems and recommended solutions. However, we feel that it is important not just to focus on negative points but also to highlight a number of positive elements which are currently focusing attention on the benefits of good corporate governance. A number of these are anecdotal and based on discussions with private business groups which have not formed the principal focus of our study. They include: A number of rapidly growing private groups see the need to raise additional equity in the medium term, as they reach the limits of investment which can be financed by bank debt. This view is strengthened by the high real cost of bank debt in Mongolia, to which we have referred in earlier reports. Action Plan Page 7

11 19.2. Some companies are considering Initial Public Offerings (IPOs) in markets outside Mongolia, for example Mobicom, which is looking at a possible IPO in Hong Kong or Shanghai Some closely held JSCs may see a family-dominated Board of Directors (BOD) as an obstacle to expansion. In such situations, a more rigorous corporate governance regime may create possibilities for replacing ineffective directors with outside expertise. 20. Section C of this Action Plan contains detailed recommendations on specific revisions of the legal framework, as well as a discussion of enforcement issues. 21. Section D discusses the approach to formulating a Code of Good Corporate Governance. 22. Section E issues discusses the steps involved in establishing an Institute of Corporate Governance, developing programmes of education and training in corporate governance, and launching a public awareness campaign in respect of corporate governance issues. 23. Section F discusses the role of independent directors, as well as the wider issues involved in the effective functioning of a Board of Directors (BOD). WE also discuss here the role played by the SPC and the potential opportunities that this creates to promote good governance practices through the example of SPC appointees. 24. Section G describes our recommendation on measures which can assist in the revitalization of the MSE, including approaches to reduce the existing number of Joint Stock Companies (JSCs) and development of measures to protect the interests of minority investors during this process. These will reduce the current administrative burden on the MSE, and thereby enable it to focus its attentions on a smaller number of larger listed companies and on developing a real market in the shares of those companies. However, revitalisation also depends on a number of other factors, not least the development of institutional investors and economic factors that encourage equity investment. 25. We believe that each of these steps could be initiated in The timescale for the work involved in implementation would be as follows: Revisions to legal framework Code of Good Corporate Governance Corporate Governance Institute - setup CG Institute - operation Education and training programmes Public awareness campaign Independent directors Measures to help revitalize the MSE Action Plan Page 8

12 C. REVISIONS TO THE CURRENT LEGAL FRAMEWORK AND OTHER LEGISLATIVE ISSUES 26. The legal framework relevant to corporate governance issues includes both law and regulation as well as mechanisms available for enforcement thereof. In our view focus should be placed at this time on the development by the relevant Mongolian Ministries and Agencies of comprehensive implementing regulations and on the development of viable enforcement mechanisms. 27. As noted in the Assessment Report, it is our general view that the existing laws of Mongolia provide a rational and comprehensive corporate governance regime. As also noted above in the summary of conclusions reached in prior Mongolia-related reports (see Appendix 2), one problem area is the perception by investors of an unstable legal environment in Mongolia. This perception is fuelled by the constant revision of Mongolia's laws. 28. Therefore, our suggested revisions to Mongolian laws have been prepared with an objective to minimize revisions and to only identify those that we deem to be either necessary or strongly advisable. The relevant provisions, and the reason for revision, are identified below. It is beyond the scope of this report, however, to provide specific language for such revisions to the law. This approach reflects our view that the most effective mechanisms for dealing with the problems currently facing JSCs are those set out in the following sections of this Report and we discuss at a number of points the arguments in favour of a non-statutory approach instead of further legislation. 29. Following the discussion of potential revisions to existing laws, this section of the report will address issues of regulation and enforcement. Revisions to the Company Law of Mongolia 30. As identified in our Assessment Report, it is our opinion that the following provisions of the CLM require revision: Article 63.1 and revise to provide that the shareholders of the company appoint the external auditor and that the auditor reports to the existing shareholders of the company and not to the board of directors. This change clearly establishes that the auditors have a legal responsibility to the shareholders who are the owners of the company. As a result, the auditors have to report to the shareholders directly if, for example, they resign from carrying out a company s audit because of dissatisfaction with management s accounting policies. In practice, the BOD will still select auditors and negotiate the terms of their appointment. However, the BOD will then have to propose them for the shareholders approval at the annual meeting. In practice also, the auditors will submit their report to the company, which will circulate it to the shareholders with the Annual Report and accounts Appendix 4 contains extracts from three sections of the British Companies Act 1985 regarding the auditors' report, its signature and auditors' duties in relation to it. (Separate sections of the Act deal with the appointment, resignation and removal of auditors.) Whilst British law is consistent with EU Action Plan Page 9

13 law generally, there is some difference in practice between the laws of the different EU member states. Thus, for example, auditors in Germany are required to report on the adequacy of internal controls Article 67.1 revise to permit any shareholders who in aggregate hold 2% or more of the company's common shares (not only 5% shareholders) to nominate candidates for election to the Board of Directors. Whereas 5% is a reasonable threshold for most resolutions, we consider that the combination of the requirements for a minimum board size of nine directors, for re-election of those directors at regular shareholders' meetings, and the use of cumulative voting at such elections, means that a nomination threshold considerably less than the required voting threshold of 11% required for a board seat under cumulative voting is appropriate. In Russia, for example, the threshold is 2%, and we believe that this has worked reasonably well. We would certainly recommend against a threshold higher than 3%, but could contemplate a threshold lower than 2%; Article revise to grant to all shareholders the right to obtain from the company a list of all shareholders (currently only 10% shareholders have this right), as this provision discriminates against small shareholders who should have the same rights as larger shareholders to obtain a list of the shareholders of the company in which they hold shares; Article 97 - revise to incorporate the concepts of beneficial ownership and persons acting in concert. At the request of the MSEC, we have included in Appendix 5 the following examples of drafting used to cover the concept of acting in concert, in various provisions related to transparency of corporate control and trigger points for mandatory bids under takeover legislation: extracts from European Union Directive on Information to be Published when a Major Holding in a Listed Company is Acquired or Disposed of (Directive 88/627/EEC), in particular Articles 1.1, 4.1, 7, and 8; extracts from a published draft of the EU's Takeover Directive (that directive was agreed by the European Parliament in December 2003 and is now subject only to final approval by the EU's Counsel of Ministers) Article 2 Definition of "persons acting on concert"; extracts from the UK's well known City Code on Takeovers & Mergers (the "Takeover Code") in particular the key rule 9.1, the definition of the term "acting in concert" used in that rule and associated notes on the rule and that definition; extract from the Russian federal law on monopolies and anti-monopoly activities definition of "the persons acting in concert"; and In view of the length and technicality of these provisions, we have not translated them from English. We believe that similar concepts have been used in a number of Asian jurisdictions, for example in Hong Kong, Malaysia and Singapore. Action Plan Page 10

14 30.7. Article 9.4 and delete these provisions which provide unlimited liability to shareholders as the circumstances in which such liability attaches is too vague, which may discourage some persons from investing in Mongolian companies if there exists a potential of unlimited liability attaching to their investments. This is an issue that is raised frequently by foreign investors contemplating an investment in Mongolia. While practical experience to date is that these provisions have not substantially limited investment in Mongolia, there is no doubt that the first time unlimited liability is imposed on an investor under these provisions, the investment community (primarily foreign investors) will be informed of such action and will react in a strongly negative manner (by withholding future investment). Revisions to the State and Local Property Law 31. Revise Article 21 of the SLPL to delete the SPC's authority to directly appoint members of the board of directors of companies with State ownership. This power is inconsistent with sound practices and singles out the State as a shareholder with special privileges. The State can obtain the same end-result by participating in the election of directors at the annual shareholder meeting. In the case of JSCs, the requirement of cumulative voting for directors ensures the State of the same proportionate representation. With respect to LLCs, the charters of companies with State ownership can be amended to provide for the cumulative voting method. Revisions to Tax Laws 32. Delete the portions of paragraph of the BEOITL that permit the Government to force companies with State ownership to pay dividends at a time and in an amount determined by the government. This provision is inconsistent with the CLM and with good corporate governance practices. If this change is enacted, the Government will still be able to receive dividends, not least because it will have influence over the appointment of at least some of the directors, but declaration and payment of such dividends would be in accordance with the proper financial cycle of the company concerned. We would highlight the basic principle that all directors must eschew conflicts of interest when participating in board decisions, and have regard only to the company's interests when acting as directors. Adoption of Comprehensive Regulations 33. As noted previously in the Assessment Report and elsewhere in this report, it is our opinion that the focus of any revisions to the legal regime should be placed on adopting comprehensive regulations governing corporate governance issues. Regulations: are promulgated at the Ministry/Agency level where there will be the highest degree of understanding of, and experience handling, the relevant issues; are designed to address relevant issues in more detail than the law; and allow for more flexibility as they can be quickly amended by order of the relevant Ministry/Agency, whereas amendments of law require the involvement of the SGH. Action Plan Page 11

15 34. In the context of corporate governance the primary regulating bodies are currently the MSE and the MSEC. It is our opinion that these entities would benefit from training programs (discussed in more detail later in this report) that would also assist with the drafting of regulations. In addition, these bodies may also welcome direct assistance in the drafting of relevant regulations from foreign experts. This is an opportune time to undertake this work in light of the recent adoption of a substantially revised SML. 35. In the drafting of regulations the relevant entities should use care to ensure that such regulations do in fact supplement the law and do not (i) contradict the written laws or (ii) attempt to implement policies that are not authorized by law. 36. It is also recommended that in connection with the preparation of regulations the relevant entities solicit input from the non-governmental parties that will be most affected (i.e. Mongolian companies, lawyers, stockbrokers and shareholder groups). Issues of Enforcement 37. As noted elsewhere, our conclusion is that the basic tools are already available for the establishment of good corporate governance practices in Mongolia. While we believe that incentives for voluntary compliance (the "carrot") are the better way to obtain compliance, there must of course also be a stick available to compel compliance where necessary. 38. Enforcement can be seen in two contexts. The first is the enforcement of law and regulations by government bodies so empowered. The second is the enforcement by individuals of their private rights, typically in the courts. 39. The two most active government entities in the area of enforcement of good corporate governance practices are the MSEC and the MSE. In addition the Bank of Mongolia (BOM) enforces provisions of the Banking Law applicable to commercial banks. Enforcement includes the ability to compel compliance as well as the ability to assess fines on non-complying companies. At present the BOM has significant powers with respect to commercial banks and is relatively active in using its powers. 40. As a background comment to the issue of enforcement, we should note that at present in Mongolia there is a lack of distinction between a JSC and a listed company, since all JSCs are listed on the MSE. In our view, the MSE and the MSEC should pursue different goals with different groups of companies (although there will be some overlap) The MSE's focus should be on the development of the MSE as a viable investment alternative for Mongolian companies and investors. This role requires the establishment of strict listing criteria and the enforcement thereof. As illustrated in the securities market diagram above, the goal of the MSE should be to make the listing of a company an indication of a particular status - a sign that the company meets high standards of disclosure, has independently audited financial statements and implements good corporate governance practices in other words, that such a listed company is in the first tier of Mongolian companies. The goal is to develop investor confidence. Companies that are listed should be companies that want to be listed. The MSE should be working with this focused group of companies, as a partner Action Plan Page 12

16 adding value to such companies and to the Mongolian economy. This carrot role of the MSE is also consistent with the plans to privatize the MSE The MSEC is the stick. It is the role of the MSEC to oversee the enforcement of Mongolian law over listed and unlisted JSCs. The MSEC's primary activities (in addition to its work with brokers and with the supervision of public offerings of shares) will be dealing with uncooperative companies that do not comply with the minimum legal requirements. 41. Article 34 of the SML probably grants sufficient enforcement powers to the MSEC. However, as the SML only came into effect from 1 st January 2003 the parameters of such powers and the practicalities of their use have not yet been tested. The MSEC probably needs to become more proactive in using these powers. Training programs would be of benefit in assisting the MSEC in this task. 42. As noted in the Assessment Report, in late 2003 the MSEC published in many Mongolian newspapers a notice informing the public that the powers of the boards of directors of many companies had terminated (automatically under the CLM) due to their failure to hold annual general shareholder meetings in We believe this to be a very positive action and encourage the MSEC to continue with these types of actions. 43. One tool missing from the MSEC's toolbox is the authority to impose significant monetary fines on non-complying companies. At present the maximum amount that the MSEC can fine a company under the SML is MNT 250,000. This amount should be raised to a level that will obtain the attention of offending companies. 44. An additional enforcement mechanism would be to give the MSE the power to de-list companies that do not comply with relevant law and regulations. While the threat of de-listing a company carries great weight in most countries, given the current realities of the MSE de-listing may not be a sufficient incentive to compel compliance by many companies at this time. The hope is, however, that over time the MSE will become a more active entity and will offer a source of capital to Mongolian companies thereby bringing significant value to a listing. 45. With respect to the enforcement by individuals of their rights, later sections in this report discuss educational initiatives that will be important to raise the level of understanding of the general population as to their rights as shareholders. 46. The biggest obstacle we have identified to the effective private enforcement of shareholder rights in the courts is the current relatively low level of understanding among Mongolian judges and legal practitioners with respect to the CLM, the SML and many of the concepts underlying good corporate governance standards. This is understandable given that both of the relevant laws have only recently come into effect. The remedy to this problem is training, as discussed later in this report. 47. In addition, court enforcement of private rights is subject to many of the problems faced by all litigants using the Mongolian court system. These problems have been fully described and analyzed in other reports. Remedies are being addressed by the government and foreign donors. It is our opinion that the court system, with all its Action Plan Page 13

17 faults, nonetheless offers at this time a viable mechanism for the enforcement of minority shareholder rights. 48. Another obstacle to individuals enforcing their rights privately is the current structure of shareholdings in most companies and the fact that most minority shareholders hold a very small number of shares and do not have the financial resources or sophistication necessary to initiate court cases. Later in this Report we discuss the possibility of pooling the votes of these small shareholders under professional financial managers who will have the necessary resources and expertise to represent their rights as minority shareholders. 49. A second possibility, noted in our Assessment Report, is the establishment of a mechanism to fund court cases to be brought by low-income minority shareholders. The Soros Foundation is presently working on such a project. The Soros project, however, has a broad mandate to consider all kinds of court cases (of which the enforcement of minority shareholder rights is probably not of the highest priority). An option is to approach other donors to obtain funding for a project specifically devoted to the financing of court cases initiated by low-income minority shareholders that promote good corporate governance practices. This funding would also be used to finance a public relations component that would inform the public as to the issues in the case and the progress of the court case. A few successful, well-publicized minority shareholder court victories would do much to obtain the attention of other offending companies. Training for Judges 50. The ability of minority shareholders to enforce their rights in Mongolia's courts is essential to the development of good practices. Court action is one of the sticks that can be used to encourage good corporate governance practices. In this connection, it is key that Mongolia's judges have a sound understanding of international best practices on corporate governance and how such practices are supported by Mongolian law, in particular the Company Law of Mongolia. 51. Perhaps training is this regard can be incorporated into existing judicial reform/judicial training programs presently operating in Mongolia. We recommend the SGHWG should investigate the available options. 52. Training programs should also be developed for personnel at the MSE and the MSEC. Much of the domestic training programs for these persons can be co-ordinated with judicial training programs or training courses being offered to company officials. 53. In addition, overseas training courses for Mongolian judges and regulators may be of benefit. Attendance at these courses would require either donor funding or funding from overseas institutions. For example, training programs available at foreign stock exchanges or with foreign country regulators should be investigated. However, we should add that domestic training courses conducted by international experts are generally more cost effective than overseas courses, so the latter should be used very selectively. 54. An additional area of judicial training/court reform pertains to bankruptcy issues. Given the complex nature of bankruptcy cases and the specialized skills (financial Action Plan Page 14

18 and accounting) needed to understand the relevant issues, thought should be given to establishing separate bankruptcy courts or designating specific judges in each judicial district who would be responsible for bankruptcy cases filed in that district. The relevant personnel will require extra training in order for them to be able to properly handle these complex cases. D. DEVELOPMENT OF A CODE OF CORPORATE GOVERNANCE 55. We recommend that a non-statutory Code of Corporate Governance be developed and promoted in Mongolia, and arrangements be made to publicise it and encourage understanding and compliance. This initiative is an important precursor to the establishment of an Institute for Corporate Governance, which we discuss in the following section. We see development of the Code as being one of the initial priority tasks arising from our recommendations. 56. We also recommend the code should be developed under the umbrella of the SGH's Corporate Governance Working Group to ensure that the key constituencies buy into the process, as this will be key to its subsequent successful implementation. 57. There are clear benefits in having a Mongolian Code of Corporate Governance: It would enhance the corporate governance regime in Mongolia without requiring detailed new legislation and in a way which is flexible It would help support existing corporate governance standards, as enshrined in legislation, by espousing key principles of governance It could close some of the gaps and clarify ambiguities in existing legislation It could enhance standards in particular areas without depending on new legislation being passed to do so It would allow for regular review and further development of corporate governance standards without new legislation being required each time If, as we would recommend, there were widespread involvement in the development of the code by stakeholders (including directors and officers of major Mongolian companies), there would be a degree of "buy-in" to the end product (the Code) which should encourage greater compliance than there is sometimes with legislation in which various stakeholders have not been involved It should result in a wider range of stakeholders (particularly board members) accepting responsibility for the nation's corporate governance standards. 58. Non-statutory codes of practice have become increasingly common worldwide in various areas of commercial life. Major failures of corporate governance in recent years have encouraged not only legal reform but also more widespread adoption of codes of corporate governance. In many countries, listed issuers have long been expected to comply with corporate governance standards beyond those in the Action Plan Page 15

19 company law, and these have frequently been set out in exchange rules or listing rules, or in non-statutory codes. 59. In the UK, obligations imposed under listing rules have for more than ten years been further supplemented by a non-statutory code, which has been recently updated. New codes have recently been adopted in, for example, the Netherlands and (supported by the EBRD) in Russia. Whilst the United States in contrast is regarded as relying more on law than non-statutory codes, many of the obligations on publicly-traded or exchange-listed companies there are imposed not in primary legislation but through SEC regulations or rules, or exchange rules (such as those of the New York Stock Exchange). 60. A disadvantage of the non-statutory code can be the lack of enforcement capability. This can be addressed in various ways. For example, exchange rules may require compliance, or individual directors and officers may be required by their professional institutes (if they are members of such bodies) to act in accordance with the code and face disciplinary measures if they do not. Mechanisms can be established to announce publicly the names of companies or individual board members or others found to have breached the code ( naming and shaming ). 61. One of the benefits of a non-statutory code is the potential flexibility which it can allow in appropriate cases, and this may be reflected also in the enforcement mechanism. Thus, a code can improve standards to a degree, but accept that there will be cases from time to time where a particular rule is inappropriate. A "comply or explain" mechanism which forces/encourages companies to comply with the code or to explain the reasons why they are not complying, can then allow shareholders and others to assess for themselves whether those reasons are valid and this in turn will have an impact on their response. 62. Increasing shareholder activism globally, but particularly in the United States and Western Europe, means that breaches of corporate governance standards can adversely affect the company or, more pertinently, its Board members. Major shareholders may work together to oust chairmen and chief executives who have abused their positions, for example. Clearly Mongolia does not yet have the institutional investors who can perform such activist roles, and some of our recommendations below may lead to the development of institutional investors in Mongolia. Nevertheless, even without such investors, the adverse publicity which can result from determinations of non-compliance could be a potent weapon in encouraging compliance with a non-statutory code. 63. In developing a Code of Corporate Governance, a variety of models and sources could be considered. Mongolia could look to European models or to the recent Russian code. Our recommendation is that Mongolia develop a corporate governance code based on the Principles of Corporate Governance promulgated by the OECD. These Principles have been developed globally, and widely discussed across Asia (by the OECD Asian Roundtable on Corporate Governance), leading to a recently republished revision which takes into account feedback from Asia and from developed and emerging markets elsewhere. We attach a copy of the latest OECD draft (in English) as Appendix 6. Action Plan Page 16

20 64. The OECD Principles have the advantage of being non-prescriptive in terms of the means of achievement of the objectives which they pursue, although some of these may be difficult to achieve without legislation. However, given that our review of Mongolian legislation has (broadly) been benchmarked against these principles, key gaps are largely identified above (in our recommended legislative changes) and in our earlier Assessment Report (where we identify shortcomings in legislation). The OECD Principles do not propose a particular model of good corporate governance; they recognise that different corporate governance models can work to achieve similar objectives and common principles apply in countries with quite distinct legal frameworks and cultures. The OECD principles would therefore provide a firm foundation for the development of a Mongolian code. 65. We should highlight an important point, that the Code of Corporate Governance and its development are a means to an end not an end in itself. By this, we mean that the emphasis should be on ensuring that any code agreed is capable of practical implementation in Mongolia. The aim is not merely to produce a document to satisfy what is perceived as international best practice. 66. One alternative to a code which we have considered would be the development of a model form of by-laws enshrining high standards of corporate governance. Although this has the advantage of ease of implementation by companies (because they don't have to "translate" a more general code into specific by-law provisions), it has the major disadvantage of potential rigidity. However, we see no objection to development of model by-laws to supplement a code. E. ESTABLISHMENT OF A CORPORATE GOVERNANCE INSTITUTE 67. Achieving good corporate governance involves much more than passing relevant laws. Beyond that it depends not only on compliance with those laws, but also on broad acceptance of the principles and spirit underlying good governance. A high level of compliance is unlikely to be achieved unless those responsible for delivering it (particularly directors and officers, legislators, and regulators, investigatory and enforcement authorities, and the judiciary) understand those principles and know or have ready access to knowledge of the required standards. 68. To support the process of promotion and implementation, we recommend the establishment of an institute focused on the improvement of corporate governance. To achieve critical mass and credibility, we believe that it will be necessary to ensure buy-in by a wide range of parties, including the corporate community. It is important that the corporate governance environment does not become factionalised, with rival bodies developing and promoting competing initiatives. That way would lie inefficiency and ultimately failure. The parties involved could include: The Mongolian banking association; The Auditors Association; The Accountants Council and Institute of Professional Accountants; The Mongolian Chamber of Commerce and Industry; Action Plan Page 17

21 68.5. The Association of Private Entrepreneurs; Individual banks and corporates (especially the larger players in the market). 69. Another possibility would be to seek the support of the Asian Corporate Governance Association (see below) in setting up a branch or affiliate in Mongolia, perhaps in cooperation with the parties mentioned in the previous paragraph, and with donor support. 70. We note that the majority of these corporate governance stakeholders are already represented in the membership of the SGH's Corporate Governance Working Group. We therefore recommend that that the SGHWG should take the initiative in taking soundings amongst the potential corporate governance stakeholders and act as a point of contact for soliciting donor support for the establishment of a Corporate Governance Institute. 71. A Corporate Governance Institute would perform a number of roles: Lead the development of the code of corporate governance Essentially support this with further guidance, for example, a handbook for company directors, a model form of job specification for company secretaries and a model form of company charter or by-laws Organise seminars, conferences, workshops and other gatherings on corporate governance issues Develop an education and training programme for existing directors and other officers (such as company secretaries and in-house lawyers) Develop corporate governance qualifications and courses for individuals seeking a career in business management. In order to avoid the risk of becoming overstretched, we recommend that the Institute work with other providers of business management courses and qualifications to facilitate the inclusion of corporate governance modules Grant, or validate, these corporate governance qualifications Working with educational institutions to help develop specific corporate governance education and training modules Acting as a sounding board for government and parliamentary initiatives in relation to corporate laws and regulations Developing ideas for formal amendment of corporate laws where appropriate Working with other professional institutes, trade associations, etc. (including but not limited to those which have sponsored or established the institute) to promote good corporate governance Working with the MCCI (or other involved parties) to launch a "good corporate governance" award as suggested below Action Plan Page 18

22 72. A Corporate Governance Institute could also act as a point of contact for donor initiatives in this field, matching opportunities for training, seminars and conferences with candidates from the groups referred to in the previous paragraphs. 73. We should also add some notes of caution. Institutes of this type (especially when supported heavily by donor funding) can frequently become inward- rather than outward-looking, with the result that they become more focused on meeting the interests of their own management than on the market which they are intended to serve. For this reason, we recommend that development of a corporate governance code should precede the formation of the Corporate Governance Institute. The process of building consensus during the evolution of the corporate governance code should hopefully lead to stronger and more broadly-based support (both financial and otherwise) for an Institute. Such consensus development should also ensure that the Institute is led by the business community which it will serve, as experience has demonstrated that this is critical for the long term sustainability of any such organisation. Examples of institutes in other countries 74. Many countries have institutes which are wholly or mainly concerned with corporate governance issues. Examples include the National Association of Corporate Directors and the American Society of Corporate Secretaries (both in the US), the Institute of Corporate Directors and the Canadian Society of Corporate Secretaries (both in Canada), and in the UK the Institute of Directors and the Institute of Chartered Secretaries and Administrators (ICSA). The ICSA has branches in Hong Kong, Malaysia and Singapore. 75. Malaysia also has its own Institute of Corporate Governance (MICG) which, like many corporate governance focus bodies in Asia, has participated in the OECD/World Bank Asia Corporate Governance Round Table. There is also an Asia Corporate Governance Association founded in late 1999 as an independent, nonprofit membership association, funded by a network of sponsors and corporate members (primarily financial institutions). It has become significantly more active in the last two years. Details and examples of Asian codes may be found at Other Corporate Governance awareness initiatives 76. We believe that compliance with existing corporate governance requirements and with any new code would be significantly enhanced if stakeholders were more familiar with those requirements. This is particularly important for members of corporate boards (who are supposed to deliver compliance) and for those such as judges and regulators who are involved in the enforcement process. However, it would be helpful too if shareholders (and indeed the public in general) were more familiar with how companies do and should operate: hence our recommendation also of a public awareness campaign. Education 77. So far as corporate board members and other officers are concerned, we believe that there is a need for education and training of various kinds. Existing board members Action Plan Page 19