ASIAN DEVELOPMENT BANK R191-00 12 September 2000 TECHNICAL ASSISTANCE TO INDONESIA FOR CORPORATE GOVERNANCE REFORM The attached Report is circulated for the information of the Board. The President approved the technical assistance on 29 August 2000. For Inquiries: Mr. K. P. Kriegsmann, Infrastructure, Energy and Financial Sectors Department (East) (Ext. 6310) Mr. P. Spantigati, Programs Department (East) (Ext. 6206)
ASIAN DEVELOPMENT BANK TAR: INO 34116 TECHNICAL ASSISTANCE TO THE REPUBLIC OF INDONESIA FOR CORPORATE GOVERNANCE REFORM August 2000C
CURRENCY EQUIVALENTS (as of 22 August 2000) Currency Unit Rupiah (Rp) Rp1.00 = $0.000124 $1.00 = Rp8,085 The exchange rate of the rupiah is under a system of free float. ABRREVIATIONS ADB Asian Development Bank BOD board of directors BOC board of commissioners BAPEPAM Badan Pengawas Pasar Modal (Capital Market Supervisory Agency) NCCG NGO National Committee on Corporate Governance nongovernment organization BAPPENAS Badan Perencanaan Pembangunan Nasional (National Development Planning Agency) MOIT Ministry of Industry and Trade MOJ TA Ministry of Justice Technical Assistance NOTES (i) (ii) The fiscal year (FY) 1999/2000 of the Government ends on 31 March 2000. The subsequent fiscal years will end on 31 December. In this report, $ refers to US dollars.
I. INTRODUCTION 1. Inadequate corporate governance and prudential regulations and their weak enforcement in financial markets are among the key reasons for the extent and severity of the Asian economic crisis, particularly in Indonesia. Prospects for a return to financial stability in Indonesia will depend on its ability to reduce inherent investment risks to manageable levels by strengthening the legal and regulatory regimes, enhancing accountability and transparency, ensuring impartial enforcement of commercial laws and regulations, and streamlining company incorporation and registration processes. During the Asian Development Bank s (ADB) Country Programming Mission, the Government requested technical assistance (TA) to assist the National Committee on Corporate Governance (NCCG) in designing and formulating a corporate governance reform program for adopting, disseminating, and enforcing corporate governance standards and practices. The Fact-Finding Mission, fielded between 11-19 April, reached an understanding with the Government on the objectives, scope, cost estimates, and implementation arrangements of the TA. 1 The TA framework is attached as Appendix 1. II. BACKGROUND AND RATIONALE 2. The introduction of sound corporate governance standards and practices involves setting in place a broad set of structures, procedures, and incentives that empower managers to create shareholder value under adequate supervision in a transparent environment and with adequate accountability. The Indonesian Government has implemented several reform measures to start improving corporate governance. These include: (i) (ii) (iii) (iv) the introduction of new capital market regulations in 1998 to allow new shares to be directly offered to the public, protect minority shareholders, and allow listed companies to buy back up to 10 percent of their issued shares; the formation of the Indonesian Debt Restructuring Agency and the Jakarta Initiative Task Force to assist companies with debt restructuring; the introduction of new tax regulations to eliminate obstacles for mergers, debtto-equity conversions, and other corporate restructuring schemes; and amendments to the Bankruptcy Law and setting up of special commercial courts to handle bankruptcy cases. 3. Indonesia already has a comprehensive legal framework for corporate governance. The Civil Code, Commercial Code, and Company Law and its regulations provide the legal and regulatory framework for the establishment, operation, and dissolution of companies with limited liability, and the rights, liabilities, and responsibilities of shareholders, managers (directors), and supervisors (commissioners). Securities issuers, and public and listed companies are subject to capital market laws and regulations. The Company Law applies to listed companies, except where capital market regulations prevail. While the legal framework is in many respects sound, deficiencies in the form of incomplete or inadequate specifications of specific laws and their implementing regulations are an impediment to the efficient operation of firms and to effective internal mechanisms of corporate governance. A concerted effort is required to provide clear guiding principles and regulations, and to ensure their effective implementation and enforcement. 1 The TA was first listed in ADB Business Opportunities in May 2000.
2 There is a need to (i) rationalize the overlap between the Company Law and capital market regulations, (ii) develop a new standard model of company articles of association, and (iii) define the rights and responsibilities of corporate secretaries. 4. The internal governance of companies as defined in the Company Law provides for a dual board structure for limited liability companies. The board of directors (BOD) is responsible for the management of a company, while the board of commissioners (BOC) monitors and advises them. 2 The BOD must allow for the inspection of the company s books and records by shareholders. However, the Company Law does not specify what books and records must be maintained nor does it stipulate consequences for failure by a company to comply with its provisions. The annual general meeting of shareholders (AGM) has broad authority as it holds powers generally not granted by the Company Law or by the company s articles of association to the BOD or BOC. In particular, the AGM appoints both members of the BOC and BOD, who are collectively responsible to the AGM. 5. Listed companies, companies involved in public fund-raising, and companies with assets of a value of at least Rp50 billion ($ 6.2 million) are required to prepare an annual report that provides audited financial statements, 3 describes the management and operation of the company, and lists the names and remuneration of the members of the BOD and BOC. Listed companies and securities issuers are required to submit annual and quarterly reports and financial statements to the Capital Market Supervisory Agency (BAPEPAM) with information on their company activities; use of funds; and investment and share ownership of directors, commissioners, and shareholders. While the reporting requirements are substantial, compliance has been weak and largely depends on the integrity of management. Better enforcement could be achieved through legislation making (i) auditors liable for negligence in performing audits, (ii) directors liable for provision of false information, and (iii) directors and commissioners liable for all commercial actions after missing the due date for filing required information to the stock exchange and company registrar. 6. A review of the Company Registration Law (and its implementation regulations) is critical to eliminate duplication in authority and responsibilities. Such a law should determine direct responsibility of the company for lodging accurate and timely information with the company registrar. The administrative procedure for the registration and authorization of a company s articles of association by the Ministry of Justice (MOJ) constitutes a major bottleneck. Whereas Article 9(2) of the law specifies that the approval period should not exceed 60 days, this is routinely extended to as long as six months. During this waiting period, the company can conduct business but all risk rests with the company s founders; this is an unsatisfactory arrangement. The authorization requirement is unusual and out of step with standard practice where simple company registration is the norm. In Indonesia, the situation is complicated by the use of notaries who are not required to go through a formal accreditation program. MOJ insists that as notaries have no formal accreditation program other than an appropriate university degree, the quality of their work cannot be guaranteed. Therefore, MOJ inspects all nonstandard elements and deviations from recommended standards in a 2 3 Indonesian law is based on Dutch law and prescribes a two-board structure consisting of a supervisory board and an executive board. Under the Indonesian law, the commissioners are the equivalent of nonexecutive directors in European companies and form the BOC, vested with all supervisory functions, while the directors are the equivalent of executive directors in European companies and form the BOD, which is responsible for managing all company affairs. By contrast, under the Anglo-Saxon law system, companies with limited liability have one BOD consisting of executive directors and nonexecutive directors. Including a balance sheet, profit and loss statement, cash flow statement, statement of debt and receivables (including bank credits), list of shareholders, and explanatory notes.
3 company s articles of association. This means that the due diligence responsibility borne by notaries is being duplicated by MOJ. Another problem area is the poorly performing company registration system. Ideally, a computerized company registration office attached to an appropriate ministry and operating on a fee-for-service or user-pays basis should be mandated to carry out company registration. At present, the Registration Office operating out of the Ministry of Industry and Trade (MOIT) lacks the capacity and technical means to carry out this function effectively. 7. Overall, Indonesia's corporate and commercial system is not working under a robust system of corporate governance. Existing rules and regulations have not been rigorously enforced. External mechanisms and enforcement through banks and capital markets, which are a feature of corporate discipline in other countries, have not functioned well in Indonesia. There has been little incentive for internal mechanisms or voluntary best practices to be introduced. As a result, the following mechanisms, common in other countries, are either unavailable or only nominally available: (i) (ii) (iii) comprehensive disclosure in corporate reporting, independent directors or commissioners safeguarding the rights of minority shareholders, and transparency in financial dealings with related parties; a sound legal system, with a good record of enforcement by an impartial judiciary (breaches in corporate governance, even if detected, are generally not pursued for judicial resolution); and external discipline exercised by the financial sector (before the crisis, capital was freely available for a complex web of well-connected individuals and conglomerates). 8. To coordinate the needed corporate governance reforms, the Government established NCCG in August 1999. 4 NCCG includes 22 members drawn from the private sector law, finance, and accounting professions as well as from the public sector. NCCG provides an institutional structure to improve the understanding and build a consensus for sound corporate governance, introduce internationally compatible standards of corporate governance, and launch efforts to strengthen enforcement capacity. NCCG has prepared a draft Code of Good Corporate Governance to provide a set of principles to guide the business sector. This draft needs to be reviewed to ensure it conforms with international norms, and can be applied by listed companies. 9. NCCG has identified a wide range of issues that need to be systematically addressed to improve governance in Indonesia. These issues range from the need to improve company registration procedures and strengthen implementation of the Company Law, to improvements in securities markets legislation, accounting, and audit standards. However, with no secretariat for its operation, NCCG has not been able to fully and effectively discharge its key responsibility of coordination. It needs assistance in the form of a highly qualified secretariat to develop detailed recommendations for revisions of key laws and regulations that incorporate the principles of corporate governance embodied in the Code of Good Corporate Governance. 4 Decree No. Kep.-10/M.EKUIN/08/1999 of 19 August 1999; Coordinating Ministry for Economy, Finance, and Industry.
4 10. Since it will take considerable time before the code is reflected in the laws, NCCG has to mobilize support from nongovernment organizations (NGOs); 5 this will facilitate the application of the code on a voluntary basis. International experience shows that over the longer term, the most powerful mechanism for enforcing good corporate governance is assertion by shareholders, company officials, and other stakeholders of their rights. This self-enforcement is either through a more active role in the governance of an enterprise, or through legal and other actions to force compliance in cases of violations. To build up the capacity for such selfenforcement by owners and stakeholders, awareness of the principles and objectives of good corporate governance, and of shareholders rights and responsibilities in particular, must be increased. 11. The Government has requested assistance from international aid agencies for implementation of sound governance. In response, ADB has provided the Financial Governance Reforms: Sector Development Program, 6 which focuses on improving governance through increased disclosure and transparency and enforcement of regulations, audit of state banks and enterprises, and the development of a legal framework for anticorruption and anti money laundering efforts. In addition, ADB is processing a loan for the State-Owned Enterprise Governance and Privatization Program. Together with the United Nations Development Programme and the World Bank, ADB is now participating in the Partnership to Support Governance Reform in Indonesia, which provides the framework for coordinated aid support for legal reform, 7 anticorruption measures, 8 decentralization, and corporate governance. 9 ADB has been asked to coordinate aid support in the latter area. Consultations have been held with all multilateral and bilateral development agencies, including United States Agency for International Development and the Dutch Government, 10 which has committed grant funds that could be used to finance improvements in corporate governance. III. THE TECHNICAL ASSISTANCE A. Objective 12. The objectives of the TA are to (i) assist NCCG in formulating a program to raise corporate governance standards by strengthening institutional capacity for adopting, disseminating, and enforcing corporate governance structures and practices, and (ii) prepare a plan for streamlining corporate incorporation and registration processes. 5 6 7 8 9 10 Such as the Indonesian Institute of Directors, Indonesian Society for Transparency, Corporate Governance Institute of Indonesia, Jakarta Stock Exchange, Indonesian Association of Listed Companies, and Corporate Leadership Development Institute. For $ 1.4 billion, approved on 21 April 1998. Supported by ADB through TA 3472-INO: A Governance Audit of the Public Prosecution Service, for $1 million, approved on 21 July 2000. Supported by ADB through TA 3381-INO: Establishment of an Anticorruption Commission, for $1 million, approved on 28 December 1999. Supported by ADB through TA 3149-INO: Corporate Governance and Enterprise Restructuring, for $2.47 million, approved on 29 December 1998. The Government of the Netherlands, through the Corporate Governance Institute of the Netherlands and the Amsterdam Stock Exchange, is providing assistance to the Jakarta Stock Exchange for corporate governance reform.
5 B. Scope 13. Working closely with relevant stakeholders in the private and public sectors, the TA will support the initiatives of NCCG to (i) strengthen, coordinate, and implement a national strategy for corporate governance reform; (ii) finalize the Code of Good Corporate Governance, defining which parts of the code apply to which groups of companies and specifying the roles of commissioners, directors, and corporate secretaries; (iii) specify changes in existing laws and regulations required to reflect the code; (iv) identify changes, if any, in existing laws and regulations to improve transparency and accountability; and (v) support cooperation with professional associations and other NGOs to promote good corporate governance. Furthermore, MOIT will receive assistance for streamlining the company incorporation process and transforming of the company registration into an efficient instrument of transparency. C. Cost Estimates and Financing Plan 14. The TA is estimated to cost $375,000 equivalent, of which $192,000 is the foreign exchange cost and $183,000 equivalent the local currency cost. ADB will finance $300,000 equivalent to cover the entire foreign exchange cost and $108,000 equivalent of the local currency cost. The TA will be financed on a grant basis from the ADB-funded Technical Assistance Special Fund. The Government will provide the balance of the local currency cost equivalent to $75,000 to finance counterpart staff, office facilities, and workshops. Appendix 2 presents the detailed cost estimates and financing plan. D. Implementation Arrangements 15. The TA will be executed by the National Development Planning Agency (BAPPENAS), and will be implemented by BAPEPAM over six months starting in November 2000. BAPPENAS will coordinate between BAPEPAM, NCCG, MOIT AND MOJ, while BAPEPAM will be the host for the NCCG secretariat and wili support NGO coordination. Implementation will be supervised by a steering committee consisting of representatives of BAPPENAS, BAPEPAM and MOIT, and the chair or secretary of NCCG. It is estimated that the TA will require six person-months of international consulting services to be provided by two individual consultants with expertise in corporate governance and law (Appendix 3 provides terms of reference). The international consultants will associate with domestic consultants who will provide seven person-months of consulting services in the same areas of expertise and operate the NCCG secretariat. The consultants will be selected in accordance with ADB s Guidelines on the Use of Consultants and other arrangements satisfactory to ADB for the recruitment of domestic consultants. IV. THE PRESIDENT S DECISION 16. The President, acting under the authority delegated by the Board, has approved the provision of technical assistance, on a grant basis, to the Government of the Republic of Indonesia in an amount not exceeding the equivalent of $300,000 for the purpose of Corporate Governance Reform, and hereby reports such action to the Board.
TECHNICAL ASSITANCE FRAMEWORK (Reference in text: page 1, para. 1) Design Summary Targets Monitoring Mechanisms Assumptions And Risks Goal Develop a basis for restoration of investor confidence in Indonesia s capital market. Purpose The objectives of the TA are to (i) assist NCCG in formulating a program to raise corporate governance standards by strengthening institutional capacity for adopting, disseminating, and enforcing corporate governance structures and practices, and (ii) prepare a plan for streamlining corporate incorporation and registration processes. Outputs Support the initiatives of the NCCG in strengthening, coordinating and planning implementation of a national strategy; finalizing the Code of Good Corporate Governance and specification of changes for regulations in line with the code; reviewing existing laws and regulations affecting corporate governance; and supporting the establishment of NGOs to promote good corporate governance. Support MOIT in preparing a plan to streamline corporate incorporation process; Agreement between the National Committee on Corporate Governance, Government and nongovernment organizations on implementation of a corporate governance strategy Design of a program that can be supported by bilateral and multilateral assistance Design of new procedures simplifying incorporation and corporate registration Suggestions for computerizaton of corporate registry, and accessibility on a user pays basis Strategy paper endorsed by the NCCG including prioritization of Agenda Matrix and time-bound action plan Endorsement of Code of Good Corporate Governance by the NCCG Recommendations for changes of existing legislation and regulation, and for drafting of new legislation, if necessary Establishment of an institute of directors and/or an institute for corporate governance Recommendation for changes of existing or development or new legislation; and Final report of consultants for time bound action plan agreed to by executing and implementing agencies, NCCG, and NGOs Lack of cooperation from NGOs Difficulty coordinating the different agencies Final report of consultants Cooperation of different ministries involved, between themselves and with the consultants Cooperation with company registrar, and between Ministry of Justice and Ministry for Industry and Trade Final report of consultants Capacity of the NCCG and Capital Market Supervisory Agency (BAPEPAM) is sufficient to support consultants. Publication of Code of Good Corporate Governance by the NCCG Final report of consultants Final report of consultants Final report of consultants Capacity of the NCCG is sufficient to support consultants. Capacity of NCCG is sufficient to support consultants. Cooperation of MOIT and MOJ. 6 Appendix 1, page 1
TECHNICAL ASSITANCE FRAMEWORK Design Summary Targets Monitoring Mechanisms Assumptions And Risks computerize registration processes. design of institutional arrangements for computerization of registration. Final report of consultants Activities Recruitment of two international and two domestic consultants to implement the TA The consultants will conduct at least two workshops presenting the results of their assignment to government staff, NGOs, and international development agencies. Inputs 13 person-months of consulting services, including 6 person-months of service from international consultants and 7 person-months of domestic consultants The team of individual consultants of (i) a team leader, who will be the corporate governance expert; and (ii) a commercial and financial law expert. The domestic consultants will include a similar set of experts. Progress reports from consultants Review missions Availability of counterparts to support consultants, and cooperation between the NCCG members, ministerial and Capital Market Supervisory Agency (BAPEPAM) staff, and consultants. 7 Appendix 1, page 2
8 Appendix 2 Item COST ESTIMATES AND FINANCING PLAN ($ 000) Foreign Exchange Local Currency Total Cost A. Asian Development Bank Financing a 1. Consultants a. Remuneration and Per Diem i. International (6 person months) 159.00 0.00 159.00 ii. Domestic (7 person months) 0.00 42.00 42.00 b. International and Local Travel 10.00 7.00 17.00 c. Resource Personnel 0.00 7.00 7.00 2. Office Equipment (printers, computers, etc.) 0.00 8.00 8.00 3. Printing, Communications, Secretariat 0.00 19.00 19.00 Administration, etc. 4. Seminars, Workshops etc. 0.00 15.00 15.00 5. Contingency 23.00 10.00 33.00 Subtotal (A) 192.00 108.00 300.00 B. Government Financing 1. Counterpart Staff 0.00 30.00 30.00 2. Office Space 0.00 25.00 25.00 3. Workshops 0.00 10.00 10.00 4. Contingencies 0.00 10.00 10.00 Subtotal (B) 0.00 75.00 75.00 Total 192.00 183.00 375.00 a Financed on a grant basis from ADB-funded Technical Assistance Special Fund. Source: Staff estimates. (Reference in text: page 5, para. 14)
9 Appendix 3, page 1 OUTLINE TERMS OF REFERENCE FOR CONSULTANTS 1. All consultants will assist the National Committee for Corporate Governance (NCCG) in designing and formulating a corporate governance reform program by transforming the Corporate Governance Policy Matrix into a comprehensive program that can be supported by the Asian Development Bank (ADB) and other international development agencies. A. Corporate Governance Expert (3.5 person-months) 2. The expert will work closely with NCGG and relevant public and private sector agencies, and undertake the following: (i) (ii) (iii) (iv) (v) (vi) Review NCCG s draft Code of Good Corporate Governance and draft revisions to strengthen the code in the light of applicable international norms and practices and in the context of the need to specify clear principles for both domestic and international firms. Review and make detailed recommendations for specific actions, their priority, time frame for implementation, and suggestions for measurement of reform progress for the corporate governance agenda matrix being jointly prepared by the Government, private sector, and ADB in consultation with other external financers. Participate in consultations with appropriate private sector associations and advocacy groups to ensure that their concerns are made fully known to NCCG. Organize two workshops to disseminate findings and principles of good corporate governance for members of NCCG and relevant nongovernment organizations. Review company registration and incorporation procedures, and make recommendations to rationalize and consolidate procedures. Evaluate data, computerization, and staffing needs to establish a modern company registry system operating on a fee-paying basis. B. Corporate Governance and Commercial and Financial Law Expert (2.5 person-months) 3. The legal expert will work closely with the corporate governance expert and cooperate with NCGG. The tasks will include but not limited to the following: (Reference in text: page 5, para. 15)
10 Appendix 3, page 2 (i) (ii) (iii) (iv) Develop detailed proposals for strengthening securities, capital markets, and banking regulations to improve corporate governance in these sectors consistent with principles articulated in Code of Good Corporate Governance. Review and make recommendations for strengthening stock exchange listing rules to incorporate principles stated in Code of Good Governance. Assist NCCG in developing its strategy for incorporating the Code of Good Governance principles in capital, financial markets, and banking regulations. Develop and implement workshops to disseminate the strategy. C. Workshops 4. The consultants will be responsible for organizing two workshops designed to disseminate the results of their work, and obtain feedback on progress made under the TA. The target audience for the workshop will be decided with the Government and will include policymakers and enterprise officials from both the public and private sectors, as well as representatives of other stakeholders and from international development agencies. D. Reporting Requirements 5. The team leader will prepare an inception report and a time-bound work program within four weeks of commencement of services, and a draft final report three months after the commencement of services. A final report will be produced within two weeks of the tripartite meeting to review the draft final report. 6. The domestic consultants work schedules and their reporting requirements will be determined by the team leader in consultation with ADB and the Government.