January 6, 2003	Monday	Ziqa’ad 2, 1423

The objective of corporate governance is to ensure transparency in business transactions and management practices.

The Securities and Exchange Commission of Pakistan (SECP) has taken a number of steps, including the issuance of Code of Corporate Governance (CCG). However, more is required, and certain clauses of the CCG need amendments. The following amendments are suggested.

Board of directors: The CCG has enumerated seven key positions vested with major responsibilities. These are the board of directors (BOD), the audit committee (AC), the chief executive officer (CEO), the chief financial officer (CFO), the chief internal auditor (CIA), the company secretary (CS), and the external auditors (EA). Although these positions (except the AC) have been in existence but a good corporate culture could not develop. One of the reasons is the centuries old principle, “responsibility and authority go hand in hand” i.e. no authority no responsibility.

In some entities, certain positions are ceremonial and as such they cannot be expected to go beyond certain limits. Certain level of independence is ensured. To curb the practice of “pick and choose” and to make the appointment “pliant and pliable”, the SECP is advised to remove certain key positions.

Responsibilities, powers and functions of the BOD: Directorship: The CCG stipulates that no person shall serve as a director of more than 10 listed companies. Keeping in view the quarterly BOD meetings, the audit committee meetings and the annual general meeting, a director of listed company may have to attend at least eight meetings of a listed company in a year resulting in over 80 meetings for 10 companies. The director cannot be expected to carry out his/her fiduciary duties with a sense of objective judgment due to the limited time at his/her disposal. If we deduct Sundays and public holidays, then about 295 days are available to attend over 80 meetings i.e. a person shall have to attend a meeting almost every fourth day. It is suggested that a person should not become a director of more than three listed companies. For unlisted and private companies, the maximum number may be fixed at five.

Statement of ethics and business practices: The CCG requires that a “statement of ethics and business practices, vision/mission and overall corporate strategy and significant policies” shall be formulated and circulated to all concerned i.e. the directors and the employees, annually. This does not specify the time. It would be better if companies were required to comply with this obligation one week before the commencement of the financial year.

Human Resource management (HRM): The HRM should be made more meaningful. The “significant policy statement” should include remuneration policy, performance evaluation criteria, and reward policy and directors’ report on staff turnover with statistics on new appointments, resignations and staff promotions during the year. The compensation package of key personnel should be in line with the company performance/industry practice with due weightage to individual’s performance. The expenditures on staff (in relation to gross revenue earned) should be duly compared with the peer group in industry and properly disclosed in the financial statements issued to shareholders and filed with the regulatory authorities.

Credit policy: In case of the NBFCs, it would be worthwhile if detailed credit policy and maximum sectorial exposure, to be taken during the forthcoming year, are clearly embodied in significant policy’s statement.

Recovery, rescheduling policy: Similarly rescheduling/restructuring, recovery and litigation policies should also be incorporated in significant policy statement.

Meetings of the board: The CCG contemplates issuance of notice including agenda at least seven days before the BOD meeting. It is suggested that instead of notice only, the company must make available complete working papers also to directors at least seven days before the BOD meeting.

Qualification of CFO: The CCG allows simple graduates with five years experience to hold position of the CFO. This qualification needs to be reconsidered in view of the highly specialized function of the CFO. Even in case of professionally qualified accountant, some experience is desirable to assume the responsibilities of the CFO. Achieving a qualification does not mean that a person has become an expert in everything. It is suggested that a member of the recognized body of professional accountants with at least 10 years post qualification experience in relevant industrial sector and 15 years post qualification experience in any other sector should be prescribed to take charge of handling the financial affairs of a listed company. Without this experience, even fresh qualified accountant shall not be able to handle the CFO’s functional responsibilities. The directors’ report (DR) to shareholders: The CCG necessitates certain information to be included in the DR “where necessary”. It is suggested to replace the words “where necessary” with “must” so that the shareholders and other users compulsorily get the information without any excuse on the part of the management. Moreover the word “executive” needs proper definition so that information is not withheld due to the interpretation of word best suited to any particular company.

Vital disclosures: In addition to inclusion of certain information, there are areas for which information must be incorporated in the DR. It must contain summarized position of the projected volume of core business duly compared with actual (sector-wise exposure), summarized budgeted financial statements with comparison of actual stating reasons for variances (reasons for improvement/deterioration in performance to be duly quantified), information regarding staff turnover with statistics on new appointments, resignations and staff promotions during the year, while notes to audited financial statements must present information regarding the expenditures on staff (as percentage of gross revenue earned) duly compared with the peer group in industry, recoveries in percentage as well as absolute amount, ranging of over-dues at proper intervals like (0-3 months, 3-6 months, 6-12 months, 1-2 years, 2-3 years and over 3 years) along with the amount of infected portfolio, income suspended under prudential regulations (for current year as well as cumulative), detail of write-offs/rescheduling/remissions etc,.; maturity profile of assets at collectible value and liabilities with proper intervals (like 0-3 months, 3-6 months, 6-12 months, 1-2 years, 2-3 years and over 3 years period) in order to assess mismatch (if any), solvency of any institution and operating efficiency of management and the institution. The present format of cash flow (required to be attached with the financial statements) does not seem to serve any valuable purpose, as it does not provide meaningful information on actual transactions/operations. This must be amended in such a way that complete information about actual operations is duly reflected in order to draw a meaningful inference.

These areas are extremely significant and must be made known to every user of financial statement.

Disclosure of interest by a director: The CS is required to place the matter before the BOD in the event of default by a director, the CEO or an executive to give a written notice of transactions in shares of the company. This clause does not seem to be practicable as far as the CS’s obligation is concerned to place the matter before the BOD. As it is not clear how the CS would come to know about the non-reporting of shares transaction by a director, the CEO or an executive.

Auditors not to hold shares: All listed companies are required to ensure that the external auditors or any partner in the firm and his spouse and minor children do not hold, purchase, sell or take any position in the shares of the company. If somebody is dealing with the shares, the company may not know this unless share transfer book closure takes place. As such this clause also needs to be revisited. Corporate ownership structure: Every listed company or proposed to be listed is required to offer not less than 20 per cent of the issued capital to general public. In order to broaden the ownership structure; it would be quite appropriate to increase the present limit of 20 per cent to 40 per cent.

External auditors and ICAP: The CCG envisages the rating of external auditors (EA) by the Quality Control Review Programme (QCR) of the Institute of Chartered Accountants of Pakistan (ICAP). In order to ensure narrowing down rather elimination of expectation gap, the ICAP has taken a number of measures. Since there is always room for improvement, therefore still a lot more is to be done to epitomize accounting fraternity at national as well as international forums in an erudite fashion for the purpose of enhancing the image of accounting profession prevailing in Pakistan.

Credit rating process: This is another borough, which needs to be given due importance in CCG. Basically, the intent of assigning any rating to an instrument, and or an institution is to exhibit financial strength in terms of its ability to meet its current as well as long-term obligations. This rating enables the prospective lenders/investors to take a decision on extending credit facility. Looking at the rating process currently in vogue, purpose does not seem to be fully served due to various shortcomings.

Firstly, the criteria for formation of a rating agency is not clear. Proper monitoring/regulatory system does not appear to be in place. Whatever rating is dispensed, there is no cross-check to guarantee its authenticity. Then, the rating scale is not free from ambiguities and lacks clear-cut line of distinction between various rating steps/notches. The decision appears to be subservient to discretion, entailing vulnerability to flawed assignment both lower than actual or higher than actual position. Due to the lack of clarity in rating criteria, the company under evaluation does not seem to be fully aware of the required standard to perk up its rating by better performance in future. The agency appears to assign credit rating on the basis of information provided by the management without any desirable level of scrutiny/corroboration. Things like manoeuvring of information is possible. This method is prone to inaccurate evaluation. In view of the above, some mechanism needs to be evolved in order to give more credibility to rating assignment.

Monitoring by regulatory authority: Although, the rating agencies have taken a number of steps to bolster regulatory/monitoring process for the corporate sector, but in view of the transfer of monitoring of the NBFCs from the State Bank to the SECP, it is essential to further strengthen its talent to deal with the new challenges. The lesson learnt from the cases like Mehran Bank, Prudential Commercial Bank, the NDFC and Bankers Equity must be kept in mind. Not only prudential regulations should be clearly worded, but monitoring must also be in the hands of experts.

The existing reporting formats should be thoroughly reviewed so that the RA is able to get early warning signals for any malpractice/deterioration in the financial health of the reporting institutions. The reporting must also enable RA to counter-check the information at an early stage. It is not sufficient to simply induct graduates, MBAs and or professional accountants (Chartered Accountants and Cost & Management Accountants) especially as departmental heads. The departmental staff in general and its head in particular must have suitable post qualification experience in the relevant sector assigned to a particular department for monitoring. The departmental head must be an expert having at least 15 years experience so that the work of the subordinate staff is not only properly supervised but training is also imparted. The monitoring programmes must be well defined and documented. One must be aware of the procedure to carry out cross-checking of the information.

Applicability to Modarabas, asset management companies, and others: It appears the CCG does not apply to the Madaraba management companies, the asset management companies and the non-listed/private companies. It is recommended to bring these companies (whose statutory audit is compulsory) too, within the ambit of the CCG.