What is meant by “governance” in the context of a financial institution (FI)? [1] Corporate governance is traditionally defined as the system by which companies are directed and controlled. The OECD Principles of Corporate Governance (2004) defines corporate governance as involving

“a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.” [2]

In the case of financial institutions, chief among the other stakeholders are supervisors and regulators charged with ensuring safety, soundness, and ethical operation of the financial system for the public good. They have a major stake in, and can make an important contribution to, effective governance.

Good corporate governance requires checks and balances on the power and rights accorded to shareholders, stakeholders, and society overall. Without checks, we see the behaviors that lead to disaster. But governance is not a fixed set of guidelines and procedures; rather, it is an ongoing process by which the choices and decisions of FIs are scrutinized, management and oversight are strengthened and streamlined, appropriate cultures are established and reinforced, and FI leaders are supported and assessed.

…continue reading: Toward Effective Governance of Financial Institutions

Regulation is the most important factor influencing strategic change at financial institutions and is the second largest threat – after economic uncertainty – to growth prospects, according to PwC’s Annual Global CEO Survey [1]. The survey, which is in its fifteenth consecutive year, canvassed CEOs at over 250 financial institutions in 42 countries late last year and provides a good barometer on market sentiment. The significance of regulation as a change driver in the financial sector has grown steadily since the recent crisis. Based on PwC’s face-to-face interviews with CEOs of some of the world’s largest financial institutions, it is clear, though, that it is not simply regulatory change, but regulatory complexity and uncertainty that are really dampening confidence in growth.

Upgrading the European Union (EU) prudential regime for banks in line with the Basel III proposals is an excellent example of both regulatory complexity and uncertainty. In July 2011, the European Commission [2] released two proposals to introduce the new regime. The bulk of the existing EU prudential regime, with the amendments necessary to introduce Basel III, is recast into a regulation – the Capital Requirements Regulation (CRR) – amongst other things to support the parallel EU goal of harmonising and deepening the internal market through a single rule book. In addition, a Directive – Capital Requirements Directive IV (CRD IV) – sets out requirements in a limited number of areas where Member State discretion is still necessary, for example in relation to corporate governance.

…continue reading: Regulatory Complexity and Uncertainty: The Capital Requirements Directive IV

Although a branch of a bank is not a separate juridical entity from the bank of which it is a component, U.S. law treats branches as separate from the head office and other branches of a bank when such differentiation is appropriate for various purposes. Branches are a hybrid structure, at the same time both an integral part of the banks of which they are merely offices and separate legal entities for a number of U.S. regulatory and commercial law purposes. This feature of bank branches is a central tenet of federal banking statutes, and the law governing U.S. branches of foreign banks in particular.

At times the status of a U.S. branch of a foreign bank under a particular statutory scheme is explicit. Such is the case with the U.S. law treatment of U.S. branches of foreign banks in insolvency. As discussed below, U.S. law treats those branches virtually as separate entities in insolvency.

In other circumstances, a particular statute does not explicitly address the status of U.S. branches of foreign banks, and the treatment has to be arrived at through an analysis of the purpose of the statutory scheme. For example, as discussed below, after a long series of no-action letters, the Securities and Exchange Commission (“SEC”) issued interpretive guidance providing that securities issued or guaranteed by U.S. branches of a foreign bank (but not its non-U.S. branches) could rely on the exemption from registration afforded to securities issued or guaranteed by a bank under Section 3(a)(2) of the Securities Act of 1933 (“Securities Act”). Thus, U.S. branches can rely on the Section 3(a)(2) exemption while the bank itself is required to register to distribute its securities in the United States.

This paper will review the treatment of U.S. branches of foreign banks under a variety of statutory schemes and explore the rationale for that treatment.

…continue reading: Separate Entity Doctrine for U.S. Branches of Foreign Banks

Wal-Mart appeared to commit virtually every governance sin in its handling of the Mexican bribery case, if the long, carefully reported New York Times story is true. The current Wal-Mart board of directors must get to the bottom of the bribery scheme in Mexico and the possible suppression by senior Wal-Mart leaders in Bentonville, Arkansas (the company’s global headquarters) of a full investigation.

In addition, the board must also review – and fix as necessary – the numerous company internal governing systems, processes and procedures that appear to have been non-existent or to have failed. And, most importantly, it must define the CEO’s core role as one which truly fuses high performance with high integrity, and does not exalt performance at the expense of integrity – and possibly discipline or remove the past CEO (still on the board) or the current CEO.

The essential allegations in the Times story are as follows:

For a substantial period before 2005, the CEO of Wal-Mart in Mexico and his chief lieutenants, including the Mexican general counsel and chief auditor, knowingly orchestrated bribes of Mexican officials to obtain building permits, zoning variances and environmental clearances, and also falsified records to hide these payments. When the lawyer in Mexico directly responsible for bribery payments had a change of heart and reported the scheme to Wal-Mart lawyers in the United States, those lawyers hired an independent firm which, after an initial look, recommended a major inquiry.

…continue reading: Wal-Mart Bribery Case Raises Fundamental Governance Issues

Users of commodity derivatives markets are now facing major changes under proposed European and US legislation. Stronger supervision of the commodity derivatives market is one of the key areas of the G20 regulatory reform agenda. In Europe, the European Commission is proposing to regulate the activities of a wider range of commodity derivatives traders through amendments to MiFID. End-users will become subject to mandatory clearing requirements for OTC derivative transactions above certain thresholds once the recently agreed EMIR proposal comes into force. For the first time, the wholesale energy market and the commodity spot market will become subject to the market abuse regime. In the US, the Dodd-Frank Wall Street Reform and Consumer Protection Act brings in a comprehensive reform of the OTC derivatives market. This publication gives an overview of the impact of the various recent European and US regulatory changes from the perspective of non-financial businesses involved in commodity derivatives trading.

Introduction

Various proposals have been introduced since the onset of the financial crisis to strengthen financial regulation across the full spectrum of financial services at international, EU and domestic levels. Previous client publications address many of these proposals. This publication draws together various threads of regulation in the context of their impact on commodity derivatives trading.

…continue reading: The Revised EU and US Regulatory Frameworks for Commodity Derivatives

In our paper, Insider Trading Restrictions and Insiders’ Supply of Information: Evidence from Reporting Quality, which was recently made publicly available on SSRN, we exploit a natural experiment involving first-time enforcement of insider trading laws around the world in order to examine the impact of insider trading restrictions on insiders’ supply of information. Following the existing literature, we measure the quality of financial reporting along four dimensions: earnings smoothing, earnings management towards positive earnings, loss recognition, and value relevance.

Empirical analyses indicate that reporting quality improves following a country’s first-time enforcement of insider trading laws only in countries with strong macro governance infrastructure, suggesting that a country’s legal infrastructures play an important role in determining earnings quality. Consistent with the prediction that firm-level governance structures significantly affect insiders’ incentives and their responses to regulations, we also find that the improvement in earnings quality is concentrated in less closely held firms.

…continue reading: Insider Trading Restrictions and Insiders’ Supply of Information

Fiscal year 2011 witnessed the SBA’s shift from domestic and foreign asset classes, to a combined global equity portfolio, with a heavier international equity weighting and a more balanced U.S. exposure. With the recent structural changes, the proportion of SBA assets invested in foreign equity markets will continue to rise, and a significant proportion may be managed internally. In 1998, for foreign equities was 7.6 percent, rising to 12.7 percent by 2003, and 18.8 percent by the end of fiscal year 2010. Upon completion of the transition to a combined global equity asset class, foreign equities composed 33 percent of FRS assets as of October 2011. As a percent of the equity asset class, foreign shares account for 56 percent and U.S. shares for 44 percent.

Coinciding with this shift, the SBA realigned its international proxy voting practices, bringing foreign voting decisions ”in-house” to match domestic SBA voting practices.

Previously, external asset managers were responsible for voting international proxies associated with SBA shares held in their funds. Since the SBA assumed this responsibility, votes are now cast by SBA staff—based on our own Corporate Governance Principles & Proxy Voting Guidelines and meeting specific research from our proxy research providers.

…continue reading: Analyzing Global Proxy Voting Practices

In our paper, Mandatory IFRS Reporting and Changes in Enforcement, which was recently made publicly available on SSRN, we examine the underlying sources of the capital-market benefits around the introduction of mandatory IFRS reporting. Prior work finds significant capital market benefits and also shows that the effects around IFRS adoption are significantly stronger in countries with stricter and better functioning legal systems, and that they are stronger in the EU than in other regions of the world. We argue that this evidence is consistent with several interpretations and that it is still an open question to what extent these positive effects around mandatory IFRS adoption are indeed attributable to the switch to arguably better, more capital-market oriented, and globally harmonized accounting standards.

We focus on market liquidity and rely on within- and across-country variation in the timing of IFRS adoption and of other institutional changes to disentangle several possible explanations. Specifically, we explore whether (i) the switch from local GAAP to IFRS reporting played a primary role for the observed capital-market benefits; (ii) the introduction of IFRS had capital-market benefits, but only in countries with strong institutions and legal enforcement; or (iii) the switch to IFRS reporting itself had little or no effect and, instead, concurrent changes to countries’ institutions drive the observed capital-market benefits.

…continue reading: Mandatory IFRS Reporting and Changes in Enforcement

GMI Ratings’ 2012 Women on Boards survey includes data on over 4,300 companies in 45 countries around the globe. The results show incremental improvement in most measures of female board representation since our 2011 report. For the first time ever, women hold more than one in ten board seats globally: 10.5% of the directors in our coverage universe are now women, a 0.7 percentage point increase from last year. At the same time, the percentage of companies with no female directors at all has fallen below 40% for the first time, to 39.8% (a two percentage point decrease since last year). Moreover, the percentage of companies with at least three women — a level that some research suggests may constitute a critical mass and allow women’s leadership styles to come to the fore [1] — has risen by 1.3 percentage points, to just under one-tenth (9.8%) of companies worldwide.

However, these global statistics mask important differences, both among individual countries and between blocks of countries at different stages of economic development. For example, when the world’s industrialized economies are viewed as a group, 11.1% of directors are women, 63.3% of companies have at least one woman on the board, and 10.5% of companies have three or more female directors. For emerging markets as a group, only 7.2% of directors are women, 44.3% of companies have at least one woman on the board, and 6.3% of companies have at least three female directors. Furthermore, national statistics within each group vary widely. For example, over 36% of Norway’s directors are women, compared to less than 13% of Germany’s and just over 1% of Japan’s; South Africa has over 17% female directors, China 8.5%, and Brazil 4.5%.

…continue reading: 2012 Women on Boards Survey

The final report of the UK’s Independent Commission on Banking, chaired by Sir John Vickers, was published on 12 September 2011. Its recommendations include ring-fencing UK banks’ retail banking operations, higher capital requirements for UK retail banks, preferential status for insured deposits in a bank insolvency and measures to increase competition in the UK banking sector. The UK government issued its formal response on 19 December 2011 and has indicated it will implement most of the recommendations. This memorandum summarises the key recommendations and their likely impact, in light of the UK government’s response.

Introduction

The Independent Commission on Banking (the “Vickers Commission”) was set up by the UK government to make recommendations for the reform of the UK banking sector, with a view to reducing systemic risk, mitigating moral hazard and reducing the likelihood and impact of firm failures. The Vickers Commission was also asked to consider competition in the UK banking sector.

…continue reading: The Vickers Report and the Future of UK Banking