Farrukh Rehman

“Good corporate governance, it’s about being proper and prosper” — Toba Beta.

On 23 April 2019, the Securities and Exchange Commission of Pakistan has issued the draft Listed Companies (Code of Corporate Governance) Regulations, 2019. Once made effective from July 1, 2019, the new corporate governance regime would be applicable to public listed companies, replacing the extant Listed Companies (Code of Corporate Governance) Regulations, 2017.

Under the new regime, the shift to the ‘comply or explain’ approach is rethinking of the corporate governance in Pakistan. Originally put forward by Cadbury Committee in the UK, the comply or explain approach underpins that companies either comply with the non-mandatory corporate governance requirements or explain why they have not.

This approach is central element to the most of corporate governance regimes around the world. Few examples include the United Kingdom, Germany, Sweden, the Netherlands, Canada, Australia, Singapore, Hong Kong and Malaysia. More recently, Japan (in 2015) and Brazil (in 2016) also introduced corporate governance requirements under the “comply or explain” framework. The alignment of Pakistan corporate governance with progressive economies is a step forward in the right direction. Enabling a practical and flexible means to companies in ensuring effective governance, would directly ease the doing of business. It would be providing the companies the opportunity to learn and improve the governance parameters, while explaining their progress towards compliance of a provision. Further, the flexibility allows organizations to think out of box as an alternate course of action could be followed, while ensuring transparency.

The new governance framework would be more driven by principles than rules, therefore company’s decision making process would be under the spotlight. It shall be the responsibility of boards to use ‘comply or explain’ principle wisely and transparently and of investors to assess alternative governance arrangements judiciously and thoughtfully.

The OECD’s ‘Principles of Corporate Governance’ based on which various jurisdictions have developed their corporate governance laws state that the legislative and regulatory elements of the corporate governance framework can usefully be complemented by ‘soft’ law elements based on the comply or explain principle. It is recognised that what works well in one company, for one investor or a particular stakeholder may not necessarily be generally applicable to corporations, investors and stakeholders that operate in another context and under different circumstances. As new experiences accrue and business circumstances change, the different provisions of the corporate governance framework should be reviewed by companies and, when necessary, adjusted.

In Pakistan, since the introduction of the corporate governance in 2002 and subsequent revisions in 2012 and 2017 the specific provisions were mandatorily required to be implemented with any exception reported as a ‘non-compliance’. Resultantly, the corporate governance implementation and monitoring has been based on the “mandatory” approach. It was acknowledged that this approach was relevant in the early years of the evolution of the corporate governance in Pakistan, providing a direct and simpler pathway to building a governance culture that reflected compliance.

However, it had also been argued that under the mandatory corporate governance regime the costs of compliance may exceed benefits. With the underlying “One size fits all” approach, it lacks flexibility especially important and relevant for the small companies, foreign multinationals and non-regulated institutions. Further, the mandatory regulations may reduce the incentives for companies to list and participate in public markets.

The draft code outlines comply or explain approach except for certain requirements which are mentioned as “mandatory”. The mandatory provisions include, simultaneous directorship in maximum seven companies, appointment of independent directors, inclusion of female director, maximum number of executive directors, formation of audit committee, appointment of auditors having registration with Audit Oversight Board, rotation of auditors for financial sector companies, publication of statement of compliance with the code and its review by the external auditors.

The notable non mandatory provisions in the draft code based on the ‘comply or explain’ principle include separation of the office of chairman and chief executive, annual evaluation of the board, its members and committees, directors training, placement of related party transactions with the audit committee, qualifications of chief financial officer, internal auditor and company secretary, internal audit structure and function, formation of Human Resource &Remuneration, Nominations and Risk Management committees, etc.

The draft code requires mandatory formation of audit committee, however, taking into account the practical aspects of listed company operations an alternate committee structure may be the formation of separate financial statements review committee, internal controls review committee and business & strategy review committee to provide focused functional attention to each of these matters.

The new reshaping governance framework is built on trust. The trust that companies would be committed to the best corporate governance practices and the trust that the regulators and other stakeholders would consider reasonable and justifiable explanations of companies as right course of action. However, consistent with the international practices on the comply or explain based governance approach, a guidance material for the companies, providing the tools and techniques in ensuring the compliance and guiding justifiable reasoning and explanation would be required.

The processes that characterize strong corporate governance systems also promote and ensure a law-compliant organisation and society. The linkage of rights and obligations, controls and oversight under the corporate governance also provide an avenue to the companies to develop and implement anti-corruption and law compliant corporate system. With this objective the corporate governance framework can require boards to develop a code of conduct for ensuring compliance with laws and regulations, including anti-corruption and bribery aspects. On a relevant note, the protection to whistleblowers through legislative measures is also required in Pakistan.

Globally there is increasing interest in sustainability issues and consequently, a growing number of calls for companies to address sustainability in their business policies and practices as well as to report on what and how well they are doing. Sustainability is not restricted to present. It is defined as an economic activity that meets the needs of the present generation without compromising the ability of future generations to meet their own needs. With sustainability instruments and reportings common in most of the world’s progressive economies, the corporate governance regulations of Pakistan can also include provision of sustainability reporting.

The relevance and importance of integrity, transparency and accountability can never be argued. Like always, and particularly with the reshaping corporate governance regime these elements would be key ingredients to a proper and prospering company and economy.

(The writer is the Chairman of Accounting Standards Board of the Institute of Chartered Accountants of Pakistan)