Conference on ‘Governance and Board Effectiveness in Public

Sector Enterprises’ April11, 2012

State Ownership Steering- The Finland Case Study

By:

Olli V. Virtanen Virtanen Associates Oy

Finland Independent since 1917

Small, homogeneous, multi-party democracy

Consensus society

World rankings Least Failed States (Fund For Peace 2011) 1

Best Countries in the World (Newsweek 2010) 1

World Happiness Index (UN 2012) 2

Least Corrupt Countries (Transparency Int. 2011) 2

PISA (student rankings, OECD 2011) 3

Most Competitive Countries (Global Economic Forum) 4

GDP per capita USD 50.090 13

Background in Finland After the WW2 state involved in heavy industries

Forest industry, metal and engineering, mining, fertilisers, tele…

SOEs accounted for about 20% of GDP (now 5-7%)

Companies poorly run, heavily in debt, state budget financed, and helped with periodical devaluations

Wake-up in the 1980s

Government statement on profitability in 1982

Concern over balance sheet and governance

Development phase (late 80s, early 90s)

Politicians recognised and approved development

Clean-up on Board of Directors

Abolishment of Supervisory Boards

Strengthening of the balance sheet

Stock market listings (SOEs)

No wholesale privatisations

Gradual expansion of ownership base

International capital markets

Last restrictions on foreign ownership abolished in -93

Corporate structure

Annual General Meeting

Shareholders

Board of Directors

Management

Auditors

Internal

audit

Comparison of Governance Models

Shareholders’

meeting

ONE-TIER

MODEL

TWO-TIER

MODEL

NORDIC MODEL

Ownership

level

Strategic

level

Operational

level

Supervisory Board

Management

Board

Board

Shareholders’

meeting

Shareholders’

meeting

Chair

CEO

Board

Chair

CEO

SOE - developments Division into three groups of SOE’s

Creation of Solidium, the holding company, 2008

Holding company, 100% owned by State

State minority stakes in listed companies

Total market value of state holdings on stock market € 22bn, about 14% of Helsinki stock exchange

Investor

interest

Strategic interest

Companies with

Strategic

importance

Companies with

Special

assignment

s

CATEGORIES OF STATE

HOLDINGS

Key principles of state ownership steering No separate state ownership code

Principles of ownership in Government Resolution

Separation of regulatory and ownership functions

In listed companies no state priviligies

Commercial companies run on commercial basis Efficiency and profitability

No distortaion of competitive market

State support measures equal to all

In all companies professional non-executive board members No politicians, maximum one civil servant

Structure of state ownership steering

PARLIAMENT

OPPOSITION

MINISTRIES MINISTRY OF

DEVELOPMENT

AID

PRIME

MINISTER’S

OFFICE

OWNERSHIP

STEERING DEPT.

GOVERNMENT

MINISTER IN CHARGE

126 74

Responsibilities of the Ownership Dept. Source: Ownership Department

Located in the Prime Minister's Office, but not under the Prime Minister

Directly accountable to the Minister responsible for Ownership Steering

Ownership strategy, analyses and monitoring, legal matters and communications

Independent organisation enables sufficient ability to react and exercise criticism

State role in SOEs

OWNERSHIP STEERING

OWNERSHIP

STEERING

DEPARTMENT

SOE

BOARD

CS

1

CS

2

CS

2

APPOINTED

MEMBER

CHAIR

Chinese wall

Premises and decision making Source: Ownership department

Essential legislation, corporate governance, government resolution and statement by the Cabinet Committee

Parliament sets shareholding limits, allocates budget resources and approves incorporation arrangements

Decisions on sales and acquisitions and on the overall governing principles are made in government plenary sessions

The Minister responsible for Ownership Steering exercises the right of action and is accountable to the Government and Parliament

Companies operating on market terms are under the Ownership Steering Department in the Prime Minister's Office

Lessons learned Pragmatism

Take your time

Motivate population (voters)

Focus on governance

Define categories for different interests

Find best people

Remember national interests

Olli V. Virtanen Virtanen Associates Oy

Hiidenkuja 6 B 4 02750 Espoo

Finland

Tel. +358-500-600462 olli.virtanen@virtanenassociates.com

www.virtanenassociates.com

Role Pakistan State Owned Policy Reforms

By:

Dr. Shamshad Akhtar

Pakistan: SOE Sector Privatization has helped scaled down the size and scale of SOE

sector

SBP data suggests: there are currently about 220 SOEs and perhaps now contribute 10% of GDP

About 140 or so are federal entities

23 of these SOEs are listed on KSE and constitute about one third of market capitalization include 7 FIs, 8 energy related entities and large companies such as PIA and PNSC

State’s presence remains overwhelmingly large in infrastructure sector 23 electricity and gas companies

17 transport and communication entities

15 financial institutions incl. insurance sector

38 manufacturing enterprises

38 support services entitites

2 mining and 2 agriculture enterprises

4/16/2012 19

Assessment of SOEs Sector is a complex endeavor –practices and trends are disturbing

The Government does not have consolidated data or central management information system which could offer a comprehensive perspective on operational and financial performance.

Ownership and oversight dispersed and fragmented being with Sector Ministries who do not have a transparent policy framework or reporting on SOEs under their domain

Quality of oversight varies as the Ministries lack capacities and understanding of the principles of governing state enterprises

Limited recognition of need for safeguarding the public assets and enhancing their market valuation

Pervasive State interference in SOE affairs and appointments, over-employment and skill mismatches

4/16/2012 20

Fiscal burden unsustainable Losses of SOEs have grown in recent years and according to some

estimates could be in the range of 1.5% of GDP or so. For e.g

Power sector is riddled with inter-enterprise arrears, tariff subsidies, rising cost of oil, and transmission losses and most of all IPP payments. The circular debt liabilities recently reached close to Rs391 billion – to raise liquidity for settling these liabilities Government floated T-bills/PIBs and is now obligated to assume this debt as well as the interest liabilities of Rs44.5 billion. Aside from continuous build up of these obligations the power entities have large receivables whose non payment generates additional complications.

PIA cumulative losses are estimated to be Rs111 billion over and above this the Government has offered to PIAC long term financing for working capital, guaranteed its borrowing and pays financial charges on selected debt securities.

4/16/2012 21

State Owned Enterprise Reforms Privatization of SOEs on agenda

The Council of Common Interest had endorsed privatization of 65 SOEs,

the Cabinet Committee for Privatization considered 23 cases including the generating and distributing companies, Pak Railways and insurance companies etc.

Progress stalled because of the political and economic uncertainty and concerns with the valuation of companies in current state.

Current focus is on developing and restructuring plans are being developed for railways, and PIAC etc.

Power Sector recovery plan: Genco Holding Company has been set up and has a private sector led Board, the four Gencos CEOs being appointed and Boards will include independent members , and PEPCO abolished and Other power related entities board transformation to follow. Circular debt issue only partially resolved but a complicated case

Restructuring plans for other SOEs under preparation incl. PIAC/Pak Railways

Good initiatives but

pace of implementation too slow,

Sequencing needs more reflection and efforts are fragmented

Sector Ministries not fully aligned with the mandate

4/16/2012 22

Strengthening Corporate Governance most crucial – reinforce few areas

Appointment of CEOs, Board and its composition.

Best way to insulate the process of appointment of CEOs and Board member from politics is to set up an independent Commission with high powered professionals to select

appoint Board members based on fit and proper criteria and a roaster of professional candidate.

CEO ought to be appointed by the Board based on defined fit and proper criteria including scrutiny of conflict of interest provisions and based on an open and competitive process and Board should ensure due process for misconduct.

The Board should include broad based and diverse skills including industry specialist, financial and human resource experts etc.

If the Government is sole or controlling owner, it is undoubtedly in a unique position to nominate and elect the board but there is often tendency to appoint excessive government representatives. Even if the government opts to nominate BOD it should perform effective due diligence in identifying, nominating and electing board members.

4/16/2012 23

Role and responsibility of Board.

The key is for the government and directors to understand that the SOE Board is accountable to shareholder and wider stakeholders and is responsible for SOE performance

Board and shareholders should have a clear understanding of the SOE Board roles and responsibility

SOE Board, like private companies, have to be involved in the Mission and Vision, strategy and oversight of the company, while delegating management to CEO

Good to have a recognition of that SOE Boards capacities need strengthening and Board has to have an understanding of the public role and functions SOEs

Directors need to develop a clear understanding of the risks and liabilities company faces and ensure risk mitigation strategies are applied to safeguard public assets and resources.

4/16/2012 24

Separation of the role of Chairman and CEOs This is quite common in Europe with German and Dutch regulators

requiring this split

In the United Kingdom, over 80% of large companies have an independent chairman, and

In US this proportion has steadily grown from a low of 16% to about 40% or so.

There is also a rise in the share of companies with independent Chairman.

Cleaving the CEO and chairman role makes senses as CEO is responsible for company management and cannot realistically be expected to self monitor and evaluate own role and performance.

Chairperson is responsible for driving the strategy and policy and for managing dynamic interaction among the Board and carrying greater compliance and reporting requirements.

Success depends on how effectively the role of Chairman and CEOs is defined and segregated.

4/16/2012 25

Formation of Committees.

The guidelines recommend rightly for SOEs to constitute range of Board committees:

audit,

risk,

human resource,

procurement etc.

These Committees to be chaired by Board members competent in this areas and be offer a clear mandate and accountability.

4/16/2012 26

Corporate Governance of SOEs The draft Public Sector Companies (Corporate Governance) Regulations

a first step but a necessary precondition for setting right the principles of internal governance at firm level.

The code for SOEs is similar to the Code of Corporate Governance applicable to the listed entities

23 SOEs who are publicly listed and are likely to be following most of the Requirements of the Code.

The proposed code offers to SOEs guidance consistent with the OECD Guidelines for Corporate Governance of State Owned Enterprises, 2005

Add to Code elucidations to offer more deeper guidance on SOEs

SOEs need to be held to higher standards of accountability than private companies as they are public assets and use tax payer money

State ownership does not automatically guarantee State control over the mission and activities of an SOE.

Recognition that the goals of SOEs are typically a more complex mixture of social, political, and commercial objectives.

there has to be simultaneous resolution of a host of external factors that adversely impact governance

4/16/2012 27

Fixing internal governance of companies is necessary but not sufficient for setting the governance right

Nurture a sound external governance framework

Consider pros and cons of decentralized model of ownership and oversight of Pakistan and centralize ownership model

Ensure competitive neutrality and contestability of markets in which SOEs operate – use the power of competition to introduce better results

Develop an objective and clear SOE policy

Convert SOEs to a proper legal structure

Develop a policy for public service obligations

Develop role and capacities of sector regulators

Develop a Watch dog and offer them tools such as corporate scorecard for ensuring transparency and compliance with the Code

4/16/2012 28

No one size fit model for centralized ownership model

A survey of OECD and study of the World Bank suggests a growing trend among its members to move from decentralized to a centralized ownership model. Under the centralized ownership model, the shareholding of SOEs have been transferred to a government holding company or in a designated Ministry or a coordinating body.

Role model being quoted world wide is Singapore established Temasek – an old Malay names “sea town” (or similar bodies with different characteristics in other countries)

Temasek is registered under Company Act and a Government linked Company

It is national holding company for SOEs shares & 100% owned by the MOF

Under Singapore’s Constitution and laws, neither the President of Singapore nor the Government can be involved in THL investment, divestment or other business decisions

4/16/2012 29

Singapore Temasek Temasek has substantial authority in its subsidiary companies and is

responsible for appointment of Board and CEOs. Exercise good government internally in THL and subscribes standards for its subsidiaries or independent statutory corporations

Strong and ethically sound civil service and statutory boards legislated by Parliament have full autonomy but accountability is strong and this together contributes to smooth function of Temasek

the President is custodial of the investments approves THL’s annual budget but there is clear separation of ownership and control and the Chairman and CEO operate with full flexibility

To institutionalize its role, Temasek has recently became more transparent and sought credit rating to establish it long term role and be supportive of raising capital

4/16/2012 30

Move to centralize ownership model In Poland, the bulk of SOEs are under the Ministry of the Treasury,

which has special units for privatization and SOE governance.

In Indonesia, the Ministry of State-Owned Enterprises exercises the states ownership rights in SOEs.

In Jordan, the ownership function are vested with the Jordan Investment Corporation

In Turkey, the Treasury and the Privatization Administration, are the legal owners of SOEs.

Re-examination of ownership functions are also critical as a uniform approach has to be adopted to nurture well SOEs for an eventual privatization that is often resisted by the relevant sector ministry whose interference in any case impacts the company performance and dilutes the accountability. In conjunction, the Government may consider

4/16/2012 31

Competitive Neutrality

State ownership should not entitle competitive edge to SOE so create a level playing field and nurture contestability in markets

Competition forces firms to minimize costs and to search for new and better ways of doing business and will enhance economic efficiency and innovation.

Enhance role and capacities of Regulators and Competition Commission to examine the SOEs role in transport, power generation and public utilities which often operate as ‘natural monopolies’ (even if private entry allowed) and examine whether state ownership is ensuring an adequate level of service provision.

Examine ways of generating competition within the market. For example, through competitive tendering – i.e. competition for the market – as an option: for e.g countries have allocated on a competitive tendering basis the public service obligation such as the domestic transport routes (air and railways), particularly for social and regional access

4/16/2012 32

Other Factors

Develop a clear SOE policy

The Government as a shareholder needs to communicate what the objectives, role and mandate of SOEs ought to be and what is their expectation regarding operational and financial performance.

The government to modernize the operating guidelines and rules.

SOEs should be allowed to be run on commercial principles, and held accountable to ensure judicious use of public resources, while serving the demands of society at an affordable price.

Convert most SOEs to standard legal structures

corporatize the departmental undertakings delivering services (such as Pakistan Railways), bodies set up under special Acts/Statues (PIA) and joint ventures (such as Development Financial Institutions).

Corporatization would contribute to overall transparency by requiring proper compilation of accounts and information, while bring companies under company and other laws and insulating companies from political intrusion. Boards should be empowered with full powers to oversee the companies.

4/16/2012 33

Other factors

Develop a policy for public service obligations.

Given its broad based implications for public, SOEs should make full disclosure of trade offs it faces, costs and quality of delivery etc.

Legislature to approve the PSO policy and its cost implications

The budget should annually provide for financing of the required subsidies in a transparent manner.

Develop the role and capacities of sector regulators

Enhance the regulatory frameworks in accordance with the sector policies

Check the compliance with sector policies, regulation and pricing regime

Involve stakeholders in consultations

Enhance advocacy of corporate governance beyond firm level and

develop awareness of the legislature and executive branch so that these bodies reinforce corporate governance.

4/16/2012 34

Conclusion: Compliance of Corporate Governance of SOEs

The Government and private sector need to reflect on how to institutionalize the reporting on compliance of Code

For listed companies, SECP is the main hub and SOEs come under the purview of standard covenants of company, securities and other key legislation and regulations.

Recommend setting up a focal unit – perhaps a public private partnership based on international best practice and sponsored with support of IFC a Commission or body which is empowered and mandated to

Collate the operational and financial performance and service standards offered vis a vis the corporate strategy and benchmarks

Develop a score card which both the listed and other SOE undertakings adopt and report their compliance relative to the corporate governance code

Offer online this information to public and the performance of comparative companies

4/16/2012 35

Thank you

Role of The Chairman in Managing Government Intervention in Board

Decisions

By:

Mr. Farooq Rahmatullah Chairman, Pakistan Refinery Limited

Cost of running state enterprises to

national exchequer & tax payer

The annual subsidy and support to state enterprises on an annualized

basis ranges from Rs.350 – 400 billion

Political

Interference!

I decide

who should be

promoted!

People to be

recruited

according to our

political needs!

I decide who

should be the

MD .

Professionalism to be

looked down upon!

Gain popularity.

Encourage

Unionism!

M.D

Chairman

Award contracts

to

people/Company

of my Choice!

Merit is not a

criteria acceptable

to political

leadership!

Nepotism &

Favoritism to

be the guiding

principles!

M.D

Chairman

Managing Government

Intervention In Board Decisions

Make sub-

committees of the

board participive &

effective!

Appointment

,remuneration in

terms & conditions of

employment of

MD/CEO and

executive directors! Help management to

identify competency

gaps within the

organization! Evaluate board

performance!

Establish a system

of sound internal

controls and to

have it effectively

implemented at all

levels!

Set targets & goals,

measure performance!

Exercise powers to

carry out fiduciary

duties with sense of

objective, judgment &

independence in best

interest of the

company!

Have directors attend

orientation courses!

Directors to elect

chairman of the

board!

Inculcate culture of

merit & rewarding

performance!

Help management in

eliminating/minimizi

ng external

interference in the

affairs of the

company!

Have qualification

and merit criteria to

appoint board of

directors!

Way forward If there is no political or government interference

and organizations work under merit regime; efficiency & performance of state own enterprises could increase by as much as 30-35%. For example OGDC’s annual revenue would increase by Rs.46 billion and profits by Rs. 20 billion.

Thank you

Making Government Directors Contribute Towards Board Effectiveness

By:

Syed Naseem Ahmad Chairman, Faysal Bank Limited

Performance of PSEs – How can it be improved

•Structure of PSEs (a) Under Companies’ Ordinance (b) Under a special enactment (c) Government involvement in Management (d) Separate ownership and management

•Mindset of the major stakeholders

•Explicitly stated intent of stakeholder (a) PSE will be left alone , no interference in day to day

management (b) What is expected of PSE - deliverables and targets.

Board of Directors

(a) Selection of qualified and experienced Directors

(b) Composition – all disciplines – financially literate

(c) Fully inducted into the organization

(d) Adopt Corporate Governance Principles

Corporate entities operating principles

(a) Systems & procedures (b) Trained & qualified personnel (c) Accountability - Financial - Ethics - Production - Sales & marketing

Thank you