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Proposed New Set of Corporate Governance Rules for Portugal
The Portuguese Securities Regulator (Comissão do Mercado de Valores Mobiliários, hereinafter “CMVM”) has recently launched a public consultation on a proposal for a new set of corporate governance rules and recommendations applicable to listed companies subject to Portuguese Law. When approved, this new regime will supersede the previous rules and recommendations enacted in 2007, thus introducing more stringent requirements for listed companies in Portugal. Among the proposed changes, remuneration and audit are the main areas of regulatory concern.
In general, the process of amending the Corporate Governance Code (as well as some additional rules on the subject, including legislation that has been enacted by the Parliament and by the Government) has been conducted under some pressure motivated by the latest financial crisis. In effect, some of the international and national recommendations and studies specifically designed to be implemented in the financial services industry seem to be now contaminating to trends for the corporate governance rules applicable to non-financial issuers. This trend strikes most market participants as surprised insofar as some issues concerning regulation of financial institutions do not seem to make any sense when applied to companies in other sectors of the economy.
Additionally, some of the provisions of the proposal under public consultation (the “Proposal”) that expressly accommodate international and domestic proposals regarding the financial sector, do not fully reflect the scope, purpose and views contained in such proposals; in some extreme cases, gold-plating and over regulatory trends seem to be the only plausible explanation for unusual solutions, on which we will focus upon in greater detail below.
These measures evidence a clear shift in Corporate Governance Portuguese standards from board independence and accountability matters to remuneration, audit and risk management; areas that have also recently proved to be major issues at European level. The outlook will appear positive should the regulators are able to distinguish between what is really needed or not.
Audit
The main provisions of the Proposal concerning audit services provide for mandatory rotation of the external auditor (and not solely of the senior audit partner) at least every seven years.
The measure of mandatory rotation of the senior audit partner at least every seven years and a two-year cooling-off period had already been implemented in Portugal under the transposition of the 8th Company Law Directive (Directive 2006/43/EC), however, it has recently been argued that this measure does not fully ensure the independence of the external auditor. In an effort to create an innovative regulation, CMVM has submitted this very controversial and “heavy regulatory touch” solution to consultation.
In a country with no previous history of corporate audit scandals, this proposal has caused a great amount of concern among listed companies and auditors, to the extent that the imposition of such a burden on companies is not sustained by empirical evidence to be a good option, and may even be detrimental to the audit function. Indeed, the time and resource consuming task of providing training and support to an auditor in its first years of activity in the company would have to be periodically repeated and the incentives for the auditor would diminish if no continuity of services could be offered as a reward for good auditor performance.
Additionally, a complete ban on the provision of non-audit services, such as tax advisory, by the external auditor (or by any entities belonging to the same group or that are “participated companies”) is also onthe discussion table.
This leads to a presumption of non-independence of the auditors that is clearly against the rationale of the 8th Directive and of the European Commission’s Recommendation 2002/590/EC. Moreover, auditors are usually apt to determine quite accurately whether their independence is at stake when providing non-audit services, listed companies and audit firms argue.
Despite being a very effective measure of preventing conflicts of interest and self-review issues, the ban on non-audit services provided by the same auditor will certainly result in a poorer audit quality and increased ancillary service fees, insofar as synergies may arise from providing both such services. Supporting this view, recently revised empirical studies have confirmed that.
Notwithstanding all the aforesaid, one of the major problems with these two proposals on audit lies on the size of the Portuguese market, in which only a couple of leading audit service providers exist. Consequently, alongside the unquestionable burden imposed on listed companies by these proposals, there is also a significant risk of competition distortion practices.
However, and on a less sombre note, these matters are imposed on a “comply or explain” basis, providing listed companies a chance to mitigate the hardship of the burdens placed upon them.
Remuneration
Remuneration is also one of the main issues in the Portuguese corporate governance debate. Pursuant to the European Commission recommendations on remuneration policies in the financial services sector and on the regime for the remuneration of Directors of listed companies and to domestic legislation enacted in June 2009 (Law no. 28/2009 of June, 19th), enhanced disclosure duties concerning remuneration will be required from both financial institutions and listed companies. Shareholders having a say over pay, through approval by the shareholders of a remuneration policy, is another main commitment, both at the internal legislative level and in the CMVM’s soft law approach.
The above referred Law no. 28/2009 of June, 19th requires the board of directors or the remuneration committee (in the case there is one) of listed companies to submit to shareholders approval, on an yearly basis, a statement on the remuneration policy of the members of the management and supervisory bodies of the company.
In accordance with the law, listed companies shall, in addition and on a yearly basis, disclose the remuneration policy of the members of such corporate bodies (approved by the general shareholders meeting), as well as their annual remuneration both on an aggregated and individual basis. Breach of these obligations may lead to the application of severe penalties.
It has been argued that disclosure of individual remuneration makes perfect sense in countries where the board itself (or through its specialized committees), apportions among directors the overall amount of remuneration set by shareholders. However, in Portugal such a practice does not exist, to the extent that the shareholders are responsible, either directly or through a remuneration committee, for setting the remuneration of the individual members of the management and of the supervisory bodies.
The proposed CMVM’s recommendatory approach to remuneration clearly complements and aims for greater completeness when compared to Law no. 28/2009, of June, 19th. Apart from introducing requirements of alignment of remuneration with the company’s long term interests and curbing excessive risk appetence, the Proposal also sets forth a significant number of measures on variable remuneration (including a claw-back provision on remuneration paid on the basis of misleading information) and eliminates “reward for failure” situations.
Other proposed recommendations include several features of European standard corporate governance practices, such as a three year vesting period for stock options and securities comprising variable remuneration, restrictions on severance payments and golden parachutes, setting of pre-determined criteria triggering the granting of stock options and securities, requiring directors not to dispose the whole of their shares in the company granted as variable compensation for a certain period of time, among several others.
The statement on remuneration policy above referred to is also subject to a few additional soft law requirements, such as: identifying employees that may have an activity impacting on the company’s risk profile – a hard task for non-financial institutions; information on severance payments and amounts paid for termination of director’s contracts. All the above demonstrate a clear attempt to establish a more stringent regime than the one set out in the European Commission’s Recommendations.
Disclosure is also a major focus: supplementing the aforementioned legislation: CMVM’s proposed regulations require remuneration disclosure to comprise both the fix and variable components of remuneration, the methods for calculating the latter and the percentage of which has already been paid or is still outstanding.
Moreover, pursuant to the Proposal, all the pension benefits acquired by directors, as well as the remuneration perceived in group companies and in entities controlled by qualifying shareholders shall be disclosed. Regarding this last item, a lot of issues have been raised by public consultation respondents, to the extent that this may amount to an intrusion in private and sensitive matters concerning companies. This latter requirement, that fails to match any other similar natured measure in any other jurisdiction, may well lead to (i) disclosure of confidential information in third party companies; (ii) unnecessary duplication of the related party transactions regime; (iii) several misunderstandings of the concept of “controlled companies” included in the wording of CMVM’s recommendation and that still awaits clarification from the CMVM.
To sum up
Corporate governance is widely viewed as a mechanism for increasing firm value. However, for such an increase in firm value to be really beneficial for companies and for the economy as a whole, the market must not suffer from corporate governance myopia, in the sense that all corporate governance enhancement measures implemented in listed companies shall indeed be perceived by the market as a step towards better management and sustainable growth of enterprises.
In a market such as the Portuguese, there is no guarantee that the market will respond appropriately to the implementation of a corporate governance regime that is too taxing on companies, risking the cure to be even worse than the disease. To that extent, and provided markets are still recovering from the latest credit drought, regulators should be implementing minimum “housekeeping” governance rules, rather than embarking in ambitious and innovative corporate governance ventures that may well be viewed as unnecessary and detrimental in this scenario.