Salient features of the new Listing Rules on Corporate Governance

New rules on Corporate Governance of the CSE are set to enhance the governance regime among Listed Companies. The Listing Rules of the Colombo Stock Exchange (CSE) now include a newly added Section 9 on Corporate Governance. This section covers several key areas that require discussion and attention:

1. Directors will not be considered ‘independent’ if they are above 70 years of age

2. Chairperson and CEO positions cannot be held by one person

3.The requirement to appoint a Senior Independent Director

4.Assessment of the Fitness and Propriety of Directors and CEOs

All Listed Entities must ensure compliance with the revised Corporate Governance Requirements of the CSE in accordance with the respective effective dates specified.

Among the main rules on corporate governance, the following areas are discussed for better understanding:

1. Directors over 70 cannot serve as Independent Directors and are categorised as Non-Independent. And why 70 and not more?

The new rules on corporate governance, as introduced by the CSE, include a provision that considers directors above the age of 70 as non-independent. This provision addresses concerns related to age and its potential impact on a director’s independence, objectivity, and ability to effectively represent shareholders’ interests.

The rationale behind this provision is the recognition that advancing age may introduce certain challenges that could compromise a director’s effectiveness. These challenges include potential declines in cognitive abilities, conflicts of interest arising from retirement or succession planning, and the potential entrenchment of long-tenured directors that may hinder board diversity and refreshment.

By designating directors aged 70 or above as non-independent, the aim is to ensure that boards maintain a certain level of diversity and fresh perspectives. This, in turn, contributes to a more effective governance framework and better protection of shareholders’ interests.

Overall, these new rules on corporate governance reflect the commitment of the CSE to promote transparency, accountability, and good governance practices among Listed Companies.

2. Chairperson and CEO positions cannot be held by one person -

Rule 9.3.3 of the corporate governance regulations stipulates that the roles of Chairman of the Board and Chief Executive Officer (CEO) should be held by separate individuals. This rule, known as the CEO duality rule, has been subject to extensive debate in the field of corporate governance. It recognises the challenges that arise when family-run businesses are involved, as family members may be resistant to separating their involvement in management.

Let’s examine the pros and cons associated with the separation of the Chairman and CEO roles:

Pros:

1. Improved checks and balances: By having two separate individuals in these roles, a system of checks and balances is established within the organisation. The Chairman provides oversight, sets the agenda for board discussions, and represents the interests of shareholders. Meanwhile, the CEO focuses on day-to-day operations. This separation can minimise the concentration of power and help hold management accountable to the board.

2. Enhanced board independence: With an independent Chairman, the board can operate more effectively. An independent Chairman is better positioned to challenge the CEO’s decisions, offer an impartial perspective, and represent the interests of all stakeholders. This can lead to more robust and independent board discussions.

3. Mitigation of conflicts of interest: Separating the Chairman and CEO roles helps minimise potential conflicts of interest. The Chairman’s primary responsibility is to protect the interests of shareholders, while the CEO focuses on executing the company’s strategy. This separation discourages situations where the CEO might prioritise their personal agenda over broader shareholder interests.

Cons:

1. Loss of efficiency and accountability: Combining the Chairman and CEO roles can result in more streamlined decision-making and enhanced efficiency. The CEO can act swiftly in making strategic decisions without requiring extensive board consensus. Additionally, it may provide a clear line of accountability since there is a single person responsible for both the strategic direction and operational management of the company.

It is worth noting that the effectiveness of separating the Chairman and CEO roles can vary depending on the specific circumstances of each organisation. While the separation is generally seen as a best practice, there may be situations where combining the positions could work well, especially in smaller companies with limited resources or in cases where a strong culture of accountability exists.

Overall, the rule regarding the separation of the Chairman and CEO positions aims to enhance governance practices and prevent potential conflicts of interest, but its applicability and impact should be carefully considered in each organisational context.

3. The role of a Senior Independent Director (SID) - 9.5.1 b(ii):

The appointment of a Senior Independent Director (SID) is mandatory in specific instances to ensure effective corporate governance and the protection of stakeholders’ interests. Let’s analyse the instances and the associated responsibilities:

1. The positions of the Chairperson and CEO are held by the same individual:

In situations where the Chairperson and CEO roles are combined, it is deemed necessary to appoint a Senior Independent Director. The SID serves as a separate and independent channel for communication and oversight within the organisation. This helps maintain proper checks and balances, ensuring that the interests of shareholders and other stakeholders are protected.

2. The Chairperson is an Executive Director:

When the Chairperson also holds an executive director position, there is a potential conflict of interest. To address this, appointing an SID is prudent. The presence of an SID allows for an independent voice and leadership within the board, promoting impartiality and effective decision-making.

3. The Chairperson and CEO are close family members or related parties:

If the Chairperson and CEO have a close family relationship or a related-party connection, concerns may arise regarding conflicts of interest and impartiality. In such cases, appointing an SID helps mitigate these concerns by providing an unbiased perspective and ensuring decision-making is carried out in the best interest of the company.

Responsibilities of a Senior Independent Director

1.Meetings with Independent Directors:

The SID should schedule meetings at least once a year with other independent directors. These meetings serve as a platform to discuss matters related to the entity, board operations, and address any concerns that may arise. By fostering open dialogue, the SID promotes effective communication and collaboration among independent directors.

2. Meetings with Non-Executive Directors without the Chairperson:

The SID should also arrange meetings at least once a year with non-executive directors, excluding the Chairperson. This enables an objective appraisal of the Chairperson’s performance and provides an opportunity to discuss any concerns or suggestions without the Chairperson’s influence.

In summary, the role of the Senior Independent Director plays a vital part in ensuring effective corporate governance. Through their independent perspective and responsibilities, they contribute to maintaining checks and balances, promoting impartiality, and safeguarding stakeholders’ interests in instances where potential conflicts of interest may arise within the Chairman and CEO positions. The SID does not have to be the most senior in terms of age and seniority in the board.

4. Fit and proper criteria for Directors and CEO

Section 89(2) of the SEC Act: “Directors or Chief Executive Officer of a Listed company shall comply with the fit and proper criteria specified by the commission. Ideally it is crucial that both parties fulfil this requirement. Mistakes, if present, should be rectified promptly, as deliberate deviations from this standard are detrimental to a robust governance regime.

It is important to consider the fit and proper criteria for directors and CEOs. Fit and proper criteria typically en-compass a range of qualities and characteristics that determine an individual’s suitability for a leadership position. These criteria may vary depending on regulatory requirements, industry standards, and organisational needs. Here are some common aspects considered in assessing fit and proper criteria:

1. Competence and expertise: Directors and CEOs should possess the necessary skills, knowledge, and experience required to fulfil their roles effectively. This includes understanding the industry, business operations, risk management, financial management, and strategic decision-making. Demonstrating a track record of relevant achievements and ongoing professional development is essential.

2. Leadership and management capabilities: Directors and CEOs need strong leadership and management capabilities to guide the organisation, make sound decisions, and drive performance. This involves demonstrating effective communication, collaboration, problem-solving, and decision-making skills. The ability to inspire and motivate others, foster a positive organisational culture, and adapt to changing circumstances is also important.

3. Financial responsibility: Directors and CEOs are often responsible for financial oversight and ensuring the organisation’s financial health. They should have a good understanding of financial matters, including financial reporting, budgeting, risk assessment, and compliance. Demonstrating financial prudence, accountability, and the ability to make informed financial decisions is crucial.

4. Independence: Independence refers to the ability to act objectively and without undue influence. Directors and CEOs should be able to make decisions in the best interest of the organisation, its shareholders, and stakeholders, without being swayed by personal or external interests. Independence is particularly relevant for independent directors who play a crucial role in providing unbiased advice and oversight.

5. Ethical conduct and compliance: Directors and CEOs should adhere to ethical standards and comply with laws, regulations, and corporate governance principles. They should promote a culture of integrity, transparency, and accountability within the organisation. Demonstrating a commitment to ethical conduct, avoiding conflicts of interest, and upholding legal and regulatory requirements are essential.

To ensure that directors and CEOs meet the fit and proper criteria, organisations may conduct thorough assessments, interviews, reference checks, and evaluations. Ongoing monitoring and periodic reviews can also help ensure that individuals continue to meet the required standards throughout their tenure. It is important for organisations to establish clear policies, codes of conduct, and governance frameworks that emphasise the importance of fitness and propriety for directors and CEOs.

Rules and regulations

Rules and regulations alone cannot guarantee ethical behaviour, as evidenced by the case of the crooked man, that no amount of rules and regulations can make him straight. While rules and regulations provide a framework for corporate governance, they are only effective when complemented by ethical values and a strong ethical culture within an organisation.

To address this limitation, organisations should focus on the following:

1. Ethical leadership: Leaders play a critical role in setting the tone for ethical behaviour within an organisation. By demonstrating ethical leadership through their actions, decisions, and communication, they can inspire and influence others to act ethically.

2. Comprehensive Codes of Conduct: Organisations should develop clear and comprehensive codes of conduct that outline expected ethical behaviour for all employees, including directors and CEOs. These codes should address potential conflicts of interest, bribery, fraud, harassment, and other ethical issues. Regular training and communication on the code of conduct are also essential to ensure that employees understand and adhere to ethical standards.

3. Stakeholder engagement: Organisations should actively engage with stakeholders, including employees, share-holders, customers, and the broader community, to understand their expectations and concerns. By considering the interests of various stakeholders and incorporating their perspectives, organisations can make more informed decisions that align with ethical principles.

4. Effective oversight: Oversight mechanisms, such as independent board committees and internal audit functions, should be strengthened to monitor and evaluate the organisation’s compliance with ethical standards. Effective oversight ensures accountability and helps identify and rectify unethical behaviour or non-compliance.

5. Ethical culture: Organisations should foster an ethical culture that promotes openness, transparency, accountability, and respect. This includes encouraging employees to speak up about ethical concerns, providing channels for reporting wrongdoing, and protecting whistleblowers from retaliation.

While rules and regulations provide a necessary foundation for corporate governance, organisations must go beyond mere compliance and address the underlying ethical values and culture. By promoting ethical behaviour from the top-down and creating an environment that values integrity and accountability, organisations can mitigate the risk of unethical practices and enhance their overall corporate governance practices.

The writer is a former Director General of the Securities and Exchange Commission of Sri Lanka and a Senior Advisor to the Finance Ministry. He now heads a boutique style legal practice corporate Legal Consultants, focusing on Financial Markets and Investments. [email protected]

(The writer is a former Director General of the Securities and Exchange Commission of Sri Lanka and a Senior Advisor to the Finance Ministry. He now heads a boutique style legal practice corporate Legal Consultants, focusing on Financial Markets and Investments. [email protected])