(First of three parts)
Following is an excerpt from the speech given by the author in a recent general membership meeting of the Bankers Institute of the Philippines (BAIPHIL).
The financial reform agenda
Recent accounting and auditing scandals have led to a new resolve on the part of regulators and business leaders to reinforce and improve standard-setting processes and require sound accounting, auditing, and disclosure practices by companies and their auditors. The unprecedented problems in the recent past have prompted efforts to restore investor confidence in our capital markets through regulatory reforms affecting both the accounting profession and corporate management. These efforts led to, for example, the enactment of the now famous Sarbanes-Oxley Act in the United States which set the stage for a new audit oversight board to regulate, inspect, report on, and in some cases enforce penalties against auditors and led to new requirements for corporate management to maintain strong internal controls and report thereon. Steps were also taken to strengthen the international accounting and audit standard-setting processes.
In the local scene, the financial regulators (Securities and Exchange Commission, Bangko Sentral ng Pilipinas and Insurance Commission) have come up with their own rules as a result of the Asian financial crisis, our own set of corporate scandals and pressure from the multilaterals like the World Bank, Asian Development Bank and International Monetary Fund as well as from big investor groups like CalPers and private equity firms. So we now have rules on corporate governance, accreditation of external auditors and for banks, risk management guidelines.
Corporate governance
Corporate governance is a broad concept which includes financial reporting and auditing. The focus on corporate governance today has highlighted the role and importance of the accounting profession. If you look at the Code of Corporate Governance, the bulk of it deals with accountability and audit. The most important board committee is the Audit Committee. Corporate governance is really about fairness, accountability and transparency which are the hallmarks of financial reporting. Let me now go to the key issues of corporate governance in the Philippines.
The international agenda for corporate governance is being driven mainly from the US, Western Europe and other developed economies. Many experts from the developing countries have questioned the applicability of the internationally accepted governance principles as their situations differ very much from those in developed countries. Foremost among these differences is the widespread ownership of listed companies in developed economies, while in countries like the Philippines, a dominant group, usually a family, controls 70 percent or more of the voting stock. In effect, the public ownership or float is usually 30 percent or less.
Having independent directors is considered a good practice. Since they are elected by the shareholders, they are effectively chosen by the controlling group or family. To be imbued with the true spirit of independence, all directors have to look after the interest of the corporation, and not only that of the controlling group. This is easier said than done, as certain decisions may involve conflicts of interest such as related party transactions. There is therefore a need to professionalize the job of corporate directors. This means that directors, especially those considered independent, must undergo proper training. Organizations such as the Institute of Corporate Directors, are now sponsoring training programs of this nature.
To ensure that the spirit of corporate governance is followed by listed entities, rigorous reinforcement of established rules must be done by our regulators.
The challenge for the Philippines is how to convince controlling groups or families in listed companies to buy into good corporate governance. They must be convinced that while there is a cost to being transparent in reporting and opening up to outsiders, it will ultimately redound to their benefit in terms of higher market value and a better reputation for the company. A lot of studies have shown that companies which practice good corporate governance enjoy a premium of as high as 30 percent in the market price of their shares.
If corporate governance is to succeed, banks must play a leading role. Banks control around 80 percent to 90 percent of financing in the country. Credit policies followed by the bank therefore influence the corporate governance practices of bank borrowers. This has been amply demonstrated in the BSP circular prescribing SEC-accredited auditors to audit the financial statement of borrowers with assets of P15 million or more. That BSP circular has gone a long way in ensuring reliable financial reporting for a significant portion of our business community.
IFRS
The implementation in 2005 of International Financing Reporting Standards (IFRS) as the accounting language for many countries has been the biggest revolution in the history of the profession. With stricter rules in classifying, measuring and reporting of financial assets and liabilities, certain flexibilities in financial reporting are no longer allowed.
The most complex standards adopted in 2005 were PAS 32 and PAS 39 which had a big impact on the banking industry. These two standards deal with the recognition, measurement, presentation and disclosures of financial instruments. In 2007, the banking industry is again required to adopt PFRS 7, Financial Instrument Disclosures. This new PFRS, which is effective for financial statements with accounting period beginning January 1, 2007, requires extensive disclosures about the significance of financial instruments for an entity’s financial position and performance, quantitative and qualitative disclosures on the nature and extent of risks. For each type of risk, a bank is required to disclose (1) the exposures to risk and how they arise; (2) its objectives, policies and processes for managing the risk and the methods used to measure the risk; and (3) any changes therein. Examples of disclosures include the breakdown of its financial assets into credit grade rating, into the type of collateral held to support the exposure, concentration of risk by sector, and/or geographic location.
(To be continued)
(Roberto G. Manabat is the Chairman and CEO of KPMG Manabat Sanagustin & Co.)