Listed companies: Changes in code of corporate governance

24 Dec, 2017

The Securities and Exchange Commission of Pakistan (SECP) has notified Listed Companies (Code of Corporate Governance) Regulations 2017 through SRO 1216(I) 2017 dated November 22, 2017.
These regulations shall be effective for the periods beginning after December 31, 2017. In addition to listed companies, these regulations shall also apply to other entities, to the extent applicable, if required under their relevant statues and underlying licensing requirements.
Salient features of the changes brought in the Code are explained below:
1. Board of Directors
A. Composition
i) Limit on directorship; number reduced
The limit on holding directorship in listed companies, including as an alternate director but excluding the directorships in their listed subsidiaries, has been reduced from the existing seven to five. This ceiling becomes applicable at the earlier of the reconstitution of the Board or one year from the effective date of this Code
ii) Independent director; now more than one
The existing code mandates at least one director to be independent and prefers that one third of the board comprise of independents. In the CCG 2017, independent directors' representation on the Board has been increased to include at least two independent directors or one third of the total Board members whichever is higher. This requirement shall be effective on reconstitution of the board, upon expiry of its current term.
Under these regulations, every independent director is required to give a declaration that he meets the qualifying criteria of Independence under the Act. This Declaration is to be submitted together with consent to act as director and then to the Chairman of the Board, annually, in the first meeting of the Board and in the event of any change affecting independence.
The criteria of independence is provided under section 166(2) of the Companies Act, 2017.
iii) Gender Diversity to be ensured
While the previous Code encouraged gender diversity in the Board, representation of at least one (1) female director on the Board is made mandatory under these regulations. The compliance is to be ensured within one year, from the notification date of the regulations or reconstitution of the board whichever is later. The said mandatory requirement also came in vide section 154(1) of the Companies Act, 2017.
iv) Executive Directors
The limit on the number of executive directors, including Chief Executive, a listed company can have on its board is now one-third of total number of directors instead of previously one-third of elected directors. As per CCG 2017 'Executive director means a director who devotes the whole or substantially the whole of his time (whether paid or not) to the operations of the company'.
B. Conflict of Interest
Presence of at least two independent directors shall be mandatory in board meetings where an agenda item involving conflict of interest of a director is under consideration. This provision has an overriding effect on the articles of association of the Company.
C. Responsibilities
i) Business Risk Review
Besides overall responsibility for governance of risk, the Board shall be responsible to undertake at least annually, an overall review of business risks faced by the Company.
ii) Prevention of Conflict through Code of Conduct
It is already the Board's responsibility to put in place a formal Code of Conduct. The CCG 2017 stresses on promotion of ethical culture and prevention of conflict of interest at all levels ie at the level of board members, senior management and other employees.
iii) Evaluation of Board Committees
The mechanism for annual evaluation that was required for the Boards' own performance is now also in place for the evaluation of committees.
iv) Whistleblowing mechanism
A whistle blowing policy is to be introduced and a mechanism to be established thereunder, to receive and handle complaints, while providing protection to the complainant against victimization.
v) Directors Presence in General Meetings
CCG 2017 makes it mandatory for directors of the company to attend all general meetings unless precluded from doing so due to any reasonable cause. The requirement of sending notice of general meeting to all directors has already become mandatory under the Act.
D. Chairman's Responsibility
The Chairman of the Board has been made responsible to issue letters to the directors, at the beginning of term of each director, setting out their role, responsibilities, obligations, powers, remuneration and entitlements.
Responsibilities of the chairman for setting agenda of board meeting and ensuring availability of reasonable time for their discussion, have been expressly stated in the regulations.
E. Placement of Issues for Board Decision
The Chief Executive Officer (CEO) has now been made explicitly responsible to place before the Board all significant issues. Following items have been added in the list of significant issues:
-- Promulgation of or amendment to a law, rule or regulations, applicability of financial reporting standard and such other matters as may affect the company and the status of compliance therewith;
-- Report on / synopsis of issues and information pursued under the whistle blowing policy, clearly disclosing how such matters were dealt with and finally resolved or concluded;
-- Quarterly details of foreign exchange exposures and the safeguards taken by management against material adverse exchange rate movement;
-- Sale of assets, investments and interest in subsidiaries and undertakings, of material amount or significant nature, which is not in the ordinary course of business;
-- Report on corporate social responsibility activities and status of adoption / compliance of corporate social responsibility (Voluntary) Guidelines 2013.
F. Training programme
The existing Code requires that after June 30, 2018, any newly appointed director on the board shall acquire the certification within a period of six months from the date of his/her appointment. Under CCG 2017 a director is required to acquire this certification within 1 year, from the date of appointment.
Besides the above, the these regulations require completion of director training program by 50% and 75% of total members of the Board till June 30, 2019 and 2020 respectively. All directors are required to be certified by June 30, 2021.
It shall be mandatory that effective from June 30, 2019 one female executive attend the training every year and at least one head of department shall undergo director's training program every year from June 30, 2021.
The provision of experience based exemption, as available under existing Code, has been retained. However, requirement of Commission's approval has been added to this exemption.
G. Committees
i) Audit Committee
a) There is a change in the composition of the committee. It shall be mandatory to have independent director as its Chairman who shall not be the Chairman of the Board.
b) The regulations provide that the Board of Directors shall ensure that at least one member of the audit committee qualifies as "financially literate".
The said expression has been defined in the regulations which means "a person who is a member of a recognized body of professional accountants or has a post graduate degree in finance from a university or equivalent institution, either in Pakistan or abroad recognized by the Higher Education Commission".
c) Chief Executive Officer (CEO) and Chief Financial Officer (CFO) shall not attend any meeting of audit committee, unless invited; including those where matters related to audit and accounts are discussed.
d) The regulations require the Board of Directors to provide resources and authority to enable the audit committee to carry out its responsibilities effectively.
e) Mechanism has to be in place where staff and management can report to audit committee, in confidence, of any actual or potential improprieties. This is besides having a whistle blowing mechanism.
ii) Human Resource and Remuneration Committee
a) Composition of the Committee has been changed to have at least one independent director.
Further, it requires that the Chairman of the Committee shall also be an independent director.
b) The regulations want this committee to meet at least once in a financial year. The secretary can be Head of Human Resource or any other person, to be appointed by the Board.
c) The regulations include the following new items in the terms of reference of the committee:
-- Recommend to the Board a policy framework on remuneration for executive and nonexecutive directors and members of senior management. Senior management is said to include first layer of management below CEO.
-- Undertake the process of annual evaluation of performance of the Board and its committees. The Committee can appoint independent consultant for the purpose.
iii) Nomination Committee
The Board of directors may constitute this committee for considering and making recommendations to the Board in respect of appointments to the Board, Committees of the Board and the Chairmanship of the Committees.
In case of formation of this Committee, its Terms of Reference (TORs) shall be determined by the Board and there should be no duplication and conflict with the TOR of Human Resource and Remuneration Committee (HR&RC).
iv) Risk Management Committee
The Board may constitute the risk management committee to carry out a review of effectiveness of risk management procedures and present a report to the Board. The terms of reference have been defined in the regulations.
H. Director' Remuneration
Mandatory requirement is being introduced to put in place a formal policy and transparent procedure for fixing the remuneration packages of individual directors for attending meetings of the Board and its committees.
The regulations provide an option to engage an independent consultant to recommend an appropriate level of remuneration for consideration of the board, in case the Articles of Association of the Company authorizes the board to determine directors' remuneration.
Policy on permissible fee for non-executive directors including independent directors, has been included in the list of significant polices to be approved by the board.
The Directors, in their report to the members, shall state the 'remuneration policy' of non-executive directors including independent directors. This includes disclosing the significant features and elements thereof.
The Companies are also encouraged to post on their website the key elements of the directors' remuneration policy.
2. Director's Report
Besides contents of the report governed by section 227 of the Companies Act, 2017, the regulations require the Directors' Report to contain following information:
-- Number of male and female directors in the composition of directors
-- Statement to the fact and disclosure of name, qualification and major terms of appointment where HR&R Committee appoints an independent consultant for the performance evaluation process of the Board.
-- Disclosure, to an appropriate extent, of the company's risk framework and internal control system.
-- Significant features and elements of directors' remuneration policy.
3. Qualification of CFO and Internal Auditor
i) Chief Financial Officer (CFO)
The requirement to become a CFO of a listed company has been changed. Managerial experience in the field of audit or accounting or in managing financial or corporate affairs function of a listed company is required. The number of years are;
a) 3 years for members ICAP or ICMAP
b) 5 years for members of any professional accounting body whose qualification is recognized as a Post Graduate Degree by HEC or has Post Graduate Degree in Finance from a University in Pakistan or equivalent qualification, degree recognized and approved by HEC.
c) Seven years for Graduates with suitable degree from a University in Pakistan or equivalent qualification from abroad, recognized and approved by HEC. Suitability of such candidate shall be determined by the Commission on the application of the Company.
ii) Internal Auditor
The revised requirement for head of internal audit has been entailed below:
a) Three years of relevant experience in audit or finance or compliance function and member ICAP or ICMAP
b) Five years of relevant experience in audit or finance or compliance function and is a
i. Certified Internal Auditor or
ii. Certified Fraud Examiner or
iii. Certified Internal Control Auditor or
iv. Post Graduate Degree in business or finance from a University in Pakistan or equivalent qualification, recognized and approved by HEC, and is a member of professional body relevant to such qualification, if applicable
c) Seven years managerial experience in the field of audit or accounting or financial or corporate affairs function with a suitable degree from a University in Pakistan or equivalent qualification, recognized and approved by HEC; subject to determination of such candidate's suitability by the Commission.
4. Internal audit
The board shall ensure that internal audit team shall comprise of experts of relevant disciplines in order to cover all major heads of accounts maintained by the company.
Performance appraisal of the Chief Internal Auditor is required to be done jointly by the Chairman of the Audit Committee and the CEO. The existing Code does not provide requirement of performance appraisal.
Removal of Head of Internal Audit has been proposed to be effected on the recommendation of Audit Committee as against the existing requirement of recommendation coming from Chairman of the Audit Committee.
5. External audit
Besides other disqualifications under the existing code, now a person being close relative of Company Secretary is also ineligible to be appointed as external auditor of the listed company.
6. Secretarial compliance certificate
There is no provision in the regulations regarding secretarial compliance certificate as it is required under the Code being superseded.
7. Penalty
In case of non-compliance with any provisions of the regulations there is a one-time maximum penalty of Rs 5 million (five million rupees) and a per day penalty of Rs 100,000 (hundred thousand rupees) in case of continuing default. The amounts of penalty are coming from section 512(2) of the Companies Act, 2017.
8. Relaxation
The Commission, has been given power to relax any requirements of these regulation, on the application of the company, if it is satisfied that it is not practicable to comply with the same.

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