CAF - Guidelines for a Latin American Code of Corporate Governance (GLACCG)

GUIDELINES FOR A LATIN AMERICAN CODE OF CORPORATE GOVERNANCEGUIDELINES

FOR A LATIN

AMERICAN CODE

OF CORPORATE

GOVERNANCE4

GUIDELINES FOR

A LATIN AMERICAN

CODE OF CORPORATE GOVERNANCE (GLACCG) The Guidelines for a Latin American Code of Corporate Governance have been drafted within the framework of a project sponsored by CAF. The Spanish firm IAAG Consultoría & Corporate Finance, S.A. (www.iaag.com) was responsible for the project, with the participation of a working team integrated by: Mr. Alfredo Ibargüen, Partner/Director Mr. José Gómez-Zorrilla, Manager Ms. María de Ibargüen Bustamante, Associate We thank the contributions and comments made by Michael Penfold and Andres Oneto.

Depository collection number: ifi74320133501733

ISBN: 978-980-6810-93-8

Editor: CAF This document was prepared by the Vice presidency of Development and Public Policies of CAF.

Graphic design: Gisela Viloria The ideas and proposals contained in this issue are the exclusive responsibility of the authors and do not reflect the official position of CAF.

The digital version of this document can be found at: http://scioteca.caf.com © 2013 Corporación Andina de Fomento All rights reserved5 CAF Prologue Capital markets in Latin American countries are still characterized by a meager level of relative development which is reflected in a low financial intricacy and an incipient stock market capitalization. This situation has become a major obstacle to increasing the regions competitiveness, as it has a direct effect on the opportunities to access larger and more efficient financing sources for production and business sector investment. Several factors explain this behavior, among others, problems of macro-economic instability, rule of law weakness and limitations on the regulatory framework and the institutions responsible for supervising markets. However, one of the factors that has caught the most

ficient financing sources for production and business sector investment. Several factors explain this behavior, among others, problems of macro-economic instability, rule of law weakness and limitations on the regulatory framework and the institutions responsible for supervising markets. However, one of the factors that has caught the most attention of financial analysts is the lack of business transparency and weak practices of good corporate governance. The subject of Corporate Governance began gaining ground at the beginning of the 1990s, as a result of privatization processes that took place in the countries of Eastern Europe. However, it was at the beginning of this century that it received more attention and analysis from the specialized media due to the scandals that occurred in important companies in the United States and other developed countries, like the cases of Enron, Worldcom and Parmalat. Corporate Governance may be defined as the set of formal and informal practices governing the relations between administrators and all those who invest resources in the company, mainly the shareholders and creditors. It is evident that good corporate governance practices guarantee a better use of companies resources, help to attain more transparent accounting practices and mitigate the problems of asymmetrical information which characterize financial markets. In these circumstances, good practices are the key to companies access to capital markets. Conversely, the absence of good practices is revealed in many forms: flaws in the opportunity to access financial information and transparency of the disseminated information, abuse of minority shareholders, lack of independence and integrity in auditing processes, hiring unsuitable personnel to carry out the functions of a company, among others. These shortcomings prohibit companies from guaranteeing an efficient management of their resources and from taking precautions with the patrimony delivered by investors and creditors. As a result, the access of companies to capital markets is limited. In this context – and in line with its commitment to sustainable development and regional integration – CAF has developed a program that promotes better corporate governance practices with the aim of strengthening this process on a regional level. As part of the activities of this program, CAF presents these Guidelines for a Latin American

In this context – and in line with its commitment to sustainable development and regional integration – CAF has developed a program that promotes better corporate governance practices with the aim of strengthening this process on a regional level. As part of the activities of this program, CAF presents these Guidelines for a Latin American Code of Corporate Governance, as an update of a document published in 2004. Its purpose is to present a set of basic norms that help build the foundations of good corporate6 governance to companies of the region, operators of capital markets and those responsible for public policies. This document is exhaustive and applicable to a very diverse spectrum of companies; it has a dynamic character and may be enriched by suggestions and recommendations that could arise when it is put into practice. Through this publication, CAF expects to continue providing solid support to companies in creating a true culture of good corporate governance. While this task is a long-term one, the adoption of these guidelines may turn into a significant contribution to the development of the regions capital markets and help to optimize the relations between companies and other suppliers of financial resources.

L. Enrique García

Executive President7 Index Section I. Introduction to the Guidelines for a Latin American Code of Corporate Governance (GLACCG) 11

I. INTRODUCTION 12

II. SCOPE OF APPLICATION 19

Section II. Guidelines for a Latin American Code of Corporate Governance

(GLACCG) 21

I. RIGHTS AND EQUITABLE TREATMENT OF SHAREHOLDERS 22

1. Principle of Equal Treatment (Guideline nº 1) 22

2. Right to the Non-dilution of Shares in the Companys Capital (Guideline nº 2) 23

3. Encouragement of Shareholders Participation and Information Collection (Guideline nº 3). 24

4. Takeover or Change of Control by Another Group (Guideline nº 4) 26

5. Clauses for the Submission to Arbitration (Lineamiento nº 5) 27

II. THE SHAREHOLDERS MEETING 29

1. Function and Jurisdiction (Guideline nº 6) 29

5. Clauses for the Submission to Arbitration (Lineamiento nº 5) 27

II. THE SHAREHOLDERS MEETING 29

1. Function and Jurisdiction (Guideline nº 6) 29

2. Regulations of the General Shareholders Meeting (Guideline nº 7) 30

3. Classes and Call for the Meeting (Guidelines nº 8, nº 9 y nº 10) 31

A. Specific obligation to summon the meeting 31

B. Time period 32

C. Media for publicizing the General Meeting Summon 32

D. Contents of the Meeting Summon Announcement 33

E. Ability to introduce subjects on the Agenda of the Meeting 33

4. Right of Shareholders to Receive Information Previous and During the Holding of the General Shareholders Meeting (Guideline nº 11) 34

5. The role of Institutional Investors (Guideline nº 12) 35

6. The quorum and the required majorities (Guideline nº 13) 36

7. Intervention of the Shareholders (Guideline nº 14) 37

8. Regulation of the Right to Vote (Guideline nº 15) 37

9. Regulation of Representation (Guideline nº 16) 38

10. Attendance of members other than the Shareholders (Guideline nº 17) 408 III. THE BOARD OF DIRECTORS. 42

1. The need to have a Board of Directors (Guideline nº 18) 43

2. Entitlement to the Board of Directors for the functions of the Definition of Strategy, Supervision, Control, Governance and Administration (Guideline nº 19) 44

3. Regulation of the Board of Directors (Guideline nº 20) 46

4. Size of the Board of Directors (Guideline nº 21) 47

5. Categories of the members of the Board of Directors (Guideline nº 22) 48

A. Categories of the Directors 48

B. Allowed Majority of External Directors on the Board of Directors 50

4. Size of the Board of Directors (Guideline nº 21) 47

5. Categories of the members of the Board of Directors (Guideline nº 22) 48

A. Categories of the Directors 48

B. Allowed Majority of External Directors on the Board of Directors 50

6. Appointment of Board Members (Guideline nº 23) 51

7. Independent External Directors (Guideline nº 24) 57

A. Appointment of External Directors 57

B. Declaration of Directors Independence 60

8. Termination of the Appointment of the Directors (Guideline nº 25) 61

9. Regulation of the rights and duties of the Members of the Board of Directors or Administrators (Guidelines nº 26) 62

A. Duties of the Directors 62

B. Rights of the Directors 64

10. Conflicts of Interest and Related-party Transactions (Guideline nº 27) 65

A. Conflicts of Personal Interest 65

B. Conflicts of Interest due to Activities 66

C. Transactions with related parties 67

11. Directors Compensation (Guideline nº 28) 69

A. Compensation Policy 70

B. Transparency of the Compensation 72

12. The organization of the Board of Directors (Guideline nº 29) 72

A. President or Chairman of the Board of Directors 73

B. Vice-President of the Board of Directors 75

C. Secretary of the Board of Directors 75

13. The Chief Executive Officer and the Senior Management (Guideline nº 30) 76

14. Dynamics of the Board of Directors (Guideline nº 31) 80

15. Committees of the Board of Directors (Guideline nº 32) 83

A. Auditing Committee 84

B. Nominations and Remuneration Committee 86

C. Risks Committee 879

IV. CONTROL STRUCTURE. 90

1. Control Environment (Guideline nº 33). 91

2. Risk Management (Guideline nº 34) 92

A. Auditing Committee 84

B. Nominations and Remuneration Committee 86

C. Risks Committee 879

IV. CONTROL STRUCTURE. 90

1. Control Environment (Guideline nº 33). 91

2. Risk Management (Guideline nº 34) 92

3. Internal Control System (Guideline nº 35) 94

4. Information and Disclosure of Risk Management Policies and Control Systems

(Guideline nº 36) 95

5. Monitoring the control structure

A. The Duties of internal auditing (Guideline nº 37) 96

B. The Duties of external auditing (Guideline nº 38) 97

V. TRANSPARENCY AND FINANCIAL AND NON-FINANCIAL

INFORMATION 100

1. Information Disclosure Policy (Guideline nº 39) 100

2. Financial Statements (Guideline nº 40) 101

3. Information for the Markets (Guideline nº 41) 102

4. Information about shareholders agreements (Guideline nº 42) 103

5. Corporate Governance Annual Report (Guideline nº 43) 104

A. Information to be included in the Corporate Governance annual report. 104

VI. FINAL REFLECTIONS ON THE IMPLEMENTATION OF THE GUIDELINES 107

Section III. Reference Guide to the Guidelines 109

PREVIOUS CONSIDERATIONS 110

Section IV – Annexes of the Guidelines 119

I. Annex I – Corporate Governance for Groups 134

II. Annex II – The responsibility of financial entities in the promotion of Corporate

Governance 134

A. Corporate Governance for banking entities 136

B. Banking entities as agents for the promotion of Corporate Governance to their clients 137

C. The “MESEG” methodology for the evaluation of governance risks of clients that receive financing. 139

III. Annex III – Corporate Governance in family enterprises 140

IV. Annex IV – Glossary of terms 1461011

Section I

INTRODUCTION

TO THE GUIDELINES

FOR A LATIN AMERICAN

CODE OF CORPORATE

that receive financing. 139

III. Annex III – Corporate Governance in family enterprises 140

IV. Annex IV – Glossary of terms 1461011

Section I

INTRODUCTION

TO THE GUIDELINES

FOR A LATIN AMERICAN

CODE OF CORPORATE

GOVERNANCE

(GLACCG)12

I. Introduction Background In 2004, CAF - Development Bank of Latin America - published the first version of the Guidelines for a Code of Corporate Governance with the collaboration of IAAG Consulting (www.iaag.com). It is available on the website of CAFs Program for Corporate Governance, at the site: http://scioteca. caf.com.

The first document, which was officially presented in Cartagena de Indias, along with the OECDs White Paper on Corporate Governance in Latin America, was subsequently revised with minor updates in 2006 and 2010. The publication of the Guidelines in 2004 became an important milestone for corporate governance, since it was a document specifically directed towards the corporate world. Thus, it had a strong practical focus and was based on the main international codes on best practices of corporate governance at the time, fundamentally the OECDs Principles of Corporate Governance and other documents on corporate governance at a national level. The pragmatic nature of the Guidelines was based on the definition of fifty-one “Measures”, related to major principles of Corporate Governance. Each Measure is composed by a variable number of “Recommendations” – a total of ninety-three – regarded as the concrete and specific practices of Corporate Governance that support each Measure. Since its first publication, the Guidelines were gradually implemented in different types of companies in the Latin American and the Caribbean region, in many cases with the support of CAF. Thanks to its solid intellectual rigor and its strong practical focus, it has contributed to strengthen corporate governance practices and its effective promotion in many companies throughout the region. Since then, the discipline of corporate governance has experienced a notable development, both on a global and regional level, providing a response to new business realities, especially after the outbreak of the global economic crisis. It made evident, among many other variables, the profound weakgovernance practices and its effective promotion in many companies throughout the region. Since then, the discipline of corporate governance has experienced a notable development, both on a global and regional level, providing a response to new business realities, especially after the outbreak of the global economic crisis. It made evident, among many other variables, the profound weaknesses that still existed in the effective functioning of corporate governance in many enterprises and entities. The aftermath of the global economic crisis resulted in a revision on a global level of the regulations and legislation in different countries, as well as the publication and update of diverse documents which compiled the best practices of corporate governance. In this context, CAF believes it is appropriate to undertake the present updating of the Guidelines that involves a profound revision and update of the contents initially set forth in the Guidelines of 2004. Both from a doctrinal/academic and practical point of view, this initiative shows further proof of the importance that CAF has given, since the implementation of the first Guidelines in 2004, to the dissemination and implementation of good practices of corporate governance in all kind of companies as a key tool to increase their competitiveness and facilitate their sustainability.13In this regard, CAF has promoted the publication of different documents with a regional scope, such as the Guidelines for a Code of Corporate Governance for SMÉs and Family Companies (Lineamientos para un Código de Gobierno Corporativo para las PYME y Empresas Familiares, 2011) or the Guidelines of Corporate Governance for State Companies (Lineamientos de Gobierno Corporativo para Empresas del Estado, 2010) and it has supported more than forty processes for the diagnosis and implementation of practices of corporate governance in private and public companies in the region. Framed in the context of the global crisis and its origin, many lessons have been learned from these processes of implementation. Despite the formal advances achieved in different countries, the problems regarding the adoption and above all, compliance with sound practices of corporate governance have not been solved and are not even close from being solved. The effects of the current crisis are, thus, a further incentive to ensure that the development of

these processes of implementation. Despite the formal advances achieved in different countries, the problems regarding the adoption and above all, compliance with sound practices of corporate governance have not been solved and are not even close from being solved. The effects of the current crisis are, thus, a further incentive to ensure that the development of corporate governance in the region will continue to be a relevant focus of attention on the part of those institutions which, by their nature and objectives, can exert an influence on the future of businesses. An example of this is the degree of influence that can be exerted by institutional investors, certain international organizations, multilateral or development banks, commercial banks and the agencies that regulate companies or the stock exchange, or even regulated sectors of the economy such as banking, insurance, energy or telecommunications. Consequently, the objective of the current Guidelines is to provide the business community of the region with a document, based on the same pragmatic focus of the 2004 Guidelines, fully updated to the needs of companies in terms of corporate governance, and that represents once again a reference framework that companies can use to diagnose and strengthen their corporate governance practices. Rationale for the Review The present Guidelines do not represent a break to those initially published in 2004, but an evolution of the same, enabling the initial ones to be adapted to the latest advances in corporate governance and to respond to the current challenges in the field, justified by three main reasons:

1. The global financial crisis has made evident the convenience of updating and deepening corporate governance practices applicable to companies. Particularly, those related to financial entities bring special attention, especially with regard to risk management, remuneration schemes for the members of their boards and senior management, and the dynamics and operational practices of their Boards of Directors.

2. In many cases, regulation itself has proven to be ineffective since it has allowed for the existence of business practices that have turned out to be especially harmful for the sustainability of companies and the creation of long-term value for shareholders. In many cases, this has led to the revision of the regulations applicable in several countries, especially with regard14

tence of business practices that have turned out to be especially harmful for the sustainability of companies and the creation of long-term value for shareholders. In many cases, this has led to the revision of the regulations applicable in several countries, especially with regard14 to voting rights, the remuneration of the Board of Directors and senior management, or the strengthening of obligations to provide full information.

3. Especially in the context of the financial crisis, behaviors that are not very ethical, but not completely unethical, have become evident in the case of administrators and managers, who have clearly put their personal interests above those of the company and of their shareholders in the medium and long-term.

Despite the business performance shown in Latin America, which has been better than that of the European or U.S. markets, the present Guidelines deal with the revision of these crucial subjects in a way that strengthens the practice of corporate governance applicable to the companies of the region and contributes to their greater sustainability. In this regard, the 2012 Guidelines for a Latin American Code of Corporate Governance have made important contributions, especially the following ones: • The dynamics and operational tactics of Boards of Directors have been reviewed, as a key aspect in the suitable exercise of their functions. • A whole new area related with the control structure has been developed, which deals with risk management and internal control. • The treatment of the remuneration of the members of the Board of Directors and senior management has been dealt in a different way. • Certain practices of Corporate Governance especially applicable to the financial sector have been included. • An Annex on Corporate Governance for business groups, which are of increasing importance to business in the region, has been included. From a practical point of view, the contents of the present Guidelines are likewise influenced by the practical experience acquired through their effective implementation, with the support of CAF, in all types of companies in the region, which ensures their full applicability to the corporate reality. This revision maintains and deepens the pragmatic focus initially found in the 2004 Guidelines, but, from a formal perspective, it has also undertaken:

the practical experience acquired through their effective implementation, with the support of CAF, in all types of companies in the region, which ensures their full applicability to the corporate reality. This revision maintains and deepens the pragmatic focus initially found in the 2004 Guidelines, but, from a formal perspective, it has also undertaken: • The inclusion of new practices of Corporate Governance in all fields, as well as a review of those established in the 2004 Guidelines. • A complete revision of the text, the sequential order and wording of the original Guidelines. • The elimination of legal references, as well as footnotes included in the 2004 version that refer to the normative framework of the countries of the Andean Community of Nations (CAN, in its Spanish initials), with the aim of extending the applicability of the present document to the Latin America and the Caribbean region as a whole. • A redefinition of the Corporate Governance areas has been accomplished for a better distribution of the proposed practices of Corporate Governance. • The simplification of the different types of companies described in the 2004 Guidelines, for a15 better adaptability to the corporate reality of the region. • The inclusion of Annexes to develop three subjects which we consider to be especially relevant: (i) Corporate Governance in business groups; (ii) the responsibility of banking entities for the promotion of Corporate Governance in the companies of the region; and (iii) Corporate Governance in family businesses. It is our wish and vision that this new edition of the Guidelines for a Latin American Code of Corporate Governance will once again be a reference document that satisfies the expectations of the business community and serves as an important tool for the effective promotion and improvement of Corporate Governance in the companies of the region. Applicability The applicability of the present Guidelines, as well as in the 2004 initial version, depends on the free and autonomous decision of the companies to which its contents are directly addressed to. However, as we remarked above, other actors classified according to their access to sources of financing, such as institutional investors, multilateral agencies, banking entities and, above all, capital markets,

and autonomous decision of the companies to which its contents are directly addressed to. However, as we remarked above, other actors classified according to their access to sources of financing, such as institutional investors, multilateral agencies, banking entities and, above all, capital markets, could make a decisive contribution to the effective promotion and real application of the Guidelines in the companies they invest in. This document is not addressed to public agencies or the legislative bodies and regulation authorities; it is fundamentally addressed to companies. Thus, the implementation of its contents will necessarily have to be based on self-regulation and consequently, will have to be incorporated into corporate by-laws, Board of Directors’ regulations or other internal norms documents considered as suitable. Taking this into account, we point out that nothing prevents legislators or regulators from establishing legal norms to strengthen some of the Corporate Governance practices proposed herein, some of which are already found, to a greater or lesser degree, in the existing normative framework of different countries. In fact, in the present Guidelines, we mention some Corporate Governance practices that should be taken into account by the legal frameworks and their respective regulators, to make them legally binding in order to enforce some minimum standards in terms of Corporate Governance. In this way, the regulatory and supervisory bodies of different regulated industries, among which stand out banking and stock markets due to their potential systemic impact, should be transformed into key actors. First, to promote and disseminate an understanding of good Corporate Governance practices among the entities they supervise, and second, to ensure the enforcement of the specific regulations on Corporate Governance considering their legitimate supervisory capacity and even their moral suasion capacities This regulation should be established by the regulator, seeking an optimum balance between the most genuine corporate self-regulation, the development of tools that fit into a form of co-regula-16 tion through the use of what is known as soft law– as in the case of national codes of Corporate

Governance developed by public and/or private social agents, or on an international level, the recommendations of the International Organization of Securities Commissions (IOSCO), and, a set of practices of obligatory compliance on the part of companies, approved in accordance with the most traditional legislative techniques, that is, through laws or regulations. Nevertheless and as the 2004 Guidelines noted, “we should not forget the recommendations of the experts at the OECD, found in the White Paper for Latin America on Sound Corporate Governance, who point out that any adjustments to the regulatory framework should be done after a careful analysis of the costs and benefits of introducing new rules, in order to avoid unintended negative effects that wind up undermining the benefits sought and thwart business activity”. In synthesis, the Guidelines still believe that voluntary self-regulation by companies themselves is the right focus when it comes to adopting and implementing practices of Corporate Governance. The assessment markets give to the companies’ Corporate Governance should help distinguish between those companies that show a sound Corporate Governance from those whose Corporate Governance is completely neutral, where they only comply with the minimal standards, and those that show a poor governance. Nevertheless, the Guidelines also recognize that self-regulation is not completely incompatible with an active participation of regulatory and supervisory agencies on the promotion of good Corporate Governance or with the issue of an adequate regulation that employs a strong and responsible exercise of supervision – in depth and in form – of those areas and practices of Corporate Governance of mandatory compliance. For that reason, these Guidelines are meant to be a useful tool for the effective promotion of Corporate Governance by regulatory bodies among the companies within their scope of jurisdiction, in addition to specifically note a number of practices that should be incorporated into the legal framework or applicable regulation. Recipients These Guidelines are fundamentally addressed to companies. It is a highly practical document that aims to maximize the dissemination and real applicability of its principles in the business community. The Guidelines maintain the principle of differentiated compliance in accordance with the type of company, just as it was laid down in the 2004 version. In this sense, the Guidelines recognize that there are two major kinds of companies:

aims to maximize the dissemination and real applicability of its principles in the business community. The Guidelines maintain the principle of differentiated compliance in accordance with the type of company, just as it was laid down in the 2004 version. In this sense, the Guidelines recognize that there are two major kinds of companies: Listed companies and financial entities Refers to all companies with capital, wholly or in part, listed on stock markets, or that are issuers of fixed income securities. Financial entities are also included in this group, considering that while some may not be listed, by the nature of their business they have to maintain the strictest level of Corporate Governance.17Non listed companies Any other kind of company not included in the previous group. The Guidelines establish that it would not make much sense to impose the same levels required for listed companies and financial entities to companies that are not listed or have closed capital, like family enterprises. For this reason, the key Guidelines and Recommendations that are specifically applicable to each type of company are described establishing a more demanding level of Corporate Governance for the listed companies than to those that are not listed. Additionally, as indicated in its Coverage of Applicability, this document presents a number of Key Guidelines and Recommendations that should be taken into consideration by legislative bodies or by agencies that regulate companies or capital markets, when issuing regulations. This should encourage mandatory compliance of the rules for companies rather than leaving it to their discretion. The Foundations of Compliance The Guidelines maintain the same fundamental principle found in the initial version of 2004, internationally known as “comply or explain”. By this, the companies that freely adopt these Guidelines must comply with their contents or explain which Guidelines or Recommendations they do not or only partly intend to comply with. The information regarding the compliance with the present Guidelines and Recommendations should be revealed in the reports on Corporate Governance of each company, or in their annual reports at the end of the financial year, which should be avail