www.pid.org.pl

Andrzej S. NartowskiPresident

Polish Institute of DirectorsAndrzej@Nartowski.pl

Corporate Governanceand

Pension Funds in Poland

www.pid.org.pl

• Corporate governance is a playground between the law and the market.

• Its frontiers are not strictly defined.• Law is constantly annexing some pieces

of the field while market produces new areas.• The play is arbitrated by the referee: Money.

Corporate governance: THE PLAYGROUND

• It is said [and sung] that Money makes the world go around.• Yet the economy is based on Trust; without it, banknotes would

be just pieces of printed paper.• Pension fund is the place where Money and Trust meet.

Money is to be invested, Trust is to be created.• Corporate governance is all about Trust. Pension funds are

expected to guarantee a well-being of future generations by implanting corporate governance into companies in their portfolios, thus transforming Money into Trust at best rate of exchange.

WHERE MONEY MEETS TRUST

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• Polish company law is deeply rooted in XIX century German tradition.

• There is a two-tier system of the companies’ organs.• Management board and supervisory board are separated from

each other. • The co-operation between them is strictly regulated.• In general, companies are overregulated, especially in the field

of reporting duties. Bureaucracy takes precedence over disclosure.

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Poland: THE LAW

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• [Strong] management board runs the company, [weak] supervisory board rather observes and than controls its activities.

• Some supervisory boards are ornamental and hold meetings once in a blue moon.

• As supervisors gain experience and competence, supervisory boards play more active roles.

• Supervisors feel themselves representatives of particular shareholders’ interests [often coming into collision] rather than of common interest.

A TALE OF TWO BOARDS

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• Due to Poland’s membership in the European Union, radical changes of domestic legislation take place in the course of implementation of EU directives on company law and corporate governance.

• Two-tier system is kept but new solutions are introduced, even if coming into collision with previously established rules.

• In consequence attempts are taken at reconciliation of past with present, water with fire…

Poland: EUROPEAN LEGISLATION

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• Under the pressure from market [and Brussels] some new phenomena in the supervisory boards are initiated: independent directors, boards’ committees [audit, remuneration], involvement in risk management, supervisory board members’ responsibility for company’s financial statements.

• Above the letter of law supervisory board contacts directly company’s employees: risk managers, internal auditors, financial staff.

• There are attempts aimed at establishing a double subordination of internal audit both to management and supervisory boards.

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Poland: ANGLO-SAXON INFLUENCE

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• In consequence, there is a rough co-existence between conservative system of company law, its heritage very much German, and modern corporate governance, its spirit at least partly Anglo-Saxon.

• As staying at crossroads is highly unpractical it may be expected that, as time goes by, an element of market will prevail.

• Expansion of corporate governance is encouraged both by the inflow of foreign capital and local shareholders activism.

AT THE CROSSROADS

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• Commonly considered to be an emerging market, Poland proudly claims to be market already emerged.

• Warsaw Stock Exchange is gaining capitalization, code of best practices is mature, foreign investments grow.

• There are several dozens of foreign companies listed in Warsaw.• Society is highly entrepreneurial, economy is promising,

privatization is in progress.• Against prevailing in Europe spirit of crisis, Poland’s prospects

seem bright. However, a stormy weather is forecasted.

Poland: THE MARKET

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• There is a dark cloud expected to come over Poland[and not a silver lining in sight]: demography.

• Society gets older. And affluent. And childless. • A considerable number of young people, the best and brightest,

emigrate to other EU countries, bearing the children there. • Budget is endangered by the alarmingly growing

pension gap.

Poland: DEMOGRAPHY

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• Supported mainly by foreign capital, pension funds entered in 1999 bringing hope and comfort to the economy.

• At present there are fourteen of them. Some are considerably big: one has 3 million members, two other approaches that number and two have over one million members.

• There are 15.5 million members of pension funds in Poland.• Pension funds collected, and earned [and lost, due to falls of capital

market] a considerable wealth of PLN 224,7 billion – approx. USD 75 billion at the end of 2011.

• Among the financial industries, banking sector is biggest in size and pension funds industry is second, ahead of insurances and mutual funds.

ENTER PENSION FUNDS

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• Since the beginning of Polish transformation in the early 1990s an aggressive invasion of politics into economy can be observed.

• Domain of State’s ownership is still of considerable size, and State tends to play a dominant role even in privatized companies where it holds a minority stake.

• Managers of companies under State’s [too] strong influence face the revolving door trauma: they often enter company only to leave soon.

TOO MUCH OF POLITICS

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• At turbulent market under dynamic transformation, pension fund industry is heavily regulated.

• There is also strict [on a daily basis] supervision of their activities; perhaps ‘surveillance’ would be more proper term.

• Pension funds had not questioned neither the need for overhelming regulation nor particular requirements put upon their activities.

• Most of industry went much further subscribing to self-regulatory Code of Best Practices of Institutional Investors (worked up with mutual funds industry).

BETWEEN REGULATIONS AND SELF-REGULATIONS

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• The biggest pension funds volunteered to adopt their own additional corporate governance obligations: the standards of behavior at general meeting of shareholders in companies they own considerable stake.

• They publish the reports on their activities at GMS’ and the stands taken in voting on particular resolutions.

• However, their example had not gather following among middle and small funds.

• Reason is simple: only The Few attend the general meetings of numerous companies, rest of funds prefers not to bother themselves.

THE MAGNIFICENT FEW

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• Pension funds are transparent and efficiently organized. • Only once the government intervened into their governance

demanding disclosure of funds’ managers individual salaries. • There were some cases of window-dressing of funds’ investment

results, severely punished by Financial Services Authority.• From time to time media takes public attention to the fact that

funds’ owners always make money while the members’ accounts depend on the market’s performance.

CORPORATE GOVERNANCE WITHIN PENSION FUNDS

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• There is a constant dispute concerning the balance of interests in companies between their shareholders and stakeholders.

• Corporate governance is oriented toward shareholders. Corporate social responsibility is oriented toward stakeholders or, in some cases, MISTAKEholders.

• Pension funds are in a very specific situation. They have to fulfill interests and expectations both of shareholders [owners] and true stakeholders [members].

SHAREHOLDERS AND STAKEHOLDERS

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• In 2011 Ministry of Finance proposed sharp reduction of pension funds’ share in individual pension contributions.

• Against protests of the part of financial community parliament adopted the proposal.

• Reason: funds heavily buy T-bonds causing growth of public debt.• Pension funds’ share had been cut from 7% do 2.3%. According to

law it will successfully grow up to 3.5% in 2017.• Shareholders of pension funds lost immediately. Stakeholders may

suffer heavy loses for decades.

THE GREAT FUNDS’ ROBBERY

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• Protests were ignored as if the well-being of generations was less important that current deficit in public finances.

• Protesters were loud but not numerous.• They were calmed when accused that their personal interests as

members of the funds’ supervisory boards or advisers to funds were at stake. In some cases the accusations were false.

• However, support of general public for keeping contribution to pension funds at previous level happened to be astonishingly weak.

• Campaign of Pension Funds’ Chamber, aimed at mobilizing society to oppose new law proved to be unsuccessful.

A FRIEND IN NEED IS A FRIEND INDEED

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• Limit of investments in shares and similar instruments is lifted each year by 2.5% [up do 42.5% in 2011, 45% in 2012, and so on].

• As the final limit will reach 90%, funds’ risk exposure will surpass generally accepted ratio of safety.

• Pension funds are encouraged to invest more and more heavily on volatile capital market. That provokes risk!

• At present limit of their foreign investment is 5% of resources [it will grow up to 30% in 2021] but at the end of 2011 it was fulfilled up to 0.48% only, mainly due to growing foreign exchange risk.

• Therefore it may be observed that pension funds behave cautiously and more responsibly than legislators advise them.

LESS MONEY, MORE RISK

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• At Polish market there is not an official corporate governance watchdog.

• The stock exchange requires from listed companies reports on their respect for, and observance of, its Code of Best Practices based upon comply or explain principle.

• Polish Institute of Directors promotes corporate governance standards and Association of Individual Investors intervenes in cases of corporate governance failures.

• The biggest pension funds feel responsibility for corporate governance in companies in their portfolios.

• Due to the size and resources of industry, pension funds are able to exercise vast influence on capital market.

CORPORATE GOVERNANCE LANDSCAPE

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• Are investors ready to pay more for shares of companies with good corporate governance?

• Some surveys say: “YES”. • They are ready to pay more [indicator for Poland is up to 23%]

if certain conditions are met. • For instance:

– majority of independent NEDs (Non-Ececutice Directors) free of ties with company;– board members own shares of the company;– company uses formal criteria for boards’ assessment.

• Good [??] news for investors: they can save money because trere are not such companies on Warsaw stock exchange.

CORPORATE GOVERNANCE PREMIUM?

• All pension funds invest in companies listed on stock exchange. At present some does not invest up to the limits allowed.

• Yet only some funds, primarily the Magnificent Few, represent the spirit of ownership.

• Each year they attend at least hundred of general shareholders meetings, annual meetings and some more important extraordinary general meetings [extraordinary meetings are extremely popular to the detriment of shareholders].

• They contact the management at least twice a year to get the true picture of companies.

THE SPIRIT OF OWNERSHIP

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• Polish IoD had been encouraging fund managers to point out listed companies deserving market’s trust.

• Fund managers used to point out companies on the top of their portfolios even if investment proved to be a disaster.

• Companies rated as the most trusted had not performed better than average with some of them performing poorly.

• In order to avoid reputational risk Polish IoD had withdrawn its patronage over rating.

• Then ranking quietly died.

WHO TRUST COMPANIES RATED AS MOST TRUSTED?

• At general meetings held in Warsaw [all pension funds are seated there] funds are represented by competent employees, investment directors or lawyers.

• At meeting held outside capital funds are represented by the employees of local branches of brokerage houses.

• Preparation to attend meetings is a tremendous time consumer.• Costs of attendance are considerable as companies are in habit

of adjourning meeting being already in course up to thirty days; breaks are numerous.

GENERAL MEETINGS ATTENDANCE

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• Companies are obliged to convene annual general meeting not later than six months after the end of fiscal year.

• Vast majority of listed companies keeps books at the rhythm of calendar year.

• It results in plethora of general meetings in the last working days of June and serious difficulties for investors interested in participation.

• This aspect of corporate governance had not been yet properly addressed.

HOT DAYS OF JUNE

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• Polish law allows companies to organize “electronic” general meetings with shareholders participating and voting via internet.

• Yet only two companies out of four hundred listed on main floor apply this solution [transmission to no-voting public is popular].

• Pension funds do not push companies for electronic meetings.• Perhaps they do not trust technological appliances or their own

ability to use them properly.

REMOTE CONTROL?

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• Pension funds usually do not propose an employee for directorship in company.

• Although Polish Institute of Directors runs a list of candidates to boardrooms [they represent experience, competence and confidence of the market] pension funds exploit rather listsof own candidates.

• They do not sit on boards as formal representatives of funds and are not instructed how to vote on particular resolutions nor they are expected to report to the funds on their activities.

• They are expected to work hard in the interest of company.

HOW CANDIDATES FOR DIRECTORSHIPS ARE SELECTED?

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• General meeting elects the members of supervisory board and pension funds are highly interested in this point of agenda [executive directors are usually elected by the supervisory board].

• Funds holding a stake in company [at least 5% of capital] are interested in election of a candidate [s] proposed by them.

• Funds are cautious in consulting their candidates with other investors or organize coalition. Such steps may be considered by the Financial Services Authority as [forbidden] action in concert.

• Therefore funds publish names of their candidates well aheadof general meetings.

HOW DIRECTORS ARE ELECTED?

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• On Polish market there is an over-average number of companies with strong majority investor, often foreign ones.

• Majority investors on principle respect the right of institutional investors to representation in supervisory board.

• However, there are some conflicts of institutional investors with majority investor on the ground of alleged transfer pricing, dividend, managers’ remuneration or related-party transactions.

• When other means of dispute resolution fail, institutional investors sometimes go to the court.

• ss PENSION FUNDS AND MAJORITY SHAREHOLDERS

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• Minority shareholders usually consider pension funds as allies.• They expect pension funds to take firm stand against corporate

shenanigans and to use all legal means at their disposal to support shareholders activism.

• They vote for pension funds’ candidates to the supervisory board.• In case of conflict with majority shareholder, or company’s poor

performance, minority shareholder expect institutional investors not to sell the shares and leave company but to stay – and fight.

PENSION FUNDS AND MINORITY SHAREHOLDERS

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• In number of companies, formerly State-owned, then floated, State keeps considerable stake.

• While in majority, State firmly stands at helm. While in minority, State stands at helm if considers the company of “strategic significance”.

• In some companies State, being in minority and using voting cap to ensure its dominant position, solely decide on the composition of both boards.

• In some companies institutional investors, if considered to behave properly, are graciousnessly “permitted” by State to elect to the supervisory board one or two candidates proposed by them.

PENSION FUNDS IN COMPANIES UNDER STATE’S INFLUENCE

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• Among the hundreds of companies listed at stock exchange’s main floor there is a handful of Edens: companies ruled jointly by institutional investors.

• There are privatized companies with small or none stake of State or other big investor.

• Pension and mutual funds own vast majority of shares and freely decide on the composition of the supervisory board.

• There is no employee representation in the boardroom.• Corporate governance in such companies is considered proper.

INSTITUTIONAL INVESTORS IN COMPANIESOF THEIR OWN

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• In companies jointly owned by big institutional investors small pension funds demonstrate their activism.

• They attend the general meetings, motion projects of meeting’s resolutions, take part in discussion, propose candidates to the board.

• It is easy for them to be active in such friendly environment.• Yet only the biggest institutional investors, including pension funds

Magnificent Few, do real efforts and pay the bill.

THE MIGHTIEST PAY THE BILL

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• Sustainable growth of company and its far-reaching strategy.• Mergers and acquisitions.• Financial statements and division of profit. Dividend.• Management remunerations: salaries and options.• Increases of share capital, especially when the shares are not to be

covered by shareholders’ pre-emptive rights. • Composition of supervisory boards, including the number

of independent [non-executive, outside] directors.• Amendments to the company’s statutes.

TOPICS OF PENSION FUNDS’ PARTICULAR INTEREST (i.a.)

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• According to law, audit committee within supervisory boardis obligatory at public interest entities only when board is composed of more then five [minimal number] of members.

• Pension funds encourage all companies in their portfoliosto establish an audit committee.

• They often propose to the board candidates with qualifications to work in audit committees.

• Reports of audit committees are evaluated by the pension funds and brought to attention of shareholders at general meetings.

FOCUS ON AUDIT COMMITTEE

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• Neither law nor stock exchange’s Code of Best Practices pay attention to the remuneration of members of audit committee.

• Usually members of audit committee are remunerated at the same levelas the other board members.

• Only the Best Practices of Audit Committees in Poland advocate for additional salary for them.

• It is a document of lesser significance, drafted by Polish chapter of ACCA and Polish Institute of Directors and not endorsed yet by stock exchange.

• However, some pension funds has already taken efforts to promote adequate additional remuneration for chairperson and members of audit committees.

FOCUS ON AUDIT COMMITTEE REMUNERATION

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• Foreign capital highly appreciate the presence and activities of pension funds on Polish capital market.

• Investors an investment banks often declare: We are pushing money to Poland because there are pension funds and we trust them, and that is official.

• They consider pension funds industry a main factor behind privatization and recent successes of economic transformation.

• It is perhaps not commonly realized that only some pension funds engage themselves in corporate governance and building value of companies in their portfolios, while majority of funds are simple free riders.

PENSION FUNDS AS SEEN BY FOREIGN CAPITAL

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• Poland aspires to create Central European Financial Centre.• In early 2000’s Ministry of Finance produced Agenda Warsaw City

2010 aimed at privatization Warsaw Stock Exchange and development of capital and financial markets.

• Agenda had been fulfilled successfully. Pension funds industry played an important role in reaching its goals.

• Now in 2012 Poland have no agenda for coming years and decades and Ministry of Finance demonstrates hostility toward the pension funds.

• Question-mark.

CENTRAL EUROPEAN FINANCIAL HUB?

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