CORPORATE GOVERNANCE EU ALIGNMENT & TURKEY

18/02/2004

1) What is Corporate Governance?

2) Why may it be relevant to Turkey?

3) What is the current state of Corporate Governance in Turkey?

4) How is Corporate Governance in Turkey likely to be affected

by EU alignment?

1) What is Corporate Governance?

“Corporate Governance” has become an international buzz phrase over

the past few years. We have read it in our newspapers & business
magazines on an almost daily basis since the collapse of Enron, WorldCom
& other major corporate names in the US & elsewhere – the most recent
of course being Parmalat in Italy.

In each of these cases the view has been that those governing or
managing the company have been the main reason for its financial ruin,
usually because they acted inappropriately in their own interests & not in
the best interests of everyone who had an involvement or stake in the
company. This includes not only all the shareholders & employees but also
those with a less direct interest such as suppliers & other creditors & those
who live in the vicinity of the business who may suffer as a result of
decisions affecting, for example, the local environment. They all have an
interest in how the company is managed.

So this led to a huge focus being placed upon how these companies were
managed & in particular there were concerns about transparency & the
accountability of management.

So, in short, the issue of Corporate Governance is essentially asking the

question – what is the best way to ensure that companies are managed in
the best interests of all those who have a stake in the company?

The reaction of Governments has tended to be split between those who

have, or are, introducing more legislation to regulate the way companies
are governed & those who prefer the self-regulation approach.

In the US, it has been the former with the Sarbanes-Oxley Act that was
passed in 2002 & which places severe sanctions on companies that do not
meet its strict requirements & personal responsibility on chief executives &
chief financial officers. Moreover it has extra-territorial effect in that it
applies to all companies with a primary or secondary listing in the US.

On the otherhand the UK has generally taken the self-regulation approach

& this is reflected in the revised Combined Code on Corporate Governance
published in July 2003. The approach of the Code is “comply or explain” &
we shall see in a minute that this is the same approach that has been
adopted by the Capital Markets Board here in Turkey.

There have also been developments in other EU countries such as the

Netherlands where a Corporate Governance Code came into force on 1
January 2004. Spain on the otherhand has taken the legislation route by
passing the Transparency Law last year & the Swedish Government is now
talking about new laws due to the failure of its business community to
take a lead towards more self-regulation.

2) Why is Corporate Governance relevant to Turkey?

There are many reasons but here I shall mention 3:

i) Foreign investment into Turkey. If Turkey wants to see an

increase in the historically very low levels of foreign investment,
potential investors must feel confident that their money will be
protected by an adequate & enforceable system by which Turkish
companies are directed & controlled. Otherwise they will look
elsewhere.

ii) EU membership. If Turkey wants to join the EU, the laws that
regulate the management of companies will have to reflect
certain EU requirements & in particular meet certain standards
when it comes to enforcement. This is all part of the EU
alignment process which I shall come back to in a moment.

iii) Turkey’s public finances - & as a result taxpayers in Turkey –

have, I would suggest, already suffered enough due to the
behaviour of errant dominant shareholders, particularly in the
banking sector. Anything that might assist in improving the
management of companies for the benefit of all stakeholders
must surely be seriously considered.
3) What is the current state of Corporate Governance in Turkey?

I don’t think that many would dispute that in Turkey Corporate

Governance, in the sense that I have explained just now, has been weak.
It is clear that many companies are not managed in the interests of all
those that have a stake in them, but they are managed primarily in the
interests of a dominant shareholder or shareholders.

For example, since 1997 20 banks have been put under the control of the
banking regulator & for more than half of them one of the formal reasons
given was that the majority shareholders had used the bank’s resources
for their own benefit.

I understand that the vast majority of companies currently listed on the

Istanbul Stock Exchange are still effectively controlled by just a few all
powerful shareholders – perhaps in some instances a single all powerful
shareholder.

On the private company side, there is still no obligation to file any form of
accounts open to public inspection.

However, overall I believe that the issue may not be so much a weakness
in the law but much more an issue of enforcement.

As regards the law, The Commercial Code & The Capital Markets Law are
the two main pieces of relevant legislation.

The Commercial Code establishes the framework for corporate governance

in Turkey. As is not unusual in civil law based jurisdictions such as Turkey,
its provisions are often general & open to interpretation & this is also the
case with its provisions that deal with corporate governance & particularly
those dealing with the responsibilities of directors. According to the Code,
directors have a general duty of care, foresight & good faith & they are
accountable to the company & shareholders for losses created by their
actions.

The Capital Markets Law governs the securities markets & established the
Capital Markets Board which itself regulates & supervises these markets &
the Istanbul Stock Exchange. The Capital Markets Board can impose
warnings & fines & it can also suspend or cancel licences & refer to the
Public Prosecutor those who violate the Law.

In practice, however, enforcement has been weak. A few examples:

Despite the fact that in 1996 the Capital Markets Board announced what
was on the face of it an onerous disclosure regime for listed companies,
there is still no strong disclosure tradition in Turkey.

There are few examples of directors of either listed or private companies

having been sanctioned for failing in their “corporate governance” duties
under either The Commercial Code or The Capital Markets Law. As regards
the Capital Markets Board, even where it has complained to the Public
Prosecutor’s office, the Public Prosecutor has usually found that it does not
have the resources to pursue the issue.

The Capital Markets Board is also responsible for investigating insider

trading which is a criminal offence under The Capital Markets Law –
although again as far as I am aware there have been very few successful
prosecutions.

Another very important related area is the bankruptcy regime. It is slow &
cumbersome & directors of failed companies are rarely brought to task. A
new Bankruptcy Law was passed last year, however many believe that it
will do little to improve the situation.

Having said that, the Capital Markets Board reacted swiftly to the Enron &
other corporate scandals & initially focused on the regulation of auditors.
In November 2002 the Capital Markets Board passed an amending
Communiqué that (1) prohibits independent auditing firms from providing
certain services to its listed audit clients so as to avoid potential conflicts
of interest; (2) requires listed companies to change their auditor after 5
accounting periods; & (3) requires all listed companies to have audit
committees.

The Capital Markets Board took another important step in July 2003 when
it published its paper “The Principles of Corporate Governance” that set
out to evaluate & improve the legal, institutional & regulatory framework
for corporate governance in Turkey. The principles are based upon the
OECD principles of corporate governance including the rights & equitable
treatment of shareholders, disclosure & transparency, the responsibility of
board members & the relationship between the company & all those
having an interest in it. The adoption of this Code is voluntary, however
the Board has indicated that it will name those companies that do not
either comply or disclose reasons for non-compliance. In other words
“comply or explain” which reflects the approach of the Combined Code in
the UK.

The stated aim of the Capital Markets Board is to continue to work

towards full compliance with EU legislation & relevant international
institutions such as the International Organization of Securities
Commissions. It has started down that road & we wish it every success.
4) How is Corporate Governance in Turkey likely to be affected by
EU alignment?

EU alignment is essentially the process Turkey has been following, &

continues to follow, as it prepares for EU membership according to criteria
adopted by the European Council in June 1993 known as the “Copenhagen
criteria”. One element of the Copenhagen criteria is the acquis
communautaire criteria which is the body of EU law that Turkey will have
to transpose into its domestic legislation & ensure that it is implemented &
enforced adequately. This process is by way of negotiation & an individual
action plan is agreed & progress is monitored against this plan at regular
intervals with an annual Report. It is this negotiation process that will
start after December this year when the EU accepts that the political
criteria have been met – Please note my positive approach to this: “when”
& not “if”!

So will these negotiations affect Corporate Governance in Turkey? The

answer is “yes”. Indeed the process has already begun & only last week
here in Istanbul at the office of the Capital Markets Board a meeting took
place between representatives of the EU candidate countries’ capital
markets. I would be surprised if corporate governance was not one of the
topics discussed – perhaps even the main topic! However, the European
Commission is still making up its mind how it intends to deal with
Corporate Governance as an EU issue & it appears that Parmalat has
resulted in a marked change in its approach.

Until very recently the Commission had accepted the conclusions of a

November 2003 Report of a High Level Group of Company Law Experts.
The Report concluded that there was no need for an EU Corporate
Governance Code & instead recommended an action plan which prioritised
short term & medium term initiatives. [The Commission stated that it:

"does not believe that a European Corporate Governance Code would

offer significant added value but would simply add an additional layer
between international principles and national codes. However, a self-
regulatory market approach, based solely on non-binding
recommendations, is not sufficient to guarantee sound corporate
governance. In view of the growing integration of European capital
markets, the European Union should adopt a common approach
covering a few essential rules and should ensure adequate co-
ordination of national corporate governance codes."]
The key policy objectives established by the Commission were to:

 strengthen shareholders’ rights & third party protection; &

 foster business efficiency & competitiveness,

& I shall just quickly summarise some of the initiatives set out in the
Commission’s Action Plan:

1) the introduction of an Annual Corporate Governance Statement –

listed companies should be required, within their annual
documents, to include a clear statement covering the key
elements of corporate governance structures and practices; the
intention is to have a Directive amending existing legislation by
2005;

2) to introduce obligations on the part of institutional investors (e.g.

to disclose their investment policy and their policy with respect to
the exercise of voting rights in companies in which they invest);
the intention is to have a Directive by 2008;

3) the development of a legislative framework aiming to help

shareholders exercise their rights (e.g. access to information,
shareholder democracy); the intention is to have a Directive by
2005;

4) the adoption of a Recommendation promoting the role of

independent non-executive & supervisory directors by 2005 & a
Directive by 2008. The proposal is that minimum standards on
the creation, composition and role of the nomination,
remuneration and audit committees should be defined at EU level
and enforced by Member States, at least on a "comply or explain"
basis;

5) the adoption of a Recommendation on directors' remuneration by

2005;

6) the creation by 2005 of a European Corporate Governance Forum

to help encourage co-ordination and convergence of national
codes and of the way they are enforced and monitored.

However, it seems that Parmalat has focused minds & it now appears that
when the Commission produces proposals to improve audit quality &
corporate governance next month, it will be a good deal more rigorous
than originally planned & will not rely so heavily on non-binding
recommendations. There is, for example, now a general expectation that
the Commission will propose binding rules for the rotation of audit
companies or audit partners.

Accordingly, what I think we are likely to see after the negotiation process
starts with Turkey is further development of the principles set out by the
Capital Markets Board in its July 2003 paper on Corporate Governance &
these developments will in turn reflect the further developments that take
place within the EU over the coming months & years. We now wait to see
whether the Commission decides to adopt binding rules or
recommendations – or probably more likely a mixture of the 2 – however
come what may they are likely to cover many of the issues listed in the
Commission’s recent Action Plan that I mentioned just now.

For its part Turkey must bear in mind that before it can finally become a
member of the EU, it must meet its obligations fully under existing
applicable legislation – unless there is a relevant exemption which is
unlikely in the case of Corporate Governance - & therefore much change
will certainly be required.

Finally, the other very important area that will continue to come under the
spot-light in the alignment process is enforcement. Appropriate laws &
rules are essential, however so is adequate & fair enforcement of those
laws & rules.