Originally from our sister publication, Advisor.ca.
Companies based in emerging markets must ensure they measure up to Canadian regulatory scrutiny if they are going to seek capital in our markets, the OSC has declared in its Emerging Markets Issuer Review.
The review was launched in July 2011, after investors began to question the veracity of corporate information flowing out of Sino-Forest. The forestry company, though listed on the TSX, conducted virtually all of its business in China.
Its stock plummeted when it was suggested it was overstating the size of its forestry holdings.
The review examined a targeted selection of 24 Ontario reporting issuers listed on Canadian exchanges with significant business operations in emerging markets. At the time of the review, there were 108 emerging market issuers listed on Canadian exchanges, with a combined market cap of over $40 billion.
One recurring problem the OSC encountered was the “tick box” approach to regulatory filings.
“One of our central concerns was the apparent ‘form over substance’ approach to compliance with applicable standards for disclosure, issuer governance, board oversight, audit practices and due diligence practices,” the report states. “In our view, the level of rigor and independent-mindedness applied by boards, auditors and underwriters in doing their important jobs should have been more thorough.
“The fact that the core operations and assets of many of the issuers were located in an emerging market jurisdiction, with very little presence in Canada in most cases, contributed to a separation between the issuer’s Canadian governance and local management functions. It also contributed to challenges for both the audit process and the performance of due diligence by underwriters.”
The regulator focused on the adequacy of issuer disclosure and corporate governance practices, as well as the important roles played by auditors, underwriters and exchanges in bringing these issuers to market.
The review calls on emerging market issuers to improve corporate governance so that it is up to snuff with Canadian standards.
The OSC pointed out that both the board and the audit committee must thoroughly understand the business and the operating environment of their company. Without such an understanding it is unclear how either can discharge their duties of care to investors.
“In some cases it appeared that the board had very little contact with senior management in the emerging market jurisdiction running the business,” the report states. “Nevertheless, all board members of Canadian reporting issuers, regardless of where they are located and where the business operations are located, are required to adhere to Canadian regulatory requirements.”
The regulator says it will work to develop transparent and consistent due diligence requirements for underwriters, holding them more accountable for the companies they bring to the Canadian market.
“The OSC expects issuers and gatekeepers to act in a manner that promotes investor protection and supports confidence in our capital markets,” said Howard Wetston, chair and chief executive of the OSC. “This review uncovered a number of areas where issuers and gatekeepers need to improve in order to meet their obligations and we will be monitoring their progress to ensure the interests of investors are placed first.”
The regulator will also seek improved access to working paper files and higher quality audit practices, especially when foreign auditors are involved.
The OSC says it will work with the stock exchanges to improve the process for listing emerging market issuers, and seek enhanced disclosure of risk factors and complex corporate structures which seem to be more common among emerging market issuers.
“In some cases, the legal or regulatory system may present impediments to foreign ownership or control and may result in the need for specific structures to enable the issuer to do business in that market,” the report states. “We were concerned that the complexity of certain corporate structures did not appear to be clear or necessary to support the EM issuer’s underlying business model.”
The OSC says boards should question the necessity of such complex structures, as they may also facilitate fraud, misappropriation of assets or misrepresentations of the company’s financial performance or condition.
The TMX Group said it welcomes the OSC report.
“While provincial securities regulators are the primary authority overseeing reporting issuers, TMX Group takes its responsibility and public interest mandate very seriously,” said Kevan Cowan, president, TSX Markets and group head of equities, TMX. “With the growth of emerging market economies, issuers and investors from these markets are expected to increasingly seek opportunity in Canada and other developed economies around the world.”
While assisting the OSC review, Toronto Stock Exchange and TSX Venture Exchange initiated extensive consultations with market participants, publicly-listed companies and other stakeholders over the last several months.
As a result, TMX Group will provide additional guidance to emerging markets issuers to complement existing rules and working practices, pending regulatory consultation and review by securities commissions, as applicable.
This guidance will focus on additional detail regarding senior management and director qualifications, corporate governance matters, and disclosure and financial reporting expectations.
“The work currently being conducted by TMX Group is part of our ongoing efforts to enhance the quality and integrity of Canada’s capital markets, a key competitive advantage both for us and for Canada,” said Cowan.