Tuesday, November 15, 2011

German Corporate Governance Code Commission Questions EU Proposal for Public Monitoring of Reason for Non-Compliance

Commenting on the European Commission Green Paper on corporate governance, the Commission on the German Corporate Governance Code expressed concern with regard to the proposal for public monitoring of the quality of a company’s explanation when it does not comply with a corporate governance code recommendation. The German Code Commission has fundamental reservations regarding a review by public authorities under a voluntary comply-or-explain code. The Commission is responsible for the annual review and, when necessary, amendment of the German Corporate Governance Code.

A public review of the quality of information contained in the declarations of conformity with a code provision does not achieve the goal of more meaningful declarations, noted the code commission, despite the substantial bureaucratic effort. Even more, such a review conducted by public entities is a violation of the recognized and valued soft-law approach, which is a general feature of the German Corporate Governance Code and other similar codes that has proven itself in the past. The same applies to the considered duty of companies not only to provide a reason for a divergence, but also to declare which measures should be taken in place of the declined recommendation.

German public companies are required to declare annually whether or not they have complied with the recommendations of the German Corporate Governance Code. Since the Accounting Law Modernization Act went into effect, companies are required not only to disclose divergences from the code recommendations, but also give a reason for these divergences. Noting that providing a reason for diverging from the Code was first required in 2010, the Code Commission said that, insofar as pertains to German companies, the Green Paper proposal seems premature.

Earlier this year, Sabine Leutheusser-Schnarrenberger, Federal Justice Minister specifically endorsed the Corporate Governance Code’s comply or explain mechanism, under which companies have duty to disclose if they follow the Code and, if the do not follow it, why not. German companies make a declaration of compliance that should be sufficient, substantive and differentiated. It should not be boilerplate. The Minister is skeptical of the European Commission suggestion of the monitoring of declarations of compliance by the authorities, which, in her opinion, runs counter to a best practices Code. Either the markets and shareholders will react to deviations from the Code or they will not, reasoned the Minister, and monitoring by the authorities will not change that dynamic.

On a separate issue, the Code Commission agrees that supervisory boards should be composed of members of differing opinions, competencies and appropriate professional experience, who are also willing and able to invest adequate time in their task as a member of the Supervisory Board, as well as critically examine the proposals and decisions of the Management Board. Furthermore, the Code Commission agrees that the composition of the Supervisory Board should be adapted to the business activities of the company.

The German Code Commission also endorses the approach of the Green Paper to emphasize the responsibilities of the Supervisory Board in the area of risk management. The Code Commission is convinced that risk management not only amounts to the identification and treatment by the company of the important risks, but also includes the fundamental decision of which risks a company should be willing to take in general.

The German Corporate Governance Code reflects this conviction in its recommendations to the Management Board to coordinate with the Supervisory Board on the strategic direction of the company, which includes an assessment of risks, and to regularly inform the Supervisory Board about the risk situation of the company, and risk management.

In the view of the Code Commission, the Supervisory Board bears the responsibility for approving the risk profile and the company's risk appetite as well as for monitoring adherence to objectives connected with the risk profile. At the same time, however, care must be taken that the Supervisory Board is not given any tasks that are clearly the responsibility of the Management Board. This should be made clear by the European Commission.

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