2012-03-29 OSC’s Identifies Concerns and Recommendations for Emerging Market Issuers

On March 20, 2012 the Ontario Securities Commission released the results of its initial review into emerging market issuers. This newsletter summarizes the key concerns and recommendations highlighted in the report.

The Ontario Securities Commission (OSC) recently released the results of its review of “emerging market issuers” which examined the disclosure and corporate governance practices of 24 Ontario reporting issuers whose mind and management are largely outside of Canada, and whose principal active operations are in regions such as Asia, Africa, South America and Eastern Europe. The review focused on the duties and responsibilities of the Board of Directors and audit committee of these issuers. As part of the review OSC staff also examined the role of other key participants in the capital markets process – namely underwriters, stock exchanges and auditors– in assisting emerging market issuers in accessing Ontario’s capital markets.

The results, published as OSC Staff Notice 51-719 - Emerging Markets Issuer Review (SN 51-719 or “the Notice”) on March 20, 2012, highlight areas of concern and make recommendations for changes to improve investor protection and the strength of the capital markets in Ontario. The staff notice does not change any existing regulations or guidance, but future changes resulting from the adoption of some or all of the review’s recommendations could have an impact on all reporting issuers, not just those that are considered “emerging market issuers”.

Concerns were centered on the following areas:

  • Level of rigor and independent-mindedness by those in management oversight, audit or due diligence functions should have been more thorough rather than taking a “form over substance” approach to compliance.
  • Whether directors of emerging market issuers obtained a thorough understanding of the business and operating environment, including political factors, legal and regulatory framework (such as banking practices), currency restrictions and other risks arising from environmental factors. Knowledge of local cultural and business practices are similarly required to support audit opinions or due diligence work by underwriters.
  • Separation of issuer’s Canadian governance and local management functions resulting in challenges for management oversight, audit and due diligence functions, particularly where language barriers exist.

Recommendations for Emerging Market Issuers: The Notice recommends that additional guidance be established for corporate governance practices where principal operations are in a foreign jurisdiction. Enhanced guidance on how CEOs and CFOs of such issuers should support their certifications of internal controls over financial reporting and disclosure controls and procedures is also suggested, including ensuring that appropriate books and records are maintained in Canada. Staff recommend better disclosures over complex corporate structures and their purpose and risk factors of investments in emerging market issuers. Minimum language competency for Canadian-resident board members in the local language of the place of the entity’s principal business operations and minimum Canadian director residency requirements are also to be considered.

Recommendations for Auditors: The Notice recommends working with audit oversight bodies, such as the Canadian Public Accountability Board (CPAB), to enhance access to working papers and improve monitoring of audit quality, including the extent of communications between group auditors and local “component” auditors, and to examine whether suitability standards for auditors of reporting issuers should be developed. Public disclosure of an auditor’s resignation from a file and the reasons for that resignation are also to be considered.

Recommendations for Underwriters: The key recommendations are to establish consistent and transparent set of requirements for the conduct of due diligence by underwriters including due diligence calls and site visits, and to institute best practices for the documentation of due diligence procedures performed.

Recommendations for Stock Exchanges: SN 51-719 recommends a review of the role of sponsors (where used) and the extent of reliance on other third parties for due diligence. In addition when listing requirements have been waived there should be greater transparency over the waiver. There may also be a need for additional listing requirements or review processes to address specific risks associated with emerging market issuer listings, for example, a requirement to maintain a meaningful “Canadian presence”.

The Emerging Markets Issuer Review observes a number of concerns over existing practices, procedures and disclosures by emerging market issuers and others that play “gatekeeper” roles for the capital markets. Those that operate in emerging markets should pay close attention to the concerns of the regulators to ensure the additional risks from operating in such markets are adequately addressed. Staff’s recommendations suggest where future additional guidance or regulation will be focused. All issuers, underwriters, auditors and stock exchanges should note in the closing remarks of the report: “We think it is also important to recognize that some of the policy issues we may pursue from the EMIR review could have broader applications and a more general benefit to our markets”.