Corporate governance is the mechanism that governs the internal workings of corporations, the efficiency of their management and the effectiveness of the voice they give to their shareholders.

Good corporate governance practices enhance the investment appeal of companies by protecting minority shareholder rights and improving the transparency of their operations and decision-making. Given the continuing trend towards globalisation, good corporate governance standards are sought by investors worldwide.

As investors turn their attention to Russian investment opportunities once again, whether these opportunities represent acquiring securities (frequently depositary receipts) of Russian issuers in the international capital markets, in-bound mergers and acquisition activity and strategic private investment or participation in the extensive privatisation programme for 2011-2013 announced by the Russian government in November 2010.

While Russian companies have continued to gradually improve their corporate governance standards, certain deficiencies remain to be addressed.

Russian corporate governance standards

There are several sources of corporate governance standards in Russia. General corporate governance rules form part of Federal Law No. 208 On Joint-Stock Companies (JSC Law).

These rules contain well-defined minority shareholder protections, such as limitations on the issuance of non-voting preferred shares (with aggregate nominal value of not more than 25% of charter capital), a 2% ownership threshold to nominate candidates to the board of directors, cumulative voting for directors, annual board elections with a maximum one-year term for directors, and preemptive rights to acquire newly-issued shares.

The rules also include a limitation on the number of executives allowed to sit on the board of directors (not more than 25%) and a requirement that there be an internal audit committee whose members may not include directors. The company's charter may contain additional corporate governance provisions not mandated by law.

Other guidance is contained in the Corporate Governance Code (CGC) adopted by the Russian Federal Commission on the Securities Markets in 2002. This guidance includes comprehensive recommendations regarding the equal treatment of all shareholders owning an equal number of shares of the same type, the dissemination of information in advance of shareholders meetings and their conduct.

It also includes recommendations regarding the independence of directors, criteria for determining their independence and practices ensuring the election of a certain number of independent directors to the board.

In addition, there are recommendations about board committees. These look at their composition and function (for example, audit committees, nomination and compensation committees), equal remuneration for all directors, procedures for approving and entering into major transactions, disclosure of information about the company and its provision to shareholders, transparent determination of the dividend amount, the independence of share registrars and internal controls.

The provisions of the CGC were modelled on and inspired by the OECD Corporate Governance Principles.

While the provisions of the CGC are only recommended, requirements based on the CGC are mandatory for companies listed in the top-tier markets of the Moscow Interbank Currency Exchange (Micex) and the Russian Trading System (RTS).

Less stringent requirements are imposed on equity issuers in the lower-tier markets of these exchanges, as well as on issuers of debt. Compliance by issuers with the CGC-based requirements must be reported to the exchanges on a regular quarterly basis.

Russian public companies are required to publish IFRS-compliant financial statements in addition to the financial statements they are required to prepare on the basis of the significantly different Russian accounting standards (RAS). Companies that are not listed may publish IFRS-compliant financial statements as a matter of best corporate practice.

All shareholders in Russian companies have the right to receive the company documents and other information specified in law, including the charter, annual report and minutes of shareholders meetings, among others.

However, only 25% shareholders have the right to receive internal accounting documents and the minutes of meetings of the company's management board (a collective executive body that is responsible for its day-to-day operations).

Recent decisions of the Russian Supreme Court have expanded the rights of shareholders, including minority shareholders, to receive trade secrets (which must be kept confidential), although documents containing state, bank, or other secrets protected by law can be redacted by the company before delivery to the shareholder.

A shareholder's right to company information cannot be limited in the bylaws and a shareholder is not required to specify the reason it is requesting specific information. If the company does not provide the requested information it may be fined.

While Russia is considered to have a relatively good legal framework for corporate governance, this framework has some weaknesses, such as the ability of companies to delay shareholders meetings and widespread delays in the payment of announced dividends.

Although Russian companies have been faulted for a lack of transparency in disclosing ultimate beneficial ownership, some improvement has been observed in this regard, as well as in the more comprehensive disclosure of financial and operational information.

Implementation and compliance

The latest available comparative study on corporate governance practices in Russia covering the years 2004-2009 published by the Russian Institute of Directors (www.rid.ru) in 2010, to which the Russian School of Economics contributed with the support of Micex and others, examined the average level of corporate governance best practices as of the end of 2009 in 150 leading Russian companies. It also compared the evolution of four main corporate governance segments in these companies for the six-year period under review.

The four segments studied were implementation of shareholder rights, governance and control bodies, disclosure and corporate social responsibility. The study also identified the most and least improved aspects of corporate governance and studied developing trends.

Of the 150 companies included in the study, 67 companies were quoted on Micex and 29 companies were state-owned, with the Russian government owning directly more than 50% of their common stock (with seven of the state-owned companies also being quoted on Micex).

These 150 companies represented 12 different economic sectors with energy companies representing 17% of the sample, metallurgical companies representing 13% and heavy equipment manufacturers representing a further 12%. The remaining economic sectors represented included telecommunications, financial services, transportation, oil and gas and construction, among others.

Corporate websites, quarterly reports, annual reports, annual RAS and IFRS accounts, as well as publicly available information, served as the main sources of data for the study.

The study demonstrated continuing overall modest improvement in corporate governance, but the level of improvements varied for the different segments and fluctuated based on the type of company examined. Overall, implementation of shareholder rights and governance and control bodies each improved by three percentage points within the sample between 2008 and 2009, reaching 54% and 56%, respectively.

The disclosure segment improved the most during the six-year period studied and reached 68% in 2009, although its growth rate slowed to 1% in that year. Growth in corporate social responsibility was flat between 2008 and 2009 and the overall percentage of companies complying remained stable at 46%.

The study concluded that listing on a Russian stock exchange and the concurrent need for the company to comply with the exchange's requirements formed the main driver for Russian companies to improve their corporate governance standards.

The figures for listed companies compared to the overall sample demonstrate this vividly with 63% of listed companies implementing corporate governance practices designed to protect shareholder rights, 66% of them regulating governance and control bodies, 79% adopting disclosure standards and 55% implementing practices relating to corporate social responsibility.

Russian companies continue to apply best corporate governance practices unevenly. According to the study, of the sample companies in 2009, 21% (up from 14% in 2008) implemented more than 70% of best practice recommendations protecting shareholder rights, while 36% of companies (down from 37% in 2008) complied with 50% to 70% of such recommendations.

With respect to governance and control bodies practices, 31% of companies in 2009 (up from 22% in 2008) implemented more than 70% of the recommendations, while 31% of companies (down from 34% in 2008)
complied with 50% to 70% of such recommendations.

With respect to disclosure practices, 53% of companies in 2009 (up from 50% in 2008) implemented more than 70% of the recommendations, while 35% of companies (down from 37% in 2008) complied with 50% to 70% of such recommendations.

With respect to corporate social responsibility practices, only 21% of companies in 2009 (down from 23% in 2008) implemented more than 70% of the recommendations, 22% of companies (up from 19% in 2008) complied with 50% to 70% of such recommendations, and 57% of companies (down from 58% in 2008) complied with less than half of such recommendations, of which 16% of companies in both 2009 and 2008 not implement any best practices in this segment at all.

A further analysis performed as part of the study demonstrated that companies in the telecommunications, energy and oil and gas sectors showed the highest implementation of corporate governance best practices overall, with heavy equipment manufacturing, food and retail trade presenting the poorest showings.

A particular area of interest, especially in view of the Russian government's current privatisation programme, is the corporate governance standards observed by Russia's state-owned companies. According to the study, state-owned companies generally lagged behind private companies in all four corporate governance segments, although in certain segments they were almost on a par with the private sector.

The study found that in 2009 state-owned companies implemented best practice recommendations on shareholder rights in 53% of the cases studied (compared to 54% for the sample overall), on governance and control bodies also in 53% of the cases studied (compared to 56% for the sample overall), on disclosures in 63% of the cases studied (compared to 68% for the sample overall) and on corporate social responsibility in 39% of the cases studied (compared to 46% for the sample overall).

State-owned companies did perform better than the private sector with respect to making dividend payments in less than 60 days and paying at least 90% of the announced amount. In addition, according to the study, state-owned companies followed significantly better practices conducting tenders for the selection of suppliers of goods and services.

State-owned companies also increased the number of independent directors on their boards, although this positive trend has generated some controversy. Often these directors meet the CGC's independence standards, but are individuals who are executives at other state-owned companies. This fact raises the issue of their actual independence.

Not surprisingly, the study confirmed that larger Russian companies have better corporate governance practices than smaller companies.

In addition, the study found that the quality of corporate governance varied among the different economic sectors.

Comparison to NYSE-listed US companies

US companies listed on the NYSE must comply with the rules of the NYSE and US securities law requirements relating to corporate governance. NYSE-listed US companies are required to have a majority of independent directors on their boards. The definition of independent director includes a de facto assessment of a director's independence by other members of the board.

In contrast, Russian companies are not required to have a majority of independent directors on their boards. Both the CGC and the Micex rules establish the number of independent directors (generally between one and three and not less than 25% of the total number of directors), depending on the type of security that is listed (equity or debt) and the market tier of the exchange in which it is traded.

Furthermore, the Russian rules for determining independence are formalistic and do not contain a requirement of de facto independence. In addition, the independent directors of NYSE-listed US companies are required to meet regularly without the participation of the inside directors. There is no similar requirement in Russia.

The NYSE rules require all US listed companies to have an audit committee, a nomination/corporate governance committee and a compensation committee composed of independent directors. The Micex rules require listed companies to have an audit committee in most cases and a nomination and compensation committee in fewer cases, depending on the market tier in which the company's securities are traded.

The Micex rules do not require listed companies to maintain a corporate governance committee, although the CGC recommends that such a committee be formed. The Micex rules do not require these committees to be made up of independent directors, although they recommend that some independent directors be included in the membership of each of them.

Under the NYSE rules, shareholders of listed US companies must approve all equity-based compensation plans and material revisions to them. Shareholders of Russian companies are not required to approve such plans. The CGC recommends that equity-based compensation plans be approved by the board of directors. NYSE-listed US companies must adopt and publish their corporate governance guidelines.

There is no similar requirement in Russia. The corporate governance guidelines of Russian companies are publicly available to the extent they are contained in the company's charter.

NYSE-listed US companies must adopt and publish a code of business conduct and ethics for their directors, officers and employees, and promptly disclose any waivers of the code for the benefit of directors or executive officers.

In Russia, the CGC recommends that companies develop internal regulations, which should be approved by their boards of directors, to describe the ethical standards that guide the company's operations.

The CEO of each NYSE-listed US company must certify to the NYSE annually that he or she is not aware of any violation by the listed company of the NYSE's corporate governance standards, qualifying the certification to the extent necessary.

The CEO must also promptly notify the NYSE in writing of any non-compliance. There are no similar certification or notification requirements in Russia.

Recent developments

The Russian Ministry of Economic Development is working currently on draft amendments to the Russian Civil Code and the JSC Law, among others, intended to liberalise the corporate governance structure of closed joint-stock companies (CJSCs).
In accordance with these amendments, CJSCs would be allowed to establish different nominal values for their shares, the board of directors of a CJSC would be able to perform the functions of a Russian corporate management board (an executive body that is responsible for a company's day-to-day operations), and director voting would be liberalised.

The board of directors would be permitted to cancel its resolutions if such cancellation does not violate the rights of third parties.

Open JSCs would not be permitted to be transformed into CJSCs if their shares (or other securities that can be converted into shares) are listed on an exchange.

The draft amendments are expected to be submitted to the Russian government for consideration by the end of the summer of 2011.

It is clear that Russian companies have made, and continue to make, progress in the area of corporate governance.

The most immediate challenge they face is to increase compliance with the recommendations contained in the CGC out of recognition that this will make it easier for them to attract the funding they need to continue to develop, grow and modernise.

Potential investors looking in on Russia should also recognise the significant strides that have been taken by Russian lawmakers and regulatory authorities to improve the investment climate in the country.

Although more needs to be done, particularly in the area of enforcement, the momentum of change is moving in the right direction.