Article by Michael Austin, Source: Cayman Finance

Corporate governance refers to the systems and processes used for directing and controlling the management of an organisation. Good corporate governance is the pre-requisite for operational success and survival in today’s competitive marketplace.

Corporate governance encompasses the relationships between an organisation’s internal and external stakeholders. Internal stakeholders include the board of directors, managers and employees. External stakeholders are the shareholders, investors, auditors and regulators. In a nutshell, corporate governance provides controls over an organisation’s relationships, strategies, objectives, accountability, transparency and compliance. Boards of directors are responsible for the governance of their companies. The shareholders’ role in governance is to appoint the directors and the auditors, and to satisfy themselves that an appropriate governance structure is in place.

Major corporate failures in 2001 and 2002 led to corporate governance practices coming under increasing scrutiny internationally. High- profile accounting frauds and financial scandals in the US — for example, Enron Corporation, Tyco International and WorldCom — led to the passing of the Sarbanes-Oxley Act in 2002, which introduced numerous regulatory and accounting reforms, with the object of restoring public confidence in corporate governance. In response to the perception that stricter financial governance laws were needed, laws — similar in nature to the US Sarbanes-Oxley Act — have been enacted in Japan, Germany, France, Italy, Australia, Israel, India, South Africa and Turkey.

More recently, the financial crisis of 2007 and 2008, also known as the ‘Global Financial Crisis’, has been attributed to several causes, with varying weight placed on each; however, and of note, the US Financial Crisis Inquiry Commission concluded that the financial crisis was avoidable and was caused, amongst other factors, by “dramatic failures of corporate governance and risk management at many systemically important financial institutions”.

From a Cayman perspective, corporate-governance principles have been receiving intense attention both from thve private sector and the regulator. Best practice has become a hot topic for discussion, particularly with reference to the global hedge fund industry, which represents a major segment of the Cayman economy.

Early in 2013, the Cayman Islands Monetary Authority (CIMA) launched a corporate-governance consultation process open for comments from all sectors (banking, insurance, fiduciary and mutual funds). This was aimed at bolstering plans to introduce corporate- governance guidelines to which all financial services entities must comply. The move largely arose as a result of international regulatory organisations (including the Basel Committee for Banking Supervision, the Technical Committee of the International Organization of Securities Commissions, the International Association of Insurance Supervisors, the Organisation for Economic Cooperation and Development, and the Financial Stability Board) calling for the adoption of more robust corporate governance standards. Although CIMA intends to extend its Statement of Guidance on Corporate Governance to all financial services entities in the Cayman Islands, the consultation process resulted in the publication by CIMA in December 2013 of a sector specific ‘Statement of Guidance on Corporate Governance for Regulated Mutual Funds.’

In a perfect world, the system of corporate governance would be ingrained in a business community and, as a result, arguably based on principles, as opposed to rules. The Cadbury Report, published in the UK in 1992 and titled ‘Financial Aspects of Corporate Governance’, took the view that corporate governance was not a matter for legislation. In contrast, corporate governance in the US is regulated essentially through the law. The Cayman Islands have traditionally favoured the principles- based approach, thus eliminating the need for detailed regulation and the associated costs. This approach is similar to that of the UK.

It is thus notable that CIMA has refrained from implementing rules or a code setting out compulsory standards. CIMA has said that stringent rules were not appropriate as the Cayman Islands is a sophisticated financial services jurisdiction with suitably qualified participants and service providers. CIMA has said a study it has conducted found “an appropriate awareness of corporate-governance expectations and a suitable application of these standards in day-to-day operations”. The more deep-rooted the system of corporate governance in a business community, the less a need for detailed regulation to ensure compliance with good- governance practices. The CIMA approach thus combines high standards of corporate governance with relatively low associated costs.

So where do we stand today? The Cayman Islands attracted global attention as a result of the Weavering Macro Fixed Income Fund Limited (In Liquidation) vs. Stefan Peterson and Hans Ekstrom case in August 2011, as a result of which the Grand Court imposed a US$111 million fine on the two non-resident directors, and handed down an extended statement of the duties and responsibilities of fund directors. Although regarded as a salutary wake-up call for directors of their responsibilities, it has been argued that the Weavering case makes it clear that the jurisdiction takes the issue of corporate governance very seriously.

From a corporate-governance standpoint, there is an increasing awareness of the importance and value of an independent board comprising experienced, credible and talented directors, and importantly, with an in-depth understanding of the company’s business. Independent directors are becoming important catalysts in good corporate governance. The existence in Cayman of a pool of professionally qualified individuals facilitates good board selection.

There is no question that there is a huge striving towards high levels of good corporate governance internationally, and likewise within the Cayman Islands. Corporate- governance processes will differ from company to company but the fundamental principles will always apply, that is to say, attention to the manner in which the Board of Directors effectively discharges its responsibilities when fulfilling its fiduciary duties (loyalty, honesty and good faith) and its duties of care, skill and diligence. The Board must determine purpose, adopt an effective governance culture, and ensure strict compliance with applicable rules and regulations.

What advantages accrue? Strong corporate-governance principles lead to operating effectiveness and promote the growth, performance and reputation of an entity. Corporate governance places risk oversight and risk management as critical responsibilities of the board, thus mitigating pitfalls. Sound corporate governance mandates diligent oversight of a company’s strategy, and the right strategy lays the foundation for how a company allocates resources, structures operations, and measures success. When well executed, the right strategy creates significant shareholder value.

About the Author

Michael Austin, a resident of the Cayman Islands, is a Chartered Accountant. He was admitted as a Fellow of The Institute of Chartered Accountants in England and Wales in 1974. He is an Associate Member of The Chartered Institute of Taxation, a Member of the Society of Trust and Estate Practitioners, a Member of the Cayman Islands Society of Professional Accountants, a Member of the Cayman Islands Institute of Directors, and a Notary Public of the Cayman Islands.

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