On November 9, 2012, the Ontario Securities Commission released OSC Staff Notice 51-720 Issuer Guide for Companies Operating in Emerging Markets (the “Guide”).
The Guide is one of the steps the OSC is taking to address concerns regarding issuers operating in emerging markets and is designed to help directors and management more effectively discharge their responsibilities. In addition to identifying potential risk areas, the Guide provides suggestions for directors and management to consider in addressing those potential risks in their businesses. It also sets out the OSC’s expectations of emerging market issuers in relation to disclosure requirements and provides examples of the level of detail that should be provided in disclosure documents.
The OSC has also committed to working with regulatory partners to develop guidance and standards to protect investors in emerging market issuers and in that respect, the Toronto Stock Exchange and the TSX Venture Exchange are also completing guidelines to further address the risks associated with listing emerging market issuers.
Specific Areas to Consider:
The Guide identifies and discusses the following eight areas for issuers operating in emerging markets to consider:
1. Business and Operating Environment
Directors and management of an emerging market issuer must have a thorough understanding of the political, cultural, legal and business environment of their foreign operations. An issuer’s directors should work to close any knowledge gap that may exist in relation to the issuer’s operating environment. Furthermore, all directors must have an understanding of Canadian regulatory requirements. If directors or management do not have an understanding of these requirements, they should work to gain the requisite knowledge. With respect to an issuer’s ongoing disclosure requirements, the disclosure should explain the business and operating environment and identify specific risks associated with operating in the relevant emerging market jurisdiction.
2. Language and Cultural Differences
It is important that the issuer have board members that have experience in the emerging market. If the board does not have any members familiar with the language and culture of the emerging market, there should be policies in place to deal with this issue, for example through the use of independent translators. The directors should also develop procedures for obtaining information from independent sources, distinct from local, non-independent directors and management.
3. Designing an Appropriate Corporate Structure
Directors and management need to be aware of legal and regulatory systems in the emerging market which may restrict foreign ownership and control. The use of complex corporate structures to deal with these restrictions can create additional risks. Management should carefully assess these structures and consider whether a simpler structure can be used to achieve the issuer’s objectives. An issuer’s disclosure should contain a comprehensive description of its corporate structure, the purpose for the structure and the benefits and risks associated with the structure.
4. Related Party Transactions
Due to different business practices, cultural norms and legal requirements in emerging markets, related party transactions may have a greater risk attached to them. Directors and management need to establish policies and procedures to identify and manage related party transactions and there should be comprehensive disclosure of them, so investors can properly evaluate related party transactions and their impact on the issuer’s operations and financial results. The issuer’s procedures for evaluating and approving related party transactions should also be disclosed.
5. Risk Management and Disclosure
Directors should adopt a written mandate that explicitly acknowledges their responsibility for, among other things, identifying and overseeing business risks. It is important that directors understand the risks associated with operating in certain jurisdictions and how those risks impact corporate operations and assets, and in particular, they should focus on risks that may have a significant adverse impact on business operations. For example, the issuer may face risks such as political instability, expropriation or nationalization of assets, foreign exchange controls or corruption. The issuer’s disclosure should describe in sufficient detail the risks involved in operating in the emerging market, the potential effects of those risks and the processes in place to deal with them.
6. Internal Controls
Directors should adopt a written mandate that explicitly acknowledges their responsibility for the issuer’s internal controls. An issuer operating in an emerging market should have particularly strong internal controls for financial reporting, due to the separation of management from the operations in the emerging market. The audit committee should actively oversee, monitor and mitigate any weaknesses in internal controls. Disclosure of material weaknesses in internal controls must be made and sufficient information should be provided so investors can properly evaluate them.
7. Use of and Reliance on Experts
There may be risks associated with using an expert in the emerging market. When an expert is used, the board should evaluate the expert’s credentials, specialized knowledge and the level of diligence exercised by the expert. Related disclosure should be accurate and sufficient for investors to understand the role played by the expert.
8. Oversight and External Auditors
The audit committee must determine whether the external auditor is competent and able to deal with matters in the emerging market. If the domestic auditor has delegated some of its work to a foreign auditor, the audit committee should look at the foreign auditor’s competence, the oversight provided by the domestic auditor and the division of responsibility between the two auditors. The audit committee should maintain frequent informal and formal communication with the external auditor, paying particular attention to delays or unusual management intervention in the audit process.
For further reference, a copy of the Guide is available here.
If you have any questions concerning this bulletin, please contact the authors or any member of the Davis Securities & Corporate Finance Practice Group.