Corporate governance in Russia is generally becoming more transparent and more information is being disclosed, thanks to increasing pressure from international investors. Improvements in these two categories are particularly imperative for Russian companies and banks that seek more foreign listings. Our Transparency Index, which monitors corporate transparency and disclosure of information for a group of the largest Russian companies representing around 90% of the Russian stock market's total capitalization, finds some recent improvement. The 2006 score for Russian companies increased to 53% from 50% (the maximum is 100). And for banks, the index rose to 48% from 36%. (For more information, see sidebar titled, "Transparency And Disclosure Studies Analyze Disclosure Of Information").
The level of corporate governance in Russia still remains below international standards, despite significant improvements over the past several years. Because of highly concentrated ownership structures, minority shareholders are exposed to risks of losses in value. The balance of influence on corporate boards does not allow independent directors and any others interested in protecting the rights of the minority shareholders to do so. Additionally, the government maintains major ownership stakes in many vital large companies, and systematically uses its sway to pursue its own strategic agenda, often against the interests of minority shareholders. The selective application of the law, inefficiency, and corruption within the regulatory bodies are also the major hindrances to the improvement of investment climate within Russia.
Many Russian companies still lack transparent ownership and operational structures and suffer from weak internal control procedures. As there is no concept of beneficial ownership, there is no requirement that this type of ownership be disclosed. Therefore, the level of disclosure of beneficial owners is not very high: 34% of total private ownership of the largest 70 companies, up from 28% of total private ownership of the largest 54 companies in 2005; and 52% of the largest 30 banks, up from 16% in 2005. For smaller companies, the percentage of disclosed ownership is much smaller. Because of the existence of nontransparent ownership structures, matters such as problematic related-party transactions and conflicts of interests of directors, registrars, and appraisal companies can go unnoticed.
Regulation concerning disclosure of financial information as well as information on beneficial ownership and various aspects of corporate governance such as shareholder rights, is weak. IFRS has been in place in banks since 2004, but this relates only to the information needs of the Central Bank of Russia, the major industry regulator. In the corporate sector, IFRS is only applied on a voluntary basis. In addition, regulation against the use of inside information is weak. Therefore, it is easy for those with access to these details to manipulate the market. It can be very important when market price of securities is used for assessment purposes, for instance, when shareholders who have accumulated ownership above the threshold of 95% launch the procedure to squeeze out the minority shareholders in accordance with the certain amendments to the Russian Joint Stock Companies Law. According to these amendments, which were adopted on Jan. 5, 2006, and became effective starting July 1, 2006, a person acquiring more than 95% of voting shares in an open joint stock company is obliged to buy out the shares held by the remaining shareholders upon their written request at market price, and also has the right to squeeze-out the remaining shareholders who hold 5% of voting shares, at market price. This exposure to share price manipulation effectively weakens the position of minority shareholders in many Russian companies.
Government corruption in Russia is relatively high. Russia ranked 121 on the list of 163 countries included in the 2006 Transparency International Corruption Perceptions Index survey results, with an index of 2.5. The scores range from 10 (clean) to zero (highly corrupt). This was only slightly better than Russia's ranking of 126 out of 158 countries, with an index of 2.4, in 2005. According to Transparency International, the index defines corruption as "the abuse of public office for private gain" and measures the degree to which corruption is perceived to exist among a country's public officials and politicians. The organization considers a score of 5.0 to be the borderline figure distinguishing countries that have a serious corruption problem from those that do not.
Finally, the internal political situation in Russia does not encourage better governance policies. After the "YUKOS affair" and tax and environmental prosecutions of other Russian companies, corporate leaders have set other priorities. These include access to the administrative resources of and affiliation with the state-controlled companies. This is perceived as a key means of protection from potential problems. These affiliations do not always have an economic rationale.
Currently, corporate governance of state-controlled companies is stagnant, and the trend is for more opacity in 2007 in view of the coming presidential election campaign in 2008. Some of the likely candidates are believed to be affiliated with these companies. We expect further state expansion, both domestically and abroad, as a way to ensure economic power supports political power.
Main Governance Issues In Russia
Russian corporate law, on the other hand is generally protective of investors in joint stock companies. It contains a number of positive clauses and has been improving in the last four years. For instance, in 2006, important changes were introduced in the corporate takeover procedures.
Generally, bylaws of Russian companies account for 67% of those rights that would ensure maximum protection of shareholders (see sidebar: "What Is Corporate Governance?"). This protection is sometimes form over substance, however, as there are still a number of important gaps, and the law is hard to enforce. It is possible, for instance, for independent appraisals of charter capital, when they are needed for share buybacks, to be provided by companies that are formally independent, but in fact influenced by the key shareholders. The same often happens with independence of directors on company boards, or independence of a company's registrar. It is difficult to insist on proving "affiliation de facto," based on a broader principle of control, when Russian law does not contain a definition of beneficial owner. Because beneficial owner is not defined, potential conflicts of interest can be obscured by any multilayer or intermediated ownership structure.
Highly concentrated ownership structures in Russia need to be taken in to account as a risk factor under such ownership structures, because typically, abuse of the shareholder rights occurs in the form of related-party transactions enforced by the majority holders. In the 70 largest public companies, large shareholdings, (blockholdings), over 25% account for 59% of market cap. In the 30 largest banks, these blockholdings account for 74%. Both indicators of concentration have only marginally decreased since 2005. Effective internal controls, as a function of an independent internal and external audit process, have not been widely developed. Of the 70 largest companies, only slightly more than a third have audit committees of the boards that are dominated by external directors.
In the private sector, companies with existing or planned foreign listings are leaders in terms of governance. Their practices approach the standards of the best-governed international companies. For example, three of the top four Russian companies with public corporate governance scores (CGS): Wimm-Bill-Dann Foods OJSC, MobileTeleSystems OJSC (MTS), and Vimpel-Communications JSC (VimpelCom) are listed on the NYSE. Therefore, they are subject to regulation by the NYSE and the U.S. SEC, including governance and transparency regulations mandated by the Sarbanes-Oxley Act of 2002. OAO TMK, one of the new listings on the London Stock Exchange, had its corporate governance score raised to 'GGS-6+' in 2006, at the time of its listing. (A CGS is Standard & Poor's Governance Services' opinion on the effectiveness of a company's corporate governance practices and mechanisms.)
In the government-controlled sectors of the economy, companies are particularly lagging behind in terms of governance and transparency. We observe highly politicized and obscured decision-making practices by corporate insiders including Kremlin-based directors. In these cases, decisions are actually made somewhere in the government or presidential administration and only communicated through the corporate board. Sometimes a decision is publicly announced before the board meets to consider it. One example is Gazprom's acquisition of Sibneft (later renamed to Gazprom Neft) in 2005.
Government representatives on the company boards are high-level state officials, who have various conflicting agendas and often no motivation to act in the interests of the company rather than in the interests of the state or a lobbying group. As a result, we find serious gaps in transparency of the state-owned enterprises (SOEs) compared with similar-size private companies. The Transparency Index of the 13 largest Russian SOEs is 51%, while for 13 private peers, it stands at 59%.
There is a negative trend in the transparency of these SOEs. Only barely above half have audit committees of the board to oversee the reporting and audit process, and less than a third have a majority of external directors on these committees. Generally, the proportion of such external directors on the boards (though independent by formal definition only), and representatives of portfolio shareholders) is only 9%, while at their 13 private peers it is 25%, and the average for the 70 Russian largest public companies is 22%. As a result, control over efficiency of financial and management practices is generally weaker at the SOEs, and minority shareholders are disadvantaged. Speculative trends prevailing on the Russian stock market, and the increased pressure on liquidity, however, make the impact of this fundamental weakness invisible in the short term.
Industry Profiles
Mobile telecommunications companies generally strong; fixed-line operators are weaker
The two mobile telecoms with public corporate governance scores have a history of strong governance standards, although in 2006 their scores were lowered below 'CGS-7', the minimum score in the category of strong governance standards. At MTS, a solid historical presence of strategic foreign investors and more than five years of U.S. listings have created a strong culture of respect for shareholder rights and transparency. In general, this continues, although the score on MTS was lowered to 'CGS-6+' from 'CGS-7' because of concerns about the reduced board representation of directors independent from the majority shareholder, Sistema JSFC, following the 2006 annual general meeting (AGM). Although we do not perceive any immediate risks in this respect, the independent directors are now less able to balance Sistema's influence and provide effective oversight of transactions involving other Sistema subsidiaries. The balancing power of independent directors is important in minimizing the general risks of concentrated ownership, even given Sistema's historically positive role in MTS.
The score on VimpelCom was lowered to 'CGS-6' from 'CGS-7' on June 8, 2006, and on July 20, 2006, affirmed and removed from GovernanceWatch with negative implications, where it was placed on Feb. 20, 2006. The score was lowered because of concerns about the inability of VimpelCom's largest shareholders, Telenor ASA and Altimo, part of Alfa Group, to resolve their long-standing dispute over the company's expansion strategy in Ukraine. This dispute has become disruptive to the board process, as demonstrated by the board's repeated failure to approve VimpelCom's budget for 2006, and threatens to affect the company's operations. (See section titled "Corporate Governance Score Review" for more details on this and other Russian companies with a public CGS.)
In the fixed-line telecom area Svyazinvest OJSC and its eight 51%-owned subsidiaries have moderate governance standards. The individual scores range from 'CGS-4+' to 'CGS-5+'. The scores on Dalsvyaz OJSC, North-West Telecom JSC, Southern Telecommunications Co. OJSC, Central Telecommunications Co. OJSC, and VolgaTelecom OJSC were raised, and the score on Sibertelecom OJSC was affirmed.
The variation in these actions is because Svyazinvest exerts both positive and negative influence on its subsidiaries. Svyazinvest has pursued several positive initiatives by Svyazinvest related to IFRS reporting, board committees at subsidiaries, software systems, strategic planning, and improvements of internal controls.
On the negative side, however, Svyazinvest's decision-making regarding some investment and finance matters is opaque and shows lack of concern for interests of minority shareholders. One such controversial initiative is the continuing payments to the not-for-profit association of telecommunications operators, known as The Noncommercial Partnership Center for Research of Telecommunications Development Problems. The use of these payments by the association is not fully transparent, and the benefits to the various subsidiaries of membership in the group are uncertain. In the past, Svyazinvest also has pursued a number of controversial purchase and divestment initiatives at its individual subsidiaries. Although the most controversial forms of this influence have become less pronounced over the past year, the ability of the minority shareholders to balance Svyazinvest remains limited. This, plus uncertainty with regard to upcoming privatization and low governance standards at Svyazinvest (75% government-owned; poor management oversight) remain major governance risks.
The score on Moscow City Telephone Network JSC was affirmed at 'CGS-5+' (but lowered to '5.5' from '5.9' on the Russia national scale) reflecting concerns about the dividend policy following the board's resolution to suspend dividend payments for 2005. Although MGTS' net income under Russian Accounting Standards rose by 476% to $310.6 million in 2005, 61% of this figure represents asset reevaluation and is not backed by cash flows. The decision to suspend dividends, initiated by the majority shareholder Comstar-UTS JSC, a subsidiary of Sistema, may have been in line with the long-term business interests of the company, but this move represented a departure from the principles set out in MGTS' charter and dividend policy. It was met by opposition from blockholder Svyazinvest, whose rights were potentially infringed.
TransTeleCom JSC currently has the lowest score of 'CGS-'4', unchanged from last year. The company is wholly owned by Russian Railways JSC, but it is not a core business for its owner. This may prevent Russian Railways from effectively assisting the development of TransTeleCom. At the same time, TransTeleCom is structurally linked to its parent company, as it leases the communications network owned by Russian Railways. The nonexecutive directors exercise their influence on TransTeleCom primarily in their capacity as Russian Railways managers, rather than through board resolutions.
Utilities affected by uncertainties of energy sector reform
Two public scores were assigned to Russian utilities in 2006 in the moderate category. The Territorial Generation Co. No. 9 OJSC (TGC-9) was assigned a score of 'CGS-4+' and Territorial Generation Company No. 1 OJSC (TGC-1) was assigned a score of 'CGS-5'. This score was "transferred" to TGC-1 from the former monopoly regional utility OJSC Lenenergo as TGC-1 was formed through the reorganization of Lenenergo and two other local utilities. (Simultaneously, the Lenenergo score was withdrawn.) This reorganization was part of the ongoing deregulation of the Russian energy sector.
The reform of the Russian energy sector began in 2003 at the initiative of RAO UES of Russia, the largest power holding in the Russian Federation. Before the reform began, the Russian government and the regional administrations regulated all tariffs for electricity and heat. The ultimate goal of the reform is to increase the efficiency of the sector and attract necessary private (including non-Russian) investments by introducing competition and transparent regulation. The key points of the reform include:
Restructuring of the RAO UES subsidiaries into separate generation, transmission, distribution, supply, dispatch, and auxiliary service companies, initially established as either subsidiaries of RAO UES, or subsidiaries of its subsidiaries;
Expanding these companies by merging them into territorial generation companies or cross-regional wholesale generation companies;
Allowing private controlling ownership in generation and supply segments, although this is not yet finalized. The initial plan included distribution of RAO UES' stakes in its new subsidiaries among its shareholders and then auctioning of the state-controlled stakes. However, this plan could be reversed in favor of other scenarios, including IPOs of the newly established consolidated generation companies;
Creating a competitive wholesale market and competitive suppliers to retail customers.
Privatization of these new generation companies, if successful, is expected to improve governance standards, and increase operating efficiencies and investments. It is still unclear, however, whether this privatization will occur, and if it does, whether all participants will be provided with equal access. The strong positions of Russian and non-Russian strategic owners pose risks to fair valuation. The Russian gas monopoly Gazprom is showing interest in the generation sector, which could intensify these risks. In addition, the structure of the future electricity market is unclear.
The current uncertainties related to electricity sector reform are a major constraint on the governance scores of the utilities. The major concerns are: future market liberalization, ongoing restructuring of RAO UES, and rules of privatization for the generating companies. The reform has been beset with delays and revisions, eroding clarity about the nature of the ultimate plan. Tariff regulation, particularly in heat generation, remains opaque and politicized, despite legal changes that were designed to create a more transparent regulatory framework. In this environment, we consider power generation companies to be very exposed to the risk of political interference, including implicit price controls and participation in uneconomic, but politically important projects.
We note commitment to improve governance procedures at RAO UES subsidiaries, where minority shareholders are given veto powers on the key board decisions, although RAO UES still dominates the boards. We have concerns regarding several corporate governance mechanisms at these companies, however. They do not have any independent directors, therefore, there is weak control over conflicts of interest of the majority shareholder and its representatives on the boards.
CGS Activity In 2006 Generally Positive
In 2006, Standard & Poor's raised eight corporate governance scores, lowered three scores, and affirmed two (see table for list of current scores). Three new scores were assigned. Of these, one was a transferal to TGC-1 from the former monopoly regional utility Lenenergo.
A number of positive trends are driving the improvements: better and more timely disclosure and more effective investor relations policies, and maturing board processes, where independence and effectiveness criteria for directors become clearer and stricter. In 2006, the progress was driven by several private companies, such as MDM Bank and TMK, whose aspirations for increasing the value of their business and getting cheaper financing were dominant in setting company values. In 2007, we expect more companies to demonstrate these tendencies.
Russian Companies Corporate Governance Scores And Their Components
Rank
Company
Global CGS
Russia national scale
Ownership structure and external influences
Shareholder rights and stakeholder relations
Transparency, disclosure, and audit
Board structure and effectiveness
1
Wimm-Bill Dann Foods OJSC
7+
7.7
7.8
7.5
8.0
7.7
2
MobileTeleSystems OJSC
6+
6.9
7.1
7.3
7.3
6.5
3
MDM Bank
6+
6.7
7.3
6.3
6.4
6.7
4
OAO TMK
6+
6.7
6.6
6.7
6.6
6.8
5
Vimpel-Communications JSC
6
6.4
5.0
8.3
7.6
6.2
6
EuroChem Mineral and Chemical Co. OJSC
5+
5.9
5.5
6.3
4.8
6.4
7
North-West Telecom JSC
5+
5.6
5.1
6.9
6.5
5.2
8
Moscow City Telephone Network JSC
5+
5.5
5.5
6.5
5.4
5.1
9
The Territorial Generation Co. No. 1 OJSC
5
5.3
5.7
5.7
4.3
5.2
10
Sibirtelecom OJSC
5
5.3
4.9
7.0
6.1
4.7
11
Dalsvyaz OJSC
5
5.3
5.0
7.1
6.0
4.5
12
VolgaTelecom OJSC
5
5.1
5.0
7.1
5.4
4.3
13
CenterTelecommunications Co. OJSC
5
5.0
4.6
7.0
5.3
4.3
14
The Territorial Generation Co. No. 9 OJSC
4+
4.8
5.0
5.3
4.5
4.5
15
Southern Telecommunications Co. OJSC
4
4.4
4.2
6.3
4.3
3.0
16
TransTelecom Co. JSC
4
4.1
4.5
5.8
3.0
3.7
Average
5.7
5.6
6.7
5.7
5.3
*The maximum is 10. OJSC--Open joint stock company. JSC--Joint stock company. OAO--Otkrytoe aktsionernoe obschestvo (Russian: open joint stock corporation).
Corporate Governance Score Review
Wimm-Bill-Dann Foods OJSC
The corporate governance score of 'CGS-6+' ('6.9' on the Russia national scale) on Wimm-Bill-Dann Foods OJSC (WBD; B+/Stable/--) reflects the effectiveness of the board and governance mechanisms in general, demonstrated by the recent CEO succession process. Sergei Plastinin, one of the founding shareholders of the company, was replaced at the helm of the company by Tony Maher, an experienced consumer products executive, formerly of the Coca-Cola system. This decision was reached through open board dialogue, with active involvement of independent directors at all stages of decision-making. In our view, the decision demonstrates both the very real influence of the independent directors and the commitment of the controlling shareholders to strong governance procedures.
As a NYSE-listed company, WBD is subject to regulation by the NYSE and the U.S. SEC, including governance and transparency regulations provided for by the Sarbanes-Oxley Act of 2002. In recent years, the controlling group has voluntarily limited its influence at the company by committing to maintain an independent majority on the board. The company has established advanced internal control procedures, and has provided a high level of transparency. Management is known for its openness to investors and analysts. On the other hand, the controlling group has diverse external interests, and WBD reports do not disclose all of these businesses. There are also certain weaknesses regarding the effectiveness of one of the board committees, and disclosure of executive pay.
Corporate governance practices at WBD include a number of strengths:
There is generally good transparency of ownership, supported by the company's listing on the NYSE.
The controlling group is committed to following strong governance practice, which is formalized in the Shareholders' Agreement and the company's Corporate Governance Code. This commitment was demonstrated by the openness of the board's decision-making regarding CEO succession.
The board has an independent majority and wide range of skills. The effectiveness of the board is supported by three committees, of which the independent audit committee, chaired by a finance expert, is the most active. The board is involved in a wide range of issues, including risk management, internal controls, acquisitions, executive succession, and remuneration.
The company is open to the investment community and has a relatively high degree of financial and operational transparency. This is supported by the company's obligation to comply with Sarbanes-Oxley and other SEC regulations.
There are effective mechanisms of independent oversight over the internal and external audit process.
There are a number of weaknesses, however:
The controlling shareholders are potentially exposed to conflicts of interest related to their external interests in agriculture, transportation, and other industries. Although we do not see any immediate risks and believe that the audit committee and the external auditor have information to monitor the related-party transactions effectively, the disclosure of these external holdings in WBD's reports is fragmentary.
There are certain weaknesses in investment planning and in other areas of internal control, including the procedures for approval of related-party transactions at subsidiaries.
Remuneration of individual managers is not disclosed.
(For more information, see “Corporate Governance Score: Wimm-Bill-Dann Foods OJSC,” published May 18, 2006, on RatingsDirect.)
Mobile TeleSystems OJSC
The corporate governance score of 'CGS-6+' ('6.9' on the Russia national scale) on Mobile TeleSystems OJSC (MTS; BB-/Stable/--), the largest cellular telephony provider in Russia and the Commonwealth of Independent States (CIS) is supported by the open dialogue that exists between Sistema JSFC, the majority shareholder, and other stakeholders in MTS. MTS is the largest subsidiary of Sistema, in which the holding company provides close management oversight, assuring accountability of management. Sistema's IPO on the London Stock Exchange (LSE) in February 2005 made the holding company more transparent and accountable, particularly for international investors. As a NYSE-listed company, MTS is subject to regulation by the U.S. SEC, and therefore is required to comply with the provisions of the Sarbanes-Oxley Act of 2002. These obligations stimulate the focus of management and the board of MTS on strengthening internal controls.
At the same time, the reduced board representation of directors independent from the majority shareholder following the 2006 annual general meeting (AGM) limits the ability of such directors to balance Sistema's influence and provide effective oversight of transactions involving other subsidiaries of Sistema.
Corporate governance practices at MTS include a number of strengths:
Sistema's commitment to raising shareholder value in MTS, and respect for the interests and opinions of other stakeholders in the company. To our knowledge, the controlling shareholder has never insisted on adopting a board decision if a minority of directors objects to it.
MTS' involvement in a major project for strengthening internal controls as required by Sarbanes-Oxley.
The wide scope of expertise represented on the board, combined with collegiate decision-making procedures and frequent board meetings, all of which contribute to highly effective board processes. The establishment of two additional committees in 2006 creates the potential for the board to have greater involvement in executive compensation and policies regarding corporate conduct.
The high degree of transparency and proactive investor relations team.
The presence of finance experts on the audit committee. Only the independent directors on the committee have voting rights.
An executive compensation plan that provides strong incentive mechanisms.
There are a number of weaknesses, however:
Representatives of Sistema form a majority on the board. Under the present board composition, the independent directors do not have a de jure authority to impose a veto on related-party transactions.
The voting power of minority shareholders is expected to decrease as a result of the share repurchase program announced by MTS. This will likely complicate their use of veto power on GSM issues requiring supermajority approval. Furthermore, the repurchased stock will retain voting rights that will be exercised at management's discretion.
The 20-F filing to the SEC, the most informative report produced by the company, is only published six months after the end of the reporting year.
There is a long dividend payout period of six months. In addition, there is no formal dividend policy.
The issue of director compensation is brought to the AGM for approval under the same agenda item as other questions of profit distribution. In addition, the company does not disclose the individual compensation of directors and executives.
(For more information, see “Corporate Governance Score: Mobile TeleSystems OJSC,” published Oct. 9, 2006, on RatingsDirect.)
MDM Bank
The corporate governance score of 'CGS-6+' ('6.7' on the Russia national scale) on MDM Bank, one of the largest private banks in Russia, reflects a maturing board process and continued establishing of solid governance practices capable of serving the interests of a broader shareholder base. This long-term vision and commitment to internationally accepted governance procedures are unique for a privately held Russian entity. The board dominated by independent directors has a tradition of open discussion and consensual decision making, while the four board committees chaired by independent directors (audit, strategy, risk, and nomination and remuneration) play an important role in building a consensus over those issues that are subsequently brought to a board vote.
The strongest corporate governance features are:
An independent board majority and a strong board process. Four active board-level committees help to increase the board's effectiveness.
The appointment of a highly experienced and reputable CEO, Michel Perhirin, in April 2006 strengthened the separation between ownership and management.
The development, approval and publication of a long-term strategy in 2006, which is positive in terms of transparency and predictability of cash flows from the investor's perspective.
High standards of transparency, including that of the ownership structure, and an active investor relations function.
The improved timeliness and quality of financial reporting. The audit committee provides close oversight of the reporting process, as well as the external and internal audit process.
However, there are a number of weaknesses that we regard as significant, particularly if MDM Bank or the group become publicly traded or more widely held in the future.
Relatively small size of the board, which currently includes six members. The replacement for the former board chairman who quit in June 2006, has not been identified so far.
The current transitional stage of the internal audit department. The replacement of the department intended to improve effectiveness led to the departure of several key employees.
Russian-language disclosure lags behind the English-language announcements in timeliness and scope. This is largely a result of the bank's focus on the interests of the Eurobond holders, the only external group of investors beside depositors.
Social strategy is absent, and the disclosure on this topic is weak.
(For more information, see “Corporate Governance Score: MDM Bank,” published Dec. 28, 2006, on RatingsDirect.)
OAO TMK (Pipe Metallurgical Co.)
The corporate governance score of 'CGS-6+' ('6.7' on the Russia national scale) on OAO TMK, the largest metal pipes producer in Russia, reflects the fact that the increased influence of the majority shareholder since the change in the ownership structure brought about through an IPO is at the same time effectively balanced by the effective board with a substantial degree of autonomy. It also factors in the transformation of TMK into a public company following the IPO, as well as a broad measure of shareholder rights provided by Russian law, and high overall transparency of the company.
The major strengths of the current governance system are:
The board's balanced composition, wide authority, and established procedures. Five independent directors on TMK's 10-seat board ensure that board decisions are in line with the interests of all shareholders. Independent directors represent a rich skill mix and demonstrate active involvement, forming majorities on three board-level committees.
High overall transparency, an effective audit process, and strong ownership disclosure. IFRS accounts were presented before the annual meeting in 2006 and interim statements were released for the first time this year.
Wide scope of shareholder rights and generally strong shareholder meeting procedures under Russian law. Further support is provided by the company's listing on the London Stock Exchange, which subjects governance procedures to U.K. regulation.
At the same time, we note that the quality of corporate governance is constrained by a number of weaknesses, including:
Certain disclosure drawbacks. A substantial amount of information has been presented only in the company's offering prospectus, which was not circulated in Russia due to regulatory constraints. We also note several drawbacks in continuous disclosure.
Concerns related to the loan extended by TMK to the majority shareholder in the course of his share buyout prior to the IPO. Risks to the company increased in connection with this transaction, albeit for a short period.
The transitional state of the investor relations function, which is still being set up.
Lack of experience in conducting shareholder meetings involving a broad shareholder base.
(For more information, see “Corporate Governance Score: OAO TMK,” published Dec. 19, 2006, on RatingsDirect.)
Vimpel-Communications JSC
The corporate governance score of 'CGS-6' ('6.4' on the Russian national scale) on Russian mobile telecommunications operator Vimpel-Communications JSC (VimpelCom) reflects generally strong governance practices of the company; at the same time it reflects concerns about the inability of the company's largest shareholders, Telenor ASA and Altimo, part of Alfa Group, to resolve their long-standing dispute over VimpelCom's expansion strategy in Ukraine. This dispute has become disruptive to the board process, as demonstrated by the board's repeated failure to approve VimpelCom's budgets for 2006 and 2007, and threatens to affect the company's operations. Telenor launched a legal battle against VimpelCom, seeking to invalidate the results of VimpelCom's extraordinary general meeting convened on Sept. 14, 2005, which approved the acquisition of CJSC Ukrainian Radio Systems (URS) with overwhelming support from minority shareholders.
Despite the ongoing dispute, the global and Russia national scale CGS on VimpelCom remain among the highest in Russia due to several important governance strengths. These include a high degree of transparency, good investor relations, and strong internal controls and executive incentive systems. Positively, the board currently retains the ability to reach consensus on issues not involving the company's operations in Ukraine. In addition to three representatives of each of the two blockholders, Telenor ASA and Altimo (part of Alfa Group), the nine-seat board includes three independent directors, two of which were nominated by the blockholders and one by minority shareholders. This composition, in conjunction with the 80% supermajority voting rule for major decisions, allows the independent directors to block any initiative that goes against the interests of minority shareholders.
VimpelCom is known among investors for its international management philosophy and commitment to maintaining high governance standards. In 1996, VimpelCom completed an IPO on the NYSE, becoming the first Russian company to be so listed. Consequently, the company is subject to regulation by the NYSE and the U.S. SEC, including governance and transparency requirements on governance required by the Sarbanes-Oxley Act of 2002. The relatively balanced influence of VimpelCom's major shareholders, Telenor and Alfa Group (26.6% and 32.9% of voting stock as of June 2006, respectively), are vital elements of the governance structure at VimpelCom. At the same time, we note that these shareholders have diverse external interests and that some of these external holdings hold the potential for conflicts of interest, and may in turn carry potential negative implications for VimpelCom.
Corporate governance practices at VimpelCom include a number of strengths:
The company has a solid track record of engaging minority shareholders in decision-making.
There is a supermajority provision with respect to board votes that allows independent directors to block any initiative that is not aligned with the interests of minority shareholders.
The company is open to the investment community and has a high degree of financial and operational transparency. This is supported by VimpelCom's obligation to comply with Sarbanes-Oxley and other SEC regulations.
There are effective oversight mechanisms for the internal and external audit process.
Compensation plans for directors and executives provide strong incentive mechanisms.
However, there are a number of weaknesses:
The dispute between the blockholders surrounding VimpelCom's operations in Ukraine is ongoing. Although the board has so far been able to carry out decisions on issues not involving the strategy in Ukraine, the dispute has prevented the board from approving the 2006 and 2007 budgets. There are also risks that board effectiveness might be further impaired should the dispute escalate. The dispute also has negative motivational effects on VimpelCom's management.
The board has only one formal committee, the finance committee, which might constrain the effectiveness of the board process. The statutory Audit (Revision) Commission performs the functions of an audit committee. Although highly effective, the members are not directors, which is not in line with best practice and the impending requirements of the Sarbanes-Oxley Act. The company is undertaking necessary steps to bring its audit oversight mechanism into full compliance with the upcoming regulatory requirements.
Remuneration of individual directors and managers is not disclosed, and there is no specialized independent board committee to oversee executive compensation.
(For more information, see “VimpelCom Governance Score Affirmed At 'CGS-6'; Off GovernanceWatch Neg On Reinstated Board,” published July 20, 2006; “VimpelCom Governance Score Cut To 'CGS-6' On Shareholder Dispute; Still On GovernanceWatch Neg,” published June 8, 2006, and “Corporate Governance Score: Vimpel-Communications JSC,” published May 26, 2005, on RatingsDirect.)
EuroChem Mineral and Chemical Co. OJSC
The corporate governance score of 'CGS-5+' ('5.9' on the Russia national scale) on EuroChem Mineral and Chemical Co. OJSC (EuroChem) reflects the substantial and systematic effort that the shareholders, the board, and management of the company have undertaken over the past years to develop governance mechanisms in line with the standards of leading well-governed public companies. These mechanisms are designed to protect the interests of all financial stakeholders, rather than those of the present shareholders. Despite the short history of the current governance structure, it appears fully institutionalized and already has demonstrated its effectiveness. In particular, the shareholders are committed to maintaining a hands-off approach to running the company. Strategic decision-making, for instance, is fully delegated to the board, which has a majority of independent directors.
The major strengths of the current governance system are:
The company's beneficial owners are committed to the development of an effective governance structure that is capable of protecting the rights of a wider shareholder base.
The volume of related-party transactions is insignificant, and the board is involved in their approvals.
The board has an independent majority and its members have an extremely high level of expertise. Three active board-level committees contribute to the board's effectiveness.
The audit process is strong, and it is supervised by a highly professional independent audit committee.
There is a clear and effective incentives plan for executives.
There is a high degree of management accountability combined with a strong system of financial planning and control. IFRS statements are produced on a quarterly basis and made available to the board, beneficial shareholders, and creditors. These statements are prepared and audited on a timely basis.
The company is committed to socially responsible behavior. EuroChem has signed social partnership agreements with all regional administrations at its major production sites. The company expects to release a social report compliant with Global Reporting Initiative standards in 2006.
However, the CGS is constrained by a number of substantial weaknesses, including:
The beneficial ownership of EuroChem and the external assets of the shareholders are not disclosed in public sources.
The board has functioned with its present composition for a relatively short time.
There is limited public disclosure of financial and operational information. IFRS statements are not publicly available at present. Therefore, information on compensation for executives and directors is not made public, nor is some other data.
The board committees have an extremely high level of involvement, potentially creating risks of engagement in semiexecutive functions.
There is no proven record of conducting general meetings for a wide shareholder base, as the related procedures are currently unnecessary.
(For more information, see “Corporate Governance Score: EuroChem Mineral and Chemical Co. OJSC,” published April 24, 2006, on RatingsDirect.)
North-West Telecom JSC
The corporate governance score of 'CGS-5+' ('5.6' on the Russia national scale) on North-West Telecom JSC (NWT), the leading fixed-line telecommunications operator in the northwest region of Russia reflects improvements in shareholder influence and transparency. We note in particular that controversial initiatives on the part of Svyazinvest, NWT's controlling shareholder, have become less pronounced over the past year. The scores remain constrained, however, by the limited opportunity for independent directors and minority representatives to balance Svyazinvest's influence, particularly given their decreased board presence following the 2006 annual general meeting (AGM). Independent directors have traditionally played an important role in NWT, to the benefit of all financial stakeholders. On the audit committee, these directors have consistently stimulated improvements in reporting and control structures.
The strengths of corporate governance practices at NWT include:
The involvement of shareholders and the board in management oversight. We particularly note the active role played by the independent directors.
The active functioning of the board and the four board-level committees, two of which are chaired by independent directors and have independent majorities.
The company's overall transparency and the effectiveness of the investor relations department. Senior executives are actively involved in investor meetings.
The improved quality of IFRS reporting, which has allowed NWT to receive an unqualified auditor's opinion for the first time this year.
The strength of shareholder meeting procedures and the substantial shareholder rights provided by Russian legislation and the company's charter.
There are, however, a number of governance weaknesses, including:
The ambiguity of Svyazinvest's influence. Although the most controversial forms of this influence have become less pronounced during the past year, the minority shareholders' ability to balance Svyazinvest remains very limited.
The dominant role of Svyazinvest and government representatives on the board.
Board compensation, which is tied to short-term financial performance. This encourages short-term focus.
The fact that the annual IFRS statements were published after the AGM.
(For more information, see “Corporate Governance Score: North-West Telecom JSC,” published Nov. 2, 2006, on RatingsDirect.)
Moscow City Telephone Network JSC
The corporate governance score of 'CGS-5+' ('5.5' on the Russia national scale) on Moscow City Telephone Network JSC (MGTS; BB-/Stable/--), a Moscow-based incumbent fixed-line telecommunications company, reflects the positive influence over the past years of the majority shareholder Sistema JFC (which holds MGTS stock via a subsidiary, JSC Comstar-United TeleSystems). Sistema's IPO on the London Stock Exchange in February 2005 made the holding company more transparent and accountable, particularly for international investors. At the same time, the score reflects the limited ability to balance the influence of Sistema by the blockholder Svyazinvest JSC, a government-controlled telecommunications holding company, and by minority shareholders and independent directors. This is particularly important in view of a substantial volume of related-party transactions between MGTS and Sistema's subsidiaries. In addition, the possibility of Svyazinvest's exit creates uncertainty regarding the development of MGTS' governance mechanisms.
The strengths of corporate governance practices at MGTS include:
Sistema's commitment to raising MGTS' shareholder value and to ensuring management accountability. Over the past few years, Sistema has been mindful of the interests and opinions of other stakeholders in the company. This is evidenced, for instance, by the fair buyout price Sistema offered to minority shareholders following MGTS' restructuring in December 2005.
The activity of MGTS' board and the wide scope of expertise among its members. The recent creation of board committees is likely to further contribute to board effectiveness.
The election to Svyazinvest's board in June 2005 of two independent directors, one of whom has experience in chairing an audit committee.
A generally good level of transparency and shareholder rights, although room for improvement remains. The company publishes audited U.S. GAAP financial statements before annual shareholder meetings.
Our analysis, however, identified several weaknesses in the company's governance system, including:
MGTS' exposure to the general risks of concentrated ownership, despite Sistema's generally positive role and Svyazinvest's continuing involvement. These risks are not balanced by strong independent representation, which is particularly important in view of the considerable volume of transactions between MGTS and other Sistema subsidiaries.
Uncertainty regarding the effect that Svyazinvest's possible exit, or its expected privatization, might have on MGTS' governance structure.
Uncertainty regarding the effectiveness of board committees, which have been created only recently.
Several disclosure shortfalls, including the exact terms of related-party transactions, audit fees, and individual compensation of executives.
An executive compensation plan that does not provide clear performance incentives.
The registrar's affiliation with Sistema.
The fact that the auditor is selected by Sistema for all its subsidiaries and provides considerable nonaudit services to MGTS.
On May 16, 2006, MGTS' board issued a recommendation in advance of the annual general meeting, scheduled for June 17, to suspend dividend payments on both common and preferred stock. According to Russian law, preferred stock acquires voting power proportional to its share in charter capital if a certain minimum share of net income under Russian Accounting Standards (RAS; 10% in MGTS' case) is not directed to dividend payment on such stock. The voting right remains effective until a dividend on preferred stock that conforms with the 10% guideline is declared. Although MGTS' net income under RAS rose by 376% to $310.6 million in 2005, 61% of this figure accounts for asset reevaluation and is not backed by cash flows.
The decision to suspend dividends, initiated by the majority shareholder Comstar-UTS JSC, a subsidiary of Sistema, was met by opposition from blockholder Svyazinvest OJSC. If preferred stock acquires voting rights, Svyazinvest's voting share will be reduced to 23% from 28%; the current level allows it to veto certain decisions requiring a 75% supermajority approval.
Although Sistema's decision to suspend dividends may be in line with the long-term business interests of the company, this move represents a departure from the principles set out in MGTS' charter and dividend policy. We also note that specific concerns of the minority shareholders, including Svyazinvest, have not been addressed, which we assess as negative from a governance perspective.
Given the company's substantial investment needs, however, the board's recommendation is not assessed negatively from a creditor's perspective, according to Standard & Poor's Ratings Services. This is a complex governance situation in which the various long- and short-term interests of particular stakeholders and the corporate entity differ.
(For more information, see “MGTS Russia National Scale Governance Score Lowered To 'CGS-5.5'; Global Scale Score Unchanged,” published May 23, 2006, and “Corporate Governance Score: Moscow City Telephone Network JSC,” published March 6, 2006, on RatingsDirect.)
Territorial Generation Company No. 1 OJSC
The corporate governance score of 'CGS-5' ('5.3'on the Russia national scale) on Territorial Generation Company No. 1 OJSC (TGC-1), an electricity and heat generation utility operating in the northwestern region of the Russian Federation reflects a balanced board structure and concentrated efforts by the company's shareholders, directors, and management to proceed with reorganization within the framework of national energy sector reform. However TGC-1 is still a newly established company in a transition period, and in this temporary state, the realization of some shareholder rights is limited. We do not score this as an unconditional weakness in its governance, but rather look at the features and the mechanisms that compensate for such deficiency. These would include transparency of the reorganization process, involvement of minority shareholder representatives in the discussions of shareholder-related matters, and strong internal controls. The company has taken some important steps toward the establishment of these procedures, but the score is still constrained by the lack of independent directors, and by the transitional format of board-management relations, which include excessive communications and micro-management by the board and its committees.
Major strengths of the current governance system are:
The two biggest shareholders--RAO UES of Russia (RAO UES), a state-owned utility group, and Fortum Oyj, one of the two largest Nordic electricity utilities, controlling competitive generation assets and utility monopoly operations, mainly in Finland and Sweden--have a strong strategic incentive to respect minority shareholder rights and ensure that the reform process is not compromised. In addition, they do not appear to have any critical conflicts of interest.
The board has a balanced composition that mirrors shareholder structure, allowing wide involvement of shareholder representatives in the discussions of strategic decisions.
Board control is strengthened by the additional oversight provided by the RAO UES committee on strategy and reform with respect to major decisions related to the reorganization.
Although financial statements are not ready yet, TGC-1 has employed a major independent international auditing firm.
Management incentives are efficient and aimed at stimulating good performance.
At the same time, we point out that the score is constrained by a number of substantial weaknesses, including:
The electricity sector in Russia and its reform process are regulated by the government, thus subject to various political risks, including the risk of delay or a complete freeze on reform that might seriously compromise shareholder value.
Since the beneficial shareholders cannot directly realize their voting rights, the director nomination process excludes beneficial minority shareholders. Although RAO UES has nominated one minority representative, this was done without coordinating with minority holders.
There is a lack of transparency in certain details of the reform process. For instance, information is unclear on the status of the valuation process, targets for the adoption and implementation of important decisions, and the status of shareholder voting rights during each transitional stage.
The TGC-1 board committee on business strategy is active and professionally involved. However, it tends to micromanage company executives, which involves excessive communications within the shareholder companies because most directors are not committee members.
(For more information, see “Corporate Governance Score: Territorial Generation Company No. 1 OJSC,” published Feb. 27, 2006, on RatingsDirect.)
Sibirtelecom OJSC
The corporate governance score of 'CGS-5' ('5.3' on the Russia national scale) on Sibirtelecom OJSC, one of the largest fixed-line operators in Russia, reflects improvements in the auditing process, as shown by the auditor's rotation resulting from an open tender. We also note the company's efforts to strengthen its internal controls and risk management system. Although our assessment of external influences at the company has been incrementally improved following our annual review, the score remains constrained by the ambiguity of the influence of Sibirtelecom's controlling shareholder, Svyazinvest OJSC, and the very limited ability of the minority shareholders to balance it. Svyazinvest has used its influence to implement a number of positive strategic decisions, such as regional consolidation and the adoption of IFRS accounting. It has also pursued a number of controversial initiatives, however, such as the recent acquisition of a minority stake in OJSC NTK Zvezda, a media company indirectly controlled by the military. We are concerned about the continuing payments to the association of telecommunications operators (The Noncommercial Partnership Center for Research of Telecommunications Development Problems). The use of these payments is not fully transparent, and the benefits to Sibirtelecom of membership in the association are not clear.
The strengths of Sibirtelecom's corporate governance practices include:
The fact that Sibirtelecom has conducted an open tender for audit services, leading to auditor rotation. Although in the minority on the tendering committee, independent directors were involved in the selection process and the ultimate decision was consensual. The company does not intend to employ the new auditor for consulting services.
Management's focus on strengthening the company's internal controls. Sibirtelecom has an experienced internal audit department and has made several important steps to develop risk management routines.
The presence of four functioning board committees, which increases the ability of independent directors to present their views and concerns to Svyazinvest representatives and ensures their involvement in management oversight. The audit committee and the personnel and remunerations committee have independent majorities.
The improved executive compensation plan and equity participation by the CEO, which aligns his interests with those of other shareholders.
Shareholder meeting procedures, which are generally in line with those of well-governed international companies.
Good overall transparency and strong investor relations.
There are, however, a number of weaknesses, including:
The ambiguity of Svyazinvest's influence. Although the most controversial forms of this influence have become less pronounced over the past year, the ability of the minority shareholders to balance Svyazinvest remains very limited.
The reduced board representation since the annual general meeting (AGM) of external directors who are not exposed to potential conflicts of interest.
The moderate frequency of face-to-face meetings by the board and its committees, excluding the audit committee. The audit committee members have limited audit experience.
The failure to publish annual IFRS statements prior to the AGM.
The fact that board compensation is tied to short-term financial performance. This encourages short-term focus.
Repeated qualifications in the auditor's opinion, although we note that these have historical roots.
(For more information, see “Corporate Governance Score: Sibirtelecom OJSC,” published Aug. 10, 2006, on RatingsDirect.)
Dalsvyaz OJSC
The corporate governance score of 'CGS-5' ('5.3' on the Russia national scale) on Dalsvyaz OJSC, the leading fixed-line telecommunications operator in the Far Eastern region of Russia, reflects the emergence of a new motivated management team of executives, together with improvements in: the audit process; the timing of IFRS reporting; and procedures for annual general meetings (AGMs). The new team has succeeded in enhancing the company's control structures and cost efficiency, as well as strengthening the investor relations function. The score also reflects improvements in disclosure on back-tax claims presented to the company in February 2005. Specifics of these claims, amounting to $25.6 million, are now available on the company's Web site. As an additional positive governance feature, we note the increased board representation of independent directors following the company's extraordinary general meeting on Sept. 28, 2006.
The score remains constrained by the dominant influence of the company's controlling shareholder Svyazinvest OJSC, a government-controlled holding company, over Dalsvyaz's strategic decision-making. Svyazinvest has used its influence to implement a number of positive strategic decisions, such as regional consolidation and the adoption of IFRS accounting. It has also pursued a number of controversial initiatives, however, such as the recent acquisition of a minority stake in Zvezda, a media company indirectly controlled by the military. We are concerned about the continuing payments to the association of telecom operators (The Noncommercial Partnership Center for Research of Telecommunications Development Problems). The use of these payments is not fully transparent, and the benefits to Dalsvyaz of membership of the association are uncertain. In addition, independent directors have limited ability to balance Svyazinvest's influence, especially after their representation on the board of directors decreased to three from four at the last AGM. The score remains affected by management's policy of limited disclosure of information regarding the tax claims brought against the company in February 2005, which Dalsvyaz is successfully challenging in court.
The strengths of corporate governance practices at Dalsvyaz include:
A strong and highly motivated management team, committed to improving internal controls, increasing the efficiency of the company, and strengthening investor relations.
The presence of four functioning board committees, which increases the ability of the independent directors to present their views and concerns to Svyazinvest representatives and ensures their involvement in management oversight.
The fact that Dalsvyaz has conducted an open tender for audit services, leading to auditor rotation.
Shareholder meeting procedures, which are generally in line with those of well-governed companies. In addition, the volume of information provided to shareholders prior to AGMs has increased.
Although, as in previous years, the annual IFRS statements were not published prior to the AGM, the timing of such reporting has improved significantly. The 2005 statements were published in late June 2006, compared with publication of the 2004 statements in August 2005.
There are, however, a number of governance weaknesses, including:
The dominance of Svyazinvest and government representatives on the company's board. The representation of independent directors declined after the AGM.
The limited disclosure of information on the specifics of the back tax claims and on Dalsvyaz's strategy of challenging these claims in court. Although this issue is becoming less important--as the court's decisions to date have been favorable for the company--we have observed higher standards of event-driven disclosure at leading, well-governed international companies.
The moderate frequency of face-to-face meetings by the board and board committees, including the audit committee. In addition, the efficiency of the audit committee is limited by the fact that committee members lack an audit background.
Board compensation, which is tied to short-term financial performance. This encourages short-term focus.
A repeated qualification in the auditor's opinion, although we note that this has historical roots.
(For more information, see “Dalsvyaz National Scale Governance Score Raised To 'CGS-5.3' On Improved Tax Claim Disclosure,” published Nov. 22, 2006; “Dalsvyaz Russia National Scale Governance Score Raised To 'CGS-5.1' On External Influence,” published Aug. 2, 2006; and “Corporate Governance Score: Dalsvyaz OJSC,” published July 18, 2006, on RatingsDirect.)
VolgaTelecom OJSC
The corporate governance score of 'CGS-5' ('5.1' on the Russia national scale) on VolgaTelecom OJSC reflects improvements in the timing of the company's IFRS reporting, which allowed it to publish its annual IFRS statements before the 2006 annual general meeting (AGM), and improvements in control structures implemented by its new management team. Although our assessment of external influences at the company has incrementally improved following our annual review, the score remains constrained by the ambiguity of the influence of VolgaTelecom's controlling shareholder, Svyazinvest OJSC, and the very limited ability of the minority shareholders to balance it. Svyazinvest has used its influence to implement a number of positive strategic decisions, such as regional consolidation and the adoption of IFRS accounting. It has also pursued a number of controversial initiatives, however, such as the recent acquisition of a minority stake in OJSC NTK Zvezda, a media company indirectly controlled by the military. We are concerned about the continuing payments to the association of telecommunications operators (The Noncommercial Partnership Center for Research of Telecommunications Development Problems). The use of these payments is not fully transparent, and the benefits to VolgaTelecom of membership in the association are uncertain.
The strengths of corporate governance practices at VolgaTelecom include:
The improved timing of the company's IFRS reporting, which allowed it to disclose its IFRS statements prior to its AGM for the first time in 2006.
The internal controls system, which has been strengthened by the creation of an internal audit department.
The active functioning of the board and its committees, as evidenced by frequent face-to-face meetings.
Strong investor relations. Senior executives are involved in meetings with investors.
Shareholder meeting procedures, which are generally in line with those of well-governed international companies.
The steady growth in dividend payments over the past years.
There are, however, a number of governance weaknesses, including:
The ambiguity of Svyazinvest's influence. Although the most controversial forms of this influence have become less pronounced over the past year, the ability of the minority shareholders to balance Svyazinvest remains very limited.
The reduced board representation since the AGM of external directors who are not exposed to potential conflicts of interest. None of the four board committees has a majority of independent directors.
The audit committee members' lack of audit background and their exposure to certain conflicts of interest.
The fact that board compensation is tied to short-term financial performance. This encourages short-term focus.
Repeated qualifications in the auditor's opinion, although we note that these have historical roots.
(For more information, see “Corporate Governance Score: VolgaTelecom OJSC,” published Aug. 2, 2006, on RatingsDirect.)
Central Telecommunications Co. OJSC
The corporate governance score of 'CGS-5' ('5.0' on the Russia national scale) on Central Telecommunications Co. OJSC (CenterTelecom), one of the largest fixed-line operators in Russia, remains constrained by the ambiguity of the influence of CenterTelecom's controlling shareholder, Svyazinvest OJSC, and the very limited ability of the minority shareholders to balance this influence. Svyazinvest has used its influence to implement a number of positive strategic decisions, such as regional consolidation and the adoption of IFRS accounting. Svyazinvest also initiated a reshuffle of the management team in early 2006, which led to improvements in control procedures, financial discipline, and a major cost-cutting effort at CenterTelecom. At the same time, it has also pursued a number of controversial initiatives such as the continuing payments to the not-for-profit association of telecommunications operators (The Noncommercial Partnership Center for Research of Telecommunications Development Problems). The use of these payments is not fully transparent, and the benefits to CenterTelecom of membership in the association are uncertain.
The score also reflects improvements in disclosure on back-tax claims amounting to $85.5 million that were presented to the company in April 2006. CenterTelecom's executives have commented on these claims in sufficient detail in media interviews, which has contributed to investor and analyst understanding of the causes of the claims and associated risks. We note, however, that room for improvement remains in terms of presenting the situation in greater detail in official publications.
The strengths of corporate governance practices at CenterTelecom include:
The involvement of shareholders and the board in management oversight. This was demonstrated by the appointment of a stronger and more motivated management team in February 2006.
The presence of four functioning board committees, which meet frequently.
Improvements to the audit process. The company has chosen to discontinue employing the auditor for nonaudit services. Additionally, the internal audit department is now in operation and has made several important steps toward developing fully fledged control procedures.
The improved timing of publication of annual IFRS statements. The 2005 statements were published in early July 2006, compared with September 2005 for the 2004 statements. A need for further improvement remains, however, as publication occurred only after the annual general meeting (AGM).
There are, however, a number of weaknesses, including:
The ambiguity of the influence of Svyazinvest, CenterTelecom's controlling shareholder. Although the most controversial forms of this influence have become less pronounced during the past year, the ability of the minority shareholders to balance Svyazinvest remains very limited.
The dominance of Svyazinvest and government representatives on the company's board. We note that the number of external directors who are not exposed to certain conflicts of interest declined to one from two after the AGM.
The limited disclosure of information on the specifics of the back tax claims brought against the company in April 2006 and on CenterTelecom's strategy of challenging these claims in court. We have observed higher standards of event-driven disclosure at leading, well-governed international companies.
Board compensation, which is tied to short-term financial performance. This encourages short-term focus.
Repeated qualifications in the auditor's opinion on IFRS statements, although we note that these have historical roots.
(For more information, see “Central Telecommunications Governance Score Raised To 'CGS-5' On Improved Tax Claim Disclosure,” published Nov. 23, 2006 and “Corporate Governance Score: Central Telecommunications Co. OJSC,” published Aug. 16, 2006, on RatingsDirect.)
The Territorial Generation Co. No. 9 OJSC
The Territorial Generation Co. No. 9 OJSC (TGC-9) is an electricity and heat generation company operating in the Sverdlovsk, Perm, and Komi regions of Russia. The corporate governance score (CGS) of 'CGS-4+' ('4.8' on the Russia national scale) on TGC-9 reflects the consolidated will of all the major shareholders and company management to quickly complete the company reorganization in the framework of national electricity sector reform. Both shareholders and company management used most of the mechanisms available under Russian law to allow shareholders to exercise their ownership rights during the whole reorganization process. At the same time, the dominance of the two major shareholders created the need for additional mechanisms that would protect minority shareholders' rights, such as independent oversight over the internal control system and the presence of the independent directors on the board, which the company currently lacks.
Major strengths of the current governance system are:
The two biggest shareholders, RAO UES of Russia (RAO UES) and Integrated Energy Systems (KES), have a strong strategic incentive to complete the company's reorganization as quickly and efficiently as possible. We cannot at this point see any immediate conflicts of interest on the part of the largest private strategic shareholder, KES.
The board has a balanced composition that generally mirrors the shareholder structure, allowing wide involvement of the two largest shareholders' representatives in the discussions of strategic issues.
The board control is strengthened by the additional oversight that the committee on strategy and reform of RAO UES provides concerning major decisions related to the reorganization.
The board has tended to play a central role in the decision-making process after its latest reelection.
Management incentives are aimed at stimulating good performance.
At the same time, the score is constrained by a number of substantial weaknesses, including:
The electricity sector in Russia and its reform process are regulated by the government, and are subject to various political risks, including the risk of delay or a complete freeze of the reform process, which might seriously compromise shareholder value.
One of the two major shareholders, KES, is clearly interested in acquiring a controlling stake in the company, possibly through a new share issue, which has not been yet approved by all involved parties. There is concern about the correct share valuation during this potential issue.
The only arguably independent director has yet to play an active role on the board. Generally, there is no independent oversight over the audit process and internal audit function by the board.
The cumulative voting procedures at shareholder meetings are compromised by consolidated voting of the two biggest owners, which sets a higher threshold for the election of minority shareholder representatives on the board.
Shareholders are provided with limited information about certain decisions regarding company reorganization brought to the shareholders meeting. In particular, the detailed explanation of the proposals regarding changes in asset lease agreements are provided verbally only at the shareholder meeting itself.
(For more information, see “Corporate Governance Score: Territorial Generation Co. No. 9 OJSC,” published June 22, 2006, on RatingsDirect.)
Southern Telecommunications Co. OJSC
The corporate governance score of 'CGS-4' ('4.4' on the Russia national scale) on Southern Telecommunications Co. OJSC (STC), a leading fixed-line operator in southern Russia, reflects improvements in accountability of management, which involved the active (albeit delayed) role of the majority shareholder Svyazinvest OJSC, a government-controlled holding company, and the board in making executive appointments stimulating the development of internal controls. Svyazinvest has also used its influence in the past to implement a number of positive strategic decisions, such the executive appointments at STC, which led to a financial turnaround in 2005, as well as the earlier regional consolidation and the adoption of IFRS. However, it has also pursued a number of controversial initiatives that have not been clearly explained to investors. For example, Svyazinvest has insisted that the company purchase costly IT with uncertain economic benefits, which continues to affect the company's cost base. Several divestments imposed by Svyazinvest were conducted under circumstances that were not wholly transparent. This includes the sale of STC's stake in Telesot-Alania CJSC, a regional cellular operator, which was conducted in 2005 via a closed tender and despite objections from minority shareholders.
The strengths of STC's corporate governance practices include:
The positive role of Svyazinvest and the board in achieving a financial turnaround in 2005 by means of competent executive appointments and strengthening of control structures.
STC's generally high overall transparency level, and its proactive approach to investor relations. The quality of IFRS reporting has improved.
The strength of shareholder meeting procedures and substantial scope of shareholder rights provided by Russian legislation and the company's charter.
The active functioning of the board supported by four board committees.
There are, however, a number of weaknesses, including:
The response of Svyazinvest and the board to STC's large unauthorized capital expenditures and deteriorating financials in 2004 was substantially delayed.
The board is dominated by Svyazinvest and government representatives, whose influence remains ambiguous. None of the four board-level committees has a majority of external directors without potential conflicts of interest. The ability of minority shareholders and independent directors to balance the influence of Svyazinvest therefore remains very limited.
Board compensation is tied to short-term financial performance. This may encourage a short-term focus.
STC's dividend payout plan gives preference to the majority shareholder. Svyazinvest received payment earlier than most minority shareholders in 2005.
Although the specifics of back tax claims brought against the company have become available to analysts and investors, the fact that these were not presented promptly represents a disclosure weakness.
There was a repeated qualification in the auditor's opinion, which has historical roots. IFRS accounts were not presented to shareholders before the annual general meeting.
(For more information, see “Corporate Governance Score: Southern Telecommunications Co. OJSC,” published Nov. 21, 2006, on RatingsDirect.")
TransTeleCom Co. JSC
TransTeleCom Co. JSC (TransTeleCom) is a wholly owned telecommunications subsidiary of state-owned Russian Railways JSC (Russian Railways; BBB-/Stable/--). As a market-oriented firm, TransTeleCom has developed an independent strategic vision and an organizational culture that is distinct from those of its parent company. Despite the fact that the company is closely held and currently does not have publicly traded debt, the management of TransTeleCom demonstrates a commitment to bringing the company's disclosure policy and internal structures in line with those of transparent public companies, which is reflected by its corporate governance score of 'CGS-4' ('4.1' on the Russia national scale).
The company's strongest corporate governance features are:
Strong financial control exercised by the shareholder, ensuring the accountability of management. As a part of this effort, Russian Railways requires that the company produce audited financial statements in accordance with IFRS and detailed internal reports. At the same time, while the existing procedures and reporting policies effectively protect the interests of the sole shareholder, they may not be adequate to ensure protection of other financial stakeholders.
Commitment of the shareholder to development of fully fledged governance mechanisms at the company. This includes the growing role of the board and improvements in its procedures--albeit these remain at a relatively low level.
Use of tender procedures for auditor selection, and the appointment of international firms to audit TransTeleCom's financial statements that conform to IFRS and Russian Accounting Standards (RAS).
However, there are a number of significant weaknesses, which would be magnified if TransTeleCom were to be publicly traded or widely held in the future.
TransTeleCom is not a core business for Russian Railways. This may prevent it from effectively assisting the development of TransTeleCom. At the same time, TransTeleCom is structurally linked to the parent company, as it leases the communications network owned by Russian Railways.
Comprehensive financial and operation data are not disclosed. Articles of association, bylaws, and board information are also not presented in the public domain.
The absence of independent directors and board committees, including an audit committee that could provide independent oversight over the internal control function and the audit process, hinders better governance practices. The board is dominated by senior executives of the parent company, whose expertise in telecommunications is limited to that with Russian Railways' own internal telephony service.
The role of the board of directors is not fully formalized. At present, the nonexecutive directors exercise their influence on TransTeleCom primarily in their capacity as Russian Railways' managers, rather than through the board's resolutions.
The ultimate beneficial owner of the company is the federal government. This creates potential conflicts of interest, as the state also holds indirect controlling stakes in a number of competing telecom companies, including long-distance carrier Rostelecom OJSC.
The board has only limited involvement in the compensation policies of TransTeleCom's management. There is no board-level compensation committee.
(For more information, see “Corporate Governance Score: TransTeleCom Co. JSC,” published Jan. 17, 2006, on RatingsDirect.)
Sidebar: Transparency And Disclosure Studies Analyze Disclosure Of Information
The corporate governance framework should ensure timely and accurate disclosure of information on all material aspects of a company's operations. Standard & Poor's Governance Services transparency and disclosure (T&D) studies examine various items relating to three blocks:
Ownership structure and shareholder rights,
Financial and operational information, and,
Board and management structure and process.
We analyze information included in the three major sources of public information: annual reports, Web-based disclosures, and public regulatory reporting.
In 2002, we published our first T&D study of companies selected from the following indices:
S&P/IFC Emerging Asia,
S&P/IFC Latin America,
S&P Asia-Pacific 100, and
S&P/TOPIX 150 (Japan).
In April 2003, we released our study of the S&P Europe/350 companies. In addition, in 2004 and early 2005, we published a number of studies devoted to corporate governance disclosure by companies in various countries of the East-Asian region, including Hong Kong, Singapore, Indonesia, Malaysia, and Thailand. In addition, in June 2005, we published the Turkish T&D Survey, which analyzes the disclosure practices of 52 largest Turkish companies with the most liquid stock. This research was updated in 2006. In 2002, we published our first survey of T&D by the largest Russian public corporations. As a result of the continued interest among investors and analysts, we have been updating our Russian corporate survey and continuously developing the methodology. The latest annual update of the T&D survey was published on Nov. 8, 2006. In 2005, the first T&D study of Russian banks was published. The second such study was released on Oct. 12, 2006. Separately, in June 2005, we published a survey of T&D by Russian state-owned companies at the request of the OECD Roundtable on Corporate Governance. Most recently, we published our first T&D study of the largest Ukrainian banks.
A company's transparency score should not be compared with its corporate governance score (CGS), or otherwise interpreted as a measure of governance standards. A CGS is our assessment of a company's corporate governance practices, which is not limited to information disclosure. In addition, these scores are assigned on the basis of an in-depth, interactive analytical process involving both public and nonpublic data. However, we view corporate transparency as an important factor affecting a firm's attractiveness to investors and an important element of corporate governance.
Sidebar: What Is Corporate Governance?
Corporate governance is the system of interaction of a company's management, board of directors, and shareholders designed to ensure the company's value is maximized and that all financial stakeholders receive their fair share of its earnings (see “Special Report: Corporate Governance Influence On Public Policy Dialogue Will Continue Into 2007,” published on RatingsDirect on Dec. 18, 2006, for a list of recent articles on this topic). A corporate governance score (CGS) reflects Standard & Poor's Governance Services' assessment of a company's practices and policies and the extent to which these serve the interests of the company's financial stakeholders, with an emphasis on shareholders' interests. These governance practices and policies are measured against our corporate governance scoring methodology, which is based on a synthesis of international codes, governance best practices, and guidelines on good governance practice.
The four components of our analysis are:
Ownership structure and external influences;
Shareholder rights and stakeholder relations
Transparency, disclosure, and audit; and
Board structure and effectiveness.
Each of these components has several subcomponents. Companies receive subscores on each component, and an overall score. The scores range from '1' (the lowest) to the maximum score of '10'. These scores fall in to three ranges: 7 to 10, 4 to 6, and 1 to 3.
A company with a CGS of 7 to 10 has strong global governance standards.
Ownership structures do not pose conflicts
Shareholder rights are well defined and protected
High transparency and disclosure (according to IFRS or U.S. GAAP)
Effective board structure and active engagement by nonexecutives and independent directors
A company with a CGS of 4 to 6 has basic governance standards in place, although certain shortcomings are apparent. Among them, the ownership structures and the board are often the weakest areas of assessment.
A company with a CGS of 1 to 3 has fundamental weaknesses or holes in governance practices. No Russian companies fall within this category.
Companies with the same global score have, in our opinion, similar company specific governance processes and practices overall, irrespective of the country of domicile. The scores do not address specific legal, regulatory, and market environments, and the extent to which these support or hinder governance at the company level, a factor that may affect the overall assessment of the governance risks associated with an individual company (see Country factors). We also assign these scores on a separate Russia national scale.
GovernanceWatch
A GovernanceWatch designation may be used to highlight the fact that identifiable governance events and short-term trends have caused a CGS to be placed on review. GovernanceWatch does not mean that a change to the CGS is inevitable. GovernanceWatch is not intended to include all scores under review, and changes to the CGS may occur without the CGS having first appeared on GovernanceWatch.
Country factors
Although we publish country governance analyses from time to time, it is important to note that we do not currently score individual countries. However, consideration of a country's legal, regulatory, and market environment is an important element in the overall analysis of the risks associated with the governance practices of an individual company. For example two companies with the same company scores, but domiciled in countries with contrasting legal, regulatory and market standards, present different risk profiles should their governance practices deteriorate i.e., in the event of deterioration in a specific company's governance standards, investors and stakeholders are likely to receive better protection in a country with stronger and better enforced laws and regulations. However, in our opinion, companies with high corporate governance scores have less governance related risk than companies with low scores, irrespective of the country of domicile.
For a full explanation of our criteria for measuring corporate governance standards, please refer to the latest edition of “Corporate Governance Scores And Evaluations Criteria, Methodology, And Definitions.”
Analytic services provided by Standard & Poor's Ratings Services (Ratings Services) are the result of separate activities designed to preserve the independence and objectivity of ratings opinions. The credit ratings and observations contained herein are solely statements of opinion and not statements of fact or recommendations to purchase, hold, or sell any securities or make any other investment decisions. Accordingly, any user of the information contained herein should not rely on any credit rating or other opinion contained herein in making any investment decision. Ratings are based on information received by Ratings Services. Other divisions of Standard & Poor's may have information that is not available to Ratings Services. Standard & Poor's has established policies and procedures to maintain the confidentiality of non-public information received during the ratings process.
Ratings Services receives compensation for its ratings. Such compensation is normally paid either by the issuers of such securities or third parties participating in marketing the securities. While Standard & Poor's reserves the right to disseminate the rating, it receives no payment for doing so, except for subscriptions to its publications. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.
