SPEECH/03/35

Speech by Frits Bolkestein

Member of the European Commission in charge of the Internal Market and Taxation

Corporate Governance in Europe

Address to Conference on Corporate Governance at Clilfford Chance

Amsterdam, 30^th January 2003

Ladies and Gentlemen,

Thank you very much for your invitation to share with you some views on Corporate Governance, a subject which is very high on my political agenda.

Corporate Governance, i.e. the way in which companies are directed and controlled, is attracting an ever increasing attention on both sides of the Atlantic. This interest derives not only from painful past experiences but also from the growing awareness that a sound corporate governance framework is a key condition for properly functioning and liquid capital markets. It reflects the empirical evidence that well run companies, with proper disclosure, outperform the indices.

The corporate governance debate: different approaches

Within the European Union, Member States have different systems of corporate governance different approaches, which reflect their individual views about the roles of corporations and the way in which industry should be financed.

The debate about corporate governance started first in countries with more developed equity markets: institutional shareholders became more active because they wanted to make sure that management would indeed manage the company in a way which would maximise the shareholders' interests. The increasing importance of capital markets within the EU, but also some spectacular corporate failures - which very much destroyed the public's confidence in financial markets triggered the debate on corporate governance issues also in the rest of Europe. Here the debate is, however, more focussing on the protection of minority shareholders.

Over the last decade, forty or so corporate governance codes relevant to the European Union have been adopted at national or international level, with the aim of better protecting the interests of shareholders and/or stakeholders. These codes have undoubtedly had a positive influence on capital markets in general. But they have unfortunately proven unable to prevent the recent wave of unexpected corporate failures.

In my view, two main lessons may be drawn from these failures.

Firstly, they arose on both sides of the Atlantic, which seems to indicate that, per se, no national system is intrinsically better than another. What is really important is not the formal structure under which companies operate, for example the one-tier or the two-tier board, but the corporate governance practices adopted to make sure that the formal structure effectively serves the interests of shareholders and stakeholders.

Secondly, I think that a "soft-law-approach", a self-regulatory market approach combined with disclosure and transparency obligations should be the guiding principle for any initiative in corporate governance. However, such a self-regulatory market approach, based on non-binding recommendations, might not always be sufficient to guarantee the adoption of sound corporate governance practices. A limited number of made-to-measure rules might therefore be necessary, so markets can play their disciplining role in an efficient way.

The European Commission did not await the most recent corporate failures to start working on a series of issues. The Financial Services Action Plan identified already in 1999 a series of initiatives which we deemed necessary to achieve deep and liquid capital markets. One of them is the new Proposal for a Takeover Bids Directive, presented by the Commission in October of last year, which seeks to offer European companies greater legal certainty for cross border takeover bids. On of the main objectives of this proposal is certainly the fight against entrenched boards and the protection of minority shareholders a core principle of corporate governance.

But let me now focus more specifically on the efforts of the European Commission in the area of corporate governance in the strict sense of the word, and on our intention for the immediate future.

I believe that the responsibility of the regulator is to set up the framework, which then enables the markets to play their disciplining role in an efficient way. If there are differences in national corporate governance arrangements, this may create uncertainty for both issuers and investors. And these uncertainties present serious obstacles for a truly functioning single capital market. And, - I have mentioned this earlier I believe it to be crucial that we do everything to restore the investor's confidence in our financial markets, which has tremendously suffered in the wake of the recent scandals.

The European Commission is and remains committed to creating a single capital market in Europe and is, therefore, determined to play an active role also in the corporate governance debate.

Until now, Community law remains almost silent on the subject of Corporate Governance. The Commission was, however, convinced of the need for an initiative in this area, and announced in its 1999 Financial Services Action Plan that it would launch a review of the corporate governance codes relevant to the EU. The full comparative study, prepared for the Commission by Weil, Gotshal & Manges LLP, was finalised in March 2002.

The conclusions of this study are interesting:

Firstly, the main differences between Member States are found in differing company law and regulation (for example, with respect to issues like one-tier / two-tier boards, workers' participation, or the principle of one share/one vote) as opposed to the corporate governance codes which show a remarkable degree of convergence.

The existence of many codes in the EU is not perceived as a difficulty by issuers and this for three reasons. First of all, issuers continue to operate primarily on their domestic market, which means that most of the time they are not faced with foreign codes. When they are, code provisions are pretty similar. And finally, if there are some differences, code provisions are not binding anyway.

The study concludes that the EU should not devote time and effort to a European corporate governance code. So - should there be an initiative in the area of corporate governance at EU level at all?

This key question was clearly one of the most important ones, which had to be examined by the High Level Group of Company Law Experts chaired by Jaap Winter, which I appointed in September 2001. You are undoubtedly aware of the excellent Final Report of the Winter Group, which was presented on 4 November 2002 and which has been welcomed by both the Council and the European Parliament.

The forthcoming Action Plan on Company Law

For me, it is now a matter of utmost priority to come up with a Communication on company law and corporate governance I intend to do so by the end of the first quarter of 2003. In that Communication, the Commission will present its Action Plan, identify the necessary actions, define priorities and most importantly, determine whether the necessary initiatives should use binding or non binding instruments.

We will draw an important part of inspiration for our future initiatives from the recommendations of the "Winter Group", which are presently examined in depth by my services. Despite the urgency of the issue, we do, however, not intend to act in haste, but we will remain committed to thorough and wide consultation in this very sensitive area. And we do not intend to act solely through legally binding acts namely directives or regulations but we will use all tools that we have available: legislative and non-legislative, whatever is more appropriate for a given problem.

Having said that, and pending the results of further consultation with Member States and stakeholders on this issue, I don't think that we need to establish a comprehensive EU Corporate Governance Code. We can, however, not ignore that there are presently differences in corporate governance arrangements that frustrate the realisation of a single capital market. But we are also aware of sensitivities in this area any initiative at EU level should therefore only address those barriers that truly arise in practice. This is why our work should in principle not go beyond publicly traded companies.

Given the multitude of corporate governance efforts in the Member States, I also firmly believe in co-ordinating these efforts. The ultimate goal of such enhanced co-ordination would be to foster convergence not only as far as the contents of the codes is concerned, but also regarding monitoring and enforcement of compliance with the codes.

Without already going onto too much detail after all, my services are still working on the proposal for this Action Plan - I would also like to stress that extensive "disclosure" will be one of the key elements of our proposed actions. I firmly believe in "transparency" and "information" I am convinced that easily accessible and usable information is a powerful tool for the shareholders, and all new electronic means should be used to provide this information fast and efficiently.

These new electronic means should also be used for exercising the shareholders' rights be it for voting or for participating in general assemblies.

The role of non-executive and supervisory directors and the remuneration of executive directors will most probably be subject to specific action at EU level. These issues, as well as the management's responsibility for financial statements, will be among the priority actions of our future Work Programme and this should come as no surprise, when you think back to the recent US scandals which heated the debate on corporate governance and which triggered a legislative Act in the US you have already heard a lot about today the Sarbanes-Oxley Act.

Which brings me to my last point: Of course be the analysis of the recent developments in the United States and the Sarbanes-Oxley Act will be an important element in the preparation of the Company Law Action Plan.

The much discussed and heavily debated Sarbanes Oxely Act covers mainly auditing issues, but it also contains some corporate governance provisions. In both cases, the Commission has been very active in the analysis of the various problems created by its extra-territorial application, with a view to negotiating acceptable solutions with the US SEC. Over the last weeks, an intense activity took place at all EU levels in this respect.

In all our initiatives we made it very clear that the European Union consistently and strongly supports the objectives of the SOA to enhance corporate governance, audit and accounting standards in the United States. Nevertheless, we voiced our concern about the potential impact of the SEC implementing rules - we clearly wanted to avoid the undesirable extra-territorial effects of the Sarbanes-Oxley Act.

We identified the issues at the source of the main conflicts of laws and tried to find common solutions. I made it clear to Congress and the US administration that we have seven broad areas of concern, namely:

the registration of audit firms with the new Public Company Accounting Oversight Board;

the direct US access to EU audit working papers;

the audit committee requirements;

the rules on auditor independence;

the issue of loans to Directors and Executive Officers (notably for banks);

the certification of financial reports;

and the certification of internal control.

And I think we have been quite successful in demonstrating this, and in convincing the SEC of many of our arguments. On 23 January, the SEC finished a major round of rulemaking implementing the Sarbanes-Oxley Act. We believe the outcome has been quite positive for the European Union and, at this stage, we feel that many of our comments have been taken into account.

Although we still have to analyse the final rules, which have not yet been published, the SEC has given foreign companies, lawyers and auditors some significant relief to accommodate legal conflicts with foreign jurisdictions. This is particularly the case with regard to audit committees and auditor independence issues. Moreover, foreign lawyers seem to have been fully exempted from the SEC rule imposing reporting duties on lawyers.

So certainly there has been a step in the right direction. But there are more issues of concern that need to be resolved. For example direct US access to audit working papers and registration of EU audit firms with the new US oversight board. And, of course, of primary importance in all these negotiations will be the ability of the EU to demonstrate that appropriate regulatory initiatives are being taken in the EU, too.

Conclusion

Corporate governance rules are a crucial ingredient for determining the overall attractiveness and prosperity of capital markets, and the European Commission is committed to take appropriate initiatives.

In Europe, investors need to be better organised, more vociferous and advocates of corporate change. With full disclosure of corporate governance practices, markets will work even more efficiently.

But a sound corporate governance framework will be achieved neither by the markets acting only on their own, nor by the introduction of an overly prescriptive legal infrastructure. The challenge we are all facing here is to find the right balance between regulatory and market-based incentives and penalties.

Thank you very much.