On November 9, 2012, the Ontario Securities Commission (“OSC”) released Staff Notice 51-720 – Issuer Guide for Companies Operating in Emerging Markets (the “EM Guide”). The EM Guide highlights key areas of risks for directors and management of Ontario reporting issuers who have significant business operations located in emerging markets or whose management for the most part are located outside of Canada (“EMIs”), and provides guidance on managing such risks from a regulatory perspective. Prior to producing the EM Guide, the OSC selected for review twenty-four EMIs, of which 14 were non-resource issuers (which was all of the then listed non-resource EMIs) and 10 were resource issuers (which was approximately one-third of the then listed resource EMIs), and commenced an in-depth review of the quality and adequacy of their compliance with disclosure and other regulatory requirements. The review also assessed the effectiveness of the gatekeeper roles played by auditors and underwriters with respect to such issuers. The results of the review were published in OSC Staff Notice 51-719 – Emerging Markets Issuer Review on March 20, 2012, which identified material regulatory deficiencies or concerns in over half of the EMIs reviewed in connection with corporate governance practices, complex corporate structures, related party transactions and risk management and internal controls.
The purpose of the EM Guide is to assist EMIs and their directors and management with respect to corporate governance and disclosure practices to help them meet regulatory and investor expectations in Ontario’s capital markets. More specifically, the EM Guide sets out questions that directors and management of EMIs should consider when addressing the key risk areas, and clarifies the OSC’s expectations regarding compliance with existing disclosure requirements, including comparing examples of deficient disclosure versus sufficiently meaningful disclosure. The EMI Guide even provides helpful specific considerations and disclosure tips.
The EM Guide provides the following guidance and recommendations in eight key risk areas:
- Business and operating environment – Canadian directors of EMIs may have limited knowledge and experience regarding the EMI’s operating environments; however, a board and management must have a thorough understanding of the political, cultural, legal and business environments of the company. The underlying rationale is that meaningful disclosure to investors can only be provided when management and the board thoroughly understand the details and risks of a company. As a result, directors and management must be aware and exercise additional diligence to close any possible information gap (importantly, this gap can relate to the need for non-Canadian directors to understand the expectations of the Canadian capital markets and the need for Canadian directors to understand the EMI’s operating environment). The EM Guide suggests issues that directors should consider with respect to the EMI’s foreign operations including (among others) (i) the role of the foreign government or government-related entity, (ii) any existing restrictions or conditions imposed by the foreign government or government-related entity (iii) the likelihood of such restrictions or conditions in future, (iv) who within the EMI manages the relationship, (v) the effect of the legal environment in the foreign jurisdiction, and (vi) what regulatory requirements are or may be applicable. In addition, the EMI’s disclosure should address the challenges, unique characteristics and risks of operating in these markets in detail.
- Language and cultural differences – The board of an EMI should include members who have appropriate experience in the emerging market in order to assist the board in identifying risks associated with the company and the foreign jurisdictions in which it operates. Any differences with respect to language or culture of an emerging market and any challenges that arise as a result should be addressed by appropriate policies developed by the board. Such policies could include the use of an independent translator to overcome language or cultural barriers, the inclusion of independent board members with an understanding of business operations in the emerging market or visits to foreign operation sites to mitigate the geographic distances between the board and local operations.
- Corporate structure – While recognizing that complex structures may be necessary due to legal or regulatory requirements with respect to foreign ownership, boards should be cognizant of the potential risks that flow from such complex structures. In particular, boards should be wary of impediments to decision making in structures where there is a separation of control and voting rights. Meaningful disclosure should address why the structure is necessary, any risks associated with the structure and how these risks are managed.
- Related parties – Related party transactions represent a heightened risk for EMIs due to the differences in local business practices, cultural norms and legal requirements. Boards should have appropriate policies, procedures and scrutiny in place to identify, evaluate and approve of related party transactions in order to avoid potential abuse and protect investors. In addition, proper disclosure of related party transactions should include, at a minimum, details of the transaction, the identity of the related entity and description of the relationship, the business purpose, the recorded amount and any ongoing contractual commitments resulting from the transaction.
- Risk management and disclosure – Boards of EMIs should ensure that there is a sufficient understanding of the legal, regulatory, political and cultural risks of an emerging market in order to recognize how these risks impact the corporate structure, operations and material assets of the EMI. While recognizing risks is imperative, boards should also adopt written mandates and implement appropriate systems to manage these risks. An EMI’s disclosure should provide sufficient information on both the risks associated with operating in an emerging market and the EMI’s current risk management strategy.
- Internal controls – Strong internal controls are an important factor in dealing with the unique risks of operating in an emerging market where company oversight and operations may be taking place in different jurisdictions and where differences in time zone, language and cultural differences may impede the accuracy and timeliness of financial reporting. Implementing appropriate internal controls can provide the necessary checks and balances on the operations taking place in emerging markets, thereby reducing the risk of inaccurate financial reporting and ensuring that appropriate information is reported on a timely basis.
- • Use of and reliance on experts – When using experts in emerging markets, boards should be aware of differences in the rules of professional conduct and standards of care and must appropriately evaluate experts’ credentials and specialized knowledge before electing to use or rely upon these experts.
- Oversight of the external auditor – The EMI’s audit committee should enquire and evaluate the external auditor’s approach in auditing the areas that present risks specific to the EMI. In addition to formal meetings with the external auditor, it is recommended that the audit committee maintain frequent, informal communication with the external auditor in order to obtain information about the audit on a real-time basis paying particular attention to any signs of delays or unusual management intervention.
The EM Guide indicates that the OSC is working with regulatory partners, including the Investment Industry Regulatory Organization of Canada (IIROC) as it reviews underwriting due diligence standards and the Canadian Public Accountability Board (CPAB) with respect to reliance on foreign auditors’ work products, to promote industry best practices and standards in each area of regulation. The EM Guide also notes that the Toronto Stock Exchange (“TSX”) and TSX Venture Exchange (“TSX-V”) are finalizing additional guidance to address risks associated with listing an EMI, including clarification of the expectations on issuers and the advisory community. These new requirements are expected to be published by the TSX and TSX-V for comment later this month.
Following its EMI review and the release of the EM Guide, the OSC has adapted its process of selecting issuers for continuous disclosure review to incorporate the key risk factors outlined above. Similarly, the prospectus review process has been enhanced to address identified risks associated with EMIs. Going forward, we can expect that the OSC will be particularly mindful of these risk factors and that all public disclosure of resource issuers with significant operations in emerging markets should meet the standards as set out in the EM Guide.
The EM Guide can be found here.
Next Steps for Management and Boards
The EM Guide is a helpful roadmap not only for management and directors of EMIs, but also for the underwriters, auditors and lawyers who work with them. In fact, elements of the EM Guide can well apply to non-EMIs.
If the EMI is planning on becoming a reporting issuer in Canada (IPO, RTO or simply applying for a listing on the TSX or the TSX-V) the considerations included in the EM Guide should be an integral part of the process of arranging for the experts and locally knowledgeable directors for the EMI who can ensure that everyone concerned in the process has sufficient understanding. Obtaining advice, memoranda, opinions, etc. will ultimately be fundamental not only in ensuring that due diligence defences are available but, more importantly, will be fundamental in ensuring a time and cost efficient process.
If the EMI is already a reporting issuer in Canada, management and the board should be reflecting on the considerations in the EM Guide and determining what processes must be put in place and what additional disclosure is appropriate to include on a going forward basis for the EMIs future continuous disclosure filings.