introduction

On November 9, 2012, the Ontario Securities Commission ("OSC") published Staff Notice 51-720 Issuer Guide for Companies Operating in Emerging Markets (the "Issuer Guide") to provide assistance to emerging market issuers ("EMIs") and their directors and management on their governance and disclosure practices. All market issuers benefit from specific guidance that help them meet regulatory and investor expectations, but EMIs face unique challenges and the Issuer Guide: (i) highlights potential areas of risk or red flags that may warrant further scrutiny; (ii) sets out questions that directors and management should consider when deciding how to address risks of doing business in emerging markets; and (iii) outlines the OSC's expectations regarding compliance with existing disclosure requirements. The Issuer Guide is intended to help clarify existing continuous disclosure requirements under securities legislation for EMIs and not intended to create new obligations or modify existing ones.

The Issuer Guide follows a regulatory review of EMIs by the OSC and the publication of the OSC's findings and recommendations in Staff Notice 51-719 Emerging Markets Issuer Review in March 2012. The review identified deficiencies with respect to EMI corporate governance practices, complex corporate structures, related party transactions, and risk management and internal controls.

overview

The Issuer Guide identifies and provides guidance in the following eight areas for consideration: (1) business and operating environment; (2) language and cultural differences; (3) corporate structure; (4) related parties; (5) risk management and disclosure; (6) internal controls; (7) use of and reliance on experts; and (8) oversight of the external auditor.

  1. business and operating environment

The board and management of EMIs must have a thorough understanding of the political, cultural, legal and business environment in which the company operates as well as the Canadian marketplace and its legal and political framework. Because Canadian directors of an EMI may have limited knowledge and experience regarding the EMI's foreign operations and operating environment, they must be cognizant of the need to exercise additional diligence. Further, EMIs, their management and board are reminded that they must adhere to Canadian regulatory requirements regardless of the location of the company's operations. An EMI's public disclosure should highlight the challenges and risks of operating in that emerging market.

  1. language and cultural differences

The board of an EMI should include members that have appropriate experience in that emerging market. They should be mindful of placing full reliance on local management or local board members who are not independent and seek independent input from other sources. One challenge that EMIs often face relates to differences in language and culture. Boards should devise appropriate policies such as the use of an independent translator to overcome these barriers. They should also consider including independent board members who understand how business operations are carried out in the emerging market, as well as arranging for site visits to mitigate the geographic distance between the board and the local business operations.

  1. corporate structure

While there may be important reasons for establishing complex corporate structures, these structures may be difficult to understand and may present additional challenges for the board of an EMI with respect to effective decision-making. Boards should consider the risks that may flow from complex structures such as fraudulent activities or distorted financial statements. An issuer's disclosure should contain a clear and understandable description of its corporate structure, as well as an explanation of how that structure facilitates the company's business and aligns with the parameters of its operating environment. The disclosure should also point out the risks associated with the structure and how those risks are managed.

  1. related parties

Related party transactions may present a greater risk for EMIs because of differences in local business practices, cultural norms and legal requirements. Accordingly, boards and management of EMIs must effectively identify and monitor related party transactions in order to prevent potential abuse and protect investors. This involves putting appropriate policies, procedures and scrutiny in place to identify, independently evaluate and approve related party transactions. EMIs should, at a minimum, disclose: (i) the relationship and identity of the related person or entities; (ii) the business purpose of the transaction; (iii) the recorded amount of the transaction and the measurement basis used; and (iv) any ongoing contractual or other commitments resulting from the transaction.

  1. risk management and disclosure

Boards should adopt a written mandate that expressly acknowledges their responsibility for the identification of principal risks of the company's business and oversight of the implementation of appropriate risk management systems. Boards of EMIs should be particularly sensitive to the risks associated with those emerging markets, and understand how the risks of operating in such markets impact the corporate structure, operations and material assets of the company. They should recognize that risk analysis and mitigation techniques that may be suitable for North American business operations may be less effective in emerging markets. In their disclosure, EMIs should provide sufficient information about the risks associated with operating in a particular emerging market and ensure that the disclosure is entity-specific.

  1. internal controls

It is recommended for boards to adopt a written mandate that acknowledges responsibility for the company's internal control and management information systems. The unique risks of operating in an emerging market increases the need for strong and appropriate internal controls, which can provide checks and balances on the local operations to reduce these risks. The audit committee should actively oversee the monitoring of any identified weaknesses in internal controls and the risks they create. Both the audit committee and the board should oversee the timely remediation of weaknesses and the mitigation of any related risks. Disclosure regarding material weaknesses in internal controls should be specific, transparent and contain sufficient details.

  1. use of and reliance on experts

EMIs may hire industry professionals or experts with special knowledge to assist with complex matters in their emerging market operations. However, boards are reminded that industry professionals in an emerging market may not be subject to the same rules of professional conduct and standard of care as they would be in the Canadian market. Therefore, they must assess the quality of the advice provided and determine whether they can rely on such advice. Boards should ensure that their disclosure with respect to experts' interests is adequate and sufficiently detailed.

  1. oversight of the external auditor

An EMI's audit committee should determine if its external auditors have the appropriate expertise and experience to carry out its audits and effectively oversee the external auditors' work. To do this, the audit committee should maintain frequent informal communication with the external auditors, obtain information regarding the audit on a real-time basis and formally meet with the auditors at the planning and completion stages.

observations and suggestions

The Issuer Guide is one of the OSC initiatives to help directors and management of EMIs to more effectively discharge their responsibilities. The OSC is currently working with the Canadian Public Accountability Board on issues of common interest with respect to the audit related concerns identified. The OSC will also work with the Investment Industry Regulatory Organization of Canada as it reviews underwriting due diligence standards. Further, the Toronto Stock Exchange and the TSX Venture Exchange are currently finalizing additional guidance to address risks associated with listing EMIs, and expect to publish the new requirements for comment in November 2012.

The Issuer Guide is also a clear indicator that EMIs need to rigorously focus on the design and operation of their corporate governance structures, including their board and management composition, their disclosure controls and procedures and their internal control over financial reporting, in order to address the risks identified by the OSC. EMIs can anticipate higher scrutiny moving forward, and failure to follow the Issuer Guide may inhibit an EMI's ability to raise capital in view of higher regulatory and underwriter scrutiny. EMIs can also expect that this scrutiny will only increase as the OSC implements its mandate to increase underwriter, auditor and listing standards.

It is recommended for EMIs to review their corporate governance structures in order to assess how they measure up to the Issuer Guide with a view to: (i) acting proactively to identify corporate governance weaknesses that could lead to disclosure issues or financial statement restatements, which could trigger regulatory review or litigation exposure; and (ii) enhancing corporate governance policies, procedures and controls in anticipation of any financings, as underwriters will likely focus on the issues noted in the Issuer Guide moving forward.

Specific measures that EMIs may want to consider include: (i) reviewing conflict of interest policies and procedures to assess whether related party transactions are approved in accordance with the Issuer Guide; (ii) reviewing corporate governance and nominating committee charters to require that board composition be reviewed annually with reference to the Issuer Guide and the risks that EMIs face; (iii) reviewing "boilerplate" disclosure of corporate structure, related party transactions and risk factors included in the EMI's annual information form and management's discussion & analysis in order to ensure the Issuer Guide is being followed; and (iv) reviewing the board mandate to ensure that the board is responsible for the principal risks associated with the EMI's business as well as implementing appropriate risk management systems.

It should also be clear that businesses from emerging markets that wish to become public companies in Canada, whether through an IPO or a qualifying transaction using the capital pool company program, will also need to pay particular attention to the Issuer Guide.