1. 2005 is an important year for Corporate Governance in Europe. By the end of this year, the Commission is aiming to have completed its Action Plan on the subject. How this is executed will have important consequences for investors, companies, and, critically, for the stock and other financial markets of Europe. We have an opportunity to become the location of choice for international listings, with benefits to the European Capital markets, or we could, if things go wrong, wind ourselves in the shroud of over-legislation and over-regulation.

2. What I want to do this morning is to highlight some of the issues we face, and how the Commission seems to be addressing them. I have a many-fold interest in this, as the current Chairman of the International Corporate Governance Network (ICGN), as a member of the Commission’s European Corporate Governance Forum, as a corporate director and as an investor.

3. You will all know that, under Commissioner Bolkestein, Jaap Winter, a member of the ICGN incidentally, led a high-level group of company law experts to look at, and recommend a corporate governance regime for Europe. His report, that recommended a ‘comply or explain’ regime for the EU, very similar to that pioneered by Sir Adrian Cadbury’s report 12 years ago, should be the structure followed in Europe. I commented then that this conclusion must be unique: a group of lawyers recommending that there should not be legislation. However, some legislation will be necessary, and, for all of us, lawyers and non-lawyers, it is the extent and degree of this legislation that will determine whether the spirit of ‘comply or explain’ will survive, or whether we will become law-dominated, as the structure is in the US. I am, incidentally, attracted to the Dutch formulation of ‘comply or explain’ as included in the Tabaksblat Code, which is ‘apply or explain’. It seems somehow much less confrontational, and reminds us Brits that the Dutch often speak our language better than we do ourselves. Derek Higgs is also taken with the formulation.

4. The areas in which law will be necessary are two: disclosure and the ability of shareholders to exercise their ownership rights. Without sufficient disclosure, the investor is unable to make sensible and informed judgements about the issues. However, I have always made a distinction between disclosure and transparency. Too much information, badly or deviously presented, may even be worse than too little. One only has to consider the Enron annual return to the SEC, where some of the details of the special purpose vehicles were certainly included, but not in a transparent way. That is particularly true of many remuneration reports. They may take up several pages of a report, but the potential outcomes of the schemes described appear nowhere, and the investor is left in the dark about whether they are appropriate. What needs to be disclosed as a minimum?

5. The outside shareholder needs to have confidence in the figures presented. In the US, this has been legislated for through Sarbanes-Oxley. In Europe I hope that we will not follow this example. The extra-territoriality of Sarbanes-Oxley has caused a lot of anguish among European companies with listings in the US, or even with a relatively small number of US-based shareholders, which makes them subject to SEC regulation. The European Commission has, we understand, met both the SEC, and, more importantly in this context, the Public Company Accounting Oversight Board, to seek to modify the effect on non-US corporations. Apart from being given time to bring themselves into the remit of Sarbanes-Oxley, it appears that the US will be content with something that gives ‘equivalence’ to Sarbanes-Oxley in the European jurisdiction. What is not clear is what this ‘equivalence’ needs to be, or what undertakings the Commission has given over this. If ‘equivalence’ dictates the introduction of EU-wide legislation along the lines of Sarbanes-Oxley, then I would be dismayed. The costs of Sarbanes-Oxley, particular Section 404 which requires a company to describe in depth its financial control mechanisms, are large. While it is true that, in some EU countries, the focus on financial controls and risks are rather modest, it would make no sense to legislate on this in detail. The introduction of Audit Committees, as recommended by all reputable governance codes, and a report by this committee to shareholders, is already indicated by a separate Directive, to the dismay of the Association of British Insurers, which believes, I think, that this already undermines the subsidiarity test enshrined in ‘apply or explain’. Will the existence of Audit Committees and suitable risk control disclosures satisfy the US regulators? If so, all well and good. If not, we are headed for trouble.

6. The fact that the EU is going to have a comprehensive, but not legislative, structure of corporate governance presents, to my mind, a fantastic opportunity for the European securities market. You will all have noted that there have been very, very few IPOs of international companies in the US since the introduction of Sarbanes-Oxley. Indeed, most companies that are listed in New York for historical reasons are anxious to remove themselves from this burden. Some companies find themselves under the stern gaze of the SEC because they have more than 300 US shareholders, and, again, many are trying to escape this trap too. The extra-territoriality of Sarbanes-Oxley is not unique in US law. I have pointed out to my American friends that the precedent for a foreign power trying to reach into the UK’s sovereignty is not encouraging for them. The Pope tried to do this through much of the Sixteenth and Seventeenth Centuries, but he failed to achieve his ends. The imposition of Sarbanes-Oxley may indeed turn out to be as big a mistake for the US securities markets as was the introduction of a withholding tax on US bonds in the 1960s. Markets developed the Eurobond market, where no such tax was imposed, and a flourishing US dollar bond market was established where the long arm of the US regulators and legislators could not reach. That may be the case here, and I hope we will grasp it. Europe could become the market of choice for international equity fund raising. Whereas 20 years ago, the large US investors might not have been keen to invest via a foreign market, preferring instead to buy foreign securities listed in New York, they have no such inhibitions today. They have confidence in the legal and governance structures that some European markets exhibit; we also have the liquidity and breadth of investors. Let us hope that the Commission does not throw this opportunity away by introducing something as expensive and bureaucratic as Sarbanes-Oxley.

7. What else will the Action Plan insist on? The speakers from Cleary, Gottleib are going to touch on some of these when I have sat down, but I will touch on some that investors have traditionally emphasised. The Commission has already consulted on the role of independent non-executive directors and executive remuneration. Most European corporate governance codes acknowledge the importance of the former and accept the need for more information on the latter. However, the ownership structure of most continental companies is significantly different to that of US and UK companies. Typically the Anglo-American shareholder base is widely diffused, and there is no controlling shareholder. In continental Europe there is often a controlling shareholder, either through a large, but not majority share, or even through a biased voting structure where economic and voting interests do not coincide. These shareholders can be families, or governments, other companies, or financial institutions such as banks or insurance companies. In France they have what are known as the ‘hard nuts’, the noyeaux durs. These can be friendly shareholders who undertake not to sell their shares without the overt approval of the management. It is often said that outside shareholders should be delighted to have a large controlling shareholder, since the interest of the controlling shareholder will be for long-term shareholder value par excellence. However, outside shareholders have had too many bad experiences to swallow this entirely. Families don’t seem to understand the difference between their private and their public company interests, often selling them back and forth at what appear to be the wrong price. Governments can be even worse as core shareholders. France Telecom, in the late 1990s, was encouraged by the government to become a national champion, indeed an international champion. But M.Jospin’s Socialist government laid down one condition. The company was not allowed to issue equity, because that would reduce the State’s interest to below 50%. Consequently France Telecom used cash to buy assets at what we all now agree were the wrong prices, with terrible consequences for the group’s finances.

8. The question of independent directors is therefore just as important for continental Europe as for the UK. Unfortunately some of the European codes of corporate governance explicitly exclude these controlled companies from some of the measures to ensure independent directors. The Swedish Code published at the turn of last year, comments ‘Persons with links to major shareholders usually constitute a majority on the board, and only a few directors are independent of the major shareholders.’ The Code recommends that two such wholly independent directors be appointed. The French Bouton Code similarly excludes controlled companies from its strictures on independent directors on boards. I would observe that it is in precisely these cases that the outside shareholder needs the most protection. Having boards that have a majority of independent directors, on the strictest definition, will give greater protection to the outside shareholders, and should reduce the cost of capital as a result. The controlling shareholder can always exercise that control through voting, so why do they need to control the boardroom? You might think therefore that I am in favour of an EU-wide directive on this, but I am not. It is my view that the market will decide. A market where truly independent directors predominate in the boardroom, by practice or by the exercise of a governance code through a listing authority, is more likely to receive the savings of the international community than one where such protection is not available.

9. To some degree the pass has been sold already on differential ownership rights in Europe. The Takeover Directive was only agreed to because it preserves the rights of Swedish company law to allow differential voting, of up to ten votes per share for some shares against one per share for most shares. One share does not equal one vote. This is disappointing, and shareholder groups will continue to lobby for change here. I think it is extremely unlikely that such a change will be manifested in the Action Plan, because the Takeover Directive is relatively recent, and created enormous anguish before the compromise was reached.

10. There is a possibility that some in the EU will try to build on this exception by suggesting differential voting rights for ‘short-’ and ‘long-term’ shareholders. This already exists in France, where a holder can be awarded double votes if shares are held for more than a year. This issue is likely to become more hotly debated over the next few years as the impact of Hedge Funds continues to grow. Now the name Hedge Funds is totally misleading. It covers a multitude of sins. Most of these funds are not hedged in any meaningful way at all. Those that invest in equities can be long/short funds, but mostly they are net long. After all, if these funds really were hedged, they would not need net capital (except, they cry, for regulatory purposes), let alone the $1 trillion they now claim to manage. No, most of the equity hedge funds are net long funds, but with very concentrated portfolios. Some of these funds take a long-term view; others trade as though taking a 2% profit on a share in a day was the purpose of investment management. It is very good business for my colleagues at Morgan Stanley, one of the leading prime brokers, but it makes many companies deeply uncomfortable. In this building there may be some who give thanks to the influence of hedge funds on companies, but the Deutsche Borse boards have been complaining that they are here today, gone tomorrow shareholders. I take a purist view of this. A shareholder is a shareholder, and to distinguish between them is not a good idea. Only those who are as old as I am will remember the attempt to distinguish between short-term capital gains and long-term capital gains in tax. Indeed, the current UK capital gains tax regime has elements of that in it even today. It is not a happy precedent, since it distorts economic decisions. I simply observe that this is likely to be an issue that will come to the fore again during 2005.

11. Corporate Europe is also unhappy with the disclosure requirements being suggested by the Commission in its consultation document on executive remuneration. You will have read that many large German companies have resisted the part of the Cromme Codex that mandates the disclosure of the remuneration of the management board by individual. The German government is now threatening to legislate on this, since there has been no sensible explanation of why this should not happen. Shareholders feel strongly that remuneration structures and outturns should be disclosed to them, since this is where the agency problem may be at its most acute. Although the Supervisory Boards of German companies are theoretically independent of management, too often the Chairman of the Supervisory Board is the ex-Chief Executive of the Management Board, and the other management-appointed directors on the Supervisory Board are Chief Executives themselves. Consequently there is a risk of ‘management capture’ – a risk that exists in single-tier boards too. I acknowledge freely that disclosure has had a downside too. There has been a game of leap-frog. I have still not seen a remuneration report that says its strategy is to pay executives a bottom quartile base salary. Indeed, far too many say they aim to pay a top-quartile salary. That becomes redolent of Garrison Keillor’s Lake Wobegone, where all the children were above average. Only the fund management industry itself is as guilty. Companies often advertise themselves as providing ‘top quartile performance’ thereby guaranteeing three quarters of its clients a disappointing experience. But leapfrogging is, to my mind, more a function of weak non-executives than it is of disclosure.

12. Perhaps the only area in which ‘apply or explain’ will not be sufficient is in the area of the exercise of shareholder rights. This is the ‘plumbing’ of corporate governance. Shareholders are effectively disenfranchised if it is simply impossible for their representative to exercise their votes at a meeting in a way that does not involve jumping through so many hoops that it needs a gymnast, not an investment manager, to act on their behalf. The chain of instruction from beneficial owner, through the investment manager, through the custodian to the registrar and back again is too long, and the time taken in the process is often longer than the time given to respond. With so many markets now having more than 25% of total shareholdings held by foreign investors, this puts these holders at a real disadvantage. One of the most striking of the obstacles is what is known as ‘share blocking’. This dictates that, if you wish to exercise your vote at an annual meeting, you are effectively prevented from selling your shares for up to three weeks. Very few institutions, except perhaps for the index-trackers, are prepared to give up their liquidity in this way. The International Corporate Governance Network has made a comprehensive response to the Commission’s consultation document on Shareholder Rights, which is available on our website. The Commission is going to have a second round of consultation starting imminently, so it is not too late to influence what will certainly need European legislation to ensure that shareholders are indeed able to exercise their rights fully. This is a highly technical area, and I don’t have time to go into more details of where the plumbing needs fixing. I have been appointed the ‘rapporteur’ on this issue for the EU Corporate Governance Forum, which has met only once so far, but meets again in June to discuss this particular subject (among others). I would be happy to listen to any views that people in the audience have on this, either now, or after the conference.

13. I hope I have made it clear that there is a lot of work to do for the Corporate Governance Action Plan to be brought to a conclusion. There are substantive issues to face. There are risks to the model we have become so familiar and comfortable with over the last ten years in this jurisdiction. I am partly reassured by the fact that the Commission has said clearly that it has no plans ‘at the present’ for a Europe-wide corporate governance code, and that Commissioner McCreevy comes from an economic liberal background. The legal codes of EU countries are so diverse, and the social meaning of a company differs between countries, that trying to impose one model is simply madness. The markets will decide. There will not be a race to the bottom. Those of us who believe that good corporate governance reduces the cost of capital will, I hope, be able to show that those jurisdictions with good corporate governance codes, which are taken seriously, by companies and by shareholders, will be more liquid, and more highly rated than those where shareholders are treated with less deference. It is inherently unlikely that we will follow the model of gambling, where the domicile of the bookmaker seems to be dictated by the excess liberality of the regime, (particularly in their case, in tax matters). A well regulated market with protection for shareholders, but without excessive legislation, is likely to prove the winner. That is what some European markets have now; let’s make what we can of that advantage.