On March 20, 2012, the Ontario Securities Commission (OSC) published Staff Notice 51-719 Emerging Markets Issuer Review that summarizes the OSC's review of emerging market issuers (EM Issuers) and outlines principal sources of concern relating to issuer governance and disclosure, underwriter conduct, the role of auditors and the exchange listing process.
The review was initiated by the OSC in July 2011, in response to concerns that investors in EM Issuers may be exposed to inappropriate risks. For the purposes of conducting this review, OSC staff considered a number of criteria in determining whether a reporting issuer was an EM Issuer. Staff focused on issuers with the following characteristics:
- whose mind and management are largely outside of Canada; and
- whose principal active operations are outside of Canada, in regions such as Asia, Africa, South America and Eastern Europe.
The report outlines the main areas where improvement is required and where the OSC expects to see concerted action taken by issuers, underwriters, auditors and exchanges in order to protect investors and uphold the integrity of public disclosure.
Specifically, and of particular interest to EM Issuers, the OSC will examine ways to, among other things:
- improve corporate governance practices of boards of emerging market issuers;
- develop transparent and consistent due diligence requirements for underwriters;
- enhance disclosure of risk factors and complex corporate structures relevant to emerging market issuers; and
- work with the exchanges to enhance the listing process to address the unique concerns raised by emerging market issuers.
EMERGING MARKET ISSUERS IN CANADA
Issuers listed on the TSX, TSXV and CNSX as at April 30, 2011, and having headquarters in jurisdictions other than Canada, the US, the UK, Western Europe, Australia and New Zealand, totalled 108 with a total market capitalization of approximately C$40 billion. This was in contrast to a total of nearly 4,000 exchange-listed reporting issuers in Canada, having a total market capitalization of C$2.39 trillion.
OSC Staff expects that EM issuers, their auditors, underwriters and other advisors, as well as the exchanges, will address the concerns identified in their review and will, where necessary, take immediate steps to improve their practices to effectively discharge their responsibilities to protect investors. OSC staff set out a list of recommendations for further work needed to address their principal concerns which, in most cases, do not involve the creation of new policies or rules but instead involve the development of guidance, best practices or enhanced vigilance to support compliance with current requirements.
The recommendations with respect to EM Issuers include:
- Corporate Governance Practices - establish guidelines related to the responsibilities of the board and its committees in order to fully understand the business, operating environment and risks for EM Issuers. To the extent the board has limited experience in the cultural and business practices of the foreign juris diction, their manner of oversight must be adjusted to mitigate the risks that may arise as a result of this lack of understanding. Some suggestions include obtaining translations of key business documents instead of relying on local management and requiring a minimum level of competency in the foreign language for Canadianresident board members.
- Corporate Structures - provide detailed disclosure to investors of complex corporate structures and their purpose as this will promote a better understanding of the management and operations of the EM Issuer and reduce the risk of an organization structure that facilitates inappropriate activity, such as fraud or misappropriation of assets, or misrepresentations about an EM Issuer's financial performance or condition.
- Risk Management - internal controls should be adjusted to reflect the particular risks of having significant business operations located in an emerging market, including: (a) political factors, such as government instability and changing governmental policy that may affect legal rights, such as property ownership; (b) the legal and regulatory framework, given that emerging market jurisdictions may have less developed legal or regulatory systems; (c) the movement and conversion of currency out of the foreign jurisdiction, which could hinder the repatriation of profits to Canadian investors; and (d) legal title to assets.
- Disclosure of Risks - requiring better explanations of risk factors relevant to EM issuers and raising investor awareness of risks associated with investments in issuers whose principal operations are in foreign jurisdictions.
As part of the review, OSC Staff recommended that underwriters should participate in the offering process with a healthy amount of skepticism regarding management claims and develop a full understanding of an EM Issuer's finances, management, operations, industry and country of origin. Underwriters should also document their findings in a clear and concise manner.
OSC Staff were concerned that auditors may not have undertaken sufficient procedures to understand and appropriately scrutinize the information provided to them by an EM Issuer and/or foreign 'component' auditors. OSC Staff recommended, among other things, working with the Canadian Public Accountability Board to analyze whether securities rules could be enhanced to allow more information sharing in connection with the oversight of audit firms and examining whether suitability standards for auditors of reporting issuers should be developed.
We understand that the TMX Group is in discussions with other institutions and market participants, including the various Canadian securities commissions, the Canadian Public Accountability Board, auditors and investment bankers with a view of implementing new guidance, procedures or requirements for EM Issuers to complement existing rules and working practices. Areas of focus are expected to include additional details regarding senior management and director qualifications, corporate governance matters, and disclosure and financial reporting expectations.
Heenan Blaikie has significant experience in connection with raising capital in Canada and compliance with applicable Canadian securities legislation by emerging market issuers. If you have any questions on the subjects addressed in this Securities E-News or would like assistance in assessing the burdens and restrictions that emerging market issuers and investment dealers face in trying to complete a prospectus offering, please feel free to contact us.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.