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The corporate governance quality is one of the major aspects taken into account in the selection of investment targets.

The Russian corporate governance practice formed itself under the influence of several negative factors, in particular:

•  the low level of transparency of Russian businesses and the Russian market;
• inadequacy of the regulatory framework;
• unsatisfactory Russian law enforcement system, including efficiency of many courts;
• specific operative motives of Russian managers and large shareholders, with their  main focus on fighting for control over joint-stock companies or diversion of their financial flows rather than increasing their capitalization and profitability;
• low liquidity of most Russian companies' securities.

Fundamental problem of the corporate governance in Russia is the fact that insiders (controlling shareholders and the management) encroach on the rights of minority shareholders, down to depriving them of their rights of ownership, by:

• transfer pricing;
• assets stripping;
• dilution of capital;
• restructuring/merger transactions;
• improper information disclosure (lack of transparency).

In most of their research, investment analysts fail to place proper focus on evaluating corporate governance risks.

The Institute Mission - to help investors identify the best-governed companies for investments in Russia, based on:

• in-depth legal review of corporate documents (corporate charter, minutes of shareholders' and boards' meetings, other internal documentation);
• evaluation of the information transparency of companies;
• assessment of corporate governance risks based on the review of the corporate documents and the information subject to disclosure; financial documentation and auditors' reports; information on material corporate events;
• evaluation of the regulatory framework, including opportunities for the protection of investors' rights in court.

Investors' Russian experience has shown that one major prerequisite for successful business is a more careful review of the corporate governance practices of Russian companies as opposed to their counterparts in other countries. As the opportunities for conducting that kind of research are not available to all investors, a need was felt for developing an indicator that would reflect the state of the corporate governance of a particular target company.

The Corporate Governance Quality Rating (the CORE-rating) was offered as such indicator reflecting the specific risks inherent in investing in Russian businesses. In the context of the Institute's rating research its experts prepared reviews of the corporate governance practices of the rated companies.

The corporate governance quality of companies was evaluated on the basis of a proprietary methodology that enabled the Institute to arrive to an objective assessment of the rated companies' corporate governance practices. The methodology was developed by the Institute's experts, under a supervision and with direct involvement of members of the Blue Ribbon Panel, including renowned international and Russian corporate governance experts, heads of some of major investment funds, specialists from the World Bank, the International Financial Corporation, the European Bank for Reconstruction and Development, etc.

The methodology was based on the following principles:

(1)    Independence: the Institute conducted its reviews at its own initiative, irrespective of any need or actual request of the evaluated company; companies didn't pay for the rating;

(2)    Objectivity: the rating methodology was designed in such a way as to minimize any bias. Rather than providing his or her own opinion with respect to the particular matter under review, the expert would just identify the presence or absence of certain facts;

(3)    Use of information available to a regular minority shareholder: the Institute owned minimal shareholdings in all the rated companies and only used the information available to a regular minority shareholder for its reviews.

Calculation of the corporate governance quality ratings was based on 2 groups of source data:

-          information subject to mandatory disclosure, any additional information publicly disclosed by the company; information disclosed to regulatory authorities (the Federal Commission for Securities Markets of Russia). A shareholder, acting legally, can only make his or her decisions based on information publicly disclosed by the company or information available from other public sources (mass media, market analysts, etc.). Thus, no information unavailable to investors was used in the rating calculation;

-          companies' replies to written inquiries and telephone calls on behalf of the Institute as a shareholder. In practice, owners of small shareholdings seeking to obtain information about the company encounter some real problems, and tackling those problems costs them time and money. In order to evaluate the real attitude of a particular company towards its shareholders, the Institute, itself being a shareholder, would send various inquiries to the company and subsequently monitor the handling of such inquiries by the company.

Companies were assessed by 6 main parameters reflecting various corporate governance aspects:

• Information disclosure (promptness of the disclosure and completeness of documents disclosed publicly and upon shareholders' requests, etc.)
• Shareholders' equity structure (controlling groups, clarity of the ownership structure, etc.)
• Structure of the Board of directors and executive management bodies (affiliations, remuneration, quality of the records of meetings, etc.)
• Principal shareholders' rights (the right to participate in the company's management, the right to receive dividends, etc.)
• Expropriation risks (such as asset stripping, transfer pricing, dilution of shareholders' equity, etc.)
• Corporate governance history (past violations of shareholders' rights, problems with regulatory authorities, financial reporting standards, audit reports, etc.).

The Institute's proprietary methodology offered an opportunity to get a real picture of the state of corporate governance in a particular company, as well as identify problems faced by investors.

In the period from 2000 to 2003, assessment of companies' corporate governance quality was conducted on a quarterly basis; companies included in the rating represented key sectors of the economy and accounted for over 90% of the capitalization of the Russian market.

 What others have to say about CORE-Ratings

 Market

 William  Browder,
 Managing Director, Hermitage Capital Management (Moscow)
 (June 2001)

                   “This corporate governance rating system is based on company analysis from the standpoint of an ordinary minority shareholder, without access to privileged information and without any bias resulting from the company paying for the analysis. In my view, this is most objective method of analysis and produces valuable insights for investors”.

 
Government

 M. Dmitriev,
 First Deputy Minister of Economic development and Trade of Russia
 (April 2001)

                 “Already in 2002 a portion of mandatory deductions to the RF Pension Fund will be allocated to mandatory reserves. It is a rather significant amount - the investment resources volume exceeds 1 bln. US Dollars.
            In the perspective we view investments in Russian corporate securities as a key component of the future investment portfolio for placement of mandatory reserves of the accumulation pension system…
            Formation of the portfolio should be based on mechanisms of passive investing in an investment index built of Russian leading companies…
            We will add a new criteria to the basic aggregate investment index - information of various independent rating agencies, doing corporate governance rating in Russia. These are ICLG and Standard&Poor’s…
            Ratings by ICLG and S&P should be information sources of equal right to adjust the structure of the investment portfolio in the part of pension  reserves”…

 Rated companies

 A. Sinenko,
  Surgutneftegaz
 (April, 2001)

             “…The company is seriously concerned about the obtained rating. …An interesting mismatch: 25th place in the rating and, at the same time, serious interest on behalf of investors. I would formulate this question as follows: why is our market, i. e. investors who form it, looking at some other indicators instead of corporate governance?…Obviously, before the market starts looking at corporate governance ratings as well, nothing will change in this country, at least for our company…Of course, we are not happy with 25th place…”