40838 Bank Corporate Governance in Azerbaijan 5002 Survey Results Survey Results Bank Corporate Governance in Azerbaijan Survey Results Baku, Azerbaijan 2005 This report is available free of charge, in print or electronic form, at the following address: International Finance Corporation Azerbaijan Corporate Governance Project 21 Istiglaliyyat Street The Venetian Palace, Second Floor Baku AZ1001 Azerbaijan Tel: +994 12 497 7698 Fax: +994 12 497 0891 http://www.ifc.org/acgp © 2006 International Finance Corporation Any or all portions of this report may be reproduced, without prior permission, provided the source is cited as follows: Azerbaijan Corporate Governance Project, International Finance Corporation, World Bank Group, 2121 Pennsylvania Ave., N.W., Washington, D.C. 20433, United States of America. Table of Contents INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 INTERNATIONAL FINANCE CORPORATION AND CORPORATE GOVERNANCE . . . . . . . . . . . . . . . . . . . . . . 5 ABOUT THE INTERNATIONAL FINANCE CORPORATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 IFC'S FOCUS ON CORPORATE GOVERNANCE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 IFC AND AZERBAIJAN . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 THE SURVEY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 OBJECTIVES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 METHODOLOGY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Questionnaire Design . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Selection of Survey Participants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 IMPLEMENTATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 EXECUTIVE SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 ORGANIZATIONAND OWNERSHIP OF BANKS INAZERBAIAN . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7 AWARENESS OF AND COMMITMENT TO GOOD CORPORATE GOVERNANCE PRACTICES . . . . . . . . . . . . 8 SUPERVISORY AND MANAGEMENT BOARD PRACTICES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 SHAREHOLDERS' RIGHTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 DISCLOSURE AND TRANSPARENCY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 ORGANIZATION AND OWNERSHIP OF BANKS IN AZERBAIJAN . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 BANKS AND THEIR MAJOR OPERATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 YEARS IN OPERATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n NUMBER AND DISTRIBUTION OF BRANCHES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 NUMBER OF EMPLOYEES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 NUMBER OF CUSTOMERS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 MAIN OPERATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 LEGAL FORM . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 METHODS OF RAISING CAPITAL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 RECENT INCREASES IN CAPITAL REQUIREMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 SHARES AND REGISTRATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 SHAREHOLDERS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 NUMBER . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 DESCRIPTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 STATE PARTICIPATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 AFFILIATIONS OF MAJOR SHAREHOLDERS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 AWARENESS OF AND COMMITMENT TO GOOD CORPORATE GOVERNANCE PRACTICES. . . . . . . . . . . . . . . . . . 19 COMPLIANCE WITH CORPORATE GOVERNANCE PRINCIPLES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 CORPORATE DOCUMENTATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 CORPORATE CHARTERS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 BYLAWS AND POLICIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 IMPROVING CORPORATE GOVERNANCE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 OBSTACLES TO IMPROVING CORPORATE GOVERNANCE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 MEASURES TO IMPROVE CORPORATE GOVERNANCE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 COMPLIANCE WITH THE NATIONAL BANK CORPORATE GOVERNANCE REGULATION . . . . . . . . . . . . . . 23 SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 SUPERVISORY AND MANAGEMENT BOARD PRACTICES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 DIVISION OF RESPONSIBILITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 SUPERVISORY BOARD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 NUMBER OF MEMBERS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 FREQUENCY OF MEETINGS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 PREPARATION FOR MEETINGS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 PERFORMANCE EVALUATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 REMUNERATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 BOARD COMMITTEES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 MANAGEMENT BOARD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 FUNCTION AND DESCRIPTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 FREQUENCY OF MEETINGS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 COMMUNICATION WITH THE SUPERVISORY BOARD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 CONFLICTS OF INTEREST . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 RELATED PARTY TRANSACTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 SHAREHOLDERS' RIGHTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 AUTHORITY AND FUNCTIONS OF THE ANNUAL GENERAL MEETING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 PROCEDURES FOR SHAREHOLDERS' MEETINGS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 NOTICE TIMELINESS, METHOD AND INFORMATION PROVIDED . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 SHAREHOLDER ATTENDANCE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 EXTRAORDINARY SHAREHOLDERS' MEETINGS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 VOTING PROCEDURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 DISCLOSURE OF RESULTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 DIVIDENDS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 DISCLOSURE AND TRANSPARENCY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 COMPLIANCE WITH IFRS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 MANDATORY DISCLOSURE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 ANNUAL REPORT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 DISCLOSURE OF SIGNIFICANT TRANSACTIONS AND RELATED PARTY TRANSACTIONS . . . . . . . . . . . . . . . . . 39 SOURCES OF INFORMATION FOR POTENTIAL INVESTORS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 FINANCIAL CONTROL AND AUDIT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 FINANCIAL CONTROLS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 AUDIT COMMITTEE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 INTERNAL AUDIT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 INDEPENDENCE OF THE INTERNAL AUDIT FUNCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 EXTERNAL AUDIT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 APPENDIX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44 B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n Introduction INTERNATIONAL FINANCE CORPORATION AND CORPORATE GOVERNANCE ABOUT THE INTERNATIONAL FINANCE CORPORATION The International Finance Corporation (IFC) is the private sector arm of the World Bank Group. IFC's mission is to promote sustainable private sector investment in developing countries, thereby contributing to reducing poverty and improving the quality of life in these countries. IFC finances investments with its own resources and by mobilizing capital in the international financial markets. IFC also provides technical assistance and advice to governments and businesses. Since its foundation in 1956, IFC has invested nearly $40 billion of its own capital andhassyndicatedmorethan$20billionininvestmentinsome2,800companiesin140countries. IFC'S FOCUS ON CORPORATE GOVERNANCE IFC is a leader among multilateral financial institutions in integrating corporate governance considerations into all phases of the investment process. IFC's long history of direct involvement in structuring investments, appraising investment opportunities and nominating board members has allowed it to put corporate governance principles into action. By focusing on good corporate governance practices in client companies, IFC can manage risk and add value to its clients. In addition to the benefits to individual client companies from IFC's work in improving corporate governance, these efforts contribute to IFC's broader mission to promote sustainable private sector investmentandstrengthencapitalmarketsindevelopingcountries. B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n 6 INTRODUCTION IFC AND AZERBAIJAN IFC approved its first loan in Azerbaijan in 1995. Since then, it has committed $465 million in financing to projects in Azerbaijan. IFC's strategy in Azerbaijan is to help diversify the country's economic base and support growth and the creation of employmentinnonoil sectors.IFC'sareas ofstrategic focus inAzerbaijan include: strengthening the financial sector by promoting domestic and foreign competition in the banking sector and by providingtechnicalassistancetolocalprivate banks promoting the development of micro, small and medium enterprises through lines of credit to local private banks and by providing technicalassistance supporting investment in the agricultural sector by targeting competitive agroprocessing ventures and identifying areasforpotentialIFCsupport acting as a catalyst for foreign direct investment in competitive nonoil sectors, particularly those focusing on exports or on generating foreign income and those involving privatization of critical manufacturing activities or infrastructure supporting increasedprivateprovision ofpublic services suchashealth care and education supporting investmentinthe oilandgas sectors,including oilexportpipelines promotingalevelplayingfieldfordomestic and foreign investors broadening opportunities to obtainfinancingfor privateenterprises outsidetheoil sector IFC launched the Azerbaijan Corporate Governance Project (ACGP) on January 26, 2005 with funding from Switzerland's State Secretariat for Economic Affairs (SECO). The project staff works with companies and banks to improve their corporate governance practices, with the government ofAzerbaijan to improve the regulatory framework for corporate governance in the country and with educational institutions to ensure that future business leaders are introducedtocorporate governance principlesoverthecourse of their education. THESURVEY OBJECTIVES The survey set out to analyze the current state of corporate governance practices in Azerbaijani banks and to determine the extent to which they implemented internationally recognized corporate governance best practices. The survey was also intended to provide baseline data against which the impact of ACGP's corporate training events, consultations and pilot programs on corporate governance practices can be measured, thus furnishing a basis for possible futuretechnicalassistanceprograms. METHODOLOGY Questionnaire Design ACGPstaff developed the questionnaire for the survey based on IFC's experience with corporate governance projects inRussia, Ukraineand Georgia. The draft questionnaire was tested in five commercial banks in order to identify and correct deficiencies in the questions and the interview instructions. The questionnaire and survey methods were reviewed and revised based on these testresultsandon consultationswiththeinterviewers. Selection of Survey Participants Except for one bank with headquarters in Ganja (the country's secondlargest city), all banks in Azerbaijan were headquartered in Baku (the capital) at the time of the survey. The banks surveyed were all located in Baku. Thirtyfour of the fortythree commercial banks operating in the country at the time of sampling (79.1%) were included in the survey. IMPLEMENTATION The questionnaire was administered in the course of an interview with each participant. The results herein are based on their responses, recorded as given and not verified using other sources of information. Consequently, this self reported data may include inflated, adjusted, or otherwise biased information, given in order to avoid admitting to violations of thelaworsimply to portraythecompanyandits practicesinafavorable light. The survey team began work inAugust 2005.Alocal research company, Sigma, conducted the interviews. TheACGP staff trained the interviewers in corporate governance practices and principles. Interviews with company representativesbeganinAugust2005 and theACGPteamreceivedthe compileddata inNovember 2005. B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n Executive Summary This report is an analysis of the results of a survey of thirtyfourAzerbaijani commercial banks with respect to their corporate governance practices. The survey was based on a questionnaire and interview. The participating banks were all located in Baku, Azerbaijan. In a majority of cases, the survey respondents were either managementboardmembersoritschairperson 1 Thekeyfindingsfromthesurveydataarehereinconsideredinthefollowingbroadcategories: organizationandownership awarenessofandcommitmenttocorporategovernancepractices supervisoryandmanagementboardpractices shareholders'rights disclosureandtransparencypractices ORGANIZATIONANDOWNERSHIPOFBANKSINAZERBAIJAN By law, all banks must be registered as open joint stock companies; however, four respondents (11.8%) reportedthattheirbankswereinviolationofthisfundamentalrequirement. Onlythreeofthebankssurveyed(8.8%)wereownedbyaholdingcompanyoragroupofcompanies. 1 See Chart A1 "Respondent's Position" in the Appendix. B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n 8 EXECUTIVE SUMMARY Only six of the thirty respondents who answered the question (20.0%) reported that their banks issued preferredshares. Onlyoneofthebankssurveyedwasstate-owned,withthegovernmentowning50.2%oftheshares. Ownership in most banks in Azerbaijan was concentrated and most had only a small number of shareholders. In over onethird of the banks surveyed, an individual shareholder had a controlling interest. In addition, quite often (in 40.6% of the banks surveyed) relatives of major shareholders were likewise major shareholders. Major shareholders were often involved in the management of banks as members of either the supervisory board or the management board. In 41.2% of the banks surveyed, the largest shareholder was a member (quite often, the chairperson) of the supervisory board. The management board included one of the three largest shareholders in 17.6% of the banks surveyed. That figure would have been even higher but for the lawprohibitingashareholderwhoowns20%ormorefrombeingamemberofthemanagementboard. The banking sector was experiencing general growth and development and the National Bank ofAzerbaijan had recently increased the capital requirements for banks.As a result,Azerbaijani banks were seeking, and planned to continue to seek, infusions of capital. Of the banks surveyed, 91.2% had attracted investment overthepreviousfiveyearsand97.1%plannedtoseekmorecapitalinthenextthreeyears. Of the banks surveyed, 73.5% were listed on the Baku Stock Exchange. However, public offerings were not the banks' preferred method of raising capital. Rather, 60.6% of respondents said that they preferred to seek capitalfrominternationalfinancialinstitutions. AWARENESS OF AND COMMITMENT TO GOOD CORPORATE GOVERNANCE PRACTICES Of the thirtyfour respondents, thirty (88.0%) stated that they understood corporate governance principles. However, in the course of conducting seminars and other training events, theACGP observed that few bank managers were actually knowledgeable in corporate governance best practices. It seems likely, therefore, thatsomerespondentsdidnotwishtoadmittheirlackofknowledgeinthisarea. Most respondents rated the level of compliance with corporate governance best practices in their own banks as better than that of the banking sector generally and better than that of corporate governance legislation. In the course of the survey, 38.3% of respondents rated their own corporate governance at the maximum level, while only 11.8% assessed corporate governance in the banking sector at that level and only 14.7% rated corporategovernancelegislationatthemaximumbestpracticeslevel. Respondents seemed to perceive the benefits of corporate governance in terms of operational efficiencies rather than as protections for shareholders and other stakeholders. For example, only one (2.9%) said that disclosurewasanimportantbenefitofgoodcorporategovernance. Respondents placed little value on integrating corporate governance principles beyond the legally required minimum. Most banks had adopted new charter provisions to comply with recent legislative changes, but only a handful of respondents stated that their banks had gone beyond the legislative requirements to include further provisions dealing with fundamental corporate governance issues. For example, only 14.7% indicatedthatprovisionsregardingindependentdirectorswereincludedinthebank'scharter. According to respondents, the three major obstacles to improving corporate governance practices were ineffective legislation (cited by 61.8%), the scarcity of specialists competent in the field (41.2%) and the generallackofawarenessofthesubject(26.5%). Encouragingly, fifteen of the respondents (44.1%) reported that they were seeking to improve corporate governance in their banks and had documented improvement plans. In order of the frequency of responses, their corporate governance improvement priorities were to establish supervisory board committees, train boardmembersandimplementtheInternationalFinancialReportingStandards(IFRS). Anotherindicationthatbankswereseekingtoimprovetheircorporategovernancewasthatfourteen(41.2%) of the banks surveyed had hired consultants specializing in corporate governance training. (Local firms provided this service in all but one instance.) Nearly all respondents (94.1%) indicated that they were interestedinreceivingtrainingincorporategovernance. SUPERVISORYANDMANAGEMENT BOARD PRACTICES The responses to questions regarding the duties of the supervisory board indicated that, instead of B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n EXECUTIVE SUMMARY 9 exercising oversight, the supervisory board (not the management board) was managing the daytoday operationsofthebank. In 67.6% of the banks surveyed, the supervisory board consisted of the legally mandated minimum of three members.Theresthadfivememberboards. Most of the banks surveyed held the legally required minimum of four supervisory board meetings per year. Only two banks (5.9%) held these meetings two or three times a year. However, the survey indicated that banks should improve their pre and postmeeting practices.Although all but 8.8% of respondents indicated that they had established procedures for providing materials to members prior to the meetings, only half reportedthattheyincludedminutesofthelastmeeting. Effectively, there was no evaluation of supervisory board performance. Only eight banks (23.5%) had carried outaboardassessmentwithinthelasttwoyears. Development of remuneration systems for supervisory boards is needed. Of the banks surveyed, 52.9% did not remunerate supervisory board members at all and 41.1% based remuneration solely on net profit without regardtootherfactorssuchasresponsibilities,meetingattendance,orthebank'sgrowth. The management board consisted of five members in 44.1% of the banks surveyed, three members in 35.4%,sevenin14.7%,fourinoneofthebanks(2.9%)andnineinoneother(2.9%). Potential conflicts of interest are a serious concern given that 44.1% of the banks surveyed had no bylaws requiringconflictdisclosureorapprovalofrelatedpartytransactions. SHAREHOLDERS'RIGHTS Alloftherespondentssaidthattheycompliedwiththelegalrequirementtoholdanannualgeneralmeetingof shareholders (AGM) in 2004. However, less than half (44.1%) said that they had complied with the requirementtonotifyshareholdersofthemeetingatleastfortyfivedaysinadvance. Among those who gave notice of theAGM and provided premeeting materials, 94.1% included an agenda, 41.1% included a description of each agenda item, 44.1% enclosed the annual report and financial statements and 32.4% provided supporting documents related to the agenda. Notably, only 17.6% included proxyvotinginstructions. Significantly, 55.9% of respondents indicated that changes to the agenda were permitted during the AGM, eventhoughthispracticecontravenesbothgoodcorporategovernancepracticeandrelatedlegislation. Although not prohibited by law and arguably permissible, cumulative voting is not common in Azerbaijan. Only20.6%ofthebankssurveyedelectedthesupervisoryboardthroughcumulativevoting. In general,AGMs were well attended. In roughly threequarters of the banks surveyed, at least 85.0% of the shareholders attended the most recent AGM. Also, a little over half of the banks surveyed indicated that at least 66.7% of the minority shareholders attended. Although attendance was high, shareholders did not necessarily have adequate opportunity to exercise their rights: 91.2% of the banks surveyed indicated that votingtookplacebyashowofhandsandonly35.3%acceptedvotesbyproxy. The results of AGMs were most commonly communicated verbally; for 64.7% of the respondents it was the main method of disclosure, followed by regular mail (14.7%) and registered mail (5.9%). A further 14.7% reported that they either communicated this information in another manner or did not know how the results were communicated. Roughly a quarter of the banks surveyed (26.5%) did not makeAGM results available tothepublic. A significant number of respondents (32.4%) refused to answer questions on the payment of dividends. Sixteen of the twentythree (69.6%) who did answer said that they had not paid dividends for the years 2002 to 2004. Only seven said that they had declared dividends in any of those years and only four had declared dividendsinallthreeyears. Twenty of the banks surveyed (58.8%) had held extraordinary shareholders' meetings in the last two years. Mostoften,thepurposewastoseekapprovaltoamendthecharter. DISCLOSUREANDTRANSPARENCY The Law of the Republic of Azerbaijan on Accounting2 and the Law of the Republic of Azerbaijan on Banks3 require banks to prepare financial reports in accordance with IFRS. The passage of these laws signified a 2 June 2004. Hereinafter, the "Accounting Law". Note that the effective date of this legislation was November 2004. 3 January 2004. Hereinafter, the "Law on Banks". Note that the effective date of this legislation was March 2004. B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n 10 EXECUTIVE SUMMARY step toward improving disclosure and transparency in the banking sector. However, even though all banks surveyedweresaidtocomplywithIFRS,thesurveyrevealedthatimprovementisneededinthisarea. In addition to financial disclosure, stricter legislative provisions regarding nonfinancial disclosure now apply to banks, and practice is improving in this regard. For example, 88.2% of respondents said that their annual reports were made public. This is a promising trend, but the content needs improvement. Only 5.9% disclosed the names of beneficial shareholders and provided profiles of the members of the governing bodiesofthebank,andonly2.9%disclosedtheshareholdingsofthoseindividuals. Most respondents (91.2%) claimed that they disclosed financial information upon request and 82.4% said that most information was disclosed in the annual report. In practice, however, a significant number regularly failedtomeeteventheminimumdisclosurestandardssetbylaw. Disclosure of significant transactions was not common practice. Only 35.3% of the banks surveyed disclosed both related party transactions and transactions in excess of 10% of the book value of the bank's assets.Afurther 8.8% disclosed related party transactions only and 5.9% disclosed significant transactions only,but47.1%didnotdiscloseanyofthisinformation. Supervisory board committees play an important role in corporate governance best practices. In particular, a supervisory board audit committee is critical to an effective internal control system. In general, most of the banks surveyed met the minimum legal requirements and complied with best practices regarding the formation of their audit committees. Most banks (91.2%) had an audit committee and the same percentage had an internal audit function. Staffing a competent audit committee is a challenge inAzerbaijan, but 67.6% compliedwiththeminimumlegalrequirementthattheauditcommitteeconsistofatleastthreemembers. In most of the banks surveyed (76.5%), the audit committee met at least quarterly. Roughly a quarter (23.5%) indicated that the committee met less frequently, which not only fails to meet best practices standards, but is alsoinviolationoftheRegulation on Implementing Corporate Governance Standards in Banks.4 Banking legislation requires independence in the audit function. The survey responses suggest that audit committees were not truly independent and that internal audit departments were not operating independently of management. For example, in eight of the banks surveyed (23.5%), most members of the audit committee were bank employees. The majority of the audit committee members were independent in onlynineteenofthebanks(55.9%). Seventeen respondents (50.0%) reported that most members of the audit committee were knowledgeable in finance, as in international best practices, and fourteen (41.2%) reported that at least one member of the auditcommitteewasafinanceand/oraccountingspecialist. Over half of respondents (58.8%) said that their internal audit functions had established an effective audit program. However, only 38.2% indicated that the internal audit function included periodic assessment of the bank's internal control systems and only 26.5% said that regular and extraordinary internal audits of the bank werecarriedout. Only 29.0% of the banks surveyed reported that the internal audit function appropriately reported to the audit committee as required by legislation and in accordance with best practices. Annual external audits were performed in all of the banks surveyed. In 79.4%, these services were performed by an international firm rather than a local audit company. Changing auditors was common, and 47.1% of the banks surveyed (sixteenbanks)hadchangedtheirexternalauditorduringthelastthreeyears. 4 November 2004. Hereinafter, the "National Bank Corporate Governance Regulation". B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n Organization and Ownership of Banks in Azerbaijan To understand the status of corporate governance in the Azerbaijani banking sector, some general information about the sector is necessary.Azerbaijan had only fortyfour licensed banks as of January 1, 2006. Of these, forty onewereprivatelyownedandtwowereownedbythestate. According to the National Bank of Azerbaijan, as of January 1, 2006 the total assets of Azerbaijani banks were approximately USD $2,451.5 million. Loans, not including loss provisions, totalled approximately USD $1,566.3 million. Total deposits were approximately USD $1,400.0 million. Total capital was approximately USD $401.74 million.5 The banking sector is in development and there has been rapid growth. For example, from December 31, 2004 to December 31, 2005, total assets increased by 35.1%. Corporate governance practices are likewise in a state of development. Since appropriate good governance measures are dependent on operating circumstances, the following overview of the banks surveyed will provide context for the information gathered about their corporate governancepractices. 5 National Bank of Azerbaijan, Bulletin of Banking Statistics (Dec. 2005), available at www.nba.az. B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n 12 ORGANIZATION AND OWNERSHIP OF BANKS IN AZERBAIJAN BANKSANDTHEIR MAJOROPERATIONS YEARSINOPERATION In the first six years following independence (1989 to 1994), as Azerbaijan made the initial transition to a market economy, more than 200 banks were established. Twentysix (76.5%) of the banks surveyed were created during this period. Six (17.6%) were established between 1995 and 2000 and two (5.9%) were created between 2001 and2004. Chart 1. Formation of Banks Surveyed (%) 17.6 5.9 1989-1994 1995-2000 2001-2004 76.5 NUMBER AND DISTRIBUTION OF BRANCHES At the time of the survey, there were 360 bank branches in the country (an average of 8.3 branches per bank), of which 280 (78.0%) were branches of the banks surveyed. The International Bank of Azerbaijan (IBA) and Tekhnikabank had thirtyfive and twentyfive branches respectively. Three of the banks surveyed had no branches at all. The rest had an average of 7.6 branches. Branches were not spread geographically; 60.0% of them were located in Baku and 11.8% of the banks surveyed did not have branches outside Baku at all. Excluding IBA,thebankssurveyedeachhadanaverageof4.6branchesinBakuand2.8branchesinotherareas. NUMBER OF EMPLOYEES The banks surveyed varied considerably in size of staff.About a quarter of them (eight banks) had fewer than fifty employees. The largest portion (35.3%) was in the medium range, with 51 to 150 employees. Ten banks (29.4%) were quite large financial institutions, with staff of 151 to 250. Only three banks (8.8%) had more than 250 employees. B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n ORGANIZATION AND OWNERSHIP OF BANKS IN AZERBAIJAN 13 NUMBEROFCUSTOMERS Of the banks surveyed, 17.7% had fewer than 1,000 customers, 35.3% had between 1,001 and 10,000, and 14.7%hadbetween10,001and50,000.IBAhadmorethan250,000customers. Chart 2. Number of Customers (%) 17.7 26.5 Up to 1,000 1,001-10,000 10,001-50,000 2.9 50,001-250,000 2.9 Over 250,000 Did not know 35.3 14.7 MAIN OPERATIONS Chart3showsthecurrentdistributionofbankingservices,basedonprofitfromthegivenactivityasaportionofthe total income of the bank, assessed by respondents on a scale of one to ten with ten being the most important. The chart also shows the distribution of those services based on the banks' strategic plans and national economic developmentpriorities. Chart 3. Current Main Operations and Strategic Growth Priorities (%) 75.0 Servicing corporate accounts 72.0 68.0 Corporate lending 64.0 64.0 Deposits 73.0 Retail banking 56.0 58.0 55.0 Retail/consumer lending 46.0 49.0 Cash services including credit cards 41.0 46.0 Trade finance 41.0 33.0 Housing (mortgage loans) 41.0 29.0 Investment 39.0 Current operations Strategic growth priorities Note: Total exceeds 100%. (Respondents were allowed multiple responses.) B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n 14 ORGANIZATION AND OWNERSHIP OF BANKS IN AZERBAIJAN LEGALFORM Under the Law on Banks, banks can be registered only as open joint stock companies.Though this legislation had been in force for over a year at the time of the survey, four of the banks surveyed (11.8%) were still operating as closed joint stock companies. Thirty respondents (88.2%), including the representatives of two banks currently operating as closed joint stock companies, believed that the open joint stock company form was best for banks in terms of legal status, regardless of the legal requirement or the number of shareholders and other ownership factors. It is likely, therefore, that banks not already so registered will soon reregister as open joint stock companies. Most of the banks surveyed (82.4%) were not owned by other companies, three (8.8%) were owned by holding companies,one(2.9%)wasasubsidiaryandtwo(5.9%)hadsubsidiariesoftheirown. METHODSOFRAISINGCAPITAL Thirtythree respondents (97.1%) indicated that they planned to raise new capital in the next three years. Of those, most (70.6%) stated a preference for equity investment, with 42.4% seeking foreign direct investment and 39.4% looking for local direct investment. With the nascent bond market inAzerbaijan gaining ground, onethird of the banks surveyed reported that they envisaged a bond issue within the next three years. Of the banks surveyed, 60.6% had plans to seek funds from international organizations. The least popular method of raising capital was throughapublicofferingontheBakuStockExchange(24.2%). Ten respondents were unwilling to issue shares of any kind to raise funds. Six of them said they were reluctant to change the bank's ownership structure, three cited the high cost of issuing shares versus borrowing from IFIs and onebelievedthatshareswouldnotbeattractivetoinvestors. Nineteen respondents (55.9%) were negotiating with potential investors. A further eight (23.5%) planned to identify investors later in the year and six (17.6%) planned to find investors within three years. Only one bank had notmadeplanstoseekinvestors. Most of the banks surveyed (73.5%) were listed on the Baku Stock Exchange. Of the rest, one had plans to become listed within three years. The rest were either not going to be listed or had no decision in place yet. None of the banks was listed on any other stock exchange, but two had plans to undertake a listing on a foreign stock exchange. Although most banks' shares were traded on the Baku Stock Exchange, trading was rather thin. In 2004, total bank shares issued and placed was $21.0 million. In fact, 47.1% of respondents noted that their shares did not circulate onthesecondary marketin2004and35.3%didnotknow onewayortheother.In2005,newbankshares on the market increased, with $65.0 million in shares issued and $54.0 million in shares placed, but trading volume on the secondary market was only $4.0 million.6 This activity involved only a few banks and represented just1.4%ofthetotalnominalvalueofallbanksharesasofJanuary1,2006.7 During the last three years, 17.6% of the banks surveyed repurchased shares from shareholders. Notably, most (66.7%) repurchased the shares at a nominal price rather than at fair market value.The remainder did not give the repurchaseprice. 6 Note that this number reflects the volume of trading on the secondary market of the Exchange and does not represent the actual volume of tradingon theoverallsecondary market.CorrespondencefromtheBakuStockExchange,Sept.4,2006(onfilewithauthor). 7 According to the National Bank ofAzerbaijan, the total paidin capital of all banks inAzerbaijan was $233.3 million as of January 1, 2005 and $288.0millionasof January1, 2006. NationalBankofAzerbaijan,Bulletin of Banking Statistics(Jan.2006),availableatwww.nba.az. B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n ORGANIZATION AND OWNERSHIP OF BANKS IN AZERBAIJAN 15 RECENT INCREASES IN CAPITAL REQUIREMENTS Owing to the increased minimum capital requirements set by the National Bank of Azerbaijan,8 and general development and growth in the banking industry, all but two of the banks surveyed increased their charter capital during the last three years. Their means of doing so included issuing additional shares to existing shareholders (55.8%),raisingthenominalpriceofsharesincirculation(11.8%)andnewpublicofferings(20.6%). Chart 4. Means of Meeting Increased Minimum Capital Requirements (%) Shares issued to existing shareholders 55.8 New public offering 20.6 Increased nominal value of issued shares 11.8 Did not increase capital 11.8 Within the last five years, thirtytwo of the banks surveyed (94.1%) attracted external investment. Of these, five banks (15.6%) sold shares to local investors, five (15.6%) sold shares to foreign investors, two (6.3%) offered shares on the stock market, eight (25.0%) issued bonds and eleven (34.4%) obtained a line of credit from an internationalfinancialinstitution. Chart 5. Sources of Financing (%) 3.1 15.6 Foreign direct equity investments Domestic direct equity investments 34.4 Public offering 15.6 Bond issue Loan from an international organization Other 6.3 25.0 SHARESANDREGISTRATION The banks surveyed mainly issued common shares. Thirty banks provided complete information on this matter and among those, common shares constituted 96.5% of the nominal value of all shares issued. Only six of those banks (20.0%) issued preferred shares, at an average of 14.0% of total shares. The highest portion reported was 27.0%.Theceilingprescribedbylawis25%. Most of the banks surveyed (76.5%) registered their securities with an independent registration bureau, in most cases the National Depositary Center of the Republic ofAzerbaijan. Only one used another external registry. One bankdidnotprovideanyinformationand20.6%saidthatthesecurityregisterwasmaintainedbythebankitself. 8 As of January 1, 2004, the minimum capital requirement set by the National Bank was USD $2.5 million.As of January 1, 2005, it was $3.5 million and as of January 1, 2006, it was $5 million. Effective January 1, 2006, the minimum capital requirement for new banks becameAZN 10million(approximately USD $11million) andexisting banks mustmeetthiscapitalrequirementon orbeforeJuly1,2007.NationalBankof AzerbaijanBoardDecreeNo.18 (Jun.30,2005)andNationalBankofAzerbaijan Board Decree No. 38(Dec.29,2005). B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n 16 ORGANIZATION AND OWNERSHIP OF BANKS IN AZERBAIJAN SHAREHOLDERS NUMBER The average number of shareholders in the banks surveyed was small. Most commonly, shares were concentrated in a few individual shareholders, and 55.9% had between four and ten shareholders. Five banks (14.7%) had only three shareholders, and three (8.8%) had over fifty shareholders, including one with 832 and anotherwith1,425. Chart 6. Number of Shareholders (%) 14.7 8.8 3 20.6 4 to 10 11 to 50 Over 50 55.9 DESCRIPTION Foreign investors held 15.0% of the common shares of the banks surveyed. Azerbaijani legal entities and individuals owned 85.0%. Of the Azerbaijani portion, the government accounted for 1.5%. This mainly consisted of the government's share in the charter capital of the IBA. The IBA's charter capital was several times greater than the average charter capital of the other banks surveyed and the government owned 50.2% of its shares. The IBAwas the only bank with direct government investment (via the Ministry of Finance) in its charter capital. State owned entities had some minimal investment (an average of 1.6%) in the charter capital of five of the banks surveyed (14.7%). The highest level of investment by a stateowned nonbanking institution in one private bank was46.0%. Chart 7. Description of Shareholders (%) Supervisory board members 32.0 Azerbaijani individuals except supervisory and management board members 30.0 Foreign entities/individuals except supervisory 15.0 and management board members Azerbaijani private entities 15.0 Management board members 4.0 State-owned entities 1.5 Government (direct) 1.5 Other 1.0 B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n ORGANIZATION AND OWNERSHIP OF BANKS IN AZERBAIJAN 17 The survey showed that ownership of banks was highly concentrated. Often, one or two shareholders had a controlling interest. In 20.6% of the banks surveyed, one shareholder held over twothirds of the shares. In 14.7%, one shareholder held between onehalf and twothirds of the bank's shares. Thus, in more than onethird of the banks surveyed, one individual had a controlling interest. Although 41.2% of the banks surveyed had shareholders who individually owned less than 2% of the shares, their collective participation in the paidin capital was very small. Excluding two banks with a large number of minority shareholders, banks that had shareholders holding less than 2% had an average of 11.9 of them. The average number of shareholders was 4.4 for all banks surveyed(againexcludingthetwobankswithalargenumberofminorityshareholders). Ownership was further narrowed through family relationships: 38.3% of the banks surveyed had major shareholders who were related to other shareholders in the same bank. On the other hand, only 2.9% had shareholders whose business associates in other activities also owned shares in the same bank. More than half (52.9%) reported that their shareholders did not have family or business relationships with other shareholders in thesamebank. Chart 8. Affiliations of Shareholders (%) 5.9 Relatives were also shareholders 38.3 Business associates were also shareholders No family/business relationship 52.9 with other shareholders No answer/did not know 2.9 As shown in Chart 9, in 41.2% of cases the bank's largest shareholder was a supervisory board member (usually the chairperson). In 14.7% and 20.6% of cases respectively, a supervisory board member was the second or thirdlargest shareholder. It should be noted that there was overlap in these figures: in some banks, all three of the largestshareholdersweresupervisoryboardmembers.Infourofthebanks,thetwolargestshareholders wereon the supervisory board. Over all, about 33.0% of shareholders (holders of common shares) were members of the supervisory board and 4.0% were members of the management board, indicating that shareholders were deeply involvedinthedaytodaymanagementofbanks. STATE PARTICIPATION The government or a stateowned enterprise was the largest shareholder in only two of the banks surveyed. As mentioned, the government owned 50.2% of IBA.Astateowned credit institution owned 46.0% of another private bank.Notably,moreofthelocallargeshareholderswereindividuals(61.7%)ratherthanlegalentities(26.5%). B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n 18 ORGANIZATION AND OWNERSHIP OF BANKS IN AZERBAIJAN Chart 9. Major Shareholders (%)9 41.2 Supervisory board members 14.7 20.6 2.9 Management board members 11.8 2.9 2.9 State-owned entities 2.9 0.0 14.7 Foreign entities/individuals except supervisory and management board members 14.7 8.8 5.9 Azerbaijani private entities 11.8 8.8 17.7 Azerbaijani individuals except supervisory and management boards members 20.6 23.5 14.7 Other/N/A 23.5 35.4 First major shareholder Second major shareholder Third major shareholder Note: Total exceeds 100%. (Respondents were allowed multiple responses.) In 17.6% of the banks surveyed (27.0% of those that provided complete information on this matter), a management board member was one of the three largest shareholders. This figure would likely have been higher if not for the legal provision that an owner of over 20% of the shares of a bank may not be a member of the bank's managementboard. AFFILIATIONSOFMAJORSHAREHOLDERS The survey found that, frequently, members of a bank's supervisory board were relatives of the bank's controlling shareholder. Taking into account that, as mentioned, the largest shareholder was often also on the board, many supervisoryboardscanbeconsideredcontrolledbyonemajorshareholder. SUMMARY In recent years, there has been dramatic expansion and development inAzerbaijan's banking sector. In the year 2005alone,totalbankassetsincreasedby35.1%,loansincreasedby48.9%anddepositsincreasedby34.1%. Corporate governance practices in banks were likewise in a state of development. With very few exceptions, the ownership of most banks was highly concentrated. Often, the major shareholders were involved in the management of the bank as members of the supervisory board or in management.As a result, existing corporate governancepracticesresembledthepracticesofcloselyheldcorporations.Anyimpetus tomodifythosepractices camemostlyfromrecentlegislativechangeinitiatedbytheNationalBankofAzerbaijan. Many banks were seeking investment from international financial institutions as the preferred source of capital. The need for increased capital arose from regulatory requirements and from growth. In order to attract external investment,however,bankswillhavetoimprovetheircorporategovernancepractices. 9"Major shareholders" means the shareholders who individually hold the three largest percentages of the bank's shares. B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n Awareness of and Commitment to Good Corporate Governance Practices IFC focuses on good corporate governance practices in order to add value to client companies and manage risk. Investors look to good corporate governance practices as a key indicator of shareholder value and effective stewardship. As mentioned, most of the banks surveyed (97.1%) were planning to raise capital from external sources. Adherence to corporate governance principles will be a key factor in their ability to attract investors. Of the banks surveyed, 85.3% indicated that they were knowledgeable in corporate governance principles, specifically the Organisation for Economic Cooperation and Development Principles of Corporate Governance (2004)(hereinafter,the"OECDPrinciplesofCorporateGovernance"). COMPLIANCEWITHCORPORATEGOVERNANCEPRINCIPLES In addition to gauging awareness of good corporate governance practices in the banking sector, the survey sought respondents' views on the level of compliance with corporate governance best practices in their own banks, in the country's banking industry and in corporate governance legislation. Their responses varied dependingonthebodyassessed: 38.2%ofrespondents(thirteenbanks)scoredcorporategovernancepractices in their own banks at the maximum level (four or five points on a fivepoint scale), while only 11.8% (four banks) rated the banking sector in general at the maximum level and only 14.7% (five banks) assessed corporate governancelegislationatthemaximumlevelofcompliancewithbestpractices. Only 20.6% of respondents scored compliance with corporate governance practices in their banks at a minimal level (one or two points), but 47.1% assessed compliance in the banking sector in general as minimal and 47.1% assessedcompliancewithbestpracticesinAzerbaijan'scorporategovernancelegislationasminimal. The survey responses notwithstanding, based on observations in the course of providing technical assistance, the ACGP believes that the number of respondents who actually understood corporate governance was much lowerthantheirselfassessmentindicated. The survey also asked respondents to indicate the most important benefits of good corporate governance. The top B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n 20 AWARENESS OF AND COMMITMENT TO GOOD CORPORATE GOVERNANCE PRACTICES Chart 10. Perceived Benefits of Good Corporate Governance (%) Improved decision-making process 55.9 Increased operational efficiency 41.2 Improved reputation 35.3 Increased transparency of supervisory board and/or management board 32.4 Mitigation of risk (takeover, blackmail by shareholders, unfair use of information by competitors) 23.5 Better access to capital markets in Azerbaijan and abroad 20.6 Prevention/resolution of internal conflict 17.6 Protection of shareholders' rights 17.6 Protection of stakeholders' rights 17.6 Enhanced ability to attract investment 17.6 Improved efficiency of coordination between shareholders and management board 11.8 Improved disclosure 2.9 Note: Total exceeds 100%. (Respondents were allowed multiple responses.) three responses were improving the bank's decisionmaking process, increasing the bank's operational efficiency andimprovingthebank'sreputation.Chart10showsallresponses. Fundamental governance principles such as shareholders' or stakeholders' rights and disclosure were seen as benefits much less frequently than factors such as increased operational efficiency and an improved decision making process. Only one respondent indicated that improved disclosure was an important benefit of improving corporategovernance. CORPORATE DOCUMENTATION CORPORATE CHARTERS In general, the survey indicated that the governing documents of banks needed improvement. For example, only 14.7% of banks included in their charters a provision regarding the appointment of independent directors. The charters of only 23.5% had provisions on the treatment of minority shareholders in the event of a takeover or merger. Even though both the law and good corporate governance practice preclude any restriction on the transferofshares,almostaquarterofthebankssurveyed(23.5%)includedsuchrestrictionsintheircharters. Chart 11. Charter Provisions in Place (%) Defining authority/responsibilityof management board 82.4 and its head Procedures for annual general meetings 79.4 General principles of shareholders rights 73.5 Procedure for establishing supervisory board committees 50.0 Qualifications required for supervisory board members 44.1 Treatment of minority shareholders in the event of a takeover 23.5 Prohibition/restrictions on sale of shares 23.5 Requirements/criteria for independent directors 14.7 Requirements for rotation of external auditor 8.8 Note: Total exceeds 100%. (Respondents were allowed multiple responses.) B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n AWARENESS OF AND COMMITMENT TO GOOD CORPORATE GOVERNANCE PRACTICES 21 Some notable provisions were commonly included in the banks' charters. For example, 82.4% of respondents indicated that their charters included such fundamental provisions as defining responsibility and authority as between the management board and its chairperson. General principles of shareholders rights were included in 73.5%ofchartersand79.4%includedproceduresfortheAGM. BYLAWS AND POLICIES Most banks had adopted basic bylaws with respect to the activities of the bank's governing bodies. For example, most banks had bylaws regarding the AGM (64.7%), the supervisory board (67.6%), the management board (73.5%), the audit committee (70.6%) and the internal audit function (73.5%). Most of those without such provisionsindicatedthattheyplannedtointroducetheminthenearfuture. Fundamentaldocumentationwas inplaceatmostbanks, butthesurveyshowedthatfewerbanks hadadequately documented policies concerning compliance with corporate governance best practices. Only 23.5% of respondents had a written policy with respect to a corporate secretary and 55.9% had no plans to implement one. Twothirds of the banks surveyed had no written policies concerning supervisory board committees or the payment of dividends. At the time of the survey, recent legislation had required all banks to report financial information in accordance with IFRS, yet only 32.3% of the banks surveyed had any bylaw with respect to disclosure.Chart12showsthebylawsandpoliciesinplace,alongwithrespondents'planstoimplementthosenot currentlyinforce. Chart 12. Existing and Planned Bylaws and Policies (%) 64.7 Annual general meeting 23.5 11.8 67.7 Supervisory board 23.5 8.8 73.5 Management board 17.7 8.8 70.6 Audit committee 20.6 8.8 23.5 Corporate secretary 20.6 55.9 32.3 Supervisory board committees 41.2 26.5 14.7 Corporate governance for a company group 20.6 64.7 32.3 Disclosure 38.2 26.5 32.3 Dividends 50.0 17.7 73.5 Internal audit function 17.7 8.8 32.3 Code of corporate governance 61.8 5.9 32.3 Code of ethics 53.0 14.7 In place Planned Not planned/did not know Note: Total exceeds 100%. (Respondents were allowed multiple responses.) B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n 22 AWARENESS OF AND COMMITMENT TO GOOD CORPORATE GOVERNANCE PRACTICES In most of the banks surveyed (82.4%), the management board was responsible for developing policies and bylaws. In almost half, the supervisory board or the chief legal counsel also participated in developing these documents. IMPROVING CORPORATE GOVERNANCE OBSTACLES TO IMPROVING CORPORATE GOVERNANCE A key objective of this survey was to determine the extent to which the banks applied key corporate governance principles and to identify obstacles to improving corporate governance. The most frequently mentioned obstacle (61.8%) was ineffective corporate governance legislation. Next was the scarcity of specialists qualified in the field (41.2%),followedbythegenerallackofawarenessofthesubject(26.5%). Respondents rated ineffective legislation as the most serious obstacle to improved corporate governance, yet they also rated this legislation as "much better than average." On a scale of one to five (with one meaning "bad" and five meaning "good"), respondents gave an average rating of four to the legislation covering areas such as registration/startup, AGMs, composition of the supervisory board and management board and shareholders' rights.Itisdoubtful,therefore,thatlegislationisindeedthemainobstacle. MEASURESTOIMPROVECORPORATEGOVERNANCE Almost half of the banks surveyed (fifteen, or 44.1%) had a written corporate governance improvement plan, approved by the supervisory board or the AGM. When asked to identify the measures they believed would improve corporate governance, 52.9% indicated the establishment of supervisory board committees; however, establishing such committees became mandatory with the passage of the Law on Banks and the National Bank Corporate Governance Regulation. Other frequently mentioned priorities included training of supervisory board membersandimplementationofIFRS. Chart 13. Priorities for Improving Corporate Governance (%) Establish supervisory board committees 52.9 Train supervisory board members in corporate governance 38.2 Implement IFRS 23.5 Hire corporate governance consultant 20.6 Implement a remuneration system for supervisory board members 17.6 Establish an audit committee 17.6 Disclosure information quarterly 14.7 Adopt a corporate governance code 11.8 Appoint independent members to 11.8 the supervisory board Introduce an internal control system 8.8 Establish the corporate secretary position 5.9 Introduce an internal audit function 2.9 Note: Total exceeds 100%. (Respondents were allowed multiple responses.) B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n AWARENESS OF AND COMMITMENT TO GOOD CORPORATE GOVERNANCE PRACTICES 23 B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n Supervisory and Management Board Practices B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n SUPERVISORY AND MANAGEMENT BOARD PRACTICES 25 Chart 14. Responsibilities of the Supervisory Board, Management Board and AGM (%) 11.8 Representing the bank 88.2 0.0 5.9 Electing chair of supervisory board 0.0 94.1 2.9 Electing supervisory board members 0.0 97.1 8.8 Approving remuneration of supervisory board 0.0 91.2 35.3 Appointing head of management board 0.0 64.7 44.1 Appointing management board members 0.0 55.9 79.4 Approving remuneration of management board 8.8 11.8 67.6 Approving governing bodies bylaws 11.8 20.6 55.9 Approving other bylaws 41.2 2.9 70.6 Setting strategy 11.8 17.6 8.8 Developing operating plan 88.2 2.9 76.5 Approving budget 5.9 17.6 Supervisory board Management board Annual general meeting Note: Total exceeds 100%. (Respondents were allowed multiple responses.) B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n 26 SUPERVISORY AND MANAGEMENT BOARD PRACTICES SUPERVISORYBOARD NUMBEROFMEMBERS Good corporate governance practice requires that boards be large enough to encompass individuals with a range of specific finance, legal and commercial skills. On the other hand, a board exceeding a dozen members can be unwieldy. The law in most Eurasian countries prescribes a minimum number of board members, ranging fromthreetofive.10 InAzerbaijan,theminimumforbanksisthree. Threemember boards were most common (67.6%) in the banks surveyed, followed by fivemember boards (29.4%). Onebankhadasevenmemberboard.Theaveragewas3.7. Chart 15. Description of Supervisory Board Members (%) 22.2 Major shareholders and persons affiliated with major shareholders Independent 10.2 Other 67.6 FREQUENCY OF MEETINGS The Law on Banks requires that the supervisory boards of banks hold meetings at least quarterly. Most of the banks surveyed complied, convening meetings monthly (44.1%) or quarterly (38.2%). Meetings were held less frequentlythanquarterlyinonlytwobanks. Chart 16. Frequency of Supervisory Board Meetings (%) 44.1 2-3 times a year 5.9 Quarterly Monthly Other 11.8 38.2 10Corporate Governance in Eurasia: A Comparative Overview, OECD Roundtable, Kyiv, Ukraine (May 2004). B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n SUPERVISORY AND MANAGEMENT BOARD PRACTICES 27 PREPARATION FOR MEETINGS Most banks held the requisite number of meetings, but the survey showed that preparation for meetings needed improvement. Although all but 8.8% of the banks surveyed had established procedures for distributing materials to members prior to the meetings, some important documents were frequently lacking. For example, only half of the respondents reported that minutes of the last meeting were included. Chart 17 shows the documents provided. Chart 17. Materials Provided in Advance of Supervisory Board Meetings (%) Agenda 88.2 Explanation of each agenda item 70.6 Most recent financial statements 61.8 Draft resolutions 58.8 Minutes of last meeting 50.0 Other 2.9 Note: Total exceeds 100%. (Respondents were allowed multiple responses.) The reported periods for providing notice of the meeting and supporting materials were more than two weeks (17.6%), one to two weeks (26.5%) and one week (41.2%). In two banks, board members received the materials thedaybeforethemeeting. PERFORMANCE EVALUATION The survey results showed that inAzerbaijan, as in most developing economies, selfassessment of supervisory board performance is not a wellestablished practice. Within the last two years, the supervisory board carried out selfassessment in only eight of the banks surveyed (23.5%). The concept is quite new in Azerbaijan and the 23.5%figureisprobablyinflated. REMUNERATION Appropriate remuneration of the supervisory board is a principle of good corporate governance. Notably, Azerbaijani legislation allows for remuneration of supervisory board members to be computed as a percentage of the company's net income. Roughly half of the banks surveyed (47.1%) paid the supervisory board members for their services. Of those, 41.2% based the remuneration on the net income of the bank. In determining remuneration, none of the banks took into account factors such as the market value of shares, meeting attendanceoradditionalresponsibilities. Interestingly, more than half of the banks surveyed (55.9%) did not have contracts with the members of the supervisory board. Fourteen banks had contracts resembling employee contracts with the board members, governed by the strict provisions of the Labor Code of Azerbaijan. Only one bank had civil contracts in place, governedbythemoreflexibletermsoftheCivil Code of Azerbaijan. Chart 18. Remuneration Criteria for Supervisory Board Members (%) Tied to bank net income 41.2 Tied to bank gross income 23.5 Fixed monthly amount 23.5 Based on evaluation of board activity 5.9 Not tied to any indicators 5.9 B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n 28 SUPERVISORY AND MANAGEMENT BOARD PRACTICES BOARD COMMITTEES Board committees play an important role in corporate governance best practices. These committees became mandatory with the advent of the National Bank Corporate Governance Regulation. As a result, most banks had formally established the requisite committees, at least on paper. As mentioned, all of the banks surveyed had established a credit committee, most had an audit committee and many had an assetliability management committee.Chart19showstheexistingandplannedboardcommittees. Chart 19. Existing and Planned Committees (%) 91.2 Audit committee 8.8 0.0 32.3 Strategic planning committee 32.3 35.4 5.9 Nomination and remuneration committee 11.8 82.3 8.8 Corporate governance committee 38.2 53.0 11.8 Conflict resolution committee 14.7 73.5 11.8 Ethics committee 14.7 73.5 100.0 Credit committee 0.0 0.0 79.4 Assets-liability management committee 14.7 5.9 38.2 Information technology committee 32.3 29.5 53.0 Risk management committee 23.5 23.5 In place Planned Not planned/no answer Note: Total exceeds 100%. (Respondents were allowed multiple responses.) B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n SUPERVISORY AND MANAGEMENT BOARD PRACTICES 29 MANAGEMENT BOARD FUNCTION AND DESCRIPTION By law, all banks must have a management board as well as a supervisory board. The management board is intended to be responsible for the daytoday operations of the bank. There is no upper limit on the size of the management board, but it must be an odd number and a minimum of three. The banks surveyed had five (44.1%), three (38.2%), or seven (14.7%) individuals on the management board. One bank had nine members. Women participated on the management boards of fourteen banks (41.2%). The average age of the management board membersinthebankssurveyedwasthirtyeight. The Law on Banks has some minimal requirements regarding the competency of board members, but some of the banks elaborated upon those requirements in their charters. For example, twentysix of the banks surveyed (76.5%) had competency requirements such as education and experience for management board members. For comparison, twentythree (67.6%) had competency requirements for supervisory board members. The key functionsofthemanagementboardareshowninChart14above. FREQUENCY OF MEETINGS The number of management board meetings per year ranged from four to 219 among the respondents. In part, the discrepancycanbeattributedtoeach respondent'sdefinitionofaformalmeeting.Mostrespondentssaidthattheir management board met daily to discuss minor issues, but these meetings were considered informal and not recordedinminutes.Othersdidconsiderthesedailymeetingsformalandreportedthemassuch. COMMUNICATION WITH THE SUPERVISORY BOARD Corporate governance best practices include having in place a system for the management board to report to and regularly communicate with the supervisory board, designed to enhance the operating efficiency of the bank. The management board reported to the supervisory board in writing in all of the banks surveyed. These reports were made quarterly (44.1%), monthly (38.2%), at every meeting of the supervisory board (11.8%), or annually (2.9%). In only eighteen of the banks surveyed (52.9%) did the management board report to the supervisory board verballyaswell.Chart20showsthereportingintervalsandmeans. Chart 20. Management Board Reports (%) 38.2 Monthly 23.5 44.1 Quarterly 5.9 2.9 Annually 0.0 11.8 At every meeting 23.5 Written Verbal Note: Total exceeds 100%. (Respondents were allowed multiple responses.) B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n 30 SUPERVISORY AND MANAGEMENT BOARD PRACTICES CONFLICTS OF INTEREST Good corporate governance practice requires that supervisory board and management board members disclose conflicts of interest and abstain from voting on resolutions when a conflict exists. Ten respondents (29.4%) reported that their banks had regulations requiring conflict disclosure and seven (20.6%) had regulations requiring abstention from voting where a conflict exists. Notably, only two respondents (5.9%) indicated that membersofthesupervisoryormanagementboardseverabstainedfromvotingowingtoconflictsofinterest. RELATEDPARTYTRANSACTIONS As discussed at a recent OECD Corporate Governance Roundtable,11 supervisory boards must take a much more active role in managing and disclosing conflicts of interest and related party transactions. The Law on Banks requires that the supervisory board approve related party transactions. In the majority of the banks surveyed (64.7%), this responsibility did indeed rest with the supervisory board. In the rest, related party transactions were approved by the management board (23.5%), or occasionally at theAGM (5.9%).Two respondents (5.9%) did not answerthequestionordidnotknowtheanswer. SUMMARY The survey revealed an unsatisfactory degree of compliance with good corporate governance practices at both the supervisory board and management board levels. Both bodies often performed functions beyond the scope oftheirresponsibility,tothepointofviolatingthelaw. Most supervisory boards were composed of major shareholders or their affiliates.Asmall percentage of the banks surveyedhadindependentmembersontheirsupervisoryboards,buteventhatmodestnumberissuspect. As to form, most banks complied with the requirements set out in law, such as the minimum number of supervisory board members, the minimum number of supervisory board meetings per year and the requisite committees. However,improvementisneededinpracticeandfunction. In addition, potential conflicts of interest are a serious concern. A sizeable number of banks (43.6%) had no bylawsrequiringeitherconflictdisclosureorapprovalofrelatedpartytransactions. 11 Corporate Governance in Eurasia: A Comparative Overview, OECD Roundtable, Kyiv, Ukraine (May 2004). B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n Shareholders' Rights By law, the shareholders are the ultimate governing body of a bank. TheAGM is their opportunity to participate in managing their investment and to ensure that their interests and rights are protected. What follows is a discussion of the practices related to protection of shareholders' rights among the banks surveyed, including their compliancewithcorporategovernancebestpracticesandAzerbaijanilaw. AUTHORITYAND FUNCTIONS OFTHEANNUALGENERALMEETING Azerbaijani banking legislation confers more authority and functions on bank AGMs than nonbank corporate legislation assigns to other companies. As mentioned, some bank AGM prerogatives are exclusive and may not be delegated; others are nonexclusive and may be delegated to the supervisory board. The banks surveyed largely, but not fully, complied with allowing the AGM to execute its exclusive rights. For example, while theAGM usually elected the supervisory board members (97.1%) and the chair (94.1%), only 58.9% of respondents reported that theAGM approved the issuance of securities such as bonds. More remarkably, less than half of the banks surveyed indicated that theAGM approved the annual report or significant transactions (more than 25% of the net book value of assets). Chart 21 shows the exclusive rights of the AGM and the degree to which respondentscompliedineachcase. B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n 32 SHAREHOLDERS' RIGHTS Chart 21. Exclusive Functions Performed by the AGM (%) Elect supervisory board members 97.1 Elect supervisory board chair 94.1 Approve share issues 79.6 Approve declaration and distribution of dividends 67.6 Appoint head of management board 64.7 Approve significant transactions 47.1 Approve annual report 44.1 Approve bylaws of governing bodies* 20.6 Approve remuneration of management 11.8 board members Note: Total exceeds 100%. (Respondents were allowed multiple responses.) *Note that the AGM has the exclusive right to approve bylaws of all of the bank's governing bodies, except for approval of the management board bylaws, which may be delegated to the supervisory board. The survey showed that, in most cases, theAGM delegated its nonexclusive rights. None of the banks surveyed involved the AGM in approving the internal control system, the risk management system or transactions of up to 25% of the bank's total assets. TheAGM approved the bylaws with respect to the bank's governing bodies in only 20.6% of the banks surveyed (which they should do, except for approval of the management board bylaws, which may be delegated to the supervisory board) and the annual budget in only 17.6%. In a substantial number of banks, theAGM did not oversee the audit function. However, the supervisory board is permitted to perform these functions and, as mentioned, more than twothirds of the supervisory board members were major shareholders and/or their representatives. It can be inferred, therefore, that the interests of minority shareholders are susceptibletoinfringementbydelegatingthesefunctions.Chart22showsthenonexclusivefunctionsoftheAGM andthedegreetowhichtheyweredelegatedtothesupervisoryboard. Chart 22. NonExclusive Functions Performed by the AGM (%) Approve securities issues (other than shares) 58.9 Appoint members of management board 55.9 Initiate extraordinary audits 44.1 Appoint external auditor 20.6 Approve budget 17.6 Approve terms of contract with external auditor 11.8 Note: Total exceeds 100%. (Respondents were allowed multiple responses.) B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n SHAREHOLDERS' RIGHTS 33 PROCEDURES FORSHAREHOLDERS'MEETINGS At the AGM, shareholders have the opportunity to exercise their basic rights as providers of equity capital by voting on important matters concerning the company. Legislation requires banks to hold a meeting of the shareholdersatleastannually.Allrespondentssaidthattheycompliedwiththisrequirement. NOTICETIMELINESS, METHODANDINFORMATIONPROVIDED Where good corporate governance is practiced, the AGM agenda is carefully prepared and the meeting is properly conducted. Shareholders aregivenampleopportunitytoraiseconcerns andputquestions totheboard. It is important, therefore, that shareholders receive adequate information in advance of the meeting in order to enable them to give due consideration to the items to be discussed. Indeed, legislation requires banks to provide shareholders with certain information in advance of the AGM, such as time and place, the agenda and the recommendations of the supervisory and/or management board with respect to each agenda item. All of the banks surveyed complied with the provision requiring an annual meeting, but less than half (41.2%) complied with the requirements with respect to appropriate notice. Shareholders must receive notice of an AGM at least forty five daysinadvance.Chart23showsthenoticegivenbythebankssurveyed. Chart 23. Timeliness of Notice (%) More than 45 days 41.2 21 - 45 days 23.5 8 - 20 days 20.6 7 days or less 8.8 No answer/did not know 5.9 Notices were most commonly sent to shareholders by registered mail (61.8%). Other methods included an announcementinthepressanddeliverybyhand. Chart 24. Methods of Giving Notice (%) Registered mail 61.8 Announcement in the press 38.2 Hand delivery, acknowledged by the recipient 29.4 Electronic mail 26.5 Announcement on the bank's website 14.7 Announcement in the bank's office 14.7 Note: Total exceeds 100%. (Respondents were allowed multiple responses.) B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n 34 SHAREHOLDERS' RIGHTS The materials prepared by the banks surveyed to accompany the notice included the agenda (94.1%), a description of each agenda item (41.2%), supporting documents related to agenda items (32.4%) and the annual report and financial statements (44.1%). Notably, only 17.6% included proxy voting instructions. ChartA23 in the Appendixshowstheresponsesinmoredetail. In most cases (82.4%), the agenda was prepared by the supervisory board. Shareholders proposed agenda items routinely (44.1%), rarely (17.6%), or never (11.8%). Notably, 55.9% of respondents said that changes to the agenda were permitted during the meeting, if deemed necessary. Not only does this practice fail to conform to internationalbestpractices,itisalsoprohibitedbylaw.Chart25showsthetreatmentoftheagendainmoredetail. Chart 25. Preparation of the Agenda (%) Developed by the supervisory board 82.4 Amended during the annual general meeting 55.9 Shareholders routinely propose agenda items 44.1 Developed by the management board 29.4 Shareholders rarely propose agenda items 17.6 Shareholders never propose agenda items 11.8 Note: Total exceeds 100%. (Respondents were allowed multiple responses.) SHAREHOLDER ATTENDANCE The survey results indicated that AGMs were well attended by both majority and minority shareholders. Of the thirtytwo respondents who answered this question, only three said that less than 75% of the shareholders attended the last AGM and 75.0% said that shareholders attendance was at least 85%. Typically, shares were concentrated in a small number of individuals and it is likely that these high attendance figures reflect the difficulty of reaching a quorum without most of them present. However, minority shareholders were also said to attend AGMsinhighnumbers,asshowninChart26. Chart 26. Attendance by Minority Shareholders at the last AGM (%) More than 66% 52.9 >33%-66% 17.7 >10%-33% 8.8 Less than 10% 14.7 No answer/did not know 5.9 B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n SHAREHOLDERS' RIGHTS 35 EXTRAORDINARY SHAREHOLDERS' MEETINGS Twenty of the banks surveyed (58.8%) had held an extraordinary shareholders' meeting (ESM) in the last two years. In twelve of those (58.8%), the supervisory board called for the ESM. ChartA25 in theAppendix contains further information on the bodies reported to have initiated ESMs. The most common reason given for convening an ESM was to seek approval of amendments to the charter. Chart 27 provides more detail on reasons for holding anESM. Chart 27. Reasons for Extraordinary Shareholders' Meeting (%) Approval of amendments 50.0 to the charter Approval of share issue 45.0 Reelection of supervisory board 45.0 and/or management board Approval of special contracts 10.0 Other 15.0 Note: Total exceeds 100%. (Respondents were allowed multiple responses.) VOTING PROCEDURES In general, the banks surveyed showed a lack of awareness of appropriate mechanisms to protect the rights of minority shareholders, including with respect to voting procedures. For example, only 35.3% applied proxy voting. Chart 28 shows the degree to which various voting mechanisms were present in the banks surveyed. Only 20.6% allowedcumulativevoting.Onebankallowedblockvotingandanotherhadblockingvotemechanismsinplace. For counting votes, 5.9% of the banks surveyed used cards and 2.9% used paper ballots. Most (85.3%) accomplishedvotingbyashowofhands. Chart 28. Voting Mechanisms (%) Cumulative voting 20.6 Subscription rights 8.8 Blocking vote 2.9 Block voting 2.9 None of the above/no answer 64.8 B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n 36 SHAREHOLDERS' RIGHTS DISCLOSUREOFRESULTS Good corporate governance practice requires adequate dissemination of the results ofAGMs. The majority of the banks surveyed (64.7%) announced results to shareholders before the meeting adjourned, 14.7% sent a report to shareholders by regular mail, 5.9% sent it by registered mail and 11.8% used other means. Half of the banks surveyed published the results, 26.5% did not disclose the results to the public and the rest disclosed the informationbyothermeans.Fordetailsregardingdisclosure,seeChartA26intheAppendix. Chart 29. Means of Communicating AGM Results to Shareholders (%) Announced before meeting ends 64.7 Sent by regular mail 14.7 Communicated by other means 11.8 Sent by registered mail 5.9 No answer/did not know 2.9 DIVIDENDS In good corporate governance practice, executive officers are held accountable for the bank's profitability. This seldom happens in Azerbaijani banks. In fairness, however, banks need to retain earnings in the early stages of growthandAzerbaijanibankshavebeenoperatinginafreemarketeconomyforarelativelyshorttime. Eleven respondents refused to answer questions related to dividends. Of those who responded, sixteen (69.6%) did not pay dividends for the period 20022004. Only seven declared dividends for any of those years and only fourdeclareddividendsforallthreeyears. Three of the seven banks that paid dividends (42.9%) paid them less than fifteen days after the dividend was declared,two(28.6%)paidwithin16to60daysandtwoothers(28.6%)paidwithin61to180days. SUMMARY While it is encouraging that banks were holdingAGMs, improvement is needed in the procedures for giving notice ofandconductingthesemeetingsandwithrespecttoshareholders'rights. The shareholders of banks are not fully exercising their legally mandated rights and the current voting practices may be infringing upon the rights of the small number of minority shareholders in the banking sector. One of the fundamental incentives for investing in shares, potential dividends, appears to be absent in most Azerbaijani banks. This is a poor reflection on performance, even taking into account the need to retain earnings in the early stagesofgrowth. B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n Disclosure and Transparency Effective disclosure, which includes financial disclosure and transparency, is fundamental to good corporate governance and essential for building investor confidence. Recent changes in the legislation applicable to banks require heightened levels of disclosure and transparency. These include the regulation requiring all banks to report financial results in accordance with IFRS. Improved legislation is in place, but time will tell whether improved practices will follow. Disclosure and transparency are sensitive issues and respondents were less responsivetoquestionsinthissection. COMPLIANCEWITHIFRS In terms of disclosure, 2004 was a significant year for the banking sector. The Law on Banks and the Accounting Law were both passed in 2004, whereupon banks were required to adhere to IFRS in their financial reporting. Not surprisingly, all respondents reported that their banks complied with the new law. However, analysis of data indicated that only 52.9% were actually disclosing audited financial statements in compliance with IFRS. (See Chart29.1). B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n 38 DISCLOSURE AND TRANSPARENCY MANDATORYDISCLOSURE Annual reports, including financial statements and information on major shareholders and top management, promote transparency and help protect investors. Making this information public helps ensure transparency in the market generally. Azerbaijani banking legislation requires that banks disclose the annual report, balance sheet, profit and loss statement and audit report including an audit opinion. Chart 29.1 shows the level of compliance with eachoftheserequirementsasreportedbyrespondents. Chart 29.1 Compliance with Mandatory Disclosure Requirements (%) Balance sheet 100.0 Profit and loss statement 91.2 Annual report 88.2 Audited financial statements prepared in accordance with IFRS 52.9 External audit opinion 41.2 Note: Total exceeds 100%. (Respondents were allowed multiple responses.) Although 85.3% of respondents said that they were aware of the OECD Principles of Corporate Governance, compliance was remarkably low. For example, none of the banks surveyed disclosed information on insider trading or blocking votes. Only a negligible percentage disclosed related party transactions, information on board members, or largest single client exposure. Chart 29.2 shows respondents' compliance with recommended disclosure items under best practices of corporate governance. Chart A28 in the Appendix provides further detail. Chart 29.2 Compliance with Best Practices Related to Disclosure (%) Capital adequacy figures 14.7 Material event reports 14.7 Biographical information on management board members 11.8 Coporate governance principles and policies 11.8 Identity of beneficial controlling shareholders 8.8 Charter and/or bylaws 8.8 Biographical information on supervisory board members 8.8 Identity of all beneficial shareholders 5.9 Remuneration of each member of the supervisory board 2.9 Remuneration of each member of the management board 2.9 List of related parties 2.9 Largest exposure by industry/client 2.9 Information on insider trading 0.0 Identity of beneficial blocking shareholders 0.0 Remuneration of supervisory board members on collective basis 0.0 Remuneration of management board members on collective basis 0.0 Note: Total exceeds 100%. (Respondents were allowed multiple responses.) B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n DISCLOSURE AND TRANSPARENCY 39 ANNUAL REPORT The OECD Principles of Corporate Governance and the principles developed by the Basel Committee on Banking Supervision12 both contain recommendations with respect to information to be disclosed in a bank's annual report. Although 88.2% of respondents said that they published annual reports, the quality of these reports is questionable in light of their responses regarding the information disclosed therein. For example, only 5.9% of the respondents indicated that they named the beneficial shareholders and provided profiles of board members. Moreover, only 2.9% indicated that they disclosed the shares owned by those individuals. Further detail is providedinChart30. Chart 30. Information Included in Annual Reports (%) External auditor's opinion 64.7 Goals and strategies 50.0 Audit committee report 38.2 Audited financial statements including notes 38.2 Report of the supervisory board chairperson 32.4 Management discussion and analysis 32.4 Corporate governance policies and principles 23.5 Market share and major groups of clients 20.6 Ownership structure, dividend policy and history 17.7 Beneficial shareholders and shares held 5.9 Profiles of members of the governing bodies 5.9 Remuneration of supervisory board members 2.9 Shares held by members of the governing bodies 2.9 Environmental and social impact 0.0 Note: Total exceeds 100%. (Respondents were allowed multiple responses.) DISCLOSURE OF SIGNIFICANT TRANSACTIONS AND RELATED PARTY TRANSACTIONS In OECD countries, regulators require the disclosure of transactions involving company directors and their associates because of the fiduciary nature of the director's role. In most Eurasian countries also, related party transactions are considered material and are therefore subject to mandatory disclosure.As discussed at a recent OECD Corporate Governance Roundtable,13 however, compliance and enforcement are notoriously weak throughout the region. The Roundtable concluded that in order to increase the effectiveness of supervisory boards in Eurasia, the boards must take a much more active role in managing and disclosing conflicts of interest andrelatedpartytransactions. Currently inAzerbaijan, disclosure ofrelated party transactions is minimal owing tolack of legislated requirements and lack of compliance with good corporate governance practices. Of the banks surveyed, 8.8% disclosed related party transactions and 5.9% disclosed significant transactions (in excess of 10% of the book value of the bank's assets).Only35.3%ofrespondentsdisclosedbothand47.1%disclosedneither. 12 Enhancing Corporate Governance for Banking Organisations, Bank for International Settlements, Basel Committee on BankingSupervision (Feb.2006) 13 Corporate Governance in Eurasia: AComparative Overview,OECDRoundtable,Kyiv,Ukraine(May2004). B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n 40 DISCLOSURE AND TRANSPARENCY Chart 31. Disclosure of Significant and Related Party Transactions (%) No information disclosed 47.1 Both related party transactions and significant transactions 35.3 Related party transactions 8.8 Significant transactions 5.9 No answer/did not know 2.9 Of the twentyone respondents (61.8%) who gave reasons for nondisclosure or incomplete disclosure, nine (42.9%) cited of the absence of a legal requirement, eleven (52.3%) referred to a lack of demand for the informationandone(4.8%)expressedfearofrepercussionsintheformofactionbyregulatoryauthorities. SOURCES OF INFORMATION FOR POTENTIAL INVESTORS According to respondents, information on a bank's management, operations and financial condition was available to potential investors from published annual reports (82.4%), published quarterly reports (41.2%), the bank's website (73.5%) and directly from the bank upon request (91.2%). Given the survey results regarding disclosure as shown in Charts 29.1 and 29.2, however, it is clear that the only practical means for investors to get information was to approach the bank itself. The annual and quarterly reports seldom included the most important information. Chart 32. Sources of Information for Investors (%) From the bank, upon request 91.2 Published annual report 82.4 Bank's website 73.5 Published quarterly reports 41.2 Note: Total exceeds 100%. (Respondents were allowed multiple responses.) FINANCIAL CONTROL AND AUDIT Effective financial controls are fundamental to good corporate governance and essential for building investor confidence. The bodies principally responsible for implementing financial controls in Azerbaijani banks are the audit committee (and in some cases its predecessor, the revision commission), the internal audit function and the external auditor. In particular, an adequate internal audit function is essential to good corporate governance through its role in ensuring compliance with governance laws and regulations, ensuring that systems of risk management and internal control are functioning properly in order to safeguard assets, enhancing disclosure and transparencyandsupportingethicalpracticesandcommunication. FINANCIALCONTROLS The Law on Banks made the revision commission in banks obsolete as of March 2004. Nevertheless, 14.7% of respondents claimed that financial control was the responsibility of the revision commission.Afurther 35.3% said it was the responsibility of the audit committee,14 26.5% said it was part of the internal audit function, 20.6% claimed it was the responsibility of the management board and one respondent (2.9%) stated that none of the aforementionedbodieswasresponsibleforfinancialcontrol. 14 Before the Law on Banks was passed in March 2004, the institutional framework for banks included a "control and revision commission" responsible for the financial control function. When the new law came into effect, the audit committee began to replace the revision commission. Since the functions are comparable, it may be said that in effectively 50% of the banks surveyed, the audit committee was responsibleforfinancialcontrol. B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n DISCLOSURE AND TRANSPARENCY 41 AUDIT COMMITTEE In good corporate governance practice, committees of the supervisory board perform a variety of important duties in the company. The audit committee is particularly important, as it is responsible for reviewing the effectiveness of the company's internal audit functions and for ensuring the integrity of the financial statements and the independence of the external auditor. Banks are required by law to have an audit committee. Of the banks surveyed, 91.2% had one and 8.8% had only the audit committee's predecessor, the revision commission. Similarly, 91.2% of respondents indicated they had an internal audit function. One of the banks had all three bodies. The National Bank Corporate Governance Regulation requires, as best practices also suggest, that the audit committee should meet at least quarterly. Most of the banks surveyed (76.5%) met this requirement, but 23.5% metlessoftenthanquarterly. Chart 33. Frequency of Audit Committee Meetings (%) 4 times per year 35.3 More than 8 times per year 20.6 2-3 times per year 17.6 5-8 times per year 11.8 Once per year 5.9 No answer/did not know 8.8 Most of the banks surveyed (67.6%, or twentythree) complied with the legal requirement that the audit committee haveaminimumofthreemembers.Elevenbanks(32.4%)hadauditcommitteeswithmorethanthreemembers. The chairperson of the audit committee was described as independent in twentythree of the banks surveyed (67.6%). Nineteen (55.9%) reported that the majority of the audit committee members were independent and eight (23.5%) indicated that at least one member was independent. In only eight (23.5%) were most of the audit committeemembersbankemployees,whichseemstolendcredencetheotherfiguresrelatedtoindependence. However, theACGP's experience inAzerbaijan suggests that, in practice, most audit committee members are not independentaccordingtobestpracticescriteria. According to international best practices, audit committee members should be knowledgeable in finance. Seventeen respondents (50.0%) reported that most members of the audit committee were qualified and fourteen (41.2%)saidthatatleastonememberwasafinancialand/oraccountingspecialist. Chart 34. Description of the Audit Committee (%) Independent chair 67.7 Majority of independent members 55.9 Majority of specialists in finance and accounting 50.0 At least one specialist in finance and accounting 41.2 At least one independent member 23.5 Majority of bank employees 23.5 No audit committee 8.8 Note: Total exceeds 100%. (Respondents were allowed multiple responses.) B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n 42 DISCLOSURE AND TRANSPARENCY INTERNAL AUDIT An effective bank internal audit function should determine whether the bank has sound systems of internal controls to protect the organization against loss, regularly test and evaluate those control systems, assess risk and make recommendations for improvement and followup. Over half (58.8%) of the respondents indicated that their internal audit functions were effective, yet only 38.2% stated that the internal audit included periodic assessment of the bank's internal control system and only 26.5% said that regular and extraordinary internal audits of the bank were carried out. When asked about the functions of the internal audit, respondents cited ensuring the accuracy of accounting entries (67.6%), performing regular and extraordinary internal audits (52.9%)andascertainingthatthefinancialstatementswerefreeofmaterialmisstatement(32.4%). INDEPENDENCE OF THE INTERNAL AUDIT FUNCTION To be effective, the internal audit function must be independent of management and free of interference in determining the scope of the audit, performing the work and communicating the results. The Law on Banks and the National Bank Corporate Governance Regulation, as well as best practices, require that the audit committee overseetheinternalauditfunctionandthattheinternalauditdepartmentbeaccountabletotheauditcommittee. This was put into practice in only 58.8% of the banks surveyed. In 38.2%, the supervisory board provided oversight for the internal audit department, in 8.8%, it was the management board and in 5.9%, theAGM was said toberesponsible. Chart 35. Responsibility for Oversight of Internal Audit (%) Audit committee 58.8 Supervisory board 38.2 Management board 8.8 Annual general meeting 5.9 No internal audit function 8.8 Note: Total exceeds 100%. (Respondents were allowed multiple responses.) Additional data further illustrated the lack of independence in the internal audit function. For example, best practices and legislation both require the audit committee to be responsible for approving the internal audit work plan. However, this was the case in less than half of the banks surveyed (47.1%). In the rest, management or the financedepartmentwasresponsibleforthisapproval. Chart 36. Responsibilty for Approval of the Internal Audit Plan (%) Audit committee 47.1 Supervisory board 44.1 Head of the management board 11.8 Finance director/chief accountant 5.9 Note: Total exceeds 100%. (Respondents were allowed multiple responses.) B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n DISCLOSURE AND TRANSPARENCY 43 EXTERNAL AUDIT By law, the shareholders must either approve the appointment of an independent auditor at theAGM or delegate approval to the supervisory board. International firms provided audit services for 79.4% of the banks surveyed and 20.6% used a local audit firm. With respect to the independence of external auditors, it is notable that only a little over half of the respondents (55.9%) reported that the external auditors performed no services for the bank otherthanconductingtheannualexternalaudit. Changing auditors was common and 47.1% of the banks surveyed (sixteen banks) had changed their external auditor in the last three years. The reasons given were unsatisfactory quality of work (50.0%), changes in the law applicabletoexternalaudits(18.8%)andauditfeeconsiderations(31.2%). Chart 37. Reasons for Changing External Auditors (%) Unsatisfactory quality of work 23.6 Cost considerations 14.7 Changes in legal requirements for 8.8 external audit Did not change external auditor 52.9 Note: Total exceeds 100%. (Respondents were allowed multiple responses.) SUMMARY The recent legislation requiring banks to adhere to IFRS in their financial reporting was certainly a positive step and will lead to improved disclosure and enhanced transparency in the banking sector. However, the survey found that significant improvement in bank practices remained to be implemented in this regard. The same was true of the audit functions in banks. Although all banks were said to have an internal audit function in place, the survey revealed important deficiencies with respect to its structure and independence. In addition, all respondents claimed full compliance with IFRS, but not all of the banks were audited in accordance with the International Standards on Auditing. Specifically, the financial reports of some banks were not certified by an independent auditor in line with best practices. Without that certification, the financial statements of banks will be considered unreliablebythepublic. B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n Appendix INTRODUCTION Chart A1. Respondent's Position (%) Management board member 44.1 Management board chairperson 32.4 Chief accountant 32.4 General counsel 17.6 Supervisory board chairperson 11.8 Supervisory board secretary 8.8 Supervisory board member 2.9 Note: Total exceeds 100%. (Respondents were allowed multiple responses.) B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n APPENDIX 45 ORGANIZATION AND OWNERSHIP OF BANKS IN AZERBAIJAN Chart A2. Average Numbers of Shareholders, by Percentage of Share Ownership 5.2 2.7 1.7 1.3 1.0 1.0 Over 66.67% >50% - 66.67% >25% - 50% >10% - 25% >2% - 10% less than 2% Chart A3. Participation on the Supervisory Board and/or Management Board by Family Members of Controlling Shareholders (%) 64.7 Supervisory board 23.5 11.8 76.4 Management board 11.8 11.8 No Yes Did not know Note: Total exceeds 100%. (Respondents were allowed multiple responses.) Chart A-4. Corporate Affiliations (%)15 2.9 8.8 5.9 Bank is a bank holding company Bank is a parent company Bank is a subsidiary Bank is not part of a group of companies 82.4 15UnderAzerbaijani legislation, a "bank holding company" means a legal entity that owns one or more subsidiaries that have a bank license. The activity of such a parent company is regulated and controlled by the bank regulating authorities of the state where the company's headquarters areregistered.(Law on Banks,ch.1, art1.) B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n 46 APPENDIX Chart A-5. Volume of Trading in the Bank's Shares on the Secondary Market, 2004 (%) 5,001 - 10,000 shares 2.9 10,001 - 50,000 shares 8.8 Over 50,000 shares 5.9 None/no answer 82.4 Chart A-6. Methods of Increasing Charter Capital in the Last Three Years (%) Issued additional shares to current shareholders 55.9 Issued additional shares to the public 20.5 Raised nominal value of issued shares 11.8 Did not increase charter capital 11.8 Chart A-7. Sources of External Investment in the Last Five Years (%) Loans from international organizations 35.3 Issuance of bonds 23.5 Foreign direct investment 14.7 Domestic direct equity investment 14.7 Share issue through public offering 11.8 Chart A-8. Plans to Seek Investment in the Next Three Years (%) Currently negotiating with potential investor(s) 55.9 Planned to initiate negotiations within the year 23.5 Planned to initiate negotiations within the next three years 17.7 No plans/no answer 2.9 B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n APPENDIX 47 Chart A-9. Planned Sources of External Investment in the Next Three Years (based on thirtythree responses) (%) Loans from international financial institutions 60.6 Foreign equity investment 42.4 Domestic equity investment 39.4 Issuance of bonds 33.3 Issuance of shares 24.2 No answer/did not know 6.1 Note: Total exceeds 100%. (Respondents were allowed multiple responses.) Chart A-10. Responsibility for Preparing Internal Bylaws and Policies (%) Management board 82.4 Supervisory board 50.0 In-house legal counsel 44.1 External legal counsel 14.7 Corporate governance committee 2.9 of the supervisory board Secretary to the supervisory board 2.9 Corporate secretary 2.9 Other 11.8 Note: Total exceeds 100%. (Respondents were allowed multiple responses.) Chart A11. Main Obstacles to Improving Corporate Governance in the Bank (%) Inadequate legislation 61.8 Lack of qualified specialists 41.2 Lack of information/knowledge 26.5 Concern that increased transparency carries significant risk (bankruptcy, acquisition, etc.) 8.8 Concern that competitors would benefit from 8.8 disclosure of information currently kept confidential Note: Total exceeds 100%. (Respondents were allowed multiple responses.) B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n 48 APPENDIX AWARENESS OF AND COMMITMENT TO GOOD CORPORATE GOVERNANCE PRACTICES Chart A12. Rating of Corporate Governance in the Bank (on a scale of 1 to 5, with 1 as "bad" and 5 as "good") (%) 41.2 35.4 17.6 2.9 2.9 1 2 3 4 5 Chart A13. Overall rating of Corporate Governance in Azerbaijani Banks (on a scale of 1 to 5, with 1 as "bad" and 5 as "good") (%) 41.2 26.5 20.6 8.8 2.9 1 2 3 4 5 Chart A14. Rating of Regulatory Legislation Related to Corporate Governance Practices in Azerbaijan (on a scale of 1 to 5, with 1 as "bad" and 5 as "good") (%) 38.3 23.5 23.5 11.8 2.9 1 2 3 4 5 B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n APPENDIX 49 Chart A15. Rating of the Quality of Specific Existing Legislation (on a scale of 1 to 5, with 1 as "bad" and 5 as "good") Establishing and organizing the supervisory board 4.1 Controlling the bank's financial and economic activitity 4.1 Organizing annual general meeting 4.0 Holding annual general meeting 4.0 Protecting shareholders' rights 4.0 Disclosure to shareholders 4.0 Issuing of securities 3.9 Establishing and organizing the management board 3.9 Liquidating the bank 3.8 Division of duties and responsibilities 3.8 Establishing supervisory board committees 3.7 Disclosure to stakeholders 3.6 Registration 3.6 Corporate conflict resolution 3.0 Chart A16. Governing Body Responsible for Financial Oversight for the Last Reporting Year (%) Audit committee 35.3 Internal auditor/audit department 26.5 Management board 20.6 Revision commission 14.7 Other 2.9 Chart A17. Governing Body that Approved Related Party Transactions (%) Supervisory board 67.6 Management board 23.6 Annual general meeting 5.9 Other/no answer 2.9 B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n 50 APPENDIX Chart A18. Services Provided by Consultants (%) Bringing corporate documents into compliance 26.5 Financial and governance strategy 26.5 Issuing securities 20.6 Preparing the annual report 17.6 Organizing and holding annual general meeting 11.8 Solicitation of investment 8.8 Note: Total exceeds 100%. (Respondents were allowed multiple responses.) Chart A19. Areas of Interest for Obtaining Training or Advice (%) Corporate governance assessment 88.2 Effective board practices 52.9 Drafting and/or reviewing the charter and bylaws 35.3 Disclosure and transparency 32.4 Shareholders' rights 17.6 Other 5.9 Not interested in training 5.9 Note: Total exceeds 100%. (Respondents were allowed multiple responses.) B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n APPENDIX 51 SUPERVISORY AND MANAGEMENT BOARD PRACTICES Table A1. Characteristics of Supervisory Boards in the Banks Surveyed Average number of members 3.7 Average number of female members 0.5 Average number of independent members 0.5 Average age of members 40.9 Average number of members who are bank staff 5.9 Average duration of meetings (minutes) 103.0 Average number of participants per meeting, last year 4.6 Chart A20. Notice of Meeting and Background Materials Provided to Supervisory Board Members (%) Up to one week 41.2 One to two weeks 26.5 More than two weeks 17.6 Day before 5.9 No established practice 8.8 Table A2. Characteristics of Management Boards of the Banks Surveyed Average number of members 4.7 Average number of female members 0.8 Average age of members 37.9 Average number of meetings per year 43.0 Chart A21. Abstention from Voting by Any Member of the Supervisory or Management Board Due to Conflict of Interest, 2004 Financial Year (%) No abstentions 88.2 Abstentions occured 5.9 No answer/did not know 5.9 B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n 52 APPENDIX SHAREHOLDERS' RIGHTS Chart A22. Distribution of Duties among the Governing Bodies (Supervisory Board, Management Board and the Annual General Meeting) (%) Approving transactions with a value 17.6 of less than 10% of book value of assets 82.4 0.0 Approving transactions with a value 85.3 of 10%-25% of book value of assets 14.7 0.0 50.0 Approving transactions of over 2.9 25% of book value of assets 47.1 17.7 Issuing shares 2.9 79.4 38.3 Issuing securities other than shares 2.9 58.8 61.7 Selecting external auditor 14.7 23.6 50.0 Approving engagement of external auditor 38.2 11.8 38.2 Approving annual report and 17.7 annual financial statements 44.1 52.9 Initiating extraordinary audits 2.9 44.2 23.5 Approving declaration and distribution of dividends 5.9 70.6 Implementing and maintaining 58.8 internal control system 41.2 0.0 Implementing and maintaining 41.2 risk management system 58.8 0.0 Supervisory board Management board Annual general meeting Note: Total exceeds 100%. (Respondents were allowed multiple responses.) Chart A23. Materials Provided to Shareholders with the Notice of the Meeting (%) Agenda 94.1 Annual report 44.1 Financial statements 44.1 Description of each agenda item 41.2 Supporting documents related to agenda items 32.4 Proxy voting instructions 17.6 Other 2.9 Note: Total exceeds 100%. (Respondents were allowed multiple responses.) B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n APPENDIX 53 Chart A-24. Shareholder Attendance at the Last Annual General Meeting (%) More than 85% 70.6 >75 - 85% 14.7 >50% - 75% 5.9 50% and less 2.9 No answer/did not know 5.9 Chart A25. Impetus for Extraordinary Shareholders' Meetings (%) Supervisory board 58.8 Management board 29.4 Major shareholders 5.9 No answer/did not know 5.9 Note: Only twenty of the banks surveyed had held ESMs. Chart A26. Means of Communicating Results of Annual General Meeting to the Public (%) Published in the media 50.0 Through branches/representative offices/subsidiaries 14.7 Not communicated 26.5 No answer/did not know 8.8 B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n 54 APPENDIX Chart A27. Means of Delivering Information to Shareholders (%) 47.1 52.9 Financial statements 44.1 44.1 8.8 47.1 47.1 50.0 14.7 Operating results 17.7 2.9 29.4 17.7 20.6 Names of minority 0.0 shareholders 35.3 2.9 23.5 14.7 29.4 Names of senior 2.9 managers 32.4 2.9 35.3 20.6 32.4 Charter and bylaws 0.0 35.3 2.9 11.8 Distributed at AGM Distributed before the AGM Published in the press Provided upon request Delivered by post Published on website Note: Total exceeds 100%. (Respondents were allowed multiple responses.) B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n APPENDIX 55 DISCLOSURE AND TRANSPARENCY Chart A-28. Compliance with Best Practices Related to Disclosure (%) Balance sheet 100.0 Income statement 91.2 Annual report 88.2 Audited financial statemens prepared in accordance with IFRS 52.9 Cash flow statement 38.2 Statement of changes in equity 38.2 Quarterly reports 32.4 Notes to financial statement 26.5 Material event reports 14.7 Capital adequacy figures 14.7 Corporate governance principles and policies 11.8 Biographical information 11.8 on management board members Identity of beneficial controlling shareholders 8.8 Charter and/or bylaws 8.8 Biographical information 8.8 on supervisory board members Identity of all beneficial shareholders 5.9 List of related parties 2.9 Remuneration of supervisory board members on individual basis 2.9 Remuneration of management board members on individual basis 2.9 Largest exposure by industry/client 2.9 Identify of beneficial blocking shareholders 0.0 Information on insider trading 0.0 Remuneration of supervisory board 0.0 members on collective basis Remuneration of management board 0.0 members on collective basis Note: Total exceeds 100%. (Respondents were allowed multiple responses.) B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n 56 APPENDIX Chart A29. Frequency of Reporting to Governing Bodies by Internal Auditor/Internal Audit Department (%) Monthly to the financial manager/chief accountant 38.3 Monthly to the management board 32.4 Quarterly to the financial manager/chief accountant 14.7 Quarterly to the management board 2.9 Prior to supervisory board meeting 2.9 No reporting 8.8 Chart A30. Impetus for the Most Recent Audit Committee Inspection (%) Audit committee 67.6 Supervisory board 29.5 Management board 2.9 Chart A31. Services Provided by the External Auditor in Addition to the Audit (%) Tax consulting 20.6 Business consulting 14.7 Legal services 2.9 None 61.8 Note: Only thirtytwo of the banks surveyed responded to this question. B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n APPENDIX 57 Table A3. Distribution of Duties: Supervisory Board (SB), Management Board (MB), Audit Committee (AC), Internal Auditor/Internal Audit Department (IA) and the External Auditor (EA) (%) Function/Responsibility SB MB AC No IA EA answer Perform regular and extraordinary internal audits of the bank 14.7 2.9 26.5 52.9 0.0 3.0 Ultimate responsibility for timely and reliable financial reports 0.0 67.6 5.9 11.8 5.9 8.8 Oversee the implementation of the financial and business plans 82.4 11.8 0.0 2.9 0.0 0.0 Establish accounting policy statements 8.8 67.6 2.9 5.9 0.0 14.8 Review the accuracy of accounting entries and check 2.9 17.6 8.8 67.6 0.0 3.1 the accuracy and timeliness of document flows Assure that the financial statements are free of material 2.9 47.1 8.8 32.4 0.0 8.8 misstatement Investigate related party transactions and cases of conflict of interest26.5 20.6 8.8 26.5 8.8 8.8 Prepare periodic financial reports/statements 0.0 85.3 0.0 0.0 14.7 0.0 Consult on and make recommendations for improvements 14.7 26.5 23.5 14.7 11.8 8.8 to the bank's operations Assign responsibility, delegate authority, establish policies 47.0 41.2 5.9 0.0 0.0 5.9 to provide a basis for accountability and control Establish control activities encompassing policies and procedures to ensure that directives are achieved 41.2 35.3 14.7 5.9 0.0 2.9 Convey the message that integrity and ethical values will be 20.6 55.9 14.7 2.9 0.0 0.0 maintained Implement procedures and policies for the internal control system 14.7 47.0 20.6 11.8 0.0 5.9 and risk management Implement corrective actions recommended by auditor 14.7 73.5 0.0 5.9 0.0 0.0 and/or supervisory authorities Monitor internal controls, including compliance with laws, regulations and policy statements 35.3 14.7 17.6 26.5 0.0 5.9 Enforce policies and procedures 5.9 88.3 2.9 0.0 0.0 2.9 Establish an effective audit program 11.8 2.9 58.8 14.7 0.0 11.8 Periodically assess internal control system 23.6 8.8 38.2 26.5 0.0 2.9 Approve the system of internal control 64.7 11.8 17.6 0.0 0.0 5.9 Review actions taken by management to deal with material control weaknesses and verify that those actions are adequate 61.8 0.0 14.7 20.6 0.0 2.9 B a n k C o r p o r a t e G o v e r n a n c e i n A z e r b a i j a n