Business Integrity
High quality corporate governance can have a developmental effect by enhancing a company’s reputation, improving internal controls, and ultimately helping it seek commercial backing. Robust business integrity practices help mitigate compliance, reputational, and operational risks, and protect companies from the large fines and jail time can result from unethical behaviour. Fund managers should address these issues in every investment.
1. Anti-corruption
Corruption can be defined as the offering, requesting, giving or receiving of a financial or other advantage in order to induce or reward the improper performance of a role, duty or function. Corrupt practices come in many different forms, including bribery, kickbacks, facilitation payments, embezzlement, fraud and extortion. Bribery is prohibited under the OECD Anti-Bribery Convention and considered a criminal offence in nearly almost every jurisdiction.
Bribery
A bribe is a payment made or received, directly or indirectly, financial or otherwise to obtain improper advantage. Bribes can be demanded or offered at almost any point in a company’s interaction with government officials, but are most common during public procurement processes, licence or permit acquisition and at infrastructure checkpoints such as customs terminals. Common forms of bribery include cash, gifts, hospitality, political donations, charitable contributions, in-kind support, employment of relatives and the awarding of contracts to companies owned by officials or their relatives.
Kickbacks
A kickback is a bribe where a portion of the undue advantage is returned or ‘kicked back’ to the person giving the advantage. Kickbacks are most common in procurement processes.
Facilitation payments
Facilitation payments (or speed payments) are bribes paid or received to facilitate or expedite the performance of a routine governmental action. They differ from outright bribes in that they are not for the purpose of obtaining or retaining an undue advantage, but rather in exchange for faster or improved access to services to which one is legally entitled. Facilitation payments are most common in dealings with low level officials. In some countries it can be considered normal to provide small unofficial payments under certain circumstances. However, this practice is illegal in most countries.
Why is combating corruptions so important for companies and investors?
Corruption hurts good businesses and hinders economic development (e.g. it can increase the overall cost of providing public services such as education, water and sanitation). The payment or receipt of bribes, kickbacks and facilitation payments is illegal and the companies and individuals involved can face large fines and jail time.
In some countries bribes and facilitation payments may be treated by some as just another cost of doing business in difficult environments, momentum against such practices is growing and governments, companies and investors across the globe are strengthening their anti-corruption efforts.
Development Finance Institutions, take a ‘zero tolerance’ approach to corruption and is committed to preventing bribery in all its investments. Raising business integrity standards in emerging markets has a positive developmental effect as it helps improve company performance, develop access to capital and reduce investment risks.
Further Resources
2. Anti-money laundering
Money laundering can be defined as the process by which the true origin and ownership of the proceeds of criminal activities are disguised in order to be used without suspicion. Money laundering takes many forms including:
Trying to turn money raised through criminal activity into ‘clean’ money (‘classic’ money laundering)
Handling income from acquisitive crimes such as theft, fraud and tax evasion
Handling stolen goods
Being directly involved with any criminal or terrorist property, or entering into arrangements to facilitate the laundering of criminal or terrorist property
Criminals investing the proceeds of their crimes in any financial products
Money laundering a global problem
Money laundering is a global problem and frequently occurs across borders. Recent advances in technology and the increasing number of online business transactions have exacerbated the problem. Money laundering techniques are flexible by nature and easily adapt to the business environment of any jurisdiction. Money launderers often have vast resources at their disposal and receive professional assistance to carry out their activities. Countries with developing economies or those undergoing changes in their financial system are particularly vulnerable and can be lucrative markets for money launderers.
Money laundering practices
There are three recognised parts to a money laundering process:
Placement: This is the physical placement or depositing or cash into banks and other financial institutions such as currency exchanges. Deposited cash and assets are then converted into other financial instruments such as traveller’s cheques, payment orders or are used to purchase expensive items for resale. Money launderers often use banks and financial institutions in less regulated countries to deposit cash and then transfer it to banks in regulated environments as ‘clean’ funds
Smurfing: This is a form of Placement where many small cash deposits are made instead of a single large one. Smurfing allows money launderers to evade local regulatory reporting requirements applicable to cash transactions. Cash based businesses are an obvious point of entry into the financial sector for illegal funds.
Layering: This is the separation of the proceeds of criminal activity from their source through the use of many financial transactions (layers). Layers may include multiple transfers of funds between financial institutions, early surrender of annuities without regard to penalties; cash collateralised loans, letters of credit with false invoices/bills of lading. The use of layers of financial transactions can disguise the origin of funds, disrupt any audit trail and provide anonymity. Money launderers seek to move funds around and change both the form of the funds and their location to make it harder for law enforcement authorities to identify ‘dirty’ money.
Integration: This is the final part of the money laundering process and involves integrating laundered money back into the financial system in such a way that it re-enters as apparently legitimate funds that can be retained over the long term.
Terrorist Financing
There are a number of similarities between the movement of terrorist property and the laundering of criminal property and some terrorist groups are known to have well-established links with organised crime. However, there are two key differences between terrorist property and criminal property:
Often only small amounts are required to commit individual acts of terrorism. This increases the difficulty of tracking terrorist property
Terrorist organisations can sometimes be funded from legitimate income such as charitable donations. It is difficult to identify the stage at which legitimate funds become terrorist property
Terrorist organisations usually require significant funding and large amounts of property to adequately resource their activities. Terrorist property and funds are often controlled via a number of sources and use modern techniques to manage funds and move them between jurisdictions without detection.
Politically Exposed Persons
Politically Exposed Persons (PEPs) are people who hold or have held (during the previous year) prominent public positions, either domestically or internationally. PEPs include:
Head of State or government
Senior politicians (e.g. Ministers and Deputy or Assistant Ministers)
Senior government, judicial or military officials
Senior executives of state-owned corporations or important political party officials
Members of Parliament
Members of Supreme Courts, of constitutional courts, or of other high-level judicial bodies
Members of courts of auditors or of the Boards of central banks
Ambassadors, chargé d’affaires and high-ranking officers in the armed forces
Members of the administrative, management or supervisory bodies of state-owned enterprises
The family members and close associates of PEPs should also be treated as PEPs
The involvement of PEPs or their close family members and associates should not automatically stop a transaction from going ahead. The involvement of a PEP in a transaction instead should be regarded as an orange light and trigger enhanced due diligence, including further checks and additional internal procedures to ensure their wealth has been legitimately generated.
Establishing whether individuals or legal entities should be regarded as a PEP or their close associate is not straightforward and can present difficulties. Search engines, both general and specific (subscription required) can often help identify potential PEPs, however close associates and family members can prove more difficult to identify.
If an employee or Partner suspects or holds information to suggest a customer or counterparty may be a PEP or involved with a PEP they should contact the Business Integrity (BI) Officer immediately. No transaction should be undertaken until the deal/investor sign off sheet has been approved by the BI Officer.
Why is combating money laundering so important for companies and investors?
There are significant reputational and commercial risks if investing alongside a person who is using a portfolio company to launder money. These include:
The true value of the company is likely to be uncertain as turnover and bank balances may be artificially inflated.
Should law enforcement authorities start to investigate the company it may be difficult to sell it, and assets can be frozen or seized.
The fund manager and its investors risk criticism and reputation damage for associating with or investing alongside criminals.
Further Resources
3. Corporate governance
The Organisation for Economic Co-operation and Development defines corporate governance in its 1999 Principles of Corporate Governance as the system by which business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as the board, managers, shareholders and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it provides the structure through which the company objectives are set, and the means for attaining those objectives and monitoring performance.
Why is corporate governance important for investors?
Good corporate governance makes good business sense as a key part of the value creation process. Good corporate governance increases profitability and returns on investment, reduces investment risks and mitigates reputational risk, and thereby contributes to economic development and a sustainable investment environment. Good governance is not only associated with sound and commercially successful companies, but also with companies committed to high standards of business integrity, and environmental and social impact. In the broader context, corporate governance promotes transparency, integrity and the rule of law, thereby increasing the protection of investors’ interests, which are vital to maintaining investor confidence and attracting foreign investors. Further, the UK’s 2018 Corporate Governance Code emphasises the need for companies to build trust with their stakeholders and calls on them to develop a corporate culture that aligns the company purpose, business strategy, and promotes integrity and values diversity.
Further Resources
When considering the effectiveness of board governance, it’s important to remember all aspects of a company’s business, which includes subsidiaries.
Institute of Directors’ Corporate Governance Code
Corporate governance has many definitions. The Institute of Directors provides a factsheet that discusses the definition of corporate governance and the legal framework around the concept, outlining the main principles of the UK Corporate Governance Code.
IFC Corporate Governance Progression Matrix
IFC provides a toolkit to help assess current governance in a company.
Board members have a responsibility to act with diligence, care and skill, in the best interests of a company. The Ethics Resource Centre provides organisations with a platform to engage with peers and learn new insights into ethics and compliance.
Directors have a fiduciary responsibility to act with a duty of care. The Institute for Global Ethics provides members with tools, frameworks and processes to help analyse ethical decision making and act accordingly.
An organisation’s code of ethical conduct is a critical tool in managing BI risks. The Consultative Committee of Accountancy Bodies provides a guide for businesses on developing and implementing a code of ethical conduct.
IFAC’s guide Defining and Developing an Effective Code of Conduct
A company’s ethical code of conduct must be effective and implemented with the support of the board. The International Federation of Accountants provides guidance on developing and implementing a code of conduct in a value-based culture.
A code of conduct must reflect a company’s operating environment. The EY Global Code of Conduct provides an example of a company’s ethical framework forming the basis of its business decisions in its operating context.
A company that has sub-committees must clearly state its terms of reference (TORs), which should include the scope of its E&S and BI responsibility. An example of clearly outlined TORs can be seen in Unilever sub-committees.
3. Economic sanctions
Economic sanctions are imposed by national and international bodies as a means of exerting political and economic pressure on states through restrictions on trade relationships or travel.
They can be imposed by governments, the European Community or by supra-national institutions such as the United Nations. They may bar trade with a country or an individual, or place restrictions on trade with specific sectors (e.g.Jade trading in Myanmar or nuclear technology with Iran).
Why are such sanctions so important?
Sanctions are imposed for significant political and trade reasons and are backed up by criminal penalties that are rigorously enforced. Breaching economic sanctions would have a significant adverse effect on the reputation of the fund manager and its investors.
Further Resources
Whistleblowing
Whistleblowing is an essential tool to strengthen accountability and combat corruption. A well-designed and well-implemented whistleblowing system can encourage people to report corrupt practices, which in turn strengthens a company’s oversight systems and helps reduce corruption in the long term.
Policies & Procedures
Companies should have robust whistleblowing policies and procedures, evidenced by:
A clear statement of the policy: Fund managers should ensure there is a clear statement that the company is open to whistleblower reports from staff and third parties and that it will investigate and, where appropriate, act upon such reports. The policy should guarantee that employees are protected from any adverse consequences for reporting corrupt practices.
Systematic communication of the policy and procedures: Fund managers should ensure the whistleblowing policy and procedures are communicated to all employees (e.g. via the staff handbook and in regular training).
The appointment of a member of senior management responsible for overseeing implementation of the policy and procedure: Fund managers should ensure that a member of the senior management of each company has been assigned responsibility for overseeing and reporting to the Board on the implementation of the whistleblowing policy.
Further Resources