Corporate Governance and the Pension Fund Industry

2. Corporate Governance and the Pension Fund Industry Introducing Corporate Governance Indices

3. Overview • Why are investors interested in Corporate Governance • Introducing Corporate Governance Indices • How will investors use corporate governance indices • Impact of the indices on corporate behaviour • Future direction Peter de Graaf

4. Why are Investors interested in Corporate Governance • Investors are beginning to see corporate governance as a major risk to shareholder value: • Corporate scandals • Increased shareholder activism • Excessive executive remuneration becoming a concern • Dangers of stock options as a form of remuneration for executives • Changing stakeholder expectations Peter de Graaf

5. FTSE/ISS Market Research – key findings (May/June 2004) • Interest in corporate governance is growing • The majority (88%) of respondents expected interest in corporate governance to increase over the next two years • 75% of respondents expected their consideration of corporate governance factors in their day-to-day operations to increase over the next two years • A significant number of respondents expect there to be a linkbetween corporate governance and investment performance • 94% thought CG contributed either significantly or a little to shareholder value • 86% thought that CG contributed significantly or a little to reducing portfolio risk Peter de Graaf

6. Academic Studies – governance and risk mitigation • Examined how various characteristics of the board of directors and a company’s other governance features affect the occurrence of corporate fraud at the company • Covered the time frame 1978 through 2001 • “…found that the presence of audit committees and compensation committees and the independence of these committees are significantly related to the occurrence of fraud.” • “In particular,although independent outside directors predominated on the audit and compensation committees, the presence of outside directors who were not independent because they had business or personal ties to the company significantly increased the likelihood of fraud in the sample.” Peter de Graaf

7. Fitch Study • Studied Impact of Corporate Governance on Fitch Ratings’ Credit Ratings Process • Focused on key governance factors relative to bondholders: • Board independence and quality • The presence of related party transactions • The integrity of the audit process • Executive compensation relative to company performance • Differing ownership structures (in particular, majority-controlled and family-owned companies); • Fitch used CGQ, other quantitative measures, and contextual analysis to evaluate the quality of companies’ governance practices. Peter de Graaf

8. Fitch Study- conclusions “Parallel to the low upside return but potentially high downside risk inherent in bonds, corporate governance tends to have an asymmetric impact on credit quality. Therefore, while strong governance practices generally will help ensure the likelihood of timely contractual payment, a fundamental governance weakness can have crippling consequences to the company’s viability.” Peter de Graaf

9. Investors need Tools to evaluate Corporate Governance • International investors require: • A consistent and cost-effective standard to measure governance practice across a range of international companies • Tools to evaluate companies’ corporate governance risk within a typical portfolio • They will look to reward companies with best governance practices and underweight companies with the worst governance practices to reduce portfolio risk Peter de Graaf

10. Introducing Corporate Governance Indices

11. FTSE/ISS Corporate Governance Indices (CGI) • FTSE Group have come together with Institutional Shareholders Services (ISS) to develop a new set of indices for investors • ISS is the premier corporate governance services agency • With more than 15 years of experience ISS is considered to be an authority on proxy issues and corporate governance • Based in the US, more than 950 institutional and corporate clients worldwide • The objective of the indices is to optimise the standard FTSE index constituents by using ISS Corporate Governance scores to form the FTSE/ISS CG Index family Peter de Graaf

12. Introduction to the Corporate Governance Index Rating • FTSE and ISS have identified a set of common themes using a wide range of accepted standards and codes Peter de Graaf

13. Compensation systems for Executive & Non- Executive Directors (9%) Executive and Non- Executive stock ownership (9%) Structure and independence of the Board (44%) Shareholder Rights and Protections (21%) • Independence and • integrity of the • audit process (17%) FTSE/ISS Corporate Governance Themes • More than 60 corporate governance criteria across 5 broad themes Peter de Graaf

14. Compensation systems for Executive & Non- Executive Directors Evaluates the structures and schemes that are in place for rewarding the Executive and Non-Executive directors Executive and Non- Executive stock ownership Examines whether executive and non-executive equity ownership is aligned with shareholders interests Evaluates a company’s capital structure with respect to dual-class shares and restricted voting shares as well as the existence of any anti-takeover devices Equity Structure FTSE/ISS Corporate Governance Themes • More than 60 corporate governance criteria across 5 broad themes Peter de Graaf

15. The composition and processes of the board are examined as well as the structure and independence of key standing committees Structure and independence of the Board Examines the audit process and the composition of the audit committee as well as the fees and services provided • Independence and • integrity of the • audit process FTSE/ISS Corporate Governance Themes • More than 60 corporate governance criteria across 5 broad themes Peter de Graaf

16. CGI Rating Variables – ranked by order of importance within each theme Peter de Graaf

17. CGI Rating Variables – continued Note: Some of the ratings factors are also looked at in combination under the premise that corporate governance is enhanced when selected combinations of these criteria are adopted. Peter de Graaf

18. Evaluation Theme Indicator 1 Shareholders may call a special meeting 2 Are shareholders permitted to call a special meeting? 3 Shareholders may not call a special meeting 4 The company's disclosure documents do not specify if shareholders are allowed to call a special meeting 5 Introduction to the CGI Rating • For each theme a number of indicators are used to evaluate their corporate governance ratings. Each indicator is assigned a score depending on its evaluation: • The indicators range from evaluating the independence of the board members, to the treatment of option re-pricing Peter de Graaf

19. Indicator Score High Score Low Score Introduction to the CGI Rating • Within each of the 5 themes the companies’ indicator scores are added together • The companies are then ranked by their indicator score: • the highest at the top, the lowest at the bottom Peter de Graaf

20. Indicator Score CG Rating for each Theme High Score 5 4 3 2 1 Low Score Introduction to the CGI Rating • For each theme companies are allocated a rating between 1 and 5: • Companies with a high indicator score are given a 5 • Companies with a low indicator score are given a 1 Peter de Graaf

21. Theme 1 Theme 2 Theme 3 Theme 4 Theme 5 5 Good CG Practice Overall Company CGI Rating 4 3 2 Poor CG Practice 1 Introduction to the CGI Rating • The overall company CGI rating is a combination of each of the five themes’ ratings Peter de Graaf

22. The Index Design • The objective of the indices is to exclude the poorest governance performers in each separate market • The review aims to capture approximately 80 per cent of each index universe market cap • Scores provided on a relative percentile basis compared to index and and sector groups; scores from 1 (poor) to 5 (excellent) Peter de Graaf

23. FTSE All Share (LMS) FTSE Developed (LM) FTSE US All Cap (LM) FTSE Developed Europe (LM) FTSE Eurozone (LM) FTSE Japan (LM) FTSE ISS UK CGI (LMS) FTSE ISS Developed CGI (LM) FTSE ISS Europe CGI (LM) FTSE ISS Euro CGI (LM) FTSE ISS Japan CGI (LM) FTSE ISS US CGI (LM) Underlying Universe FTSE ISS Corporate Governance Indices FTSE ISS CGI Real Time Indices The FTSE ISS CG Index Series Peter de Graaf

24. Corporate Governance Indices – Impact and Future Direction

25. Portfolio management and stock selection Company analysis A basis for index-linked financial products How can the Indices be used? • A tool to evaluate corporate governance “risk” across an international portfolio using a single, integrated index and ratings system • A basis for company engagement programmes • A risk management tool for portfolios looking to overweight the best, and to underweight the worst corporate governance practices • A benchmark for corporate governance weighted funds Peter de Graaf

26. Portfolio management and stock selection Company analysis A basis for index-linked financial products How can the Indices be used? • A benchmark to measure governance practice across international markets • A global standard that allows for: • Within-sector and cross-sector comparison • Regional/country comparisons • A basis for company engagement programmes Peter de Graaf

27. Portfolio management and stock selection Company analysis A basis for index-linked financial products How can the Indices be used? • Indices used as the basis for corporate governance weighted structured products and public funds: • OTC and on-exchange derivative products • tracker funds • exchange traded funds Peter de Graaf

28. How will the new CGI impact on Corporations? • Provides a communication tool for companies regarding their governance practices • Optimises access to capital for the best corporate governance performers • Offers a benchmark for companies to measure their performance against their peers • Will become a transparent global standard for companies to aspire to and exceed Peter de Graaf

29. Indices can make a Difference • FTSE4Good - Standards have risen since start and have been met by more and more companies 2004 900 Companies 2003 838 companies 2002 784 companies 2001 711 companies Human Rights criteria enhanced Environment criteria enhanced Peter de Graaf

30. Market driven – developing the Index Continued evolution Peter de Graaf

31. Constituent Consultation Peter de Graaf

32. Future Direction • The company rating system will evolve and be refined to take account of market trends and developments in Corporate Governance • Coverage to be extended to Emerging and Small Cap Markets • Further regional and country indices Peter de Graaf

33. Questions

34. Contact Details Peter de Graaf Director of Public Affairs FTSE Group Tel No: 020 7448 1880 Email: peter.de.graaf@ftse.com