Assessment and Recommendations

Corporate governance framework

Following its independence in 1991, Estonia, a country of 1.3 million people, embarked on a path of rapid economic, legal and regulatory change. All governments since then have had a strong commitment to open markets and limited state intervention in the economy. This has allowed Estonia to develop an open, competitive market economy with high rates of foreign direct investment, and strong economic growth up until the global financial crisis, averaging 8.2 per cent from 2001-2007. Estonia’s market-oriented approach has also reflected a policy of rapid political and economic integration with Europe, which led to its admission into the EU in 2004 and to a series of amendments to its capital markets and company law architecture to ensure its consistency with EU directives. Estonia’s capital market, nevertheless, is quite limited, with just 14 companies listed on the Tallinn Stock Exchange’s main listing segment.

During the early 1990s, Estonia embarked on a path of mass privatisation, supported by its 1993 Privatisation Act and the establishment of an Estonian Privatisation Agency to oversee the process. That same year, Estonia established the Securities Market Act to regulate the public offer of securities and trading on regulated securities markets. Ten commercial banks, nine brokerage firms and several state players founded the Tallinn Stock Exchange in 1995. A year later it opened for trading with 11 securities listed. In 2004, the joint Baltic OMX market was created, bringing Estonia, Lithuania and Latvia together under a common trading platform. In 2008, the Baltic OMX market became part of the newly formed NASDAQ OMX Group, the largest publicly traded exchange company in the world. This provides single point access to the three Baltic countries plus four Nordic country exchanges (Copenhagen, Helsinki, Iceland and Stockholm).

Shortly after Estonia’s independence, there were an estimated 10 000 small state- owned enterprises and approximately 500 medium-to-large SOEs. By 1995, the privatisation process was seen as largely completed, with 90% of non-infrastructure companies privatised. By 1999, the private sector generated some 80 per cent of GDP (according to official estimates), one of the highest proportions in Eastern Europe. As of February 2010, the Estonian government retained ownership interest in 36 SOEs, 30 of which are fully state-owned, along with 29 “quasi-corporations” (generally foundations) which are less commercially-oriented, with social, educational, cultural or entrepreneurial objectives.

The Estonian capital market is small and is characterised by low liquidity and concentrated ownership. Most shareholders (61 per cent) are based in Estonia, while investors based in Sweden and Luxembourg are the next largest owners of Estonian shares at 6.6 per cent each, followed by the Netherlands, the United States and Finland. The number of listed companies has declined from a peak of 18 in 2007 to 14 on the main market by early 2010, following three de-listings and one company moving to a secondary level for smaller companies, which has just one listing. Market capitalisation reached a peak of EUR 4.6 billion in 2004, or 49 per cent of GDP. Market capitalisation had dropped to

EUR 1.3 billion by February 2010, following a sharp drop in the market during the financial crisis and, most recently, as a result of the delisting of Estonia’s largest listed company, Eesti Telekom.

Estonia’s legal framework, supported by frequent amendments driven mainly by European Union directives, now appears to have the essential elements of an overall corporate governance framework. Gaps identified earlier, in particular related to audit requirements and standards and SOE oversight, have been addressed through recently enacted legislation, while others, such as the role of independent directors, are subject to voluntary guidelines. As the market for listed companies is small and relatively illiquid, market mechanisms play a limited role in providing incentives for good corporate governance. However, most market observers expressed the view that Estonian companies follow legal corporate governance requirements.

Estonia’s Financial Services Authority (FSA) could play a more important role in ensuring that Estonian listed companies comply with various corporate governance- related requirements. Fines issued to date have been low, and efforts to prosecute market abuse cases have had only limited success, although this has improved recently. Improved co-operation between the FSA and the Public Prosecutor’s Office is a welcome step, but further steps would be desirable to increase the sanctioning capacity of FSA to deter noncompliance. Changes in Estonia’s personal data protection laws have now been finalised and should enable Estonia to sign up to IOSCO’s Multilateral MOU on Consultation and Cooperation on Exchange of Information, which will enhance its capacities to deal with crossborder cases.

Responses to Estonia’s “comply or explain” Corporate Governance code by Estonian companies have been uneven. Some of the CG code’s recommendations are already required by law, while others are purely voluntary. Although the FSA issued a critical 2008 report on the adequacy of company corporate governance reports, responsibility for improving such reporting should not fall on the companies alone. Better compliance could also be achieved by bringing together the FSA, the Stock Exchange and relevant market players to review and update the CG code to ensure greater clarity about what is legally required, what is voluntary, and the nature and extent of explanations sought in relation to each of the recommendations. The development of clearer questions and guidance on the type of information required, along with the establishment of mechanisms to enforce reporting requirements, would lead to better corporate governance information for the market.

The Estonian authorities plan to review the Corporate Governance code in late 2010. This review should consider making some of its recommendations legal requirements, for example to strengthen disclosure and board independence, as described in greater detail below.

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