Recommendation B-SKOK on Good Corporate Governance Practices for Cooperative Savings and Loan Associations

Financial Supervision Commission
Recommendation B-SKOK concerning good practices in the field of corporate governance of cooperative savings and loan associations Warsaw, June 2015

Introduction
This document was issued pursuant to Article 62(2) of the Act of 5 November 2009 on cooperative savings and loan associations (consolidated text: Journal of Laws of 2013, item 1450, as amended; hereinafter: the SKOK Act) and constitutes a collection of good practices regarding the corporate governance of cooperative savings and loan associations (hereinafter: associations). Corporate governance is understood here not only as a set of rules defining internal relations between the members of the association and its bodies, but more broadly as a set of basic rules concerning the organization of the association, the processes operating within it, and management principles, as well as relations between the association and external entities providing services on its behalf. The provisions of the Recommendation aim to introduce and harmonize minimum standards for prudent and stable management of associations in the field of corporate governance, thereby reducing the operational risk associated with imperfections or lack of rules of conduct, practices, systems, and internal regulations. The Recommendation refers to the most significant principles of corporate governance from the perspective of the supervisory goal over associations, which is ensuring the financial stability of associations, the correctness of financial activities conducted by associations, the safety of funds accumulated in associations, and the compliance of association activities with the provisions of the SKOK Act. These objectives therefore define the scope of the Recommendation, which, among other reasons, does not coincide with the scope of the Code of Good Practices and Rules of Conduct of Cooperative Savings and Loan Associations adopted by the resolution of the Ordinary General Meeting of the National Association on 22.06.2012. Nevertheless, the Recommendation confirms and strengthens the provisions of the aforementioned Code in many areas. This applies in particular to issues regarding the self-help and cooperative nature of the association's activity, relations with members, and strengthening the ties binding them. The Recommendation also takes into account the fact that corporate governance studies and recommendations have also been issued by the World Council of Credit Unions (WOCCU). It should be borne in mind that WOCCO studies and recommendations are addressed generally to credit unions operating worldwide, in various legal systems, and therefore do not take into account a number of differences resulting from Polish law regulations or even the fact that associations in Poland are subject to financial supervision. This applies, for example, to the issue of association bodies or rules for managing the association. WOCCO regulations in this area largely refer to solutions adopted in the Anglo-Saxon system, where there is no division into a management board and a supervisory board, and the competencies of these bodies are divided between the body responsible for organization,
supervision, and some aspects of management (board of directors) and the body responsible for the day-to-day direction of the credit union's activity (general manager). For these reasons, not all WOCCO recommendations are suitable for direct application to Polish associations. Nevertheless, to the extent that they are applicable, the Recommendation does not contradict them. Moreover, in many areas, WOCCO recommendations may constitute a good complement to the Recommendation or even the provisions of the SKOK Act. This applies in particular to defining desirable qualification requirements for body members or rules for managing conflicts of interest. It should also be emphasized that a number of general solutions in the field of corporate governance for all institutions subject to the supervision of the Financial Supervision Commission, including associations, have also been recommended in the Corporate Governance Principles for Supervised Institutions adopted by the Commission. This recommendation has a special character in relation to these principles and, in the event of any discrepancies, should take precedence in application. Scope of application of the recommendation and the role of the National Association The Recommendation aims to systematize and introduce general, most significant from the perspective of the Financial Supervision Commission, guidelines regarding corporate governance in associations. The purpose of this Recommendation, however, is not to indicate specific, adequate solutions for all associations in this regard. In other words, the Recommendation and its individual provisions cannot be applied directly by associations, and the principles specified by it require implementation into the statutes and internal regulations of associations, and above all into the practice of their activities. The basic general principle for implementing and applying recommendations resulting from the Recommendation should be the principle of proportionality. According to this principle, adopted solutions regarding corporate governance should be appropriate, proportional to the size and specificity of the activity of a given association (in particular, taking into account the members of the association and the ties binding them) and rational from the perspective of real needs and economic accounting. When introducing specific organizational, regulatory, or practical solutions, the association should demonstrate their proportionality, rationality, and justification, in accordance with the "comply or explain" rule. Taking into account the tasks of the National Association specified in Article 44(2) of the SKOK Act, the Financial Supervision Commission expects the National Association to take an active part in the process of implementing the provisions of this Recommendation, thereby contributing to the most efficient conduct of this process and to reducing organizational burdens for associations related to it. The participation of the National
Association may consist, in particular, in supporting associations in drafting internal regulations required by the Recommendation or adapting the organization, including internal systems and functions, to the size and specificity of the activity of associations, which is of particular importance especially for small associations, gathering a relatively small number of members and employing a small number of workers.

Key provisions of the Recommendation
The Recommendation is based on observations and experiences related to supervisory activities conducted towards associations, including in particular the findings of supervisory inspections carried out in associations, the assessment of statutory solutions of associations, and analytical activities. The Recommendation covers the following areas:

1. organization and organizational structure of the association,
2. bodies of the association,
3. membership in the association and ties,
4. outsourcing of activity,
5. key internal systems and functions.
   These areas have been recognized as priorities for regulation in the form of a Recommendation of the Financial Supervision Commission, due to the risk that arises in the activity of associations in connection with irregularities and threats identified during supervisory activities in these areas.
   The issue of association organization is very heterogeneous, which is related to the large diversity of associations in terms of their size, number of affiliated members, degree of complexity of activity and internal processes associated with it. There are associations whose activity is entirely conducted in one branch by only a few employees, as well as those having over 100, or even 200 full-time positions and several hundred branches throughout the country. For these reasons, it is impossible to indicate identical organizational requirements for all associations indicating the need, for example, to separate specific cells in the organizational structure or to absolutely separate specific functions or internal processes. Nevertheless, supervisory experience allows pointing out the following most significant aspects of association organization requiring regulation:

• comprehensiveness of the association's organization, so that it serves the realization of the association's goals and takes into account the most important elements, such as: organizational structure, methods of management and control, internal reporting, information flow and document circulation, determination of activity goals and methods of their realization,
• formalization of the organization in written internal regulations,
• determination of the organizational structure, competencies, and tasks of bodies and individual organizational cells operating in the association.
  Despite the regulation of the issue of association bodies and their competencies in legal provisions, the Recommendation devotes much space to this area, specifying the principles of mandate realization by bodies and their members, emphasizing in particular the responsibility that lies on them. In particular, the Recommendation indicates:
• direct responsibility of the management board of the association for the entirety of management processes,
• individual responsibility of members of the management board and the supervisory board for the functioning of the bodies of which they are members,
• support for the quality of management in associations by activating members of associations and bodies in which they participate, making the ties binding them more realistic, and strengthening mechanisms of ownership control,
• the need for transparency of body operations and avoiding conflicts of interest, including as a result of personal (family) ties between body members.
  One of the basic problems requiring regulation in the SKOK system is the progressive departure of associations from the self-help – membership character and the weakening, and in some cases even the collapse, of consciousness and membership ties. This situation is one of the main causes of the high level of credit risk in the SKOK system and its undercapitalization. Reversing this state will be a long and tedious process, requiring on the one hand the engagement of the entire environment, and on the other hand, concrete and decisive actions by association bodies. The Recommendation indicates the following issues in this regard:
• the need for the existence between members of the association of ties of a real nature, not only formal professional or organizational ties indicated in the SKOK Act,
• the responsibility of association bodies for creating and cultivating ties and activating members and verifying the fulfillment of the tie requirement,
• the need to emphasize the obligations of members regarding maintaining ties, in particular through active participation in the general meeting or meetings of member groups and in controlling the functioning of the association and its bodies, as well as respecting basic norms and values associated with the activity of the association, which are self-help, loyalty towards other members, and timely settlement of debts to the association.
  The Recommendation also contains a broad reference to the outsourcing of the association's activity, i.e., entrusting an external entity (entrepreneur or foreign entrepreneur) with intermediation in concluding and changing contracts for the performance of financial services or performing factual activities related to these services. This area raised particularly significant reservations revealed both during supervisory inspections and analytical supervision. The outsourcing model adopted by associations most often involved the separation of an organized part of the enterprise in the form of a team of material (buildings, equipment, office equipment, etc.) and intangible assets, including the trademark, and liabilities (from employment relations, from the lease of premises, etc.) serving the association in conducting operational activity (sales department, cash handling, etc.), and then contributing such separated assets to a company in exchange for shares in that company. Associations simultaneously concluded contracts with companies regarding the provision of services to the associations in the scope previously performed by the disposed part of the enterprise. These contracts were often very unfavorable for the associations. As a result of such transactions, associations divested themselves of assets serving the conduct of their operational activity and became dependent on the services of the company, often lacking the financial capacity to recreate these assets. Such action should be assessed as generating high operational risk on the part of associations.

The Recommendation responds in particular to the following identified irregularities and threats related to the discussed phenomenon:

• non-compliance with the provisions of the SKOK Act prohibiting the outsourcing of association management, and in particular the management of risk associated with conducting the association's activity, including the management of assets and liabilities, making creditworthiness assessments and analyzing credit risk, and internal control,
• limiting the association's influence on the distribution network and shaping the service offer,
• marginalization of the management board's role in key matters (management of assets and liabilities, activity costs, and offer),
• lack of internal regulations specifying the rules of cooperation with external service providers and their transparent selection, as well as ensuring the management of relations with these external service providers, including resolving issues (avoiding) ties with persons from the association's management,
• lack of connection between the decision on outsourcing and risk assessment and economic accounting.
  From the perspective of perceiving the association as a supervised financial institution, operating by charging risk on funds entrusted to it under the title of repayment, an important problem observed by supervision is the lack of appropriate accounting and organization of key systems and internal functions for managing this type of institution, such as: risk management, internal control and ensuring compliance of activity and processes (compliance), financial planning, management information. The Recommendation indicates the need to take these issues into account in the organization of the association, without prejudging the form in which this should be done. Such a form should be adapted to the real needs and possibilities of the association resulting from its size and specificity, including the degree of complexity of activity. The Financial Supervision Commission expects that the Recommendation concerning good practices in the field of corporate governance of cooperative savings and loan associations, constituting an annex to Resolution No. …./2015 of the Financial Supervision Commission of 23 June 2015 (Journal of Regulations of KNF item ….), will be implemented no later than 31.03.2016.

List of Recommendations
Organization and organizational structure of the association Recommendation 1 The association should be appropriately organized, i.e., operate according to formalized and clearly formulated rules. The organization of the association should include in particular the organizational structure, principles of management and control, internal reporting systems, information flow and document circulation, determination of activity goals, and methods of their realization. Recommendation 2 The organizational structure of the association, understood as the arrangement and relations of bodies and organizational cells and the positions included in them, is the basic element of the association's organization. It should be hierarchical, complete, transparent, and unambiguous, and adequate to the size and specificity of the association's activity. Bodies of the association Recommendation 3 The bodies of the association operate on the basis and within the limits of legal provisions and the statute, as well as other written internal regulations (regulations), in a documented, transparent, and understandable manner for the members of the association, who, within the limits specified by legal provisions, have the right to control the operation of bodies and hold body members accountable for the realization of their entrusted functions. Recommendation 4 The General Meeting or the Meeting of Representatives and the Meetings of Member Groups are responsible in particular for the proper selection of members of the supervisory board in terms of meeting the requirements specified by legal provisions and possessing appropriate qualifications to perform functions, as well as for holding members of the supervisory board accountable for their activity. Meetings of Member Groups are also responsible in particular for:

1. proper selection of representatives to the Meeting of Representatives,
2. determining the method of realization of the representative's mandate,
3. periodic accountability of representatives, as well as the management board and supervisory board for their activity.
   Recommendation 5
   The supervisory board should perform its tasks actively, by holding regular meetings. Regardless of the responsibility of the supervisory board, as a body, for exercising control and supervision over the activity of the association, and regardless of any internal division of competencies among members of the supervisory board, they bear responsibility for the functioning of the supervisory board and for the proper and active realization of its tasks. Recommendation 6 The supervisory board is responsible in particular for the proper selection of members of the management board in terms of providing assurance of prudent and stable management of the association, possessing appropriate qualifications to perform functions, and meeting other requirements specified by legal provisions, as well as for the ongoing accountability of members of the management board for their activity, in particular through analysis and critical assessment of management decisions and their implementation. Recommendation 7 The management board of the association is responsible for the entirety of management processes in the association, i.e., for conscious decision-making and implementation of decisions concerning the resolution of matters important for the functioning of the association, making choices of goals, methods, and means of action, including the organization of the association and its activity, directing its day-to-day activity, planning, and controlling achieved results. Membership in the association and ties Recommendation 8 The activity of the association should be based on the principle of self-help and the conscious, voluntary association of members connected (integrated with each other) by a real tie, which association, in the interest of these members and exclusively for their benefit, conducts activity aimed primarily at satisfying their demand for basic financial services. Outsourcing Recommendation 9 Entrusting an external entity (entrepreneur or foreign entrepreneur) with intermediation in concluding and changing contracts for the performance of financial services or performing factual activities related to these services (outsourcing of activity), including through the separation of an organized part of the association's enterprise, should be justified by real organizational needs related to the realization of the association's goals, the interest of the association's members, and economic accounting. In the case of outsourcing of activity, it is necessary to ensure:
4. compliance with restrictions resulting from legal provisions, especially those concerning the prohibition of outsourcing association management, and in particular the management of risk associated with conducting the association's activity, including the management of assets and liabilities, making creditworthiness assessments and analyzing credit risk, and internal control,
5. full influence of the management board on the operational activity of the association,
6. consideration of the specificity and basic goals of the association and the risk associated with outsourcing,
7. maintenance by the association of control over service quality and data security,
8. transparency and independence in the selection of service providers, including avoiding ties between members of the association's bodies and entities to which activity is entrusted.
   Key internal systems and functions
   Recommendation 10
   Key internal systems and functions should be described in the internal regulations of the association adopted by the management board and approved by the supervisory board.
   Recommendation 11
   The association should have an internal control appropriate to the size and specificity of its activity and effective, aimed at reducing risk associated with the association's activity by ensuring:
9. correctness of administrative and accounting procedures, as well as financial reporting and reliable internal and external reporting,
10. compliance of activity with legal provisions and internal regulations, market standards, and taking into account supervisory recommendations.
    Recommendation 12
    The association should identify the types of risk occurring in its activity and possess written policies for managing this risk, adequate to the size and specificity of this activity.
    Recommendation 13
    The service activity of the association should be conducted on the basis of short- and medium-term written financial plans adopted by the management board of the association, covering at least planned: revenues and costs, investment expenditures, capital demand, income statement, and balance sheet.
    Recommendation 14
    The association should have a management information system, based on systematic reporting, providing information enabling the bodies of the association to make decisions within their competencies.

I. Organization and organizational structure of the association
Recommendation 1
The association should be appropriately organized, i.e., operate according to formalized and clearly formulated rules. The organization of the association should include in particular the organizational structure, principles of management and control, internal reporting systems, information flow and document circulation, determination of activity goals, and methods of their realization.
1.1. The organization of the association should support the cooperative and self-help character of the association and serve primarily the correct, safe for the funds accumulated in the association, realization of its basic goals, which is providing members of the association with basic financial services, indicated in Article 3 of the SKOK Act.
1.2. The organization of the association should ensure solutions activating members and strengthening the ties binding them, and in particular encouraging members of the association to participate in the constituent bodies of the association (General Meeting, Meeting of Representatives, Meetings of Member Groups) and facilitating such participation.
1.3. The organization of the association, including in particular its organizational structure, should be transparent, understandable, and internally consistent, and adapted to the size and specificity of the association's activity, including taking into account the number of members of the association and the nature and intensity of the ties binding them.
1.4. The organization of the association should be exhaustively regulated in the statute of the association and other written internal regulations, such as regulations, procedures, instructions. The statute of the association should specify the types of internal regulations and the principles and procedures for their issuance.
1.5. The management board is responsible for designing, implementing, and proper functioning of the organization of the association.
1.6. The concept of the Association's organization prepared by the management board should be subject to approval by the appropriate constituent body (General Meeting or Meeting of Representatives) or the supervisory board – depending on the competencies of these bodies established in legal provisions or the statute of the association.
Recommendation 2
The organizational structure of the association, understood as the arrangement and relations of bodies and organizational cells and the positions included in them, is the basic element of the association's organization. It should be hierarchical, complete, transparent, and unambiguous, and adequate to the size and specificity of the association's activity.

2.1. The organizational structure of the association should take into account all organizational cells and managerial positions operating in the association, as well as key systems and functions. Organizational cells and managerial positions in the association should be defined and identified.
2.2. The organizational structure should ensure the division of tasks, powers, duties, and responsibilities between organizational cells and positions in a manner:

1. hierarchical – by establishing the hierarchy of positions, rules of subordination, and dependencies and decision-making paths, as well as the flow of information and circulation of documents; in particular, solutions should be avoided in which the same organizational cell or the same position is subordinate to different managerial positions;
2. complete – by taking into account all areas of activity...

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