In its 2003 Corporate Governance Sector Assessment Project, the European Bank for Reconstruction and Development (EBRD) observed that corporate governance legislation in Hungary is in "high compliance" with the Organization for Economic Cooperation and Development (OECD) Principles of Corporate Governance. A World Bank assessment conducted the same year confirmed that the Hungarian regulatory and legislative framework with regard to corporate governance is "robust." Nonetheless, both assessments identified key deficiencies. For instance, per the EBRD report, while minority shareholders received equitable treatment, the redress mechanism needed to be improved. In its more detailed analysis, the World Bank pointed out weaknesses in the role and functioning of the supervisory board and in share registration. Some of these issues have since been addressed. According to a 2007 EBRD report, significant corporate governance legislation was enacted in 2006 and 2007. Most importantly, a new Companies Act has been introduced. Also, the Budapest Stock Exchange approved a non-binding guide on Corporate Governance Recommendations, which takes into consideration the OECD principles and European Commission regulations.

General Overview

A 2003 World Bank assessment benchmarked Hungary against the Organization for Economic Cooperation and Development (OECD) Principles of Corporate Governance. According to the report, Hungary invested significant resources in improving its legislation to comply with the European Union (EU) Directives. Overall, the World Bank described Hungary's legislative and regulatory framework for corporate governance as "robust." Another 2003 Corporate Governance Sector Assessment Project (published in 2004) conducted by the European Bank for Reconstruction and Development (EBRD) confirmed that corporate governance legislation in Hungary is in "high compliance" with the OECD Principles. However, deficiencies were observed in both the assessments. For instance, the World Bank report identified "general weaknesses" of the supervisory board and also "a conflict between law and practice in the area of share registration" (p. 1). Additionally, a 2005 EBRD assessment of Hungary's commercial laws noted that "while Hungary offers equitable treatment for minority shareholders, the redress mechanisms available should be improved" (p. 11). The World Bank made detailed recommendations in three key areas: legislative reform, institutional strengthening, and voluntary/private initiatives. The World Bank recommended the creation of a "share registration working group" and the development of a corporate governance code. Some of these issues have since been addressed. Per the EBRD's 2007 report, in that year the Budapest Stock Exchange (BSE) approved a non-binding guide on Corporate Governance Recommendations which takes into consideration the OECD principles and European Commission regulations. Further, the 2007 EBRD report noted that significant corporate governance related legislation was introduced in 2006 and 2007.

According to details of the legal structure provided in the 2005 EBRD report, the Companies Act is the primary law governing corporate governance. The Act covers the regulation of limited-liability and joint stock companies. The limited liability company is the most widely used form in Hungary. Per a 2007 EBRD report, a new Companies Act was introduced in 2006 which provides the option to choose between one-tier and two-tier system. In a one-tier system, all the powers rest with the board of directors, and the board is responsible for electing its members. In a two-tier system, the members of the board of directors and the members of the supervisory board are elected by the shareholders' meeting. The other key law, primarily affecting listed companies, is the Capital Markets Act (CMA), enacted January 1, 2002. According to the World Bank report, "the CMA was the product of a thorough legislative reform aimed at creating a more flexible and favorable legal environment, correcting inefficiencies and flaws in the legal framework and bringing Hungarian legislation in line with EU laws" (p. 2).

The 2003 World Bank ROSC reported that the PSZAF was established in April 2000 as an integrated financial supervisory authority for the securities, banking, and insurance sectors. The PSZAF is modeled on the UK's Financial Service Authority and is both independent and self-financing. The World Bank added that the PSZAF, although adequately empowered and staffed, lacked "authority to issue legally binding regulations," making it likely that the regulator would "face difficulties in responding quickly to corporate governance violations not spelled out in law or regulation" (p. 2). At the time of the IMF's 2005 FSSA Update, the PSZAF had supervisory authority over the Budapest Stock Exchange (Budapesti Értéktõzsde, or BSE), the Budapest Commodities Exchange (BCE), securities intermediaries, and investment fund managers. In September 2005, the BCE was integrated into the BSE. In 2003, the BSE became a shareholder company, with the Vienna Stock Exchange and the HVB Bank Hungary (now "Unicredit Bank Hungary") as majority shareholders. After a strong decline in 2002, the market capitalization of the BSE recovered to 26 percent of GDP, as noted in the IMF's 2005 FSSA Update. Although capital markets in Hungary have grown and diversified since 2000, the stock exchange remains illiquid due to low trading volume, and domestic bond markets are still underdeveloped, as reported in the 2008 U.S. Department of Commerce (DoC) Country Commercial Guide. As of 2008, there are 61 listed companies on the BSE

In its 2008 Doing Business report, the World Bank rated investor protection in Hungary as being slightly below the regional average. The Investor Protection Index is a subcomponent of the World Bank's 2008 Doing Business Indicators, and consists of three aspects of investor protection: transparency of transactions (Extent of Disclosure Index), liability for self-dealing (Extent of Director Liability Index) and shareholders' ability to sue officers and directors for misconduct (Ease of Shareholder Suits Index). The indices range between 0 and 10, with higher values indicating greater disclosure, greater liability of directors, greater powers of shareholders to challenge the transaction, and therefore, better investor protection. Hungary scores 2.0 in the disclosure index, against a regional average of 4.9 and an OECD average of 6.4. It scores 4.0 in the Director Liability Index, against a regional average of 3.8 and an OECD average of 5.1; and it scores 7.0 in the Shareholder Suits Index, against a regional average of 6.3 and an OECD average of 6.5.

The Principles

Principle I: Ensuring the Basis for an Effective Corporate Governance Framework

II

According to the 2003 World Bank assessment, Hungary invested significant resources in improving its legislation to comply with the European Union (EU) Directives. Overall, the World Bank observed that Hungarian legislative and regulatory framework with regard to corporate governance is "robust." The main law dealing with corporate governance is the Companies Act of 1997 supplemented by the CMA, which primarily governs listed companies. Regarding the CMA, the World Bank noted that "[it] was the product of a thorough legislative reform aimed at creating a more flexible and favorable legal environment, correcting inefficiencies and flaws in the legal framework, and bringing Hungarian legislation in line with EU laws" (p. 2). The 2007 EBRD report observed that there have been some significant legal developments affecting corporate governance in Hungary, including the introduction of a new Companies Act and the Corporate Governance Recommendations of the BSE. Furthermore, the report noted that "pursuant to Section 312 of the Companies Act the board of directors of the companies listed on the Budapest Stock Exchange must present a compliance statement (i.e. summary of the corporate governance practice of the company in the previous year and the deviations from the corporate governance guide of the Budapest Stock Exchange) at the annual shareholder's meeting" (p. 3). However, the reports do not directly address Hungary's compliance with this principle.

Principle II: The Rights of Shareholders and Key Ownership Function

EN

In its 2003 Corporate Governance Country Assessment, the World Bank rates Hungary's observance with the sub-principles of Principle II as follows: "Rights to participate in fundamental decisions" was rated as "observed," indicating that all essential criteria are met without significant deficiencies. "Disproportionate control issues" and "Functioning of control arrangements" were rated as "largely observed," indicating that only minor shortcomings are observed, which do not raise questions about the authorities' ability and intent to achieve full observance in the short term. "Basic shareholder rights" and "Shareholders Annual General Meeting rights" were rated "partially observed," indicating that while the legal and regulatory framework complies with the principle, practices and enforcement diverge. Finally, "Cost/benefit to voting" was rated as "materially not observed," indicating that, despite progress, deficiencies raise doubts on the authorities' ability to achieve observance.

With regard to certain compliance gaps with this principle, the World Bank recommended legislative and regulatory reforms. A 2007 EBRD report also identified a few deviations from the OECD sub principles and noted that, due to introduction of new legislation and the consequent lack of sufficient court practice, "the enforcement of certain rules of corporate governance is not surely provided" (p. 7).

Principle III: The Equitable Treatment of Shareholders

EN

In its 2003 Corporate Governance Country Assessment, the World Bank rated Hungary's observance with the sub-principles of Principle III as follows: "Prohibit insider trading" was rated as "observed," indicating that all essential criteria are met without significant deficiencies. "Equitable treatment of shareholders" was rated as "largely observed," indicating that only minor shortcomings are observed which do not raise questions about the authorities' ability and intent to achieve full observance in the short term. Finally, "Board/management disclose interests" was rated as "partially observed," indicating that while the legal and regulatory framework complies with the Principle, practices and enforcement diverge.

The World Bank recommended moving towards the "one-share/one-vote" principle and suggested a review of current practices, to be followed by the issuance of best practice recommendations. Additionally, the World Bank suggested a significant increase in fines for the violation of reporting obligations, along with a review of differences between international standards and Hungarian Accounting standards. A 2004 World Bank assessment of Hungarian accounting practices noted that differences exist between Hungarian and international standards. More recently, a 2007 EBRD assessment also reported certain departures from the OECD sub principles.

Principle IV: The Role of Stakeholders in Corporate Governance

EN

In its 2003 Corporate Governance Country Assessment, the World Bank rated Hungary's observance with the sub-principles of Principle IV as follows: "Stakeholder rights respected," "Redress for violation of rights," "Performance-enhancing mechanisms," and "Access to information" were all rated as "largely observed," indicating that only minor shortcomings are observed, which do not raise questions about the authorities' ability and intent to achieve full observance in the short term.

The World Bank advised Hungarian authorities to pay attention to international developments with regard to the use or abuse of stock options and also recommended an assessment of creditor rights and insolvency framework. More recently, the 2007 EBRD assessment reported certain departures from the OECD sub principles.

Principle V: Disclosure and Transparency

EN

In its 2003 Corporate Governance Country Assessment, the World Bank rated Hungary's observance with the sub-principles of Principle V as follows: "Fair and timely dissemination" was rated as "observed," indicating that all essential criteria are met without significant deficiencies. "Disclosure standards" was rated as "largely observed," indicating that indicating that only minor shortcomings are observed, which do not raise questions about the authorities' ability and intent to achieve full observance in the short term. Finally, OECD sub principles "Standards of accounting and audit" and "Independent audit annually" were rated as "partially observed," indicating that while the legal and regulatory framework complies with the principle, practices and enforcement diverge.

The World Bank recommended reviewing sanctions for non compliance with the applicable requirements, developing a code of best practices, and creating special committees on audit including quality assurance arrangements. More recently, a 2007 EBRD assessment also reported certain departures from the OECD sub principles.

Principle VI: The Responsibilities of the Board

EN

In its 2003 Corporate Governance Country Assessment, the World Bank rated Hungary's observance with the sub-principles of Principle VI as follows: "Access to information" was rated as "observed," indicating that all essential criteria are met without significant deficiencies. "Treat shareholders fairly" and "Ensure compliance with law" were rated as "largely observed," indicating that only minor shortcomings are observed, which do not raise questions about the authorities' ability and intent to achieve full observance in the short term. The sub-principles "Acts with due diligence" and "The board should be able to exercise objective judgment" were rated as "partially observed," indicating that while the legal and regulatory framework complies with the Principle, practices and enforcement diverge. And finally, "The board should fulfill certain key functions" was rated as "materially not observed," indicating that, despite progress, deficiencies raise doubts on the authorities' ability to achieve observance.

The World Bank recommended developing a voluntary corporate governance code and a code of best practices. The 2007 EBRD assessment also reported a few departures from the OECD sub principles. However, some of these issues have since been addressed and the BSE approved a non-binding guide on "Corporate Governance Recommendations" which takes into account the 2004 OECD principles and the latest European Commission legislation.