Ethical Boardroom Summer 2016

Published by Ethical Board Group Limited | www.ethicalboardroom.com

Summer 2016

Keeping it above board Proxy advisory reform act

Will new legislation undermine investors?

The internet of things

an argument for cyber resilience

ERM and internal audit

a golden opportunity for reinvention

Gender equality in Latin America How momentum is starting to build

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The unavoidable shift from shareholders to stakeholders

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Rebuilding trust in Big Business

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Ethical Boardroom | Contents

CONTENTS Commentary

8 10 12

Rebuilding trust in big business The unavoidable shift from shareholders to stakeholders

Culture to capital A healthy corporate culture is vital to the success of any business

Solving the problem of short-termism Rather than accepting the short-term thinking of legal, business and cultural structures, we should focus on changing them

14

Boardroom refreshment Bringing in new directors is a delicate yet valuable way of building a visionary board

16

Corporate governance in Latin America Spending time and resources on governance upgrades will see a positive return on investments

mIDDLe eaSt

18 20

36 38

Trust beyond the boardroom Developing and maintaining relationships to achieve objectives Gender equality in Latin American boardrooms Much needs to be done to achieve greater gender diversity

SoUtH amerICa

42

Global News: Latin America Corporate governance standards, bribery and shareholders

BoarD GoVernanCe

44

Standing in line How a strong control environment has layers that will stop or modify undesirable behaviour

48

Paradigm paralysis in ERM & internal audit The internal audit profession needs to reinvent itself to better respond to the emerging expectations facing senior management and boards

Global News: Middle East Cybersecurity, gender diversity, compliance and corruption

54

Who owns corporate governance in the Middle East?

It is a time of discovery in the MENA but inviting investors and issuers to the table is a step in the right direction

58

BoarD LeaDerSHIP

24

Splitting the CEO and chairman roles Calls for boards to separate the roles of CEO and chairman continue to rise but the benefits are not so cut-and-dried

28

Achieving higher board effectiveness A board will not raise its game unless it commits to a regular and systematic review of its people and processes

32

Autism within the boardroom Recognising and harnessing the potential of neurodiverse employees

4 Ethical Boardroom | Summer 2016

28

Coming out of the shadows Nomination committees are emerging from the shadows and becoming broader, more rigorous and more proactive in their role

Seven steps to successful personal governance Strong and sustainable corporate governance can only happen if those in charge can demonstrate solid personal governance

nortH amerICa

62

Global News: North America Pershing Square, Volkswagen, women on boards and principles of good corporate governance

tHe eB 2016 CorPorate GoVernanCe awarDS

64

Introduction & Winners list We reveal our North and South American award winners

74 12

76

Contents | Ethical Boardroom

aSIa & aUStraLaSIa

66

Global News: Asia & Australasia Investors, ASX and SOE boards

aCtIVISm & enGaGement

68

Activist investors: Staying ahead of the pack Activist investors are here to stay and are changing the business landscape

70

Communicating in a time of crisis The media’s analysis of how a company reacts to a crisis receives almost as much comment as the crisis itself

90

74

Hazards of the right of first perusal Proxy advisory firms aren’t the only ones concerned by moves to limit US investors’ constitutional rights

76

Informing the investor community Empowering investors and changing corporate behaviour by ‘traffic light’ ratings of company performance

eUroPe

80

Global News: Europe Audi, Dutch whistleblowers, BT Romanian SOEs and the BHS scandal

rISk manaGement

54

82

The internet of things: an argument for cyber resilience Being unprepared for the growing threats in a changing digital infrastructure

86

Third-party compliance: Doing the right thing for the sake of it Minimising risk and reputation damage is often a path to the moral high ground

90

Tackling risk in the 21st century Three lessons from decision makers on how to be better prepared

94

Compliance in the insurance industry Changes to the insurance framework in the UAE and Middle East

44

aFrICa

98

Global News: Africa King IV, United Bank, Panama Papers and gender diversity Summer 2016 | Ethical Boardroom 5

Ethical Boardroom | Foreword

Welcome to the Summer 2016 edition of Ethical Boardroom magazine

Theresa May pledges corporate crackdown Moments before discovering she would become the next British prime minister, Theresa May – at an event in Birmingham – outlined new proposals to crack down on boardroom excess and rebuild trust between corporate Britain and voters.

Since the financial crisis of 2008, investors have been under increasing pressure to keep management of underperforming companies accountable for their failures.

May’s bold announcement included plans to put employee and consumer representatives on company boards and place tighter controls on executive pay.

Her discontent is with the effectiveness of non-executive directors who “are often drawn from the same narrow social and professional circles as the executive team”. With workers represented on the boards of companies in many European countries, including Germany, Denmark and Sweden, May pledged to have “not just

6 Ethical Boardroom | Summer 2016

consumers represented on company boards, but workers as well”.

The new Prime Minister has also outlined plans to give shareholders stronger powers to block remuneration packages, making votes binding rather than merely advisory. Her proposals outstrip the current rules that mean companies have to hold a vote on future pay policies every three years.

In this Summer 2016 edition of Ethical Boardroom, Joanne Bouchard addresses how May’s plans illustrate how leaders of organisations must aspire to being held accountable to higher standards, conscious of their duty to serve stakeholders beyond shareholders (page 8).

We also hear from Tim Leech and Lauren Hanlon on why a major paradigm shift in risk management and assurance thinking is necessary to create and better preserve shareholder value (page 48).

Other topics covered in this issue include the Corporate Governance Reform and Transparency Act of 2016, corporate governance practices in the Middle East and the importance of boardroom refreshment.

Contributors List | Ethical Boardroom

Our thanks to this issue’s contributing writers ALISSA AMICO Managing Director, GOVERN, Economic and Corporate Governance Center JOHANNE BOUCHARD Governance and leadership advisor to boards, CEOs, executives and entrepreneurs DONATO CALACE ESG Specialist at eRevalue PATRICIA Q. CONNOLLY Executive Director of the Drexel University LeBow College of Business Center for Corporate Governance NUNO FERNANDES Professor of Finance and Director of Strategic Finance at IMD STEPHEN HADDRILL Chief Executive Officer of the Financial Reporting Council FREDY HAUSAMMANN Managing Partner, Amrop Switzerland and Vice Chair, Amrop EMEA

SARAH HOPWOOD UK International Speaker & Business Consultant GERRY KANE Cybersecurity Segment Director, Risk Engineering, Zurich Services Corporation DAVIT KARAPETYAN IFC Regional Corporate Governance Lead for Latin America and the Caribbean

CRISTINA MANTEROLA On behalf of the Egon Zehnder Latin American Diversity Team DAVID MARKS Managing Director of Levity Crop Science TOM McLEOD Managing Consultant, McLeod Governance

MOHAMMED HASAN KHAN Chief Risk and Compliance Officer, RAK Insurance

JAMES MELVILLE-ROSS Senior Managing Director, Strategic Communications, FTI Consulting

ALISTAIR KING Content and Communications Manager, Bureau van Dijk

ANDREW NINIAN Director of Corporate Governance and Engagement at The Investment Association

TIM LEECH & LAUREN HANLON Tim is the Managing Director; Lauren is a Director at Risk Oversight Solutions Inc

KATHERINE RABIN Chief Executive Officer, Glass, Lewis & Co

JON LUKOMNIK Author of What They Do With Your Money and Executive Director, Investor Responsibility Research Center Institute

MALA SHAH-COULON Executive Director, Corporate Governance at EY SUSAN STAUTBERG Chairman and Chief Executive Officer of WomenCorporateDirectors Foundation

EDITOR Claire Woffenden DEPUTY EDITOR Spencer Cameron EXECUTIVE EDITOR Miles Hamilton-Scott ART DIRECTOR Chris Swales CHIEF SUB Sue Scott ONLINE EDITORS Allegra Cartwright, Hermione Bell PRODUCTION MANAGER Jeremy Daniels MARKETING MANAGER Vivian Sinclair SUBSCRIPTIONS MANAGER Lucinda Green HEAD OF ONLINE DEVELOPMENT Solomon Vaughan ONLINE DEVELOPMENT Georgina King, Rosemary Anderson CIRCULATION MANAGER Benjamin Murray HEAD OF SALES Guy Miller SALES EXECUTIVE Michael Brown PRODUCTION EDITORS Tobias Blake, Dominic White VIDEO EDITOR Frederick Carver VIDEO PRODUCTION Tom Barkley BUSINESS DEVELOPMENT Dammian Botello, Giles Abbott, Gerald Fox, Steven Buckley ASSOCIATE PRODUCER Suzy Taylor ADMINISTRATIVE ASSISTANT Abigail Fitzwilliam HEAD OF ACCOUNTS Penelope Shaw PUBLISHER Loreto Carcamo Ethical Board Group Ltd | Ethical Boardroom Magazine 1st Floor, 34 South Molton Street, Mayfair | London W1K 5RG S/B: +44 (0)207 183 6735 | ISSN 2058-6116 www.ethicalboardroom.com | Ethical Boardroom | twitter.com/ethicalboard Designed by Yorkshire Creative Media | www.yorkshirecreativemedia.co.uk.

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Summer 2016 | Ethical Boardroom 7

Commentary | CSR

Rebuilding trust in big business

The unavoidable shift from shareholders to stakeholders

8 Ethical Boardroom | Summer 2016

CSR | Commentary

Theresa May has taken a stand early in her tenure as the Prime Minister of the UK, calling for corporate Britain to embrace a new vision that includes protectionism, honouring the voices of workers and considering more than just profits when judging whether or not a company has been successful.

Illustration by Brendon Ward www.inkermancreative.com

In essence, I interpret May’s position as a clear request to summon healthy governance and healthy leadership to build, to sustain and to grow healthier organisations. It is a request to fully engage as humans for humans, individually and collectively.

While shareholders are due a just return, it is time for all constituencies to be conscious and aware of their respective roles and responsibilities and to exhibit the will to succeed beyond profits and power. Leaders of our organisations must aspire to being held accountable to higher standards, conscious of their duty to serve stakeholders beyond shareholders. In effect, boards themselves need to realise that their oversight is inclusive of stakeholders’ interests and relentless diligence towards elevated corporate social responsibility (CSR).

Many visionary, successful CEOs, such as Marc Benioff of Salesforce.com in the US, are inspiring other CEOs and their boards to ensure that the needs of all stakeholders are met, not just the shareholders. They understand that the impact on communities, our economic ecosystem and future generations is too great to neglect the stakeholders (a company’s investors, employees, customers, partners, suppliers, consumers, their industries, the environment, local and global governments and their communities). Boards must evolve and grasp that the ultimate realisation of success is beyond just achieving a return on any investments and short-term financial success milestones. With a shift towards organisational health and a long-term outlook, a board is humbly faced with the great responsibility of the outcome of its decisions within a highly interconnected global and digital ecosystem and must assume its responsibility within that ecosystem, ensuring regulatory compliance and readily supporting corporate social responsibility and sustainability.

Moreover, while the board and management have the responsibility to ensure that their organisation complies with legal and ethical standards in achieving results, the board also has a duty to question how performance priorities are established that will not overrun their stakeholders and will not be a source of irrational and/or unhealthy behaviours.

Examining recent corporate scandals, favouring of short-term financial results, unscrutinised strategy and aggressive

Johanne Bouchard

Governance and leadership advisor to boards, CEOs, executives and entrepreneurs performance priorities can often lead management and employees to give preference to achieving results at any cost, considering corporate misconduct, deviant behaviours and bypassing compliance to governance standards, all eventually resulting in systemic issues that we can no longer refuse to address.

Rating whether the performance of our organisations is successful can’t be narrowly dependent on financial metrics, but must intrinsically be tied to human factors: engaged employees, satisfied customers, trusted partnerships with suppliers and consumers, strengthened communities and a social and ecological environment that is not depleted by corporate actions.

This consideration of stakeholders beyond the shareholders is emerging as the sensible model for business globally and here are some of the common denominators I’ve observed in the companies that are moving successfully to this model.

Top-down commitment

The companies that have been most publicly successful in shifting their focus towards this more inclusive definition of success have support for the approach beginning at the very top. The CEO is often the instigator and, at very least, the undisputable leader of the company’s stakeholder-centric vision, and the board and executive leadership team are in clear alignment for the model to succeed.

May’s position is a clear request to summon healthy governance and healthy leadership to build, to sustain and to grow healthier organisations. It is a request to fully engage as humans for humans, individually and collectively When I mentioned Marc Benioff earlier, it wasn’t casual. His commitment to corporate social responsibility is indistinguishable from Salesforce’s commitment – they are one and the same.

This can also be said of Richard Branson, whose personal commitment to water scarcity is expressed through Virgin’s partnership with whole earth water, just one example of his CSR being synonymous with Virgin’s CSR.

Measurable metrics

Saying that a company prioritises stakeholders is not the same as showing that this is happening and measurable data is the best way to show that progress is taking place. One

example is Procter & Gamble’s ‘five priority CSR areas’: human rights, employee rights, environmental protection, community involvement and supplier relations. Each of these five areas can be tracked by specific key performance indicators (KPIs) and P&G employs people whose specific responsibility it is to do just that.

Follow-through

Again, there’s a difference between stipulations that a corporation serves its entire ecosystem of stakeholders and demonstrating that this is more than a public relations gambit. The companies that are truly pursuing this course are able to demonstrate year-over-year growth in CSR metrics and they make the news for more than just profitability and shareholder returns.

Delta Airlines, a US-based airline carrier, for example, made the news recently for distributing $1.5billion to its employees in record profit sharing. The employee benefit was the headline and the company’s reported $5.9billion in 2015 profits became a footnote to it.

Emphasising stakeholders is recognising and conscientiously acknowledging their interests in the entire business ecosystem, not exclusive of achieving and realising financial performance goals. It is paying attention to the role and the responsibilities of corporations in our society and proactively assessing the effect of corporate decisions on society and the environment.

When boards govern, they have an opportunity to establish their commitment to ‘valuing people’ throughout the ecosystem the business affects, as no corporation grows and exists in isolation. A board that commits to serving the interests of stakeholders is more likely to have to adapt its composition, structure, behaviour, CEO compensation and its functioning to this new role. This can be for the greater good and for the good of the company.

Being in tune with a company’s effects on the world it exists within seems so obviously reasonable when stated this way that perhaps the truly remarkable aspect of this shift is that the shift is remarkable at all. In my opinion, it is unavoidable.

Summer 2016 | Ethical Boardroom 9

Commentary | Corporate Culture

Culture to capital Embedding a healthy corporate culture through improving behaviour and high-quality reporting is vital to the success of any business Since the crisis, trust in business has been dented. The public, media, politicians and others are more willing to call out companies when they see actions that are inappropriate or people fail to live up to the ethics and behaviours expected of business.

Today’s digital age, particularly social media, can escalate a problem extremely quickly, causing damage to a business’s reputation and fortunes. Companies must establish a culture that can prevent poor behaviour, which encompasses all levels of the organisation, so it is embedded in the ‘DNA’ of all staff. This will benefit the business itself, as well as its stakeholders, investors and the UK economy in the long term.

At the Financial Reporting Council we are highlighting good corporate 10 Ethical Boardroom | Summer 2016

Stephen Haddrill

Chief Executive Officer of the Financial Reporting Council practice through the Culture Coalition, a collaborative project with the IIA (Chartered Institute of Internal Auditors), CIPD (Chartered Institute of Personnel and Development), CIMA (Chartered Institute of Management Accountants), IBE (Institute of Business Ethics) and City Values Forum.

The aim of this Coalition is to highlight good practice and promote the importance of a healthy corporate culture in sustainable growth and value protection. We have had a very encouraging response from many individuals and organisations who all fed into our report of observations.

This brings together a number of practical, market-led observations designed to help boards and companies establish and embed their desired culture.

Good governance

The FRC strives to promote high-quality corporate governance and reporting in the public interest. Trustworthy information helps meet the needs of investors, generates confidence in the stewardship undertaken by corporate boards and is an important indicator of good culture in action. High standards of corporate governance and reporting are important for the fair and effective functioning of the capital markets that benefits investors, companies and the wider public interest.

We are custodians of the UK Corporate Governance Code, which, since 1992, has played a strong and positive role in defining and helping companies to set down in practice what good corporate governance means. The Code is not a rulebook and the FRC does not wish it to be viewed as such.

The comply or explain approach gives companies flexibility in how they govern

Corporate Culture | Commentary HEALTHY CULTURE Organisations need to create an environment of support and harmony

themselves. Boards should give extensive thought to how they apply the principles of the Code and consider carefully when they wish to depart from its provisions, providing a clear rationale when this is the case.

The FRC is aware that strict adherence to the principles and provisions of the Code is not, on its own, necessarily an indication that company culture is completely healthy.

Codes set out principles for best practice that, if followed, make bad behaviour less likely to occur; and public reporting can make it harder to conceal such behaviour.

But, by itself, a code does not prevent inappropriate behaviour, strategies or decisions. Only the people, particularly the leaders within a business, can do that.

The board must define the purpose of the company and what behaviours it wishes to promote in order to deliver its business strategy. It involves asking questions and making choices that will benefit the company now and in the future. This focus on the longer term was underlined in 2014 when the Code introduced a ‘viability statement’ to strengthen boards’ attention on the longer term and the sustainability of value creation. This will also provide

investors with an improved picture of the state of the business and its prospects.

Through the Culture Coalition the roles of the board, executive management, CEO and middle management have been explored.

Boards and executives play different roles.

The board’s role is to influence, assess and monitor culture while the executive role is to drive and embed culture throughout the organisation. The two are most powerful when the purpose and values of the company are linked to its strategy and business model.

Many argue that the CEO is the single person with the most influence on culture.

Boards have a responsibility in selecting, performance managing and holding CEOs to account. It is important to embed the values throughout the organisation through engaging middle management, aligning HR processes – from job advert to training and development – and ensuring appropriate reward structures.

Investors also have a role to play in ensuring a viable culture is in place and should engage with companies to build understanding of their long-term strategy.

This is encouraged by the FRC’s Stewardship Code. The Stewardship Code, launched in

Companies must establish a culture that can prevent poor behaviour, which encompasses all levels of the organisation, so it is embedded in the ‘DNA’ of all staff

2010, has increased the quality and quantity of engagement between directors and investors. Many investors and companies approach engagement in a spirit of trust, openness and constructiveness, which are key elements in any corporate culture.

Focus on investors

Adopting a more stakeholder- as well as shareholder-centric approach is a vital component of corporate success and essential to building trust. A positive culture is one that seeks to take proper account of shareholder and stakeholder concerns, backed up by incentives, clear communication and training opportunities to promote the delivery of value.

We intend to explore these and other findings in more detail at our annual FRC conference, Culture to Capital: Aligning Corporate Behaviour with Long-term Performance.

When there is a healthy culture, the systems, the procedures and the overall functioning and mutual support of an organisation exist in harmony. Boards need to ask the right questions and make the right decisions that will help foster a suitable culture that can then be entwined into the business model. This will contribute to the overall success of your business and create an environment on which investors can depend and that will continue to prosper in the long run.

Summer 2016 | Ethical Boardroom 11

Commentary | Short-termism

Jon Lukomnik

Author of 'What They Do With Your Money' and Executive Director, Investor Responsibility Research Center Institute

Solving the problem of short-termism Instead of accepting the short-term thinking of legal, business and cultural structures in capital markets, we should focus on changing them Issues around short-termism are near the top of the agenda for virtually every board member concerned with sustainability – and for good reasons.

Larry Fink, CEO of BlackRock, the world’s largest investor, made headlines worldwide with his letter to CEOs, asking them to combat the forces of short-termism.1 An academic study found that three-quarters of senior American corporate officials would not make an investment that would benefit a company over the long run if it would derail even one quarterly earnings report.2 Investors overdiscount the future, meaning that they don’t fully appreciate cash flows more than a few months away and there is no reason to think corporate officials or board members are any less myopic. “This is a market failure,” explains Andrew Haldane, chief economist of the Bank of England.

“It would tend to result in… long-duration projects suffering disproportionately… including infrastructure and high-tech investments… often felt to yield the highest long-term returns and hence offer the biggest bang to future growth.”3 Such myopia also reduces boards’ willingness to deal with systemic risks, such as climate change. The “tragedy of the horizon” is how Bank of England governor Mark Carney termed that failure.4 Underinvestment and inaction in the face 12 Ethical Boardroom | Summer 2016

of risk are symptoms. What is the cause?

Absent discovering how and why what may be called ‘Economic Attention Deficit Hyperactivity Disorder’ infects the boardroom, the odds of reversing it are slim. Many directors claim they react to investor pressure, so let’s start there.

Investing for the long term used to be the rule. Even in the 1930s, following the Great Depression, the average holding period of a New York Stock Exchange traded stock was 10 years. It is now around six months. While high-frequency traders certainly have some effect on that number, even traditional institutional investors turn over the entire value of their portfolios every year, on average.5 Why? The list of what has changed is lengthy. Technology has changed trading, resulting in less frictional cost. Fixed commissions are ancient relics. Capital has been democratised in most developed markets. The list goes on and on. But two root causes often escape scrutiny: the business model and the culture of the investment management industry. Simply put, they incline

Short-termism | Commentary

towards trading, not investing and ownership. We should understand them as ground zero for the short-termism epidemic.

Today’s investment industry is dominated by modern portfolio theory (MPT). Developed in the early 1950s, MPT popularised such basic concepts as diversification, which have proved a boon to investors and society. But it changed the focus from companies to the securities they issue.6 MPT enabled the idea of benchmarking returns against ‘the market’, for instance, comparing how your portfolio of stocks did against the FTSE 100 or CAC 40. The result is a marketplace in which trading is the primary tool managers use to try to beat the market.

There is a business reason for this: investment managers are paid based on the amount of assets under management and relative performance drives investment flows.

But it doesn’t necessarily help the end investor.

Indeed, most traders trail the overall market.

But they feel a need to distinguish themselves from their competitors. This need for relative, not absolute, is pervasive and perverse, even stopping some investors from taking action that they know would benefit their investors over the long term. So, for example, one large investor admitted that devoting resources to stewardship, rather than trading, is not desirable because, though it would reward the people who invest through his funds, it would not give his investors “a benefit that is distinct from other shareholders”.7 The dominant culture of investment management firms reinforces the short-termism of the business model.

Two-thirds of all institutional money managers trade more than they anticipate or even want. While they cite a number of motivations, one is that culture affects them: they sometimes trade to justify themselves. In the face of fast-moving markets, it’s hard to sit and not trade, even when that is the right thing to do. Behavioural biases and culture play a role in STRATEGY RETHINK rapid-fire Tackling short-termism goes beyond the boardroom trading.8

Yes, many investors have become short-term focussed, but rather than build defences against Economic ADHD at the boardroom door, we invited it in.

We now compensate executives largely in equity-linked compensation. The purpose of that is to align corporate management (and sometimes corporate directors) with how investors think. The unintended consequence has been to bring short-termism into corporate strategy. We should not be surprised that when we pay people in a currency that moves up and down with every market movement, those people care about those market movements.

So what is to be done?

In general, the proposed solutions divide into two complementary camps. The first aims to reinstate balance in the boardroom.

Among the best-known ideas are suggesting that US companies end quarterly guidance9 and lengthening the measurement period for executive compensation and changing the performance measures to better focus on drivers of a company’s future growth rather than stock market price.10 But it is the second area of focus that may be more effective in the end. The members of this camp ask what the purpose of a capital market is and does the level of trading serve that purpose? In effect, they attack the root cause of short-termism: if capital markets can be refocussed on investing and owning, rather than trading, then board members will be encouraged to focus on sustainable growth over time.

These reformers are reexamining fundamental assumptions in all corners of the capital markets: Legal – James Hawley, Keith Johnson and Ed Waitzer have written a succession of articles arguing that fiduciary duty is, and should evolve to consider longer term sustainability issues.11 Business model – Generation Management published a white paper seeking to change how investment managers are paid.

“Most compensation schemes emphasise short-term actions disproportionately… Instead, financial rewards should be paid out over the period during which these rewards are realised.”12 Stewardship – The International Corporate Governance Network, representing asset owners and asset managers in 47 countries with $26trillion under management, was scheduled to unveil its stewardship principles in June.13 Culture – This year, London Business School instituted a requirement that all Masters in Finance graduates must take a course entitled The Purpose of Finance.14 Hopefully, other universities will follow its lead.

Empowering savers – Shareaction is an organisation that monitors investment managers on behalf of savers. It believes that long-term thinking is “the best way to guarantee healthy returns”. After a decade in the UK, it has expanded to Europe and is rumoured to be considering a US initiative.

Short-termism is an epidemic. It is antithetical to sustainability and an unwanted intruder in the boardroom. Combatting short-termism will require attacking it, not only in the boardroom, but also in the capital markets where it originated.

Letter from Lawrence Fink, February 1, 2016. 2John R. Graham, Campbell R. Harvey and Shiva Rajgopal, The Economic Implications of Corporate Financial Reporting, Journal of Accounting and Economics 40, nos 1-3 (December 2005); 3-73. 3Andrew Haldane, The Short Long speech, May 2011. 4Mark Carney, Speech, September 2015 5James Saft, The Wisdom of Exercising Patience in Investing (Reuters, March 2, 2012). 6Harry Markowitz Portfolio Selection, Journal of Finance 7, (March 1952): 77-91. 7Financial Times, June 16, 2003. To Jones to Keep Citigroup Fund Unit on Song. 8Danyelle Guyatt and Jon Lukomnik Does Portfolio Turnover Exceed Expectation?, Rotman International Journal of Pension Management 3, no 3 (Fall 2010): 40 9See for instance, http://www.aspeninstitute.org/sites/default/ files/content/docs/bsp/EGInFocus.pdf . Accessed May 29, 2016. 10IRRC Institute and Organizational Capital Partners, The Alignment Gap between Creating Value, Performance Measurement and Long-term Incentive Design, 2014. 11See for example, Hawley, Johnson and Waitzer, above, as well as articles in the Cambridge Handbook of Institutional Investment and Fiduciary Duty (2014), 12Generation Investment Management, Sustainable Capitalism, February 15, 2012. 13www.icgn.org. Accessed May 30, 2016 14https:// www.london.edu/education-and-development/masterscourses/masters-in-finance/programme-content/corecourses#.V17PIzUuwcE. Accessed June 13, 2016 1

Summer 2016 | Ethical Boardroom 13

Commentary | Board Succession

Susan Stautberg

Chairman and Chief Executive Officer of WomenCorporateDirectors Foundation

Boardroom refreshment Bringing in new directors is a delicate yet valuable way of building a visionary board As industries, markets, technologies and geopolitical realities become more disrupted each day, how can boards best respond? Uncertainties about even short-term developments are forcing companies to think more carefully about who will steer the company through this unknown future – including the people sitting around the boardroom table.

Even as external forces are shifting more rapidly than ever, board turnover within companies remains persistently low. The American Spencer Stuart Board Index reports that only 376 new independent directors were added to the S&P 500 in 2015 – averaging just 0.78 new directors per board. And the average age of independent directors is 63.1 – more than two years older than it was a decade ago.

But at the same time, there is a growing movement for shake-ups in the boardroom.

Both activist shareholders as well as more vocal traditional investor groups – from CalPERS to BlackRock to State Street – are demanding fresh blood on boards and many are calling for more rigorous director evaluations and for explanations defending board candidates’ qualifications.

Refreshment – a challenging topic for boards

This greater scrutiny of directors has posed a challenge for boards around the topic of board refreshment, with strong feelings on both sides of the issue. There is understandable resistance about moving fellow directors off the board. Even if many directors have

14 Ethical Boardroom | Summer 2016

experienced a circumstance in which a board member was not actively contributing to the company’s governance, if not actually damaging the company, the situation is fraught and very delicate; no one (well, few of us) wants confrontation.

And most companies lack the processes that make director roll-off easy. The 2016 Global Board Survey conducted by the WomenCorporateDirectors Foundation (WCD), Spencer Stuart, Professor Boris Groysberg and Yo-Jud Cheng of Harvard Business School and researcher Deborah Bell – surveying corporate directors from public and large private company boards in 60 countries – reported that only 36 per cent said that their companies had term limits for directors and only 26 per cent of respondents said that their companies had a mandatory director retirement age.

But directors themselves are often at odds with these policies. Sixty per cent of directors in this survey believe that there should be term limits for directors and 45 per cent believe in a mandatory retirement age. The actual practice at these companies has not caught up with directors’ opinions.

The question of measuring director effectiveness – beyond just relying on wait-it-out term and age limits – has certainly gotten more traction in recent years. More than two-thirds of the board survey respondents (68 per cent) said that their

MUSICAL CHAIRS Board refreshment is an important best practice for many boards today

Board Succession | Commentary boards conduct performance evaluations of directors. More than 30 per cent of these companies bring in external, third-party firms to conduct the evaluations and more than a third of the directors claimed that their board has used a director evaluation to move a person off the board.

Exiting a board member appropriately can vary widely, depending on the person involved, the length of their tenure and the relationships with their fellow board members, so the decisions made around this must be made on a case-by-case basis. And there are many who argue against even the most ‘objective’ of roll-off criteria, such as term limits. For example, if a company is experiencing a period of sudden crisis or other disruptive change, would an age or term limit remove a strong and longstanding director just when continuity is needed the most?

Does a director’s deep knowledge of the history and ‘DNA’ of a company provide value when the core mission might be in question?

Keeping the board visionary These are important – and tough – questions for any board and ones that rightfully cause boards to often move slowly in making decisions around

If a board is to be visionary – to bring not only oversight and insight to the company, but also foresight – it must strive to continuously ensure that the best mix of directors is sitting around the table both general policies of board renewal and individual cases of directors who may need to move on. But board refreshment – whether through objective criteria, such as age and term limits, or through meaningful performance evaluations and requirements,is, for many, an important best practice for boards today. If a board is to be visionary – to bring not only oversight and insight to the company, but also foresight – it must strive to continuously ensure that the best mix of directors is sitting around the table.

A recent governance report from WCD and the KPMG Board Leadership Center – Seeing Far and Seeing Wide: Moving Toward a Visionary Board – emphasises the value of keeping boards continuously honed. “Even the most visionary board will become myopic if not enough effort is made

to keep it fresh,” says the report. “To keep the board future-focussed and expansive in thinking, directors must be held accountable for meeting expectations and moving on if circumstances change.”

The authors of the report – a diverse, global group of directors and board advisors with decades of direct experience on boards – do acknowledge the challenges around board refreshment: “This is among the most difficult issues faced by many boards and handling it well requires courage and tact,” they say. Yet there is consensus from the authors in making sure that the board is always keeping an eye toward what is needed for the future: “Even with the best directors, circumstances change and the board may need skills and experience that are different from those that added value in the past.”

Selecting the right tool in the refreshment toolbox

Bringing these different skills and experience onto the board can take many forms. Refreshment might require term or age limits, or individual director evaluations – along with moving directors off who don’t hit their marks. But it also might mean a robust director training and education programme that can bring current directors up to speed in terms of industry or geographic knowledge or technology changes that are part of a company’s strategy going forward.

Directors may disagree with the tools for refreshment, but almost all can agree that being visionary requires that boards take a hard look at the people around the table and ask: Do we have the right people on the board? And, if not, what are we going to do about it?

Summer 2016 | Ethical Boardroom 15

Commentary | Latin America

Davit karapetyan

IFC Regional Corporate Governance Lead for Latin America and the Caribbean

Corporate governance in latin america Companies in Latin America that invest time and resources into corporate governance upgrades will see a positive return on their investments Recently, International Finance Corporation (IFC) was considering an investment in a particular Colombian state-owned enterprise. As we evaluated this prospect, we naturally looked at the enterprise’s corporate governance and ways to mitigate the risk of political interference, in line with the just-updated OECD (Organisation for Economic Co-operation and Development) Guidelines on Corporate Governance of State-Owned Enterprises. We held fruitful discussions on relevant governance modifications and on implementation timing.

But then, we hit a roadblock. At issue was the removal of the ministers from the company’s board of directors. The government parties resisted this measure. On the surface, it appeared that they just didn’t want to do it because this was yet another change being imposed on them from the outside.

A look beneath the surface revealed that the company actually had good reason to push back. The removal of all ministers at once would have meant a significant loss of leadership continuity and institutional, industry and market knowledge. Company leaders believed that the institution would need this presence during the early years of new investment as the company’s business operations expanded.

Such episodes are not uncommon. They represent a classic corporate governance conundrum, as investors, regulators and other external forces pressure companies for a blanket set of improvements without regard to their unique circumstances. The companies might not have the capacity or the political 16 Ethical Boardroom | Summer 2016

will to take them on in the time frame desired.

Moreover, excessive governance requirements might not produce the value added for investors themselves.

If the mismatch remains unresolved, the risk is that companies will do only the minimum needed to obtain the investment.

And, more than likely, they will have invested time and money in a formal governance exercise that will not yield tangible benefits of better governance – improved company performance, reduced risk, greater operational efficiency, better access to capital, stronger strategic decision making and increased shareholder value, among them.

The company perspective: why fix something that isn’t broken?

With the exception of a few enlightened companies, governance upgrades are not inherently high up on Latin American companies’ agendas. It is a natural inclination to maintain what seems to be working just fine – call it the “Why fix something that isn’t broken?” syndrome – particularly if a change is going to cost money, take up time and disrupt the status quo.

latin america companies say pressure to change is key reason for corporate governance improvements Accessing capital or reducing cost of capital

Achieving better operational results

Ensuring sustainability Resolving governance issues in family-owned businesses

MOTIVATION

Facing external market pressures

Balancing (sometimes) diverging shareholder interests

1 Source: Practical Guide to Corporate Governance: Experiences from the Latin American Companies Circle

Some of Latin America’s top companies – regional corporate governance leaders and members of the well-respected Latin American Companies Circle – have cited the presence of a force pushing for change as the most common motivation for corporate governance improvements. But when forced to make sweeping changes that include actions that might not be relevant or could cause unintended consequences – as with the Colombian enterprise – company owners may procrastinate on implementation. Or, they may agree to changes on paper that will never be integrated into day-to-day practice. Even if they agree to changes and have the best intentions, their capacity to effect change in a way that would contribute to their bottom line might be overestimated.

The investor perspective: desire to protect their investments

On the other hand, investors want the maximum. And they want it yesterday.

They want their clients to follow internationally accepted best practices – or as close as they can get to this standard. They want to establish checks and balances over decision making. And they want transparency in the use of company resources and operations. This way, they can maximise their ability to influence the direction of the company and protect their rights and interests.

Investors, especially foreign investors, will push for an even greater degree of governance modifications, often to meet minimum requirements from their own markets. In such instances, companies may be pressured to take on more than they can handle or faster than they can implement.

The result is compliance as a formality. Such was the case of the Latin American company with an important American investor. To meet US regulations, the company was asked to set up several board committees, including an audit committee. The five-member board, comprised of representatives of the controlling family and the investor, complied with the

Latin America | Commentary

directive and set up the committee – on paper.

In actuality, the audit committee never met.

So, the company remained vulnerable to the problems that the ‘good governance’ was intended to prevent.

Finding common ground: negotiating for CG actions that meet everyone’s needs

At IFC, we have seen the value in an approach that starts by analysing the investee’s strategy, operations and plans going forward to understand the unique corporate governance risks they face. This analysis happens as part of our standard due diligence process for every investment. Then we design appropriate governance solutions, along with contractual enforcement mechanisms, to address the risks. This leads to positive outcomes, both for the company and for us as development finance investors.

In the end, it’s the approach that worked for the Colombian state-owned company. We negotiated with the company’s representatives to settle on a mutually acceptable solution: gradual removal of the ministers from the board and an independent chairman.

Corporate governance improvements almost always start as a compliance exercise but, if done right, companies will come to see the value over time What starts as a compliance exercise can end as a value creator Corporate governance improvements almost always start as a compliance exercise but, if done right, companies will come to see the value over time. Listed companies must meet regulatory requirements. Unlisted companies in search of capital must meet investors’ own governance requirements.

But one has only to look at business headlines in Latin American newspapers to see that minimum compliance with governance requirements – compliance for compliance’s sake – will not be enough to protect a company from risky corporate behaviours.

However, if done right, companies will come to see the value of meaningful corporate governance enhancements and embrace the process as their own.

Evidence from Latin American companies shows that a high quality corporate governance system can make a real difference. One recent empirical study reveals a 21.7 per cent average return on equity for firms affiliated with the

Companies Circle compared to a 16.7 per cent average return for more than 1,000 listed Latin American companies. The Companies Circle member firms, recognised for their corporate governance leadership, also reported better ability to withstand market downturns, such as the global financial crisis.1 At a time when the World Bank estimates that the Latin American region is expected to face another year of weak economic performance, finding the right match between investor needs and company appetite for governance improvements is more important than ever. It will ensure that the companies investing time and resources into governance upgrades will see a positive return on these investments. This will help strengthen companies so they can weather volatilities and attract the capital they need to prosper. And the resulting uptick in economic activity will create jobs, encourage development and contribute towards a return to regional growth.

A Practical Guide to Corporate Governance: Experiences from the Latin American Companies Circle, International Finance Corporation, 2009.

1

Summer 2016 | Ethical Boardroom 17

Global News Middle East

RAK businessman accused of embezzling billions

Cybersecurity rises up the corporate agenda Cybersecurity has become an increasingly important issue for non-executive directors in the Middle East, according to a survey by Deloitte.

The EMEA 360 Boardroom Survey found that growing awareness and higher priority is being given to cyber risk issues, as well as an increased focus on innovation and digitisation.

Despite its importance, less than half of those surveyed said that their organisation had an action plan in place to deal with cyber risks and just five per cent said they had

UAE companies get compliance extension Businesses in the United Arab Emirates have been granted an extra year to comply with the new Commercial Companies Law, aimed at raising levels of good corporate governance.

Reforms to strengthen the legal and regulatory landscape in which business is conducted in the UAE came into force on 1 July 2015 with companies given until the end of June 2016 to make mandatory amendments or face being automatically dissolved.

The decision by the UAE’s Ministry of Economy to extend compliance with the new Commercial Companies Law by one year to 30 June 2017 has been welcomed by John Martin St. Valery, CEO of Dubai-based Links Group.

Writing in Gulf News, he said: “Ensuring that companies have adequate time to comply with the new law signals to us the willingness of the government to support private sector growth.”

18 Ethical Boardroom | Summer 2016

nominated a current board member as their cybersecurity expert with the remainder either believing that this was a matter for collective board responsibility or that management dealt with it.

Digitisation was ranked 12th in boardroom priority, up seven places from last year’s ranking, with digital innovation also high on boards’ agendas. Only nine per cent said that their organisation did not have an innovation plan, with six per cent of those claiming they were in the process of developing one.

Too few women in the top spots

The Middle East is undervaluing the talents of half its workforce, says a co-author of a book highlighting the low percentage of working women in the GCC compared to the rest of the world.

Game Changers: How Women In The Arab World Are Changing The Rules And Shaping The Future claims that as few as five per cent of leadership roles in the Gulf are held by women.

“Given the fact women on average in this region outperform men in all educational areas, it is having an impact on productivity and on positivity in the workplace,” says David Jones, who co-wrote the book with fellow researchers Sophie Le Ray and Radhika Punshi.

The book suggests that no amount of effort will be successful without “cultural, behavioural and attitudinal shifts to the concept of greater diversity and inclusion among women and especially among men”.

The Government of Ras Al Khaimah has accused the former chief of its investment authority, Dr Khater Massaad, of stealing $1.5billion.

According to a dispatch carried by the UAE’s state-run WAM news agency, Dr Massaad “has already been tried and convicted by the UAE Criminal Courts for corruption and fraud” and is facing further criminal charges following “global embezzlement and mismanagement”.

The news agency claims investigations have “exposed Massaad’s corrupt conduct and dealings and demonstrate practices which have affected many countries, including Bangladesh, the UAE, Nigeria, Switzerland, Georgia, and the DRC”.

New governance code in Oman comes into effect Oman’s new code of corporate governance will help companies run their activities more efficiently and will also give a boost to corporate social responsibility, according to the Capital Market Authority (CMA).

The code, which came into effect on 21 July 2016 after a year’s ‘grace period’, places emphasis on transparency, accountability, fairness and responsibility in the boards and managements of all listed companies.

The new code stipulates that directors who have been elected for the first time or re-elected must undergo some qualification in corporate governance and sustainability through training programmes at a company’s expense.

Middle East | Corporate Governance EVOLUTION OF GOVERNANCE All countries in the Middle East, bar Iraq, have implemented new or revised governance codes

Who owns corporate governance in the Middle East?

Alissa Amico

Managing Director, GOVERN, Economic and Corporate Governance Center

As a field of research, corporate governance emerged on the stage in the 1990s and has managed to stay in the role of a leading actor for the past 25 years.

Corporate scandals uncovered by the latest financial crisis have undoubtedly helped underpin it as a research field of relevance to corporations and their investors and regulators.

While the notion of good governance has different meanings, depending on the legal 20 Ethical Boardroom | Summer 2016

and regulatory frameworks, ownership structures and the leadership of individual companies, there is universal acceptance that governance is necessary to enhance corporate performance or, at the minimum, to mitigate risks and protect shareholder equity.

In the Arab world, corporate governance standards emerged initially in the banking sector as banks were – and to this day remain – the most important financial sector institutions in the region, while capital markets have been slower to develop. Securities

regulators in the region started to pay attention to corporate governance 15 years ago when Oman and Egypt introduced first corporate governance codes aimed at listed companies.

Since then, all countries in the first region except Iraq have introduced and revised their corporate governance codes, most of which now apply to listed companies on a comply-or-explain basis.

Revisions and upgrading of existing rules

The regulators’ approach to governance has

Corporate Governance | Middle East been dynamic: only in the past year, Kuwait and Oman have both substantially revised their corporate governance codes while Saudi Arabia and Egypt are currently in the process of revising their codes and related regulations.

Most corporate governance codes in the region are now broadly in line with international standards, although in a few countries, such as Morocco and Egypt, they still apply on a voluntary basis and progress has been slower to realise than, for example, in Gulf markets.

In parallel, the companies law has also seen significant evolution in Kuwait, Saudi Arabia and the United Arab Emirates in the past three years, positively impacting corporate governance practices in privately held companies. Although this is a step in the right direction, policymakers need to give further consideration to the governance of large family-controlled firms as many of them are effectively ‘too large to fail’ and getting their succession planning right is fundamental to their sustainability. The failure of a large family-controlled conglomerate in the region would have a ripple effect on the domestic banking sector.

Less evident progress has been made with respect to governance of state-owned firms.

Unfortunately, in most countries of the region, state-owned enterprises are not subject to company laws with the result that their standards of governance remain generally lower than in listed and private sector firms, except for companies such as SABIC and Etisalat, which have been partially privatised through public equity markets. The transfer of state-owned firms to sovereign funds that has occurred in Bahrain and is currently taking place in Saudi Arabia has proven to improve their efficiency and governance practices.

Governance primarily driven by compliance

And yet, in working with policymakers, regulators, and companies in the region over the past decade, the phrase that constantly emerges in conversations is that corporate governance requirements are essentially viewed by boards and management as a compliance exercise. One of the reasons underpinning this compliance-oriented approach to governance is the low level of institutionalisation of most equity markets in the region. Our analysis of the ownership structures of MENA-listed companies indicates that private pension funds account for only three per cent of the market capitalisation of MENA equity markets, investment funds for six per cent and alternative investors, such as private equity and hedge funds, for only one per cent.

Another reason is the low levels of interest and capacity of domestic institutional investors to act as stewards of the companies in which they have investments. The levels of investment in equity markets by domestic pension and mutual funds and insurance companies is lower than in OECD countries,

and sovereign investors are dominant owners in most equity markets, followed by family offices. While across the region, sovereign investors account for more than 40 per cent of the overall market capitalisation, they generally do not participate in the governance process except by nominating directors in companies where they have block holdings.

A third important reason why advancing good governance practices – whether diversifying boards or providing better disclosure – has been challenging is linked to the fact that Arab companies do not ‘vote’ in the adoption of these requirements.

While corporate governance codes and regulations are occasionally subject to a consultative process, this is not always the case and the process of soliciting their views is often unstructured.

Weak involvement of the private sector

Listed companies are clear stakeholders in the regulatory process and hence should be involved in the process of developing standards or recommendations on corporate governance.

Investors also have a role in defining standards and need to be engaged, if not for any other reason then to encourage them to consider their own stewardship capacity. And yet, in most Arab countries, corporate governance in listed companies remains in the clear turf of securities regulators.

In the GCC countries which have the largest equity markets in the countries, corporate governance codes were introduced by securities regulators (except in Bahrain, which has a unified regulator) with whom the vast majority of regulatory and enforcement powers

In the Arab world, corporate governance standards emerged initially in the banking sector, as banks were – and to this day remain – the most important financial sector institutions in the region, while capital markets have been slower to develop are vested. Until recently, exchanges had few roles in defining and enforcing governance requirements - the few notable exceptions are exchanges in Morocco, Egypt and Oman.

Only in Morocco the corporate governance code was a result of the work of a commission with public and private stakeholders. The consequence of this approach is that the private sector often perceives governance requirements as being arbitrarily imposed, which hence, limits its role to arguing in favour of a ‘light touch’ regulatory approach.

For example, in Kuwait, the first corporate

governance requirements adopted were made mandatory and companies grappled to adapt to their requirements until more recently the code was changed to a comply-or-explain basis. In Saudi Arabia, the regulator has, over the years, moved to a more consultative decision-making process, making governance codes available online for a public consultation.

Stock exchanges gaining more responsibilities

Although historically exchanges in the region had few self-regulatory powers, including in the area of governance, this is changing as a number of them are currently privatising and demutualising. The Kuwait Stock Exchange is the first exchange in the region to have transitioned from state to private ownership earlier this year and the Bourse de Casablanca is close to completing its demutualisation. The Saudi Stock Exchange and Beirut Stock Exchange have announced plans to privatise; Oman and Jordan are considering corporatisation.

It may appear paradoxical that exchanges in the region are inheriting regulatory responsibilities and moving towards the self-regulatory status at a time when they are transitioning to private ownership and management. Globally, exchanges’ transition to private ownership has often been accompanied by a reduction of regulatory authority, in particular with reference to their own listing. Self-listing is so far rare in the Arab world, with only the Dubai Financial Market being traded on its own platform.

For the evolution of governance in the region, the fact that Arab exchanges are gaining some regulatory authority is likely positive, especially considering that they will continue to operate with a public good perspective and hence will be unlikely to engage in any regulatory ‘race to the bottom’.

An important reason for this is that stock exchanges in the region are closer to the private sector than securities regulators, as many of them have brokers and other private sector participants on their boards.

How to improve investor engagement

The private sector should be involved in the standard-setting process and doing so would result in its ownership of the devised governance rules. Indeed, a recent report by the French securities regulator (Autorité des Marchés Financiers), which examined corporate governance codes in 10 developed European markets found that only in Spain had the corporate governance code been developed by the regulator in a group of private and public experts. The other nine jurisdictions had various models, ranging from codes being developed by an issuer association (in France) to a corporate governance committee (in Italy) to a dedicated governance watchdog (in the United Kingdom).

Summer 2016 | Ethical Boardroom 21

Middle East | Corporate Governance INVEsTOR ENGAGEMENT Involving institutional investors in the corporate governance debate can create a demand for good governance in the region

In the OECD member countries, codes were developed by regulators in less than half of the countries. Countries such as Germany and Korea have deferred this responsibility to the ministry in charge of the company law. In Hong Kong, a country whose financial sector the GCC countries regard highly, the role of public regulators is limited to monitoring disclosure or breaches of the securities law, as corporate governance rules are mostly supervised and enforced privately.

Giving exchanges more authority over corporate governance opens the door to private sector engagement in corporate governance. Additional private sector engagement in the corporate governance debate in the region could be stimulated in a multitude of ways, drawing on experts from leading corporations, NGOs, institutional investors and family groups.

National corporate governance commissions established in the Netherlands, Italy and other countries have so far only been adopted in Morocco, and in recent years it has been inactive.

Chambers of Commerce are often powerful bodies in the region, especially in the GCC countries, and have the capacity to represent the views of the private sector in the public debate on governance. Institutes of directors and corporate governance centres, which now exist in most countries in the region could also contribute to this process. Last but not least, 22 Ethical Boardroom | Summer 2016

capital markets and investor associations – to the extent they exist in various countries of the region – could also be usefully drawn in the corporate governance debate.

Developing investor and asset management associations, such as the Investment Management Association in the UK or the French Asset Management Association (Association Française de la Gestion Financière), is an important priority for the region in its own right to set and promote self-regulatory standards for the sector. Their engagement in the corporate governance debate can help create a demand for good governance so it is not perceived by the listed companies as a purely regulatory requirement.

What is the benefit for the private sector?

Investors and issuers alike need to realise that by being involved in the regulatory process, they stand to gain by, for instance, arguing for a level-playing field in governance between state-owned and private companies. They also need to realise that raising governance standards is a precondition for attracting foreign investment. They should see their involvement as an opportunity to contribute to this objective. If local institutional investors do not voice their views on the governance of their investee companies, further opening of GCC markets to foreign investors might result in the latter importing engagement tactics.

Ultimately, if the engagement of the private sector leads to a weakening of the requirements in such as way that is

If local institutional investors do not voice their views on the governance of their investee companies, further opening of GCC markets to foreign investors might result in them importing foreign engagement tactics unacceptable to the regulators, they always have the upper hand to bring back the regulatory pendulum in their favour. However, as highlighted by the European experience cited above, the risk of this appears to be low.

The upside of better private sector involvement in the standard-setting process is significant insofar as it can help regulators better gauge obstacles in the implementation of rules and support real ownership of the governance agenda by private sector leaders.

Corporate governance is fundamentally linked to ownership structures and yet the MENA region is still in the process of discovering its owners. So far, the majority stakeholders in the corporate governance agenda have been the securities regulators and this has helped expedite the rule-making process. In a world where stock exchanges were state-owned and where the largest institutional investors were sovereign, this model was arguably efficient and effective.

As markets in the region are undergoing a seachange, inviting issuers and investors to the table where regulatory decisions are taken is an approach that should help further align the quality of corporate governance practices with the aspirations of Arab capital markets for the next decade.

Board Leadership | Management

Patricia Q. Connolly

Executive Director of the Drexel University LeBow College of Business Center for Corporate Governance

Splitting the CEO and chairman roles Calls by analysts, governance experts and legislators for boards to separate the roles of CEO and chairman continue to rise but the benefits of doing so are not cut-and-dried Is splitting the role of chairman and CEO in the best interest of the company? Although the question is hardly new, it continues to be a topic of interest for directors and key stakeholders.

Boards are feeling increasing pressure on two major fronts – both from regulators and activist shareholders who favour separation of the roles.

In 2010, the SEC under Dodd-Frank adopted rules that required companies to disclose in their proxy statements why its board chairman and CEO positions are unified or separated. Since 2005, the S&P 500 Index has received more than 300 proxy proposals from shareholder activists, institutional investors and proxy advisory firms requiring the separation of the two roles.1 Are these stakeholders correct? Let’s explore the facts.

Outside of the United States, having separate chair and CEO roles is much more common. For example, 76 per cent of companies in the FTSE 100 (UK), 50 per cent of companies in the DAX (German) and 55 per cent of companies in the TSE 60 (Canada) had independent board chairs.

2 In the S&P 500 Index (US), 48 per cent of companies have split the chair/CEO role, which is a 19 per cent increase since 2005.

Although there has been momentum in US corporations toward separate roles, one may wonder why there has been reluctance to embrace the concept as quickly as their UK counterparts. For one, the unified role has history and sentiment on its side.

24 Ethical Boardroom | Summer 2016

Corporations with a joint chair and CEO have been operating effectively for years.

Those in favour of a unified role argue that no clear theoretical or empirical evidence exists linking a separate role to increased corporate performance. One research study found no statistical relationship between the independence status of the chairman and operating performance. 3 A second study did not find evidence to support a change in independence (separate or unified) has any impact on future operating performance.4 Furthermore, additional research found companies that split roles as a result of investor pressure have negative returns around the announcement date and lower operating performance. 5

When a board’s chairman is also the CEO, that individual is tasked with driving the operational goals of the firm while monitoring his or her self Supporters continue to argue that a unified chair/CEO role ensures strong central leadership and oversight. Even when faced with declining sales and a $6billion trading loss in 2012, the shareholders of JPMorgan Chase voted to preserve Jamie Dimon’s role of chairman and CEO because they believed in his leadership during a time of financial and economic uncertainty. Analysts in favour of Dimon’s dual role voiced concerns over declining sales at other corporations directly following separation of the role, which

resonated with JPMorgan Chase’s shareholders, despite the lack of scholarly evidence supporting those claims.

Those in opposition of a unified role argue that a combined chair/CEO allows for the corporation’s decision making process to lie in his or her hands with minimal checks and balances. They believe that having a separate chair increases the board’s independence from the management team, which leads to greater oversight. However, the opposition questions the validity that the split of the chair/CEO role actually creates independent leadership.

A 2009 study examined directors considered independent by NYSE standards and those who are socially independent in relation to the CEO. The research found board members who shared social connections to the CEO, but were considered independent by NYSE standards, were likely to pay the CEO more and less likely to fire a CEO following poor operating performance.6 Despite there being no clear evidence that a separated or unified role directly links to increased operating performance, research does lend support to those in favour of the separation of the chair/CEO role in the area of executive compensation. Research conducted in 2012 by the Harvard Law School Forum on corporate governance and financial regulation found that executives in a combined CEO/chair role earned a median of $16million annually; whereas, a CEO plus a separate, independent chairman earned a median of $9.3million combined. It is the board’s responsibility to vote on executive compensation packages, so when the CEO is also the chairman, he or she is voting on their

Management | Board Leadership

own compensation package. In addition to this conflict of interest, issues involving board dynamics may arise. Directors may find it difficult to vote for smaller compensation increases with the chair/CEO a part of the decision making process.

In addition to greater executive compensation packages, studies show that corporations with a combined chair/CEO role present greater risk for investors and provide lower stock returns in the long run. Five-year shareholders see returns 28 per cent higher at companies with separated roles than at those with a unified role.

Additionally, research has found the corporations with a combined role present greater accounting and ESG risk than those with the separated roles.

Due to the separation costing less, presenting less risk and being a better investment, those in favour believe these practical considerations make the case for separate chair/CEO roles.

The role of the board is to provide strategic oversight and to ensure the corporation is operating in the best interest of the shareholders. When a board’s chairman is also the CEO, that individual is tasked with driving the operational goals of the firm while monitoring his or her self. This calls into question if a joint role is good corporate governance. It is believed that a board led by an independent chairman is more likely to better identify areas of improvement within the company that stray from the strategic vision.

It is difficult to expect a single individual to be immersed in the operational details of company all the while self-governing.

It is unfortunate that I end this on a cliché, but clichés exist for a reason. One size does not fit all. I expect this discussion to be ongoing among directors as boardrooms continue to engage in leading practices.

There is no doubt that this topic will remain one of intrigue to investors, regulators and researchers. I personally look forward to continuing the dialogue.

CONFLICT OF INTEREST? The debate over the combined roles of chair/CEO isn’t over yet

1 Larcker, David F. and Tayan, Brian, Seven Myths of Boards of Directors (September 30, 2015). Rock Center for Corporate Governance at Stanford University Closer Look Series: Topics, Issues and Controversies in Corporate Governance No. CGRP-51 2Board Leadership: The Split CEO/Chairman Structure Debate. – Deloitte CFO – WSJ. Deloitte, 29 June 2012. Web. 07 July 2016. 3Boyd, B. K. (1995), CEO duality and firm performance: A contingency model. Strat. Mgmt. J., 16: 301–312. 4Baliga, B. R., Moyer, R. C. And Rao, R. S. (1996), Ceo Duality And Firm Performance: What’s The Fuss?. Strat. Mgmt. J., 17: 41–53.

5 Dey, Aiyesha and Engel, Ellen and Liu, Xiaohui, CEO and Board Chair Roles: To Split or Not to Split (16 December, 2009). Chicago Booth Research Paper No. 09-23.

6 Hwang, Byoung-Hyoun and Kim, Seoyoung, It Pays to Have Friends (August 1, 2008). Journal of Financial Economics (JFE), Forthcoming.

Summer 2016 | Ethical Boardroom 25

Board Leadership | Effectiveness

Achieving higher board effectiveness A board will not raise its game unless it commits to a regular and systematic review of its people and processes

LONG-TERM VALUE Boards should take nothing for granted 28 Ethical Boardroom | Summer 2016

Effectiveness | Board Leadership

Achieving higher board effectiveness goes well beyond adhering to rules, regulations, legal and ethical compliance.

While there are many experts who address the regulatory requirements, an aspect that requires the utmost attention, and is often underestimated and even ignored, is the human element.

That is the basic and subtle dynamics and the complexities inherent in having individuals with diverse experience, different views and perspective, and varied cultural and personal backgrounds gathering a few times a year to serve an entity to which they are not privy on a day-to-day basis. It’s further complicated by the fact that these individuals often don’t know each other outside of their board service.

How can a board maintain its independence, make critical decisions, provide valuable and timely insights to management and be effective as a group of individuals if they have minimal access to the ins and outs of an organisation?

How can they truly assess the leadership potential of the CEO, the board and management and effectively minimise vulnerabilities and risk when they’re outsiders?

There are initiatives that a board should commit to that can heighten the potential of every director within the context of their roles and responsibilities, allowing them collectively to achieve higher effectiveness. It is fundamentally critical to the board’s ability to stay current, effective and focussed in enhancing long-term shareholder value.

These initiatives include: board meeting follow-ups with the chair and the CEO; on-boarding and integration of new directors; educational sessions; strategic planning sessions; and CEO, board and management leadership effectiveness assessments.

Board meeting follow-ups with the chair and CEO

Whenever directors come together to meet to fulfill their roles and responsibilities, the chair and the CEO can’t assume that the directors have felt that they’ve made their optimal contributions; that they didn’t feel intimidated or even shy to share their insights. That they felt at ease with the dynamics of the meeting, were satisfied with the results of the board meeting and were comfortable with the way the chair led the meeting and the CEO interacted as an executive director. It is important for a chair and for the CEO to take the initiative of reaching out to all directors immediately after the meeting to do a simple check-in.

This provides an opportunity to gain input about the meeting’s outcomes as well as following up with each director on a one-on-one basis to seek their views about the meeting. It’s an opportunity to constructively

Johanne Bouchard

Governance and leadership advisor to boards, CEOs, executives and entrepreneurs share their expectations about the director for that meeting and his/her level of preparedness for that meeting and any committee duties, rather than not addressing it or postponing it to an annual board effectiveness assessment.

The individual directors’ effectiveness (including the CEO) as well as the chair’s, are too important not to be handled after each meeting.

These check-ins are significant to ensure that the possible ‘elephants in the boardroom’ are promptly addressed. They also enable each director and the chair, and each director and the CEO to get to know each other better.

In any relationship, it is important to have the ability to readily share what works, what is missing and what could have been done better.

It takes time and, from my experiences with boards, it makes a great difference when every director is prepared to allocate time between meetings to evaluate the prior meeting before attending the next one. These frank exchanges benefit the chair in preparing the agenda for the next meeting and in leading the board meeting itself. Furthermore, it is also the chair’s responsibility to poll each director, in person or over the phone, to get a pulse about his/her ability to stay abreast of the strategy.

integration event can last 30 minutes to an hour and is planned and professionally facilitated, thus ensuring that the board doesn’t create a climate of ‘us and them’ as the board augments and/or is refreshed.

Proper on-boarding and integration enables new directors to quickly get to know the rest of the board and enables all board directors to further connect, respect and trust each other. While a brief session, it is very powerful to welcoming an incoming director and to further integrating all existing directors within the board.

Educational sessions

Our business ecosystem is becoming more complex and is being intermittently disrupted. A board can’t afford not to be current on the trends that can affect their organisation, even if, at a glance, the trend might not appear to have any potential impact on their strategic roadmap. It is important for a CEO with his/her chair to be on top of trends and to identify specific topics that need to be addressed internally at a high level to keep the board informed as a group – but not necessarily within the scheduled meeting, due to time constraints.

I have written in the past about ‘the four pillars’ that make a great relationship between a chair and a CEO. One of the pillars is communication. It is crucial for the chair and CEO to take the time to speak in person, or at On-boarding least on the phone, or remotely and integration via video-conferencing tools How can a board to check in about their It is tempting to let a director join a board and attend his/her relationship, their effectiveness maintain its first meeting without proper in their respective roles and independence, on-boarding. A board can’t to ensure that together they make critical afford for a new director to join address how to keep the board for his/her first board meeting current about market and decisions, without a formal on-boarding industry dynamics. Topics provide valuable can include how the digital process. A director is a human being who is being asked to economy is impacting and timely participate, not to simply fill in the organisation; the insights to a seat. A formal on-boarding cybersecurity evolution and can include a meeting with the its associated threats; new management chair and the CEO shortly after considerations for and be effective strategic the director has been voted in the organisation, vis-à-vis as a group of by the board to formally corporate social responsibility; welcome him/her, confirm shifting the organisation’s individuals their expectations and his/her focus from shareholders to having minimal expectations in having joined stakeholders; making an the board; bring the director access to the ins organisational commitment up to date with any crisis, to sustainability, etc. and outs of an strategic priorities and There is a plethora of topics networking opportunities that a board must address organisation? where he/she could specifically and can’t realistically address provide insights; and to update within their formal meetings. the director about board governance processes This creates an opportunity for the board to the directors need to understand. further align on strategic priorities, to further It is good business, tactful and sensible to ascertain how vulnerable the composition of acknowledge the need to create a proper its board may or may not be and whether the introduction of the board and the organisation board composition needs to be refreshed or for all new directors as well as introducing and augmented. Industry and expert speakers integrating the incoming directors within the can be invited to present and conduct small board. An effective on-boarding and roundtables at these educational sessions.

Summer 2016 | Ethical Boardroom 29

Board Leadership | Effectiveness

Strategic planning sessions

Since the National Association of Corporate Directors (NACD) in the United States stipulates that boards have the responsibility to engage in the development and amendment of strategy, it is imperative for boards to participate in an annual strategic planning session – in addition to each director staying current about the industry trends. Not only are strategic planning sessions important to aligning the board on strategy, but they also contribute to evaluating human behaviour dynamics and assessing the entire leadership potential of the board.

Directors must be and stay fully informed about the organisation they serve. In particular, when directors are independent, they must have knowledge of the industry and about the business they commit to serve, given that they are not connected to the business, meeting only four-to-six times a year. Better aligned boards can be more effective in assessing the accuracy, completeness, relevance and validity of information presented to them.

A board has an opportunity to really see in action the effectiveness of their CEO when participating in the annual strategic planning session. Likewise, a CEO gets the same opportunity to experience first-hand the agility of its board during such sessions.

The adoption of strategic planning sessions enables the CEO to share with the board more openly and for directors to share more openly among themselves, with the CEO and with management. I have often seen as a result of these sessions healthier effectiveness within the entire Pivotal Leadership TrioTM (Board, CEO and Executive Team).

CEO, board and management leadership effectiveness assessment

The effectiveness of a board is highly dependent on having the right leader for the organisation during major and critical strategic inflection points of the organisation, having the right leader of the board with the optimal board

JOINT EFFORT Directors need to work collectively as a board

The chair (and CEO) should commit to an annual strategic planning session.

This initiative ensures that: ■ Board effectiveness is not affected by information asymmetry that would impede its ability to adequately provide guidance, make decisions and constructively challenge the executive team. The board must be continually informed about industry dynamics, the competitive landscape, the organisation’s business model, its value proposition and its strategic milestones. It is unrealistic that a board can approve financial projections, detect overly ambitious production targets and ascertain budgets and profitability objectives without a clear understanding of strategy and key strategic performance indicators ■ The board is exposed to organisational dynamics and to the dynamics of the CEO with selected or most key executive members, which will assist with its identifying warning flags about the company’s strategic priorities and help reconsider performance indicators as needed 30 Ethical Boardroom | Summer 2016

composition, and the right leadership in all functional areas of the organisation.

A board needs to know when the CEO can’t step up to leadership and organisational challenges, as well as when any board director or member of the management team can’t fulfil their role.

CEO leadership effectiveness assessment

For the board to adequately fulfil its duty of addressing CEO succession, it has a responsibility to evaluate the CEO’s leadership effectiveness. A board can’t assume that the CEO has the skill set, experience and leadership maturity to lead the organisation through different stages of growth, crisis and changes.

This initiative should be conducted by an objective third party. The process should include: ■ A custom and comprehensive inquiry, specifically created to evaluate the CEO of the organisation that the board serves ■ A custom inquiry to address the CEO’s role as an executive director on the board

■ In-person meetings conducted between the CEO and a third-party professional, and between each direct report to the CEO and the third-party professional and each director of the board and the third-party professional ■ Presentation of the CEO’s leadership effectiveness results to the CEO and the chair before being presented to the board as a group

Board and management leadership effectiveness assessments

The evaluation of the directors and the management team also needs to be conducted annually to appropriately support overall succession planning. These should ideally be conducted at the same time as the CEO’s to maximise everyone’s time. For the board assessments, the process should include: ■ A custom and comprehensive inquiry, specifically created to evaluate the board thoroughly ■ In-person meetings between directors and the third-party professional ■ Custom inquiries to capture the insights of the CFO, the CHRO and the general counsel ■ In-person individual meetings between the CFO, the CHRO, the general counsel and the third-party professional ■ Presentation of the board leadership assessment results to the chair and the governance chair before they’re presented to the board as a group A similar process needs to be adopted for the management team.

It is good practice for the board assessment inquiry to include a director self-assessment, a peer review and an examination of the governance practices.

Leadership effectiveness assessments are natural processes and need to be positioned as such and should not be threatening.

Achieving higher board effectiveness has to be intentional by all directors, individually and collectively as a board, beyond check lists and formal systematic processes.

Without a conscious intention, a board will not raise the bar of its effectiveness to the level where it can and should operate.

While maintaining independence, the board has to be cognisant of the importance of not assuming anything at any time, not overlooking the need to coalesce on priorities, calibrating and stepping back afresh each time it works together, being in alignment on strategic priorities and refreshing leadership as needed.

Directors can’t afford to underestimate the cultural and values tone they are establishing with their CEO. The board has to pause and ask itself every time it gathers if it is as effective as it should be.

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Board Leadership | Autism

David Marks

Managing Director of Levity Crop Science

Autism within the boardroom

Companies that recognise and harness the potential of neurodiverse employees will reach a broader range of talent I am a scientist, and entrepreneur, a businessman. I have won multiple awards for my work and have been a company director since my early 20s. I have set up businesses that have gone for IPO and developed technology used around the world by some of the very largest multinationals in my industry. I have many patents. I also have a condition, one shared by some of the most influential figures in human history, including Einstein, Newton, Tesla and Turing.

That condition is autism and this article sets out to characterise the condition and to examine why so few autistic people are represented in the boardroom, why we should care and what can be done to improve it.

Autism is a condition characterised by difficulty with social interaction, social communication and restricted interests and behaviour patterns. There are almost as many forms of autism as there are autistic people and each of us is unique.

As a spectrum disorder there are people at either end that are entirely dissimilar.

The public perception of autism often bears little relation to the reality for many autistic people at the ‘higher functioning’ end of the spectrum’.

32 Ethical Boardroom | Summer 2016

Received opinion tends to filter down from portrayal of fictional characters in popular culture. For many people, the archetype for autism is of the form portrayed in the hit movie Rain Man, which has become an unhelpful stereotype to people with autism at the higher functioning end of the spectrum.

This article will focus on people with Autistic Spectrum Disorder (ASD), sometimes called Asperger Syndrome or high functioning autism. This form of autism is commonly stereotyped as being like the character Sheldon Cooper in the popular US sitcom The Big Bang Theory.

Autism is more common than many people realise.

In the UK, it is estimated that around one per cent of the population has autism, or around 700,000 people People with ASD see, hear and feel the world differently to other people. It is not an illness, it cannot be ‘cured’ (neither does it need to be); rather, it is a different type of brain function (neurodiversity) and many people on the spectrum see it as an important aspect of their identity and personality. By definition, people with ASD are level or higher in intelligence than the general (neurotypical) population and many people with ASD are highly

intelligent. They do however have difficulties understanding social cues, reading body language and facial expression, and in communicating. They are often shy and introverted but do not have learning disabilities and indeed are often highly gifted academically in their field of interest.

There is a large mismatch between the mainstream idea of autism as an illness and what many people with ASD are like. The reality is that many people that have autism are highly capable individuals that have a lot of positive attributes to bring to the table. Indeed, many of the most innovative people in world history have had autism.

Autism is more common than many people realise. In the UK, it is estimated that around one per cent of the population has autism, or around 700,000 people. Similar statistics are to be found in other nations with the US at two per cent and South Korea at 2.5 per cent with differences likely down to how good the education system is at testing.

The estimated global population of people with ASD is 31 million people, approximately the population of Canada.

When you consider that ASD is characterised by academic ability being at or higher than average, it is sobering to look at employment prospects for those on the spectrum. In the UK it is believed that only 15 per cent of people with ASD are in paid employment and this in a

Autism | Board Leadership group with above average academic ability.

It is no surprise then that with so few people with ASD able to function in the workplace at all that we don’t see autistic people in the boardroom. This article will explore possible reasons why such a talented pool of people are so underrepresented in the workplace and boardroom.

1

It’s an extroverted world Increasingly, the workplace is an extraverted world and that leaves people with ASD, who are typically introverted and uncomfortable in unfamiliar groups and environments, at a disadvantage. Communal environments are hard places for people with ASD to function as they need a quiet space where they can concentrate without distractions. This goes against the trend for open-plan offices.

They are unlikely to be in the public eye, will be at the back of the queue for any team-building exercise, neither will they be seen much in social media. They may struggle to form friendships with colleagues and be isolated from groups. In a nutshell, they are not visible enough and that can mean that the work they do is overlooked. style 2 Communication People with ASD tend to be very

straight-talking, honest and like to be precise. You may think these are admirable qualities, until you are on the receiving end. Someone with ASD will be the person in the room that will tell you they don’t like a new hairstyle (rather than politely lie), or the one that tells their boss (or the boss of the boss) that their plan is flawed, the one that will be honest about their sales forecast, the one that will tell customers about the downsides of a product.

They will wish to fully understand a situation before making a decision and will insist on having all the detail. They will not drop a point if they feel it important.

They find it hard to know when to enter a conversation and can talk over people and enter into monologue, which can be hard for people to deal with.

They can miss social cues and will not notice if they have offended people. It can be very hard for people with ASD to function on a board as their style of communication can disrupt the flow of conversation and come across as dogmatic and hostile.

People with ASD are not out to win friends INCLUSIVE THINKING and influence people Companies should look and that counts for the best talent against them in the without being blinded by neurological conditions workplace.

Summer 2016 | Ethical Boardroom 33

Board Leadership | Autism

3 Appearance People with ASD do not pay much

attention to social norms and this is sometimes reflected in their dress sense; they can be slightly eccentric and inflexible.

I recently turned up to sign off on a six-figure investment into my company with fluorescent green shoelaces (the others had snapped that morning and I put in a pair I found in a cupboard). It did not occur to me that anyone would even notice, but it raised a few eyebrows.

I have dressed pretty much the same way since school and am unlikely to change. Neither do I much care what other people look like.

Our body language is not normal, either; things that are easy for the general population are pretty hard for people with ASD who frequently struggle with eye contact, knowing when to smile, knowing when to shake hands, etc. We have to work hard to appear normal and learn coping mechanisms. To the casual exponent of body language, we can look shifty or unconfident, which is far from the case.

process (neurodiversity) and way of looking at problems and will often come up with very different solutions. This is an advantage that can lead to innovation and breakthroughs.

It is no coincidence that people with ASD are more prevalent in industries that are less customer facing, such as the science and technology sectors, where it is all about end product. There are studies showing that the proportion of people diagnosed with ASD is far higher than average in Silicon Valley.

This is a pool of talent and thought that really can contribute to business and should be represented in boardrooms. In the same way that failure to have representation from different genders, social or racial backgrounds

of discrimination 4 Fear There are probably more people with

ASD in your business than you realise. It is an invisible minority as there are no outward physical attributes associated with it and due to fear of discrimination many people with autism conceal it. Because of this many people in the workforce are being held back due to lack of support that would enable them to flourish.

In listed companies in particular there can be a culture of prejudice whereby it is commonly thought that autism may be perceived as a negative by investors. This needs to be addressed in the same way any other prejudice would be.

5 Focus What makes many people with ASD

gifted is extreme focus on their area of interest. This is also the facet of their personality that causes them problems. I have been known to spend days without eating and frequently will still be working at 4am, not having noticed the time passing. For someone with ASD, work can become consuming at times. The downside of that is that we can only really focus on one thing at a time, which leads to missed appointments and deadlines sometimes. I have been known to drive 100 miles past my home on the motorway before noticing I missed the turn off when thinking over a tricky problem. Paperwork gets forgotten or lost as I am easily distracted.

Why should we turn this around?

Autistic people have many positive attributes.

The same condition that gives them a social impairment, also gives them an extreme ability to focus on their interests. If those interests coincide with their profession, then people with ASD can become very high achievers given the correct environment in which to thrive.

Autistic people have a very different thought 34 Ethical Boardroom | Summer 2016

Autistic people have a very different thought process and way of looking at problems and will often come up with very different solutions. This can lead to innovation and breakthroughs leads to a lack of innovation, so too does a lack of representation of autistic people.

Neurodiversity leads to diverse problem solving, ideas and outlooks and businesses that tap into this are likely to benefit.

So how might we be able to improve the representation of people with autism in business? n Create an environment for autistic staff that works for them. Let them work hours that suit and let them have their own

space. Don’t force social activities on them and judge them by their outputs n Encourage openness about autism. Many autistic people conceal their condition due to fear of discrimination. Organisations need to do more to more to ensure people with ASD feel able to discuss their condition. Execs need to know a little about ASD. If people at the top are less ignorant then it filters down n Understand how to manage ASD employees’ communication difficulties, rather than just let both sides get frustrated. Some training to help the ASD employee pick up better on cues can lead to better integration n When someone has ASD in senior management or in the boardroom, take some time to manage communication.

If a board member had a wheelchair would you criticise them for being unable to climb the stairs? No, of course not, the company would install a ramp. Similarly, someone with ASD will have problems dealing with the style of communication in a corporate boardroom. This can be managed by some basic training to help the ASD member pick up on cues of when not to speak, and the rest of team understanding how to better communicate with the ASD member n Play to strengths and manage weaknesses.

This is no different to managing anyone, but perhaps with an extreme personality it is even more important. If you have an ASD board member, allocate them the things they shine at. In computing or science-based industries ASD people shine at explaining the technology, but may not be the best spokesperson for HR issues where they may be a little too blunt Of course, autistic people also have a role to play in improving their lot. It is an invisible condition, but maintaining an appearance of normality is hard, stressful and leads to burnout. Autistic people that have done well need to step up to the plate and become advocates for others that share the condition.

I made a conscious decision after many years of not disclosing my ASD, to inform the people I work with and employ as well as my clients and customers that I have ASD. I have been surprised and pleased with the response I have had. I have found that some of the other business people I deal with have confided in me that they also have ASD. This is one of the reasons I am writing this article. I wish to encourage those of us in the business world with ASD to ‘come out’. We owe it to the 85 per cent of the ASD community that cannot get employment to help break down negative stereotypes. We need to show how much ASD employees, entrepreneurs and innovators can contribute. This more than anything else will give the business community the stimulus to be more inclusive.

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Trust beyond the boardroom

Developing and maintaining meaningful and positive relations can build trust and empowers leaders to achieve their objectives

“Stop shouting at him, take him out to lunch and ask him to tell you what he told me.”

The MD just looked at me. He could see I was concerned.

My remit had been to mentor a valued manager who was making odd, inappropriate client-facing mistakes. The three of us agreed on a series of one-to-one sessions over six months. What I didn’t expect after session one was to be highly suspicious that the manager had irrational thought patterns.

Trust is a significant aspect of emotional quotient (EQ). There are five layers of trust: self, relational, organisational, market and societal. Much has been written on the subject, not surprisingly, as low levels of EQ are one of the pivotal reasons for the breakdown of relationships while abundance leads to the success of a team.

I had made a promise. Both MD and manager trusted me, knowing I would only disclose work-related information the manager chose to share. Any private information would remain private.

When we give our word it should be sacred.

If one is not trusted, then people won’t share 36 Ethical Boardroom | Summer 2016

Sarah Hopwood

UK International Speaker & Business Consultant their truth, particularly if they feel vulnerable.

My unexpected dilemma was that the private information was disturbing.

Emotional quotient, better known as emotional intelligence, is the art of identifying, understanding and managing your emotions and those of others and is predominantly about choosing to respond, rather than react. I needed to make sure the MD responded appropriately.

Recognising trust, testing it and, critically, knowing what to do when it is absent empowers leaders and decision-makers to achieve their objectives: to avoid loss and win.

Trust breeds trust. Mistrust breeds mistrust. Motives are key. I once carried out a survey assessing client’s automatic levels of trust when meeting someone for the first time. The reaction?

■ Most said it was 50-50 i.e. there was a level of trust ■ Gasps were heard when the minority signaled no trust

■ The few who voted complete trust were thought naïve What do you think? Most reading would, of course, say “it depends on the circumstances” and rightly so.

How to recognise trust

In my experience, trustworthy people are straight-talkers motivated by something bigger than one person. They confront reality, clarifying expectations while demonstrating respect.

They have the ability to right wrongs; showing accountability coupled with extending trust.

Trusted people keep commitments and show loyalty, transparency and deliver results.

Much of our understanding of trust will be influenced by our personal experience, especially through childhood.

Many years ago, an experiment was carried out assessing the ability of four- to five-year-olds to deny short-term pleasure in order to receive reward, i.e. delay their gratification. They were invited to either eat one marshmallow or wait a short while when the person would return to give them a second portion.

Those who waited blocked their ears and closed their eyes so they couldn’t see or hear

Emotional Intelligence | Board Leadership preoccupied with WIIFM (What’s In It For Me).

Listen or watch out for betrayals: if they are doing it to someone else, they will do it to you.

Smoke and mirrors – you may not be able to pinpoint what isn’t right, however, your intuition will ring alarm bells. You are either consciously or unconsciously spotting incongruences.

Distraction – when someone is drawing you away from the scent. Distraction is designed to interrupt us, selling another thought or seduce us into another scene or picture; tasked to move us from this to that, shifting you away from the evidence.

A questionable circle of friends – we become the average of the top five people we spend most of our time with.

A person with secrets – most secrets should not be.

Blame culture – exhausting and expensive for everyone concerned. Mistrust in that environment is corrosive.

Inappropriate behaviour – when we break our own core values we often display inappropriate or irrational behaviour, from unexpected silence – I call it ‘hitting mute’ – to sharing too much information.

How to test trust

EFFECTIVE RELATIONSHIPS Board members need to establish a mutual trust

the others eating. Very similar to the self-discipline we display when we are acting in trust. Not always easy… but then, no-one has ever said it would be!

The children were then followed for a number of years. It revealed those who deferred the pleasure were happier and more successful.

I wonder how the results would have weighed had they assessed each child’s level of trust; trusting that the person with the marshmallows would return.

From a tender age, many experience a breakdown of trust, especially within the family, so why on earth would they then trust someone outside the family? Trust is a firm belief in the reliability, truth or ability of someone or something. Mistrust is to be suspicious of, or have no confidence in them.

The devil is in the detail. Acts of trustworthy traits are often seen in the little, seemingly insignificant behaviours of an individual or team. What we do when no one is watching.

A good benchmark is seeing how much they trust themselves – that would determine the level of trust I give them.

Signs of mistrust

Untrustworthy characters are often

■ Start by giving them responsibility for resources – you will then know if they can move on to implementation ■ Personal core values reveal where the heart is – ask them for their key words ■ Assess their locus of control – the extent they feel in control of the events that influence their life ■ Bad habits – addictions can be created quickly yet hard to break ■ Use your intuition – always test, though, you could be wrong ■ Fear can drive bad behaviour – it often comes from fatigue and loneliness ■ ‘Show me your friends and I will show you your future’ – look at who is behind the person ■ Bribery, bullying and manipulation might be the cause ■ Hear what you see – may sound odd, but listen hard When recruiting, I use an anagram to assess trust: ■ Transparency – I believe the truth always comes out ■ Respect – how they treat themselves, subordinates & things ■ Universal – ability to see the bigger picture/diversity ■ Suspension – for me this is a great gift ■ Time smart – self-disciplined and doing what they say they will do

The rewards of trust

■ It avoids loss and our levels of influence and authority are protected ■ We develop our character, above reputation. A good reputation

should be the by-product of good character ■ Cultivates wisdom without pain.

Trustworthy people keep their word, avoid gossip, act right, tell the truth, they’re generous and honest, often reaching out to help others – giving is the reflex action to right reasons and motives ■ Un-attachment. Not ‘if I do this, you do that’. Business should feed this trust like a muscle, keeping it exercised to stay well ■ Elimination is as important as eating.

Do not associate with anyone who has a negative influence over your ability to be trustworthy

How to work with people you don’t trust

■ Meet them where they are. Trust them at their level of trust – revealed by the way they trust others and themselves ■ Be careful about your own pride – always do what is right, even when it feels wrong. ‘It is better to light a candle than curse the darkness’ ■ Challenge behaviours and bring conversations out into the light ■ A tactic perceived, looses its value.

Counter these actions with consequences! Train your brain to respond rather than react ■ Demonstrate trust. Whatever we focus on expands – even better, whatever we focus on strengthens!

■ Start them with small tasks and build levels of trust. Create new habits

Building trust

■ Agree the rules of the boardroom, remembering that thoughts of suspicion increase at times of confusion or mixed messaging. Agree a mantra, or a few key words, reflecting core values ■ Get the person to gain ownership by asking them to paraphrase what has been agreed and ...keep a trail. ‘Completed Staff Work’ by Archer L Lerch is a great example as to how to ensure staff and colleagues take responsibility ■ Trusting behaviour usually breeds trusted responses and motivation. Practise suspension. This gives time for us to respond, avoiding loose judgments – stopping the typical ‘knee-jerk’ reaction.

Look behind the person – to this day I regret misjudging someone through their unreliability, anger and erratic behaviour, later learning they had health issues – hurting: riddled with fear. They died later that year ■ ‘One strike and you are out!’ In business I would rarely give someone a chance to do it again. Harsh? Maybe. Two strikes would be my maximum.

The MD did follow my advice and I released him from our contract.

Summer 2016 | Ethical Boardroom 37

Board Leadership | Gender Diversity

Gender equality in Latin American boardrooms

Much needs to be done to achieve greater gender diversity in Latin American boardrooms but the foundations for change are starting to build In developed countries, gender diversity now has a permanent place on the agenda of corporate boards. No longer merely a matter of social responsibility, a diverse boardroom is regarded as a sign of having a rigorous director nominating process.

As investors and other observers focus greater scrutiny on board composition, having a gender-diverse board has become a global standard of corporate governance excellence and as Latin America becomes an increasingly important part of the global economy, it makes sense to examine how its largest companies are faring on this score, too. With that goal, Egon Zehnder examined the boardroom gender diversity of 155 leading publicly traded companies in Argentina, Brazil, Chile, Colombia and Mexico – countries for which there was a significant amount of readily available data.1 The companies within each country represented a range of industries and all had a 38 Ethical Boardroom | Summer 2016

Cristina Manterola

on behalf of the Egon Zehnder Latin American Diversity Team market capitalisation of $1billion or more. We supplemented this baseline statistical analysis with confidential interviews with 33 board chairs – all but four of whom were men – and interviews with 28 additional female board members from a total of 61 companies.2 Three key findings can be distilled from our research. First, Latin America lags behind Europe and the United States and Canada in boardroom gender diversity – although the gap is less jarring when viewed in historical perspective. Second, there are significant differences between the five countries in the level of boardroom presence women command. Finally, our interviews, combined with our examination of the political, economic and business environment in each country, identified four key factors that will play a significant role in how boardroom gender diversity unfolds in Latin America in the coming years.

Latin America in perspective

When comparing the five Latin American countries as a group with Europe and the United States and Canada, we see that Latin America is notably behind the other two regions, both in terms of the presence of women in the boardroom and in the rate of annual increase of seats held by women.

While the rate of change in Latin America is positive, it is clear the region must accelerate its diversity efforts for meaningful change to take hold.

But it is also important to put these figures in context. Europe and the United States and Canada have been grappling with gender diversity in senior business ranks for a generation. If there are some male board chairs in Latin America who argue that there are too few qualified women to sit on boards, it was not too long ago that the same argument was heard in developed countries. Indeed, it is our view that rather than portray some regions as doing well and others as doing poorly, it is more constructive to think of boardroom gender diversity as a trajectory,

Gender Diversity | Board Leadership

FiGure 1: PerCentAGe oF boArds with At LeAst one FeMALe direCtor ■ = 2011 ■ = 2013 ■ = 2015 Percentage figures = CAGR

80.2%

Europe

US/Canada

Latam

FiGure 2: PerCentAGe oF boArd seAts heLd by woMen ■ = 2011 ■ = 2013 ■ = 2015 Percentage figures = CAGR

14.0%

12.8%

15.9%

21.1%

6%

17.1%

14%

with some countries further ahead on the same path than others. (See Figures 1 and 2.)

Intra-regional differences

The significant differences between the five countries illustrates the importance of the national economic and political environment in achieving boardroom gender diversity, with Colombia and Argentina representing two ends of a spectrum (See figures 3 and 4.).

In the early 1980s, Colombia began establishing greater equality for women in politics when its president, Belisario Betancur, appointed women to all vice-ministerial positions – (eventually, women were appointed to three ministerial roles).

This established the beginnings of a pipeline of women who had developed their boardroom credentials though governmental positions of high visibility and responsibility.

This pipeline was further strengthened in 2000 with the establishment of quotas mandating that women account for at least 30 per cent of all senior government positions at the national and regional level. The results of

1

The economic downturn The economic slowdown and uncertainty that is currently gripping much of Latin America has in many quarters pushed ‘soft’ initiatives, such as boardroom gender diversity, down the agenda in favour of tasks that have an immediate effect on the firm’s financial health and market position.

As one board chair in Argentina said to us: “First, we should solve the base of the pyramid: institutionalism, growth, financial markets in Argentina. After that we can talk about gender and corporate governance.”

At the same time, there is a body of research that suggests that times of uncertainty are when diverse perspectives are needed the most. For example, decision-making groups comprised of both men and women have been shown to outperform groups comprised only of men. “Women always have a different business perspective,” said one female board director of a Mexican company we interviewed. “It is essential to bring different perspectives and backgrounds to board discussions and help companies be more innovative and thereby improve company financial performance.”

Europe

US/Canada

6.4%

6.1%

5.9%

2%

Factors going forward

From this baseline, how will boardroom gender diversity in Latin America unfold in the coming years? While it is not possible to make concrete projections, we see four factors that will affect the region’s trajectory.

46.5%

2% 42.6%

74.7%

70.9%

3%

42.2%

88.8%

83.3%

73.5%

5%

12.7%

these developments can be seen today in the relatively high levels of gender diversity in Colombian boardrooms. Colombia also has a higher percentage of single parent households compared to other Latin American countries in the study (84 per cent versus the regional average of 65 per cent3), suggesting a culture in which the economic independence of women has been more thoroughly established.

Argentina, by contrast, has in recent years suffered from high inflation and until recently had imposed trade and exchange The economic slowdown regulations rates that deterred and uncertainty that is foreign investment. multinational currently gripping much Numerous corporations left the of Latin America has in country and those that remained were many quarters pushed necessarily focussed on ‘soft’ initiatives, such short-term profitability rather than in as boardroom gender establishing corporate diversity, down the governance best agenda in favour of practices. In addition, Argentina’s capital tasks that have an markets had become immediate effect on the less accessible and smaller in size, removing firm’s financial health another potential force for encouraging adherence to global boardroom norms.

Latam

FiGure 3: PerCentAGe oF boArds with At LeAst one FeMALe direCtor 67%

Colombia

50%

Chile

46%

Brazil Mexico

42%

Argentina

40% 0

10

20 30 40 50 60 70 80 Percentages

FiGure 4: PerCentAGe oF boArd seAts heLd by woMen 14%

Colombia

8%

Chile

6%

Brazil Mexico

5%

Argentina

6% 0

2

4

6 8 10 Percentages

12

14

16

Summer 2016 | Ethical Boardroom 39

Board Leadership | Gender Diversity In our work with boards looking to fill board seats and appoint senior managers, we have encountered both points of view.

Our expectation is that boards that regard gender equality as a social responsibility are likely to give it less priority during challenging times, while those that see it as business imperative will continue to increase the diversity of their boardrooms. example of government 2 The As illustrated in the above discussion

of Colombia, government institutions can play an essential early role in providing opportunities for talented women to showcase their leadership potential. Last fall’s Argentine elections provide a more recent example, with women being elected or subsequently appointed to several key posts, including Vice President, three cabinet ministries, Governor of the Province of Buenos Aires and CEO of Aerolineas Argentinas, the national airline.

This direction will be further strengthened by efforts to repatriate capital, which should have the effect of making Argentine companies more active in the capital markets – and thus subject to more scrutiny on corporate governance standards and metrics.

On the other hand, when government conspicuously fails to provide opportunity for female leaders, the result can be swift public disapproval. In May, when Brazil’s interim President, Michel Temer, named the country’s first all-male cabinet since the 1970s, he faced a backlash that only partially subsided after he appointed Maria Silvia Bastos Marques to head the Brazilian Development Bank. This reaction may be a sign that even though Brazil is in the middle of the pack on boardroom gender diversity, expectations and willingness to change are high. regulations 3 Encouraging Our interviews uncovered widespread

opposition – by board members of both genders – to the government-imposed quotas on board composition that are seen in Europe.

However, subtler nudges have been both accepted and effective. For example, Chilean securities regulators implemented a rule last June requiring publicly held companies to release statistics on the gender, age, nationality

40 Ethical Boardroom | Summer 2016

and tenure of their board members.

One result has been a substantial increase in the number of women represented on Chilean company boards (see Figure 5). As one Chilean board chairman commented: “We need to measure diversity and publicise the results.

We need to tell businessmen, ‘The winning company is the one that includes women. This is a matter of competition, not of fairness’.” female leadership pipeline 4 The Increasing the number of women on

boards requires increasing the number of women in the pool of qualified director candidates. That, in turn, calls for a larger pipeline of female executives being groomed to take P&L responsibility of major business units and, ultimately, of companies as a whole.

This is the case not just in Latin America, but also in Europe, the US and Canada.

In all regions, strengthening the pipeline of female P&L executives requires addressing work-life issues, particularly involving family responsibility. While developed nations are inching their way to greater parity at home, in Latin America the family is still overwhelmingly considered the woman’s domain. As one female board member for a Brazilian company noted: “It is harder for women to advance in their executive careers due to the family responsibilities, so they do not reach the senior roles and do not ascend to boards. Things have to change culturally and at home.”

Latin America also has further to go in countering traditional cultural biases regarding women’s leadership ability. As one female board member of a Mexican company told us: “In general, female candidates have to show greater credentials than their male counterparts.”

While gender bias and gender roles are large-scale social issues, there is an opportunity for companies to take a proactive role in driving change. For example, a Mexican financial services firm we work with recently created positions for two ‘rising star’ female executives when the opportunity to hire them arose. A Mexican conglomerate client recently reconfigured a senior female executive’s role to allow for flexitime and the possibility of working from home. We expect accommodations like this will increasingly become the norm as time goes on.

FiGure 5: PerCentAGe oF 40 Most ACtiveLy trAded ChiLeAn PubLiC CoMPAnies with At LeAst one woMAn on the boArd* 50%

43%

40% 30%

25% 18%

20% 10%

8%

0% 2010 2011 2012 2013 *Note that this is a larger sample than the 22 Chilean companies examined elsewhere in the study.

Conclusion

In our interviews with Latin American board chairs and directors, we found a wide range of perspectives and approaches to gender diversity in the boardroom. In our view, this reflects a healthy debate on a complex topic.

As companies in developed countries well know, there are many issues involved, from the inertia of self-selecting networks to the division of family responsibilities, and no single path to addressing them.

Looking at Latin America as a whole, we see a growing acceptance of the fact that boardroom gender diversity is an unavoidable cost of entry into the upper tier of global corporate citizenship. The open question is how rapid the change will be. The answer will be determined by the way in which companies, board chairs, government agencies, professional associations, controlling shareholders and women executives themselves proactively address different aspects of the equality equation according to their own resources and perspectives. As this process unfolds, we at Egon Zehnder look forward to contributing to the dialogue.

Data for this survey was taken from BoardEx as of July 2015, with corrections and clarifications made by Egon Zehnder Research. Of the 155 companies from Latin America, 10 were from Argentina, 70 from Brazil, 22 from Chile, 12 from Colombia and 41 from Mexico. The study also included data from 1283 companies from Europe and 2091 companies from the United States and Canada, all with a market capitalisation of US$1billion or more.

2 http://www.egonzehnder.com/leadership-insights/2016egon-zehnder-latin-american-board-diversity-analysis.html 3 World Family Map 2014, Social Trends Institute 1

The leaders you’ll need tomorrow.

Where are they today?

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Global News Central&South America

Airline to pay $22million settlement LATAM Airlines has agreed to pay more than $22million (£16.75millon) to settle civil and criminal charges under the Foreign Corrupt Payments Act. Latin America’s largest airline will pay the US Securities and Exchange Commission (SEC) after an investigation into a scheme involving illicit payments to Argentine union officials.

According to the SEC findings, in 2006 chief executive Ignacio Cueto Plaza approved $1.15million in payments to a third-party consultant, who may have

passed some money to union officials in the midst of a dispute between the airline and its union employees in Argentina.

Ealrlier this year, Cueto Plaza agreed to pay a SEC $75,000 penalty and attend anti-corruption training.

LATAM Airlines said it has “cooperated fully with relevant authorities throughout this process”, adding that “significant improvements” had been made to compliance and internal accounting since the events.

Brazillian bank CEO faces bribery probe

The CEO and three executives at Bradesco, Brazil’s second largest private sector bank, have been charged with plotting to avoid a tax fine.

As part of an investigation, known as Operation Zealots, into the bribery of tax officials, CEO Luiz Carlos Trabuco Cappi and other bank officials were arrested by Brazil’s federal police.

The three executives face accusations of influence peddling, corruption, racketeering and money laundering, reports claim.

Petrobras class action on hold Wal-Mart dodges shareholders’ Mexico claim A US federal appeals court has rejected shareholder claims that executives and directors of Wal-Mart Stores Inc allowed and then covered up bribery by officials at its Mexico unit.

The 8th US Circuit Court of Appeals in St Louis upheld a lower court dismissal of a federal lawsuit accusing former chief executives Mike Duke

and Lee Scott of breaching their duties in failing to stop alleged bribery at Wal-Mart de Mexico.

Shareholders sued Wal-Mart and its board of directors after a newspaper’s investigative report detailed an alleged bribery scheme involving Wal-Mart’s Mexico subsidiary and Mexican government officials.

Argentinian regulator vows to adapt Argentina’s securities regulator CNV is to focus on corporate governance standards and making the market attractive for foreigners, according to a report.

In an interview with Reuters, Marcos Ayerra, president of CNV, said the regulator is “optimistic” that tax amnesty laws introduced by the new government will boost investment in the local market.

“We can’t have a mature and solid capital market, if we don’t have a mature and solid regulator,” Ayerra said.

“We’re looking to simplify the regulatory burden... such that there are more foreign investors looking to invest locally.”

42 Ethical Boardroom | Summer 2016

A US appeals court has put a class action case against Brazil’s state-controlled oil company Petrobras on hold, pending the resolution of an appeal.

Petrobras at the centre of a massive corruption investigation known as Operation Carwash, has been accused of inflating the value of more than $98billion of its stock and bonds through years of corruption.

The Brazilian company is appealing a lower court ruling allowing shareholders to pursue their claims as a group. The court ruled in favour of Petrobras on a technicality regarding class certification, rather than whether the the case has merit. It is not clear when a new trial will be set.

In August, Brazilian federal police rearrested two former top executives of construction company Queiroz Galvao as part of the Operation Carwash probe.

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Board Governance | Control

Tom McLeod

Managing Consultant, McLeod Governance

Standing in line...

A strong control environment is one where the organisation holds individuals accountable for their responsibilities in the pursuit of the agreed objective Recently, I was standing in line at the airport security, duly observing what is surely one of modern life’s tribal dances. Pull the computer out of the bag. Place the computer in the tray. Declare to the security guard that there are no weapons. Declare that I am not planning to perfume myself while standing in line – thereby making sure that I had declared any aerosol. And declare that I was close to losing the will to live having to do this so often.

As we danced the dance of modern security, a gentleman approached the security check-in point and said in a hurried voice: “I checked in about an hour ago and had to go out – do I need to check in again?”

Without missing a beat the security guard – who also appeared to be losing the will to live after what I can only imagine was a long shift – looked up and said: “No exception.”

One would have thought that may have been the end of the conversation and the natural moment that we all moved one step forward in the progression towards the airport’s secure kingdom. Alas no. Our friend decided that at that time and at that place he was going to question the logic of the airport security with a person that had no interest (or known incentive) to change; no ability to change and no experience in change.

“This is appalling,” said our friend. “What you are saying is that you don’t trust my word!” he continued indignantly.

44 Ethical Boardroom | Summer 2016

“No exception,” was the deadpan reply.

The interaction was sufficiently conspicuous that it drew the attention of what appeared to be two supervisors to our line. It was at that point that the loudly articulated exasperations of his fellow travellers and the fact that the security guard had numbers – not to mention logic – on his side that the gentleman submitted himself to the dance.

As he was collecting his worldly possessions from the other side of the security check-in point the gentleman turned to me and said: “It has worked before!”

When management seek to change a process, they need to be demonstrating that change has been properly socialised and communicated The incident and the interaction was a beautiful microcosm about what constitutes (and what does not constitute) a strong control environment and – paradoxically – the importance of training.

Let’s examine the control environment element

Despite their global inconsistencies in design and execution the world over, we now have an expectation that when we travel we will be searched before we board the plane or indeed before we are allowed to be in the general proximity of the plane and passengers.

That is the first stage of developing a strong control environment.

What are stakeholders’ expectations with regards to how well controlled the area/process should be? If you don’t set this well – and early – what can happen is that no one understands the need for the control in the first place.

Translating this experience to the work environment when management seek to change a process, they need to be demonstrating that change has been properly socialised and communicated.

The role of a well-functioning board here is to ask the most basic of questions – why? Why is there a change? Why was the previous control environment not sufficient? How will we make sure that the new control environment is as strong as what we currently have?

How will stakeholders know the control environment has changed?

There is a time and a place for not alerting people to a change in an underlying process but those times nearly always start and end with the suspicion of fraud or malicious misadventure.

So, assuming that now is not one of those times, one needs to consider how the control environment and indeed the change to the control environment is communicated. Tell the stakeholders that there is a change likely and what you will find more often than not is that the desired behaviour becomes the norm in anticipation of the change.

Control | Board Governance

A CONTROL ENVIRONMENT People expect to be searched at airports Summer 2016 | Ethical Boardroom 45

Board Governance | Control At the airport security check-in that our friend visited, the control environment is communicated by the physical presence of signs, machines and human resources.

It is telling – indeed screaming to – even the least observant traveller that this is a moment in their journey where they have to submit themselves to what is effectively a risk assessment before they are allowed along their way.

Communicating strengthened accounts payable processes in an enterprise-wide accounting system rarely has the communication signals luxury that is afforded a security check-in point. In such instances, the best way to communicate is then often by the exultations of senior management.

Boards should be asking of senior management what the executive leadership team has done to be a spokesperson for the improvement of the organisational control environment. If the answer is nothing or very little, not only will you will never have a strong control environment, but, as a board member, you are also more than likely to be overseeing an organisation that is lacking an aspirational tone at the top.

Measuring the control environment

The next area that we need to consider is the measurement of the control environment.

How many people each and every day at the checkpoint that I was queuing at to seek to bypass the intended security controls? How many people actually bypass the security controls?

The first question should be a relatively easy measurement to determine –it is, after all, a case of pure maths. The number of people passing through the gates against the number of those that raised a concern about passing through the gates.

The second question is much harder to measure but measure it you must. A strong control environment can tell you how often it has failed. How often the expected control has not operated in the way that was expected of it.

Remember how our traveller friend said: “It has worked before!” While I have never been privy to the intimate workings of an airport security checkpoint I am making an educated guess that there is surveillance policing our every move. The visual deterrence element of the surveillance has obviously not worried my fellow traveller previously. Would, however, his behaviour change if he knew that there was a post security check-in analysis of the footage to identify and monitor those who have fatigued the security control system to the point that it has failed?

A strong control environment has layers – if one layer fails there is another layer that is designed to stop or modify the undesirable behaviour. Before we discuss the importance of training, one needs to give consideration to the role of continuous improvement in the 46 Ethical Boardroom | Summer 2016

establishment and maintenance of strong and robust control environments.

Sadly, as a result of malfeasance of deranged individuals, airport security has had to improve to reflect the changed circumstances.

Assume for one moment that hadn’t happened. The airport security check point control would deteriorate over time if it stayed the same. The reason? People would start to understand how to game the system. They would – like our friend – start to work out what works and does not work. One of the most successful ways to counter this natural deterioration is to constantly self-assess the strength of the control environment.

Self-assessment in this context could be an examination of the totality of the process or indeed a mere fraction thereof. This then leaves us with the importance of training.

The need for training

As our friend tried to beat the airport security check in system you will recall he was met with (what was a very stony faced, non expressive) “no exceptions”. This response could have been the automatic response but I suspect not. It was more than likely the result of good, regular, clear and comprehensive training.

Many years ago we found ourselves with a day to spare in Dallas, Texas. We decided to spend it retracing the important historical monuments in the assassination of the 35th President of the United States of America, John F Kennedy. After walking the Grassy Knoll and visiting the Texas School Book Depository we decided to see how long the drive was to Parkland Memorial Hospital.

In a memorial section just inside the hospital we came across one of the most

DALLAS COUNTY HOSPITAL DISTRICT Office Memorandum, 27 November 1963 To: All Employees At 12:38 p.m., Friday, November 22, 1963, President John F. Kennedy and Texas’ Governor John Connally were brought to the Emergency Room of Parkland Memorial Hospital after being struck down by the bullets of an assassin.

At 1:07 p.m., Sunday, November 24, 1963, Lee. H. Oswald, accused assassin of the late president, died in an operating room of Parkland Memorial Hospital after being shot by a bystander in the basement of Dallas’ City Hall. In the intervening 48 hours and 31 minutes Parkland Memorial Hospital had: 1. Become the temporary seat of the government of the United States.

2. Become the temporary seat of the government of the State of Texas.

3. Become the site of the death of the 35th President.

4. Become the site of the ascendency of the 36th President.

5. Become site of the death of President Kennedy’s accused assassin.

6. Twice become the center of the attention of the world.

7. Continued to function at close to normal pace as a large charity hospital.

What is it that enables an institution to take in stride such a series of history jolting events? Spirit? Dedication? Preparedness?

Certainly, all of these are important, but the underlying factor is people. People whose education and training is sound. People whose judgment is calm and perceptive.

People whose actions are deliberate and definitive. Our pride is not that we were swept up by the whirlwind of tragic history, but that when we were, we were not found wanting.

(Signed) C. J. Price, Administrator

DEALEY PLAZA The scene of the assassination of President Kennedy in Dallas in 1963

impressive pieces of correspondence that we have ever read. It was the reproduction of a memo written four days after the murder of President Kennedy (see right). There is stanza contained within it that sums up what enables a strong control environment: whose education and 1 People training is sound whose judgement is calm 2 People and perceptive whose actions are deliberate 3 People and definitive

Our security guard at the airport check-in was the beneficiary of good training that enabled him to state clearly and calmly that there was to be no exception to the rule that everyone had to be checked.

His actions were deliberate and definitive – there was no ambiguity in his behaviour or in his response to the mischievous actions of the traveller.

Next time you stand in line at an airport security check-in, remind yourself that for all its frustrations it is a great example of what a strong control environment should be.

If the board is thinking about it, we’re talking about it.

Since 1999, KPMG’s Audit Committee Institute has been helping boards and audit committees focus their agendas on what matters most.

For timely insights and informed, board-level perspectives on top-of-mind issues, visit kpmg.com/globalaci Audit Committee Institute

© 2015 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. The KPMG name and logo are registered trademarks or trademarks of KPMG International.

Board Governance | Enterprise Risk Management

Tim Leech & Lauren Hanlon

Tim is the Managing Director; Lauren is a Director at Risk Oversight Solutions Inc

Paradigm paralysis in ERM & internal audit Boards and CEOs around the world are being told repeatedly from multiple sources that they need to do a better job managing and overseeing risk and, most recently, ‘risk culture’.1 Unfortunately, current methods of providing stakeholders with assurance that risk management processes are effective are fundamentally the same methods that have been used for decades.

The 2008 global crisis is a graphic illustration of their inability to cope with an increasingly fast moving and complex world. This article is a call to boards, CEOs, law makers, regulators, investor groups and others for a major paradigm shift in risk management and assurance thinking to create and better preserve shareholder value.

Paradigm paralysis in the enterprise risk management (ERM) and internal audit communities blocks their ability to see new methods available to better meet the needs of stakeholders. This article will outline status 48 Ethical Boardroom | Summer 2016

The internal audit profession needs to reinvent itself to better respond to the emerging expectations facing senior management and boards quo ERM and internal audit paradigms; describe why the current paradigms are blocking progress; and propose some simple, but radically different ideas to assist boards, CEOs and ERM and internal audit specialists make the paradigm shift necessary to drive positive change.

Paradigm paralysis: ERM methods

Although there is wide variation in how companies have implemented ERM, the most common feature is the creation and maintenance of ‘risk registers’ as a foundation.

The extent risks identified are linked to the company’s business objectives and strategies varies greatly. Supplementing the risk registers

are ‘risk heat maps’ that depict individual risks in terms of likelihood and consequence. Risk heat maps may, or may not, depict residual risk, the risk remaining after considering risk responses/risk treatments on a single risk.2 These risk registers are typically maintained

by ERM specialists or internal audit groups and results are reported upwards to the board.

ERM paradigm flaws

The primary drawback of this risk-centric ERM paradigm is that it looks at risks in isolation from the company’s top value creation and value preservation objectives (see the sidebar for the authors’ definition).

This approach does not allow decision makers to see the current state of residual risk linked to the achievement of the company’s most important objectives.

All of the risks relevant to individual objectives are not looked at in totality in terms of their collective effect on the achievement of specific objectives. The process does not produce information to evaluate the acceptability of the current residual risk status (i.e. is it within risk appetite/ tolerance?). It also creates confusion and uncertainty around who is really responsible for the risks identified, as assigned ‘risk

Enterprise Risk Management | Board Governance owners’ may not align with those responsible for achieving the linked objective(s). This risk-centric approach has also tended to focus more on value preservation objectives (e.g. ‘three lines of defence’) rather than a balance, which puts at least equal emphasis on value creation/strategic objectives.

VaLue CreaTion objeCTiVe Objectives key to the long-term success of the enterprise that will create enhanced shareholder value (e.g. increase market share by 20 per cent) VaLue PreserVaTion objeCTiVe Objectives that, if not achieved, have significant potential to erode stakeholder value (e.g. ensure reliable financial statements disclosures) Another flaw is that the process is typically completed as a static annual or semi-annual exercise with a heavy compliance connotation.

The risk assessment methodology used to populate the risk register and risk heat maps is often not the same assessment approach used by internal audit to complete internal audits, or the assessment approach used by other specialists groups, such as safety, compliance, insurance, quality, etc. It is also important to note that the dominant ERM method to identify risks is ‘brainstorming’, based heavily on the knowledge and experience of participants. The full range of methods available to identify significant risks is rarely used. Key risks linked to top strategic objectives are often missed. The approach often does not consider the full range of risk responses/risk treatments available as it tends to focus heavily on ‘controls’ linked to individual risks, not the full range of risk responses/treatments.

Another critical flaw of the current ERM paradigm is that when work units are candid and disclose very serious and material retained risk positions, the result in some companies is that the area is then scheduled for a traditional internal audit – in essence, participants are punished for being upfront and disclosing information key to better decision making and a healthy risk culture.

Another significant concern is that the areas that are generally low risk from a culture perspective often do the best job identifying and disclosing risks and residual risk status.

Groups and executives that represent major risk to the organisation culturally are least likely to candidly disclose significant risks and the true retained risk position.

The way forward: a board -driven ERM paradigm shift

Boards and CEOs need to take the time to understand the substantial differences between risk-centric and objective-centric assessment risk management frameworks.

More information on the business case for objective-centric risk management vs traditional risk-centric approaches that use risk registers as a foundation can be found online.

barriers To CHange ■ Influential ERM guidance sources, including COSO and ISO 31000, while defining risk in terms of its ability to effect achievement of objectives, implicitly endorse risk-centric approaches to risk management that use risk registers, not objectives registers, as a foundation. COSO and the authors of ISO 31000 do not advocate that the process should start by identifying and prioritising objectives, then make conscious decisions on which objectives warrant the cost of formal risk assessments. The COSO ERM exposure draft issued in June 2016, while increasing the focus on value creation objectives, stops short of calling on companies to create and use objectives registers as a foundation for ERM. ■ It may be a very uncomfortable and unfamiliar exercise for the board and management to agree on the top value creation and value preservation objectives. This reluctance prevents efficient entity level resource allocation and decision making. An objective-centric approach focusses first on defining the top objectives key to sustained long-term success – it seeks a balance between value creation and value preservation. A risk-centric/risk register ERM approach is often quite vague on its linkages to top value creation/ preservation objectives and rarely makes a link to performance.

■ Management has to take on substantially greater ownership and act as primary risk assessor/reporter for the company’s top objectives, including providing a report and opinion on the overall residual risk status for each objective to the board. This is a fundamental shift that requires changes to how management and traditional ERM and internal audit teams interact and discharge their responsibilities. It may also include a fundamental risk culture shift, where candidly described significant negative residual risk positions is rewarded, not punished by internal audit and senior management.

■ A global shortage of staff with the knowledge and skills to implement an objective-centric risk self-assessment framework. Business schools are still in their infancy in producing enterprise risk management curriculum beyond traditional internal audit and accounting courses that teach control-centric models heavily linked to effectiveness of internal controls over financial reporting and IT security. Those schools that do cover risk management holistically generally teach ERM methods that use risk registers as a foundation.

■ The use of the three lines of defence (3LoD) endorsed by the Institute of Internal Auditors (IIA) and some regulators as a risk governance framework. 3 The IIA 3LoD model sees the board and CEO as stakeholders who receive information, not active and key participants in the risk management process. It perpetuates the notion that risk management is fundamentally about hazard avoidance and defence – not a key support tool to take risks intelligently and drive increased stakeholder value.

■ The IIA has not actively supported a shift from traditional risk-centric ERM methods and control and process-centric direct report internal audit methods to a management-driven, objective-centric risk self-assessment approach. IIA guidance on how to assess the effectiveness of ERM frameworks does not call for an evaluation of whether the approach being evaluated is assessing risks linked to a company’s top value creation and value preservation objectives.

Require a robust management-driven, objective-centric risk self-assessment framework that uses an objective register as the foundation. Risk management efforts should be aligned with the top value creation and preservation objectives to ensure optimal capital allocation. The objectives register should include the company’s top value creation and value preservation objectives.

These should be defined by management and reviewed by the board. ‘Owner/sponsors’ should be assigned to each objective.

Owner/sponsors are responsible for assessing and reporting on the state of residual risk related to each of the objectives to the CEO and the board using an ISO 31000 compliant assessment methodology (for an example of an objective-centric/ISO 31000 compliant approach see the RiskStatusline™

assessment approach shown on page 50).

Conscious decisions should be made on the target level of risk assessment rigour and independent assurance. The board should receive regular reports on the residual risk status of the objectives in the register, including the current Composite Residual Risk Status (CRRR). A sample set of definitions for CRRRs is also on page 50.

Require that the CEO or his/her designate regularly (bi-annually or quarterly) provide the board with a consolidated report on residual risk status linked to the company’s top value creation and value preservation objectives. This simple step has great potential to drive the necessary changes to the way management and all of the specialist assurance groups do their work.

Summer 2016 | Ethical Boardroom 49

Board Governance | Enterprise Risk Management Assign responsibility to ERM specialist staff to implement and maintain a robust objective-centric risk self-assessment framework. This repositions the role of risk specialists to one where their primary role is providing training, facilitating objective-centric management-driven risk self-assessments and helping the CEO produce reliable consolidated reports for the board on the residual/retained risk status of top value creation and preservation objectives.

Require annual opinions from internal audit on the effectiveness of the company’s risk management framework and reliability of the consolidated report from the CEO to the board on company’s residual/retained risk status linked to top value creation/ value preservation objectives.

Paradigm paralysis: internal audit The internal audit profession is based on a core paradigm, largely unchanged since the

End result objectives (implicit or explicit)

Internal/external context Threats to achievement/risks?

Risk treatment strategy Risk mitigators/controls Risk transfer, share, finance (selected consciously or unconsciously)

2015 Risk Oversight Solutions Inc.

Residual risk status

Acceptable?

Re-examine risk treatment strategy and/or objective and develop action plan

NO

YES

Risk treatment optimised?

What this means is often unclear as their audit plans often do not cover the company`s top value creation/strategic objectives.

Internal audit coverage expressed as a percentage of the entire risk universe of a company is rarely more than 10 per cent in any given year. Results of individual internal audits are reported to management and summary reports provided to the audit committee of the board of directors.

Internal audit paradigm flaws

The key flaw in the current internal audit paradigm is that it does not position responsibility for assessing risks and reporting upwards on the state of residual risk linked to the company’s most critical value creation and value preservation objectives squarely with the people that should have primary responsibility – management. It discourages management from learning how to formally assess and report on residual risk status linked to key

CoMPosiTe resiDuaL risK raTing DeFiniTions

RiskStatuslineTM

NO

profession began, that calls for internal auditors to audit a unit, topic, process, or other ‘audit universe’ element and form an opinion as to whether the auditor believes the ‘internal controls’ in the audit universe subject matter are ‘effective’ or ‘adequate’.

From a technical perspective, this approach is called a ‘direct report audit engagement’.

Internal auditors must, of necessity, use a direct report audit approach in cases where management has not self-assessed and made a formal representation on the state of risk.

When this does happen, internal audit can use an ‘attestation’ approach that reports on management’s self-assessment. Unfortunately, the percentage of companies where management complete self-assessments and report on the state of residual risk linked to key value creation and preservation objectives is still a very small percentage of the total.

Ironically, most internal audit departments claim their audit methodology is ‘risk based’.

YES – Move on

0 Fully acceptable Composite residual risk status is acceptable. No changes to risk treatment strategy required at this time. (NOTE: this could mean that one or more significant risks are being accepted. Information on accepted concerns is found in the residual risk status information) 1 Low Inaction could result in very minor negative impacts. Ad hoc attention may be required to adjust composite residual risk status to an acceptable level 2 Minor Inaction or unacceptable terms could result in minor negative impacts.

Routine management attention may be required to adjust composite residual risk status to an acceptable level 3 Moderate Inaction could result in or allow continuation of mid-level negative impacts. Moderate senior management effort required to adjust composite residual risk status to an acceptable level 4 advanced Inaction could allow continuation of/or exposure to serious negative impacts.

Senior management attention required to adjust composite residual risk status 5 significant Inaction could result in or allow continuation of very serious entity level negative impacts. Senior management attention urgently required to adjust composite residual risk status to an acceptable level 6 Major Inaction could result in or allow continuation of very major entity level negative consequences. Analysis and corrective action to adjust composite residual risk status required immediately 7 Critical Inaction virtually certain to result in or allow continuation of very major entity level negative consequences. Analysis and corrective action to adjust composite residual risk status required immediately 8 severe Inaction virtually certain to result in or allow continuation of very severe negative impacts. Senior management/board-level attention urgently required to adjust composite residual risk status 9 Catastrophic Inaction could result in or allow the continuation of catastrophic proportion impacts. Senior management/board level attention urgently required to adjust composite residual risk status and avert a catastrophic negative impact on the organisation 10 Terminal The current composite residual risk status is already extremely material and negative and having disastrous impact on the organisation. Immediate top priority action from the board and senior management required to prevent the demise of the entity

saMPLe suMMary rePorT For senior exeCuTiVes anD THe boarD Corporate

Description

l

Ensure that financial statements are reliable and in compliance with GAAP Safeguard and enhance ABCs reputation

l

50 Ethical Boardroom | Summer 2016

CRRR Composite End result update objective owner/ residual risk date rating (CRRR) sponsor(s) 6/12/2014 6 — Major Tim Leech Tim Leech

4 — Advanced

6/10/2014

Potential to increase entity value Medium

Potential to erode entity value Low

High

High

Current risk Independent assessment assurance level (IAL) rigor (RAR) Low Medium (M) Very Low (VL)

Medium

Enterprise Risk Management | Board Governance value creation/preservation objectives (i.e. it’s not their job to assess and report, so why do they need the skills to do it?). Internal audit coverage is usually a small percentage each year of the total risk universe and often has a heavy bias towards value preservation and financial accounting controls.

The audit plan often does not cover the company’s most important value creation/ strategic objectives and is often not well integrated with the work of other assurance groups, including ERM, safety, IT security, environment, compliance, insurance and others. The traditional internal audit paradigm often puts serious political pressure on business units to put in place additional ‘internal controls’ linked to the topic audited, even when residual risk status in other areas linked to key value creation/strategic objectives not covered by internal audit warrant more of the scarce risk treatment resources.

Our work globally suggests that only a small percentage of internal auditors today use objective-centric risk assessment methods on their audits that conform to risk assessment methods defined by the global risk management standard, ISO 31000, or COSO ERM 2004/ED 2016. A large percentage of internal auditors report opinions on sufficiency of internal controls, not the full range of risk responses/risk treatments in place. This can result in seriously flawed results and opinions.

An opinion from internal audit on whether internal controls are effective, or not, is fundamentally an opinion from the internal auditors on whether they think residual risk status is acceptable to the company and the board – information the internal auditors often don’t have and decisions internal auditors aren’t authorised or trained to make.

It is important to note that the Financial Stability Board (FSB) and the Institute of Internal Auditors (IIA) are increasingly calling on internal audit groups to assess and report on all of their company’s risk management processes.4 When internal audit is the group with primary responsibility for completing documented risk and control assessments this requires internal audit report on itself – a violation of audit independence standards.

The way forward: a board/CEO-driven internal audit paradigm shift

Boards and CEOs need to call for implementation of robust objective-centric risk self-assessment frameworks that use an objective register as the foundation. See details above.

When an objective register is used as a foundation for ERM it defines the role of owner/ sponsors, ERM specialists, and independent assurance staff

barriers To CHange (ConTinueD) ■ A large percentage of companies and their boards have not embraced the need for management to self-assess and report on the state of residual risk linked to their most important value creation and value preservation objectives and report consolidated results upwards to the company’s board of directors. As long as management in a company is unwilling to perform this role, internal audit must continue to do direct report audit engagements on a small percentage of the risk universe (i.e. there are no management representations on risk status on key objectives to audit, hence attestation internal audit engagements are not possible) ■ Because the majority of companies in the world today have not implemented robust objective -centric risk self-assessment frameworks, a large percentage of the IIA curriculum, training, and certification standards are built on the direct report audit paradigm with a heavy focus on internal auditors opining on the sufficiency of ‘internal controls’. A massive and concerted effort would be required to equip internal auditors with the skills necessary to form opinions on the reliability of objective-centric risk self-assessments as many internal auditors lack the skills to complete them. Many internal auditors are not currently trained to complete ISO 31000/COSO ERM compliant risk assessments and, by extension, not equipped to report whether objective-centric risk assessments done by management are reliable ■ Many boards and senior executives don’t believe internal audit can add significant value to their company’s top value creation objectives and are content to have internal audit focus on a relatively narrow range of objectives with a heavy focus on financial controls, IT security, business continuity, fraud prevention and other value preservation/defence areas

and, by definition, focusses resources on objectives key to long-term value creation and preservation.

Require internal audit use the company’s objectives register not an audit universe as their work foundation.

Once management with the assistance of ERM specialists has completed the assigned risk assessments at the defined level of risk assessment rigour, internal audit completes quality assurance reviews where internal audit has been defined as the independent assurance providers to achieve the target independent assurance level defined in the objectives register. For some objectives in the objectives register the board and/or C-Suite may assign other independent assurance providers. The primary goal of internal audit is to provide the board with opinions on the effectiveness of company’s enterprise risk management processes and the reliability of the consolidated report from the CEO to the board on residual risk status. Internal audit should also flag any areas where they think management is accepting of residual risk that Boards and CEOs levels they believe may be outside need to play a of the CEO and/or the board’s risk appetite/tolerance. key role driving Ensure the internal audit a quantum team is staffed appropriately paradigm shift in to contribute on top value and value risk management creation preservation objectives.

This can include management and assurance programmes and hiring thinking to make rotation of staff from non-traditional improvements internal audit backgrounds (i.e. outside of accounting, in risk culture IT security, external audit).

A call to action — boards and CEOs need to drive paradigm shift efforts

Globally, the ERM and internal audit professions have a serious case of paradigm paralysis that is impeding their ability to help boards and CEOs meet new risk governance expectations. Boards and CEOs need to play a key role driving a quantum paradigm shift in risk management and assurance thinking to make improvements in risk culture. When paradigm paralysis occurs it is always worth remembering the words of Albert Einstein, “Insanity: doing the same thing over and over again and expecting different results”. 5 Expecting the same internal audit and ERM methods used over the last 20 to 30 years to produce dramatically different and better results for stakeholders is poor judgement at best. The authors hope that the paradigm shift ideas in this paper will help drive further thought leadership and the developments necessary to produce the quantum paradigm shift in ERM and internal audit methods necessary to help boards and CEOs better meet new risk governance expectations.

1 Example: See Financial Stability Board Principles for an Effective Risk Appetite Framework sent to regulators around the world http://www.fsb.org/wp-content/uploads/r_131118.pdf 2Note: COSO uses the term ‘risk responses’. ISO 31000, the global risk management standard uses the term ‘risk treatments’. In both cases the term refers to the full range of ways to finance, share, transfer, mitigate, avoid and accept risk. 3See Office of Superintendent Financial Institutions June 2016 E21 Operational Risk Guidelines for an example of a regulator endorsing ‘Three Lines of Defense’ 4See Financial Stability Board Principles for an Effective Risk Appetite Framework http://www.fsb.org/ wp-content/uploads/r_131118.pdf and IIA Research Foundation Auditing Risk Assessment and Risk Management Processes 5 Source: Albert Einstein. (n.d.). BrainyQuote.com. Retrieved 29 June, 2016 , from BrainyQuote.com Web site: http://www. brainyquote.com/quotes/quotes/a/alberteins133991.htm)

Summer 2016 | Ethical Boardroom 51

Ethical Boardroom Keeping it Above Board

“Essential reading for boards who want to stay ahead of the governance curve�

Board Governance | Nomination Committees SELECTION PROCESS Nomination committees need to consider overall board composition

Coming out of the shadows

Nomination committees are emerging from the shadows and becoming broader, more rigorous and more proactive in their role While much attention has focussed on the activities of a board’s remuneration, audit and risk committees, the nomination committee is emerging from the shadows as more companies recognise their potential.

nomination committee is increasingly called upon to take a more significant role in helping achieve the right balance, knowledge, skills and attributes in order for the board and its committees to operate effectively.1

Despite being regarded as the poor relation, of the main board committees, the

Traditionally nomination committees may have been more reactive than other

54 Ethical Boardroom | Summer 2016

The role of the nomination committee

Mala Shah-Coulon

Executive Director, Corporate Governance at EY committees – perhaps meeting only when a director was leaving the board for the purpose of identifying a replacement. Also unlike the audit and remuneration committees, there isn’t a natural reporting or regulatory cycle leading to a wide variety of approaches to the committee’s function.

Nomination Committees | Board Governance

In recent times, however, there has been a rethink on the role that this committee can play and how it can be improved. This is especially so due to relatively short tenures – on average non-executive directors and CEOs are on boards for about 5 years.

Today’s nomination committees therefore need to think broadly when directors step off the board - whether planned or unexpectedly - what the departure may mean for the board composition now and going forward and how best to communicate to investors about current Leading FTSE and future plans.

350 companies Although there is no natural regulatory trigger are increasingly for nomination committee planning ahead for activity, its work should be co-ordinated with existing both emergency board discussions about and ‘steady state’ company strategy, board situations, to prepare evaluations and succession planning. Staff and skills for unexpected retention are a business board changes and imperative and yet many executive pipelines have to identify potential tended to be inadequate candidates several when it comes to providing a years out from taking sustainable pool of talent.

Leading FTSE 350 on a board role companies are increasingly planning ahead for both emergency and ‘steady state’ situations, to prepare for unexpected board changes and to identify potential candidates several years out from taking on a board role.

Three ways to improve

A new joint report by EY and ICSA: The Governance Institute, “The nomination committee- coming out of the shadows” outlines findings and views gathered from a series of roundtable discussion with board chairman, nomination committee chairs and members, and company secretaries from over 40 listed companies predominantly in the FTSE 350.2 Insight from these discussions has shone a light on some of the current practices and behaviours of nomination committees, with many of the representatives indicating their companies were expanding the role of their nomination committee, as well as adopting a more professional approach to the recruitment and selection of candidates.

Three main ways that many companies are looking or should be looking at improving the way their nomination committees operate have been identified.

1

Looking deeper into the company to identify and help develop its future leaders While talent development remains primarily the responsibility of management, boards

have a duty to secure the long-term health of the company. There is a growing view that the board, through the nomination committee, has to take some responsibility for ensuring not only that potential future board members are being identified and developed, but also that there is adequate ‘bench strength’ in management to run key parts of the company with some nomination committees considering the top 50-200 talent. The nomination committee needs to be satisfied that there is a pipeline of talent that will sustain the company in the long term. In doing this, it should also gain some visibility on whether the talent pipeline has future leaders who will instil and exemplify a company’s culture or bring about necessary change.

There are key points that boards and nomination committees should consider: ■ The extent to which you look across the market and internally to identify four or five potential successors to the CEO ■ How deeply into the organisation the committee should be looking to identify future talent ■ For executive appointments, the balance between providing oversight and execution – especially in how the committee gets exposure to talent ■ The best way to develop the skills of future executive leaders in the business ■ If supporting executives in taking up non-executive director (NED) roles will enable them to better carry out their role ■ Where executives take NED roles outside the company, the practical impact, time commitment and support they may need to fulfil both roles the net wider to identify 2 Casting potential directors

According to the FT–ICSA Boardroom Bellwether report (a twice-yearly survey of FTSE 350 companies that seeks to gauge the sentiment inside UK boardrooms), 58 per cent of company secretaries said their executive pipeline has a sustainable pool of talent. 3 Companies, therefore, need to consider the impact on their board and to look at a wider pool of candidates in order to identify people with the skills needed to meet the challenges they face. This reflects both a growing awareness of the benefits of, and demand for, more diverse boards, and changes in the skill sets needed, such as a greater focus on digital technology.

Gender, ethnic and geographical diversity is also important for businesses operating across many different markets, leading to companies looking beyond the ‘usual suspects’ to find people with different experiences and backgrounds.

Summer 2016 | Ethical Boardroom 55

Board Governance | Nomination Committees fORWaRd PLaNNING Leading boards are developing long-term strategies in their succession planning

Points for boards and nomination committees to consider: ■ How to challenge headhunters to look beyond the ‘usual suspects’ by providing more specific job specifications ■ The value of carrying out social style tests on the board to better understand its make-up and approach to decision-making ■ Potential benefits of setting up an advisory board to access more niche skill sets and expertise ■ Obtaining informal feedback from your company secretary’s network on how candidates operate or behave in practice further ahead than 3 Thinking the immediate replacement

of a retiring board member Leading boards now look much further into

The nomination committee plays a crucial role in the effective functioning of boards; linking the board’s director recruitment, selection and succession planning processes to the company’s strategic goals the future when developing their long-term strategies for the business with nomination committees expected to develop a clear view of the needs of the business over a range of time horizons, informed by the company’s strategy, and plan accordingly.

As well as keeping on top of emerging talent challenges in an ever-evolving business environment, more predictable succession planning is also a vital part of the nomination committee’s role, such as understanding when individuals are due to leave the board.

While traditionally NEDs could be appointed for three terms of three years,

12 quESTIONS fOR bOaRdS aNd ThEIR NOMINaTION COMMITTEES TO CONSIdER skills does the board need to deliver the company’s strategy 1 What (over the relevant period) and deal with changes in the business environment?

If the board needs new skills, when will they be needed and what is the plan 2 for acquiring them? will you manage the next cycle of board appointments and reappointments, 3 How and how do board and director evaluations feed into that process? is the nomination committee’s contingency plan for dealing with any 4 What unexpected departures from the company board? assurance do you need from management about the nature and quality of their 5 What executive and senior management development programmes? How involved does

the board or individual directors want to be in those programmes?

How visible are potential executive directors to you and what role might you play in their development (for example, through mentoring)?

What is your policy on executive directors and senior managers serving as NEDs on other boards?

What is your plan for ongoing training and development of directors after they have joined the board and how do the results from your board evaluation feed into this?

What criteria are used by the board and its advisors to identify potential NEDs? How objective are they and how are you satisfied they will not rule out individuals who have the necessary skills but may, for example, be lacking board experience?

What processes do you have for assessing the character and behaviours of potential new directors?

How could you improve your reporting and terms of reference to give shareholders and other stakeholders better insight into and assurance on how the nomination committee is exercising its responsibilities?

How could the nomination committee’s interactions with other committees, e.g. the remuneration committee, be improved?

6 7 8 9

10 11 12

56 Ethical Boardroom | Summer 2016

with many completing the full nine years, frequently NEDs have chosen to leave the board earlier, perhaps after six years.

Points for boards and nomination committees to consider: ■ How to link longer-term strategy to succession plans ■ Having open conversations about future career plans as a board in order to sequence board succession appropriately

Conclusion: a crucial role

Good governance is about boards continually asking the right questions of themselves and of management in order to gain assurance on the performance and behaviours of the business. The nomination committee plays a crucial role in the effective functioning of boards by linking the board’s director recruitment, selection and succession planning processes to the company’s strategic goals.

It is time for boards to better utilise the nomination committee, take a more proactive role and bring it out of the shadows.

Given 63 per cent of listed companies cite people-related risks, including staff and skills retention, as one of their principal risks4, making it the second most common principal risk disclosed by boards, it is encouraging that we are starting to see a shift. A highly effective board is essential if companies are to produce sustainable returns for their shareholders, stakeholders and wider society.

1 http://blog.icsa.org.uk/diversity-is-not-just-aboutgender-time-for-nomination-committees-to-step-up/ 2 http://www.ey.com/UK/en/Issues/Governance-and-reporting/ Corporate-governance/EY-the-nomination-committeecoming-out-of-the-shadows 3http://www.thecorporatecounsel. net/nonmember/docs/08_15_ICSA.pdf 4EY: Reflections on the past, direction for the future http://www.ey.com/UK/en/ Issues/Governance-and-reporting/Corporate-governance/ EY-Annual-reporting-in-2014

LOOK TO THE IIA FOR RESOURCES ADDRESSING ETHICS, GOVERNANCE, BOARD-LEVEL CONCERNS AND MORE

Visit The IIA’s Audit Committee Resource Exchange to gain an in-depth understanding of internal audit best practices. www.theiia.org/goto/ACResources Sign up for a free subscription to Tone at the Top, a bimonthly publication with concise information and perspective on top-of-mind issues and guidance for boards, audit committees, and senior management.

The CBOK 2015 Stakeholder Study seeks to gain a global perspective and understanding of stakeholders’ expectations of internal audit’s purpose, function, and performance. The stakeholder report is scheduled for release in 2016.

2015-1371

www.theiia.org/goto/ACResources

Board Governance | Personal Governance

Seven steps to successful personal governance Fredy Hausammann

Managing Partner, Amrop Switzerland and Vice Chair, Amrop EMEA

Strong and sustainable corporate governance can only happen if those in charge of organisations can demonstrate solid personal governance Trust in leadership is at an all-time low.1, 2 Tales of incompetence, negligence or malpractice dominate business headlines, affecting the lives of millions in our globalising, inter-connected world. Other reports paint a grim picture of executives whose mental and physical health, private lives and values are collapsing under the sheer weight of information and work overload.

58 Ethical Boardroom | Summer 2016

Personal Governance | Board Governance SELF-DEVELOPMENT Personal governance takes account of private and professional goals

is a powerful way to support reflection, learning and personal development.

New concept, deep roots

How can senior managers make a change for the better in their own lives and, by association, in corporate leadership and governance? Because we would argue that strong and sustainable corporate governance can only happen if the people in charge of organisations can demonstrate solid personal governance.

Then we can start taking steps towards a more credible and more widely accepted form a of governance as a whole.

We add the personal governance dimension to the existing concepts and rules of corporate governance.

Seven building blocks of governance

The seven building blocks of personal governance form a pathway for managers to create good corporate governance and leadership. It all starts with ourselves; by establishing a meaningful personal mission and set of values; by engaging in healthy self-reflection and continuous self-development; by better managing stress, balancing our work and private lives and interests – and ultimately our reputation.

The seven principles of personal governance provide important keys to help managers shape their role. As it becomes ever more of a priority to achieve the best possible interplay between work and private life, the ‘orientation framework’ provided by personal governance can make it easier to handle role conflicts between those two worlds.

Organisations need to establish the conditions most likely to nourish good personal and corporate governance and create a sense of shared responsibility together with employees. Among these conditions, personal governance coaching

Is personal governance anything new? Well, given its special characteristics and its close relationship with top management and corporate governance, we can cautiously say yes.

In recent years, corporate and managerial social responsibility, management ethics and work-life balance have all been talked about at length. Still, personal governance has very deep roots. It has a lot in common with ‘self-care’, a theme we can trace back to Ancient Greece. For Plato, self-care was a pre-condition for moderation in exercising power over others. 3 In the 1980s, the theme of self-care was taken up by philosophers, such as Michel Foucault (The Care of the Self ). Peter Senge also presents compelling arguments in The Fifth Discipline – the Art and Practice of the Learning Organization. He defines ‘personal mastery’ as the discipline of self-leadership and personal development.

Organisations need to establish the conditions most likely to nourish good personal and corporate governance Why managers matter

As the financial crisis of 2008 starkly revealed, managers, and particularly senior managers, have central social and socio-political importance. Via their behaviour, they set the course for economic development. The way in which they relate to their function, their contract and their company can never be treated lightly. As such, the behaviour of managers is openly monitored – and judged – and inextricably linked with corporate governance.

Fredmund Malik is an Austrian economist and business consultant. For him: “The company is the only, (and therefore most important), social institution to create prosperity. It demands management. So management is the most important shaper, developer and directive organ of modern

society – all the more so as state politics, in our global economic context, are pushing at national borders and have lost any effectiveness in answering the questions that matter the most. By inference, management is also the most important profession in a company. Almost everything depends upon the quality and conscientiousness with which the profession is practised. High demands need to be placed upon management – and fulfilled.”

There’s no question about it. The societal influence of companies (large companies most directly, small to medium companies more indirectly), and therefore their managers (our so-called economic leaders) is enormous.

Not surprisingly, that influence has been repeatedly seized upon in discussions about top management salaries.

Yet, in these statements, Malik is only dealing with the commercial aspects of societal health. As we have experienced, the role of companies and their management has also been dragged into the epicentre of world events, giving them an unprecedented social role and responsibility. Are supervisory and executive bodies sufficiently aware of their impact on society? Whatever the case, the conclusion is clear. Functions with this much influence on society need outstanding personal governance if they are ever to practise credible corporate governance and guarantee their positive effect on the world around them.

Summer 2016 | Ethical Boardroom 59

Board Governance | Personal Governance

Welcome to personal governance

In summary, corporate governance has central, social importance. Many, if not most, people have been directly affected by the successes and failures of large private and state-owned businesses on an emotional, financial or even existential level.

Personal governance, meanwhile, is a conscious, strategic and operative/situational form of self-steering and permanent personal development. It is a beacon for the way in which we lead our lives and organise our private CV. It is a psychological contract with ourselves.

This contract implies expectations regarding our actions and commitments. An important corollary – playing a key role in personal governance – is the psychological contract between company and employee. This regulates mutual expectations in a way that goes beyond the formal framework of the employment contract.

Personal governance is aligned with a personal mission, one that takes equal account of private and professional goals and is based upon these. Our personal mission also covers social and or political engagement.

The seven principles of personal governance — code of best practice So, what do you ideally see in a director who embraces personal governance?

1

Life plan and goals A personal mission within easy reach, serving as a common thread and leitmotiv Ethical behaviour A high-awareness of their personal value system and ethically responsible action principles Self-reflection High capacity for self-assessment and self-regulation: ■ They opt for functions in which their strengths and preferences can most ideally be expressed, avoiding (or clarifying) role conflicts (clashes between private or professional roles) ■ They are aware of the most productive use of time, allocating their energy accordingly ■ They regularly reflect upon and check their behaviour. For example, via coaching, peer coaching and feedback Dealing with stress Knowledge and recognition of personal stressors (destructive causes of distress, i.e. negative) and awareness of the right (work)load for themselves and for others: ■ Coping strategies (ways to overcome problems and diminish load) are close at hand and are situationally deployed, checked, adapted and, when necessary, effectively substituted ■ They are able to reach out for help in difficult situations – via coaching, professional/personal consulting, etc

2 3

4

60 Ethical Boardroom | Summer 2016

development 5 Personal Developing (self, others) via

ongoing study and inquiry Personal interests and passions Strong fields of interest and passion outside the scope of professional responsibilities: ■ They can experience ‘flow’ experiences (Mihály Csíkszentmihályi) – a state of complete immersion in an activity ■ They visibly and skilfully stake a claim on their personal space and time ■ They make space for political and/or social engagement Reputation Alertness to personal reputation and that of company

6

7

Working with the principles — adopting and adapting

How can we make the step from recognising the seven principles of personal governance to really anchoring them in our daily practice and behaviour? Seven principles are neither definitive nor conclusive. We should constantly adapt them to our fresh experiences and discoveries. We should put them in a situational context, taking account of our personal needs and our current, individual ‘reality’. As such, the principles are intended to act as a ‘working paper’.

This brings us to another important point.

It might seem as if compliance with the seven principles will turn us into superheroes. Not only will we achieve a perfect balance between all facets of our professional and personal lives but we’ll also make an active contribution to the common good! However, this perfect (and 1. Life plan and goals 2. Ethical behaviour

7. Reputation

6. Personal interests & passions

Personal governance

5. Personal development

4. Dealing with stress

3. Selfreflection

Personal governance is a conscious, strategic and operative/situational form of self-steering and permanent personal development probably rather restless) person would find almost no time for the all-important passive regeneration, which is handled in principles 5 and 6.

Finally, the conditions within each principle don’t all need to be fulfilled simultaneously.

In any case, this is impossible. In the course of our lives, it’s a question of striking a balance, taking individual principles into account to a minimal degree, without accumulating a mass of demands and creating overload.

What’s next?

So far, we have presented the case for personal governance, provided definitions and introduced the seven principles of a code of best practice. Each of these principles, with its leading questions and vital signs can be unpacked further.

In our next article, we start with the personal mission. What does a personal mission really mean? What key questions do we need to ask ourselves from a managerial and organisational perspective?

1 2015 Edelman Trust Barometer – 15th Annual Trust and Credibility Survey 2Crossan, Mazutis and Seijts, (2013) In Search of Virtue: The Role of Virtues, Values and Character Strengths in Ethical Decision Making.

Journal of Business Ethics, 113:56seven–581 3 Plato, Pseudo Platonic Dialogue of Alkibiades

Global News North America

Three US states take on Volkswagen New York, Massachusetts and Maryland have accused Volkswagen and its affiliates of selling tens of thousands of cars installed with ‘defeat devices’ and covering up the deception.

Three US states are suing Volkswagen alleging that the company knew its cars had been engineered to cheat US pollution tests and had concluded that “breaking the law and risking the imposition of fines was an acceptable cost of doing business”.

The lawsuits allege that Volkswagen submitted false emissions data to regulators and sought to eliminate evidence when an investigation began.

It is reported that around 25,000 cars were affected in New York, 15,000 in Massachusetts and nearly 13,000 in Maryland with Volkswagen and its affiliates selling 600,000 affected cars US-wide.

OEB unveils draft guidance on corporate governance The Ontario Energy Board (OEB) has developed corporate governance guidance for the region’s regulated natural gas and electricity utilities to ensure a “more consumer-centric regulatory framework”.

It said that by implementing corporate governance guidance, the OEB is working proactively to protect the interests of consumers, promote efficiency and effectiveness and facilitate a financially viable sector.

According to the OEB, while utilities will not be required to adhere to the guidance, they are expected to consider the guidance when developing their corporate governance practices.

Pershing Square sells Canadian Pacific shares Hedge fund Pershing Square has unloaded its entire stake in Canadian Pacific Railway, almost five years after becoming its major shareholder.

Pershing Square, owned by investor Bill Ackman, sold all its 9.8 million shares in Canadian Pacific Railway in a series of trades arranged by Bank of America, Credit Suisse and JPMorgan Chase.

Canadian Pacific has been among Ackman’s most successful investments; the stock has almost quadrupled since 2011 when he first

62 Ethical Boardroom | Summer 2016

bought the stock. Yet despite speculation that the sale was driven to help offset losses from Pershing Square’s investment in pharmaceutical Valeant, Ackman said that the fund intends to use the proceeds of the sale to fund one or more new investments.

Earlier this year, Pershing sold 16.85 million shares in Zoetis, the former animal health arm of Pfizer, and offloaded 20 million shares in Mondelez International, the food and beverage company.

CEOs issue principles of corporate governance Good corporate governance is critical to the health of public corporations and markets in the US and creates economic growth and better financial futures for workers, retirees and investors, according to a group of CEOs. In a united effort to overhaul corporate governance, leading executives from companies, including Blackrock, JPMorgan Chase and General Electric, have unveiled the Commonsense Corporate Governance Principles.

The principles outline a number of recommendations and guidelines as to the roles and responsibilities of boards, companies and shareholders.

Women on boards ‘boost businesses’

Qualified female board members can bring a company work experience and different perspectives of looking at an issue from a consumer and employee standpoint, according to a female entrepreneur.

Sukhinder Singh Cassidy, a former Google executive and founder of theBoardlist — an online talent marketplace of qualified female tech executives for board candidates — says gender diversity can lead to greater company performance.

Since theBoardlist launched a year ago, the website has more than 1,200 women listed as qualified board applicants, endorsed by hundreds of current executives, and has placed three board members through the service.

“We feel really good because we look at the pipeline of demand and see that it’s growing,” said Cassidy in an interview with USA Today.

DISRUPTIVE TRENDS CONVERGE WITH BOARD MATTERS

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Corporate Governance Awards | Introduction

Ethical Boardroom North & South America award winners 2016 Corporate governance – the dynamic between a company’s management, its board, its shareholders and other stakeholders – provides the structure through which the objectives of the company are set, achieved and monitored.

In Colombia, Latin America’s fourth largest economy, significant progress has been made through reforms to improve the management of state enterprises and increased efforts to raise corporate governance standards.

Earlier this year, Colombia was accepted into the Corporate Governance Committee of the international economic organisation the Organisation for Economic Co-operation and Development (OECD) – recognition of the country’s work towards becoming more efficient, more transparent and more successful.

According to the OECD, the Colombian state has demonstrated its commitment to facilitating minority shareholders’ and interest groups’ rights and has practices that could be regarded as good examples internationally for their effectiveness, such as in matters relating to equal treatment of shareholders’ or stakeholders’ engagement.

In the US, practicing sound corporate governance, to ensure better long-term growth and performance at public companies, sits at the top of the agenda for many business leaders.

In an open letter and nine-page document of governance principles, the heads of major investment firms, including the CEOs of heads of JP Morgan Chase, General Electric, General Motors and Verizon Communications, outlined their effort to find common ground on how US public companies should be run.

The principles, intended to provide a basic framework for sound, long-term oriented governance, include the notion that “truly independent corporate boards are vital to effective governance”, so no board should be

Practicing sound corporate governance, to ensure better long-term growth and performance at public companies, sits at the top of the agenda for many business leaders.

64 Ethical Boardroom | Summer 2016

beholden to the CEO or management and that “every board should meet regularly without the CEO present, and every board should have active and direct engagement with executives below the CEO level”.

Another principle proposes that effective governance requires constructive engagement between a company and its shareholders – so that a company’s institutional investors making decisions on proxy issues important to long-term value creation should have access to the company, its management and, in some circumstances, the board. Similarly, a company, its management and board should have access to institutional investors’ ultimate decision makers on those issues.

The Ethical Boardroom Corporate Governance Awards recognise and reward outstanding companies, who have exhibited exceptional leadership in the area of governance. The awards highlight the important role that corporate governance plays in dictating a company’s success and a board’s contribution to the creation of long-term value.

Ethical Boardroom is proud to announce the Ethical Boardroom Corporate Governance Awards 2016 Winners in the Americas.

AwArds

The Winners | Corporate Governance Awards

WinneRs 2016 the AmericAs

NOrth AmericA 2016 PhArmAceuticAls Bristol-Myers squiBB Oil & GAs suncor energy inc.

FOOd & BeverAGe general Mills inc. cONGlOmerAtes general electric coMpany FiNANciAl services BMo Financial group utilities aVangriD inc. retAil Wal-Mart stores inc. techNOlOGy MicrosoFt corporation AutOmOtive ForD Motor coMpany telecOms Verizon coMMunications inc.

AirliNes Delta air lines inc. sOuth AmericA 2016 cONstructiON grupo graña y Montero AirliNes gol linhas aéreas inteligentes s.a FiNANciAl services Banco De chile Oil & GAs ultrapar participacoes s.a. utilities enDesa chile cONGlOmerAte grupo sura retAil cencosuD s.a. iNdustriAl services Ferreycorp saa miNiNG Vale s.a.

Summer 2016 | Ethical Boardroom 65

Global News Asia & Australasia

Investors buoyed by Japan’s improving corporate governance European and US investors are optimistic about the prospects of Japan following the structural reforms introduced by Prime Minister Abe as part of his Third Arrow reforms, a report claims.

According to the BNY Mellon survey Investor Sentiment On Japanese Reform, many investors are encouraged by the introduction of the Corporate Governance Code, despite the fact that adherence is voluntary and on a comply-or-explain basis.

7-Eleven brings in new directors Convenience store giant 7-Eleven has appointed three new non-executive directors to its board, following revelations last year that it had significantly underpaid thousands of workers.

Sandra Birkensleigh joins as chair of the audit and risk committee, Elizabeth Gaines as chair of the retail operations committee and Dharmendra Chandran as chair of the people committee.

“Sandra, Elizabeth and Dharmendra come to 7-Eleven with diverse and highly relevant skillsets, particularly in leading-edge corporate governance, finance, strategy, executive leadership and cross-cultural engagement,” said 7-Eleven chairman Michael Smith.

However, investors say they are aware of the risks in investing in the country. The risk most cited by those investors surveyed is that the government’s monetary and fiscal policies may prove to be ineffective at revitalising the Japanese economy.

The report also highlights that a longstanding criticism of Japanese companies was that they tend to carry excessive cash on their balance sheets that many investors feel should be returned to the shareholders.

ASX appoints new chief executive

Singtel tops list of governance rankings

Dominic Stevens has taken over as managing director and chief executive of Australian Securities Exchange Ltd (ASX), following the resignation of Elmer Funke Kupper earlier this year.

Stevens has been an independent nonexecutive ASX director since 2013 and served on its audit and risk committee and on a number of its clearing and settlement boards.

Elmer Funke Kupper resigned following allegations that Tabcorp, the gaming company he once led, made a $200,000 payment to the family of Cambodian prime minister Hun Sen. The Sydney Morning Herald reported that a payment was made while Tabcorp was looking at setting up an online betting business in the country in 2010.

Service provider Singtel has been named Singapore’s most well-governed and transparent company for the second year running, under an enhanced index of Singapore’s corporate governance standards.

Singtel topped the rankings of the latest Singapore Governance and Transparency Index (SGTI), published annually by CPA Australia, NUS Business School’s Centre for Governance, Institutions and Organisations (CGIO) and the Singapore Institute of Directors.

Mr Melvin Yong, Singapore Country Head at CPA Australia, said: “Standards of corporate governance among Singapore-listed companies have continued to scale new heights every year since 2011. But in comparing the best performers with the rest of the market, it is clear that much work lies ahead to bring those with weaker governance on this journey.”

Women urged to join state-owned enterprise boards The New Zealand government has called for more women to apply for roles on several state-owned enterprise (SOE) boards.

Women with skills in governance, management, company law and financial matters are being encouraged to join the boards of Airways Ltd, AsureQuality Ltd, Meteorological Service of New Zealand Ltd and Quotable Value New Zealand Ltd. State-Owned Enterprises Minister Todd McClay and Minister for Women Louise Upston says women are under-represented and they want that to change.

Upston said: “Mr McClay and I are committed to increasing the percentage of women on stateowned enterprises’ boards to at least 45 per cent.”

66 Ethical Boardroom | Summer 2016

Activism & Engagement | Investor Activism

Activist investors: Staying ahead of the pack Activist investors are relatively new, but very influential, players in international capital markets. While some activist proposals may fall short, activism is here to stay.

Activist investors are shareholders at publicly traded companies who attempt to affect change in an organisation either by directly appealing to, or putting heavy pressure on, the company’s board of directors, bypassing the normal advisory process.

The scope of activist investors’ actions varies depending on their assertiveness and on what exactly they seek to change at a given company.

The firms that activists target tend to underperform relative to their industry.

Due to activists’ aggressive attitude toward management and hostile approaches to short-term profit making, they are often perceived as corporate raiders, green mailers or asset strippers.

Types of activism

Hedge fund activism is among the most aggressive and involves shareholders who usually seek a significant change in a company’s strategy, financial structure, management or board composition.

More common, but less conflictual, investor activism consists of shareholders playing a NO ESCAPE Activist investors are here to stay

68 Ethical Boardroom | Summer 2016

Like it or not activist investors are here to stay and are radically changing the business landscape

Most recently, activists have been targeting management composition and capital allocation decisions. They often attempt to bring in new management teams, create operational efficiencies, and impose financial restructuring or divestments through the selling of assets.

Nuno Fernandes

Investors can try to bring about change in a number of different ways. They might lobby softly behind the scenes, stating their intentions in meetings or through letters. The most aggressive attacks can come in the form of loud media campaigns against management in an attempt to force their hand through public pressure on specific issues. Either way, the first step is usually to gather a coalition of like-minded investors, such as pension fund or other asset managers, who want to see greater returns on their investments.

The motivations behind today’s activist investors are myriad. They typically involve some level of perceived underperformance, mistakes or non-transparent processes. Shareholders may take action when they believe stock prices are undervalued compared to industry peers, that conglomerates are misallocating capital and have businesses without synergies, that a specific transaction was ill-advised, or that executive pay and company performance evaluation processes are opaque.

Professor of Finance and Director of Strategic Finance at IMD part in deciding how much executives are paid. This is referred to as say-on-pay and originated from concerns about top executives deciding on their own remuneration and overpaying themselves. In the US, say-on-pay was a provision of strong post-financial crisis legislation referred to as Dodd-Frank, which has sought to improve accountability and transparency in the American financial system. Due to the interconnectedness of international financial institutions and business entities, the legislation has had sweeping effects all over the world.

Engagement by activist investors can focus on a number of different aspects of a company. Zealous shareholders’ preferred targets are: governance and policies; executive compensation plans; audit and risk management; overall company strategy; or breaking up or merging large groups in order to shift focus back to core business activities.

Methods and motivations

Growing influence

In 2015, hundreds of companies worldwide, such as General Motors, Dow Chemical,

Investor Activism | Activism & Engagement

ACTIVIST TArgeTS by geOgrAPHy

ACTIVIST TArgeTS by SeCTOr

Issuer HQ Location US Canada UK Australia Europe (excluding UK) Asia Other

Sector Basic Materials Conglomerates Consumer goods Financial Healthcare Industrial goods Services Technology Utilities

Total

April 2016 April 2015 2016 YTD 80 68 232 1 4 20 5 4 17 2 7 19 5 8 22 1 3 19 2 1 4 96

95

333

Companies publicly subjected to activist demands by company HQ location

Nestlé, Xerox and Mondelez, were subject to so-called activist investors; 2016 has also been a big year for investor activism.

Investors David Einhorn and Carl Icahn have both used their large stock holdings in Apple to exert pressure on the company to make changes, such as returning capital to shareholders from the company’s massive cash reserves of around $150billion.

In 2014, Trian Fund tried to use its influence as an investor to get PepsiCo to separate its snack and beverage arms and ultimately succeeded in having one of its advisors placed on the PepsiCo board of directors.

Bill Ackman, of Pershing Square Capital Management, the 10th largest shareholder at Proctor and Gamble in 2013, was able to force the then CEO Robert McDonald out of the company by criticising his performance and promising higher stock prices.

A dispute between Trian fund (again) and the board of directors at DuPont over whether DuPont should have divided into two companies resulted in a victory for DuPont CEO Ellen Kullman, who stood her ground and resisted Trian’s proposal. But Kullman ended up resigning months later. DuPont subsequently merged with Dow chemical after being the focus of another activist investor firm, the hedge fund Third Point. The merger is still underway and calls for the company to spin off into three separate entities. Trian fund

April 2016 April 2015 2016 YTD 8.3% 9.5% 13.5% 1.0% 2.1% 0.6% 9.4% 8.4% 7.8% 22.9% 17.9% 25.8% 10.4% 8.4% 8.4% 4.2% 7.4% 5.1% 26.0% 26.3% 23.1% 14.6% 16.8% 14.1% 3.1% 3.2% 1.5%

Proportion of companies publicly subjected to activist demands by sector

is reported to have been consulted for input on the merger.

In 2013, activist hedge fund manager, Dan Loeb of Third Point wrote a letter to Sony, urging it to split up its entertainment and electronics businesses. The proposal put forth that shareholders be given a chance to invest further in Sony Entertainment, creating an infusion of capital, while streamlining its offer of electronics, focussing on profitable products and cutting loss-generating ones.

Sony’s board rejected Third Point’s proposal.

Third Point expressed its “disappointment” that Sony was turning down its proposal and issued a statement saying that it would “explore further options to create new values for shareholders following talks with the Sony management”. Sony’s share prices proceeded to drop following the news.

In 2014, Sony announced the sale of its computer business to Japan Industrial Partners, Inc., one of the domestic funds specialised in restructuring businesses.

The company also made a structural reform of its television business, spinning it off into a wholly owned subsidiary later that year.

Time to be wary?

While activist investors don’t always succeed in getting exactly what they want, their actions can be highly influential even when they fail to achieve their specific goals.

What is certain is that they are here to stay; at least for the foreseeable future.

Your company needs to be prepared to be an activists’ target. Their rise is associated with a stronger focus on shareholder value. What’s the best way to prevent their attack? By maintaining strong company performance. Make sure that you maximise value across all of your businesses and, if you are a conglomerate, that there are solid synergies between your different enterprises.

Despite criticism, the empirical evidence is clear; share prices and operating performance at targeted companies often improve after activist involvement.

It is best summed up by Warren Buffet, who said: “If every company were well-managed, there would be no reason for activists. The truth is, at some companies, the managers forget who they’re working for.”

Your company needs to be prepared to be an activists’ target. Their rise is associated with a stronger focus on shareholder value. What’s the best way to prevent their attack? By maintaining strong company performance

Summer 2016 | Ethical Boardroom 69

Activism & Engagement | Crisis Management

SHEDDING LIGHT An immediate response isn’t always possible; but indefinite delay is damaging

Communicating in a time of crisis Increasingly we see that the media’s analysis of how a company reacts to a crisis receives almost as much comment as the crisis itself Almost every day we seem to wake up to a new crisis with news of an embattled board working around the clock to save a firm’s reputation. And in this era of digital communications, it goes without saying that a crisis can gain momentum more quickly and reach further than ever.

How management responds to a crisis says a lot about the way they do business, especially now that public criticism extends 70 Ethical Boardroom | Summer 2016

beyond the comparatively well-behaved world of traditional media to anyone with a Twitter account and an opinion. This can be hard for a CEO to take, but now, more than ever, a measured but timely response is critical.

Like many things, preparation is key and as part of this exercise we would suggest boards consider five ‘big questions’ when creating their response strategy: scale, advice, sacrifice, stakeholders and perspective.

Scale: Just how important is this?

The first few hours of a crisis can make all the difference between a company being seen as

James Melville-Ross

Senior Managing Director, Strategic Communications, FTI Consulting

acting in a credible and responsible way and, therefore, hopefully making a speedy recovery, or not. A proportionate response is what matters; too little and a company can look as if it is not taking the crisis seriously, too much and it can turn something serious into a full-blown disaster that throws the future of the business in doubt. The best thing a CEO can do when a crisis first arrives

Crisis Management | Activism & Engagement

is to call the executive committee together as quickly as possible in order to understand what has gone on and, importantly, where the unfolding issue may yet go.

In situations like this, the media will demand immediate information that a company may simply not have. For example, exactly how many people have been affected?

How did things go wrong? How is the company going to put it right? And very often last but not least, how will the company ensure this never happens again? The point to remember here is that one does not have to agree to do interviews if there is nothing to say and a statement of intent – for example, offering an ‘immediate and urgent review’ may be sufficient as a temporary stopgap while facts are being collated.

But the byword here is ‘temporary’. The flipside to a lack of information is that, within a few hours, inaccuracies can be traded as fact online and reacted upon by angry individuals giving a knee-jerk

response – particularly if the company has decided to keep its head down.

There are many examples of companies that have clearly preferred to get all the facts together before offering a thoughtful and considered reply, but by the time it had all of the answers, the crisis has threatened to engulf the business. This offers a clear insight that there is an optimal timeframe whereby companies should engage with the outside world and waiting months is simply too long. A lengthy information vacuum left by the business leaves others, particularly competitors, to chip away at a company’s reputation by making ill-informed ‘background’ comments.

The ideal, therefore, has to be something in between offering an immediate interview where the facts are still unknown and therefore misstatements could be made, and spending months carrying out a forensic

The best thing a CEO can do when a crisis first arrives is to call the executive committee together as quickly as possible in order to understand what has gone on

review by which time the original problem could have escalated into a catastrophe.

Advice: The lawyers are telling me one thing; the PR people are telling me another

A lawyer’s job is to avoid liabilities and therefore unsurprisingly they can be keen to try and distance a company from any suggestion of wrongdoing. A public relations specialist, on the other hand, is motivated by protecting the reputation of a business and therefore will push for a more full and frank response – sometimes, but not always, to the point of making a full apology. Unsurprisingly, these two viewpoints can be at polar opposites at exactly the time when a CEO is looking for consistent advice from his or her advisers.

Both views have merit. Claiming too much responsibility can open the door to litigation and huge settlements. Yet hiding behind legal statements when a company has clearly breached the contract of trust they have with a customer could have far wider repercussions at the end of the day than pounds and pence alone. Increasingly, lawyers acknowledge this point of view.

Summer 2016 | Ethical Boardroom 71

Activism & Engagement | Crisis Management Ideally, the two sides should come to a compromise that is workable from all perspectives. We all know of situations where the legal argument has clearly won out and a company has steadfastly refused to accept any responsibility even when the ethical and moral ground screams otherwise (see the Thomas Cook case study). Sometimes in these situations it really is for the CEO and board to take a step back and put themselves in the shoes of a customer or other stakeholder group.

Legalities are all very well but a pragmatic approach could well turn the situation around and restore that vital trust before it is too late.

Sacrifice: are we going to need a sacrificial lamb?

Should the scale of the crisis demand it, there may be a clear need for a large gesture in order to recover trust. This could take the form of a member of the senior management team falling on their sword, a major product recall or potentially even exiting from a part of the business altogether.

Again, as above, though, the key is to move with caution. When a crisis hits it is all too easy to ‘sack the manager’ when he or she may actually have a great deal of useful knowledge in order to help the business to move past the immediate problem. A crisis is often a marathon rather than a sprint and companies should keep the long game in mind.

Stakeholders: who really matters?

When a storm hits it can be all too easy to lose sight of what really matters, particularly when one has the mighty Fourth Estate to contend with. Communication is not a science and there are no rights and wrongs but again, pragmatism plays an important part.

Crises are, by their nature, leftfield events that can throw a business off course, so if the crisis is customer-related such as the result of litigation or negligence, what plans have been put in place for customer communication to be sent out quickly and efficiently? What about suppliers? A crisis can often spell uncertainty and worry on the part of suppliers concerned they will not be paid for their goods. This can affect trade credit rapidly and therefore quickly turn a smaller incident into a major issue for a business. And what communications channels are available to the business? Is there a reliable list of channels with corresponding individuals who will manage each one alongside communication templates to be used?

It is all too easy for companies to become distracted by the everyday and lose sight of managing these key relationships that keep the whole show on the road.

From a PR perspective, it is imperative that companies create proper channels through which issues can be dealt with in a timely and responsible way. There are always things that can go wrong. But handling these things with sensitivity can make all the difference. Then, if 72 Ethical Boardroom | Summer 2016

stEERinG oUt of DAnGER The first few hours of a crisis can make all the difference for your survival chances

and when issues do arise, having a proper crisis manual in place could at least help to alleviate some of the stress that can be caused by people not having thought it through beforehand.

For example, having names and contact details of key individuals, draft letters, press releases, Q&As and other key documentation in one place can make a huge difference in a fast-moving situation where time is of the essence.

Perspective: How can we make the best out of a bad situation?

The temptation in a crisis is to feel unreasonably targeted. It can be a lonely place to be, particularly for a CEO, and there are plenty of examples of people who have not fared well when put in the eye of the storm.

However, with a little humility – recognising the issue and being brave enough to apologise where necessary, a CEO can recover and indeed enhance their profile in the eyes of stakeholders as someone who has learned from past mistakes.

The public, customers, markets and the media are warm to the concept of a phoenix rising from the flames and if one can show a rapid, appropriate and transparent response to a crisis then it is possible to emerge with more credibility than less.

In summary

The single biggest thread that brings all of the above together is planning. A crisis manual that is a living, breathing document that is kept up to date, clearly owned by the executive committee and is within easy reach of the key business decision makers is absolutely critical to making any of the above work efficiently. Too often companies leave these things to gather dust on a shelf while technology’s rapid advance can create new ways for crises to emerge.

Scenario planning is also another useful tool to practise and refine how a company would respond should the worst happen. For example, what impact could a particular crisis have on a given stakeholder group and how the business would respond to that? Also, which third parties would come out for or against a business in any given situation and how could the company deal with that? Has the business considered the impact of a social media campaign following a crisis and how would it run and maintain rapid response should that happen?

AnAtoMy of A CRisis — thoMAs Cook: “I learnt a lesson from our crisis: don’t listen to lawyers”

I

t took nine years for Thomas Cook to apologise to the family of Bobby and Christi Shepherd (aged 6 and 7) after their deaths from carbon monoxide poisoning in 2006, while on a Thomas Cook holiday in Corfu.

Peter Fankhauser, the CEO of Thomas Cook, admitted that it should have come sooner but admits that he “got caught up in corporate behaviour. I listened too much to lawyers”.

It’s hard to understand how any company, particularly a holiday company, could have missed the opportunity to apologise sooner for the accident, but the case study provides a classic example of the importance of seeing the wood for the trees in the midst of a crisis. For boards, it underlines the importance of deciding early on who is the most important stakeholder in all of this and making sure that your communications approach takes them into consideration before others.

Activism & Engagement | Proxy Advisors PROXY VOTING CHANGES Opponents of the legislation argue it would muzzle proxy advisory firms and undermine investors

Hazards of the right of first perusal Proxy advisory firms aren’t the only ones concerned by moves to limit US investors’ constitutional rights

74 Ethical Boardroom | Summer 2016

Proxy Advisors | Activism & Engagement

Imagine if the government forced reporters to allow the subjects of their articles to review the draft text of those articles. That’s what the Corporate Governance Reform and Transparency Act of 2016 (H.R. 5311) in the US would mandate for proxy advisory firms, such as Glass Lewis.

The Bill, as drafted, would damage investors in public companies by attempting to muzzle research providers that provide them with the data, analysis and voting recommendations they use in fulfilling their fiduciary obligations related to proxy voting (see SEC Staff Legal Bulletin No. 20, issued 30 June 2014).

Investors use proxy advisor reports to help them decide how to vote thousands of proposals submitted for shareholder vote at public company shareholder meetings, most of which are held between March and May. H.R. 5311 would strip proxy research providers of their independence by granting to public company executives the right of first perusal of their reports – a product paid for by investors. Fundamentally, this is an attack on the shareholder rights of long-term owners, such as the pension funds of police officers, firefighters and teachers, as well as the current and future retirees who invest their IRAs and 401ks in mutual funds. With less information and time to review reports, shareholders will be less able to hold companies accountable for poor returns, overpaying underperforming executives and ignoring shareholders.

Threat of litigation

The Bill tramples on fundamental First Amendment rights by requiring that proxy advisors allow company executives to review their reports, tantamount to censoring, before the reports are sent to paying clients, i.e. the investors. The Bill would also allow companies proxy advisors to accept their edits or face the implied threat of crippling litigation if the edits are not accepted. This would, in effect, give corporate executives editorial control over proxy advisor reports. No other research analysts are subject to these prior review rules; in fact FINRA prohibits this to avoid conflicts.

The Bill also would require the SEC to develop a new registration scheme for proxy advisors, further inhibiting competition in a market that is dominated by two significant competitors. In the aggregate, the provisions in the proposed Bill threaten the survival of proxy advisors. Without access to services provided by proxy advisors, the costs to investors would significantly increase as they would have to do all the data gathering, translation of detailed meeting materials, analysis and custom vote application themselves. This is not to

Katherine Rabin

Chief Executive Officer, Glass, Lewis & Co mention the potential loss of hundreds of jobs at proxy advisors if investors are unwilling or unable to pay additional fees to cover the costs of the Bill’s new mandates.

Voting decisions

competitors formed an industry group to develop the Best Practice Principles for Providers of Shareholder Voting Research and Analysis (BPP), which were launched in 2014 following a global consultation on the BPP in 2013. Signatories to the BPP apply the principles to their activities globally.

The principles encourage transparency, conflict management and disclosure, and engagement with companies. Glass Lewis meets the principles’ standards by making its full guidelines, research approach and methodologies, conflict avoidance and disclosure policies, and engagement procedures available publicly on the company website.

Investor consumers of proxy advisor services hold the advisors accountable and are satisfied with the current system; it is telling that the call for regulating advisors is coming not from investors but from the companies that are the subject of the advisors’ reports.

Justification for the Bill rests on dubious claims of high levels of influence of proxy advisors based on a narrow, conjectureriddled analysis. However, even a broad examination of various academic evidence shows a wide divergence in findings, indicating the difficulty of proving the purported influence. Actual voting outcomes at US public company meetings belie these claims. For example, since the launch of the non-binding executive compensation vote in 2011, Glass Lewis has recommended Public opposition against 14-18 per cent of these say-on-pay Indeed, investor organisations and individual proposals whereas approximately two per institutional investors, including the Council cent of such proposals fail to pass each year; of Institutional Investors (CII), Investment average shareholder support is more than Company Institute (ICI), the International 90 per cent. Voting results for other Corporate Governance Network, California proposals, such as election of directors, State Teachers Retirement System, Ohio also differ materially from advisors’ voting Public Employees Retirement System, Florida recommendations. In any case, proxy advisor State Board of Administration and the guidelines generally reflect the voting Washington State Investment Board, have guidelines of their clients, the majority of expressed publicly their opposition to the whom make their own voting decisions. legislation. The CII, an association mainly Other regulators, including the body that of employee benefit plans, warned that represents all the securities regulators in the Bill “could weaken Europe, ESMA, and the CSA public company corporate in Canada, determined after Proxy advisor governance in the United comprehensive reviews that States; lessen the fiduciary neither binding nor quasiguidelines obligation of proxy advisors binding regulation of proxy generally reflect to investor clients; and advisors was warranted. reorient any surviving proxy ESMA recommended the the voting advisors’ to serve companies industry develop a code of guidelines of rather than investors”. conduct to address concerns The ICI noted the useful raised in the consultation their clients, the guidance provided by the SEC while the CSA determined majority of whom Staff Legal Bulletin No. 20 that proxy advisers should make their own and specifically highlighted not be required to register as concerns about the Bill’s investment advisers. voting decisions creation of a right of action for Glass Lewis and its largest companies, the requirement to permit issuers to ‘review, comment on and influence draft recommendations’ and the requirement for the SEC to assess the adequacy of proxy advisors financial and managerial resources, a task the ICI notes is better undertaken by mutual funds themselves.

We agree with investors and other regulators that no additional regulations are warranted, particularly rules so onerous as to neutralise proxy advisors.

Summer 2016 | Ethical Boardroom 75

Activism & Engagement | Investors

Informing the investor community A ‘traffic light’ rating of company performance is empowering investors and effecting a change in corporate behaviour

FOCUS ON THE UK There are increased efforts to improve the productivity of both companies and the economy 76 Ethical Boardroom | Summer 2016

Investors | Activism & Engagement

The way that UK companies are being run is under the spotlight more than ever before.

Gone are the days when corporate governance issues – from executive pay to environmental and social matters – were esoteric topics exclusively scrutinised in the pink pages of the national press.

Alongside the media fervour is an increased regulatory and political focus on UK companies post the financial crisis of 2008, to ensure that they are acting in the best interests of their customers, shareholders and wider society.

This pressure has also raised questions about how institutional investors engage with the companies they own on behalf of their clients and whether they actively hold them to account.

The investor’s role

The UK’s investment industry collectively manages more than £5.5 trillion of assets and holds around a third of the UK equity market.

Therefore, the fund management industry plays a huge role in ensuring higher standards of UK corporate governance and it is vital that it has all the information it needs to do so at its finger tips.

As the trade association representing the entire breadth of the UK’s investment

Andrew Ninian

Director of Corporate Governance and Engagement at The Investment Association community, The Investment Association (IA) provides a range of services and products to help our members highlight to companies the issues of importance as well as how companies are responding and operating in this space.

At the heart of this work is the Institutional Voting Information Service (IVIS).

What is IVIS?

IVIS essentially does what it says on the tin – it provides information to institutional investors, which we believe they should consider prior to voting.

It conducts in-depth research of UK-listed company annual reports, analysing the key issues that investors should be aware of.

It is different to other corporate governance

research providers as it does not provide directed voting advice, instead highlighting issues or concerns for subscribers to consider.

Off the back of this research, IVIS produces reports designed to be a ‘one-stop-shop’ – providing investors with all of the information they need ahead of voting at an annual general meeting (AGM) and to help shape their views of the companies they own on behalf of their clients.

The reports are broken down into three key areas: the proxy report, the corporate governance report and the environmental, social and governance (ESG) Report.

The proxy report offers a comprehensive commentary on the resolutions that are to be proposed at a general meeting. This allows investors to have a clear and concise breakdown of what the key areas of consideration are, ahead of them voting at an AGM on issues, such as executive remuneration and share capital management.

The UK’s investment industry collectively manages more than £5.5 trillion of assets and holds around a third of the UK equity market

Summer 2016 | Ethical Boardroom 77

Activism & Engagement | Investors The corporate governance report covers board and committee composition, particularly considering issues around director independence and a company’s adherence to the UK corporate governance code. It also outlines information on auditor tenure and the level of audit and non-audit fees.

ESG reports look at whether companies are appropriately reporting on how they are addressing and embracing ESG issues.

These reports are given a rating in line with the recommendations of our own guidelines on responsible investment disclosure.

These guidelines outline that boards need to take account of the significance of ESG matters and that annual reports must clearly summarise the ESG-related risks and opportunities that may significantly affect the company’s short- and long-term value and how they might impact on the future of the business.

HOLDING SWAY The investment industry can itself is acting as a catalyst for economic improvement

IVIS upholds the views and expectations that Investment Association members have of UK companies through a set of principles and guidelines. As well as the responsible investment disclosure guidelines, we also publish principles around executive remuneration and share capital management. All of our principles and guidelines are updated yearly to ensure that they continue to resonate with the market.

Along with the Financial Reporting Council’s UK corporate governance code, our principles act as the foundation of every report’s findings and they allow us to be independent and objective in the way that we assess companies we cover.

The scope of the service is not limited to just the big name companies of the FTSE 100, it produces more than 750 reports every year examining all AGMs and general meetings for companies in the FTSE All Share Index as well as the top 50 companies in the FTSE Fledgling Index.

Who is it for?

The service is of most significance to the UK and international investment community as it 78 Ethical Boardroom | Summer 2016

does the groundwork and helps investors analyse corporate governance disclosures and exercise their voting rights.

It is also available to advisory firms, such as lawyers, consultants and public relations agencies and allows them to keep up to date on market sentiment relating to their clients and their competitors.

The reasoned voice

concern, while a green coded report indicates an issue that has now been resolved. Red and amber tops typically account for 40 per cent of the reports published on an annual basis.

Some of this year’s most notable examples would include the likes of Shire PLC, Weir Group, CRH and Smith and Nephew.

Leading change

Voting at AGMs is only one weapon in an investor’s arsenal that can help push for positive change in the governance space.

One could argue that voting against proposals or practices is a last resort as it often means that companies have not listened or understood investor concerns.

Alongside the IVIS service, the IA works with both companies and their shareholders to enhance the corporate governance standards in the UK. We have regular meetings with companies of all shapes and sizes to discuss areas of interest to the fund management community.

If our membership feels that our voice is not being heard behind closed doors, we often send an open letter to company chairs to publicly hit home the issues that shareholders wish to see addressed.

For example, last year the industry called for improvements to the way in which bonuses are disclosed by UK companies. We issued a warning to companies that do not provide comprehensive disclosure around the awarding of bonuses that they would receive a red top alert from IVIS and to expect shareholder disapproval.

We are pleased to say that this has resulted in progress this year and investors are now enjoying greater levels of transparency around the performance achieved for the award of variable pay.

The IA’s productivity action plan We have also embarked on a project to revolutionise outlines how we as investors can play a the productivity of UK pivotal role in rebuilding the country’s companies and the economic foundations by encouraging economy as a whole.

Our productivity action more long-term investment plan outlines how we as investors can play a pivotal on the companies they hold and we wish to role in rebuilding the country’s economic inform, rather than impose on them, how they foundations for a better future by encouraging vote at company meetings. more long-term investment.

We therefore do not issue direct voting One of the major recommendations of the recommendations. Instead, we highlight project is that UK-listed companies should key issues and breaches of best practice no longer report on a quarterly basis. through our unique colour coding system.

We believe that this will shift companies’ This gives us flexibility in our dealings with mindsets from short-term goals and companies and the ability to consider aspirations and refocus company reporting well-reasoned arguments. to a broader range of strategic issues that The proxy report and the corporate mean the most to long-term investors. governance code report are each issued with a The action plan is a more diverse piece of colour code or ‘top’ which helps to highlight work than solely concentrating on corporate the severity of issues to be considered. governance issues, but it seeks to act as a The colour showing the strongest concern is blueprint for how the investment industry red, followed by amber which raises awareness can improve how UK companies and the of particular elements of the report. A blue wider economy operate. The investment ‘topped’ report indicates no areas of major industry is leading the charge.

Through our membership we have an in-depth understanding of the concerns of both shareholders and companies themselves and, therefore, are able to have our finger on the pulse of the key issues that investors are most interested in.

Our principle-based approach enables us to act as the ‘reasoned voice’ in the market by giving unbiased analysis of the issues at play.

Investors quite rightly have differing views

Global News Europe

Audi boss pays back expenses Audi CEO Rupert Stadler (right) has reportedly reimbursed the car company for the costs of a staff beer party following an ‘internal revision’, according to a German magazine.

Bild am Sonntag reported that the head of Volkswagen’s luxury car brand has paid back 12,500 euros (£10,532) that he had claimed for a ‘beer contest’ with 30 top managers in 2015 after the event was reclassified as a private party.

Separately, VW has agreed to set aside $15.3billion to fund buy-backs, fixes and promote environmentally clean transport solutions in the United States following the emissions scandal. It could, however, still face criminal proceedings. Deputy US Attorney General Sally Yates said a federal investigation was looking at “multiple companies and multiple individuals” involved in an “unprecedented assault on our environment”.

Dutch whistleblower law takes effect A new law designed to help employees in the Netherlands report workplace misconduct came into effect in July.

The House for Whistleblowers Act (Wet Huis voor Klokkenluiders) applies to private and public organisations based in the Netherlands that have more than 50 employees and will establish new rules for internal whistleblower policies as part of corporate governance.

Affected companies are now obliged to formulate official policies that allow employees to report workplace breaches, such as unsafe conditions or corruption.

Romanian focus on state-owned enterprises More than 30 officials from the Romanian Ministry of Economy attended a two-day workshop in July that addressed good corporate governance of state-owned enterprises.

The event, co-organised with the European Bank for Reconstruction and Development, discussed “how the state, as a company owner, should manage its responsibilities more effectively and make its enterprises more competitive, efficient and transparent”.

Sorana Baciu, state secretary at the Ministry of Economy in Romania, said: “The government of Romania has made significant efforts in the last six months to improve corporate governance and strengthen the regulatory framework. This workshop… is part of the ministry’s efforts to strengthen the state’s role as a responsible and active shareholder to foster the implementation of proper corporate governance standards in its companies.”

80 Ethical Boardroom | Summer 2016

Poor governance led to BHS scandal Sir Philip Green’s rush to drive through the sale of British retailer BHS has been slammed as “the culmination of a sorry litany of failures of corporate governance and greed”.

In a scathing attack, a joint parliamentary committee called the collapse of the British stores group, with a loss of 11,000 jobs, “the unacceptable face of capitalism”.

Iain Wright MP, chair of the Business, Innovation and Skills Committee, said: “The sale of BHS to a consortium led by a twice-bankrupt chancer with no retail experience should never have gone ahead and this was obvious at the time. There was a complete failure of corporate governance, with Sir Philip bulldozing the sale through, without proper oversight or challenge from his weak and impotent board.”

The Institute of Directors is among those demanding reform in the wake of BHS’s collapse.

Independent board to run BT’s Openreach BT Group is to make “significant governance changes” in a bid to persuade the UK telecoms regulator that the company should not be broken up.

The main changes will see the creation of a separate board for BT’s local network business Openreach, with an independent chair and a majority of independent members, as a way to increase transparency.

According to BT, other changes include a greater delegation of strategic, operational and budgetary responsibilities and an enhanced consultation process with industry on future investment plans.

Risk Management | Internet of Things

Gerry Kane

Cybersecurity Segment Director, Risk Engineering, Zurich Services Corporation

The internet of things: An argument for cyber resilience Many companies are unprepared for changing digital infrastructure and need to recognise threats and prioritise solutions The internet as we have known it until recently has been a global network that allows individuals and organisations to connect with one another and to vast sources of information; any time, from anywhere there is an internet access point.

One notable feature of this network is that it has been used to connect people via the computing devices that they own, i.e. there has been someone at a keyboard entering information or executing scripts in order to ‘dialogue’ with other devices or humans similarly connected to the internet.

The internet of things (IoT) is a similar concept with the key difference being the removal of the human from the information exchange. Now the dialogue involves devices without human intervention. Devices such as security systems and HVAC systems in commercial properties or a home, flow controllers in pipelines, performance monitoring sensors in automobiles and health monitoring medical devices. The IoT, then, is simply an extension of the internet as we have always known it, with many more connectable devices – perhaps as many as 50 billion by 2020.

Benefits of internet of things — the good news

This explosion in growth of connected devices is happening for very simple reasons – these devices may bring benefits to those who use them and profits to the companies who make them. These

82 Ethical Boardroom | Summer 2016

benefits may come in the form of productivity, safety, convenience, efficiency or even quality of life. In our personal lives, we are already seeing ‘wearables’ that monitor our health and contribute to our well-being.

We are becoming accustomed to smart homes with refrigerators able to sense when they are getting empty and order groceries on their own. We read about vehicles that are either self-driving or are able to sense dangerous conditions and react accordingly without driver action. Farms are becoming more efficient by having sensors that monitor soil moisture and nutrient levels and begin irrigation and fertilisation only when it is needed and only where it is needed.

An oil rig can inform a computer that it’s a month away from needing repairs.g repairs.

Risks of interconnectivity — the bad news

As is often the case, the benefits of the IoT are accompanied by an equal amount of risk. Each of the billions of devices connected to the internet now and in the future, whether it is a wearable, a thermostat, a home appliance or a smart car, is similar to a traditional computer in several ways.

First, since they are ‘connected’ they present an entry point to a network or at least one other device. Just as a lost or stolen laptop or mobile phone can provide an unauthorised user access to local data or remote resources on

the same network, so too, can a connected, unmanned device on the IoT. And while data theft is certainly a key concern, even more frightening is the thought of the potential damage that can be done when an unauthorised user is able to manipulate the exchange of information between the connected device and its controller and thus send bogus instructions to the device, causing it to do harm. A related threat is a distributed denial-of-service attack in which a hacker controls not just a single IoT device but hundreds or thousands of them. By having each of those devices attempt to connect to a target website simultaneously, the hacker can take down that company’s servers or customer-facing web applications and/or demand ransom in order to stop the attack.

Perhaps of greater concern than the threat scenarios themselves, though, is the fact that these connected devices, like traditional computers, often come to the marketplace with insufficient built-in security. Because time to market is so critical to companies competing in this space, product development cycles may be shortened with quality assurance and information security steps curtailed. The result is a product that enters the marketplace with vulnerabilities, i.e. weaknesses in the design or the configuration of a product that

Internet of Things | Risk Management

a hacker can exploit. Highlighting this phenomenon, a 2014 Hewlett Packard internet of things research study found that 10 commonly used IoT home security devices each had an average of 25 vulnerabilities on board when they were sold.

Since vulnerabilities are not being addressed in development and are usually only discovered once a product is in use, they can’t always be easily remediated.

The ‘patching’ process that we use to keep our desktops, laptops, tablets and phones updated and free of vulnerabilities may not work for many devices now connected on the IoT, or may require user intervention which could lead to confusion, errors and ultimately no reduction in vulnerabilities.

Evolution of cyber breaches — property damage and bodily injury

The idea of ‘vulnerable’ systems is very concerning when we consider bringing shop floor automation, SCADA controls and other process-related systems into the IoT. Automated processes have been around for many years but were not a significant security concern until these systems became connected to the internet.

Many of these systems were built using hardware and software that are no longer supported by the vendors who produced them originally. This means that patches are no longer being developed and distributed to remediate vulnerabilities that are constantly being discovered. Without such support, these systems become rife with exploitable vulnerabilities, a dangerous scenario considering that these systems manage critical electric grids, water treatment plants and chemical facilities. The fear is that a destructive attack on systems like these could cause widespread physical harm to both organisations and individuals.

The threat has already been realised. Stuxnet was a Trojan inserted into Iran’s uranium enrichment facilities

ENTRY POINT Unmanned IoT devices provide unauthorised users access to local data

in 2007 that caused centrifuges to spin out of control and break down. In late 2014, massive damage was caused to a German steel mill after hackers forced a blast furnace to malfunction. More recently, hackers with ties to Syria infiltrated a water utility’s control system in an undisclosed US location and changed the levels of chemicals used to treat tap water.

Business attitudes to cyber needs

Cyberattacks have become a fact of life and businesses today are often left with difficult risk-management decisions related to cybersecurity and how best to handle the risks they face – deciding whether they should retain the residual risk of a cybersecurity breach or transfer it through the purchase of insurance.

Historically, there was a high degree of reliance on IT to simply manage the security and privacy exposures, but more highprofile breaches have gotten the attention of C-suite executives and boards of directors.

C-suites now see the importance of increased communication and bringing all key stakeholders to the table, including risk management, general counsel and supply chain teams. While there is increased awareness of the threats, businesses are still struggling to understand the risks associated with cybersecurity issues: the full scope of their exposures and how best to protect themselves and their customers.

Risk mitigation solution — a mindset of resilience

For years, the threat of being hacked was either ignored or was addressed simply with firewalls and antivirus software. As cyberattacks and data breaches became more prominent, organisations responded with more investment in preventive technologies – security products designed to keep malware and the bad guys out of networks altogether.

But it eventually became apparent that prevention may not provide complete security and perhaps the IoT brings this into even sharper focus based on the threat scenarios and the financial, physical, legal and reputational damage that a cyberattack can bring to bear. While investment in prevention is still necessary and worthwhile, state-of-the-art information security is becoming more and more about detection and resilience.

Cyberattacks have become a fact of life and businesses today are often left with difficult risk management decisions related to cybersecurity and how best to handle the risks they face Summer 2016 | Ethical Boardroom 83

Risk Management | Internet of Things Organisations are accepting that at some point they will be hacked, but they are building out their detective controls so that indicators of compromise are discovered quickly and are isolated, disabled and removed before they can do major harm. Here are some key steps to creating and maintaining a philosophy of resilience: ■ Adopt a cybersecurity framework, such as the NIST Cybersecurity Framework Created in 2014 by the National Institute of Standards and Technology, the NIST CSF is a valuable tool, not just for the information security department, but also for cross-functional teams charged with defining and prioritising the information necessary to build security into an organisation.

There are five key activities outlined by the framework for a good security programme: identify the data and processes that need to be protected and conduct thorough risk assessments on those processes and data, as well as the hardware, software and network devices that are involved; protect those assets through the implementation of technical, physical and administrative controls; detect threats within the network by close and continuous monitoring of controls; respond to threats with a documented and tested Incident Response Plan; and finally, recover any lost information or assets.

The NIST framework was designed to protect critical infrastructure, such as banking and energy systems, but the standards have been adopted by everyone from retail chains to the Italian government. Nearly a third of US firms are already using the framework, according to ‘Best Practices in Implementing the NIST Cybersecurity Framework’ a 2016 analysis by technology research firm Gartner.

■ Elevate the cyber and IoT issues to the C-suite Information security can no longer be considered an ‘IT thing.’ The impact of a cyberattack, particularly on the IoT, can be devastating or even terminal to an organisation. C-suites and boards must be kept aware of these risks so that they can provide the support and resources needed to provided security and resilience ■ Educate everyone on the importance of data security Humans are indeed the weakest link in the security chain. A security awareness and training program is the lowest cost security measure with arguably the highest return on investment ■ Extend beyond the four walls of the company Engage with an insurance carrier or a broker’s risk management team in an ongoing, comprehensive review of all 84 Ethical Boardroom | Summer 2016

ROBOT DEVICES Billions of devices are now connected through IoT applications

business partner relationships, including how those vendors/partners approach their own exposures and controls and how the vendors suppliers’ approaches fits into their overall resilience plan ■ For developers of IoT products – bake security into the development process For security to work well, it must be considered in the very earliest stages of product development and reassessed and retested as part of all subsequent stages. Security, if it is to be effective, must be baked in, not bolted on

Conclusion

The future of IoT is exciting because of the improved convenience, productivity and profit it offers both the producers and users of connected devices.

As more devices become connected, risks amplify and many companies are frankly unprepared. Still, the tools needed to make the IoT more secure already exist – companies and institutions have to recognise the threat and prioritise the solutions. It isn’t going to require any new concepts or any new technologies, but rather a commitment to the fundamentals of a proven cybersecurity framework, such as the NIST CSF.

Businesses must encourage a culture of awareness from the boardroom to the mailroom; identify all possible risks and have a risk management framework from which to work. Those that do can prove most resilient and quickly get back to meeting the expectations of their customers and their shareholders.

Disclaimer: The information in this publication was compiled from sources believed to be reliable for informational purposes only. All sample policies and procedures herein should serve as a guideline, which you can use to create your own policies and procedures. We trust that you will customise these samples to reflect your own operations and believe that these samples may serve as a helpful platform for this endeavour. Any and all information contained herein is not intended to constitute advice (particularly not legal advice). Accordingly, persons requiring advice should consult independent advisors when developing programmes and policies. We do not guarantee the accuracy of this information or any results and further assume no liability in connection with this publication and sample policies and procedures, including any information, methods or safety suggestions contained herein. We undertake no obligation to publicly update or revise any of this information, whether to reflect new information, future developments, events or circumstances or otherwise.

Moreover, Zurich reminds you that this cannot be assumed to contain every acceptable safety and compliance procedure or that additional procedures might not be appropriate under the circumstances. The subject matter of this publication is not tied to any specific insurance product nor will adopting these policies and procedures ensure coverage under any insurance policy.

Risk Management | Compliance

Third-party compliance: Doing the right thing for the sake of it We live in an age of lightning-fast social media, where disgusted customers vote with their feet like never before. The need for watertight, reputation protection – much of it preventative – is at an all-time high, particularly when dealing with third parties.

And there are other pragmatic reasons for examining who you’re working with: if you stem the flow of cash into money laundering, tax evasion and black-market activities, legitimate businesses and the macro-economy will prosper.

But should the media glare and economics, as well as the law, be our only motivations?

Indeed, are they everyone’s? And are some companies going above and beyond in their ethical activities, especially in their interactions with third parties?

What are third parties?

Before we go on, let’s clarify exactly what we mean by ‘third party’. The term has a variety of narrow definitions in business and law, some implying a layer of separation between two parties. But in the expanding world of enhanced due diligence (EDD), it’s become much broader, extending to any person or entity outside your organisation with whom you have any sort of contractual relationship. Far from separation, it implies inextricable closeness.

These third parties could be your customers, suppliers, agents and distributors, or joint-venture business partners. Indeed, ‘business partner’ could be used as a near-synonym for third party in the context of ongoing and significant relationships.

Gone are the days when trade was purely transactional; we must all now engage in 86 Ethical Boardroom | Summer 2016

Minimising risk and reputation damage is often a path to the moral high ground

Alistair King

Content and Communications Manager, Bureau van Dijk Know Your Customer (KYC) and Know Your Supplier (KYS) programmes to mitigate reputational or regulatory risk.

But back to the theme of ‘doing the right thing’ for the sake of it. Thinking of the boardroom, corporate social responsibility might spring to mind. But it sometimes goes further than that.

Enlightened self-interest

Consider Richard Branson’s Virgin Group. I recently attended a conference at Sir Richard’s Oxfordshire home.1 My golden ticket was in recognition of the detailed company data that Bureau van Dijk supplies from its Fame database to help compile the Sunday Times Fast Track 100 list, which Virgin sponsors.

Interviewed by his group’s CEO, Branson focussed on the culture of family businesses – the group is still privately owned and staff includes his daughter and son – and he outlined the importance of company values and brand integrity. He also spoke about reputation management, which struck a chord with me, as earlier this year I produced a white paper on getting to know your third parties through better due diligence.2 Few would dispute the scale of Branson’s entrepreneurial ambitions when he started out in the 1960s. But his success has allowed him to pursue philanthropic ventures. As well as dealing directly with charities, he works

with and encourages third-party enterprises in parts of the developing world.

What I’d describe as examples of enlightened self-interest, these ventures have arguably furthered the success of Branson’s businesses, too and, as he confirmed at the event, they have for more than a decade been the focus of his own day-to-day activities.

In 2004, he set up the not-for-profit Virgin Unite foundation to ‘unite people and entrepreneurial ideas to create opportunities for a better world’. The foundation has a number of overlapping aims. Some of them are purely charitable.

But it also exists to foster ideas of better, more ethical ways of doing business.

In a guest blog on the Virgin Unite website on the subject of things entrepreneurs should consider when starting a business, Gayle Northrop, president of Northrop Nonprofit Consulting, says: “This question is often asked, ‘Isn’t being a socially good business more expensive?’ The answer is, ‘Yes, it can be, but doesn’t have to be.’ There is an ever growing list of business practices that prioritise people and planet, which cost less and generate more revenue.”

That last point is echoed in Virgin Unite’s activities but also in Branson’s wider for-profit group. For example, as part of Virgin’s general commercial operations, its self-imposed supply chain standards have for two years included guidelines on protecting sea mammals.

“In February I announced that Virgin businesses will only continue to work with suppliers that pledge to no longer take sea mammals from the wild,” said Branson in 2014, referring to a new internal policy that most closely applies to his Virgin Holidays division.

“I feel strongly that this is a very positive development for the industry. Although many of our suppliers have not taken whales or dolphins from the wild for years, the Virgin Pledge seeks to build much-needed momentum to effectively

Compliance | Risk Management DATA EMPOWERMENT Readily available information helps screen out risky third parties

end a brutal practice that continues to this day,” he added.

Branson has set the bar high and many of us are too busy building our businesses to divest much of our time into making the world a better place. But it’s with steps, such as these that we can do our bit to at least make it less of a bad place. With the right tools, getting our supply chain in order is one of the best places to start.

Beyond Branson

In June this year, the Bureau van Dijk blog reported on a story from Supply Management magazine, in which Jaydeep Solanki, head of global purchasing and supply chain at General Motors Holden in Australia, said that always focussing on what you can control and not worrying about things you can’t control was the best advice he got from one of his mentors.3 “I always remind my team to follow this as we manage our global purchasing and supply chain,” Solanki added. He makes a good case – up to a point.

Certainly, there’s not much we can do about unknown unknowns and he goes on to highlight unpredictable risks, such as

natural disasters, major accidents, terrorism-related disruption or ‘a simple malfunction in one stage of the supply chain we did not expect to happen’.

But when examining your third parties, you’d be surprised at how much control you actually can exercise, particularly when considering what you might think are known unknowns.

Third-party vetting and ethical procurement At least this is the contention of Ted Datta, Bureau van Dijk’s director of governance, risk and compliance solutions at Bureau van Dijk’s London office.

Branson has set the bar high and many of us are too busy building our businesses to divest much of our time into making the world a better place Summer 2016 | Ethical Boardroom 87

Risk Management | Compliance Bureau van Dijk holds information on more than 200 million companies on its databases, such as Fame that covers the UK and Ireland, and Orbis, which covers the world.

The databases in its range make available company financials, ownership structures and the like. They also have information on whether individuals associated with companies – such as directors and owners – are on PEPs and sanctions lists.

Datta draws my attention to a recent document compiled by Kroll and the Ethisphere Institute: The Year of Global Expansion and Enforcement: 2016 Anti-Bribery and Corruption Benchmarking Report . The section on third-party due diligence talks of the ‘sheer volume of third parties that companies must manage’.

Nearly half of respondents to the report’s worldwide compliance survey said that they engage with at least 1,000 third parties, while 17 per cent of all the respondents claim to deal with more than 25,000.

Unless you have an astonishingly well-staffed team of investigators, surely those are too many companies to vet in a meaningful, watertight manner, right?

Not necessarily, according to Datta.

“The trick is to find the relevant two or three-hundred to escalate and thoroughly investigate,” he says. “25,000 is not unimaginably high when working with us in the right way,” he adds. “Our platforms help you automate the screening of low-risk companies – the majority – and identify those that need enhanced third-party due diligence.”

structures, brought into sharp focus in the wake of the Panama Papers revelations.

If you use the right tools to analyse these, the warning signs – particularly of being ‘sanctioned by extension’ through beneficial ownership – are much easier to spot.

From an ethical point of view, beneficial ownership is at the heart of these considerations and, as a boon to the more ethically conscious decision makers, some platforms let you choose a lower ownership percentage threshold than the regulations prescribe.

This makes it easier to rule out doing business with companies owned at least in part by the ‘wrong’ people, thereby protecting your reputation – and your conscience.

As a by-product of this research, you can also gain a better understanding of the

the OECD’s Small and Medium-Sized Enterprises (SME) Policy Index.

Or you might be keen to guarantee a certain level of diversity in your supply chain, whether that’s based on a company’s location, its number of employees, financial information, its company status or how long it’s been trading.

Maybe you want to select and filter by the number of female directors on a company’s board, by ethnic minority criteria or by the age of company directors and owners. Or you might want to trace lines of ownership to make sure that a company you’re thinking of working with – itself in an “innocent” industry or sector – isn’t owned or part-owned by any companies involved in areas that you feel uneasy about.

These areas might be in oil, gas or other fossil fuels, for example. They might involve CLEARER FOCUS Warning signs are much easier to spot using the right tools

Risky businesses

There might be causes So what risks are thrown up when examining these you want to champion third parties? The biggest through your third-party area is sanctioning, either financial risks relationships – and that of people or organisations. associated with They might be judged to doing business should be your privilege be too closely connected with these with proscribed activities companies. Are they – money-laundering, drugs trading or a good credit risk? Will they deliver on time or worse – or they might operate in sanctioned might they fold, crippling your supply chain? jurisdictions, such as Iran, Myanmar, By adopting this approach, you can easily North Korea, Sudan and Syria. If you include do the right thing commercially and in countries where involvement with the matters of ethical certainty. government is a barrier, the list of countries, The road less travelled organisations and people is even longer But what of less objectively dubious activities, and harder to track. Politically exposed or simply the more nuanced choices you want persons (PEPs) associated with your third to make about the people and organisations parties can also be revealed, a concern for you collaborate with? some risk appetites.

For whatever reason, there might be certain But there are ways you can mitigate these causes you want to champion through your risks; the main challenge often being how to third-party relationships – and that should be identify whether a company you’re considering your privilege. In these scenarios, it’s less working with is suspicious. about checking and screening companies that You will have your own definition of are already on your radar and more about ‘suspicious’. It might relate to official actively seeking out companies to work with sanctions lists, either of companies or of based on your own very specific criteria. people associated with them. Or it might tie in The right tools can, for example, help you with your own ethical code. Crucial to any identify companies according to their place on assessment are corporate ownership 88 Ethical Boardroom | Summer 2016

certain types of mining or activities involving deforestation or pollution. Or they could be in a number of food and agricultural industries whose operations are clouded by environmental, humanitarian or employment issues. These might include intensive farming, palm oil production, coffee, chocolate, bananas, honey, milk, fruit-picking, cockle-picking – the list goes on.

Screening an entire corporate group becomes possible With these considerations and parameters, tools can help you explore and make sense of your network of relationships. It’s all about data empowerment.

And this empowerment makes it easier to do the right thing – what you consider to be the right thing – often simply for the sake of doing the right thing. www.bvdinfo.com/en-gb/blog/data-management/ shaking-up-dull-businesses-an-audience-with-sir-r www.bvdinfo.com/en-gb/about-us/white-papers/ really-getting-to-know-your-third-parties 3 www.bvdinfo.com/en-gb/blog/supplier-andcredit-risk-management/procurement-teamsurged-to-focus-on-what-they-can 1

2

Take a Step in the Right Direction Securimate automates the complexities of third-party management.

Built precisely to address FCPA regulations and the latest DOJ and SEC guidelines, Securimate helps multinationals deliver a credible and defensible compliance program. Take steps to ensure that your third-party compliance program can withstand regulatory scrutiny.

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Š2015 Securimate, Inc. All rights reserved. www.securimate.com

Risk Management | ESG Issues

Tackling risk in the

21st century Three lessons from decision makers on how to be better prepared In April 2016, Unilever removed Malaysian palm oil manufacturer IOI from its supplier list after the Roundtable of Sustainable Palm Oil (RSPO) watchdog suspended it for several violations of the ‘no deforestation, no peat and no exploitation’ policy.

Shortly after, a string of other corporations, including Kellogg’s, Mars, Nestlé, Hershey’s, Colgate-Palmolive, Johnson & Johnson, Procter & Gamble, SC Johnson, Yum! Brands and Reckitt Benckiser disengaged with IOI; and other companies, such as Dunkin’ Donuts, are verifying if IOI is in their list of suppliers, with plans of removing it if so.

Such substantial action taken by a swathe of high-profile consumer brands begs the question: what is the rationale supporting these decisions?

Managing risk along the supply chain, where ‘risk’ entails new dimensions, such as the ones mentioned in the RSPO policy (deforestation and forced labour), are increasingly appearing in corporate compliance and risk management programmes as companies recognise the longer term risks associated with so-called ‘soft issues’.

Indeed, the definition of business accountability today is much broader than 10 years ago as it includes a diverse array of issues, ranging from board composition and gender equality to human rights and climate change.

Evidently, such broadening has implications in terms of new forms of risk to control, the emergence of which influences the role of key decision makers and how they shape processes and controls in their organisations. Companies need to ask themselves: “What issues should be on our radar? How does this influence and impact decision making?”

Identifying emerging issues

An area of increasing interest and importance to corporations is the systematic inclusion and review of environmental, social and corporate governance issues – often referred to as ESG. The demand for greater attention to the wider interests of stakeholders is driving the ESG agenda forward. Institutional investors are demanding corporations disclose 90 Ethical Boardroom | Summer 2016

Donato Calace with contributions from Marjella Alma and Erin Levey

ESG Specialist at eRevalue

and manage ESG issues, with the United Nations Principles for Responsible Investment (UNPRI) signatories representing more than $60 trillion in investment funds in 50 plus countries.1 The wider public also pays increasingly close attention to the activities of corporations; and companies need social buy-in from the wider stakeholder community in order to maintain their ‘social licence’.2 Not understanding and managing the wider array of issues puts companies in a vulnerable position with stakeholders and the approach to managing these issues can be confusing for a number of reasons.

First, the use of umbrella terms, such as ESG or CSR (Corporate Social Responsibility), contributes to the isolation of such issues.

In many organisations, CSR is siloed in peripheral departments – in many cases these departments’ activities and resources are not deemed a priority, or wholly connected to the business case. The risk associated with deeming such issues as a ‘nice to have’ and not measuring specific environmental, social and governance issues, such as board composition, forced labour or conflict minerals, is that the corporate agenda may be blind to areas which require inclusion across multiple business departments – legal counsel, risk management, investor relations, procurement, auditors and senior management.

Second, the number of regulations regarding environmental, social and governance topics disclosure is rising rapidly. 3 The call for greater transparency comes from governments, international institutions, such as the EU and its highly anticipated directive on non-financial reporting, stock exchanges

RISK ASSESSMENT Even so-called soft issues can knock a company off course if not anticipated and managed correctly

ESG Issues | Risk Management and indexes, investment funds and supply chains. From a business perspective, corporate reporting means having a robust process in place to be able to disclose a public account detailing how a given issue is managed.

Third, data concerning non-financial dimensions is mostly unstructured, non-quantitative and hardly commensurable in figures. It is dispersed in reports, laws, regulations, guidelines and news. Consequently, it takes a lot of time to access, extract, analyse and synthesise knowledge from these various sources, making it a real pain point for risk assessment and risk management.

Corporate reporting means as a business, you have to be able to tell a public story about how you manage a given issue. This requires you to have a plan and a process in place.

What the leaders do

Companies with complex and global value chains want to be in the driver’s seat in order to get ahead of the new forms of risk and assess if there is a way to convert them into opportunity

Companies with complex and global value chains want to be in the driver’s seat in order to get ahead of the new forms of risk and assess if there is a way to convert them into opportunity. Their aim is to adopt a data-driven approach to assess how environmental, social and governance -related issues may affect the different areas of their business and to understand how they can best control risks.

The following case studies provide illustrative insights from decision makers in multinational companies (generic names are used to ensure anonymity), what new risks and opportunities they consider and why these are important to their business.

Cases are presented from the perspective of three different decision makers: the general counsel of a consumer goods company, the risk manager of large bank and the CFO of a pharmaceutical company.

Consumer goods company

Earning and maintaining the customers’ trust is vital and the risks of boycotting and class actions are extremely high, especially with regards to supply chain related issues.

The view of the General Counsel: “There are issues along global supply chains that are extremely difficult to monitor and the challenge is to extract hard facts from anecdotal data. One way to do this is to be able to capture early warning signals; these signals often come from soft law and principles. This trend is very new.

We prefer a regulated environment rather than a cloud of uncertainty. Recently, it has become so obvious that regulation needs to be addressed differently; a more holistic approach is needed as legal counsel needs to have a form of ‘informal’ or ‘soft’ audit. The division between the legal function and public affairs is fading – especially if our mission is to build trust and accountability. Our role now involves helping the company to engage through a constructive dialogue with the Summer 2016 | Ethical Boardroom 91

Risk Management | ESG Issues stakeholders – because, in the end, they validate the early warning signals. That’s why we created a global advocacy committee putting together public affairs, legal, regulatory and consumer communications (labelling, etc.), which reports regularly to the board.”

Large bank

employment practices, board composition, controversies, etc. Disclosure on non-financial topics reduces information asymmetry; transparency is the next big thing.

“From the CFO perspective, these issues are now being increasingly reported in financial reports and SEC filings. They are changing fiduciary duty. But more refined analysis is needed. We need to be able to demonstrate if and how these areas are relevant for the ROI and the financial bottom line – in other words to understand if they are material. To make decisions in an informed way we need to be ahead of all this. As a CFO, I need to understand all the costs, visible and hidden, related to a decision.”

This company is a major player in the financial services industry, operating as a commercial bank and investment bank with branches in different countries, therefore facing different economic and regulation systems in various jurisdictions. The view of the Chief Risk Officer: “What has changed and is changing in terms of risk management for the New risks, new lessons Chief Risk Officer is the risk management Three main lessons can be drawn from the framework, in particular from the issue stories above, with the key objective of identification standpoint. The new trend ensuring companies are prepared to manage requires connecting qualitative issues to the emerging issues before they pose real threats characterisation of risk. Three key processes or provoke damage and to be quick to react are needed: expansion of the degree of control and minimise the impact if a crisis occurs. through access to new areas of information; ensuring that the process of control is SYSTEMiC Less systematic and robust; and integration of control the conversation in all the departments.

“People tend to be caught in their daily REGULATORY routine, preoccupied with the specific & LEGAL tasks they look at. Hence, it is not COMPETITIVE necessarily common to go outside of that scope and that’s where STRATEGIC intervention is needed. Maybe there are other issues you RISK PYRAMID REPUTATIONAL should be looking at with a broader lens. New input Business for risk assessment and Unit 1 the management of a larger set of issues Business across all the value Unit 2 chain is needed, Business especially as companies are Unit 3 increasingly held responsible for modern slavery, data protection Business More and conflict minerals along their Unit 4 control value chains.”

Pharmaceutical company

This company operates in the complex pharmaceuticals industry, where investment in time-intensive research and development projects is key to long-term competitive advantage and success.

The view of the Chief Financial Officer: “I used to work in [one of the big four consultancies]. I have always looked at sustainability, ESG, CSR as something ‘soft’.

People just think these are not relevant to them.

But when you break these down to plain issues and can demonstrate the business case, they do think they are relevant to them. These issues are now coming up in laws and regulations.

“From the perspective of investments, ESG and socially responsible investing is still a niche business for specialised asset managers and owners. Nonetheless, today every investor and rating agency collects information beyond the financial scope: 92 Ethical Boardroom | Summer 2016

1

No matter how weak, signals are important to the preparation for new form of risks Given that they are facing new challenges and responsibilities, companies need robust safety nets built on systematic control processes. The ability to assess in detail specific issues with a data-driven approach is a key component of activating these nets. language of strategic 2 The accountability talks issues ESG,

CSR and other umbrella terms are obscure black boxes. Decision makers need data on the issue level to close the gap between the ‘knowable universe’ and the ‘visible universe’ of information. Then, data-driven analysis must inform the assessment of the corporate impacts of the issues, highlighting areas that are moving from a ‘nice-to-have’ to a ‘musthave’ on the business strategy, competitive,

industry, regulatory, public opinion and stakeholder levels. This process drives the conversion of these new risks into opportunity.

The breadth of the areas 3 Integration involved in these processes embraces

all the departments in the organisation, as shown in the cases provided. Decision makers from the different corporate functions need a common platform to discuss information coming from such diversified domains and in turn this has to be translated to a language familiar to them. In other words, it needs to be data-driven, robust, comparable and issue-specific.

One of the most dangerous risks is the illusion of preparedness; the automatic assumption that everything is monitored, under control and that nothing is slipping under the radar.

The new norms in business accountability

These insights from companies confirm that the types of issues previously considered ‘soft issues’ or a ‘nice to have’ are increasingly relevant across the organisational value chain.

■ Regulatory and legal controls are complex and widening as the volume of hard and soft regulation, as well as the number of related judicial disputes, is globalised ■ Strategic management is moving to material coverage of ESG, as the fiduciary duty of managers towards the shareholders, the stakeholders and the company itself is changing ■ Competition takes advantage of wider risk and opportunity measures, as it affects variations in market share, revenues, costs, stock quotation, cost of equity and debt ■ Reputation management is increasingly important to stakeholders, as the public opinion can get harsh on sensitive topics, such as child labour. The challenge then is extending the organisation’s control across a wider array of issues, whereas historically, companies have had limited insights and limited capacity to influence and act. This approach calls for connectivity between different sources of information (e.g. corporate reports, regulation, news, social media) and consequently, different types of information (quantitative qualitative and narrative).

So what are the key takeaways from all of this?

■ Understand the issues ■ Review the importance from a competitive, regulatory and reputational standpoint ■ Implement these insights into your business strategy www.erevalue.com 1 www.unpri.org/about 2www.theguardian.com/ sustainable-business/2014/sep/29/social-licenceoperate-shell-bp-business-leaders 3Today there are 10 times more non-financial disclosure requirements than there were only three years ago.

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Risk Management | Compliance

Compliance in the insurance industry Upcoming changes to the insurance framework in the UAE and Middle East will have short-term cost and long-term gain

Mohammed Hasan Khan Chief Risk and Compliance Officer, RAK Insurance

At a time when the regional economy in the GCC is endeavouring to recuperate from a series of financial crises, low oil costs and is confronting remarkable difficulties coupled by a wave of risky political risks, insurance regulators in the region are working towards bringing the industry’s supervisory rules and monitoring standards to higher levels.

These difficulties are turning out to be all the more genuine, as political and conflict dangers are on the ascent in the wake of

CHANGES IN THE GCC Focus is on creating a solid and transparent insurance market in the region 94 Ethical Boardroom | Summer 2016

the most recent local uprisings. The development of a solid, modern and transparent insurance market has also proved to be a critical component of the financial reforms and the development of the industry in this region. As the Takaful (the name for Islamic-compliant insurance) market is expected to grow nearly 15 per cent every year in the following five to seven years and the insurance penetration rate to ascend from one to three per cent in the same time frame, the overall insurance market (conventional and Takaful) in the region will be no less than 10-times bigger in the following 10 years.

Regulatory landscape and recent developments

Insurance regulators in the Gulf have presented or are presenting various new directions anticipating what would support the financial soundness of the industry over the long haul. They are following international best practices by moving towards risk-based solvency capital regimes.

Changes – for example calculation of solvency and minimum capital requirements, the compulsory independent review of solvency

Compliance | Risk Management and technical reserves, focus on active risk management, as well as the introduction of more structured investment portfolios with maximum asset exposure limits – are finally being implemented.

The UAE and Qatar are introducing more exhaustive regulations, while Bahrain, Kuwait and Oman are, as of now, focussing on particular viewpoints, for example, an increase in capital requirements as well as enhancements in asset quality and reporting requirements for both conventional and Takaful insurers.

These developments are respected by both the industry and experts as positive for the credit attributes of the market place and for policyholder protection. However, regardless of expanding economic partnership and policy coordination within the GCC, insurance regulations and supervisors are still at different stages of maturity within the region.

These changes are likely to provide more alleviations to the financial soundness of the industry over the long haul, prompting better security for policyholders and enhanced credit profiles for insurers, resulting from better capital management and advanced operational controls.

Recent reforms in the UAE insurance market

The UAE has a dedicated supervisory body, the UAE Insurance Authority (IA).

Insurance business transacted in the region’s specialised financial services hub, the DIFC in Dubai, is supervised by an independent framework set up by the designated regulatory body in this zone.

The IA recently issued regulations governing the financial status of insurance and Takaful companies, a move widely seen as developing

the industry and bringing it in line with Solvency II in Europe.

The IA’s release of decisions is beckoning the next wave of major regulatory developments in the GCC insurance industry since the actuarial reviews imposed on the Saudi market in 2013. The reforms have been awaited among players in the UAE, who have been calling for changes to the way businesses operate in the cut-throat environment.

Since becoming an independent body in 2007, the IA has introduced rules on various areas, from banc assurance and brokerages to Takaful. But the latest regarding solvency and capital adequacy are arguably the most highly anticipated and discussed in recent years with the potential of creating far-reaching results.

I am highlighting some key sections of the new UAE regulations, focussing on the solvency margin and minimum guarantee fund; asset liability management and the basis of calculating technical provisions determining the company’s assets that meet the accrued insuring obligations.

1

Solvency The solvency requirements include provisions related to solvency margin, minimum capital requirements, minimum

Insurance regulators in the region are working towards bringing the industry’s supervisory rules and monitoring standards to higher levels

guarantee fund, solvency capital requirements and assessment of solvency in key risk areas.

There is no change to the minimum paid-up capital requirements for direct insurers and for reinsurers. Regulations on solvency margin requirements were developed based on the key principles of Solvency II, in particular, the use of the one-year view and the 99.5 per cent risk tolerance of solvency risk, which align with European regulations. These are aimed at providing an early warning system to detect flaws in companies’ financial conditions.

The solvency measures will empower management to better comprehend their organisation’s operations by recognising which dangers are most critical and expend the most capital. CEOs should be able to modify capital necessities through measures, for example, changing their reinsurance programmes, adjusting investment allocations and adapting their underwriting profile.

An understanding of risk-based solvency calculations should allow insurers to better protect themselves against financial shocks and limit volatility in their operations. liability management 2 Asset The asset liability management (ALM)

requirements provide ceilings on how insurers may allocate their investments. The purpose of these requirements is to ensure that companies diversify their assets and avoid high-risk concentration. Furthermore, each company must create an investment committee that ensures adequate separation of functions between implementation, registration, delegation, settlement and related auditing activities.

Summer 2016 | Ethical Boardroom 95

Risk Management | Compliance Another significant requirement is for each insurance company to develop a policy for investment and risk management that complies with the risk tolerance level determined by their board of directors, which will need to approve and review the policy annually. The policy has to cover the general investment strategy and appropriate risk management regulations, including the mechanism to control such regulations. In addition, all companies will need to conduct a stress test of all its investments on an annual basis.

The asset composition of most insurers’ investment profiles is currently highly weighted towards real estate and equity assets and investment allocation to higher-risk assets has historically driven volatility in the level of shareholders’ equity of UAE insurers.

Insurers’ balance sheets remain vulnerable to market shocks, particularly given that assets are concentrated in the UAE and benefit from little geographical diversification.

The new rules should provide greater stability of returns to insurers’ investment profiles and this way lessen unpredictability RISING COSTS Insurers could be stung by increased compliance costs

96 Ethical Boardroom | Summer 2016

emerging from fluctuating asset prices on their operations and balance sheets. Given that capital necessities of domestic insurers are to a great extent driven by investment risk, de-risking of the asset base will improve the financial strength of the companies.

Technical provisions 3 These regulations are aimed at regulating

the principles of calculating technical provisions and standardising them for fair comparison and objective analysis of the positions of companies by the IA, as well as to provide statements that reflect the financial positions of the companies.

With the standards now becoming law, compliance and enforcement will thus be the key words for the UAE insurance industry The IA has stipulated that all UAE insurers must come into line with International Financial Reporting Standards (IFRS).

Companies will need to conform to standardised actuarial practices and reserves will be subject to yearly actuarial reviews.

Actuarial oversight is given high priority, with actuarial certification of the adequacy of the mathematical reserving practices required at least quarterly and annually.

The metrics to be identified in these reports are set forth with a high degree of specificity.

A requirement for actuarial-led reserve setting, monitoring and reporting will

enhance reserve adequacy and improve underwriting profitability by encouraging insurers to set premiums in line with underwriting risks and become increasingly selective about the risks they underwrite.

These enhanced regulations and implied additional costs of monitoring, managing and reporting may also encourage consolidation among some smaller market players, potentially reducing competitive pressures and aiding market stability.

Enforcement is key

The regulations are extensive and represent a sea-change for UAE insurers. The condition for this is compelling implementation. The IA will require the appropriate resources and expertise to actively regulate the market according to these new standards and must be prepared to take appropriate action in the case of breaches.

With the standards now becoming law, compliance and enforcement will thus be the key words for the UAE insurance industry going forward.

Impact on the industry

Insurers could be hit by rising compliance costs as a range of regulatory reforms sweeps through the sector. Regulators across the region have announced a number of reforms amid stiff competition in the insurance sector.

But the costs of revamping internal systems could deal some insurers a tough blow; in the short term, the cost of regulatory compliance will rise as insurers will need to add expertise and improve their systems to meet the new regulatory requirements. The smaller and less well-capitalised insurers will find the new regulations particularly challenging, while larger companies should be able to cope with the additional demands.

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Global News Africa

Final King IV to be officially unveiled The King Report on Corporate Governance for South Africa, King IV, which emphasises the critical role of stakeholders in the governance process, will be launched at a conference in Johannesburg on 1 November.

The full day event will feature an international panel of speakers and will also introduce the King IV interactive mobile application.

Angela Cherrington, CEO of the Institute of Directors in Southern Africa, said: “King IV introduces some important updates to the landmark King III report. In addition, it

breaks new ground by differentiating clearly between principles and practices, and linking practices to outcomes — all with a view to making implementation easier.”

King IV recommends the establishment of a social and ethics committee (SEC) as a prescribed board committee as best practice for all organisations and offers “more practical guidance on how to integrate its principles into the way organisations do business”.

Female directors lead to better corporate citizens Listed companies with gender-diverse boards are better corporate citizens than companies with male-dominated boards, according to a Stellenbosch University study.

The study investigated the relationship between board gender diversity and corporate citizenship for a sample of South African companies listed on the Johannesburg Stock Exchange between 2009 and 2015.

It found a statistically significant positive relationship between the percentage of female board directors and a company being included in the FTSE/JSE Responsible Investment Index, and a positive, but not statistically significant, association between board gender diversity and the broad composite measure of corporate citizenship.

Significant positive relationships were also identified between female board representation and certain corporate citizenship actions, such as having an environmental quality management policy, having emissions reduction targets and receiving green awards.

New Panama Papers ‘exposes secret deal in Africa’ Journalist investigations into the use of offshore bank accounts include new revelations about businessmen in Nigeria, Kenya, Namibia, Egypt and Algeria, according to AllAfrica.com.

It reports that the International Consortium of Investigative Journalists’ latest research on the Panama Papers — leaked documents from law firm Mossack Fonseca — has exposed “fresh details about the misuse of corporate secrecy and hidden wealth in Africa”.

Businesses in 52 of Africa’s 54 countries used offshore companies created by Mossack Fonseca, a law firm that specialises in creating companies often sold and used for anonymity or lower taxes.

Although many of these companies do legitimate business, ICIJ identified 37 companies within the Panama Papers that have been named in court actions or government investigations involving natural resources in Africa.

98 Ethical Boardroom | Summer 2016

United Bank For Africa appoints new CEO Kennedy Uzoka’s appointment as the new group managing director and chief executive officer of the United Bank for Africa has been hailed as a testament to the strength of the company’s succession planning process.

Uzoka (right) took on the mantle of leadership from Phillips Oduoza, who retired on 31 July 2016 after completing two terms of three years each. Prior to his appointment, Uzoka was the deputy managing director of UBA — one of Africa’s leading banking groups.

“Kennedy Uzoka’s appointment has once again proven the resilience of our succession planning process and the value we place on having in place a strong corporate governance system,” said Tony Elumelu, UBA’s chairman.

Kenya banks need more women at top Lack of opportunities for critical work experience, poor mentoring and coaching have been highlighted as key barriers to women wanting to enter management and leadership positions in the Kenyan banking industry.

According to the Kenya Bankers Association, out of 38,000 employees in Kenyan banks, women account for 52 per cent, yet there are only three female chief executives and two others leading their boards as chair. Government-owned banks have the worst record, with no women represented in top management.

Treasury cabinet secretary Henry Rotich has linked poor performance of state-owned banks to lack of female representation in senior management positions and said more women in top positions would help improve corporate governance.

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