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

Winter 2020

Keeping it above board

REGULATORS AND AML ENFORCEMENT Key considerations for non-US banks

GLOBAL AUDIT COMMITTEES Key issues for auditors in 2020


European proxy advisor guidelines

TRANSPARENCY IN PROXY VOTING Shareholders face increased scrutiny


Spotlight on Switzerland

Challenges and opportunities for Swiss boards: climate change, corporate governance & compensation


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ISSN 205 8- 61 1 6

Ethical Boardroom | Contents


Editor’s Letter & Contributors The US SEC’s spotlight on proxy advisory firms



Friend or foe? The Convergence of Private Equity and Shareholder Activism


Spotlight on proxy process SEC’s proposed actions on shareholder proposals and proxy advisors could alter the governance landscape



On the certainty of death and taxes Directors of companies that operate globally face important conflicts of interest



Global News: Europe Board shakeups, Belgian tax probe and insider trading


Shareholder activism in Switzerland An insight into the latest trends and developments


Corporate governance in Switzerland Is there a lack of mutual understanding and required rethinking in enterprises’ CSR?


Climate change: are we travelling in the right direction? Switzerland has so far avoided regulating a light-touch legal framework when it comes to sustainable finance. Is it time that changed?

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Executive remuneration trends in Switzerland Challenges and opportunities in the Swiss executive compensation landscape

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Contents | Ethical Boardroom




Introduction & Winners list We reveal our 2020 European Corporate Governance Award winners


BoC: Recovery from crisis The Bank of Cyprus is the focal point of the country’s economy




Global News: Asia & Australasia Shareholder activism, gender diversity and boardroom changes


The power of private engagement The differentiating factor in shareholder engagements within Japan



Stewardship and responsible investment How Eurizon Capital helps companies integrate financial instrument selection methodologies that take into account ESG factors and SRI principles

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SEEing beyond ESG The social, economic, environmental (SEE) impact measure reinstates the economic dimension to its rightful place


Expectations for European 2020 AGM Season The main themes from the new proxy advisor guidelines for Europe


Transparency in proxy voting and advice Shareholder advisors need to review their practices following increased scrutiny of how they make recommendations


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Ethical Boardroom | Contents



Global News: North America Proxy advisors. boardroom revamps and gender diversity



Finding your next CEO Forward-looking organisations are driven by well-thought-out strategies


Three top board diversity mistakes Having a robust plan will power success and help you avoid common pitfalls



Boardroom balancing... The best governing bodies are evenly mixed – but how is that achieved?


Demand for diversity The push to create a diverse workforce will intensify in 2020 as boards recognise the benefits


A world in flux Corporate directors are critical to helping companies navigate the uncertainty


Corporate governance is not agenda management Smart boards simplify decision-making ecosystems to enable the next version of their organisation




Global News: Middle East & Africa Crypto fraud, anti-money laundering and corporate governance

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Contents | Ethical Boardroom


Ethical & governance momentum by institutional investors The challenges and opportunities within Middle East markets

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2020 global audit committees The challenges and issues facing auditors in the year ahead


Better board oversight A guide to where boards of directors can look for useful insight


It’s time to become a better business Why 2020 is the year to reshape your code of conduct and build a culture of integrity



Global News: Latin America & Caribbean Board appointments, corporate governance and investment deals




Fintech-friendly onboarding A guide to third party risk management and fintech/financial services partnerships


Regulators’ long reach in AML enforcement Key considerations for members of the boards of non-US headquartered banks

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Ethical Boardroom | Foreword

SEC’s spotlight on proxy advisory firms Welcome to the Winter 2020 edition of Ethical Boardroom magazine Proxy advisors across the world hold significant influence over corporate governance issues. With full transparency, investors who rely on the advice, services and reports of proxy voting advice businesses would be kept aware of any potential conflict of interest and understand the methodology behind their analyses. In the US, regulators are close to passing new rules governing proxy advisers, such as Glass Lewis and Institutional Shareholder Services, that aim to improve the accuracy and transparency of their advice. The Securities and Exchange Commission’s (SEC) proposed regulations require proxy advisors to disclose any potential conflicts of interest

to clients, allow companies to provide feedback on proxy advice (including factual mistakes) before it is disseminated to institutional shareholders, and permit companies to attach reports that include an active hyperlink to the proxy advisors’ recommendations. Supporters of the SEC proxy rule shake-up say the changes will go a long way towards eliminating errors and, ultimately, help shareholders make informed proxy voting decisions. According to a January 2020 survey from Willis Towers Watson, 83 per cent of 105 US public companies surveyed believe the SEC proposed rules, if finalised, would cause proxy advisers to be more transparent.

However, the Council of Institutional Investors takes the view that the proposed rules would be detrimental to shareholder rights and would ‘pressure proxy advisory firms to take a more management-friendly approach in their reports and vote recommendations’. In this issue, on page 12, Allie Rutherford and Eric Sumberg at PJT Camberview discuss how the SEC’s guidance may prompt proxy advisors to take a more rigid approach to following stated guidelines rather than taking a more case-by-case approach to evaluating management and shareholder proposals. While on page 54, Paul Rose and Robert J. Watkins of Ohio State University, also put the spotlight on the SEC proposals and discuss how shareholders deserve transparency on how proxy advisors arrive at their recommendations.

Supporters of the SEC proxy rule shake-up say the changes will go a long way toward eliminating errors and, ultimately, help shareholders make informed proxy voting decisions

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Contributors List | Ethical Boardroom


VINCENT KAUFMANN CEO of Ethos Foundation, Switzerland ELEFTHERIA KOUMOULI Manager of Governance & Markets Compliance Dept., Group Compliance Division, Bank of Cyprus PCL

REMO SCHMID & PROFESSOR ALEXANDER WAGNER Remo is a Partner at PwC Switzerland. Alexander is an Associate Professor at the Swiss Finance Institute and University of Zurich

AMIT BATISH Editor-in-Chief at Equilar

DAVID LEDERMANN Partner at Lenz & Staehelin

PEDRO SERRANO Founder & Managing Partner of Smart Governance, CAVEDIGITAL

DR DEBRA BROWN President and Chief Executive Officer of Governance Solutions

TIM J. LEECH Managing Director, Global Operations at Risk Oversight Solutions

LIZ SIDOTI Managing Director at Abernathy MacGregor

TIMOTHY COPNELL Executive Chairman at KPMG’s UK Audit Committee Institute

GREG MATTHEWS, NICOLE TRAWICK & SARAH GROSS Greg is a Partner, Nicole a Manager and Sarah an Associate at KPMG

SVEN STUMBAUER Senior Advisor at Norton Rose Fulbright LLP

ANELIYA S. CRAWFORD & MATTHEW J. GRUENBERG Aneliya is a Partner in the New York office of Schulte Roth & Zabel LLP (SRZ) in the Shareholder Activism and M&A and Securities Groups. Matthew is Special Counsel at the firm DR PETER CROW is an experienced company director and expert on corporate governance BARBARA A. HELLER & CHRISTOPH WENK BERNASCONI Barbara is a Managing Partner and Christoph a Senior Partner at SWIPRA Services Ltd

PAOLA PEROTTI Managing Partner at GO Investment Partners PAUL ROSE Associate Dean for Academic Affairs & Robert J. Watkins/Procter & Gamble Professor of Law, Moritz College of Law, Ohio State University ALLIE RUTHERFORD & ERIC SUMBERG Allie is Managing Director and Eric is a Director at PJT Camberview DR ASSEM SAFIEDDINE & LEILA ATWI Assem is Professor of Finance, American University of Beirut. Leila is Managing Partner, Business engineering experts (B.e.e.)

PETER SWABEY Policy and Research Director at The Chartered Governance Institute REBECCA TURCO Senior Vice President of Learning & Content at SAI Global CRISTINA UNGUREANU Head of Corporate Governance at Eurizon Capital DANIELE VITALE Head of Governance UK & Europe at Georgeson, London

EDITOR Claire Woffenden EXECUTIVE EDITOR Jason Gordon DEPUTY EDITOR Spencer Cameron ART DIRECTOR Chris Swales CHIEF SUB Sue Scott HEAD OF ONLINE DEVELOPMENT Solomon Vaughan ONLINE DEVELOPMENT Georgina King, Rosemary Anderson SUBSCRIPTIONS MANAGER Lucinda Green MARKETING MANAGER Vivian Sinclair CIRCULATION MANAGER Benjamin Murray HEAD OF SALES Guy Miller PRODUCTION EDITORS Dominic White VIDEO EDITOR Frederick Carver VIDEO PRODUCTION Tom Barkley BUSINESS DEVELOPMENT Michael Brown, James Walters, Henry Smart ASSOCIATE PRODUCER Lea Jakobiak HEAD OF ACCOUNTS Penelope Shaw PUBLISHER Loreto Carcamo Ethical Board Group Ltd ● Ethical Boardroom Magazine ● 51 Philpot Street ● London E1 2JH ● 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 Printed in the UK by Cambrian Printers. Images by www.istockphoto.com All information contained in this publication has been obtained from sources the proprietors believe to be correct, however no legal liability can be accepted for any errors. No part of this publication can be reproduced without prior consent from the publisher.


Winter 2020 | Ethical Boardroom 9

Commentary | Private Equity

Aneliya S. Crawford & Matthew J. Gruenberg

Aneliya is a Partner in the New York office of Schulte Roth & Zabel LLP (SRZ) in the Shareholder Activism and M&A and Securities Groups. Matthew is Special Counsel at the firm

FRIEND ORFOE? FOE? The Convergence of Private Equity and Shareholder Activism

The lines between shareholder activist strategies and traditional private equity strategies are starting to become blurred.

Historically, private equity firms have adhered to the ‘rules of the road’ set out by companies looking to explore strategic alternatives or realise monetisation events for their equity holders. The company, after approval from its board, engages a financial advisor and the firm is approached by the bankers to do a deal on, generally, the company’s timeline. They follow the auction process set out by the company and its advisors and look to gain support of the board for their proposed transaction terms. Once the deal is signed, the board recommends the transaction to its stockholders, fully aware of the buyout firm’s intentions. Until the time of execution, the buyout firm’s interest stays out of the public eye. Most importantly, the deal is ‘friendly’: a buyout firm will not proceed in a transaction without support of the company’s board. This strategy has allowed private equity (PE) firms to monopolise potential value creation at cheap, underperforming companies. Activist firms, on the other hand, have traditionally taken a different approach, looking to gain a toehold by acquiring an equity position without the board’s consent and effecting change by launching campaigns in the public. The activist will take its argument to the stockholders directly and may target board representation or force other strategic initiatives to be 10 Ethical Boardroom | Winter 2020

THAT’S WHAT FRENEMIES ARE FOR Activists are starting to add private equity tactics to their arsenal www.ethicalboardroom.com

Private Equity | Commentary undertaken by the company by leveraging public pressure on the board. Recently, however, activists have added more ‘friendly’ buyout initiatives to their strategic arsenal.

Why is this happening now?

As activism continues to gain reputational currency, activist firms are raising more capital locked over longer duration. They are aggressively looking for new opportunities and taking longer term operational views of potential target companies. Premier, well-capitalised activist funds may have holding periods of five to seven years and are increasingly focussing their efforts on restructuring the businesses of their targets, not unlike the management style of private equity firms at their portfolio companies. With all this spare capital, yet fewer opportunities, activists are deploying their competency of running businesses to acquire entire companies. However, activist involvement may drive up the value of a company’s stock, costing a private equity firm looking at a potential take-private of a public company. Private equity firms also face pressure to deploy capital on a timely basis under their fund documents and are further supercharged by the low interest rate environment with the support of the Federal Reserve. Attractive new deal opportunities are not easy to find due to high valuations. With this intense competition for value creation, activists and private equity firms are increasingly under pressure to imitate each other’s strategies and counter these effects.

How are activists converging with private equity?

Activist funds are exploring more PE-like initiatives through a variety of strategies. Activists have teamed up with private equity firms to provide equity co-investments on a deal-by-deal basis, allowing the buyout firm to stand out as the face of the acquisition group and leveraging the buyout firm’s operational expertise in evaluating opportunities and monetising the investment within a relatively expedited timeline. Alternatively, activists may create their own private equity investment arm, bringing such expertise in-house and providing a diversified portfolio of strategies for investors. Famed activist investor Elliot, with its private equity arm Evergreen Coast Capital,


is a prime example of this investment product diversification. In either case, the activist may initially acquire a toehold position and run a more traditional campaign, pushing for the sale of the company. This often catalyses interest from potential acquirors and makes the company more open to a bid from a PE fund, even where no formal strategic alternatives review process is under way. When an activist’s PE arm is among those interested, it is particularly hard for the company to argue that there is no acquisition appetite for its business and the activist may reduce the cost of its acquisition through the toehold purchased without a premium.

How are private equity firms converging with activists?

Private equity firms have also started to adopt activist tactics, such as the acquisition of toeholds, as a way to force a dialogue with the company about a buyout. Golden Gate, Hudbay Minerals and Sycamore Partners have all tested this approach. Private equity firms’ fund documents typically restrict them from engaging in hostile transactions, proxy contests or other strategies favoured by activists. Further, traditionally toehold, or minority investments in public companies, will generally be restricted under the firm’s fund agreements to a small percentage of total fund capital. Of late, many of the structural impediments to private equity engaging in activist strategies are starting to fall.

Activists and private equity firms are increasingly under pressure to imitate each other’s strategies Some private equity firms are launching new ‘management friendly’ funds with the flexibility to take minority positions in companies and leverage expertise from their firm’s private equity professionals. The fund may provide operational support to the company from its operations experts in a minority equity position, a hybrid of sorts between an activist investment and a full take-private acquisition. To gain the support of company boards, these specialised investment funds are also holding themselves out as potential white knights against activist players by taking up key portions of the public float and offering strategic defensive advice. In markets where hostile merger and acquisition (M&A) activity has sustained, PE firms have generally found important reputational reasons to consistently show up as the friendly player. However, record amounts of capital raised and intense competition are changing these attitudes.

What should boards expect from an activist engaging in traditional private equity strategies? An activist may establish a toehold before looking to ultimately conduct a friendly transaction with the company with the board’s support. This is in contrast with the more traditional private equity model and the differences are immediately apparent, often as early as the negotiation of a customary confidentiality and non-disclosure agreement. The private equity firm, without any existing position in the company, will often sign up to a full standstill, effectively forcing it to go through the board to make any transaction proposals. Negotiating a confidentiality agreement with an activist with an existing toehold may be a more protracted process, as the activist may look to be able to trade in the position while simultaneously reviewing a potential transaction and conducting due diligence. Although it is ultimately up to the investor and its legal counsel to determine if the investor is in possession of material non-public information, the activist may require that the company provide notice of trading windows for directors and officers or seek to place an affirmative obligation on the company to ‘cleanse’ the activist of material non-public information by putting information provided to the activist in the public domain. It will be important for stakeholders and advisors on both sides of the table to appreciate the nuances of the relationships and mindset of the parties in crafting documentation to set the rules at the out set of the diligence process, rather than relying on a ‘one size fits’ all approach.

Where do we go from here?

We are seeing the demarcation between traditional private equity and shareholder activism fade, with each investor group utilising strategies from their counterparts across the line. We believe this convergence is a reflection of the strength and institutionalisation of the activist strategy, on the one hand, and a pursuit of flexibility by private equity, on the other. Our expectation would be that private equity firms’ aversion to hostile approaches will also diminish as strategies by active managers, activist hedge funds and traditional sponsors evolve, blend and borrow elements from the others. It remains to be seen whether this trend will last and how deeply the strategies will converge. The current frothy valuations and extremely competitive investment landscape would suggest that private equity and activism will continue to utilise each other’s strategies in pursuit of stronger returns. Winter 2020 | Ethical Boardroom 11

Commentary | US Proxy System

Spotlight on proxy process SEC’s proposed actions on shareholder proposals and proxy advisors could alter the governance landscape Allie Rutherford & Eric Sumberg

Allie is Managing Director and Eric is a Director at PJT Camberview

The public comment period for two of the most potentially impactful rulemaking proposals from the US Securities and Exchange Commission (SEC) in recent history came to a close in early February. Hundreds of comments were submitted by stakeholders across the investor, governance and issuer communities on proposed changes to rules governing shareholder proposals and regulating proxy advisors. How these comments will impact the final

form of the SEC’s proposed rules remains to be seen, but what is clear is that any rulemaking on these topics has the potential to significantly alter fundamental aspects of the corporate governance landscape, possibly in unintended or unpredictable ways.

Proposed rule amendments

The genesis of this rulemaking dates to 2010 with the publication of the Concept Release on the US Proxy System, an SEC review of the US proxy voting system, including the integrity of the voting process and the role of proxy advisory firms. The ‘proxy process’ review was reinvigorated in 2018 by current SEC chairman Jay Clayton, who held a roundtable in November of that year to discuss proxy advisors, shareholder proposals, and proxy voting mechanics and technology. In August 2019, the Commission took further steps by providing an interpretation and related guidance that proxy advisor advice generally constitutes a ‘solicitation’ under federal proxy rules as well as guidance on the responsibilities of investment advisors with regard to proxy voting.

SHAREHOLDER VOTING DEBATE The US SEC has proposed a series of rules on proxy voting

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US Proxy System | Commentary The two proposed rule amendments build upon and, in some instances, supersede the SEC’s prior actions. For shareholder proposals, the new rules would raise ownership thresholds for submitting proposals and require greater support for proposals to be eligible for submission in future years. As proposed, the new rule would replace the ownership requirement to submit a shareholder proposal from $2,000 or one per cent of a company’s securities for one year to a sliding scale. A shareholder would be able to submit a proposal if they held $2,000 worth of a company’s stock for three years, $15,000 worth of stock for two years or $25,000 worth of stock for one year, under the new proposed rule. The rules would also raise the vote requirement for a shareholder proposal to be eligible for resubmission from current levels of three per cent, six per cent and 10 per cent of votes cast for matters voted on, respectively, once, twice or three or more times in the last five years to thresholds of five per cent, 15 per cent and 25 per cent, respectively. In addition, it would prohibit certain proposals from resubmission if the proposal has been voted on three or more times in a five-year period and it has received over 25 per cent support, but hasn’t received majority support, and experienced a decline of 10 per cent or more compared to the immediately preceding vote. For proxy advisors, the SEC’s proposed rules would codify the interpretation and guidance provided in August by the Commission that furnishing proxy voting recommendations, research and analysis is considered to be engaging in proxy solicitation which would have the effect of treating proxy advisor reports as solicitation materials. This would mean that proxy advisors would be subject to the same anti-fraud provisions relating to false and misleading information applicable to other entities that file solicitation materials, such as corporate issuers and shareholders.


In addition, the proposed rule would revise the requirements that proxy advisors need to fulfil to be granted exemptions from the information and filing requirements of the proxy rules. This includes providing additional disclosure of material conflicts of interest in proxy advice, as well as requiring that issuers and those who are soliciting votes (such as an activist investor) would have two opportunities to review and provide commentary on proxy advisor reports prior to issuance. The first review period would be related to when the company files its proxy and the other would be a final review prior to when the proxy advisor sends reports to its clients. This differs from current practices in which ISS provides a draft proxy report to S&P 500 companies for review prior to publication while Glass Lewis makes available a review of the data in its reports to all issuers.

The proposed changes may have impacts on other elements of the voting process. The SEC’s proposed guidance may prompt proxy advisors to take a more rigid approach to following stated guidelines rather than taking a more case-by-case approach to evaluating management and shareholder proposals. Certain investors with more limited resources to dedicate to proxy voting and analysis may take a similar approach. The requirement for proxy advisors to provide two opportunities for review of their reports prior to publication may delay final publication of the reports, which would give investors less time to review reports prior to the vote deadline. This could limit issuers’ ability to engage with investors to seek to resolve concerns or answer questions that may allow an investor to make a case-by-case decision or override existing voting guidelines. In addition, the proposed rules Implications for place issuers and investors conducting investors and issuers non-exempt solicitations (e.g. activists Some of the more prominent investors conducting a proxy contest) on equal ground who have submitted comments to the SEC with regard to their ability to review and on the proposals have characterised them append responses to proxy advisor reports, as limiting shareholder a right that previously rights. While the neither party had If investors feel that proposed rules may been granted. their ability to influence change the current The final form of dynamics around these proposals is now companies through the proxy advisors and being considered by shareholder resolution shareholder proposals, the SEC. While some of process is curtailed, they the new requirements they could have an even broader impact. are slated to be subject may be encouraged to For example, if to a one-year transition turn with increasing investors feel that their period following ability to influence publication of final frequency to the companies through rules, the new rules convening power of the shareholder would be implemented resolution process is at a time when shifts investor coalitions curtailed, they may be in investor behaviour encouraged to turn with increasing have already begun to impact the corporate frequency to the convening power of governance landscape. In recent years, many investor coalitions, such as the Climate large institutional investors have sought Action 100+ or the Human Capital to differentiate themselves by building out Management Coalition, which seek to effect their stewardship and proxy voting teams, change through collective engagement, investing more resources in research and letter writing and vote campaigns. In voting processes and creating their own the absence of an opportunity to vote on models to better assess issuers’ governance, shareholder proposals, investors may be compensation and sustainability practices. more inclined to launch vote campaigns A recent example of this can be found against directors and/or vote against other in BlackRock’s dual 2020 letters to CEOs proposals on the ballot to express their and its clients in which the asset manager views. And, if fewer shareholder proposals identified specific actions it will take in its make it to the ballot, asset managers may investment and stewardship activities to come under increased pressure to better prioritise sustainability. Many companies demonstrate to asset owners (their have responded to this broader shift by source of capital) their commitment enhancing their practices and disclosure to stewardship through support on ESG and other topics to ensure that they for those proposals or enhanced stay on the frontfoot with their investor disclosure around their base and other stakeholders. It is in this engagement efforts, particularly context that the SEC’s proposed rules in instances when they will be implemented, with wide-ranging decline to support and potentially unpredictable outcomes shareholder proposals. for investors and issuers alike. Winter 2020 | Ethical Boardroom 13

Commentary | Taxation

On the certainty of death and taxes Directors of companies that operate globally face important conflicts of interest Alissa Amico

Managing Director, GOVERN Center

Large corporations are getting larger and their operations more porous in terms of their physical location and business lines. The largest company in the world today, in terms of its valuation, may be Saudi Aramco, but the oil and gas company is an exception to the rule: the most sizeable global firms are predominantly a product of the fourth industrial revolution.

Their operations are international, their DNA is technology-based, and their revenue source is intangible services. Indeed, in today’s borderless world, the place of a firm’s incorporation or registration is generally dictated by a choice of tax jurisdiction rather than where its operations or the customer base is located. Where these activities are recognised – in accounting terms – has a fundamental impact on the structure of the global economy and on national wealth. It is a high-stake and complex game of catch-me-if-you-can between governments and companies. Since the revenues of technology companies, such as Google and Facebook, are difficult to attribute, given the nature of their business, creative accountants have over the years learned to recognise them in countries such as Ireland, where tax rates are competitively positioned and where large corporations have special tax agreements. In recent years, tax

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competition among countries has fostered an industry of its own and the European Commission is hence attempting to stop arbitrage among its member states. For policymakers, the leitmotif for doing so is the unfolding world of technology companies and their implications on the global economy. Indeed, last year France was first to flex its muscles and announce a unilateral imposition of taxes on revenues of foreign technology companies generated domestically. Italy and Spain are currently considering similar measures, despite ongoing threats of American tariffs retaliation. These are rare examples of governmental muscle-flexing in an era where state power seeing a retrenchment in face of increasingly influential corporations with significant lobbying resources. Indeed, over the past decade, responsibilities traditionally in the purview of governments have been shifting to the corporate sphere, leading to an erosion of social democracy globally. To compensate for companies’ growing role as not only actors with economic, but also social and political power, corporate managers and directors have been bestowed with ever expanding responsibilities, from managing climate change to creating employment. As such, the very concept of what is a corporation has shifted from an entity responsible to a defined set of shareholders to a Santa Claus, catering to a diverse global set of stakeholders. Signs of budding stakeholder capitalism are everywhere. The talk in global capitals, including Wall Street, which has incarnated the essence of the capitalist system, has shifted from compliance discourse that dominated the immediate post-financial crisis years, to personification of the corporation as an agent of social change. Corporate laws in France and the United Kingdom have recently been amended to reflect a transition from a shareholder-driven to a stakeholderdriven purpose of the corporation. International organisations and regulators are also adjusting their songbook. Davos has published a new

corporate purpose manifesto that claims that ‘a company is more than an economic unit generating wealth: it fulfils human and societal aspirations as part of a broader social system’. All over the world, bells are heralding a new era of stakeholder capitalism, yet this discourse is missing a critical component on which the corporate-societal contract is based: taxes. Recently, European Union member states again blocked legislation requiring companies to provide public reporting of their revenues and taxes by country, prompting an outcry of civil society. This is a consequence of a number of EU countries, such as Ireland or Luxembourg, blocking tax transparency proposals of which they will be clear losers as the Apple and Starbucks cases have already highlighted.

To encourage better disclosure and put a stop on tax arbitrage, the Organisation for Economic Co-operation and Development (OECD) recently proposed a minimum corporate flat tax, notably aimed at technology companies www.ethicalboardroom.com

Taxation | Commentary

To encourage better disclosure and put a stop to tax arbitrage, the Organisation for Economic Co-operation and Development (OECD) recently proposed a minimum corporate flat tax, notably aimed at technology companies. This proposal is fundamental to underpinning a more just revenue distribution in the global economy and also to rebalance power relations between governments and corporations, eliminating one of the key reasons for corporate lobbying. As global technology behemoths are diversifying their holdings – with Facebook venturing into electronic currency and Apple into health services – the focus on establishing a minimum global tax rate will only gain in importance. If accepted, the flat tax solves the problem of arbitrage not only because corporate

managers will no longer have the opportunity to shop around for low tax jurisdictions, but also because they will no longer be conflicted in terms of their duties. While tax rates and director duties are defined domestically, shareholders and stakeholders are located globally. As such, directors – especially of technology companies that operate globally but are generally located in the US – face important conflicts of interest. Herein lies the Catch 22: if corporate directors agree to minimise taxes in one jurisdiction at the expense of another, their duties to shareholders may be fulfilled but their responsibilities to other stakeholders are compromised. This is not without legal consequence as a number of countries, such as Australia, require directors to attest that they have effective policies to manage tax risk. Doing so in the context where Australia and the US are in a spat over tax treatment of American technology firms is challenging at best. In the world where taxation rules of the game are

evolving in the opposite direction to national governance frameworks, it also has legal and compliance implications. Until a global framework regarding tax treatment of technology companies and, indeed, other multinational firms is agreed upon, Benjamin Franklin’s famous adage that ‘in this world nothing can be said to be certain, except death and taxes’, can actually be questioned. As a concept, taxes are certain, but where they are due is far from clear. The changing structure of the global economy in the wake of the fourth industrial revolution means that existing taxation rules are antiquated. Equally importantly, they are in disaccord with governance frameworks which that require corporate boards to be cognisant of their responsibilities towards a nebulous, undefined group of stakeholders. This conflict requires not only a globally accepted tax framework but also an international agreement on director duties with respect to tax planning. Placing higher responsibilities on corporate directors in the absence of such framework is at best naïve.

UNCERTAIN TIMES Globalisation means existing tax rules are now antiquated


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Credit: media.group.renault.com/Rvweuters

Global News Europe

Italian Luca de Meo is named new Renault CEO

Renault has announced that Luca de Meo (left), the former head of Volkswagen’s Seat brand, will be appointed its next chief executive on 1 July 2020. Clotilde Delbos, Renault’s interim chief executive, will become deputy chief executive once the Italian-born Mr de Meo joins. Renault has been searching for a new chief executive after former boss Thierry Bolloré was ousted last October, along with a number of other executives associated with former chairman of the RenaultNissan-Mitsubishi alliance group of companies, Carlos Ghosn. The car manufacturers have been struggling to recover from Ghosn’s dismissal after an internal investigation sparked by his arrest in Japan on financial misconduct charges.

Airbnb joins calls for a new EU technology regulator Airbnb has backed calls for the creation of a digital regulator for the EU after winning a landmark court case that meant it could be classed as an online platform rather than a property agent. France’s Association for Professional Tourism and Accommodation (AHTOP) complained that Airbnb was acting as an estate agency without a licence, breaching a local act known as the Hoguet Law. But the company won its battle to remain exempt from onerous European property regulations in a landmark ruling last month in the Court of Justice of the European Union and called for a ‘single European oversight body for digital services’. In January, Airbnb announced its intention to publish annual reports for its stakeholders in addition to financial reports.

Belgian tax authority settles part of Frasers probe Retailer Frasers Group has said the Belgian tax authority has concluded most of its investigation into an alleged failure to pay a tax bill that equated to around £571million. The company, owned by UK businessman Mike Ashley and formerly called Sports Direct International, first revealed it was being pursued by Belgian authorities last July. According to Frasers Group, Belgian tax authorities had confirmed in writing that it

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was satisfied with its explanation regarding 73 per cent of the money. The retailer said the issue ‘has been resolved with no payment of VAT liabilities or associated penalties and interest to be made by the company or any member of its group’. It said its advisers will continue to ‘fully engage and work with the Belgian tax authority in order to resolve the smaller remaining matters referred to in the process as soon as possible’.

Swiss regulator bans former bank boss

Swiss financial watchdog Swiss Financial Market Supervisory Authority (Finma) has banned a former head of a Swiss bank from financial activities over a serious case of insider trading. The unnamed former chief executive is banned from acting in a management capacity for four years and from trading in securities for six years, the supervisor said. Finma said the former CEO made unlawful profits over several years from trades through his wife’s accounts at other banks, based on sensitive market information. The chief executive had ‘repeatedly and systematically’ violated supervisory law, it added, citing instances of insider trading.

Sky’s UK CEO to lead European operations The boss of Sky’s business in Britain has been promoted to also oversee its German and Italian operations, in a management shake-up. Stephen van Rooyen (right) will become chief executive for UK and Europe, with the heads of Sky Italia and Sky Deutschland reporting to him. The current head of Sky’s continental operations, Andrea Zappia, will become CEO of ‘new markets and businesses’, as parent company Comcast looks to target new markets across Europe. According to the Daily Telegraph, Sky’s Group CEO Jeremy Darroch told staff in a memo that the restructure would bring the company’s existing operations ‘together in a way we have not done before’.


The European Confederation of Directors’ Associations (ecoDa) is an independent actor and a unique umbrella organisation representing the main national institutes of directors in Europe. Our member institutes cover in total about 50,000 individual directors across 21 countries, sitting on the board of companies of all sizes and sectors. All our member institutes are well recognised in their country and are well-recognised market players in regard to corporate governance. We are the European Voice of Board Members. In order to support our advocacy role, we have developed The Corporate Governance Dialogue with the aim of reflecting on the future evolution of corporate governance and the governance trends and challenges that business firms and other organisations are confronted with. Consequently, the CG Dialogue wants to identify and discuss what the next topical issues in corporate governance will be, what the role of tomorrow’s board members will be, bringing awareness of the participants of new emerging topics that will impact their organisation and their market. Our next topic will focus on how to organise corporate governance in non-hierarchical organisations. In addition, ecoDa has developed an unique European module for directors and supervisory boards. The training programme is targeted at directors with a cross-border mandate in their board activities, or at directors seeking to gain a European perspective on board functioning and corporate governance. Our next session is scheduled on 31 March and 1 April.

If you would like to be involved in our debates or subscribe to our training programme, please email contact@ecoDa.org or visit www.ecoDa.org

Europe: Swiss Focus | Activists

Shareholder activis An insight into the latest trends and developments David Ledermann

Partner, Lenz & Staehelin

It’s hard to believe that 25 years ago there was no federal statute in Switzerland regulating public takeovers. High-profile shareholder activist campaigns that played out in 2018 and 2019, the recent efforts of Swiss legislators to bring to a close the decade-old process of modernising the code governing corporations limited by shares, signal a major change in both public and regulatory attitudes to corporate behaviour. Back in 1995, the impetus behind the adoption of the Stock Exchange and Securities Trading Act (an act that has now been abrogated by the entry into force on 1 January 2020 of the Financial Institutions Act (FIA) after partial abrogation on 1 January 2016 following the entry into force of the Financial Market Infrastructure Act (FMIA)) was the recognition that since the end of the Cold War, Switzerland could no longer rely solely on its reputation for political stability and for being an investor ‘safe haven’. It needed to adjust to rapid

technological developments and increased competition among financial centres and modernise its legal framework by promoting transparency and clear governance rules, notably in public takeover situations. The rapid growth of institutional investors following the introduction in Switzerland in the mid-80s of a comprehensive mandatory pension fund system (with an ever-growing appetite for safe, revenue-generating investments) also contributed, and arguably still contributes significantly, to the development of a legal framework promoting transparency, good governance and permitting shareholder activism. In 2018, the investments of all Swiss pension fund institutions represented 115 per cent of Switzerland gross domestic product – approximately CHF770billion.

The Sika/Saint-Gobain battle

Shareholders’ activism in Switzerland was initially focussed on corporate control before expanding to the issues of good corporate governance and executive compensation (with corresponding evolution of the legal framework along the way). Shareholders’ activism in connection with change of control or corporate amalgamation still makes up the bulk of the recent high-profile cases. Take the case of Sika, a construction chemicals manufacturer based in the Canton of Zug with a market capitalisation

of CHF25billion (January 2020 figure). The Burkhart family who owned around 16 per cent of the company and 52 per cent of the voting rights because of the dual-class capital structure of Sika, attempted to secure a control premium over the SIKA trading price by selling Sika’s competitor Saint- Gobain the family investment vehicle holding the Sika shares. It was an attempt that the board of directors of Sika and the remaining shareholders opposed. The board of directors of Sika argued that under Sika’s articles of association, the contemplated transfer was subject to the consent of the board, which was further entitled to limit the voting right of the Burkhart family investment vehicle to five per cent in such a situation – in effect preserving the status quo, blocking any attempt to replace the board of directors with more pliable members and preventing the contemplated transfer to going forward. After a judicial battle of more than three years (during which the market value of the Sika shares continued to appreciate), the matter was settled out of court. SaintGobain never gained control of Sika (but did make a profit out of the whole transaction), thereby preserving the independence of Sika (the avowed goal of the independent members of the board of directors). More importantly, from a shareholder activist perspective, the dual-class capital structure, the transfer restriction clauses in the articles and the

Shareholder activism in Switzerland was initially focussed on corporate control before expanding to the issues of good corporate governance and executive compensation 18 Ethical Boardroom | Winter 2020


Activists | Europe: Swiss Focus

sm in Switzerland ability to limit the voting rights of an acquirer to five per cent of the voting rights (all measures meant to entrench the majority shareholder but which ultimately backfired) were eliminated in favour of retaining a single class of registered shares without any transfer restriction.

Panalpina takeover

The case of Panalpina is another emblematic case where provisions in the articles of association designed to entrench the historical controlling shareholder were, this time, ultimately not sufficient to preserve the independence of the company from an acquirer. In January 2019, Danish company DSV made a $4billion share and cash offer for Swiss logistics group Panalpina, a 24 per cent premium of the closing share price (which actually was not such a great offer, considering that in 2018 the Panalpina shares had lost 25 per cent of their value).


Winter 2020 | Ethical Boardroom 19

Europe: Swiss Focus | Activists The initial offer was rejected by the controlling shareholder of Panalpina, the Ernst Göhner Foundation (EGF) with 46 per cent of the share capital. That ignited criticism from activist investors Cevian Capital and Artisan Partner Fund that a provision of Panalpina’s articles of association limiting the voting rights of any shareholder with more than five per cent of the share capital to five per cent of the voting rights and from which EGF was notably exempted, was giving EGF a de facto veto right on any acquisition proposal: as any acquirer would make a condition of its offer the elimination of such restrictive provision in the articles, and as such elimination would require a resolution of the shareholders’ meeting, EGF would be able to control such a resolution. Although EGF and Panalpina attempted to respond to these criticism by proposing to remove the restrictive provision in the articles (although even without such provision a shareholding of 46 per cent was very likely to leave EGF with a controlling stake), ultimately the pressure of the market was too strong. DSV improved its initial offer twice and eventually presented a $4.6billion all-share offer, which was supported by the board of directors of Panalpina, EGF Cevian Capital and Artisan Partner Fund. Interestingly Cevian Capital initially opposed the proposal of EGF to remove the five per cent voting right restriction, arguing that such restriction should apply to all shareholders, including EGF, and threatening legal action. It is generally considered that the efforts of Cevian Capital and Artisan Partner Fund were a key factor in securing an improved offer from DSV, which the independent members of the board of Panalpina could eventually not oppose.

Sunrise and UPC merger

Another interesting case is the aborted Sunrise/UPC merger transaction where minority shareholders thwarted the plans of Sunrise management to acquire cable operator UPC Switzerland from Liberty Global. On 27 February 2019, Sunrise announced that it had agreed to purchase UPC Switzerland for CHF6.3billion (consisting of CHF3.6billion in assumed debt and CHF2.7billion cash payment to Liberty Global) to be financed through a CHF4.1billion rights issue, which required shareholders’ approval. After its representatives on the board of directors of Sunrise had initially approved the contemplated acquisition of UPC Switzerland, Freenet, a German mobile operator and the largest shareholder of Sunrise soured on the deal, resulting in an announcement in August 2019 that it would vote against the CHF4.1billion rights issue proposed by Sunrise management on the grounds that the price tag was too high and 20 Ethical Boardroom | Winter 2020

that Sunrise would fare better without acquiring UPC. This generated a fierce response from Sunrise with public accusations that Freenet representatives on the board of directors of Sunrise had been obstructive, made requests which were either inappropriate from a governance standpoint or downright illegal and breached their fiduciary duty, which resulted in the fairly drastic decision to exclude Freenet board representatives from any subsequent board discussion on the Sunrise/UPC transaction. With its reference shareholder pretty much alienated, Sunrise decided in September 2019 to improve the terms of the transaction for Sunrise existing shareholders by reducing the offer rights from CHF4.1billion to CHF2.8billion, relying on more debt (and therefore reducing the dilution of existing shareholders). With activist shareholders such as Germany’s Active Ownership and Axxion coming out against the transaction, and proxy advisor ISS recommending to vote against it, Sunrise came to the realisation a few days before the appointed shareholders’ meeting of 23 October 2019 that there was no majority supporting the transaction. It then took the highly unusual (and legally questionable) route of calling off the shareholders’ meeting, which triggered some virulent reactions from activist shareholders as Axxion had requested (and obtained) that, in addition to the vote on the UPC transaction, the dismissal of the chairman of the board and another board member be part of the meeting’s agenda.

aktiengesellschaft) was slowly reaching its conclusion, more than 13 years after its initiation. The revision, which is expected to enter into force not earlier than 2021, is certainly an improvement over the current law in a number of aspects, such as the simplification of the incorporation process, a greater flexibility in increasing and decreasing the stated capital of the company, in convening shareholders’ meetings, and in passing shareholders’ resolutions. With respect to governance and shareholders’ rights, the improvements are much more modest and are essentially

A shareholder or group of shareholders must have at least 10 per cent of the stated capital of the company or shares aggregating CHF1million in par value to be able to request that an item be added to the agenda of a shareholders’ meeting By calling off, the board of Sunrise deprived its shareholders of the right to exercise their votes in a duly called shareholders’ meeting. The highly unusual move probably saved Sunrise from some very public embarrassment but ultimately Freenet and its activist shareholders allies won with the transaction abandoned (at the cost of a CHF50million break fee for Sunrise). The chairman and vice-chairman of the board of Sunrise announced that they would not seek re-election to the board in 2020 and the CEO of Sunrise resigned with immediate effect on 3 January 2020.

Revised obligations

While such high-profile cases were proceeding in 2018 and 2019, the process of revising the section of the Swiss Code of Obligations governing the corporation limited by shares (société anonyme/

limited to publicly listed companies with a lowering of the shareholding threshold required by law for shareholders to add an item to the agenda of a shareholders’ meeting or to request the summons of an extraordinary shareholders’ meeting. Currently, a shareholder or group of shareholders must have at least 10 per cent of the stated capital of the company or shares aggregating to CHF1million in par value to be able to request that an item be added to the agenda of a shareholders’ meeting or to request the summons of an extraordinary shareholders’ meeting. Under the draft legislation, such threshold will be reduced for listed companies to one per cent or three per cent (the two legislative chambers of the Swiss parliament are still to agree on the figure) of the share capital or voting rights to add an item to a shareholders’ meeting agenda and five per cent to request the summons of an extraordinary shareholders’ meeting. www.ethicalboardroom.com

Activists | Europe: Swiss Focus While this looks like a significant improvement, in practice many large listed companies have already provided in their articles of association for lower thresholds. In the example of Sunrise above, the threshold set forth in the articles of association to request that an item be added to the agenda is set at one per cent and the threshold to request the summons of an extraordinary shareholders’ meeting is set at three per cent. Consequently, it is not expected that the entry into force of the revision will significantly increase shareholder activism in Switzerland.

organisational measures to improve the representation of women on the board of directors and at the level of senior management. The draft legislation simply provides that if the representation of women on the board of directors and at the level of the senior management is below 30 per cent and 20 per cent, respectively, a Swiss listed company will be required to explain in its annual report to the shareholders why these minimum thresholds have not been satisfied and what measures are being taken to remedy this situation in the future. It remains to be seen whether this ‘comply or explain’ method,

FOCUSSING ON ESG REPORTING Shareholders are putting pressure on listed companies

Diversity on boards

On the sensitive governance issue of the representation of women within the board of directors and at the level of senior management of Swiss companies, the revision contains only modest proposals, which will apply only to listed companies. Since 1981, Switzerland’s constitution mandates that men and women must be treated equally, which means not only promoting equal legal rights for men and women but also actual equality (de facto) in all domains such as family, education and labour. Almost 40 years later, male/female parity on the board of directors and at the level of senior management of Swiss companies is far from being achieved. Within the 100 largest Swiss companies, female senior executive represents less than 10 per cent of senior management and female board members represent only 20 per cent of all board membership. In its current state (which is not expected to change), the revision does not provide for any mandatory level of representation for women (quota) or any mandatory steps, objectives or www.ethicalboardroom.com

inspired by the Swiss Code for Best Practice of Corporate Governance (a set of guidelines issued by the trade association Économiesuisse) will trigger a substantial increase in women representation in Swiss listed companies, but there are precedents where such an approach has yielded rapid changes (the drastic reduction of executive members on the board of Swiss listed companies comes to mind).

Human rights and the environment

The other governance topic heavily debated now in Switzerland, is the issue of the responsibility of Swiss companies for violation of human rights and/or environmental abuse committed outside of Switzerland either directly or through entities belonging to or controlled by such Swiss companies. This debate revolves around a constitutional initiative that was filed with the Swiss authorities in October 2016, aimed at holding Swiss companies accountable for such violation of human rights and/or

environmental abuse. At first the initiative did not seem to get any public traction and the Federal Council proposed a year later to simply dismiss the initiative without any counterproposal. However, with the issues of climate change and related social and environmental responsibility of multinationals making more and more headlines, one of the two chambers of the Swiss parliament decided to prepare draft legislation to address the concerns of the constitutional initiative, while limiting its initial scope. Where the constitutional initiative provided that all Swiss companies (with a limited exemption for small and mid-sized companies) could be held liable for violation of human rights and environmental abuse committed outside of Switzerland either directly or through entities belonging or controlled by them, the parliament counterproposal would only apply to Swiss companies with more than 500 employees and more than CHF80million of turnover. The draft legislation also limits the liability of Swiss companies to situations resulting in loss of life, physical harm or property damage and provides that such companies would not be held liable in such situations if they can demonstrate that they were in compliance with applicable local legislation or were not in a position to direct the actions of the controlled entity responsible for the actual violation of the relevant legislation. In the summer of 2019, the Swiss government came up with its own counter-proposal to the constitutional initiative – a project that is significantly more favourable to Swiss business than the parliament counter-proposal as it completely eliminates any specific liability provision, preferring an approach where Swiss listed companies would only be required to publish annual reports on their compliance with human rights and environmental legislation in the foreign countries where they operate. The Swiss government proposal has been adopted by the other chamber of the parliament and it seems unlikely that the two chambers of the parliament will ever agree on a legislative counter-proposal to the constitutional initiative. It is therefore expected that the initiative will be submitted to the people’s vote at the end of 2020. Irrespective of the result of such a vote, we can expect in the future increased shareholder activism in Switzerland in the fields of social and environmental responsibility. Swiss banks are already facing significant pressure for their role in financing the fossil fuel industries, and activist shareholders will certainly be pushing for Swiss listed companies to report on their efforts to conduct their business in a way that promotes rather than prevents the achievement of the United Nations Sustainable Development Goals (SDGs). Winter 2020 | Ethical Boardroom 21

Europe: Swiss Focus | Advertorial

Barbara A. Heller & Christoph Wenk Bernasconi Barbara is a Managing Partner and Christoph a Senior Partner at SWIPRA Services Ltd

Corporate governance in Switzerland

Is there a lack of mutual understanding and required rethinking in enterprises’ CSR? The discussions regarding corporate social responsibility (CSR) or environment, social and governance (ESG) issues are ever present.

Investment portfolios should become increasingly greener, more social and more sustainable, while companies are publishing increasingly comprehensive CSR reports. 22 Ethical Boardroom | Winter 2020

Nevertheless, or perhaps precisely because of an increasing flood of CSR information and the muddle of terms, the common understanding of how to deal with CSR seems to be low. The results from the seventh SWIPRA Corporate Governance Survey, that are discussed in this article, provide factual evidence on this gap in mutual understanding. SWIPRA is an independent Swiss corporate governance specialist, supporting

its corporate clients with a holistic view on corporate governance. We take into consideration the perspectives of a variety of stakeholders to achieve broad acceptance for companies’ governance structures and CSR efforts. As part of its activities, SWIPRA is conducting independent research and market analyses, among others the yearly SWIPRA Corporate Governance Survey that is providing representative views from Swiss listed www.ethicalboardroom.com

Advertorial | Europe: Swiss Focus companies and their institutional Swiss and international shareholders.

Corporate social responsibility — mind the gap

reporting. However, it does not mean to just provide more information but other, new ways of disclosure. Expectations on members of the boards of directors in this regard are increasingly high and we see a substantial need for action.

FIGURE 1: Which was your institutional shareholders’ primary governance engagement topic during the financial year 2018? (issuers only)

26% Compensation Society and shareholders’ high and increasing expectations with regard to Strategy 25% Corporate governance and corporate social responsibility and Board of directors 23% corporate citizenship are mostly met with CSR — a story of integration No governance According to the surveyed companies a lack of mutual understanding as to ‘how’ 10% engagements and depicted in Figure 1 (right), recent a business is run and managed: Only 17 per Dividend/payout engagements focussed primarily on the cent of institutional investors indicate that 8% governance topics of ‘compensation’ (26 they recognise how companies integrate Environmental 6% & social per cent), ‘strategy’ (25 per cent) and ‘board CSR into their corporate strategies. On the of directors’ (23 per cent). Only six per cent other hand, only 41 per cent of companies Risk management 1% stated that CSR, overall, remained an listed in Switzerland understand how 0 5 10 15 20 25 individual key topic in the investor dialogue. institutional shareholders incorporate CSR Percentages Consistent with SWIPRA’s holistic approach information into their investment decisions. As a result, the performance of a board will, to corporate governance, this indicates that And for only 48 per cent of the participating going forward, be increasingly evaluated non-Swiss shareholders try to understand companies is it clear how information on based on how effectively corporate social how CSR is integrated in the corporate CSR impacts shareholders’ voting behaviour responsibility is integrated with corporate governance framework, at annual general meetings. objectives. Accordingly, shareholders will in particular in their These gaps in mutual Society and demand more transparency in this regard. assessment of ‘corporate understanding can be bridged shareholders’ This is consistent with the observation that strategy’, ‘composition with a change in the way companies finding themselves in such of the board’ and disclosure is done and by expectations problematic situations tend to perform ‘remuneration structures’. intensifying the dialogue with regard below average over the longer term. As a consequence, this between boards of directors Investors are now even prepared to deviate integrated approach is and institutional investors to CSR and from their long-time demanded focus on becoming increasingly (‘engagements’). 73 per cent of corporate clearly defined, quantitative performance important for boards of the shareholders participating citizenship are directors. 54 per cent of indicators in remuneration systems. Instead, in such engagements aim they now increasingly call for the inclusion institutional investors at developing a better mostly met of qualitative CSR indicators (see Figure 3 consider the speed and understanding of the with a lack of over page). Seventy-nine per cent of investors quality of addressing CSR individual situation of a consider strategically relevant CSR goals company. Yet only 45 per cent understanding issues (such as compliance important in the short-term bonus to foster failures, environmental of Swiss institutional investors as to ‘how’ a a long-term sustainable business, although damage, incidents involving engage in such a dialogue, around 44 per cent view this as giving the compared to 89 per cent of business is run employees, etc) a suitable board greater discretion in determining measures to evaluate board non-Swiss investors. The latter and managed variable remuneration. For the first time, the performance. At the same usually hold relatively large majority of investors (69 per cent) expects time, the understanding stakes in Swiss companies and qualitative targets, especially related to CSR, of CSR is also important to better assess predominantly pursue a passive investment to not only have a negative impact on the opportunities and risks of a business model approach, tying them to the member stocks short-term bonus (in the event of nonand the long-term value creation as basis of an equity index over the long term. achievement or failures), but to also have a for social welfare. A majority (60 per cent) These investors revealed in the survey positive impact, analogous to financial KPIs, of non-Swiss investors say that they use this that they predominantly use engagements in the event of target (over) achievement. for assessing the board (see Figure 2, below). to actively influence their investee companies’ governance structures. Consequently, changes in corporate FIGURE 2: How suitable are the following indicators to measure the performance of a governance, in particular related to board of directors? (Survey 2019, percentage values reflect answers suitable and very suitable; left-hand side represents investors’, right-hand side issuers’ responses) compensation and corporate social responsibility, are usually initiated by Business strategy execution (e.g. KPI target large investors during the year, rather 77.8% 85.1% achievement matching strategic guidance) than at the AGM, a fact that may be clear intuitively, but now is strongly supported Development of TSR 60.9% 54.1% by this representative survey. Speed and quality of addressing CSR and In SWIPRA’s holistic view, companies 54% 35.1% compliance (reputational) issues can and should implement their strategies in different ways. When assessing various Development of objective risk measures 50% 18.1% business models, market participants (e.g. beta, bond risk premiums, WACC, etc.) must be able to understand risks and Corporate social responsibility (CSR) opportunities as well as the related socially 47.6% 35.1% framework and its strategic integration responsible actions and the relevance of corporate culture arising from each model. 39.1% 23.3% Executive management (CEO) turnover This requires an intensified dialogue and an 100% 75% 50% 25% 0% 25% 50% 75% 100% increasingly forward-looking, integrated www.ethicalboardroom.com

Winter 2020 | Ethical Boardroom 23

Europe: Swiss Focus | Advertorial

As a consequence, investors become increasingly critical of the composition of boards of directors. Only 19 per cent of the investors believe that the boards of directors in Switzerland are acting diligently enough in the area of corporate social responsibility. And only 36 per cent of institutional investors are satisfied with the disclosure of the composition and succession planning of the board of directors (2018: 37 per cent). Also, only 25 per cent of asset managers consider the structures of Swiss boards to be appropriate to ensure independent decision-making. Two-thirds of investors are taking the view that chairpersons of board committees should, in principle, be independent from management and also from the chairperson of the board to ensure objective decision-making. Further, a majority of investors believes that large

About SWIPRA Services

At the core of SWIPRA’s approach is the firm belief that corporate governance is the overarching principle of corporate businesses. Corporate governance is not a short-term ‘we against them’ story, but rather one of mutual understanding and trust over the long term, a view that has by now also received support by independent research. When providing advice on governance structures of companies, it is and has always been 24 Ethical Boardroom | Winter 2020

There are still large differences in opinion on voting rights between Swiss and non-Swiss 3 – Somewhat 18.3% 24.7% institutional shareholders. Just 38 per cent agree of Swiss asset managers and only 11 per cent of pension funds believe that benefits from 2.8% 24.7% 2 exercising voting rights exceed the costs. 1 – Do not agree 0% Remarkably, 66 per cent of non-Swiss asset 80 60 40 20 0 20 40 60 80 managers take the opposite view. The majority of companies (65 per cent) believe Percentages that their institutional shareholders exercise their voting rights with sufficient duty of information gaps between the chairperson care. This may be the result of the fact that and the other members of the board of shareholders having a regular dialogue with directors may impair the individual the companies are also those exercising members’ contribution. their voting rights. Compensation — pay for what? Overall, the SWIPRA Corporate The relationship between performance Governance Survey 2019 provides insights and bonus amount, ‘pay for performance’, into the current state of corporate governance remains a critical issue in the disclosure and provides an outlook on the key topics that of compensation. Only 13 per cent of will lead the engagement discussion in the institutional shareholders are really run up to the Swiss AGM season 2020. SWIPRA’s principle to interact with issuers and investors to enhance the mutual understanding of individual businesses, to create well-fitting and broadly accepted governance frameworks and to clarify issues that may have gone uncommented on or were misunderstood by the market. SWIPRA is promoting disclosure (one-way communication) and engagements (two-way communication) as suitable and efficient complementary tools for the boards of directors to address their stakeholders. For this reason, SWIPRA has developed a holistic approach to assess corporate governance and CSR frameworks of companies. The pillars of this approach, consolidated in the ‘SWIPRA Governance Cycle’, are shown in the graphic, right. SWIPRA’s holistic approach and integrated view on corporate governance and corporate social responsibility guide the identification and management of relevant

PORATE GOVERN COR ders & sta AN A keho R hol lde CE C IP hare rs S Y SW :

SWIPRA Services’ integrated approach to corporate governance for a sustainable business


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AGM ballots: diligent, despite costs


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thought-leadership in Switzerland Independent and practically relevant research and PR activities supporting the Swiss market, regulatory processes and the public, with objective views on corporate governance and corporate social responsibility



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SWIPRA Services is a Swiss corporate governance specialist providing services to listed companies and their boards of directors as well as to institutional investors. Its operations are based on four pillars:

5 – Fully agree

satisfied with the reporting on ‘pay for performance’. Since current systems with a focus on financial performance indicators already seem very unclear from the investors’ point of view, increased inclusion of qualitative, non-financial targets is likely to further increase complexity. CSR targets will hence increase the challenges and need improvements in the way disclosure and traceability of ‘pay for performance’ is done.

s ge pon m sibi en lity t :

Board of directors — responsibility and independent decisions

FIGURE 3: CSR targets are necessary to guide individual behaviour towards long-term sustainability and should be included in compensation systems (Survey 2019, percentage values reflect answers suitable and very suitable; left-hand side represents investors’, right-hand side issuers’ responses)

Value creation & pa reporting & eng you T age t p HE me olic nt y

Investors are, therefore, looking to create incentives for CSR behaviour as a basis to achieve long-term corporate goals. This is consistent with academic evidence, as research shows the increasing importance of CSR for investors: CSR is no longer a niche or special topic but is seen as a central component of good corporate governance, which generally correlates with improved corporate performance.

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governance risks. SWIPRA integrates personal practical knowledge and experience with principles of value-based management and empirically relevant findings. SWIPRA Services is the exclusive partner of Morrow Sodali in Switzerland. SWIPRA Services AG Claridenstrasse 22, 8002 Zürich +41 55 242 60 00 www.swipra.ch info@swipra.ch www.ethicalboardroom.com

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Clearing the path Our fully integrated corporate team, one of the largest in Switzerland, has deep expertise, resources and industry insight to accompany the boards of Swiss public companies through the increasingly complex challenges of corporate governance. Our team is dedicated to providing cutting-edge advice and tailor-made services, combining Swiss and international best practice to clear the path and translate your business vision into success.

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Europe | Climate Policy

Switzerland has so far avoided regulating a lighttouch legal framework when it comes to sustainable finance. Is it time that changed? Vincent Kaufmann

CEO of Ethos Foundation, Switzerland

Acknowledging the significant risk of climate change, Swiss asset owners are increasingly considering part of their fiduciary duties to look at how climate risks and opportunities may impact their portfolios.

With 47.24 million tonnes of CO2eq emitted in 2017, Switzerland’s direct CO2 emissions accounts for less than 0.01 per cent of the global CO2 emissions.1 However, when looking at the financial flows, including assets under management in Switzerland, they totalled just under CHF7,000billion in 2018, thus financing a much larger portion of global CO2 emissions. The Swiss equity market also counts some of the largest CO2 emitters in the world. The cement producer LafargeHolcim, for instance, emitted about 165 million tonnes of CO2eq in 2018, mainly due to energy consumption. Nestlé, the largest food and beverage company in the world, is responsible for about 113 million of CO2eq

mainly in its supply chain which accounts for more than 90 per cent of its total CO2 emissions. These two Swiss companies alone emit six times more CO2 than Switzerland does as a country.

Swiss banks under scrutiny

The Swiss financial centre is also playing a crucial role when it comes to financing the energy transition and achieving the goal of the Paris Agreement to make financial flows consistent with a pathway towards low greenhouse gas emissions and climateresilient development. However, Swiss banks are late to take adequate steps. This creates significant reputational risks for the Swiss financial centre. According to the report Banking on Climate Change 2019, the two largest Swiss banks, Credit Suisse and UBS, remain heavily involved in fossil energy with a total of $57billion of fossil fuel lending and underwriting for Credit Suisse and $25billion for UBS between 2016 and 2018.2 The strong involvement of Credit Suisse triggered some climate activists to target the bank over the past years. A recent case even went viral on social media. A dozen climate activists have gone on trial for storming a Credit Suisse office in Lausanne, Switzerland, and playing tennis inside – an allusion to Credit Suisse ambassador, the Wimbledon tennis champion Roger Federer, whom they have asked to cut links with the bank. Using Roger Federer with the hashtag #RogerWakeUpNow gave this case a worldwide echo with the New York Times reporting on it, climate activist campaigner Greta Thunberg re-tweeting it to her four

million followers and Federer himself commenting on this issue for the first time while preparing the Australian Open in a burning Australia: “I’m committed to using this privileged position to dialogue on important issues with my sponsors”. 3 The public attention also prompted Credit Suisse to announce in December 2019 that it will stop financing the development of new coal-fired power plants. The district court in Lausanne acquitted the activists and revoked the CHF21,600 fine for trespassing. The president of the court and sole judge deemed their action ‘necessary and proportionate’ given the climate emergency. In his view, their stunt was ‘the only effective way to get the bank to respond’ and ‘the only way to get the necessary publicity’ from the media and the public.

Pension funds: Engage rather than divest

Despite the strong pressure from civil society, many investors remain reluctant to divest from fossil fuels or CO2-intensive sectors as such divestment may create tracking errors against traditional benchmarks. Among investors that want to de-risk their portfolios while decarbonising the real economy active ownership, in particular climate engagement, is gaining traction. Within this approach, investors act as responsible owners of the companies included in their portfolios and use their shareholder rights. By initiating a boardlevel dialogue, investors encourage their

Climate change: Are we travelling in the right direction? 26 Ethical Boardroom | Winter 2020


Climate Policy | Europe portfolio companies to adopt a long-term perspective, to review their strategy and to steer capital expenditure towards lowcarbon solutions. During a climate-related engagement, investors typically urge companies to decarbonise their business models and align them with the goal of the Paris Agreement. Concrete engagement asks are, for example, the disclosure of carbon emissions, emissions reduction targets based on climate science (sciencebased targets) and collaboration with suppliers to decarbonise supply chains. As far back as 2004, the Ethos Foundation launched an innovative approach to allow investors to engage in a constructive dialogue with companies on environmental, social and governance issues. The launch of the Ethos Engagement Pool (EEP) Switzerland by two Swiss pension funds and Ethos in 2004 had the goal to pool the assets of Swiss asset owners in order to gain leverage in the engagement activities, facilitating direct access to board members and senior management. Sixteen years after its launch, the EEP Switzerland counts more than 140 members with total assets of more than CHF220billion4 (See Table 1, right).

Positive results from engaging companies

As part of Ethos’ engagement efforts on climate change, Ethos takes actively part in the global initiative Climate Action 100+,


Despite the strong pressure from civil society, many investors remain reluctant to divest from fossil fuels or CO2-intensive sectors as such divestment may create tracking errors against traditional benchmarks which targets the largest CO2 emitters in the world, including LafargeHolcim and Nestlé. As a Swiss-based investor leading dialogues on governance issues and sustainability with both companies for many years, Ethos took the role of ‘lead’ engager on both companies, together with APG at Nestlé and Hermes EOS at LafargeHolcim. For both companies, some notable developments have been achieved over the two past years.

Ethos and APG met Nestlé’s chairman of the board and senior management several times for very thorough discussions about the company’s plan to decarbonise its operations and, more importantly, its supply chain. In addition, several telephone calls to follow up the discussion and check on the measures taken took place. Finally, Ethos attended the 2018 and 2019 annual shareholder meetings and made statements urging Nestlé to set ambitious reduction targets, expand its reporting and take concrete measures in its supply chain. At the end of 2018, Nestlé agreed to report in line with the Task Force on Climate-Related Financial Disclosures (TCFD) recommendations and in September 2019 the company committed to net zero emissions by 2050. 5 The decarbonisation of the construction materials (cement) industry is one of the biggest challenges in the transition to a low-carbon economy.

TABLE 1: EVOLUTION OF THE NUMBER OF MEMBERS OF THE ETHOS ENGAGEMENT POOL SWITZERLAND 2019 2018 2017 2016 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004

143 137 132 129 127 101 91 87 76 53 30 17 7 6 5 3

Winter 2020 | Ethical Boardroom 27

Europe | Climate Policy The fabrication of cement is a very carbon-intensive process with currently only limited technical possibilities to meaningfully decrease associated carbon emissions. It is, however, promising to see some positive signs after a phase of intensive engagement with LafargeHolcim. After meetings between the chairman of the board, senior management and statements by Ethos at the 2018 and 2019 annual shareholder meeting to underline the demands, the company announced in September 2019 the appointment of its first chief sustainability officer. The chief sustainability officer has been appointed to the executive committee with a clear brief to decarbonise LafargeHolcim.6 In December 2019, another key engagement ask was met when the science-based targets initiative approved LafargeHolcim’s carbon reduction target.7 To execute its decarbonisation strategy, LafargeHolcim also communicated the allocation of CHF160million to reduce its carbon footprint. By installing advanced equipment that allows the increased use of low-carbon fuels and recycled material, the company plans to reduce carbon emissions by 15 per cent over the next three years. 8 Switzerland is also characterised by its strong insurance and re-insurance industry with two of the world’s largest global players headquartered in the country. Climate change is particularly relevant for the insurance industry as it can impact both sides of the balance sheet: assets and liabilities. Acknowledging these risks and following many years of dialogue with Ethos, the insurance industry has taken several measures in 2019 with Swiss Re and Zurich Insurance Group being the co-founders of the UN Net-Zero Asset Owner Alliance. Zurich and Swiss Re have both committed to net zero-emission investment portfolios by 2050.

Swiss legislation landscape

Despite Switzerland’s indirect contribution to climate change via its financial industry and some of its largest domiciled companies, Switzerland is relying on self-regulation in the fields of sustainable finance and climate stewardship. In comparison to the European Union and its EU action plan on Sustainable Finance, there is currently no plan to reinforce the legal framework towards sustainable finance in Switzerland. There is also no plan to require mandatory sustainability reporting for listed companies, in particular regarding climate risks and opportunities. A legal opinion requested by the Federal Office for the Environment (FOEN) in October 2019 has the goal to find out to what extent the currently applicable Swiss law already prompts financial actors to take into account climate risks and impacts on their activities. This legal opinion concluded that Swiss financial market participants are obliged by law to take climate 28 Ethical Boardroom | Winter 2020

risks into account in cases where they are required by law to consider all significant risks. This is regularly the case when calculating capital and liquidity requirements. Under current financial market law, however, Swiss financial market participants are not obliged to integrate climate impacts into their investment and advisory processes. Current transparency obligations do not oblige financial market participants to make public the climate impacts of their activities. In Switzerland, the political discussion on whether and how appropriate legislative measures should be taken is still ongoing. The government is charged with clarifying the need for regulation and proposing

Despite Switzerland’s indirect contribution to climate change via its financial industry and some of its largest domiciled companies, Switzerland is relying on self-regulation in the fields of sustainable finance and climate stewardship appropriate measures to parliament. As part of the self-regulation process, the FOEN and the State Secretariat for International Finance (SIF) initiated in 2017 a first round of pilot tests to analyse the compatibility of financial portfolios with the goals of the Paris Agreement. All Swiss pension funds and insurance companies were invited to have their stock and corporate bond portfolios tested. About 80 Swiss investors voluntarily took part in the assessment. The average investment portfolio analysed during this test reached an average of four to six °C global warming far above the two° global warming goal of the Paris agreement. A new test will be organised in 2020 to see if any improvements were achieved.

Regulate for the sake of competitiveness?

placing too much of a burden on its financial centre and companies. Such confidence in the free market to solve the climate crisis may be overestimated. While it may work for some actors for which the license to operate is at stake, it is clearly insufficient for many companies that are not facing the same pressure from their stakeholders and have low incentive to invest over the long term to tackle the climate issue. In fact, acting on climate is increasingly urgent and civil society is expecting additional measures on the political side. This desire has been reflected at the latest elections in October 2019, which saw a ‘green’ wave and the green party winning 21 additional seats in parliament, thus becoming the fourth largest political force in Switzerland. The pressure will therefore increase on the regulatory side. Failing to regulate while the EU is pushing its action plan on sustainable finance may also pose a risk for the reputation of Switzerland. The fate of banking secrecy in Switzerland could serve as a warning as to what can happen if the writing on the wall is ignored. For too long the government and representatives of the financial industry tried to save banking secrecy only to have to abandon it completely and, in a rush, once the pressure from other countries became overwhelming. 1 https://www.bafu.admin.ch/bafu/en/home/topics/climate/ state/data/greenhouse-gas-inventory.html 2https://www. banktrack.org/article/banking_on_climate_change_fossil_ fuel_finance_report_card_2019 3https://www.nytimes.com/ aponline/2020/01/07/business/bc-eu-switzerland-climateactivists.html?auth=login-email&login=email 4https:// www.ethosfund.ch/en/products-and-services/companydialogue 5Nestlé, Nestlé accelerates action to tackle climate change and commits to zero net emissions by 2050 [Press release] https://www.nestle.com/media/pressreleases/ allpressreleases/nestle-climate-change-commitmentzero-net-emissions-2050 6LafargeHolcim, Appointment of Magali Anderson as first Chief Sustainability Officer to the Executive Committee [Press release]. https://www. lafargeholcim.com/appointment-magali-anderson-first-chiefsustainability-officer-executive-committee 7LafargeHolcim, CO2-reduction targets validated by Science Based Targets initiative (SBTi) [Press release]. https://www.lafargeholcim. com/CO2-targets-validated-Science-Based-Targets-initiativeSBTi 8LafargeHolcim, LafargeHolcim allocates CHF 160 million to reduce carbon footprint in Europe [Press release]. https:// www.lafargeholcim.com/ lafargeholcim-reducecarbon-footprint-europe

As a small country with few natural resources, the competitiveness of Switzerland is based on innovation and a liberal regulatory framework. The government is hoping to apply a similar approach to financial markets and climate change to avoid


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Europe | Executive Pay

Executive remuneration trends in Switzerland Challenges and opportunities in the Swiss executive compensation landscape

Remo Schmid & Prof. Alexander Wagner

Remo is a Partner at PwC Switzerland. Alexander is an Associate Professor at the Swiss Finance Institute and University of Zurich

This article comments on two key developments and challenges in the executive remuneration landscape in Switzerland (and in other countries).

First, finding the right quantum of compensation remains challenging for boards. Also, while pay-for-performance discussions in annual reports have improved, there is still some level of dissatisfaction among shareholders. This provides competitive opportunities for companies. Second, simplifying pay design while retaining appropriate incentives is another big challenge. We propose one simple, yet effective system for achieving this goal. In the outlook, we also note that shareholders are increasingly interested in having a link of compensation to ‘corporate social responsibility’ issues.

Challenge and opportunity 1: Levels of compensation and the pay-performance-link

One of the perennial challenges for boards is to set the right quantum of compensation. While ultimately every board has to decide what is right for their company, a broad view of the market can help assess the attractiveness of a pay package offered. Although the structure of pay does affect the value of any given expected level of pay due to different risk characteristics of different compensation structures, the overall level – and its link to performance – still receives significant attention. To begin, and for context, consider first some key facts for the largest 100 listed Swiss companies. These consist of the 20 SMI companies, the roughly 30 SMIM companies and the roughly 50 small-cap companies. We have data since 2007, but we typically use 2009, the first post-crisis 30 Ethical Boardroom | Winter 2020

year, as a comparison point. The 2019 data is not publicly released by companies yet, so we refer to 2018 compensation data in this article (See Figure 1, right). First, the total sum of executive compensation in the largest 100 Swiss companies in 2018 was about CHF1.3billion, slightly below the sum in 2009. Thus, executive compensation is a sizable component of company expenses. Interestingly, there has been a shift among companies. The total sum paid to the SMI executives in 2018 was CHF709million (-15 per cent since 2009); the aggregate sum paid to the SMIM executives was CHF300million (+/- zero per cent); the sum paid to small-cap executives was CHF306million (+22 per cent). Second, median compensation levels have gone up (suggesting that any fall or stability in compensation on the aggregate level is due to a decrease of the highest amounts). In particular, in 2018, the median SMI firm spent CHF30.4million on executive compensation (+13 per cent since 2009), the median SMIM firm CHF11.8million (+13 per cent) and the median small-cap firm CHF5.7million (+32 per cent). Similarly, compensation of the median CEO in 2018 was substantially higher than in 2009 in all three groups of companies. The median CEOs of SMI, SMIM and small-cap companies in 2018 received CHF6.5million (+18 per cent), CHF3.2million (+49 per cent) and CHF1.4million (+16 per cent), respectively. The median CEO of an SMI company thus received around two times the pay of his or her counterpart in an SMIM company (down from 2.6 times in 2009). The median CEO of an SMIM company received around 2.2 times the pay of his or her counterpart in a small-cap company (up from 1.8 times in 2009). See Figure 1, right. Third, what about pay-for-performance?1 On the data through 2017, when in a given year a Swiss company achieves a total shareholder return (TSR) in the top tercile of TSRs in the same industry in that year, variable CEO compensation disclosed as given for that performance year increases relative to the previous year by around 9.5

per cent at the median. In the bottom tercile of industry-adjusted share performance, variable CEO compensation falls by around 3.8 per cent compared with the previous year. Indirect effects can be more significant: companies are more likely to change their CEO when performance is lower. Specifically, in the top tercile of relative TSR, the probability of a CEO turnover is around 14 per cent; in the bottom tercile, it is around 21 per cent. Because after a turnover due to poor performance, CEOs tend to work at smaller companies (if at all), a strong board can induce substantial implicit pay-for-performance. This effect (which economists refer to as ‘career concerns’) can, thus, also create ex-ante incentives for strong performance. Fourth, even where a pay-for-performance link exists, shareholders are sometimes not clear on it. A survey conducted by SWIPRA shows that out of around 80 large institutional investors (asset managers and pension funds) not a single one said in 2019 that they were ‘very satisfied’ with the comprehensibility of pay for performance reporting of Swiss issuers. There is some good news: the fraction of explicitly ‘dissatisfied’ investors has fallen from more than 50 per cent in 2016 to around 25 per cent in 2019. Still, there remains work to be done. Indeed, this also presents an opportunity for companies to differentiate themselves from their competitors. Also, recent research demonstrates that higher quality value reporting to the outside supports better decision-making inside the company. 2 www.ethicalboardroom.com

Executive Pay | Europe IMPORTANCE OF PAY Executive compensation is a sizable component of a company’s expenses

The concerns with complexity and poorly understood incentives are perhaps most visible in the context of equitybased compensation. Stock Awards for Right Strategy (STARS) provide a simple, transparent alternative

Challenge and opportunity 2: Making equity-based pay work

Many compensation systems are extremely complex. When a reward system becomes intractable for stakeholders and dysfunctional for the very people it is supposed to incentivise, it is time to rethink and redesign. Indeed, many large shareholders have also become critical of complex compensation systems. The concerns with complexity and poorly understood incentives are perhaps most visible in the context of equity-based compensation. One popular vehicle for

FIGURE 1: MEDIAN CEO TOTAL COMPENSATION (IN CHF) IN THE 100 LARGEST SWISS LISTED COMPANIES 9,000,000 8,000,000 7,000,000 6,000,000 5,000,000 4,000,000 3,000,000 2,000,000 1,000,000 0

2007 2008 2009 2010 2011 2012 2103 2014 2015 2016 2017 2018 ■ SMI ■ SMIM ■ Small-cap


share-based remuneration is performance stock units (PSUs). These consist of the right to be allocated shares in the future if the executive (a) remains with the company (service condition) over a period of multiple years and (b) meets the defined targets over a specific performance period (performance condition). The performance criteria often comprise total shareholder return or earnings per share measured (or a combination) over a period of three to four years. Each PSU unit typically not only gives the right to be allocated one share at vesting, but normally comes with an additional lever, increasing the factor to two or even 2.5 shares per unit if targets are exceeded. Conversely, if minimum targets are not met, zero shares will be allocated. Importantly, in terms of the payout profile, PSUs are similar to stock options: In the best case, managers participate disproportionately in the increase of the share price; and as is the case with an option, there is the risk that the manager never receives any payout from their rights if the threshold is not met. The board must undertake a comprehensive critical analysis to decide whether such a leveraged and complex instrument is in line with the company strategy and the risk appetite. Winter 2020 | Ethical Boardroom 31

Europe | Executive Pay We have recently developed a new FIGURE 2: CONTRASTING STARS AND PSUs remuneration approach, which we call Stock Awards for Right Strategy (STARS). Definition of strategic Measurement of achievement Vesting/share Stock This proposal uses shares to reward objectives for one year of strategic objectives allocation Awards past target achievements that are (derived from multi-year plan) Grant of STARS, if any (in CHF or %) (One share per for Right strategically relevant. Figure 2, right One STARS) Strategy KPI measurement illustrates the typical process over time and (STARS) contrasts it with PSUs. There is nothing Performance Period (1 year) Vesting Period (e.g. 3 years) new as such in giving a bonus in the form Performance Period (e.g. 3 years) of shares. However, the key points about the system presented here are, first, the Performance KPI measurement specific alignment of remuneration targets Share with the company’s strategic objectives Definition of strategic Measurement of achievement Units and, second, the consideration of the and/or share price of strategic and/or share price (PSUs) changes of the manager’s equity over targets for three targets (vesting e.g. 0-200%) years PSU grant Share allocation, if any time (wealth lever). First, STARS put the board’s role of equity value are also reflected in the leading the company into the future in research also highlights that the ESG remuneration discussion and assessment the spotlight. The strategic objectives triad – consisting of environmental (E) Additional factors play a role. First, that underpin STARS must be tailored and social (S) performance, not only there are situations in which an excessive to the company’s specific business model. governance (G) aspects – is highly relevant focus on equity is not suitable. Highly The specific set of performance indicators for shareholders. Overall, companies would, indebted companies may do well to use that best documents the achievement therefore, do well to find ways of explicitly ‘inside debt’, i.e. to incentivise managers of strategic (interim) objectives must incorporating CSR and ESG criteria into to take account of the depend on the company’s their compensation systems. position of creditors individual situation. STARS How can companies avoid the traditional Executive directly (and not only do not dictate best practice concern with such measures, namely, remuneration indirectly via the value of for the targets. For example, that they can be abused by poorly a board may come to the is a key factor by equity). Second, regulatory performing management to claim valuable frameworks can also limit conclusion that digitalisation contributions to society and broader which effective the design opportunities, is a key topic for the company. goals while destroying shareholder value? boards can which is particularly This could result in One way is to link them to STARS, as applicable in the case corresponding, specific described in the prior section. Under distinguish of financial sector one-year targets (milestones) such a system, ESG and CSR performance themselves companies. Third, this being defined. Ultimately, is not juxtaposed with shareholder this aspect will also feed into performance but is fundamentally and from uninspired, discussion sets aside tax law aspects. Still, we cash flow and then into the positively connected with it in the long run. mediocre hope that as a basic design share price. However, a board In summary, the topic of executive choice, many companies must be able to specify a remuneration remains highly controversial. “best practice” will see the merits of clear strategic vision of the More importantly, seen as an opportunity, followers STARS going forward. company with corresponding it remains a key factor by which effective strategic objectives and should boards can distinguish themselves from Concluding remarks: reward management for their achievements uninspired, mediocre ‘best practice’ corporate social responsibility in execution even if these efforts are followers. A rational and long-term focussed and compensation design not rewarded by the stock market in the remuneration system is a necessary, For a long time, corporate social short or even medium term. This requires rather than a sufficient condition for responsibility (CSR) was a topic for executive a (sometimes tricky) balancing act. The value-generating corporate governance. remuneration mostly as a risk factor. board and the management must not The board and executives together must Companies and managers with poorly remove themselves completely from the take a holistic view that tightly links calibrated compensation systems faced needs of the shareholders. Nevertheless, the design of the remuneration system, ‘headline risk’. More recently, CSR itself it seems to us essential that courageous the composition of the board and the has become a key design element for boards pursue the strategic objectives executive/shareholder engagement and compensation. Indeed, a survey conducted for their companies and underpin as value reporting. by SWIPRA in 2019 revealed that 78.9 well as reinforce these with suitable 1 For details, we refer to the PwC Insights 2017, per cent of investors consider CSR remuneration systems. available at: https://www.pwc.ch/en/insights/hr/ targets in compensation systems as key Second, if STARS are used consistently exco-insights/exco-insights-2017.html 2See Eugster and Wagner, 2019, ‘Value Reporting and Firm to long-term sustainability. Importantly, over time, managers may build up Performance’, Journal of International Accounting, while the discussion of whether the share substantial share positions over the years. 3 Auditing and Taxation, available at https://papers.ssrn. Owing to the wealth impact on the price already reflects CSR considerations com/sol3/papers.cfm?abstract_id=1879804 3The managers’ shares (or shares to be allocated (as it perhaps should, from a theoretical figure suggests that STARS are earned over a period of three years (for example) after grant. This means in the future), the management perceives perspective) is interesting academically, it that the share allocation occurs only at the end of the changes in business development in terms appears somewhat moot when considering (vesting) period in the case of an active employment of the change in the equity value of the the survey result: 35.3 per cent of the relationship. This makes sense in view of the desired long-term orientation of the managers. However, it is company. Especially when managers hold issuers believe that CSR performance also possible to allocate blocked or unblocked shares substantial share positions, these value is reflected sufficiently in financial immediately to the management as long as they fluctuations can be significant. It is, performance and only 17.6 per cent of the are required to build up and hold a defined number therefore, essential that these changes in investors agree with this statement. Recent or defined value in shares of their own company. 32 Ethical Boardroom | Winter 2020


Corporate Governance Awards | Introduction

Corporate governance is not a ‘box-ticking exercise’ CORPORATE GOVERNANCE AWARDS

2020 European Award Winners 2020 High-quality corporate governance contributes to long-term company performance. Companies need to improve governance practices and reporting if they are to demonstrate their positive impact on the economy and wider society. Continued high-profile corporate failures, such as Thomas Cook, Carillion and Patisserie Valerie, have raised concerns in the UK around many companies’ effectiveness in considering and reporting on risks to their long-term sustainability. The Financial Reporting Council (FRC) revamped the UK Corporate Governance Code in 2018, introducing guidelines for boards to engage with workforces, investigate concerns over conditions, pay or harassment, and scrutinise corporate culture. But in its recent annual review, the UK financial watchdog warned that although there ‘were pockets of good reporting’, many of Britain’s biggest companies are still taking a ‘tick-box’ approach to try to achieve full compliance with the code rather than provide any meaningful explanation of how they follow the principles in practice. The FRC found that many large, listed companies prioritised ‘strict compliance’ while failing to improve corporate culture,

34 Ethical Boardroom | Winter 2020


diversity or consider the views of shareholders or the public. And, while the majority of companies declared themselves fully code compliant, ‘many annual reports lacked information on the outcomes of governance policies and practices, including any areas for future

The FRC found that many large listed companies prioritised ‘strict compliance’ while failing to improve corporate culture, diversity or consider the views of shareholders or the public

improvement’. Other analysis concluded that many companies were failing to implement a ‘clear purpose’ or effective corporate culture, instead substituting ‘slogans or marketing lines’ and that ‘very few’ committees had so far detailed how they have engaged with workers. The FTC has urged companies to put greater focus on the outcomes of implementing the code in 2020, ‘in particular on the board’s effectiveness and decision-making, and how this has led to sustainable benefits for shareholders and wider stakeholders’. It also warned that reporting on workforce-related issues needs to improve to meet investor demands and reflect modern-day workforces, and encouraged distinctive reporting of a high quality to differentiate the approaches companies take and provide confidence to investors. 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 its Corporate Governance Awards Winners in Europe.


The Winners | Corporate Governance Awards

AWARDS2020 Pulp & Paper Stora Enso Oyj Finland


Construction Balfour Beatty Plc Engineering Smiths Group Plc UK

INSURANCE GOVERNANCE RSA Insurance Group Plc United Kingdom

Automotive BMW Group AG Germany

OUTSTANDING WORK IN GOVERNANCE Ritva Sotamaa Unilever Plc United Kingdom Conglomerate Veolia

David Frick Nestlé S.A.

Food & Beverage Nestlé S.A. Switzerland

Insurance AXA S.A. France

BEST CEOs EUROPE 2020 LUIGI FERRARIS Terna SpA — Italy Financial Services Banco Bilbao Vizcaya Argentaria (BBVA) Renewable Energy Acciona S.A. Spain

ANNICA BRESKY Stora Enso Oyj — Finland Holding Atlantia SpA Transmission Terna SpA Italy

MARK SCHNEIDER Nestlé S.A. — Switzerland JOSÉ MANUEL ENTRECANALES Acciona S.A. — Spain

Corporate Governance Awards | Bank of Cyprus


COMPLIANCE HELPS BoC BOUNCE BACK The Bank of Cyprus has successfully overcome the 2013 Cypriot financial crisis


BoC: Recovery from crisis Bank of Cyprus (BoC) has come a long way since the heady days of 2013 when it took over the responsibility of €11billion in emergency liquidity assistance (ELA) by the now-defunct Laiki Bank, while depositors experienced a ‘haircut’ on their savings.

Wasting no time in the drive to bounce back, and following John Hourican’s appointment as CEO in August 2014, the bank raised €1billion in fresh capital. The move attracted international investors and saw the appointment of Dr Josef Ackermann as chairman of the board of directors. Other significant appointees brought a unique set of skills and experience to the boardroom. The corporate governance structure was overhauled and new procedures and policies were put in place. The board focussed on compliance with the regulatory framework and followed a ‘shrink to strength’ strategy, which included divestment of its 36 Ethical Boardroom | Winter 2020

The Bank of Cyprus is the focal point of the country’s economy Eleftheria Koumouli

Manager of Governance & Markets Compliance Dept., Group Compliance Division, Bank of Cyprus PCL non-core business abroad. The strategy to revive the bank was premised on a strong set of values along three reform pillars. The values comprised high ethical standards of accountability, integrity, transparency, fairness, equity, sustainability and ethics, all fundamental to good governance. The reform pillars were as follows: to focus activities by shrinking to strength; to repair the bank, restoring confidence in it and to gradually address the challenge of excessively high non-performing exposures (NPEs); and last but not least, to rebuild the Bank. This last pillar entailed developing an effective senior management team,

improving efficiency and strengthening and diversifying revenue generation. December 2014 saw the bank’s return to both the Cyprus Stock Exchange (CSE) and Athens Stock Exchange (ASE). In late 2015 the Real Estate Management Unit (REMU) was established to professionalise the onboarding, management and sale of repossessed property. 2017 was a year of major achievements. The last remaining portion of the ELA was repaid and on January 19 BoC shares commenced trading on the LSE. The listing in Cyprus was retained. Determined to commit to the highest standards of corporate governance and transparency, the board decided to comply with the UK Corporate Governance Code on a voluntary basis. Today, the bank is the only institution in the region that is concurrently governed by three different corporate governance frameworks (UK Code, Cyprus Stock Exchange (CSE) Code and the Governance Directive of the Central Bank of Cyprus), by four different jurisdictions (Cyprus, UK, Ireland and the European Union). www.ethicalboardroom.com

Bank of Cyprus | Corporate Governance Awards Management focussed all efforts on rebuilding a financially sound, trusted and even safer organisation. It continues to focus on driving a customer-centric, transparent, non-bureaucratic, modern and strong set of values throughout the organisation. These values and principles emphasise ethical behaviour, zero tolerance for all forms of financial crime, and strict adherence to compliance requirements. The bank respects and furthers clients’ interests, while gaining a deeper appreciation for each and every one of its employees. These essential hallmarks of a modern banking landscape help safeguard the bank’s reputation going forward.

MOVING FORWARD BoC has reformed and reshaped its governance framework

To better serve its customers, the Bank of Cyprus is investing in improved products and services and modernising its agenda. It is leading the economy and the financial sector in digitisation, its customers already reaping the benefits with online access to banking services through their computers, tablets and mobile devices. BoC Group retains the largest market share in outstanding deposits and loans, as well as the lion’s share in credit expansion. BoC Group also serves the insurance needs of its clients through two highly efficient and dynamic insurance companies, which themselves have the largest market share in life insurance and the second largest share in the non-life insurance market. The Bank is moreover committed to providing credit to the recovering Cyprus economy, which has consistently been one of the fastest growing in Europe. Management is targeting new and exciting lending in selected industries such as tourism, professional services, information/ communication technologies, health, energy, education and green projects. Despite some constraints, demand for bank credit is on the rise. A major enhancement of the existing legislative framework governing bank loan foreclosures, insolvency and local sales, and the introduction of new legislation www.ethicalboardroom.com

on loan securitisation in 2018, have brought the Cypriot legal framework closer to best practices in Europe. The bank embarked on an intensified strategy of further accelerating the reduction in balance sheet risk through a major reduction of non-performing exposures (NPEs). By the end of 2018, the bank had slashed NPEs by €10billion or about 70 per cent compared to December 2014 – equivalent to approximately 50 per cent of the country’s gross domestic product (GDP). With the bank’s access to capital markets reinstated, it raised a €250million Tier 2 bond in January 2017 and another €220million of Additional Tier 1 (AT1)

Ackermann stepped down and Takis Arapoglou – who has extensive experience in international capital markets and the banking world – was elected chairman of the board. Six months later, Hourican departed and Panicos Nicolaou, previously the director of corporate banking, was appointed as CEO. The Bank of Cyprus Group is set to continue on the path clearly paved by the board, achieving even better results. The banking industry in Europe and elsewhere is changing rapidly, driven by existing structural constraints, such as the need for further consolidation, but also the ongoing digitisation process and the IT revolution. Naturally, the Cypriot banking system will stay abreast of developments in the global financial system, seeking to stay competitive in an increasingly interconnected environment.

To better serve

capital in August 2018. Today its customers, the Bank carries approximately the Bank of €4billion of surplus liquidity, deposits have grown by Cyprus is €5billion since 2014, and, by The bank is confident it investing in the end of 2018, the bank held can tackle the challenges a market share of 34 per cent that lie ahead, such as further improved in resident deposits and 38 per reducing its stock of NPEs, products and cent in non-resident deposits. containing its cost structure, Its loan-to-deposit ratio is optimising its funding services and strong at 67 per cent – more structure, and continuing to modernising than adequate to fund loan modernise its operations. its agenda balances and far better than It has set out to be a European bank averages. benchmark among the best The board played a critical leadership well-governed European institutions, having role in debating, endorsing and monitoring made remarkable progress since the events the implementation of an appropriate of March 2013. The bank is extremely proud reform strategy. of its robust and effective set of structures, Under the board’s guidance, the bank strives policies and functions that define to ensure strict compliance with all prudential management principles and management capital and other regulatory requirements. decision-making. Most notably, this includes the strictest enforcement of all requirements for knowBank of Cyrpus Head Office your-customer, anti-money laundering, data 51 Stassinos Street, Strovolos, P.O. confidentiality, and other compliance issues. Box 21472, 1599. Nicosia, Cyprus The bank prides itself over its performance in (+357) 2212 8000 these areas, not least for taking the bold step www.bankofcyprus.com of closing existing accounts or refusing to info@bankofcyprus.com open new accounts for individuals and legal entities posing elevated risks. In May 2019, and following five years of successfully chairing the BoC board, Dr Winter 2020 | Ethical Boardroom 37

Global News Asia Pacific

Goldman Sachs excludes Asia in diversity pledge Goldman Sachs has announced it will not handle initial public offerings (IPOs) for companies that lack either a female or ‘diverse’ director, although the rule won’t apply to IPOs in Asia. Asia, along with the Middle East and Latin America, is excluded from the bank’s diversity goals, despite how common all-male boards are in the region. Finance company MSCI revealed in a December 2019 survey that of 126 companies in its MSCI World index with no female directors, 108 were Japanese and nine were Chinese or Hong Kong-based. According to Bloomberg, Goldman will consider implementing the plan in Asia and other regions over time after ‘consulting with its clients, as diversity awareness improves in those areas’ and that it will ‘consult with its clients in those areas to improve board diversity’.

McFarlane named new Westpac chair Westpac has announced the appointment of John McFarlane to the bank’s board as non-executive director and chairman-elect. McFarlane, who will succeed chairman Lindsay Maxsted in April, has the task of steering the Australian bank and financial services provider through a money-laundering scandal. In November, Australian financial crime watchdog AUSTRAC filed a lawsuit accusing Westpac of 23 million

breaches of anti-money laundering laws and facilitating payments between known child abusers. Shareholders have also filed a lawsuit in the US against Westpac that seeks to recover damages related to disclosure issues with the bank’s financial crime monitoring.

38 Ethical Boardroom | Winter 2020

Scores of current and former staff at Australian investment bank Macquarie, including CEO Shemara Wikramanayake, have been linked to a German tax scam investigation. German prosecutors and tax authorities are seeking to recover billions of euros from traders and banks that allegedly profited from schemes known as ‘cum-ex trades’. This involved participants in a network lending each other shares in large companies so that to tax authorities there would appear to be two owners of the shares, when there was only one. In a statement to the Australian Stock Exchange, Macquarie confirmed the investigation involved 60 current and former employees, including the company’s former chief executive Nicholas Moore. Macquarie said it ‘continues to cooperate with German authorities in relation to an historical German lending transaction in 2011’ and that ‘no information of detail or particularity has been provided regarding the naming of these people other than that it relates to short selling-related activities’.

Wipro starts search for new CEO

Activist targets takeover of Toshiba unit A fund backed by Japan’s most prominent activist investor has launched a takeover bid for a subsidiary of Toshiba that produces industrial robots. Investor Yoshiaki Murakami tabled a hostile bid of up to $235million for control of Japan’s Toshiba Machine. Murakami’s bid came hours after Toshiba Machine confirmed it had agreed to sell its

execs caught up in tax scandal

stake in NuFlare Technology — a provider of equipment used to make computer chips — to Toshiba Corp, even though manufacturer Hoya Corp had offered to pay a higher price for the shares. Toshiba Machine said in a statement that the planned takeover could potentially disturb the company’s effort to maximise its corporate value and the interests of other shareholders.

Abidali Neemuchwala is stepping down as chief executive officer and managing director at Indian IT services company Wipro due to family commitments. Wipro said in a statement that its board of directors has initiated a search to identify the next CEO, with Neemuchwala staying in place until a successor is appointed for ‘a smooth transition and to ensure that business continues as usual’. Sanchit Vir Gogia, chief analyst, founder and CEO of consultancy company Greyhound Research, told The Hindu BusinessLine that the departure was expected and that the new CEO ‘should have the skill sets to take the company to a new level’. “Wipro should hire a person who is strong in hardware and software services; the CEO should come across as someone who has a more balanced view of both the new and the old,” Gogia said.


















Minority Shareholders Watch Group (MSWG) was set up in the year 2000 as a Government initiative to be part of a broader Capital Market framework to bring about awareness primarily on minority shareholders interest and corporate governance matters through shareholders activism and engagement with stakeholders. MSWG is a professional body licensed under the Capital Market & Services Act 2007. It is self-governing and non-profit body, funded predominantly by the Capital Market Development Fund (CMDF). It is an important channel of market discipline, encouraging good governance with the objective of creating sustainable value. Since incorporation, MSWG has evolved into a respected and independent corporate governance research and monitoring organization in the capital market. It highlights and provides independent views and guidance to investors.

Asia | Shareholders in Japan

Paola Perotti

Managing Partner, GO Investment Partners

The power of private engagement The differentiating factor in shareholder engagements within Japan Rivers of words have been written on how companies and investors can engage effectively. Yet, as an astute colleague of mine often remarks, investors do not engage with companies but with individuals.

Perhaps such simple truth is the reason why psychotherapist Esther Perel, who shot to fame with TED Talks and her podcasts on couples and relationships, has recently launched a new podcast How’s Work? exploring what makes great working relationships. She argues that communication is key: “Listen. Just listen. You don’t have to agree. Just see if you can understand that there’s another person who has a completely different experience of the same reality.”

Both these comments spring to mind when I look at the results of a preliminary study carried out by Professors Marco Becht, Julian R. Franks, Hideaki Miyajima and Kazunori Suzuki on the engagements carried out by Governance For Owners Japan (GO Japan) since 2009. The study’s working title is Private vs. Public Activism in Japan: Agendas, Engagements and Outcomes (‘the study’). As a Japan specialist, Governance For Owners Japan works closely with clients’ investment




Outstanding balance

No outcome Success for cases that rate ended (n=18) 2009 10 0 10 9 1 90.0% 2010 7 0 17 6 1 85.7% 2011 2 0 19 2 1 100.0% 2012 1 0 20 1 #N/A 100.0% 2013 3 3 20 2 #N/A 66.7% 2014 3 1 22 3 #N/A 100.0% 2015 3 4 21 3 #N/A 100.0% 2016 5 4 22 4 1 80.0% 2017 2 3 21 0 #N/A engagement 2018 3 3 21 0 #N/A in progress Total 39 18 30 4 76.9% * Engagements started in 2017 and 2018 are excluded from reporting success rate because it typically takes two years to obtain an outcome. Source: Becht, Franks, Miyajima and Suzuki (2019) 40 Ethical Boardroom | Winter 2020

At least one outcome


Shareholders in Japan | Asia and ESG teams to identify companies not attracting the correct value in the market. We then engage with these companies to improve the business, which ultimately leads to an increase in market value. Our engagement philosophy is straightforward: we pride ourselves in taking a culturally effective, constructive approach to engagement; we work with the company’s top management team; and we do not believe that a hostile approach will be effective in Japan, at least not on a sustainable basis. The purpose of the study was to show whether our style of private (i.e. confidential or ‘behind closed doors’) engagement generated better returns than more conventional, aggressive activism. Governance For Owners Japan shared data on all our corporate engagements since we started our business with the researchers. The study is noteworthy as access to private interventions data is rare and the effect of such interventions cannot be observed in studies that rely on public information alone. Recent academic evidence prior to this study had already confirmed that hostile activism cannot be as successful in Japan as it is in the United States. In fact, in Returns To Hedge Fund Activism: An International Study – Becht, Franks, Grant and Wagner (2017), the authors concluded that: “Engagement outcomes, such as board changes and takeovers, vary across countries and significantly contribute to the returns to activism. Japan is an exception, with high initial expectations and low outcomes.”

The preliminary results of the new academic study goes one step further and shows that ‘private’ engagement as practiced by us in Japan delivers abnormal (‘excess’) returns. Table 1 (below, left) shows that the success rate of engagements carried out by Governance For Owners Japan stands at 76.9 per cent. Such rate of excess returns can be compared with that of more conventional activists, which have a success rate of 35.8 per cent (see Table 2, below). This result is even more striking as both styles of engagements have almost identical mean cumulative abnormal returns (CARs) around the announcement of outcome. In other words, in periods around the outcome announcement, the average share price improvement is about the same whether the engagement was carried out by Governance For Owners Japan or activist funds, as Table 3, below, shows.

TABLE 3: CAR AROUND OUTCOME ANNOUNCEMENT GO Japan Activists n =31 n =43 9.05% 8.63% -10 ~ +10 (2.13)* (6.01)** 6.57% 6.58% -2 ~ +2 (3.16)** (9.02)** 5.16% 5.55% -1 ~ +1 (3.21)** (9.48)** “Period” shows the trading days before and after the date of outcome announcement. The first figure in each cell reports the cumulative abnormal returns (CAR) over the period, and the second figure in brackets reports t-statistics, where “*” and “**” showing that the statistic is significant at 5% and 1% level, respectively. Period

Source: Becht, Franks, Miyajima and Suzuki (2019)

TABLE 2: PUBLIC ACTIVISM BY ACTIVIST FUND Start Proposal Year 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Total

1 2 0 10 12 17 5 9 4 1 0 0 1 7 7 8 8 12 16 120

At least one outcome 0 1 0 4 2 8 0 3 2 0 0 0 0 4 3 5 4 3 4 43

Success rate 0.0% 50.0% #N/A 40.0% 16.7% 47.1% 0.0% 33.3% 50.0% 0.0% #N/A #N/A 0.0% 57.1% 42.9% 62.5% 50.0% 25.0% 25.0% 35.8%

Board Payout Strategy M&A

0 2 0 1 1 2 0 1 0 0 0 0 0 4 2 1 1 4 7 26

1 2 0 3 8 10 4 4 2 1 0 0 1 1 4 7 7 7 10 72

0 1 0 0 1 2 0 1 0 0 0 0 0 2 1 4 3 3 4 22

0 0 0 6 3 5 0 4 2 0 0 0 0 1 1 0 2 3 0 27

Removal Others of poison pill 0 0 0 0 0 0 0 1 0 0 1 0 0 1 0 3 0 0 0 0 0 0 0 0 0 0 0 0 1 0 0 0 0 0 1 4 2 2 5 11

(c) Kazunori Suzuki, 2019 (This work is by JSPS Core-to-Core Program, A. Advanced Research Networks)


Winter 2020 | Ethical Boardroom 41

Asia | Shareholders in Japan When we consider why private engagement yields CARs as high as more aggressive activism, we need to address the nature of the exchanges that take place between investors and companies. In the 2018 Summer Edition of Ethical Boardroom, I summarised the lessons investors can learn from companies that have implemented successful and sustainable organisational changes. I held it that the main takeaways were that it takes time and a large number of stakeholders need to be persuaded. Effective communication is clearly key. In this article I address what effective communication between investors and investee company may look like and why ‘private’ engagement may engender the better returns outlined in the study. In my view, a constructive and culturally effective approach to engaging and a clear policy that all discussions are and will remain confidential are the essential conditions of any dialogue. At Governance For Owners Japan, we believe that engagement with companies is best accomplished by experienced local professionals who are based in their home regions and understand local laws, local regulatory requirements and, most important, local culture. Engagement in a manner that is culturally acceptable in Japan is fundamental to our approach; we call this the ‘Japanese way’ of engagement. Physical proximity of our team enables

investors to follow market-specific maintaining robust relationships. Even developments closely and improve dialogue more importantly, if the management with investee companies. of a company is meeting an investor that However, many investors running global has been known to go public, they will portfolios may not have the time or the never really be willing to communicate resources to access their portfolio in a productive and open manner. companies locally through local staff. They We thus believe that the engagement may thus engage infrequently and through model most likely to yield results is one the medium of English. where respecting confidentiality is essential. Because our approach emphasises We want to encourage a constructive dialogue with boards and management, we debate between us and management that have found that a richer may generate a change in and more nuanced corporate strategy. In our We believe that vocabulary makes us view, only a solid sense engagement with of security about the better at appreciating the perspectives of others framework in which companies is best private and thus communicating discussions occur, can accomplished by allow the frank and robust ideas more effectively. Investors unable to devote experienced local exchange of views that is the time and without the essential to bring about professionals linguistic skills, struggle change. Such solid sense to understand why of security can only be who are based management may have a established if the manager of in their home different view or timeframe an investee company is clear regions and as to how the business that the investor will never should be developed. go public if communication understand You are also highly unlikely breaks down. local laws, local to establish effective This is our promise to all communication channels the companies with which regulatory with an investee company engage in Japan and, as requirements and, we when only meeting the study shows, our Japan management once a year. -specific approach is also most important, Regular contact is proving to be successful and local culture fundamental to building and value-adding for investors.

THE JAPANESE WAY OF ENGAGEMENT We believe it is best to collaborate with experts based in that location 42 Ethical Boardroom | Winter 2020


Providing bespoke solutions for responsible investors in Japan since 2007 We draw on our accumulated knowledge and expertise in corporate governance in Japan to deliver tailored solutions to clients no matter where they are in the world.

Governance for Owners Japan KK 3-7-1 Kasumigaseki Chiyoda-ku Tokyo 100-0013 Japan

Tel: +81 (0)3 5532 3080 ww www.goinvestmentpartners.com

Activism & Engagement | Advertorial

Stewardship and Responsible Investment

Good corporate governance, sustainable business practices and well-functioning markets are essential for investment company Eurizon to safeguard the wealth of clients. In our investment choices, we integrate environmental, social and governance (ESG) factors and sustainable and responsible investment principles to pursue performances and remain sustainable while creating value for our clients. Our aim is to support the development of valid and sustainable businesses, and we do so by promoting responsible growth and high governance standards across the companies we invest in. In this way, we can help them achieve sustainable earnings and increase their economic and financial value, ultimately creating value for their final clients and the civil society.

How Eurizon Capital helps companies integrate financial instrument selection methodologies that take into account ESG factors and SRI principles Cristina Ungureanu

Head of Corporate Governance, Eurizon Capital Eurizon was a pioneer in the consideration of responsible investment, being the first asset manager launching ethical funds in Italy, back in 1996. In recent years, Eurizon has strengthened and evolved its approach to active and responsible investment. In 2015, Eurizon created a separate corporate governance division, overseeing the adoption of the Italian

stewardship principles, being the first asset manager in Italy to implement such activity with dedicated resources. Becoming a signatory to the UN PRI in 2015 and integrating the ESG factors in the investment decision process for the active portfolios in 2017 have further redefined how Eurizon thinks about company performance and investment decisions. Another important step, taken this year, has implied shaping the corporate governance and sustainability activities by creating a single ESG unit under the investment division. This move is meant to align our stewardship and portfolio management activities even more, to achieve full integration and have a holistic approach towards our issuer companies, while promoting the ESG culture in our organisation.

Stewardship for Eurizon has become an action, not only a position

In fact, active ownership and responsible investment now permeate all areas of




Eurizon is the co-founder of the UNEP FI Asset Management working group

Eurizon was the first AM company in Italy to offer ethical funds



Eurizon is Treasurer and member of the UNEP FI Governing Council UNEP FI

Eurizon is co-chair of the UNEP FI Asset Management working group

44 Ethical Boardroom | Winter 2020



Eurizon underwrites the Italian Stewardship Principles

Eurizon is founding member of the Business Economy Environment (BEE) at the European Parliament



Eurizon intergrates ESG and SRI principles into its investment process and launches EF Sustainable Global Equity

Eurizon underwrites the Principles for Responsible Investment (PRI)



Eurizon creates a dedicated structure: ESG & Strategic Activism

Eurizon launches EF Absolute Green Bonds and chairs the Disclosures, Indices & Metrics working group of the European Banking Federation


Advertorial | Activism & Engagement business; Eurizon considers these as important values, which will further drive the way we conduct our investment activity. Eurizon is a strong believer that good corporate governance creates value for the company, for investors and for society. Companies with high standards of governance embedded in their organisation and processes are more likely to achieve profits sustainable over time and to increase their value both economically and financially. We have seen the definition of corporate governance get broader and broader, evolving to meet the changing needs of the society. While at its origins it was seen as a way of enabling shareholders to be assured that their investments were being properly looked after, (i.e. focus on internal controls and audit), the definition now talks about corporate governance – together with sustainability – being means of fostering long-term growth and trust in business, contributing to more inclusive societies. The concept of Stewardship is aligned with Corporate Governance and Sustainability and needs to be applied both ways: to investors and companies. It is about looking at the long-term interests of the business. The stewardship activity is fundamental for Eurizon, both for traditional investment focus and for those related to ESG topics. Eurizon has always held dialogues with issuer companies on financial and strategic matters, but in recent years we have increasingly focussed on aspects linked to governance, while the environmental and social factors have been significantly growing in importance. Highly active and responsible shareholders are rapidly heading towards an engagement approach where it would be impossible to talk about corporate strategies without addressing all three variables: E, S and G. We are totally working on the basis that only a strong ESG proposition can safeguard a company’s long-term success.

The benefits of stewardship accrue over several years and these have already started to be clearly felt – both within our system and on the side of our issuer companies that we monitor and engage with. By weaving a healthy corporate culture and governance into the business model, companies are not just contributing to the overall success of their own business but also creating an environment on which investors can rely. Investors can leverage this through stewardship; thus, both companies and investors are geared to create sustained growth in the economy.





Future approach

Going forward, our main priorities relate to further contribute to shaping high standards of corporate behaviour and performance at companies where Eurizon invests worldwide, within an integrated context: governance and sustainability – investment decision-making. Eurizon will continue to look beyond compliance and one-size-fits-all voting and engagement policies. Instead, seeking specific information from individual

companies that help understand the fundamentals of the business and its strategic goals. A paramount attention is towards our clients, whose demand for active stewardship and ESG integration has increased, looking for sophisticated investment opportunities. Our interaction with clients is moving from a purely transactional relationship to a more collaborative one.

About Eurizon

Eurizon Capital SGR is the investment company of the Asset Management Division of the Intesa Sanpaolo Group. In Europe, Eurizon has the following subsidiaries: Eurizon Capital S.A., a Luxembourg asset manager with which it develops growth on international markets; Epsilon SGR, an Italian company specialised in quantitative portfolio management; the Eastern European HUB, consisting of VUB AM, a Slovakian asset manager, CIB IFM in Hungary and PBZ Invest in Croatia; and Eurizon SLJ Capital LTD (65 per cent), in the UK, a joint venture with Stephen Li Jen and Fatih Yilmaz (35 per cent), which is specialised in investment services and consulting with a focus on foreign currency management and macroeconomic research. On 25 October 2019 in the UK, the company finalised a minority investment in Oval Money (12.5 per cent), an Italian-English fintech start-up involved in the digital payment services and savings sector, with which a partnership was established. Eurizon also has a presence in Asia through Eurizon Capital (HK) Limited, an asset management company based in Hong Kong and, through its 49 per cent stake in Penghua Fund Management, one of China’s leading asset managers. Finally, Eurizon is active on international markets, thanks to the marketing of its Luxembourg funds in 25 countries, and operates its own structures in France, Germany, Switzerland and Spain.

EURIZON MISSION, VALUES, VISION At Eurizon, shared values play a vital role. As an organisation and as individuals we are linked together by a goal, that is both ambitious and important: fuelling confidence and building the future. We are proud to be part of a company whose mission is protecting and growing the assets of our clients.

Our mission

We VALUE the savings of our customers by creating and managing investment solutions that fit their needs We TRANSFORM the complexity of the financial markets into opportunities www.ethicalboardroom.com

We COLLABORATE with companies that we invest in to promote respect for sustainable growth and high standards of governance. Trustworthiness, innovation and high-quality service are our defining features

Our corporate values

BELONGING: We work with pride and participation INTEGRITY: We feel responsible for the trust of those who rely on us EXCELLENCE: We target quality of results and on-going improvement PASSION: We work with professionalism and involvement, combining head and heart

Our vision

We are committed to a culture that promotes the value of people, their aspirations, and savings at large: A FINANCIAL HUMANISM based on respect, accountability and awareness of one’s own qualities

Eurizon Capital SGR

Piazzetta Giordano dell'Amore, 3 20121 Milano, Italy +39 02 8810.1 www.eurizoncapital.it info@eurizoncapital.com Winter 2020 | Ethical Boardroom 45

Activism & Engagement | Social, Economic, Environment

SEEing beyond ESG During the course of the last decade or two, the conduct of boards of directors has become newsworthy. Questionable practices, a string of missteps emanating from the boardroom, company failures of various kinds and sanguine CEOs – and assertive executive teams that ‘take over’ – have seen boards become highly topical and targets of both curiosity and criticism in the business media and, increasingly, the wider public. Regulators and institutions have responded by producing a plethora of statutes, codes, guidelines and ‘best practice’ recommendations; the intention being to establish statutory and ethical boundaries, and to steer boards towards effective practice. Yet companies and their boards continue to suffer significant missteps or fail outright – seemingly, with metronomic regularity – despite these interventions and (supposedly) increasing levels of awareness of what constitutes good practice. Thomas Cook, the world’s oldest travel company, is perhaps the highest profile failure in 2019. But it was by no means the only one. Many correspondents have encouraged boards and directors to become adept in specific risk areas. Directors, collectively, do need to be able to identify major risks to the business on an ongoing basis and, having understood them, make informed decisions to both mitigate them and maximise the chance of achieving the agreed strategy and goals. But that is not to say directors need to become experts on climatic change, cybersecurity, disruptive technologies and other emerging risks (and opportunities) in a dynamic landscape. Not only is this wasteful and, probably futile, but it would also result in the board taking its collective eye off its core role, which is to ensure the sustained performance of the company. The unending procession of company failures raises many questions, such as the role and performance of the board, the board’s supervision of management (or lack thereof), the behaviours and motivations of directors, malfeasance and ineptitude in the boardroom, information flows and decision-making practices, and the efficacy of ‘best practice’ recommendations, not to mention the role and influence of external 46 Ethical Boardroom | Winter 2020

The social, economic, environmental (SEE) impact measure reinstates the economic dimension to its rightful place Dr Peter Crow

is an experienced company director and expert on corporate governance parties, including advisors, directors’ institutions and auditors, among others. The plain fact is that many boards struggle to assure company continuance, much less high levels of performance. What is more, corporate governance, a term originally conceived to describe the effective work of the board of directors as it seeks to both oversee and assure business performance, is now more closely associated with a range of compliance and box-ticking activities (though this is generally denied by directors when they are interviewed).

performance. The lingering challenge, for directors both individually and collectively, is to cross this Rubicon. Calls for boards to lift their game – even forfeit control to a much wider group of external stakeholders and self-appointed supernumeraries – are now commonplace, thanks to the actions of activist investors, proxy advisers and (increasingly) emergent lobby groups such as the Mouvement des Gilets Jaunes and Extinction Rebellion. By way of example, Larry Fink, founder, chief executive and chairman of BlackRock, an institutional investor, writes to the CEOs of companies that BlackRock has invested in every year. In 2019, Fink encouraged company leaders to ensure their company’s purpose – its fundamental reason for being – is embodied in the business model and corporate strategy. And with it, a broader understanding of performance and how it should be measured and reported.

ESG: an adequate measure of company performance?

Essentially, boards need to embrace their responsibility for both ensuring the on-going Chattering class performance of the company they are At this point, it would be easy to concede charged with governing and providing a and join the chattering class; to stand on straightforward account to shareholders the margins and berate all and sundry. That and legitimate stakeholders. The underlying seemingly strong and enduring companies ethos needs to be one of service: the board and continue to fail on a reasonably regular basis executive working harmoniously together, as a is a cause for much concern; team in service of the company the societal and economic and the purpose for which it Rather than consequences are not And therein lies a clue to focussing boards exists. insignificant. But let’s not get effective corporate governance, on performance board oversight and reporting. drawn into such negativity. If companies – their That the problem is dimensions boards and executive teams, multifaceted and dynamic, in particular – are to become beyond financial not structural, suggests the trustworthy again, the measures, boards optimal reporting solution is power games, hubris and to be multifaceted as well. have in practice likely ineptitude that pervades The idea of using a range of many boardrooms needs financial and non-financial become more to be exorcised. Spurious to assess company concerned about measures (and often discordant) performance was normal adherence to recommendations of practice until the early 1970s. corporate governance and things began to change prescribed ‘best But how ‘performance’ should relatively quickly from practice’ ESG be measured (many of the late 1960s, primarily which appeal to observable as a consequence of the frameworks symptoms, populist ideals or rise of neo-liberalism. ideological biases), need to be set aside. The tipping point was an article Mainstream recommendations need to by Milton Friedman, who be rethought and new approaches need to espoused the one and only social emerge. Boards need to rethink their work responsibility of business and start measuring what matters, and was to use its resources and directors themselves need to be more engage in activities designed discerning and take responsibility for to increase profits. www.ethicalboardroom.com

Social, Economic, Environment | Activism & Engagement

A NEW VISION Has the time to see beyond ESG arrived? www.ethicalboardroom.com

Winter 2020 | Ethical Boardroom 47

Activism & Engagement | Social, Economic, Environment Almost overnight, a broad church measures something else: a collection of of managers, boards, shareholders and proxies to indicate the (supposed) activists embraced Friedman’s thesis (with performance of the governance function, evangelical zeal in many cases) to justify that is, the board of directors. These include an exclusive focus on profit maximisation. diversity, board size, remuneration and audit And with it, interest in other (non-financial) committee mandate. The problem is that indicators of corporate performance these are observable and static inputs, not waned. For the next three decades or so, consequential outputs or outcomes arising the dominant measurement framework from company operations. Second, and was economic. However, things began perhaps more significantly, the ESG construct to change around the turn of the century, relegates economic performance to such an with the emergence of proposals such extent that it is not mentioned. But economic as corporate social responsibility (CSR) performance is necessary if an enterprise is to to encourage companies to become more endure over time. Few are as clear as Fink on socially accountable. this point: “Profits are in no way inconsistent A bevy of academics, consultants and with purpose – in fact, profits and purpose politicians implored boards and executives are inextricably linked. Profits are essential to think more broadly about the company’s if a company is to effectively serve all of its contribution (and impact) on society. The stakeholders over time – not only objective of much of this rhetoric seems to have been to establish a counterbalance to PROTECTING THE ECONOMIC DIMENSION perceived excesses of capitalism in the years If a company is to thrive, following Friedman’s article appearing in the it needs to measure New Yorker and changing expectations. and manage all three capitals ESG (environmental, social, governance) in particular has gained an enthusiastic following as a more complete measure of performance. Its emergence has coincided ESG has, without with the rising tide of doubt, increased concerns about the the time and energy effects of the doctrine of shareholder maximisation spent by companies promoted by Friedman. demonstrating shareholders, but also Even the Business Round employees, customers, and Table, an influential lobby, their ‘performance’ communities. Similarly, has taken a stand, issuing a as a good when a company truly statement in August 2019, understands and expresses which signalled it stepping corporate citizen its purpose, it functions with back from shareholder the focus and strategic discipline that drive primacy. Signed by 180 chief executives long-term profitability. Purpose unifies of America’s largest enterprises, the management, employees, and communities. statement is, in effect, a reversal of the It drives ethical behaviour and creates an BRT’s previous policy position. Many essential check on actions that go against others have argued that the widespread the best interests of stakeholders.” adoption of ESG principles (as a measure of CSR) could redress some of the imbalances Further, agreement (in relation to the and inequities that have become apparent efficacy of ESG as a suitable measure of as company leaders have pursued profit company performance) is far from universal. as the exclusive measure of performance Many directors have lamented – some and success. at length, but almost all privately – that ESG has, without doubt, increased the promulgation of ESG is counterthe time and energy spent by companies productive. Rather than focussing boards on demonstrating their ‘performance’ as a good performance dimensions beyond financial corporate citizen. But what is acceptable measures (the intention), boards have in ‘performance’ exactly, and how should it practice become more concerned about be measured? Is ESG adequate as the gold adherence to prescribed ‘best practice’ standard of performance measurement? ESG frameworks. The ‘G’ (governance) Author Peter Drucker’s insightful maxim element in particular adds little in terms (what gets measured gets managed) is of focussing boards on the creation of value relevant for sure, but two things limit the over the longer-term. That is because the usefulness of ESG as a sufficient measure of measurement of board performance (that corporate performance. First, only two of the is, the board’s effectiveness) carries an three elements actually measure company inherent assumption – that governance performance (E and S illuminate a company’s practice is directly linked to company commitment to various environmental and performance in a causal sense. It is not. social goals, respectively). The third, G, 48 Ethical Boardroom | Winter 2020

A more complete picture of company performance is needed If boards and shareholders are to understand company performance well, the three capitals that fuel sustained business performance (SEE – namely, social capital, economic and environmental) need to be monitored and reported in a holistic manner. The restoration of the economic dimension of performance to its rightful place alongside the social and environmental dimensions offers a more complete assessment of the company’s actual performance in the context of the wider market within which it operates. This proposal moves beyond ESG and its inherent limitations. Boards considering this proposal will find it is not onerous. Appropriate measures of social, economic and environmental performance that are both congruent and

consistent with the company’s purpose and strategy need to be identified and a high-level dashboard, developed to provide a holistic summary of company performance. Such an approach is arguably more straightforward and cost-effective than the compliance-oriented reporting (comply or explain) outlined in various corporate governance codes, or the six capitals proposal that has been heavily promoted by the Integrated Reporting Council in recent years. It has the added benefit of being useful in small-, medium- and large-scale firms. And what of governance? Rightly understood, governance is about providing steerage and guidance (a lesson dating from the Greeks), the means by which companies are directed and controlled (hat tip to Sir Adrian Cadbury). As such, governance is a function performed – not a capital consumed nor a consequential outcome or result of company operations – and, therefore, Drucker’s maxim should be applied. A section entitled ‘board performance’ within the annual report should suffice. So, to the courageous question: has the time arrived to SEE beyond ESG as a more insightful measure of corporate performance and the consequential value created? If the objective is to achieve a more balanced assessment of the company’s performance in the context of corporate purpose, strategy and the wider environment within which it operates, SEE is worthy of close consideration. www.ethicalboardroom.com


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Activism & Enagagement | Proxy Advisors EUROPE BRACES FOR AGM SEASON There is likely to be an increased focus on board responsiveness

Exp pectations for Europ pean 2020 AGM Season In November 2019, the two leading proxy advisors published updates to their voting policies that will apply for 2020. These guidelines represent some of the most influential indicators of how institutional investors are likely to approach the 2020 AGM season differently from previous years.

Below we set out the major themes that have emerged from the ISS and Glass Lewis guidelines updates and how these issues have been dealt with in the main European markets so far.

Executive remuneration (SRD II) In March 2017, the European Parliament approved amendments to the 2007 EU Shareholder Rights Directive (Directive 2007/36/EC) with the aim of encouraging ‘long-term shareholder engagement’. 50 Ethical Boardroom | Winter 2020

The main themes from the new proxy advisor guidelines for Europe Daniele Vitale

Head of Governance UK & Europe, Georgeson, London The revised Directive (Directive (EU) 2017/828) was published on 20 May 2017 (and is commonly known as SRD II). The remuneration-related provisions had to be transposed into member state law by June 2019 (but some member states have fallen behind this deadline). As a result, both ISS and Glass Lewis included updates to their European guidelines on remuneration resolutions, reflecting the SRD II requirements. Additionally, in March 2019 the European Commission published non-binding draft guidelines on ‘the standardised presentation of the remuneration report’ and ran a public

consultation on them.1 Industry participants expect the final guidelines to be issued in the coming months and it appears likely that the extent to which companies voluntarily comply with the final guidelines will be closely watched by the investor community. Therefore, ISS and Glass Lewis may make further changes to their guidelines on remuneration in future years to ensure that they are sufficiently detailed and harmonised with the emerging consensus. The ISS 2020 European updates on remuneration have introduced a provision on remuneration committee responsiveness (see below). Moreover, ISS introduced guidelines over the use of discretion by remuneration committees and boards when determining remuneration outcomes, especially taking into consideration the disclosure of significant environmental, social and governance (ESG) risks factored into remuneration decisions. Among the most notable new remunerationrelated features introduced by Glass Lewis in their guidelines we note that, regarding the www.ethicalboardroom.com

Proxy Advisors | Activism & Enagagement policy vote, they now require all the European companies to provide clear disclosure of an appropriate framework for managing executive remuneration by providing a link between remuneration and company strategy, set appropriate quantum limits and limit rewards for failure while allowing the necessary flexibility for board recruitment and development. Glass Lewis also updated guidelines about remuneration report resolutions and it will now pay particular attention to the alignment between pay and performance, the pay outcomes, as well as to the committee’s level of disclosure regarding any application of discretion.

across the seven main European markets received at least 20 per cent shareholder opposition and will likely be expected to address low shareholder support ahead of their 2020 AGMs (See Figure 1, below).

Board gender diversity

representation, which is reflected in their voting guidelines and voting decisions. Legal & General Investment Management (LGIM), one of the UK’s biggest investors, voted against the re-election of more than 100 chairs in the 2018 AGM season for failing to improve their boardroom gender diversity, up from 37 in 2017 and 16 in 2016. Last year, LGIM vowed to vote against the re-appointment of chairs in FTSE 350 companies where at least 25 per cent female representation is not established. Following a reported slowdown in progress on female board representation, investors such as the Church Investors Group indicated that they will vote against the chair of nominations committee of companies that are constituents of the main indices in Europe, USA, Australia and New Zealand, unless they have at least one female director. In August 2019, Vanguard stated that it is ‘expanding our focus to more explicitly urge boards to seek greater diversity across a wide range of personal characteristics, such as gender, race, ethnicity, national origin, and age’. Similarly, leading investors, including BlackRock and the Government Pension Investment Fund in Japan, have pushed an initiative aiming for 30 per cent of female representation. The 30% Club Investor Group seeks to ‘co-ordinate the investment community’s approach to diversity’, ‘exercise our ownership rights, including voting and engagement, to effect change on company boards and within senior management teams’, and ‘encourage all investors to engage on the issue of diversity with chairs of boards and senior management teams’. In October 2016, its UK chapter published a statement of intent stating that ‘members will use their ownership rights and undertake stewardship to encourage progress on gender diversity’. The statement of intent includes supporting the following targets by 2020: 30 per cent women on FTSE350 boards and 30 per cent women at senior management level of FTSE100 companies.

Diversity on boards of directors, and particularly female representation on boards, has received widespread attention in the last few years. At a European level, individual countries began introducing laws outlining their vision on board gender diversity in the early 2000s, before the European Commission first proposed pan-European legislation in the early 2010s. Board responsiveness The first European country to introduce In 2013, Glass Lewis added to its UK a legal requirement for minimum female guidelines a section focussed on board representation was Norway in 2003 (setting responsiveness, referencing a provision of a quota of 40 per cent). It was reported that the UK Governance Code in force at the time, a year before legislation was passed, just which stated that ‘when, in over six per cent of Norway’s the opinion of the board, corporate directors were Institutional a significant proportion of female and 70 per cent of the investors have votes have been cast against leading domestic companies a resolution at any general also increasingly lacked any female board meeting, the company should representation. Following embraced explain when announcing Norway’s example, Spain female board the results of voting what and France were also early actions it intends to take adopters, with the former representation, to understand the reasons granting large companies which is reflected eight years to include a behind the vote result’. With its new 2020 minimum proportion of in their voting guidelines, Glass Lewis has 40 per cent female directors guidelines and extended a similar provision on their boards, while the to continental Europe, voting decisions latter required relevant listed recommending that and non-listed companies to shareholders take action by either abstaining reach a minimum of 40 per cent within a or voting against a management proposal six-year period. The first pan-European when a company has failed to address step was taken in 2012, when the European shareholder dissent of at least 20 per cent at Commission proposed ‘legislation with the the previous AGM. The new guidelines further aim of attaining a 40 per cent objective of specify that ‘in the absence of an option to the under-represented sex in non-executive escalate concerns to specific board members, board member positions in publicly listed we may instead recommend a vote against the companies’ by 2020.2 Institutional investors have also receipt of the annual report and accounts’. increasingly embraced female board ISS, which, similarly to Glass Lewis, addresses board responses to significant FIG 1: PERCENTAGE OF COMPANIES WHERE AT LEAST ONE RESOLUTION shareholder dissent in its UK guidelines, RECEIVED LESS THAN 20% SUPPORT AT THE LAST AGM also expanded its 2020 European guidelines, 60% but, for the time being, its provision is Source: Georgeson data only focussed on remuneration resolutions. Its new guideline states that ‘should a 50% company be deemed to have failed to respond to significant shareholder dissent 40% on remuneration-related proposals, an adverse recommendation could be applied’. Therefore, it appears that an increased 30% focus on board responsiveness will spread across Europe and that companies that 20% experienced low support at the previous AGM may be well-advised to conduct shareholder engagements in order to understand the 10% issues and to be able to show in their annual report how the situation is being resolved. 0% During the 2019 AGM season, Netherlands UK Germany Italy (FTSE Spain Switzerland France approximately 75 large-cap companies (AEX 25) (FTSE 100) (DAX 30) MIB 40) (IBEX 25) (SMI 20) (CAC 40) www.ethicalboardroom.com

Winter 2020 | Ethical Boardroom 51

Activism & Enagagement | Proxy Advisors The proxy advisors have now also FIG 2: BOARD OF DIRECTORS FEMALE REPRESENTATION (%) introduced policies on board gender 50% Source: BoardEx diversity. ISS, which until now only 45% addressed diversity generally under the ‘environmental and social issues’ section of 40% its guidelines, has now introduced into both 35% its UK and Continental Europe guidelines 30% for 2020 that it will generally recommend a vote against the chair of the nomination 25% committee (or other directors on a 20% case-by-case basis) when there are no female 15% directors on the board of a widely held company. Mitigating factors may be the 10% presence of a female director on the board at 5% the preceding annual meeting and a firm 0% commitment, publicly available, to appoint at Spain Switzerland Germany Netherlands UK Italy France least one woman to the board within a year. The ISS updates for 2020 include a Meanwhile, for 2020 Glass Lewis has companies in Germany are also required by significant development on this front. Its introduced a new UK-specific guideline law to put forward a discharge vote on the new guidelines have expanded its existing stating that it ‘will consider recommending supervisory board and on the management expectation of a maximum four-year board against the chair of the nomination board on an annual basis (however these term (which was limited to certain countries committee at any FTSE 350 board that has votes are more symbolic as the legal position where this was already standard practice) neither met the 33 per cent gender diversity of shareholders and board members do not to all European markets, subject to a target set out by the Hampton-Alexander change based on the results of the vote). The one-year transition period. The new policy Review nor disclosed any cogent explanation fact that German supervisory board members states that ‘for general meetings held on or or plan to address the issue’. are typically elected for after 1 Feb 2021, the above policy will be It is interesting to note five-year terms may partially Many investors applied to all European companies, for that, with the proxy advisors explain why there has been consider that bundled as well as unbundled items. Beyond starting to take into account an increase in the discharge regular director that, as directors should be accountable to board gender diversity more resolutions receiving more shareholders on a more regular basis, ISS proactively in their vote than 10 per cent opposition: elections facilitate may consider moving to maximum board recommendations, France from 2018 to 2019 DAX 30 terms of less than four years in the future’. appears to be the only country shareholder companies have seen a Therefore, it may be increasingly important achieving the goal of 40 per 108 per cent increase in oversight and for companies in markets with longer cent female representation shareholder dissent over allow investors term lengths (such as Germany) or where that was floated by the board discharge votes. individual directors are not put up European Commission in Investors are increasingly to hold boards for a vote (such as Italy) to keep in 2012 (See Figure 2, above). It focussing on this topic. In accountable more May 2018, State Street issued individually mind that investors are increasingly focussing appears likely that, as investor effectively on their ability to address their concerns on focus on this topic increases, a document entitled Board the regular re-election of individual board the proxy advisors are likely to Accountability in Europe: A members and boards may suffer negative strengthen their guidelines in future years, Review of Director Election practices Across votes where there is a perception that this going beyond the basic focus on companies the Region. 3 The report argues that shorter director terms result in more accountable is not possible. with no female representation at all (as has boards that are responsive to shareholder already happened in the UK). 1 https://ec.europa.eu/info/consultations/public-consultationinterests; it therefore recommends annual remuneration-report-guidelines-implementing-shareholdersrights-directive_en 2https://ec.europa.eu/commission/ Director term lengths director elections as standard, and has presscorner/detail/en/IP_12_1205 3https://www.ssga.com/ Many investors consider that regular director called upon investors, companies and investment-topics/environmental-social-governance/2018/05/ elections facilitate shareholder oversight and regulators to work together to achieve this. board-accountability-in-europe-2018.pdf allow investors to hold boards accountable FIGURE 3: COMMON BOARD TERM LENGTHS ACROSS EUROPE more effectively. In a number of European Source: Denmark markets (including the Nordics, Switzerland State and the United Kingdom) all board members Norway Street are re-elected annually by shareholders. In Sweden the United Kingdom, annual board elections Finland were introduced during the 2011 AGM Switzerland season, following the revised UK Corporate Ireland Governance Code 2010, while in Switzerland they became mandatory from 2015 as a United Kingdom consequence of the ‘Minder Initiative’. Italy In the rest of Europe, however, the common Belgium practices are quite different, with four-year France board terms representing the most common Netherlands term length (Belgium, France, Netherlands Spain and Spain). The five-year board terms that are typical in Germany are the longest in Europe Germany (See Figure 3, right). It should be noted that 0 1 2 Years 3 4 5 52 Ethical Boardroom | Winter 2020





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Activism & Engagement | Proxy Voting

Paul Rose

Associate Dean for Academic Affairs & Robert J. Watkins/Procter & Gamble Professor of Law, Moritz College of Law, Ohio State University

Shareholder advisors need to review their practices following increased scrutiny of how they make recommendations

Transparency in proxy voting and advice 54 Ethical Boardroom | Winter 2020


Proxy Voting | Activism & Engagement

In the Wealth of Nations (1776), Adam Smith described the central problem of corporate governance: directors of publicly held companies, ‘being the managers rather of other people’s money than of their own’, cannot be expected to watch over it with the same anxious vigilance with which they would watch over their own interests. ‘Negligence and profusion’, as a result, ‘must always prevail’. Over the course of many decades, it has been the great project of shareholders, regulators, and the directors themselves to design corporate governance systems that reduce and mitigate the risk of negligence, disloyalty and wastefulness. The primary object of this attention has been management – the directors and officers managing the ‘shareholders’ money’ – and ensuring that their interests are aligned with other shareholders. Some of this alignment occurs through compensation schemes, of course, but good governance structures are also thought to be key to managing governance risk. Yet, as Stanford University’s David Larcker and Brian Tayan have noted in a recent article, after decades of research ‘we still do not have a clear understanding of the factors that make a governance system effective’. Importantly, they note that investors often conflate the concept of good governance – defined as a set of processes or organisational features that tend to improve decision-making and reduce the likelihood of poor strategic, operating, financial, or behavioural choices – with the adoption of a distinct set of


structural features like staggered boards of matters, but it is also undeniable that a directors, independent chairs and enhanced structure that works at one firm may be shareholder rights. Reviewing the academic entirely inappropriate for another. literature, Larcker and Tayan find that ‘many of Many of the governance structures the structural features commonly associated determined by proxy advisors to promote with good governance (such as board structure, good governance are accountability share structure, etc) are not shown to have a mechanisms that allow shareholders to consistent relation with performance’. more easily hold managers responsible Yet, publicly traded companies continue for governance failures or poor outcomes. to be judged by their adoption of these The elimination of staggered boards one-size-fits-all structural features, despite and embedded poison pills, for example, the lack of strong evidence supporting their subject managers to discipline by the use. Some of the pressure to adopt these market for corporate control. But the structures comes from shareholders increase in accountability has also shifted themselves, and more particularly from power to shareholders. And rightly so, large institutional asset managers, such as many would say, as shareholders are the public pension funds, that have developed ultimate owners of the company. teams dedicated to corporate governance A concern with the shift in power to issues. But rising in influence over the shareholders is that shareholders often last decade has been the proxy advisory have heterogeneous preferences, industry, which provides voting advice to particularly on environmental, social and institutional shareholders. In some cases, governance issues. And, equally important, proxy advisors are authorised to vote shares the dominant shareholder voice in public directly on behalf of these shareholders companies is not the voice of the retail using the proxy advisor’s proprietary ‘good shareholder. Public companies are not governance’ metrics, a process colloquially owned primarily by retail investors. Instead, known as ‘robovoting’. the largest percentage The proxy advisory of owners are typically Because modern industry is dominated by institutional investors, markets are two firms: Institutional such as mutual funds, Shareholder Services which hold shares on becoming increasingly (ISS) and Glass Lewis, behalf of retail investors. institutionalised and which together have been Retail investors’ direct estimated to control 97 per ownership of shares has intermediated, the cent of the proxy advisory declined steadily for most significant market. The two firms are decades. For instance, extraordinarily important according to the most governance risks in matters of corporate recent assessment by the are arguably not governance, although it is UK’s Office for National at the company debatable whether they Statistics in 2016, UK have a particular agenda individuals directly owned level, but at the with respect to corporate only about 12 per cent level of the asset governance, other than of UK quoted shares. The the desire to please their managers investing great majority of the shares institutional investor were held by institutional on behalf of others clients. The Council of investors, including unit Institutional Investors trusts, pension funds, argued as much in a 2016 letter to the US insurance companies and other financial House Committee on Financial Services: ‘ISS institutions. Proxy advisors and governance and Glass Lewis tend to follow investors on advocates have focussed considerable governance policy, not lead them… In setting attention on reducing the risk of negligence their policy frameworks, the two firms have and profusion by company managers. But, a business interest to ensure they reflect because modern markets are becoming investor (client) perspectives’. increasingly institutionalised and Regardless of whether they set the intermediated, the most significant conversation on what constitutes good governance risks are arguably not at the corporate governance or simply serve company level, but at the level of the asset as a megaphone for governance-minded managers investing on behalf of others. institutional investors, proxy advisors Nowhere is this governance risk more undeniably hold significant influence over apparent than in proxy voting. Tremendous corporate governance in major capital effort has been expended on adjusting markets around the world. This influence corporate governance structures in recent comes despite the fact that, as Larcker and years – on managing corporate managers Tayan have argued, there is tenuous support – but surprisingly little attention has been for the one-size-fits-all governance model given to managing the agency relationship advocated by the large proxy advisory through which most individuals access the firms. There is no denying that governance capital markets. Winter 2020 | Ethical Boardroom 55

Activism & Engagement | Proxy Voting In particular, how are institutional investors voting shares of the public companies they control on behalf of individual investors? And how are institutional investors using the services of proxy advisory firms to make these voting decisions? Thankfully, new rules in the UK and the US are helping turn investor attention to the crucial governance role played by proxy advisors. In the UK, the new rules implement EU Directive 2007/36/EC, and are ‘intended to make sure that proxy advisors’ clients will be able to better understand what standards of conduct the proxy advisor adheres to, how the proxy advisor ensures an adequate standard of quality in its advice and how it manages conflicts of interest, in order to help the market for proxy advisor services to function effectively’. The regulations impose a comply-or-explain rule requiring proxy advisors to adhere to and disclose a code of conduct or provide a clear and reasoned explanation why it has not done so. The regulations also require proxy advisors to identify actual or potential conflicts of interest, disclose the conflicts to clients, and provide a statement of the actions the proxy advisor has taken to eliminate, mitigate, or manage the conflict. The US Securities & Exchange Commission, too, has recently proposed rules that add additional regulations for proxy advisors, including the extension of certain disclosure and antifraud rules to proxy advice, enhanced disclosure of conflicts of interest, and provisions that allow issuers and others to dispute and comment on proxy advisors’ recommendations. The US rules in particular have received some criticism. The Council of Institutional Investors, for example, argues that the SEC’s rules ‘pressure proxy advisory firms to take a more management-friendly approach in their reports and vote recommendations’, while Michael Capucci of the Harvard Management Company characterises the rules as a ‘proxy war against proxy advisors’. The true object of regulatory action against proxy advisors, he argues, is not the proxy advisor, but the institutional shareholder; corporate managers have lobbied for such rules to ‘wrench back control from shareholders’. Doubtless, there are many directors and managers who would like to see a decrease in shareholder activism and restraining proxy advisors may ultimately diminish some of the power that institutional shareholders have gained in the corporate governance battles of the past few decades. But the new rules also help the retail shareholder, often a collateral observer in these battles, to know whether proxy advisors are acting in their interests. One regulatory gap remains. Although the new rules help provide transparency with respect to proxy advice and conflicts of interest, they still allow institutional investors to effectively outsource their 56 Ethical Boardroom | Winter 2020

governance oversight role to proxy advisors, with almost no transparency into whether or how that outsourcing has occurred. That proxy vote outsourcing is routine should come as no surprise. Given that institutional investors may hold the shares of thousands of different companies in their portfolios, proxy advisors perform a crucial role in serving as informational intermediaries that help institutions work through the massive amounts of data relating to annual shareholder voting. But for many institutions, the reliance on proxy advisors is complete: not only do they buy proxy advice from proxy

costs for investors who are mandated to vote their shares on behalf of beneficial owners, the lack of diligence with which many investors use the services of proxy advisors is cause for concern. This is particularly true when many of the governance recommendations of proxy advisors are based on little or no empirical evidence. The approach of the SEC is not to require institutional investors to conduct their own research, though the SEC does suggest that institutions ‘could consider whether a higher degree of analysis may be necessary or appropriate to assess whether any votes it casts on behalf of its client are cast in the client’s best interest’. Acknowledging that many institutions do not have the resources to conduct their own research, beneficial owners nonetheless deserve to know the bases for their institutional manager’s proxy voting decisions. Are institutional asset managers voting in lockstep with proxy advisors? How are they determining whether to follow the advice of ISS or Glass Lewis? This regulatory gap could be filled by rulemaking requiring investment fiduciaries to disclose how often their final votes aligned with any proxy advisor they employed, and whether (and what percentage of) proxy advisor recommendations were reviewed internally by an investment JUST TELL ME WHY! manager. Such disclosure would make Beneficial owners clear to beneficial owners, as well as the deserve to rest of the market, the level of diligence understand voting institutions are bringing to their fiduciary decisions responsibilities to vote proxies in the best interests of the retail beneficial owners. Such disclosure would also the new Shareholders deserve proxymirror advisor rules in transparency on the UK and the US. By ‘improving transparency how proxy advisors of proxy advisers’ arrive at their conduct and service provision’, the UK’s rules recommendations. on proxy advisors aim to Beneficial owners ‘raise standards through likewise deserve advisors, but they follow the exercise of market it unquestioningly, Likewise, transparency on how discipline’. 100 per cent (or nearly the SEC’s rules aim to institutional asset 100 per cent) of the time. ‘enhance the accuracy Data from Proxy Insight, managers use that and transparency of the a firm that tracks proxy information that proxy proxy advice voting behaviour, shows voting advice businesses that asset managers provide to investors and controlling more than $3.2trillion in share others who vote on investors’ behalf, and assets voted with ISS recommendations on thereby facilitate their ability to make US proxy votes an overwhelming 99.5 per informed voting decisions’. By seeing how cent of the time. As argued by US attorney their institutional money managers are using Frank Placenti, Vice Chair of the Corporate proxy advice, retail investors will be better Governance Committee of the American Bar able to make informed decisions about who Association, ‘despite their protests to the should manage their money. Shareholders contrary, for all practical purposes, some funds deserve transparency on how proxy advisors have delegated the exercise of their fiduciary arrive at their recommendations. Beneficial voting obligations to their proxy advisors’. owners likewise deserve transparency on Even accepting the fact that proxy how institutional asset managers use that advisors play an important role in reducing proxy advice. www.ethicalboardroom.com


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Global News North America Evolve to shut investment funds

Krishna will replace Rometty as IBM boss Arvind Krishna (right) has been elected by IBM’s board of directors as chief executive officer of the company, replacing the outgoing Virginia Rometty. IBM boss Rometty is retiring this year after almost 40 years at the technology giant. She became chairman, president and chief executive officer in 2012. She will step down as CEO and president in April but will continue as chair of the board until the end of the year. James Whitehurst, CEO of Red Hat and IBM senior vice president, will be the technology company’s next president. “Arvind is the right CEO for the next era at IBM,” said Rometty. “He is a brilliant technologist who has played a significant role in developing our key technologies such as artificial intelligence, Cloud, quantum computing and blockchain.”

PG&E Corp unveils board shakeup plan California power producer PG&E Corp has said it will overhaul its board of directors as part of a wider reorganisation proposal aimed at winning state approval for its bankruptcy exit. PG&E filed for Chapter 11 protection in January last year, citing potential liabilities in excess of $30billion from deadly wildfires in 2017 and 2018, linked to its equipment. The company said it will seek new board members with extensive safety experience and

wants half of its directors to reside in California, in an effort to address concerns about its governance and management. Chief executive Bill Johnson said the plan will allow PG&E to emerge from bankruptcy as a ‘reimagined utility with an enhanced safety structure, improved operations, and a board and management team focussed on providing the safe, reliable and clean energy our customers expect and deserve’.

Proxy advisors say yes to cinema deal Cinema group Cineworld says two leading proxy advisory firms have approved its plans to buy Canadian rival Cineplex. UK-based Cineworld has proposed a $2.8billion takeover deal of Canada’s largest cinema chain. According to Cineworld, Institutional Shareholder Services and Glass Lewis have both recommended that Cineplex shareholders vote in favour of the deal. If the deal is approved, Cineplex and if it’s approved, 165 movie theatres across Canada will become part of Cineworld’s global chain, listed on the London Stock Exchange.

58 Ethical Boardroom | Winter 2020

Canadian asset manager Evolve Funds Group is closing three of its niche investment funds, including a gender diversity exchange-traded fund that failed to draw investor interest. The exchange traded fund (ETF) provider set up the Evolve North American Gender Diversity Index Fund (HERS) in 2017 to invest in top North American companies as ranked by scorecards on gender balance and gender equality. But, according to The Globe & Mail, the fund only managed to attract $4.3million in assets under management with Evolve quoted as saying it ‘did not see the inflows we originally anticipated when we launched’. HERS will be delisted from the Toronto Stock Exchange and the NEO Exchange by the end of March, alongside the Evolve Marijuana Fund (SEED) and the Evolve US Marijuana ETF (USMJ).

Sandeep Mathrani appointed as new WeWork CEO

Office sharing firm WeWork has announced that real estate executive Sandeep Mathrani is joining the company as chief executive officer and a member of the board of directors. Mathrani will report to Marcelo Claure, who will remain executive chairman, and succeeds co-CEOs Artie Minson and Sebastian Gunningham. His appointment comes as WeWork recovers from a scrapped IPO and the departure last year of co-founder and former CEO Adam Neumann. WeWork, which had been valued at $47billion, saw that fall to around $8billion following the scrapped IPO and a deal that gave Softbank 80 per cent ownership of the company in October.


Can remuneration create value? We believe that reward programmes can be a catalyst of value creation and competitive advantage when properly aligned with your business and leadership strategies. Our successful, proven methodology guides our clients through a process to find the right balance between external influences and internal goals and priorities in the design of their remuneration strategies. We are committed to our clients’ success and supporting your ability to drive shareholder value. Our perspective on remuneration strategy and practices transcends borders giving our senior consultants a unique view of what makes successful pay strategies work across many cultures and economic environments. Strategic Alignment: Pearl Meyer views executive compensation as a dynamic, highly strategic tool which—if aligned closely with business and leadership strategies—powerfully drives shareholder value. Sophisticated Analytics: Making reliable, factbased decisions requires going beyond an annual comparative review of peer group pay. Pearl Meyer provides the data and expert analysis required to activate compensation as a catalysing force for achieving organisational goals. Compliance Confidence: Along with strategic insight comes Pearl Meyer’s commitment to ensure that you stay on top of and meet regulatory requirements. Then, you can focus on strategy and analytics. Compliance considerations should inform, but not dictate, your decisions.


Tailored Solutions: There is no such thing as a one-size-fits-all executive pay program, because each organisation is unique. We work closely with you to understand your specific business situation and competitive environment. The result is a relevant, realistic, and sustainable remuneration strategy.

“Pearl Meyer has developed an index, which we call the UK CEO Value Index. The purpose of that is to change the conversation from cost to value. When you look at newspaper articles about executives, it most of the time tends to focus on the top line. How much money did he or she make over a period of time? But in many ways, the conversation shouldn’t be about that. It should be about, what did he or she do for the shareholders over the same period of time?” - SIMON PATTERSON, Managing Director and Head of the London Office, Pearl Meyer

Pearl Meyer works with hundreds of multi-national corporations headquartered in North America, the UK, Europe, and the Middle East including publiclytraded enterprises in the Fortune 500, FTSE 300, as well as private companies and non-for-profit institutions across a broad number of industries. We support compensation planning at every stage of their business life-cycle from start-up through high-growth and maturity. For more information, call +44 (0)20 3384 6712 or visit www.pearlmeyer.com/global-reach.

Board Leadership | CEO Succession SELECTING A NEW CHIEF EXECUTIVE Supporting the transition of an incoming CEO can reduce the risk of failure

Finding your next CEO Forward-looking organisations are driven by well-thought out strategies A CEO succession is one of the most important and sensitive moments in the life of an organisation. The investment by the board and a range of key stakeholders in selecting a new CEO is substantial and yet the rate of unexpected CEO turnover is surprisingly high.

A recent Russell Reynolds Associates analysis of S&P 500 companies revealed that in recent years, one in seven newly appointed CEOs left their position before the third anniversary of their appointment. That high failure rate may stem from the 60 Ethical Boardroom | Winter 2020

Anthony Abbatiello & Luke Meynell

Board and CEO Advisory Partners at Russell Reynolds

fact that few organisations understand the complexity of conducting a sophisticated and dynamic CEO succession planning exercise. Even among the best boards, fewer than 30 per cent consider it a primary focus area, according to our 2019 Global Board Culture and Director Behaviours Survey. To help mitigate the risk of excessive CEO turnover, it is essential that boards support CEO successions with a thoughtful planning process that begins a full three to five years ahead of an anticipated change. As a first step, we encourage boards to take

a forward-looking approach to strategy and reflect on context and how the company’s opportunities and challenges may evolve in the coming years. Some questions to help spur this discussion would be: how are megatrends impacting the ecosystem and the industry?; what is the most desirable future for the company for the next five years and the nature of the transformation required?; is the organisation adapted to these future challenges?; and do we have the leadership that is required to execute on this strategy successfully? By crystallising the company’s future environment, key stakeholders can then craft and align on the most relevant succession profile for the future CEO. www.ethicalboardroom.com

CEO Succession | Board Leadership By thoroughly assessing high-potential talent, we are able to identify the expertise, experiences and exposure each executive needs to prepare for consideration as a CEO candidate. Leading organisations then use these assessments to craft tailored, immersive and externally-focused development plans, which the board can regularly monitor with the help of the CHRO (and, in some cases, the current CEO). This investment in talent development means:

Organisations that embed leadership development into their CEO succession planning process generally reduce the need for an external hire when it is time to select a new leader

This forward-looking CEO succession profile is key to helping the organisation define the right talent pool to consider for its next CEO. Indeed, there should be a set of internal candidates that the board would put forward in any scenario, including key P&L business leaders, the CFO, the COO and the deputy CEO. In the context of a longterm transition horizon, however, we would recommend broadening the pool, albeit the development of the internal options is key. With the fast pace of disruption, there is a good chance that the current executive committee does not include someone who possesses the right mix of skills to lead through tomorrow’s challenges. The most promising talent may well be one or two layers below the executive committee. Uncovering multiple layers of talent can create multiple benefits. For one, it mitigates risks by expanding the candidate pool and allowing for a deeper understanding of internal talent and the strengths and gaps that may exist. It also serves as an opportunity to invest in talent development and increase employee engagement. www.ethicalboardroom.com


Future candidates focus on the right development activities to suit the firm’s needs Executive development aligns with the firm’s strategy The board has visibility into how the talent is evolving and can make adjustments over time

2 3

In our work with clients, we have supported many such top-talent development programmes as part of their CEO succession planning. Almost invariably, we find that this specialised and focussed

investment drives a boost in the confidence, engagement and retention of the executives involved (see Figure 1, below). Organisations that embed leadership development into their CEO succession planning process generally reduce the need for an external hire when it is time to select a new leader. Nevertheless, it is important for boards to broaden their horizons by understanding the external market for CEO talent. Boards should approach this from two angles:


Market intelligence: understanding what is happening and what is changing at competitors, partners and in other geographies Talent intelligence: having a specific view on external executives who could bring new and necessary capabilities to the organisation and who fit the requirements of the success profile


With this information, boards will be prepared to make a data-rich decision about which leader will best serve the organisation in the future, rather than defaulting to a presumptive nominee. However, selecting a new CEO is not the end of the succession process. To best prepare and support the future CEO, it is essential for boards to think carefully about the process of the CEO’s transition. This process identifies the organisational stakeholders, risks and strategic goals while setting out a clear programme for the transition and broader organisational impact. Supporting the transition of an incoming CEO can significantly reduce the risks of failure or derailment, decrease the time from potential to performance and improve confidence internally and externally. We recommend starting this transition support as soon as the CEO is identified (usually three to nine months prior to public announcement) and extending it through the CEO’s first year in the job. CEO transitions are inevitably complex and unpredictable. Yet, by planning ahead and taking new perspectives on the process and the candidate pool, boards can help protect their organisations from risks – and set up their future CEOs for maximum success.


Well-defined and mutually agreed upon criteria create standard benchmarks for internal and external talent

Mitigate critical risks

Improve CEO/ board effectiveness

Engage/develop top talent

Ensure business continuity, boosts market, investor and employee confidence

Leverages incumbent CEO to set the new CEO up for success

Helps future candidates focus on the right development activities to match firm strategy

Winter 2020 | Ethical Boardroom 61

Board Leadership | Diversity

No board chair or executive team ever says ‘let’s go and look for some incompetent people to serve on our board’. Nor do they say ‘let’s look for board members who look and think exactly like us’. Yet, all too often, these things happen in practice. Why?

Having a robust plan will power success and help you avoid common pitfalls Dr Debra Brown

President and Chief Executive Officer of Governance Solutions

What boards and nominating bodies do want are board members who also are not only highly competent but who together bring a mix of skills sets and experiences to the table. In other words, they want a diverse group of directors who can do the job. And yet, despite their best intentions and desires, boardroom diversity remains elusive. So much so that many boards have been throwing in the diversity towel. In 2019, PWC’s Annual Corporate Directors Survey revealed that support for diversity is fading. Even though there is significant research indicating that heterogenous teams tend to make better decisions, boards are giving up on their quest. Several years ago, I was part of a team that researched and wrote a seminal research piece for The Conference Board of Canada about diversity on boards called Women On Boards: Not Just The Right Thing, But The Bright Thing. We found that homogenous teams tend to be more cohesive and bring about high satisfaction among members of the team. But, heterogenous teams tend to make better decisions, because they have a much better process for fact finding and identifying alternatives, airing dissenting views, and therefore deliberating and coming up with – potentially, at least – a better decision at the end of the day. This is relevant because it identifies one of the key reasons why boards seem to keep hitting against a glass ceiling when it comes to the percentage of board members that are women, visible minorities, ethnically diverse, have diverse cultural heritage backgrounds, and even have different educational, socioeconomic or geographic backgrounds.


62 Ethical Boardroom | Winter 2020

Differences can also be in thinking styles, learning styles, personality types, problem-solving styles and professions. Building a board is hard work. That work is made that much more difficult if we make one or more of the three most common board diversity mistakes.

Mistake #1: Asking the wrong question

Lots of boards or nominating bodies begin their board renewal process by asking the wrong question. When faced with filling a vacant position they ask, ‘Who do I/we know?’. Sometimes, this approach works. Often, it leads to a less diverse and value-added board. It is easy to recruit people you know. It’s comfortable to follow the path of least resistance and embrace what we know and who we are at ease with. It is harder to take the time and effort needed to build diligent processes for board renewal. When we apply social science research to boards, it tells us that it is human nature for boards to replicate the current board member profile. We call this the ‘Napoleon syndrome’ because of an old legend that is told about Napoleon, the emperor of France. He was reputed to be a fairly short man, and he was also supposed in this legend to be self-conscious about his height. So, when he chose his generals, he tended to choose men – soldiers, officers – who were a little bit shorter than him. Then those generals in turn chose colonels who were just a little bit shorter than them. And the colonels chose captains that were just a little bit shorter than they were. Even though this story is almost certainly untrue, what it illustrates is that it’s human

nature to surround ourselves with people who are similar to ourselves and might even have a little less than our capacity. It makes us feel better, we tend to work better together, we’re happier and we’re cohesive. We have board meetings that go well, we finish the agendas on time, and we’re all getting along. But, at the end of the day, we’re missing out on a great deal of fact finding, divergent thinking, ideation, alternatives, and airing of dissent, that can only come as a result of having diversity in the broadest possible sense around the boardroom table. Much-needed diversity around the board table can only be achieved if we actively seek

TOP 3 BOARD DIVERSITY MISTAKES 1 Asking the wrong question 2 ‘Either… or’ thinking 3 Failure to plan

Top board diversity mistakes www.ethicalboardroom.com

Diversity | Board Leadership it. We keep hitting a glass ceiling by design. It is just because it’s easier for us to maintain the status quo. We will not actively seek diversity if we begin by asking the wrong question. A much better place to begin is with the question ‘what does the organisation need?’. Everything in governance hangs on the strategy of the organisation. The make-up of the board is no different. What is the purpose of the organisation? Where is it headed? What risks and opportunities is it facing? That all leads to the question ‘what skills experience and thought diversity profile do we need around the boardroom table?’. Ask the right questions, design the optimal board, and invest the energy it takes to recruit diverse board members.

Mistake #2: ‘Either... or’ thinking The second mistake boards make in diversity is having ‘either… or’ thinking. Many assume they need to give up competence for the sake of diversity and often equate gender with diversity. And when we hear the word ‘diversity’ in relation to the board, the first word that comes to mind is gender. The thinking goes like this: that to add women to the board means the board needs to place competence below the need for gender diversity. As a woman, I can assure you that none of us wants to be considered the ‘token woman’. To think that we are getting a board seat by virtue of our gender is an insult. Many women have tremendous skills and experience to

bring to the boardroom, just as many men do. Equally, there are many men who lack the competence to serve on a board, just as many women lack the needed skill set. Hear me when I say, you should never give up competence for the sake of gender, or any other visible form of diversity. To ensure the diversity strategy of the organisation is viewed as a legitimate process, all board selections must be made firstly on merit, while at the same time reflecting visible and other diversity needs. It’s a cas of ‘both... and’, not ‘either... or’. Legitimacy is enhanced when a board is populated by respected, experienced, senior leaders.

GETTING THE JOB DONE TOGETHER Boards want directors who bring a mix of skills and experiences to the table www.ethicalboardroom.com

Winter 2020 | Ethical Boardroom 63

Board Leadership | Diversity Diversity strategy is no different than any other corporate strategy. It should be a well-considered legitimate process, based on needs and benefits. And there are significant benefits that diversity brings. Diversity of thought makes prudent business sense. Research shows that having a board composed of men and women with diverse skills, experience, backgrounds and perspectives means: ■ Competitive advantage ■ Robust understanding of opportunities, issues and risks ■ Inclusion of different concepts, ideas, and relationships ■ Fewer decisions based on ‘group-think’ ■ Better, more balanced decision-making, dialogue and debate ■ Enhanced capacity for oversight of the organisation and its governance All board appointments must collectively reflect the diverse nature of the business environment in which the organisation operates. And they should be made on merit, in the context of the skills, experience, independence and knowledge needed for the board to be effective.

6 BENEFITS OF GENDER DIVERSITY ON A BOARD 1 Competitive advantage 2 Robust understanding of opportunities, issues and risks 3 Inclusion of different concepts, ideas and relationships 4 Fewer decisions based on ‘group-think’ 5 Better, more balanced decision-making, dialogue and debate 6 Enhanced oversight capacity experience, gender and ethnicity. It makes good business sense to take advantage of differences and distinctions among individuals in determining the optimal composition of the board. Here are other steps in the best boards’ plans: set policy. The board enshrines 2 aThey board diversity policy that includes

rationale, principles, process and targets. For example, it is common to see a target that aspires to maintain a board in which

improvements in board effectiveness over time. In this way, they can check if improved board diversity has had a positive impact on overall board performance. go public. They report annually, 5 inThey the corporate governance section

of their annual report and on their website, progress with respect to their policy and targets related to board diversity. They view going public with a board diversity strategy as a helpful step in terms of holding themselves accountable, setting an example, and providing thought leadership in their industry or jurisdiction. The key point here is that board renewal is enshrined at the board level. They approve the matrix, they set the policy, they hold themselves accountable by reporting publicly on progress toward their targets. According to the Canadian Gender & Good Governance Alliance, ‘board gender diversity is a matter of good business as much as an issue of fairness. An extensive

Mistake #3: Failure to plan

Benjamin Franklin is believed to have said ‘those who fail to plan, plan to fail!’. Churchill is credited with saying ‘those who fail to learn from the past are doomed to repeat it’. A third common mistake is that many boards say they want to be diverse, but they don’t create a plan for it, and with every new open board seat they repeat that pattern. Board renewal towards the goal of diversity in leadership, including in board composition, requires intentional effort and planning. Those who have succeeded in building value-added diverse boards started by planning. Their plans have five common steps:


They approve a formal process and board matrix. The formal process typically includes a comprehensive board profile or matrix of the optimal board, based on the strategic needs and environment of the organisation. A robust assessment of current board members against the profile is conducted to establish any gaps that need to be filled. Recruitment is focussed on filling those gaps. For the purposes of board composition, diversity includes, but is not limited to, business and industry skills and


Approve a formal process and matrix Institute a board diversity policy Direct and resource the efforts Measure progress against targets Go public

64 Ethical Boardroom | Winter 2020

ASKING THE RIGHT QUESTIONS True diversity will bring a healthy debate

each gender represents at least 40 per cent of individuals. Having a diversity policy is not a predictor of how diverse your board is. But it is a great first step towards it. They give direction and resources. 3 What is it they say about the best laid

plans of mice and men? They often go awry! If a plan is not resourced and measured, it will not happen. Boards that succeed in reaching their diversity objectives, direct their search consultant, or those tasked to recruit candidates, to deliver a gender-balanced slate of diverse and equally qualified potential candidates. If you are not intentionally looking for something and applying resources to the search, don’t be surprised if you don’t get what you are looking for. They measure progress. The board 4 terms of reference and annual workplan

require an annual assessment of progress against targets, the effectiveness of the process, and currency of the matrix and gaps. They also track the annual board evaluation results to assess the overall

Diversity strategy is no different than any other corporate strategy. It should be a well-considered legitimate process, based on needs and benefits body of research exhibits a significant relationship between board gender diversity and corporate performance’. In other words, it makes good business sense to pursue a well-rounded, diverse and credible approach to ensuring board and leadership diversity. So, you had best have a plan!

Avoid the mistakes

Avoiding the top three mistakes described above, puts some real power in your corner if you want to make progress in your diversity objectives. Don’t take the easy route. Ask the right questions. Think ‘both… and’. Have a robust plan complete with process, policy, performance measurement and public reporting. With effort and in time, the harder road will eventually become the smoother path. www.ethicalboardroom.com




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Board Leadership | Composition A DELICATE EXERCISE Finding people with the right skills will deliver better value for organisations

BALANCING... 66 Ethical Boardroom | Winter 2020


Composition | Board Leadership

Organisational success is The best governing dependent on boards working as bodies are evenly mixed – a team to anticipate the changes but how is that achieved? and challenges ahead and taking early action to ensure Peter Swabey Policy and Research Director at The that the necessary resources Chartered Governance Institute are in place to deal with them.

Diversity of thought and balance are key, but there are plenty of examples of where having the wrong mix of people at the top table has affected board equilibrium in a detrimental way and plenty of stereotypes exist who can impede the success of the board – the risk-averse director, the absentee director, the hands-on director, to name but a few. While it is generally accepted that well-balanced boards make better decisions and are more effective, the challenge of getting the right people on a governing body can be a struggle for organisations of all kinds across all sectors. Efforts have been made in recent years to address issues of imbalance in terms of gender and ethnic inequality, but much remains to be done to ensure that boards are more representative of the communities they serve and, importantly, to ensure genuine diversity of thought.

The diversity gap

Traditionally, UK boardrooms have been the preserve of white, well-educated males with years of experience in senior leadership roles under their belts. That picture remains largely unchanged, despite initiatives such as the Hampton-Alexander Review and the Parker Review. Dame Vivian Hunt, Managing Partner, UK and Ireland at McKinsey & Company, commenting on the findings of the 2019 Hampton-Alexander Review, believes that there is ‘a need for far bolder action to make leaders accountable for participation, advance women into senior and technical roles, and tackle obstacles in the way of building truly inclusive, agile organisations’. While women’s representation on boards has now passed the 30 per cent point across the FTSE 350 and is nearing the 33 per cent target set for the end of 2020, gender imbalance remains an issue at senior leadership level, with concerns about the ability of an executive pipeline to maintain this progress in the future. The top job in the boardroom, the chair, is still overwhelmingly occupied by a man. While this is expected to change in due course as more women move in to senior leadership positions, gender imbalance remains an issue for the time being with around two-thirds of all available senior leadership roles still going to men, according to the Review. The number of women being appointed to senior leadership positions is not the only www.ethicalboardroom.com

required to do, i.e. to apply their experience and expertise to the organisation and the issues it faces. Challenge is one key way in which board members can prove their value and an ‘outsider’ can frequently ask better questions as they have less to lose. According to Building a Balanced Board, research that The Chartered Governance Institute carried out into the challenges of board composition in July 2019 with Diligent, ‘some NEDs feel most effective in the first year of their tenure “before I learn how it works”. They are better able to ask the innocent but direct questions when they are newest to the board’. Directors with an international background can also bring a different approach and a very different way of challenging.

issue. Ethnic diversity is also a concern. Research published in July 2019 by The Chartered Governance Institute, London Business School’s Leadership Institute and Elisabeth Marx Associates – A View At The Top: Boardroom Trends In Britain’s Top 100 Companies – found that 98 per cent of FTSE 100 chairmen and 96 per cent of CEOs were of white ethnicity. The lack of ethnic diversity at boardroom level is further highlighted by The challenge of the findings of a December 2019 study by board composition recruitment consultancy Green Park, which The challenge for boards is to shift away found that the total number of FTSE 100 from traditional leadership demographics BAME board members, both executive and and to create and support new pathways, non-executive, had decreased to 7.4 per with defined routes of progression to senior cent from nearly nine per cent in 2018, while positions for underrepresented sections of the the number of chairs, CEOs and finance community. The focus in recent years has been directors remained at 3.3 per cent. The on gender and ethnic diversity, but attention study also found that the pipeline for must also be paid to range BAME executives was poor, of experience, perspectives following a year of zero Finding the and thinking as diversity goes growth in the number beyond visible differences, below board level, ‘raising right individual such as gender and ethnicity. significant concerns about to sit on the Technological advancements, the prospects for any future board, and at for example, are transforming improvement at board and the world at incomparable executive committee level’. the right time, speed, but many board Gender and ethnic is not easy, members are from an era that imbalance is not the only pre-dates the digital age. The concern that organisations which is why age of a FTSE 100 board need to bear in mind when the nomination average member rose from 56 years of trying to build a balanced boardroom. The A View At committee plays age in 1996 to 58.5 years in 2017, with non-executive directors The Top research also found a pivotal role averaging 60 years of age. that British boards are in appointing Having a predominance of dominated by directors older, non-digital natives and with an accountancy or directors to accountants on the board finance background (49 the board might mean that opportunities per cent) and that many to be entrepreneurial, which have the same educational younger, tech-savvy board members might background – some 25 per cent of directors have picked up on, are overlooked. were educated at Oxbridge, Harvard or another elite university or business school. The vital role of the While financial acumen and intelligence nomination committee are both desirable traits, the over-reliance Finding the right individual to sit on the on certain types of director poses a threat board, and at the right time, is not easy, to boardroom balance as it offers less which is why the nomination committee diversity of thought. plays a pivotal role in appointing directors Variety is the spice of life to the board. As noted in Coming Out Of Diversity of thought is increasingly crucial The Shadows, a piece of research that The as the list of people to whom boards are Chartered Governance Institute undertook expected to be accountable, and the list of with EY in 2016, ‘if a board lacks the right items on the board’s agenda, continues to balance, knowledge, skills and attributes, the grow. While the changing role of the board likelihood of it and its committees operating affects the detail of what is required from effectively is greatly reduced’. The role of the individual directors, it does not really affect nomination committee is, therefore, critical the essence of what it is that they are when trying to build a balanced board.

Winter 2020 | Ethical Boardroom 67

Board Leadership | Composition Nomination committees are much more forward-looking than they were. Planning ahead and considering what the board should look like in three to five years is crucial and having an active role in the broader remit of talent management and succession planning throughout an organisation is now more common as nomination committees endeavour to ensure that the board is of the right size and structure to meet the organisation’s needs.

Finding the gap

Futureproofing can be difficult as, without a crystal ball, no-one can say precisely what will occur in five or 10 years’ time. Nevertheless, given that the development of strategy is the board’s most important task, boards need to be forward-looking enough to assess what the board has and what it needs to take the organisation into the future. The use of board evaluation and skills matrices is an effective way of identifying any gaps and focussing attention on areas of need. This can result in a more focussed, competent and committed board, one that doesn’t have the additional burden of carrying any ‘deadweight’. Likewise, skills development plans are a good way of encouraging group cohesion, which can be of crucial importance in the event of a crisis when an organisation will need people to pull together. Succession planning is also a fundamental part of building a balanced board. Regular consideration should be given to when board members are expected to move on and to who might replace them, as finding the right person can be a long-term process. A good candidate might be identified who does not meet the company’s needs at that moment in time or might not be currently available, but a little black book of candidates should be established so that they can be borne in mind for the future. Identifying the objective of any recruitment and agreeing the destination at the outset is key. If organisations don’t take the time to define what it is they are looking for, they are unlikely to get the skills needed to make their strategic plan a reality. This includes being specific with recruiters as they are guided by the brief they are given. The nomination committee, chair and company secretary each has a key role to play in this. Having a clear idea of what the right person will help the organisation to achieve is the best way to approach board appointments. Boards must also look beyond the usual suspects. Some organisations still reject ‘left field’ candidates, such as first-timers for board appointments, often to satisfy regulators and investors who expect a ‘safe pair of hands’ to be appointed. Even when boards do look for a wider variety of potential directors, too many roles are advertised with a long list of ‘must-haves’ 68 Ethical Boardroom | Winter 2020

EVENING UP BOARD MEMBERSHIP Organisations must implement a clear recruitment strategy

rather than ‘be able to’. Such an approach can be counterproductive as newer directors can be more effective as they are keener to prove themselves. Furthermore, appointment criteria such as ‘must have been a FTSE CEO or CFO’ will inevitably reduce the diversity of applicants. Consideration must also be given to the type of language used to recruit board members. If the aim is to attract a young, digital native director, for example, you are unlikely to strike gold by using old-fashioned language.

Honesty pays

Even if an organisation has ticked all of the right boxes in terms of recruitment approach, there is no guarantee that a

Consideration must also be given to the type of language used to recruit board members. If the aim is to attract a young, digital native director, for example, you are unlikely to strike gold by using old-fashioned language deluge of applicants will follow. With additional pressure from regulators, the media and public, not to mention the pressure to ensure financial sustainability in the face of increasingly difficult economic and geopolitical conditions, it is little wonder that potential directors might now think twice about taking on the role. That makes it more important than ever for organisations to be truthful about what the role involves. To avoid disappointment, resentment and worse, organisations must be as realistic as possible about the work involved and the time required to do the job properly.

Ultimately, as with all types of recruitment, organisations only get out what they put in. Building a dedicated, diverse, knowledgeable, professional and experienced board requires a structured, formal and robust recruitment strategy to be in place. That includes looking at every stage of the talent pipeline to ensure that individuals are valued for their skills and capabilities and creating an inclusive environment in which all talent can thrive, and leadership stereotypes are challenged. It also requires induction and training as even seasoned professionals require development. Only then will organisations stand a chance of building a truly balanced board, one that is able to advise, supervise and challenge.

Top five things to consider


Think about whether or not the role of the nomination committee is right for your organisation and if the committee’s terms of reference, annual report and website reflect the actual remit and practice of the committee Consider what skills the board needs to deliver organisational strategy (over the relevant period) and deal with changes in the business environment Reflect on when new skills might be needed and what the plan is for acquiring them, including the plan for ongoing training/development of directors after they have joined Think about how the next cycle of appointments/reappointments is managed and how board/director evaluations feed into that process. Implement a contingency plan to deal with unexpected departures Consider what assurance the board needs from management about the nature and quality of their executive/senior management development programmes. How visible are potential executive directors to the board and how involved does the board want to be in those programmes, e.g. through mentoring?

2 3

4 5


Board Leadership | Board Diversity INCLUSIVE BOARDROOMS Diversity on boards can be achieved with clear targets

Demand for diversity As corporate America heads into 2020, companies are preparing for the beginning of a new era in governance. The governance landscape has evolved tremendously over the last several years and continues to become much more complex. As such, companies must adapt promptly and in an adequate fashion, particularly to avoid potential backlash from active investors. The question then becomes, what area of governance will define the new decade? There is no doubt that environmental, social and governance (ESG) issues have made headlines across corporate America over the last few years. Investors are paying close attention to not only if companies are addressing these issues, but also how well they are addressing them. As a result, companies are becoming more proactive in displaying their ESG efforts. According to Equilar data, 31 per cent of the Equilar 100 – the 100 largest US companies by revenue – disclosed ESG policies within their proxies in 2019. This figure represents a significant climb from just one per cent of those companies disclosing such policies in 2015 (See Figure 1). 70 Ethical Boardroom | Winter 2020

The push to create a diverse workforce will intensify in 2020 as boards recognise the benefits Amit Batish

Editor-in-Chief, Equilar ESG covers a wide spectrum of issues and it’s critical that companies focus on those that are most relevant to them. This will likely vary across companies and industries. However, among the many issues that have come to the forefront, there is one that seems to consistently be a top priority for boards and executive management teams – diversity. The push for diversity has intensified significantly across corporate America. Boards and executive management teams are facing pressure from multiple directions to add diversity to their boardrooms. Of course, diversity entails a number of elements, including experience, age, ethnicity, gender and more. Particularly across the United States, gender diversity continues to gain traction each year. There are a number of benefits that gender diversity brings to the table, including the idea that it adds unique perspectives, enhances board performance and improves

overall relationships with investors and other key stakeholders. Board directors also recognise these benefits. According to PwC’s 2019 Annual Directors Survey, 38 per cent of directors say that gender diversity is very important to their boards. While this is a slight decline from the 46 per cent that made that statement in 2018, this could speak volumes to the fact that diversity is becoming integrated more and more into regular conversations in the boardroom and directors are less inclined to push for urgency on the issue. Equilar began tracking the progress of women on boards in January 2017, with the inception of its Gender Diversity Index (GDI). At that point, just 15 per cent of board seats in the Russell 3000 were held by women and less than 25 per cent of board vacancies were filled by women. In the most recent edition of the GDI, it was revealed that nearly 21 per cent of directorships were occupied by women as of Q3 2019. This is indeed tremendous progress, as the rate of women on boards has increased exponentially since 2016. However, there still is a long way to go before boards reach gender parity – equal representation of both men and women: 90.7 per cent of Russell 3000 boards are without a woman, an alarming statistic for many key stakeholders (See Figure 2). Nevertheless, institutional investors have made it clear that the companies in which they invest should continue to make a www.ethicalboardroom.com

Board Diversity | Board Leadership


Percentage of companies

concerted effort to add more women to their FIGURE 1: ESG DISCLOSURES IN PROXY STATEMENTS, EQUILAR 100 boards. According to a 2019 report from 100 the EY Center for Board Matters, 53 per cent 4 of institutional investors say diversity should be a top issue for boards. In February of 80 2018, BlackRock – the world’s largest money manager – publicly stated that companies in which it invests should have at least two female 60 board members. Michelle Edkins, global head of investment stewardship at BlackRock, wrote a letter to Russell 1000 companies that had 40 fewer than two women on the board to ask 31% them to disclose their approach to boardroom and employee diversity. 14.1% 3% 20 1% In the United States, corporations are now 3% 6% 2% facing legislative pressure to include more 11.1% 9% 8% women on their boards. Several other 0 countries have implemented gender quotas 2015 2016 2017 2018 2019 to ensure equal representation on corporate ■ Mention ■ Disclose boards. For instance, Norway, Spain, France diversity. While ethnic diversity may not and Iceland have all implemented laws that FIGURE 2: RUSSELL 3000 receive the same level of attention from compel publicly listed companies to have at BOARDS WITHOUT WOMEN investors, legislators, the media and other least 40 per cent women on their boards. key stakeholders, companies are beginning California is the first US state to to make an effort to include minorities on implement such a quota. The new California 9.3% their boards and disclose progress. law required that public companies According to a 2018 Equilar report, 53 operating within the state had to have a per cent of Equilar 100 companies disclosed minimum of one woman on their board of the composition of their boards by ethnicity directors by the close of 2019. That minimum in 2018. While this is lower than the 66 per will be raised to at least two female board ■ At least cent of companies that disclosed members for companies with one woman composition by gender, it still five directors or at least three Companies ■ Zero women encompasses more than half female board members for must address of the largest US companies. companies with six or more Furthermore, 77 per cent of directors by 31 December diversity 90.7% companies disclosed some form of 2021. Violators of this and clearly board or director assessment on legislation will be subject to communicate ethnicity. While advancement on financial consequences. this front may be moving slower While California was the first that it is a than gender diversity, awareness US state to pass a law of this top priority adequately will likely be under more is at least visible (See Figure 3). nature, it most certainly will scrutiny than ever. Therefore, it is essential Ultimately, companies must not be the last. Illinois passed to investors that corporations plan to promptly address diversity and clearly a similar piece of legislation  in 2020 address the diversity element of ESG in communicate that it is a top in April 2019 that will require an actionable manner to not only avoid priority to investors in 2020. any publicly traded companies the pitfalls, but also reap the benefits of In particular, those companies that have based in Illinois to have at least one woman sound governance practices. previously failed to address this issue and one African American on its board of directors by the end of 2020. As greater attention is placed on diversity efforts across FIGURE 3: ETHNIC DIVERSITY & DISCLOSURE RATES corporate America, it can be expected that 80 more states will follow the paths set by 79% 77% California and Illinois. 70 With the added pressure from legislative 66% initiatives, it comes as no surprise that 60 45 per cent of new Russell 3000 board seats were filled by women in Q3 2019. Public 53% 50 companies should expect legislative efforts 40 to continue in 2020 and plan accordingly to avoid the repercussions associated with 30 inadequate diversity.

The state of ethnic diversity

The conversation of diversity on boards has centred around gender diversity for quite some time. However, the discussion is moving beyond gender as an area that is becoming a more pressing subject is the state of ethnic www.ethicalboardroom.com

20 10 0

Gender ■ Board or director assessment

Ethnicity/race ■ Board composition Winter 2020 | Ethical Boardroom 71

Board Leadership | Corporate Culture

A World in Flux In today’s interconnected and ever-changing world, the only thing companies can count on is uncertainty.

Employees are demanding engagement from management on economic, cultural and political matters. Consumers are buying in line with their beliefs while criticising big business on social media. Policymakers are making head-snapping decisions that cause stock market whiplash. Community activists are turning to local governments to restrict corporate growth. Shareholders are pressuring companies on environmental, social and governance issues far outside their traditional purview of profit-making. In this chaos, independent board directors are particularly well placed to help CEOs make sense of the unpredictable global landscape and navigate the space in which their companies compete. Indeed, because a lot of uncertainty can mean a lot of risk, the risk management part of a director’s overall job – providing strategic guidance with an eye firmly on shareholder returns – has taken on heightened importance in these times. And, now more than ever, directors need to be even more of a resource for CEOs and their management teams as companies face new challenges and seek to understand the real risk and its potential consequences within the unknown.

Directors are uniquely positioned to help navigate this rocky terrain

Their vantage point should afford them a clear-eyed view of the bigger picture, which includes the attitudes of a range of stakeholders shaping a company’s future and factors that might seem unrelated to the primary bottom-line goal but that could affect it. Especially in this environment, directors must take advantage of a higher vantage point and carve out the bandwidth needed to stay on top of crosscurrents reshaping the market, non-market and internal spheres. The most effective directors will now need to do more to really develop a 360-degree perspective on the world and, most importantly, a keen understanding of how a company’s

72 Ethical Boardroom | Winter 2020

Corporate directors are critical to helping companies navigate the uncertainty Liz Sidoti

Managing Director at Abernathy MacGregor overarching business goals and its business practices align with reality. To achieve this broad perspective, directors need to appreciate how a company’s reputation impacts its valuation and have a deeper understanding of how cultural and political moments can have long-term financial implications, depending on whether, and how, a company engages. They also should evaluate societal trends and external events that may seem unrelated to the company – the firestorm caused by a tweet from an NBA general manager about Hong Kong, transgender rights legislation, the US leaving the Paris climate accord – but that ultimately could affect the business. In addition, they should help the C-suite anticipate potential flashpoint issues with multiple stakeholder groups. And they must counsel management on the dangers of viewing Wall Street and Washington in isolation, while explaining how the constant interplay between the two affects the business in both obvious and unforeseen ways. In short, directors have a unique opportunity to situate the company in a wider social context, identify risks and opportunities, and help prioritise accordingly in these tumultuous times.

Global trends are reshaping how society views business and how business must learn to operate Some trends that have emerged in the dozen years since the Great Recession began underscore the importance of effective corporate communications as well as broad perspectives. Inside companies, employees have become more politically active, insisting on transparency and accountability

from management. A competitive talent landscape, unlimited information and news-generating and grassroots-organising technology have created collective activism perhaps more powerful than collective bargaining because workers can quickly create reputational problems using new tools at their disposal. Outside companies, investors and consumers, meanwhile, are demanding change, putting pressure on companies to address environmental, social and governance (ESG) problems. They are using their financial power and public platforms to influence and try to persuade companies to adopt sustainability platforms, become more diverse and take stands on immigration and other human rights matters. And all around, an anxious and frustrated public, fed up with a hyper-partisan, conflict-driven political system, has turned to the private sector to fill a leadership vacuum. In new and different ways, a number of publicly traded corporations and their CEOs now are taking firm leadership stances on some of society’s biggest problems, including climate change, gun control, living wages, affordable housing, decaying cities and immigration. These trends help explain why the Business Roundtable last summer released a controversial statement on the purpose of a corporation that said companies have a responsibility to serve all stakeholders – customers, employees, suppliers, communities and shareholders. In making this statement, the trade association for CEOs abandoned the notion of ‘shareholder primacy’ – that companies exist primarily to serve shareholders – that had guided companies for decades. In Washington, the political class mostly panned the announcement as a ploy to try to counter the anti-corporate narrative that Democratic presidential candidates


Corporate Culture | Board Leadership

WORLDLY WORRIES Businesses need to show leadership during an era of uncertainty and upheaval

Elizabeth Warren and Bernie Sanders have been promoting on the campaign trail. Both have made income inequality a cornerstone of their campaigns, lambasted shareholder primacy and proposed policies to rein in Wall Street. But if appeasing them was the goal, it didn’t work. Warren promptly said: “Without real action, their announcement is meaningless,” while Sanders concurred, adding: “Empty words are not enough.” On Wall Street, many criticised the statement as toothless window dressing and predicted that most companies would continue to prioritise shareholders. Plus, some sceptics observed, companies already have a more meaningful way to focus on both making money and improving society by becoming certified public benefit corporations that balance purpose and profit. “It is government, not companies, that should shoulder the responsibility of


defining and addressing societal objectives with limited or no connection to long-term shareholder value,” argued the Council of Institutional Investors. In focussing on the statement itself, however, the critics missed the bigger picture: demographics have combined with information and technological access as well as political angst to drive the societal trends that are directly pressuring companies – and companies have little choice but to respond. Their ability to win business, grow revenue and generate shareholder value now also depends on their ability to navigate today’s highly politicised, ever-changing and demanding world.

Young generations, information and angst are fuelling the trends

The biggest new reality that companies need to accept is that millennials and members of Generation Z have become more than simply a faraway concept. They have arrived. In 2020, the oldest millennial turns 39 and the oldest Generation Z turns 25, and generations that corporate executives used to think of as mere children increasingly are becoming managers, customers and shareholders. They have strong viewpoints on ways of working, income inequality and the role of business in society. They generally want to work for, invest in and buy from companies that are good societal stewards and share their values.

Winter 2020 | Ethical Boardroom 73

Board Leadership | Corporate Culture A recent Morning Consult survey this age group. At the same time, faith in found that both demographic groups are both Washington and Wall Street has fallen. far more likely than older generations to A decade after the Great Recession began, say corporations should use their influence a Morning Consult survey showed that to affect political and cultural issues. more than half of Americans distrusted And more than half of both groups say both Wall Street banks and Congress, and that a company’s reputation and positive roughly two-thirds said that the recession societal contributions are very important continues to have an impact on both the employment considerations. Given their economy and life. numbers, millennials and Generation Z will The bottom line is clear: companies have shape companies for decades the same way, little choice but to consider all stakeholder possibly as baby boomers have for the last 40 attitudes and macro societal trends and the years, perhaps even more. implications of both as they make decisions. Increasingly dominated by these Failing to understand and factor these generations, all stakeholder groups, elements into their thinking – and into their meanwhile, have become much more actions – could hurt companies across informed, empowered and fickle. Technology multiple fronts, from retaining employees, is a big reason. Investors, employees, customers, partners and shareholders to customers and community activists all now recruiting new ones. In this environment, have unprecedented and immediate access LEADING THE WAY to unlimited amounts of information to form IN UNCERTAIN TIMES their views. Digital news consumption, in Directors must stay particular, continues to steadily increase, and, informed and a recent Pew Research Center study found communicate often that about two-thirds of American adults said they at least occasionally get news from social media. Stakeholders now have widespread access to powerful tools – often literally in their hands – to publish their own opinions and organise Companies against companies they have little choose to invest in, buy from and partner with. This has choice but to meant that complaints that consider all used to be aired around office stakeholder watercoolers or in customer service lines now are attitudes and published in the virtual town macro societal narrow mindsets are square (and that town square itself is increasingly global). trends and the exceptionally dangerous. These days, simply looking through All of this greatly increases implications the financial prism without the chances for activism, consideration for what’s going especially from employees, of both as on in other universes may and can combine to threaten they make position companies for business a company’s reputation decisions failure rather than success. and, potentially, its ability to conduct business and Directors are primed to provide generate shareholder value. a 360-degree evaluation At the same time, economic anxiety has Amid all of this turmoil, how can directors shaped the political world and the public’s ensure that they are providing valuable, attitudes about business, particularly well-informed and strategic counsel to the among millennials and Generation Z, who CEOs and management teams of companies grew up in the Great Recession’s challenging on whose boards they serve? aftermath. A populist movement sprung up and steamrollered both parties, starting ■ Stay abreast of the news, trends and latest with the Tea Party in 2010, then moving research – not just on business but also to Occupy Wall Street, then to Donald in political, societal and cultural spheres Trump’s campaign and is now fuelling the – to understand a company’s place in the Warren-Sanders wing of the Democratic world and evaluate it constantly Party. Politicians stoked the fire, fashioning ■ Consider market (Wall Street and the themselves anti-Wall Street crusaders. Fed), internal (morale and retention) as Capitalism’s reputation suffered as a result, well as non-market factors (Washington particularly among young adults. A recent and social movements) when engaging Gallup poll showed that millennials and with and counselling management teams Generation Zs’ overall opinion of capitalism ■ Seek out information from cultural and has deteriorated to the point that capitalism political subject matter experts to and socialism are tied in popularity among 74 Ethical Boardroom | Winter 2020

gain a solid grasp of the mindsets of current and future employees, customers, partners and shareholders ■ Monitor foreign affairs to understand how geopolitical trends, such as shifts toward autocratic regimes, can affect not just local business interests but also corporate reputation ■ Rely on comprehensive data to help management teams set priorities appropriately and be nimble enough to help avoid unforeseen threats or seize unexpected opportunities ■ Develop insights from the research to challenge assumptions, demand diverse viewpoints in the boardroom and on the executive team and introduce new ways of thinking ■ Study how businesses have used

robust communications campaigns to speak to all stakeholders and boost company reputations – and encourage the adoption of best practices ■ Advocate for the company’s communications and human resources chiefs to have seats at the management table to consider corporate culture, all stakeholders and the times in decisions ■ Anticipate all stakeholder concerns and possible reactions to decisions – and address them before they spiral into the public sphere and out of control ■ Talk to members of every stakeholder group, especially employees, and ask: what are we not seeing in the boardroom that you see on the ground? While all this can seem overwhelming, directors who step up and embrace the challenge of such an expanded role will not only end up providing an important service to CEOs and management teams but also will help foster a life-long learning corporate culture. And that will help keep companies ahead of the curve – and their competition – and on an upward trajectory in an era of uncertainty that doesn’t appear to be ending anytime soon. www.ethicalboardroom.com




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Executive Search and Board Consulting

Board Leadership | Technology

Corporate governance is not agenda management Smart leaders simplify decision-making ecosystems to enable the next version of their Organisation Pedro Serrano

Founder & Managing Partner of Smart Governance, CAVEDIGITAL

There has been an increase in technology adoption at board and leadership team level. In the most cases, adoption has been reactive, motivated by a herd mentality of the type: ‘if they are doing it, we should do something too’.

Solutions have been mostly what one could call cosmetic, that is the retrofitting of boardrooms with projectors and screens, use of tablets and maybe agenda management software – while paper pushing, the emails nightmare and a maze of fileshares remains. It’s arguable that a misguided adoption of technology sets in and digital transformation initiatives become

technology just for technology’s sake. Or it is done with a ‘just fix my problem’ mentality that leaves the rest of the Organisation hanging out to dry. The outcome is invariably one where little valuable progress is made and where C-level executives and directors remain staring down on an Organisation that is as opaque to them as before. In this scenario, and specifically in regard to corporate governance, most digital solutions focus superficially on the important but relatively inconsequential preparation and management of meeting agendas, neglecting the rest of the Organisation. I hate to break it to you, but corporate governance is not agenda management.

A collaborative process

If corporate governance is the system of rules, practices, processes, and the actual chain of command by which companies are directed and controlled, then the modernisation of corporate governance demands a holistic approach. One where the board, the committees, the leadership team and the several stakeholders in the chain of command are not isolated islands, but instead are part of a decision-making ecosystem. This ecosystem exists as a set of processes, that is collaborated on, well documented and captured, transparent and involving the relevant chain of command from conception, to decision, to the attribution of responsibility to execute and the final execution itself. For a truly valuable decision-making ecosystem to thrive, empowering and capturing the collaboration process is key because that enables the relevant expertise of the Organisation to be found and recruited to contribute in the process of preparing proposals to be submitted to the decision-making processes. If this continues to be done on paper or email, what’s the plan if later in time the Organisation runs into trouble because of a specific proposal? The solution can’t be to ask everyone to ‘please, show me your inbox?’, in order to find out who was involved in the process and what

BUSINESS TRANSFORMATION Technology helps eliminate paper pushing

76 Ethical Boardroom | Winter 2020


Technology | Board Leadership

their contribution was – in fact, in some countries, that is against privacy laws and could be construed as a crime. What if the organisation operates in a sector that is highly regulated? The regulator pressure is there to stay and compliance is an absolute struggle if all one has is paper and email pushing around. Deadlines become a nightmare and unexpectedly one is stuck with a huge cost structure just to manage the relationship between the organisation and the regulator. In an ideal scenario, having capabilities like co-editing of documentation and request for advice processes allows a team to prepare, develop and mature a proposal with agility, escaping the back and forth emails trap, where after 15 minutes no one is able to tell who has the latest version. With a truly valuable digital solution, the technology is empowering at a very practical level by enabling efficiency, efficacy, auditability all the while providing users with a modern workplace experience where a culture of responsibility and accountability is not neglected, achieving more than the sum of each individual contribution if isolated on its own. With a good digital corporate governance solution the whole ought to truly be greater than the sum of its parts. By implementing the tools that enable collaboration as part of the process, instead of something that happens on shadow information technology tools, corporations increase productivity drastically while securing and enforcing the rules of engagement on how something is proposed inside the organisation, and on how it bubbles up in the chain of command. By implementing that same chain of command, companies can automate the rules that define what are the powers to act of each stakeholder, on each step of the reviewing and approval process: who can decide on what and when. It’s also relevant to stress that the security rights one has at a particular stage of the process are probably not the same at a further stage of that same process. Ensuring security rights are managed automatically is important so that, by default everything is considered confidential (and not the other way around) and it’s up to the defined process and the people involved in it to decide who else should have access and what kind of access. The benefits do not stop here. If the digital solution is inherently capturing the process, then it’s ensuring knowledge retention, so that the organisation retains memory long after the people who participated in the processes have moved on with their lives. With the right digital tool, these processes will continue to bubble up in the organisation, reaching C-level executives and ultimately gravitating towards higher


governance structures, finally reaching committees, the leadership team, and some end up being relevant enough to reach the board of directors. Such a tool contains different user types to match those in the Organisation, as the ones already mentioned above. Another role we can use as an example, the meeting secretaries, need to validate if proposals and their documentation are in a mature enough stage to be submitted to that specific governance body, prepare the agenda, adjust the agenda order, schedule meetings and formally summon the governance body members, formally disclose the agenda for that meeting and, when the time comes, run the meeting itself – all of this digitally. No more paper and file shares are required in such a reality. The meeting is run digitally and, as part of the process, each member accesses the agenda, the proposals in it and respective documentation, deliberating or electronically voting on each topic. By the end of the meeting, the meeting secretary pushes a button and the minutes document is automatically generated and can be digitally signed.

Having capabilities like co-editing of documentation and request for advice processes allows a team to prepare, develop and mature a proposal with agility As a follow-up, it is imperative that responsibility on executing what was decided for each proposal is defined, triggering the creation of tasks to those who need to implement it. A chain of forwarding for execution processes can spawn from this, until what was decided for that specific proposal is achieved. Or maybe that specific proposal needs to be discussed on another committee or board. In more complex scenarios, like conglomerates, there is a specific decision-making ecosystem with hierarchies, committees, leadership team and board, in each Organisation and a larger, macro, decision-making ecosystem between organisations. With this digital solution, one is architecting and implementing a fit and proper decision-making ecosystem that is collaborative, flexible, efficient, productive, responsible, accountable, auditable, secure, transparent, and that frees middle management, top management and the leadership from bureaucracy so they can tackle more value-adding tasks without sacrificing obligations that are mandatory by law and regulators.

Why should something be done about it?

We’ve been empirically observing the impacts of such approach on several organisations, while implementing Smart Governance, where the decision-making ecosystem is approached as a system critical to the organisation’s competitiveness and survivability and not as isolated islands of information to dwell on to get stuff done. These organisations have obtained palpable increases in productivity at all levels, from proponents, to middle management, to secretariat teams, to C-level executives and directors, reducing the weight on their day-to-day time consumption, enabling just-in-time access to information, while allowing everyone to achieve more. The number of proposals on a preimplementation stage double to triple on a post-implementation stage, while on a pre-implementation scenario, between each approval node in the chain of command a week would pass, on a post-implementation scenario an entire decision-making process could happen on the same afternoon. All this translates to a faster, leaner, quality-driven, modern reality, where the focus shifts from paper pushing to pushing forward. Consequently, everyone’s experience improves and, as an example, meeting secretaries no longer have to pull allnighters to produce summoning documents, agenda disclosure documents, printing and photocopying board books, and to come up with the minutes documents in time. Transparency, search capabilities and just-in-time access to information help strengthen an unexpected dimension: knowledge retention becomes more actionable and natural, because processes are no longer stuck on the email inboxes of those who participated, but instead are captured on a system that properly implements those processes. Internal politics become easier to navigate as, more and more, people become used to a new way of working where transparency, accountability, responsibility and agility are the new normal. The importance of technology and innovation is experienced on a first-person level by C-level executives and Directors, who set about driving innovation and technology adoption agendas that are more assertive and strategic, transitioning information technology and innovation from an operational and reactive role into a strategic role, and leading by example into the next era of their Organisation. By awareness, business transformation drive is triggered at the top. So, yes, corporate governance is not agenda management and today is as good a day as any to start going at it right. Will you?

Winter 2020 | Ethical Boardroom 77

Global News Middle East & Africa

Oman allows 100% foreign ownership Oman has introduced a new Foreign Capital Investment Law that offers key incentives and expanding investment sectors to foreign investors. With the exception of a small number of trades and services, 100 per cent foreign ownership of Omani companies is now possible under the new law, which came into force in January. The law, issued under Royal Decree No. 50/2019, includes several incentives and advantages for foreign investments

so as to encourage their flow into and stability in the Sultanate. Mohammed Al Badi, the acting director of the Legal Department at the Ministry of Commerce and Industry, told Times of Oman: “The expected growth rate in the investment sector in the Sultanate will not be less than 75 per cent if the legislations are implemented properly and the appropriate investment environment is created and modern regulations are activated.”

Former DSI CEO arrested in Jordan Khaldoun Al Tabari (right), the former CEO of Dubai contractor Drake and Scull International (DSI), was arrested at an airport in Jordan in January after an international arrest alert sounded by UAE. DSI has filed numerous criminal complaints with the Abu Dhabi public funds prosecutor against Tabari, family members and other former executive managers. According to DSI, Tabari has already been charged with misappropriation, fraud, embezzlement, intentional damage to public funds, profiteering and forgery. DSI said it is pursuing legal action against Tabari to get him extradited to the UAE following his arrest by Jordanian authorities at Queen Alia International Airport in Amman.

New boards as Eskom ‘unbundles’ South African power utility Eskom is in the process of appointing three new boards for its generation, transmission and distribution divisions. Eskom’s new CEO André de Ruyter said the boards would be populated by existing management. South Africa president Cyril Ramaphosa announced

78 Ethical Boardroom | Winter 2020

last year that Eskom, which produces more than 90 per cent of South Africa‘s electricity, would be split in order to open up the power sector to more competition. Speaking to the media, de Ruyter said the unbundling of Eskom ‘will definitely happen, but it has to be done the right way’.

DTB appoints director to boost governance

Financial solutions provider Diamond Trust Bank Kenya (DTB) has appointed anti-money laundering and banking operations expert Sagheer Mufti as a non-executive director. DTB has tasked Mufti, currently serving as the chief operating officer for HBL (formerly Habib) in Pakistan, with enhancing its corporate governance structure. DTB chairman Linus Gitahi told news site Standard Digital that Mufti’s appointment would significantly expand the board’s capacity to provide dynamic leadership and oversight. “The board is pleased to welcome Mr Mufti who has a set of rare skills and will undoubtedly contribute to the board’s diversity,” said Gitahi.

Dunamiscoins ‘scam’ directors charged Directors of the now-defunct Dunamiscoins Resources, an alleged cryptocurrency pyramid scheme in Uganda, have been charged with crypto fraud. Dunamiscoins Resources opened in central Uganda in November, taking money from local clients with promises of 40 per cent interest. More than 5,000 victims of the alleged cryptocurrency pyramid scheme have petitioned the Ugandan parliament, asking to refund money lost in the apparent scam. Directors Samson Lwanga and Mary Nabunya appeared in court in January and were charged with 65 counts tied to obtaining money by false pretence.


Middle East & Africa | Investors TRADITIONAL APPROACH Middle East markets are characterised by low institutional holdings

Ethical & governance momentum by institutional investors

The challenges and opportunities within Middle East markets Over the past decade, global markets have witnessed a noticeable reorientation in the views and concepts of corporate purpose. More companies are now integrating the interests of stakeholders into their decisions and operations and are shifting away from a mere focus on maximising shareholder value. Firms are indeed more actively considering and implementing ways to better serve their customers, to be mindful of employees’ interests, and to weigh the impact of their actions and activities on various ethical, social and environmental fronts.

The institutional force

While several parties, including regulators, employees and customers, are pushing in this direction, active institutional investors constitute a strong driving force. Their influence has been 80 Ethical Boardroom | Winter 2020

Dr. Assem Safieddine & Leila Atwi

Dr. Assem is Professor of Finance, American University of Beirut. Leila is Managing Partner, Business engineering experts (B.e.e.)

intensified by their growing ownership in publicly listed companies, especially in developed markets. For instance, a 2019 study by the Organisation for Economic Co-operation and Development (OECD) reveals that the holdings of institutional investors and other strategic investors reached 73 per cent, out of the total market capitalisation of firms on the global scale.1 In parallel to this surge in holdings, institutional investors are playing a growing role in upgrading the ethical and governance practices of their investee firms. One form of influence is exercised through stewardship and active engagement. Institutional investors are carrying out internal monitoring and scrutiny measures, pressuring companies and raising their voices on issues such

as board directorship, transparency and disclosures, and remunerations. Another form of influence is driven by socially responsible investing, wherein institutional investors reward the conforming firms by buying their shares and penalise the irresponsible ones by selling their shares. As a matter of fact, more investments are now being allocated to firms and funds that meet some environmental, social, and governance (ESG) criteria. The Global Sustainable Investment Alliance reports that the global assets managed under sustainable investment reached $30.7trillion in 2018, a 34 per cent increase from 2016. 2 Their proportion of total assets under management reached 26 per cent in the US and 51 per cent in Canada. A recent study by professors at the American University of Beirut also documents an increase in institutional investors’ holdings in US firms listed on Ethisphere’s list of the world’s most ethical companies during the quarter that firms are added to the list. 3 Ethisphere assesses www.ethicalboardroom.com

Investors | Middle East & Africa To answer this question, it is important and rates firms based on a spectrum of to assess how institutional investors are ethical and governance criteria, as well as positioned in these markets and what role corporate citizenship, social responsibility, they play or are ready to play. The differences and reputation factors. Firms that meet the in governance expectations driven by the criteria are included on the list. Since the ownership structures of companies in the index is certified by an independent outside region are noteworthy here. party, it is believed to be a more credible For that purpose, we examine the sample assertion of the companies’ commitment of listed companies in the four Middle East to ethical behaviour than the disclosures markets that are classified as emerging by made by the companies’ managers. MSCI: Egypt, Qatar, Saudi Arabia, and the According to the study, institutional United Arab Emirates (UAE). Given their investors not only increase their strategic MSCI listing, these markets are expected to investments in these companies but have a greater degree of accessibility, openness also do so on a long-term basis rather to foreign ownership, ease of capital flows, than temporarily. The trend is noted more and efficiency of institutional frameworks strongly among institutional investors relative to the other regional markets. As that are considered long term or strategic. such, they are expected to represent the most For example, pension funds increased attractive frameworks for institutional their holdings of ethically responsible investors, whether local or foreign. companies by as much as 13 per cent in Yet, the ownership data as of December the quarter of the listing on Ethisphere. 2019 implies otherwise. These markets are Focussing on emerging markets, a still characterised by low institutional survey reveals that long-term, strategic holdings relative to international markets. institutional investors are willing to The percentage of total outstanding shares pay a premium of up to 24.5 per cent for held by all institutional investors is 40 per well-governed companies, particularly those cent for Qatar and Saudi Arabia and 58 per in markets where the legal frameworks for cent for the UAE. The highest percentage, investor protections are weak.4 Thus, a two-way relationship is evident: 68 per cent, is noted for Egyptian companies institutional investors are getting more and is relatively close to the global average instrumental in improving the ethical, (see Figure 1, right). social, and governance practices of their The distribution of holdings across the investee firms, but they are also attracted to different categories of institutional investors companies that adopt socially responsible is also very informative (see Figure 2, right). behaviour and shy away from those that Strategic institutional investors are likely to suffer from poor governance An equally important observation is that or managerial opportunism. more than 80 per cent of the institutional This provides a strong indication of the ownership is held by government agencies, long-term value of ethical and governance individual shareholders who are mainly practices as well as the superior protection family members, or large corporations, they offer investors against including passive banks, managerial malpractice or insurance companies, family Providing unethical behaviours. In fact, offices, and other firms. All of institutional there is wide evidence that these these are classified as strategic investors with entities that are quite passive institutional investments, known as ‘smart money’, do pay their stock trading. the incentives in In off financially, operationally, Egypt, a total of 23 per to invest and cent of shares are held by and morally. For instance, it is documented that the adoption exercise active corporations, another 22 per of ethical behaviour and cent by strategic individual engagement commitment to social investors, and 16 per cent by performance are associated with in regional government agencies. The same improvements in innovation, order of holdings by magnitude companies competitive advantage, value is noted for the UAE sample. is critical chain, employee empowerment In Qatar, government agencies and motivation, among others. make up the largest percentage Good governance is also associated with of shareholders, holding an average of 16 stronger operating and financial performance, per cent of the shares (see Figure 2, above). lower risk and higher stock returns. These strategic investors exercise the regular role of attending general assemblies Institutional investors in and electing directors, and they are often the Middle East and ethical involved in management, either directly and governance practices or through representatives. But they still The picture on the global front is promising. follow, to a large extent, the traditional But do the Middle East markets have the approach of control. Their commitment potential to benefit from such trends in to governance as well as to other ethical, institutional investments? environmental, and social objectives are www.ethicalboardroom.com

mostly driven by regulatory requirements. Their decisions are also greatly influenced and constrained by political considerations in the sense that they would be reluctant to push for a major ESG change unless it is supported by a governmental policy. Investment managers with active trading strategies The second broad category of institutional investors consists of the more active investment managers. These include hedge funds, investment advisors, sovereign wealth funds, among others. They are characterised by the capacity to direct their funds to attractive and lucrative investments. Yet, they hold




57.72% 39.58%



Saudi Arabia



Egypt Qatar Saudi Arabia UAE ■ Corporation ■ Government agency ■ Holding company ■ Individual investor ■ Other insider investor

a very small percentage of shares in the regional markets. Their holdings are limited to three per cent in Egypt and six per cent in Qatar as well as in Saudi Arabia. The highest percentage of 11 per cent is noted in the UAE, half of which is held by sovereign wealth funds (see Figure 3, over page). Given their low ownership levels, these investors are still shying away from playing an active role in ESG issues. In contrast to the global markets, the engagement by these investors with the companies’ board and management is almost non-existent and there is little-to-no dialogue on the various strategic or ESG matters. Their low level of holdings also limits any influence that they can exercise, whether through trading or voting, to improve the ESG behaviour of investee companies. Winter 2020 | Ethical Boardroom 81

Middle East & Africa | Investors This situation may be, to some extent, FIG 3: HOLDINGS BY INVESTMENT MANAGERS OUT OF TOTAL SHARES explained by the lack of readiness or ■ Sovereign wealth funds ■ Total investment managers lack of incentives for the institutional investors to confront the controlling shareholders or their representatives on the board and management. But it could 10.77% also be also attributed to some structural characteristics of the markets. For example, 6.09% 6.13% 5.99% the low free float in most of the region’s 3.97% 3.54% 2.78% markets limits the number of investors who 0.55% can trade the stock as well as their influence. Qatar Saudi Arabia Egypt UAE Retail investors The ownership structures, fact, the foreign institutional investors were particularly the low percentage of shares FIG 4: HOLDINGS BY the first to raise concerns and question the held by institutional investors who follow FOREIGN INVESTORS use of funds by the firm’s management and active stock trading strategies, also point to OUT OF TOTAL SHARES the first to request the appointment of an the significant dominance of unsophisticated external auditor to investigate the issue. retail investors on trading activities. 6.14% But in order to attract foreign investments, This category of investors tends to base 4.62% 2.76% 1.97% several challenges need to be addressed. For investment decisions on speculation rather example, it is imperative that companies than on information. The engagement of Saudi Arabia Egypt Qatar UAE adopt more transparent disclosures and retail investors in ethical and governance stewardship. Providing institutional investors provide reports in foreign languages. Also, matters is certainly expected to be negligible. with the incentives to invest and exercise the trend by institutional investors to put Foreign investors A very important active engagement in regional companies is more weight on third-party verifications of distinction to note is between regional critical – and there are multiple initiatives the companies’ commitment to ESG should and foreign investors. The latter category that can support progress in that direction. be taken into consideration. As a matter of of investors is characterised by greater The significant holdings by passive, fact, 52 per cent of surveyed institutional sophistication, higher expectations, and a buy-and-hold, strategic investors in Middle investors stated that they base their research relatively more active role in pushing their East companies can in fact be regarded as an on third-party data such as governance investee companies towards the adoption opportunity. These entities have, by nature, scores or ratings.6 As such, companies in the of ethical and governance responsibility. region should be incentivised to participate a long-term view as well as strong incentives Yet, the ownership data suggests that their in awards such as those granted by Ethical to maximise the financial and stewardship role is curtailed by their low exposure to the The ownership non-financial values of investee Boardroom or to be put on such lists as the S&P/Hawkamah ESG Pan Arab Index. firms. This is supported by Middle East markets. Their structures Other important initiatives relate to the US-based evidence that holdings are limited to two per observed in the protection of minority shareholders’ long-term investors increase cent of total shares in Qatar, rights. At the regulatory level, improving their holdings the most in firms three per cent in the UAE, the region the legal frameworks for investor protection that are listed on the Ethisphere five per cent in Saudi Arabia, curtail an is a central piece of the puzzle. At the index.5 As such, a cornerstone and six per cent in Egypt. of the process starts with corporate level, cumulative voting is an In addition to poor legal active investor educating the strategic entities example of a structural instrument that frameworks for investor engagement in the region on the benefits would enhance the representation of protection and underdeveloped of adopting a fundamental minority shareholders on the board of governance structures, foreign and impede and value-driven approach to directors, and thereby give them a stronger investors are discouraged a serious ethics and governance, rather voice in decision-making. Furthermore, the by the general deficiencies in than a compliance approach. establishment of investor relations functions disclosures made by the regional advancement They also need to be given would give these investors direct access companies as well as insufficient into more access to the tools and to the company and would incentivise and coverage by analysts. This ethically techniques to implement best institute a more active engagement. intensifies their burden of practices. A parallel effort to Globally, institutional investors are tracking firms and gaining and socially widen integration of ESG at the acting as key enablers of ESG responsibility, access to reliable information responsible policy level could also facilitate whether through their internal influence (See Figure 4, above). and expedite the progress. on corporate decisions or through their Thus, the ownership practices Additionally, a greater degree investments that favour ethical and structures observed in the of exposure to the active foreign institutional well-governed companies. While this role region curtail an active investor engagement investors would certainly constitute a driving is still almost non-existent among Middle and impede a serious advancement into more force towards stronger ESG responsibility. East companies, some regulatory, market ethically and socially responsible practices. These investors would bring along some and corporate initiatives may open the door Incentives for a more of the stewardship practices that are nearly for a promising long-term shift. 1 constructive institutional role non-existent in the region. Examples of https://www.oecd.org/corporate/Owners-of-the-Worlds-ListedCompanies.pdf 2http://www.gsi-alliance.org/wp-content/ The shift towards a corporate framework that such practices include open dialogue with uploads/2019/03/GSIR_Review2018.3.28.pdf 3Ismail A., D. Jamali, treats ethical, social and governance investee firms, participation in general S., A. Safieddine, G. Samara, “Companies’ Ethical Certification and responsibility as a way of operating the assemblies, the reporting of voting results, their Attractiveness to Institutional Investors: An Intermediate Signaling Perspective,” working paper 4https://onlinelibrary.wiley. daily business, and not just as a regulatory and the engagement in proxy fights. Abraaj, com/doi/full/10.1111/jacf.12253 5Ismail A., D. Jamali, S., A. Safieddine, G. requirement to be met on paper, is a long a UAE private equity firm that recently Samara, “Companies’ Ethical Certification and their Attractiveness journey. Nonetheless, regional companies collapsed following allegations of funds to Institutional Investors: An Intermediate Signaling Perspective,” working paper 6https://onlinelibrary.wiley.com/doi/full/10.1111/jacf.12253 can benefit from the growing institutional mismanagement, is a case in point here. In 82 Ethical Boardroom | Winter 2020


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Board Governance | Audit

The challenges and issues facing auditors in the year ahead Timothy Copnell

Executive Chairman, KPMG’s UK Audit Committee Institute

Prioritising a heavy audit committee agenda is never easy and 2020 will be particularly challenging as audit committees operate against a backdrop of global volatility and economic uncertainty; and in a world where investors and stakeholders have become better informed and increasingly impactful. In this article I look at some of the issues that audit committees should keep in mind as they approach and execute their 2020 agendas.

Controlling the agenda

Maintaining (or regaining) control of the committee’s agenda is critical. In a recent global survey of audit committee members, nearly half of the 1,300 responses said it’s ‘increasingly difficult’ to oversee the major risks on the audit committee’s agenda in addition to its core oversight responsibilities (financial reporting and related internal

controls, and oversight of internal and external auditors). Aside from the raft of new agenda items, the risks that many audit committees have had on their plates for some time – those around financial planning, cybersecurity, IT, ESG, supply chain, operations, legal and regulatory compliance – continue to become more complex. “Be mindful of increasing the committee’s workload and don’t accept responsibilities that rightfully reside with the board as a whole or that cannot be reasonably achieved. Learn to say ‘no’. You can’t do everything – and if you try, you’ ll probably end up not doing anything particularly well.” FTSE100 audit committee chair Boards and audit committee chairs should be reassessing whether the audit committee has the expertise and time to oversee the risks it has been assigned. Do, for example, cyber risk and data governance require greater attention from the full board or perhaps a dedicated committee? Keeping the audit committee’s agenda focussed will require discipline and vigilance in 2020.

Assessing the scope and quality of ESG disclosures

A specific example of an issue climbing quickly up the audit committee agenda is ESG. Nearly all major companies provide some form of ESG or sustainability reporting, but there are growing concerns by a range of stakeholders – investors,

employees, customers, regulators, and activists – regarding the quality, comparability, reliability and usefulness of such information. ESG reporting has been of growing importance to institutional investors for many years, with investors demanding more information and seeking engagement with companies on core ESG issues and their impact on the company. Employee and consumer activism regarding ESG issues is in its early stages – but is also growing – particularly among millennials. The proliferation of climate and sustainability-related regulations and frameworks create a complex matrix of behaviour and reporting requirements for companies to consider. However, the overwhelming voice – and one supported by the FSB Task Force on Climate-related Financial Disclosures (TCFD) – is for greater transparency. Audit committees can focus their oversight on the quality and comparability of ESG reporting and act as a catalyst by encouraging boards and management teams to reassess the scope and quality of the company’s ESG reports and disclosures. This may be a significant undertaking and will likely include complex and time-consuming activities such as benchmarking against peers; consideration of the methodologies and standards of various firms that rate companies on ESG practices; understanding the expectations of investors and other


Global audit committees

84 Ethical Boardroom | Winter 2020


Audit | Board Governance stakeholders; and reviewing various ESG reporting frameworks for possible use by the company. Does the board have the right mix of skills to deliver on this? Should the audit committee consider acting as a formal oversight body for the activity? Consider the need for the company secretarial team to be part of these discussions to help ensure that the necessary infrastructure – controls and procedural – is in place.

While ensuring the robustness of corporate reporting in the round

Oversight over corporate reporting extends beyond ESG issues and is very much a core oversight responsibility. In times of uncertainty, whether created by political events, general economic conditions or operational challenges, investors look for greater transparency in corporate reports to inform their decision-making. Audit committees should consider the detail provided in those areas of the annual report which are exposed to heightened levels of

Audit quality is enhanced by a fully engaged audit committee that sets the tone and clear expectations for the external auditor and monitors auditor performance rigorously

risk; for example, how the going concern considerations have been approached or economic uncertainty created by Brexit and mounting trade tensions. “How understandable is the annual report? Is it really fair and balanced? There is a tendency for management to focus on the good news, but I think the audit committee’s role is to make sure that it’s more balanced and that the downsides are addressed as well as the successes.” FTSE250 audit committee chair. Stand back and think about all the awkward areas where there might be some reluctance to be open. And keep at least a weather eye on what the key investors are thinking. Some investors are becoming increasing vocal about what they want to see in corporate reporting – at a general level, at a sector level and at individual company level – but this may not be communicated directly to the audit committee or the CFO. Be conscious of what your peer companies are reporting and be prepared to be challenged on anything that appears inconsistent.

Reinforcing audit quality and setting clear expectations for the external auditor

While ESG disclosures are relatively new to the audit committee agenda, the oversight of the external audit is very much at the core of an audit committee’s raison d’ être

– albeit the external environment and the expectations placed on audit committees have changed dramatically over recent years. Audit quality is enhanced by a fully engaged audit committee that sets the tone and clear expectations for the external auditor and monitors auditor performance rigorously through frequent, quality communications and a robust performance assessment. It’s about taking the role seriously rather than just going through the motions. “You want auditors that talk candidly about difficult or sensitive issues. It may not be comfortable for the executive team but it’s essential to have this kind of dialogue.” FTSE100 audit committee chair Pay close attention to the audit reform agenda – whether that be the PCAOB’s quality control initiatives in the US, UK proposals for increased scrutiny of audit committees, mandatory joint audits and peer reviews, or other national initiatives intended to maximise audit quality. Probe the audit firm on its quality control systems that are intended to drive sustainable, improved audit quality – including the firm’s implementation and use of new technologies – and consider the results of regulatory reviews and any internal inspections and efforts to address deficiencies. Remember that audit quality is a team effort, requiring the commitment and engagement of everyone involved in the process – not just the auditor, but management and the audit committee too.

PUTTING A FOCUS ON ESG DISCLOSURES Shareholders are concerned over the quality of reporting


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Board Governance | Audit

While ensuring internal audit’s eyes and ears are focussed on key risks beyond financial reporting

In recent years, a number of highly publicised corporate crises have damaged company reputations, due in part to failure to manage key risks such as tone at the top and culture, legal/regulatory compliance, incentive structures, cybersecurity and data privacy, ESG risks, and global supply chain and outsourcing risks. The audit committee should work with the head of internal audit (and chief risk officer) to help identify the risks that pose the greatest threat to the company’s reputation, strategy, and operations and to help ensure that internal audit is focussed on these key risks and related controls. “Focus on those controls judged by management to bring the most significant gross risks down to an acceptable level. The audit plan should be designed primarily to provide the board with assurance that such controls are fully effective.” FTSE100 audit committee chair

themselves and add greater value to the business. As audit committees monitor and help guide progress in this area, we suggest three areas of focus. First, recognising that as much as 60 to 80 per cent of the finance function’s work involves data gathering, what are the organisation’s plans to leverage robotics and Cloud technologies to automate as many manual activities as possible, reduce costs, and improve efficiencies? Second, how will finance use data analytics and artificial intelligence to develop sharper predictive insights and better deployment of capital? The finance function is well-positioned to guide the company’s data and analytics agenda and to consider the implications of new transaction-related technologies, from blockchain to cryptocurrencies. As historical analysis becomes fully automated, the organisation’s analytics capabilities should evolve to include predictive analytics, an important opportunity to add real value.

and legal/regulatory compliance. This is particularly true in a complex business environment, as companies move quickly to innovate and capitalise on opportunities in new markets, leverage new technologies and data and engage with more vendors and third parties across longer and increasingly complex supply chains. “Get below the top layer and into the bowels of the company. Build yourself a network of people you can rely on to feed you information from outside the norm on what is happening in the company, why it’s happening and the underlying culture.” FTSE100 audit committee chair

And third, as the finance function combines strong analytics and strategic capabilities with traditional financial reporting, accounting, and auditing skills, its talent and skill set requirements must change accordingly. Is the finance team attracting, developing and retaining the talent and skills necessary to match its evolving needs? In this environment, it is essential that the audit committee devotes adequate time to understand the finance function’s transformation strategy.

Closely monitor the tone at the top and the culture throughout the organisation with a sharp focus on behaviours (not just results) and yellow flags. Does the company’s culture make it safe for people to do the right thing, and speak up when they see behaviour to the contrary? Help ensure that the company’s regulatory compliance and monitoring programmes are up to date, cover all vendors in the global supply chain and clearly communicate the company’s expectations for high ethical standards. Focus on the effectiveness of the company’s whistle-blower reporting channels and investigation processes through a #MeToo lens. Does the audit committee see all whistle-blower complaints? If not, what is the process to filter complaints that are ultimately reported to the audit committee? As a result of the radical transparency enabled by social media, the company’s culture and values, commitment to integrity and legal compliance, and its brand reputation are on full display.

Coupled with the challenging global regulatory environment – the array of new data privacy, environmental, healthcare, financial services and consumer protection regulations, as well as anti-bribery and corruption regulation like the UK Bribery Act and the US Foreign Corrupt Practices Act (FCPA) – compliance risks and vulnerabilities will require vigilance.

CULTURE IS KING Establish a network of informative people

Is the audit plan risk-based and flexible –and does it adjust to changing business and risk conditions? What’s changed in the operating environment? What are the risks posed by the company’s digital transformation and by the company’s extended organisation – sourcing, outsourcing, sales and distribution channels? Are we sensitive to early warning signs regarding safety, product quality and compliance? What role should internal audit play in auditing the culture of the company? Set clear expectations and help ensure that internal audit has the resources, skills, and expertise to succeed – and help the chief audit executive think through the impact of digital technologies on internal audit.

Understand how technology is impacting the finance team’s talent, efficiency and value-add Major technology changes impacting finance functions present important opportunities for them to reinvent 86 Ethical Boardroom | Winter 2020

Finally, redouble the focus on ethics, compliance and whistle-blower programmes

Culture trumps everything and the reputational costs of an ethics or compliance failure are higher than ever. Fundamental to an effective compliance programme is the right tone at the top and culture throughout the organisation, which supports the company’s strategy, including its commitment to its stated values, ethics,


Board Governance | Risk Management

Better board oversight A guide to where boards of directors can look for useful insight Tim J. Leech

Managing Director, Global Operations at Risk Oversight Solutions

Board risk oversight expectations continue to escalate. In a global world, where directors have limited time for professional development, where can/should directors look for practical information, advice and guidance? For the last 30 years of my career I have focussed on helping organisations around the world and their boards meet escalating risk oversight expectations. Those expectations accelerated rapidly following the 2008 global financial crisis and continue to accelerate as new colossal corporate governance failures, such as Wells Fargo, Boeing, Nissan and many others, come to the forefront. To stay current over the past three decades I have looked to a range of sources for updates on new developments, legal jurisprudence precedents re director standard of care, and practical ‘how to’ advice. This article gives an overview of where boards of directors that want to stay current on board oversight of risk can look for useful guidance.

Staff in the company you oversee Boards have tremendous power to demand information they want. I regularly recommend boards assign responsibility to the corporate secretary to update directors on important corporate and risk governance developments. Quarterly board updates on this subject are appropriate, given the rate of change in the world. The company’s

corporate secretary should, in turn, assign responsibility to the chief internal auditor and chief risk officer, where one exists, to provide the corporate secretary, or the board directly, with updates on relevant corporate and risk governance developments. The updates should be short (under two pages) with links to more details for those board members who are interested. Boards need to make it very clear to the board secretary that this is information they want each quarter to help them meet their corporate governance and risk oversight expectations. The information-seeking process should start by the board director(s) with primary responsibility for oversight of internal audit and risk management asking the chief audit executive (CAE) and/or the chief risk officer (CRO) a few simple questions:


Does the company use a strong first-line risk management approach where management is the primary risk assessor/reporter on important objectives, or do we rely on second- and third-line assurance groups to identify and report problem areas to the board? Does the company provide formal training to management responsible for important objectives on how to identify and assess risks and assess acceptability of residual risk linked to those objectives? If yes, how much and how often? Which assurance approach or approaches does the company use as a primary methodology to obtain assurance – objective centric, risk centric, process centric, control centric or compliance centric? Why has it selected the mix of assurance methods it uses?

2 3

More details on the 10 primary assurance methods available can be sourced online.1

Professional publications

I have been writing in the area of board oversight of risk now for many years. Many others I have great respect for write regularly for influential platforms, such as the Harvard Law School Forum on Corporate Governance, and journals targeted specifically at board directors like Ethical Boardroom in the UK, Conference Board Director Notes, Conference Board Governance Blog and the National Association of Corporate Directors in the US. I encourage you to subscribe to and monitor these sources. After 30 plus years of monitoring directorfocussed publications globally, my vote for top corporate governance advisor is an American – Martin Lipton and his colleagues at Watchell, Lipton, Rosen and Katz who regularly publish in the Harvard Law School Forum. You can access a sample of their work online.2 The posts do a great job overviewing legal standard of care for directors who are subject to US law and, more recently, other global developments and resources. Since the US represents the country that the majority of the biggest and most successful corporations in the world use to access capital, these periodic updates are relevant to board members around the globe. In addition to the legal perspective on evolving director duty of care that Lipton’s posts provide, they offer candid and well-researched views on what good directors should be asking their companies for. While some of his advice may seem like overkill to directors carrying a heavy work burden, these posts are the best I have seen. They cover the broad corporate governance space, as well as the more granular subset of risk governance.

Best new board risk oversight guidance

A new not-for-profit organisation has emerged in the UK called The Risk Coalition. Its founding members

MANAGING BOARDROOM OVERSIGHT EXPECTATIONS Directors should keep informed of the latest developments in risk governance 88 Ethical Boardroom | Winter 2020


Risk Management | Board Governance include board associations, risk associations, internal auditors and more. It has the visible support of UK regulators. In December of 2019, after releasing an exposure draft and receiving input from a broad range of stakeholders, including board members and board associations, The Risk Coalition released in final a new guide titled Raising The Bar: Principles-based Guidance For Board Risk Committees And Risk Functions In The UK Financial Services Sector. 3 Although the report cover specifically states this guidance is intended for financial sector organisations in the UK, the recommendations are, in my opinion, the best I have seen for boards in all business sectors, including not-for-profit and government functions with boards, that want to do a better job overseeing risk functions and risk governance. The Risk Coalition has indicated that it may issue another report specifically tailored to address risk oversight in other business sectors. Its 2019 guidance assumes all organisations have a risk function, which is often not true in sectors outside of the financial sector. In the foreword of this guidance there is a short paragraph that has disproportionate importance. It states: “The separate

Boards have tremendous power to demand information they want. I regularly recommend boards assign responsibility to the corporate secretary to update directors on important corporate and risk governance developments


guidance of ‘eight principles’ for board risk committees and ‘nine principles’ for risk functions is helpful. The emphasis on first-line responsibility and accountability for risk management is overdue. Hopefully, the three lines of defence model benefits from extra clarity.” This is the first authoritative guidance I have seen that specifically recommends boards call on the companies they oversee to move away from traditional internal audit and risk management and reporting methods which are, in essence, weak first-line risk governance models, to a stronger first-line risk governance approach. Strong first-line risk governance is an approach where accountability of the first line/management to regularly assess and report upwards on the state of risk linked to top value creation and preservation objectives to boards is clear; accountability to assess and report upwards rests squarely with management responsible for important value creation and preservation objectives; and management is provided with adequate training to fulfil that expectation. Paragraph 27 of Principle 5A for boards in the guide and paragraphs 29 to 33 of Principle 6 are illustrative of the emphasis on this dimension in this new guidance (see box-out, right). On page 26/36 of the report, the authors take the bold step of proposing what the Institute of Internal Auditors should do when they update IIA guidance on what is generally known as the three lines of defence model (3LoD)– an update expected in the first half of 2020: “First line management should manage risks through the disciplined application of the organisation’s risk management framework. The aim is to help the organisation achieve its strategic objectives while remaining within risk appetite. Consequently, first-line management should be the principal source of (non-independent) risk information presented to the board risk committee.”

27 Seek appropriate assurance on the completeness, accuracy and fairness of first-line management’s reporting of the organisation’s: ■ principal and emerging risks (including emerging categories of risk) and their impact on the likely achievement of the organisation’s strategic objectives in both the short- and medium-term ■ proposed or actual risk responses ■ significant incidents and near-misses, actual or likely breaches of risk appetite, overall risk profile and risk capacity In meeting this principle, the board risk committee should: 29 Assess the quality and appropriateness of board-level risk information and reporting from each of the lines of defence, including whether significant matters are escalated sufficiently promptly and the overall quality of supporting narrative and analysis 30 Challenge whether first- and second-line board-level risk information and reporting adequately leverage risk data aggregation and analysis techniques to identify latent patterns of risk and predict emerging risk trends and themes 31 Consider whether board-level risk information and reporting is both comprehensive and comprehensible, enabling nonexecutive directors to understand, probe and challenge executive management effectively 32 Seek appropriate assurance on the quality and reliability of the organisation’s risk information governance and reporting arrangements, including the adequacy and appropriateness of executive management procedures for deciding what risk-related information to present to the board and its committees 33 Confirm that risk information reporting between group entities (where relevant) and with regulatory authorities is complete, accurate and timely

Winter 2020 | Ethical Boardroom 89

Board Governance | Risk Management The statement in the foreword of The Risk Coalition guidance that states ‘the emphasis on first-line responsibility and accountability for risk management is overdue’ may be the biggest single understatement in board guidance documents that I have seen in my 35 years monitoring the space.

From international professional associations like the IIA In late 2019, the Institute of Internal Auditors released a study titled OnRisk 2020: A Guide To Understanding, Aligning, And Optimising Risk. While the authors of the guide clearly assume that enterprise risk management is fundamentally about creating risk registers/risk lists, not assessing certainty important objectives will be achieved (an assumption I have written at length on and take huge exception to), it does contain some incredibly important conclusions that point to major problems in the quality of information on risk status that boards are receiving: ■ Boards are overconfident Boards consistently view the organisation’s capability to manage risks higher than executive management – evidence of a critical misalignment between what executive management believes and what is communicated to the board ■ Boards generally perceive higher levels of maturity in risk management practices Board members’ perceptions of risk knowledge and capability place them ahead of executive management and chief audit executives, relative to risk maturity, therefore making them more likely to believe those risks are better managed ■ ‘Acceptable misalignment’ on risk is a prevalent and dangerous mindset. A majority of respondents believe some misalignment on risk perception should be expected, with some viewing it as ‘healthy’. While misalignment around individual knowledge of a risk may be acceptable, based on varying roles, misalignment on the perception of the organisation’s capability to manage a risk is a serious concern The authors go on to say on page 9/40 of the report: “One reason for this misalignment may be the quality and completeness of information flowing to boards. Boards need information that is complete, accurate, and timely, and must establish proper oversight practices to ensure this. This challenge is not unknown to boards. According to the National 90 Ethical Boardroom | Winter 2020

Association of Corporate Directors (NACD) report, 2019 Governance Outlook, ‘Directors struggle to keep up with a rapidly evolving business landscape. For the second year in a row, NACD’s public company governance survey found that a large majority of directors, almost 70 per cent, report that their boards need to strengthen their understanding of the risks and opportunities affecting company performance.’2 The cited public company governance survey also found boards are spending twice as much time reviewing information from management than from external sources, ‘revealing a heavy dependence on management views and analysis in fulfilling their oversight duties’. What’s more, more than half (53 per cent) of directors indicated that the quality of information from management must improve, ‘suggesting the board needs better, not more, information from management’.” 3 Although I am strongly against the reports and studies that have an underlying assumption that enterprise risk management means creating risk lists, and don’t think the new IIA report OnRisk identifies the real reasons boards are not getting the information they require to meet risk oversight expectations, it does shine a spotlight on a really big problem – boards are not getting the information they need to do a good job of overseeing risk.

From the Americans

In 2017, the US Committee of Sponsoring Organisations, commonly known as COSO and comprised of five accounting/financerelated organisations, released a new guidance document, on Enterprise Risk Management (ERM). Its biggest shortcoming in terms of being useful is that the full guidance is a daunting 202 pages. Unlike the clarity in the principles-based’ The Risk Coalition guidance from the UK, COSO ERM messaging to board members on what they


should be doing to oversee risk governance is obfuscated and some have labelled it ‘consultant speak’. Although it has important messages, only incredibly persistent board members are likely to have attempted to onboard key COSO ERM messages. On the positive side, COSO ERM 2018 guidance’s major contribution to better risk governance is that it stresses that risk should be seen and assessed in direct relation to the company’s strategy and objectives, and risk management should be integrated with performance. In my experience, only a small minority of companies today have integrated their ERM frameworks with top strategic objectives or performance. Although there is much to be critical about in this 2017 US guidance, the executive summary does call on boards to ask management some really important questions.

Questions for management

Can all of management – not just the chief risk officer – articulate how risk is considered in the selection of strategy or business decisions? Can they clearly articulate the entity’s risk appetite and how it might influence a specific decision? The resulting conversation may shed light on what the mindset for risk taking is really like in the organisation. Boards can also ask senior management to talk not only about risk processes but also about culture. How does the culture enable or inhibit responsible risk taking? What lens does management use to monitor the risk culture, and how has that changed? As things change – and things will change, whether or not they’re on the entity’s radar – how can the board be confident of an appropriate and timely response from management?

Best regulatory approach

Driven by the countries where my clients operate, I have had to stay up to date on what national regulators believe, in the opening words of The Risk Coalition, ‘good looks like’. The most notable regulators I track are regulators in Canada, the US, UK, Europe, South Africa and Australia.




Risk Management | Board Governance After working globally, my pick for the most useful national regulatory guidance goes to the Financial Reporting Council (FRC) in the UK. Overall, the UK Governance Code is a useful and principles-based guide. FRC has also been doing some ground-breaking research on the impact of corporate culture on corporate performance and behaviour. I believe at a high level the UK Governance Code, when combined with the new The Risk Coalition guide Raising the Bar provides a fairly comprehensive view of what boards need to be doing.

■ Monitoring and reviewing the effectiveness of the company’s internal audit function or, where there is not one, considering annually whether there is a need for one and making a recommendation to the board

Two big cautions on FRC guidance

Powerful institutional investors

In spite of the FRC being my national regulator guidance of choice, the FRC may well be a primary cause of companies globally adopting ineffective risk registers/risk listing as a foundation for their ERM frameworks. This UK-led movement to create risk lists, which came to the fore when the UK initially launched the UK Governance Code, has had the unfortunate effect of creating the illusion of effective risk management. Paragraph 28 in the 2018 Code and earlier versions is likely the main culprit:

28. The board should carry out a robust assessment of the company’s emerging and principal risks. The board should confirm in the annual report that it has completed this assessment, including a description of its principal risks, what procedures are in place to identify emerging risks, and an explanation of how these are being managed or mitigated. These words in the 2018 Code and earlier versions have caused companies to believe that they need to compile lists of ‘principal risks’ and adopt ‘risk-centric’ ERM frameworks. Unfortunately, boards have been receiving little information on the affect of the risks in these risk registers/risk lists on the certainty of achieving important strategic/value creation and value preservation objectives. The FRC would do well to rewrite the Governance Code in the area of risk oversight as soon as possible. The other main area over which I have raised concerns with the FRC in the past, is their lack of guidance for boards on how to assess the effectiveness of internal audit functions. Audit committees are responsible for overseeing the effectiveness of internal audit but little is provided to help boards know ‘what good looks like’. The Risk Coalition Raising The Bar guidance does not address this dimension of board oversight in a useful way.

In summary, while there are some significant areas for improvement, particularly the two areas noted above, the FRC UK Governance Code is still the best risk governance guidance out there right now from a national regulator. A relatively new phenomenon that boards need to be aware of is the increasingly strident risk governance expectations of institutional investors. The biggest and most powerful institutional investors in the world are calling on boards to do a better job overseeing risks that have potential to impact corporate strategy and corporate solvency. While these players that control literally trillions of dollars of capital, including behemoths like BlackRock and Vanguard,

The biggest and most powerful institutional investors in the world are calling on boards to do a better job overseeing risks that have potential to impact corporate strategy and corporate solvency

provide few practical details on ‘what good looks like’ in terms of strategy and risk oversight, they do make it abundantly clear that want to hear persuasive stories about how boards and senior management of companies they have invested in are satisfying themselves that the companies they oversee have effective risk frameworks, linked to top strategic/value-creation objectives, as well as potentially fatal value-preservation objectives, such as complying with laws, publishing reliable financial information and data security. Those interested in a quick primer on the rise in power and expectations of institutional investors can access my fall 2019 article in Ethical Boardroom titled Board Oversight of Strategy and Risk.4

Going forward

What is abundantly clear is that boards and directors that ignore the rapid escalation in risk oversight expectations do so at their peril. Corporate, as well as personal, reputations are ‘at risk’. Best wishes for success with your risk oversight work in 2020. I hope you and the companies you oversee find this advice useful. http://bit.ly/2mkJW0I 2https://corpgov.law.harvard. edu/contributor/martin-lipton/ 3http://bit.ly/2QTlP4X 4 https://riskoversightsolutions.com/wp-content/ uploads/2011/03/EB_Autum2019_TimLeech_BoardOversight-of-Strategy-and-Risk.pdf 1

RISKY BUSINESS It needs improving but the FRC’s UK Governance Code is still the best

25. The main roles and responsibilities of the audit committee should include: www.ethicalboardroom.com

Winter 2020 | Ethical Boardroom 91

Ethical Boardroom Keeping it Above Board

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

Board Governance | Corporate Culture

Why 2020 is the year to reshape your code of conduct and build a culture of integrity Rebecca Turco

Senior Vice President of Learning & Content at SAI Global

The corporate scandals we’ve witnessed in recent years are creating a new level of awareness when it comes to what can happen if ethics aren’t integral to the way organisations operate. With codes of conduct now more important than ever, how effective is yours at influencing culture and motivating employee behaviour? Events playing out globally in the last few years have shown that ethical corporate practice is seen as increasingly important from a public perception and regulatory point of view. With movements like #metoo and #timesup and broader public sentiment, expectations of workplace and social behaviour are changing. And, as the urgency for many organisations to address

workplace culture and conduct issues increases, business leaders are coming under pressure to build cultures of integrity, free of harassment, discrimination and destructive workplace conduct. Culture – the shared set of values, mindsets and assumptions distinct to an organisation – is the single biggest factor determining the amount of misconduct that will take place. The reflection of a company’s values is found in its code of conduct. Starting each year with a reaffirmation of company values is a significant opportunity to reinforce an ‘ethical tone’ for a business. Here is where simple, effective leadership can have a big impact. Despite best intentions, what we often see is company leadership rolling out a full-on communication strategy, complete with values posters that go up in every break room. All this is completely ignored by the employees. The truth is, employees don’t look just to marketing campaigns to determine what the company values are. Although it’s a start to effectively roll out a programme, it’s not enough. Organisations need the tools and solutions in place to manage ethical risk, as well as attention and focus on creating the right culture. The culture that you have within the organisation will drive the risk employees will take. Employees watch leadership behaviour, observe what gets rewarded and what gets punished and where the money gets invested to determine what a company values and what it doesn’t. In other words, they look to the culture to see what values are being supported.

Pillars of an ethical culture

Few executives set out to achieve advantage by breaking the rules, and most companies have programmes in place to prevent malfeasance at all levels. Yet recurring events show that the corporate world needs to do better. For the first time in 19 years, ethical lapses were the number one cause of CEO turnover in an annual PwC study.1 In the wake of revelations about the pervasiveness of behavioural misconduct among executives, two-thirds of the CEOs terminated from their roles in 2018 had been accused of ethical lapses, according to the May 2019 report. The rise in ousted CEOs is not because of more bad behaviour or more corporate scandals, but because boards have become more reactive to the real-time social media news cycle pressures and face greater scrutiny from investors, the public and employees. With the change in technology and the way people consume content and use social media, the engagement of employees is even more critical than ever. Employees have a very powerful voice, they are speaking to customers every day, they are the reason an organisation will succeed or fail. During 2019, a warning came from an unlikely place regarding the issue. In his annual letter to CEOs, Larry Fink, founder and CEO of BlackRock, the world’s largest asset manager, said that society is “demanding that companies, both public and

It’s time to become 94 Ethical Boardroom | Winter 2020


Corporate Culture | Board Governance private, serve a social purpose. To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society. Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate.”2 Companies now have more of an incentive to be ethical as the area of socially responsible and ethical investing keeps growing.3 Globally, sustainable investing assets stood at $30.7trillion at the start of 2018, a 34 per cent increase in two years, according to the Global Sustainable Investment Alliance (GSIA).4 The increasing number of investors seeking out ethically operating companies to invest in is driving more companies to take this issue more seriously. And chances are, the expectations for delivering on ethical responsibility – and the resultant implications for the CEO – is only set to increase. In light of this scrutiny that the CEO and boards now face, it is essential for company leadership to become more visible and vocal when it comes to ethical conduct. After all, ethics has everything to do with management. But without a supporting culture and controls imposed from the top, an organisation is susceptible to breakdowns and ethical failures, which could tarnish its reputation and diminish trust from both internal and external stakeholders. Although most business leaders intuitively recognise the importance of ‘tone at the top’ for setting ethical standards in their company, easily

overlooked is ‘tone in the middle’ and the ‘tone of the company’. These are more significant drivers for ethical employee behaviour. Good leaders produce good followers; but if employees are surrounded by co-workers who are behaving unethically, they will most likely do the same, regardless of what their bosses say. Rarely do the character flaws of a lone actor fully explain misconduct. More typically, unethical business practice involves the tacit,

Organisations need the tools and solutions in place to manage ethical risk, as well as attention and focus on creating the right culture if not explicit, assistance of others and reflects the values, attitudes, beliefs, language and behavioural patterns that define the company’s operating culture. So-called descriptive norms – how peers actually behave – tend to exert the most social influence. Most people have less difficulty knowing what’s right or wrong than they do keeping ethical considerations top of mind when making decisions. Ethical lapses can

therefore be reduced in a culture where ethics are at the centre of attention. It is essential, therefore, for managers, employees and the board to believe the need for ethical change and to be champions of that change because deeply embedding an ethical culture requires buy-in and commitment from all levels of the company. If the established corporate vision for change can trickle down, then simple acts of compliance with best practices can also rise up to shape a workplace culture of integrity. Take a look at Google – the employees did not accept a culture where misconduct is rewarded, and globally walked out and asked senior management to change their policy. This shows that somewhere in Google’s cultural DNA, speaking up is encouraged, that employees aren’t afraid to say something, and they are the voice of the business.

Getting the message across

Reputation is proving to be more salient than ever to long-term corporate success. And more companies are seeing the light and investing in their reputations – either in response to embarrassing and costly scandals or from their own foresight. To establish a sustainable reputation, cultural alignment is as important as strategic alignment. To foster a climate that encourages ethical behaviour, businesses, large or small, need a comprehensive approach that goes beyond the often-punitive legal compliance stance. And while some companies strive to go beyond hitting the bare minimum regulatory standards, the truth is there are fundamental characteristics that contribute to highquality ethics and compliance programmes. 5 Establishing strong company values and living up to them each day as an organisation is a good place to start.

a better business oardroom.com

Winter 2020 | Ethical Boardroom 95

Board Governance | Corporate Culture But there is plenty of evidence that organisations cannot solve their ethical challenges by simply introducing a set of corporate values. Though this has become a common way for companies to show good intentions, it has little to do with their ability to actually be ethical. Most companies that have gotten into trouble over the past years had nice values, yet those values didn’t stop them from engaging in egregious conduct. Every company today must have an evolving ethical framework strategy to maintain trust among their stakeholders. Organisations should look across their entire risk profile and consider their approach to ethics, culture and integrity and actively engage to protect their ethical core by moving beyond simply introducing a set of ESTABLISHING AN ETHICAL WORKPLACE Companies thrive when employees feel part of a strong corporate culture

corporate values and putting in place the tools and solutions to manage ethical risk. To change sentiment and to embed an ethical risk aware organisation, initiatives must begin and thrive internally, with employees committed to building and owning corporate culture, before they become apparent to external stakeholders. Otherwise codes of conduct, ethics policies, compliance measures and articulated values just become boxes to check and words on the wall without efforts to instil an ethical culture in the daily actions of the company. Though executives are driving the ethical strategy, employees actually play a more important role in preventing ethical lapses, especially given the rise in whistleblower protections and non-retaliation policies. Culture is driven by employees, the decisions they are making and what they say about the company. They are the voice of culture. Top and middle management need to lead, direct and participate in the culture conversation, but employees are the owners. Focussing on ethics and integrity at periodic intervals or in isolated activities is not enough. Every day, employees face complex situations and cost pressure demands to do more with less. These types of pressures, when managed appropriately, can 96 Ethical Boardroom | Winter 2020

drive people to be more efficient and innovative. When not, it can lead to poor decision-making and improper shortcuts, which can cost a company its reputation. In a deadline-driven, cost-conscious environment, the importance of ethics and integrity can be lost. This is why deliberate, simple and frequent messaging to employees is important. Ethics and compliance (E&C) is about training and communication, but it is also about having conversations around ethical and compliance issues. By using learning-centric technology and in-person, or live remote connections for working through thornier grey areas, directly allows for richer dialogue, more robust conversation, and better perspective-taking. By implementing a campaign-based approach to E&C learning,

navigate change and respond appropriately in the face of mounting pressures.

Living code of conduct

People spend much of their lives at work and want to support and align themselves with companies that do the right thing. They are eager to see their own values mirrored by the companies they choose to work with. In Glassdoor’s new mission and culture workplace sentiment survey, it found that more than half (58 per cent) of employees and job seekers say company culture is more important than salary when it comes to job satisfaction.6 Just as consumers can hold businesses accountable by holding revenue hostage, employees can play an equally, if not more, important role in shaping both a company’s day-to-day operations and future priorities. The Google walkouts are a great example of this. With workers placing a higher emphasis on the values of their employers and where scrutiny and access to information remain bountiful, companies cannot afford to be apathetic in approaching their own character. In a recent study by SAI Global, data shows that more than half of people (57 per cent) were less forgiving and mistrusting of an organisation that had allegations of misconduct in the workplace toward employees or suppliers.7 Focussing A reputation for ethics helps to on ethics attract and retain the best talent and integrity while minimising the cost of turnover. These individuals then at periodic foster and grow a work culture a business can create a central intervals or that’s built around shared values. An ethical workplace is key hub of a well-thought-out and in isolated because it allows employees to feel supported capability for driving a sense of purpose and integrity corporate values and expectations activities is on the job. When staff feel integral for conduct into the fabric of the not enough about their work, the company company culture. culture will thrive and, in turn, The code of conduct, therefore, boost morale, motivation and productivity. needs to be part of the workflow, part of In the end, creating a climate that how people access information, where they encourages exemplary conduct may seek information. It needs to be dynamic be the best way to discourage damaging and meaningful, so employees can see misconduct. Only in such an environment that the company they work for is trying do rogues really act alone. But no company to drive a healthy culture and help them will ever be perfect. Nonetheless, by make ethical decisions or to understand an integrating ethics and integrity into your ethical dilemma that they might face. overall identity, you can achieve better But the code of conduct is not a one-time self-awareness, create greater brand event, it needs to be a living code of conduct, value and work toward goals that have a one that is truly embedded into the positive impact on your business, your organisation. This is turn, helps to drive customers and society as a whole. down the number of ethical missteps and empowers employees to feel comfortable 1 https://www.bloomberg.com/news/articles/2019-05-15/ about raising concerns before they become ceos-fired-for-ethical-lapses-hit-new-high-as-complaintsmajor issues. Having employees take soared 2https://www.blackrock.com/corporate/investorrelations/larry-fink-ceo-letter 3https://www.ftadviser. responsibility for their own actions and for com/investments/2019/10/10/ethical-investing-is-havingtheir co-workers’ and speaking up when its-moment/ 4http://www.gsi-alliance.org/wp-content/ they see something that doesn’t feel quite uploads/2019/03/GSIR_Review2018.3.28.pdf 5https:// www.ethics.org/resources/high-quality-ec-programsright, is essential in maintaining a strong hqp-standards/ 6https://www.glassdoor.com/blog/ organisational foundation of integrity. That mission-culture-survey/ 7https://www.saiglobal.com/hub/ kind of foundation provides the ethical sai-global-newsroom/global-consumer-trust-is-on-theoffensive-survey-finds-2 grounding necessary for employees to www.ethicalboardroom.com

Illuminating the Top Global Risks in 2020 Explore Protiviti’s digital Executive Perspectives on Top Risks 2020 report and prepare for the risks likely to affect your organization this year. Visit protiviti.com/toprisks for the full report.


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Global News Latin America & Caribbean Ex-Vale CEO charged with murder Brazilian state prosecutors have charged Fabio Schvartsman (right), the former chief executive of mining giant Vale SA, and 15 other people with murder and environmental crimes for the Brumadinho dam disaster. Prosecutors for the Brazillian state of Minas Gerais also tabled homicide charges against five people at Germany’s TÜV SÜD, the auditing company that certified the dam as safe months before it gave way. In a statement, prosecutors said that there was a relationship of ‘pressure, collusion, rewards and conflict of interest between Vale and TÜV SÜD’. They alleged that Vale hid information about the dam’s instability to avoid hurting the company’s reputation and TÜV SÜD issued reports saying it was safe. The collapse of the tailings dam killed 270 people on 25 January 2019.

St Lucia hails itelbpo expansion on the island Jamaican business outsourcing Itelbpo Smart Solutions company has expanded into St Lucia and will open a new factory in April 2020. Itelbpo now operates eight facilities in four countries — Jamaica, The Bahamas, Mexico and the United States. According to Invest Lucia, the official investment promotion agency of the government of Saint Lucia, Itelbpo is ‘known in

Jamaica for its stellar corporate governance’. “Invest Saint Lucia has brought on board an investment partner that seems to want to invest in the wider community as a responsible corporate citizen,” the agency stated. Invest Lucia said the agreement was an example of its effective negotiations with local and foreign investors leading to new business ventures being established on the Caribbean island.

Ceron named new BMS COO

Alejandro Ceron has been appointed as the new chief operating officer of specialist insurance and reinsurance broker BMS Group’s Latin American & Caribbean division. Ceron was the founder in 2016 and CEO of his own consulting firm, focussing on corporate governance and organisational growth strategy. Jose Astorqui, CEO of BMS Latin America & Caribbean, said Ceron’s appointment would help the company to expand its operations and increase its brand recognition as it offers reinsurance services across the Latin American and Caribbean regions. Ceron, who will report to Astorqui, will be based in Miami.

Cemig unveils new chief executive

Petrobras exits Brazil governance programme Brazilian state-run oil firm Petrobras has asked to withdraw its participation in a programme certifying good governance set up by the Sao Paulo stock exchange. The company wants to leave the Distinction in Governance Program for State-Run Firms established by exchange operator B3 SA in 2015. Petrobras has spent years trying to recover from one of the world’s biggest ever corporate graft scandals. A five-year-old corruption investigation, known as Operation Car Wash, uncovered billions of dollars of bribes and overpriced contracts between Petrobras and engineering firms. According to Reuters, Petrobras believes it is no longer necessary to remain in the programme and that its exit will not weaken its governance. “The company continues to stand out, in recent years, for the continuous improvement of its corporate governance rules and internal controls,” Petrobras said

98 Ethical Boardroom | Winter 2020

Brazilian state-run power firm Companhia Energética de Minas Gerais (Cemig) has named Reynaldo Passanezi Filho as its new chief executive officer. According to a securities filing, Passanezi Filho is a former CEO of Colombian transmission company CTEEP with ‘broad experience in corporate restructuring, mergers and acquisitions, Latin America and infrastructure’. Passanezi Filho took over the role immediately, replacing Cledorvino Belini, who had been head of the company since February 2019. Belini will remain a member of Cemig’s board of directors. Reuters reports that Cemig did not say why it was replacing Belini, who was leading a revamp of the company involving job cuts and cost reductions. www.ethicalboardroom.com

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Risk Management | Fintech OVERSEEING NEW FINTECH PARTNERS Organisations need to assess a fintech’s ability to meet their control standards

Fintech-friendly onboarding So, you met a vice president of a large bank at an industry meet-up or conference and convinced her that your brand new fintech product is critical for the next phase of their project build. Awesome! Then, you pitched the product to her boss and confirmed with the bank’s technology team that your product will integrate into their existing tech stack. Even better! But don’t start fantasising about a global launch quite yet… even with the business, technology and operations on board, there are stakeholders within procurement, risk and compliance who need to sign off on the deal. Unfortunately, for many fintechs, these control functions can appear to be impenetrable gatekeepers that want to stifle innovation.1 However, it may only take a little understanding and preparation by the fintech to transform the bank vendor onboarding process from a Herculean task to a predictable and instructive exercise. This article offers guidance to fintechs on how to avoid a protracted onboarding timetable when selling products and services to regulated financial services (FS) organisations.

Understand the implications of the deal you structure

Onboarding implications differ, based on how fintechs structure agreements with a bank or FS organisation. While this is only one lens through which to view your potential business dealings with the FS organisation, it is an important consideration – if speed for signing the 100 Ethical Boardroom | Winter 2020

A guide to third party risk management and fintech/financial services partnerships Greg Matthews, Nicole Trawick & Sarah Gross

Greg is a Partner, Nicole a Manager and Sarah an Associate at KPMG contract (and receiving payment) is a key concern. Your two choices are acquisition/ joint venture or subscription service/ standard vendor contract. Acquisition or joint venture Banks are required to manage the risk from services provided by their affiliates or joint ventures. Therefore, fintechs that are acquired in whole or part may still field inquiries from the bank’s third-party risk management (TPRM) team – from initial onboarding, through risk assessment, ongoing monitoring and termination. Subscription service or standard vendor contract Run-of-the-mill, thirdparty service agreements between fintechs and FS organisations will go through the full procurement and TPRM processes, including (as applicable) competitive bid and request for proposal (RFP) processes.

Forewarned is forearmed for TPRM

TPRM defined Third party risk management is consistently listed as a regulatory priority across jurisdictions globally. In 2019, the European Banking Authority (EBA) refreshed its outsourcing guidance with granular and proscriptive requirements for FS organisations to identify, assess, monitor and manage third-party risk. 2 The general theme across all TPRM regulations is that while FS organisations can outsource an activity, they cannot outsource accountability for

the risk and therefore need to assess the fintech’s ability to meet their control standards associated with delivering that product or service. The TPRM lifecycle and what it means for you Due to the regulatory burden, client and customer scrutiny as well as board oversight, mature FS organisations have developed comprehensive TPRM programmes that adhere to a consistent, multi-phased lifecycle. Any fintech that contracts with an FS organisation will interact with the TPRM team before, during and after contracting. Initial risk assessment Your business contact (in this case, the vice president from the meet-up whom you convinced needed your product) will likely fill out a form with basic information about the product that will calculate an inherent (for which read initial) risk score for the third-party relationship. Due diligence Not all fintech products or services are created equal when it comes to TPRM. Offerings that help the FS organisation fulfil regulatory requirements, involve the sharing of confidential data, or underpin the business continuity of the bank, will trigger a higher inherent risk score. Based on the inherent risk score, a series of due diligence questionnaires covering various risks associated with your service (e.g. information security if you handle data, compliance if you interact with customers) will be triggered and sent to you to complete. www.ethicalboardroom.com

Fintech | Risk Management Make sure you have the right programmes and discipline at your end to give the bank comfort that the fintech product or service is being offered in alignment with its standards. Well-documented policies, procedures and risk management frameworks with experienced employees will greatly expedite the due diligence process. Be timely and thorough when responding to these questionnaires; we find that the back and forth between subject matter experts and fintechs can be the most painful and cumbersome part of the TPRM process. Due diligence may uncover findings or issues that the FS organisation will work to remediate with you by strengthening your risk and compliance processes and programmes. Contracting The due diligence process may lead to additional terms and conditions being included in your contract with the FS organisation. Banks will have a list of clauses that likely include the right for the FS organisation to audit you (potentially on site) and/or receive SOC 2 reports or the results of internal controls testing. Ongoing monitoring Both the risk and criticality of the third-party fintech product or service will determine how often – and how strenuously – the FS organisation will conduct ongoing monitoring. This could include the aforementioned audits and control testing, but ongoing monitoring also relates to adverse media, corporate actions and performance metrics, including adherence to service level agreements (SLAs). The main takeaway here is that TPRM is not a one-time exercise; expect continuous baseline monitoring with periodic due diligence reassessment. Termination Sadly, all good things must come to an end. When you and the FS organisation decide to part ways, it will want assurances that, among other things,

Make sure you have the right programmes and discipline at your end to give the bank comfort that the fintech product or service is being offered in alignment with its standards data was destroyed and fintech employees with access to the FS organisation have their accounts deactivated. Additionally, some FS regulations will mandate that you maintain records for a given period of time.

What banks can do to help

Despite the challenges, incorporating fintech offerings has become a business imperative for established FS organisations as they work to satisfy customer expectations and remain competitive. Many leading FS organisations are pursuing the following actions to go to market quickly with fintech start-ups:


Developing a ‘white glove’ service within the TPRM process to advise fintechs on how to complete the due diligence questionnaires and mature risk and compliance processes and programmes Funding innovation labs and accelerators to shape the growth of fintech startups and watch them over time before investing or partnering Building a data sandbox to move forward on proof of concept with dummy data in parallel with procurement and TPRM processes Integrating with a third-party assessment utility, like KY3P or TruSight, so that fintechs need only

2 3


complete due diligence assessments once; the same assessment can be leveraged by multiple banks and FS organisations

Coming back to you, fintech founder and your next steps

You’ve gotten to the end of this article and are now briefed on the complexities of the procurement and TPRM processes. Additional actions to consider include the following:


Structure the deal in a way that matches your appetite to take on your share of the TPRM requirements (acquisition, partnership, or subscription service) Prepare your risk and compliance teams to answer a plethora of TPRM assessment questions; invest in these functions to bring them up to maturity Communicate actively with your advocates in the FS organisation; if they want to close the deal, they will help shepherd you through the assessments and paperwork

2 3

While the TPRM process may seem overwhelming, the good news is that banks and FS organisations are working to streamline these processes to expedite decision-making and onboarding. Additionally, for fintechs and FS organisations who get this right, the rewards can be valuable. According to a 2019 Thompson Reuters study, ‘the greatest perceived potential benefits from fintech include enhanced productivity, efficiency and accuracy, better product delivery and customer experience, as well as improved compliance monitoring and reporting’. 3 https://www.forbes.com/sites/ronshevlin/2019/10/14/ bank-fintech-partnerships-the-fad-is-over/#6769e0fe7527 https://eba.europa.eu/eba-publishes-revised-guidelineson-outsourcing-arrangements 3Fintech, Regtech and the Role of Compliance in 2019, Thompson Reuters



WHICH FINTECHS POSE THE MOST CHALLENGE FOR TPRM PROGRAM? TPRM process filters fintechs by level of risk management and compliance maturity

Business identifies fintech partnership opportunity

2 1

Blockchain & crypto Capital markets Money transfer & remittances Insurance Lending 3 Payments & billing Personal finance Real estate RegTech Wealth Management



Source: CB Insights, Global Fintech Report Q3 19 (November 2019)


Risk and compliance maturity factors

1 2 4 6

3 5

4 5 2 1 3 6


TRPM program pursues one of two paths

Fintech has robust risk management & compliance programs Established technology firm that has familiarity with FS regulations Early-stage fintech start-up that does not have risk management or compliance programs


A. Standard TPRM process: Fintech is prepared for the standard TPRM process


B. White glove service: Fintech may require additional hand-holding to complete the TPRM process via a ‘speciality program’

Winter 2020 | Ethical Boardroom 101

Risk Management | Money Laundering

Regulators’ long reach in AML enforcement

Key considerations for members of the boards of non-US headquartered banks Sven Stumbauer

Senior Advisor, Norton Rose Fulbright LLP

The uptick in money laundering scandals continued in 2019 and, as has been the case during the past two decades, US regulatory bodies and authorities were most aggressive in enforcing US anti-money laundering (AML) and sanctions laws across the globe. When assessing AML risks and exposures, global financial institutions must continue being mindful of the US regulatory landscape and the broad authority that US banking regulators and authorities assert and exercise around the globe. Maintaining this mindfulness is even more challenging for some boards of directors of financial institutions headquartered outside the US. A natural tendency of boards and senior management is to structure AML and sanctions compliance predominantly according to the respective national standards of their headquarters, often opening themselves up to significant regulatory exposure in the US. This exposure might be more evident in the case of a global financial institution with a US branch, which potentially opens the entire financial institution to US regulatory scrutiny. But even without a branch or subsidiary, a non-US bank may be exposed to civil or criminal risk for transactions conducted in US dollars and cleared in the US.

Ignored warnings

During the past decade, there have been numerous newspaper headlines and enforcement actions revealing US regulators’ increased scrutiny of financial institutions’ boards of directors and senior management for failing to correct alleged compliance shortcomings. 102 Ethical Boardroom | Winter 2020

Active board involvement plays a crucial role in the adoption and implementation of effective enterprise AML-compliance programmes. In the past decade, several regulatory enforcement actions have called for the establishment of AML-compliance committees composed of outside directors and also called for oversight of boards of directors in remedial efforts, as well as the hiring of so-called ‘independent compliance monitors’. Enforcement actions have also held board members personally accountable for financial institutions’ lack of compliance and, in some cases, have exposed companies to shareholder litigation risk, due to a decline in shareholder value. US regulatory bodies have made this point clear through enforcement actions that often cite language such as: “The board shall ensure that the bank achieves and thereafter maintains compliance with this order, including, without limitation, successful implementation of the BSA (Bank Secrecy Act)/AML action plan. The board shall further ensure that, upon implementation of the BSA/AML action plan, the bank achieves and maintains an effective BSA/AML compliance

Not all financial institutions are identifying and measuring their AML risks effectively or correctly, resulting in inadequate controls and, ultimately, potential compliance failures programme.”1 And, again, telling a board to: “maintain a compliance committee of at least three directors, of which at least two may not be employees or officers of the bank or any of its subsidiaries or affiliates…. The compliance committee shall be responsible for monitoring and coordinating the bank’s adherence to the provisions of this order.’2 Boards of financial institutions should have considered themselves forewarned when the US Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) issued an advisory on this topic in 2014.3 The FinCEN advisory gives guidance to financial institutions and their boards. In particular, the advisory reconfirms the notion that a

financial institution can improve AML compliance culture by ensuring the following key elements are present and enforced by the board of directors:

■ Leadership is engaged ■ Compliance is not compromised by revenue interests ■ Information is shared throughout the organisation ■ Leadership provides adequate human and technological resources ■ The compliance programme is effective and has been tested by an independent and competent party ■ Both leadership and management understand how their various AML reports are used

Becoming and staying compliant – identifying, measuring and quantifying risk Basic key considerations for members of boards, in order to execute their duties effectively, are to understand the financial institution’s business and the associated AML risks, as well as the evolving regulatory and enforcement environment. While management is responsible for the implementation of sufficient AML controls, directors should play a key role in the identification of AML risks, based on the financial institution’s particular business and actively oversee management’s adherence to the financial institution’s risk strategy and risk appetite. However, not all financial institutions are identifying and measuring their AML risks effectively or correctly, resulting in inadequate controls and, ultimately, potential compliance failures. Financial institutions should assess their potential risk exposure across the entire organisation, across their counterparties and affiliates, and with regards to the products their affiliates use. For example, recent money laundering scandals across the globe illustrate that some financial institutions are still treating their affiliates as part of the same organisation, and not much consideration is given to potential AML risks as they conduct business with affiliates. It may be necessary for some boards to provide more oversight to senior management on how AML risk is measured and ultimately quantified.


KEEPING IT CLEAN Financial organisations can improve their AML compliance culture through strong leadership www.ethicalboardroom.com

Winter 2020 | Ethical Boardroom 103

Risk Management | Money Laundering One often-cited frustration by members of boards is that AML risk assessments are too often conducted utilising a simple checklist approach, rather than a dynamic assessment of the financial institution’s bank operation and the AML risk and regulatory exposure posed. Such assessments sometimes provide the board with ‘dated’ and ‘stale’ information, based on historical trends and statistics, rather than a current assessment of the AML risk. By asking some key questions aimed at taking a fresh look at inherent as well as perceived risks, boards can become more risk-intelligent even before the financial institution conducts a formal AML risk assessment. Some key considerations include:

Accurate AML risk identification and quantification are the cornerstones for a robust AML compliance programme, without which most compliance efforts will provide a false sense of security and will result in potentially significant regulatory exposure.


Although ultimate responsibility for AML compliance lies with the board of directors, their role should consist of active oversight and strategy setting, while the day-to-day management and implementation of the AML programme rests with the designated AML compliance officer. It’s necessary that members of boards have a good understanding of the AML

IDENTIFYING AML RISK Boards need to set strategies and strengthen oversight

■ Does senior management set the tone through active engagement and involvement in AML compliance (executing on the board’s strategy)? ■ Does our financial institution possess a culture of compliance that exists throughout the organisation? ■ Do we have silos that inhibit our taking a more integrated compliance approach? ■ Has management established incentives to incorporate AML compliance objectives across the organisation? ■ Are the financial institution’s reporting, technological, and other systems integrated geographically? ■ Do silos present compliance challenges that can lead to regulatory investigations and subsequent enforcement actions? ■ Does management take a holistic view of customers across geographies and the risks associated with them? ■ Are management’s compliance monitoring and testing efforts sufficient to identify potential weaknesses? When these questions are asked and answered, boards will be in a better position to more proactively manage AML risks. 104 Ethical Boardroom | Winter 2020

programme requirements, whose key components are:

held accountable for board actions, and they also revealed that AML compliance failures have forced directors to resign. In addition, several regulatory enforcement actions in the past years have called for the establishment of AML compliance committees comprised of outside directors. And several of these regulatory enforcement actions also held board members personally accountable for financial institutions’ lack of compliance and exposed board members individually to civil litigation risks.

Moving forward

As recent scandals show, AML compliance continues to be a significant challenge for financial institutions and their boards globally. Some boards appear to be taking AML compliance matters more seriously than others, depending on their actual, or perceived US regulatory exposure. However, because some countries outside the US historically have practised different, less stringent AML enforcement and/or historically lack the comprehensive anti-AML rules and regulations established in the US, boards at some financial institutions are not yet fully engaged and are often caught off guard by aggressive US enforcement actions. Recent AML enforcement actions and investigations reveal the exposure that non-US financial institutions may face, risk that increases with the existence

Accurate AML risk identification and quantification are the cornerstones for a robust AML compliance programme, without which most compliance efforts will provide a false sense of security

■ Policies, procedures and controls ■ To mitigate the moneylaundering risks posed by the institution ■ Designate an AML compliance officer with sufficient board-granted authority across the institution to implement the policies, procedures and controls ■ Ongoing and adequate training for all employees of the financial institution ■ Independent testing/auditing on an ongoing basis Boards need to be vigilant not to step back too far back from day-to-day compliance matters or to adopt a ‘head-in-the-sand policy’ that leaves AML compliance solely in the hands of senior management. However, having knowledge and understanding of the AML programme requirements and corresponding risks does not imply that directors are expected to be AML-compliance experts. Many recent AML-related articles have called for individual board members to be

of a US branch. When evaluating their regulatory exposure, multinational financial institutions with a US presence should be alert about their various business lines that interact with the US. While financial institutions without a US branch are not directly exposed to US financial regulators, they are not insusceptible to US criminal or civil inquiries for conduct abroad where there is a US nexus, such as transactions cleared through the US.

A time to act

Given this exposure, it is the right time for a number of boards to take a hard look at their AML-compliance strategy and how senior management executes the strategy set by the board. 1 Source: Selected enforcement actions issued by the Federal Reserve (2014–2019) 2Source: Selected enforcement actions issued by the Office of the Comptroller of the Currency (2014–2019) 3FIN-2014-A007 - https://www.fincen. gov/resources/advisories/fincen-advisory-fin-2014-a007


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