Ethical Boardroom Autumn 19 by Ethical Boardroom

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

Autumn 2019

Keeping it above board

BOARD OVERSIGHT

The hidden value in better supervision

DUE DILIGENCE Identify, monitor and manage third party risk

AGEISM WITHIN THE WORKPLACE

Unconscious bias can lead to flaws in decision-making

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Ethical Boardroom | Contents

COMMENTARY

WeWork for Adam Neumann Without change, shareholders are powerless to deal with any kind of mismanagement

Investing in sustainability Shareholders are allies, not enemies, in creating sustainable value

Who’s gonna drive you home? Times of uncertainty and rapid change call for a new approach to leadership

Keeping it in the family Can we have good governance in family-owned businesses?

Governance 4.0: Redefining & reinventing governance Embracing integrated thinking is key to sustainable corporate practices

ASIA & AUSTRALASIA

Global News: Asia & Australasia Poor governance, gender diversity and a CEO resignation

Japan’s unfinished reforms Dear Prime Minister, don’t give up yet!

On the road to effective board evaluations in India Unlike the US or the UK, board evaluation in India is still an emergent concept

THE EB 2019 CORPORATE GOVERNANCE AWARDS

Introduction & Winners list We reveal our 2019 Asian and Australasian winners

COVER STORY

Luxury with a sustainable soul Indian Hotels Company Limited is raising standards in hospitality and ensuring a brighter global future

4 Ethical Boardroom | Autumn 2019

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Contents | Ethical Boardroom

MIDDLE EAST

Global News: Middle East Ethical investments, boardroom shake-ups and an IPO

BOARD LEADERSHIP

CONTENTS

Building an agile board in a disrupted world Help organisations succeed by transforming the way leadership teams work together Women in the workforce Attitudes to gender equality in the boardroom may be shifting, but thereâ&#x20AC;&#x2122;s still work to be done

Ageism within the workplace Governing organisational culture, age discrimination and unconscious bias

Does your board have untapped potential? An effective board is essential to every organisation but, however well yours is doing, every board has untapped potential

42 10 52

EUROPE

Global News: Europe Transparent reporting, women on boards and shareholder investment

SWIPRA Services: A holistic view on corporate governance Swiss corporate governance specialists who provide services to companies and their boards of directors as well as to institutional investors

Sustainable listings and good governance A stock exchange listing is a mark of authenticity â&#x20AC;&#x201C; itself a sign of good corporate governance, especially in the green and sustainable investment market

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Autumn 2019 | Ethical Boardroom 5

Ethical Boardroom | Contents

RISK MANAGEMENT

Managing third party risk Leading practices in third party risk management risk segmentation

Tackling third-party cyber risk Cyber has changed third-party risk: are you addressing the challenge?

Third-party risk: The dark corner of cybersecurity Smart boards recognise that an increased focus on third-party risk is essential

BOARD GOVERNANCE

Board oversight of strategy and risk Directors need better information to meet rapidly escalating expectations

Thinking differently Are you embracing the next generation of internal audit?

Executive compensation in the US Guidelines for non-US multinational companies on establishing and managing programmes

Where was the board? Boards are at risk of being in breach of their fiduciary duty

The hidden value of governance Why itâ&#x20AC;&#x2122;s time for boards to look again at their corporate governance practices

One share, one vote Alerting investors on dual-class structures with differential voting rights

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Contents | Ethical Boardroom

THE AMERICAS & CARIBBEAN

Global News: The Americas & Caribbean Diversity progress, boardroom changes and disclosure rules

ACTIVISM & ENAGAGEMENT

110

116

Deal or no deal Shareholder activism and deal opposition campaigns in the 2019 proxy season

102

What you need to know heading into the 2020 proxy season How will 2019 trends shape the next proxy season?

106

Strategic battles in German boardrooms How informal negotiations have shaped the ‘new normal’ in activist engagement in Germany

110

Knowledge is power Maximise shareholder support for your AGM and don’t be a victim of the wolf pack

AFRICA

114

Global News: Africa Bribery fines, whistleblower woe and boardroom changes

REGULATORY & COMPLIANCE

116

Designing a tax compliance management system Now is the time to act, particularly for businesses operating internationally

118

Reimagine the future Empowering the legal team to take control of contracts

120

Beyond Kondratieff’s Hill Climate change is not a crisis – it’s a matter of behaviour

Autumn 2019 | Ethical Boardroom 7

Ethical Boardroom | Foreword

The dual-class shares debate

Welcome to the Autumn 2019 edition of Ethical Boardroom magazine The implosion of WeWork – the property leasing startup whose IPO had been one of the most highly anticipated public offerings of 2019 – is a cautionary tale. Investor concerns about losses and corporate governance saw the company’s plans for a stock market listing run into trouble, its valuation plummet and its chief executive and founder – Adam Neumann – make a sharp exit (with, reportedly, just a mere $1.7billion pay-off to help him on his way). Investors had questioned the dual-class share sale that would have given Neumann and his associates total control, even after the IPO. A dual-class stock is the issuing of various types of shares by a single company. The class offered to the general public has limited or no voting rights, while the class available to

8 Ethical Boardroom | Autumn 2019

founders and executives has more voting power and often provides for majority control of the company. Companies with dual-class stock structures say that by giving founders more power, it enables them to focus on long-term strategy, such as allowing lengthy product development cycles to mature. But investors say that it means company founders can exert outsize control over companies after they go public and that equity structures skew the alignment of ownership and voting rights. At one point, Neumann controlled the majority of voting rights through WeWork’s Class B and Class C shares, with both classes carrying 20 votes per share compared with Class A shares, which had one vote per share. Another key provision would have allowed Neumann’s wife Rebekah to lead the search for his successor should he ever become permanently disabled or die. WeWork is not a solitary case. Many of the biggest tech companies have used tiered voting classes to give founders the power to steer their companies towards

their long-term goals. Companies, including Lyft and Pinterest, all made IPO offerings this year while pursuing dual-class equity structures. At Lyft, for example, the two founders have Class B shares with 20 votes per share, giving them control of the company, even though they own less than 10 per cent of the stock. According to the Council of Institutional Investors (CII) – a non-profit association of US asset owners – a company with dual-class voting structures are essentially ‘silencing the voice of its public investors’. Since its founding in the 1980s, CII has endorsed the principle of ‘one share, one vote’; every share of a public company’s common stock should have equal voting rights. It wants US stock exchanges to propose new rules that would require newly listed companies that choose dual-class voting structures to adopt a sunset provision that clicks in within seven years of an IPO. On page 92, Lucy Nussbaum at the CII explains why it considers it important to alert investors on dual-class structures with differential voting rights.

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Contributors List | Ethical Boardroom

OUR THANKS TO THIS ISSUE’S CONTRIBUTING WRITERS ZALLY AHMADI Director, Corporate Governance and Executive Compensation, D.F. King, an AST Company NICHOLAS BENES Representative Director of the Board Director Training Institute of Japan (BDTI) DOMENIC BRANCATI CEO UK/Europe at Georgeson NICOLA BROOKS Head of Legal Operations and Transformation Services, KPMG MARSHA CAMERON & PAUL McCONNELL Marsha is the Co-Founder and Managing Partner of Paradox Compensation Advisors. Paul is the Co-Founder and Managing Director of Board Advisory PAUL W. CHAN President of the Malaysian Alliance of Corporate Directors PUNEET CHHATWAL & BEEJAL DESAI Puneet is the MD & Chief Executive Officer and Beejal is the Senior Vice President and Legal & Company Secretary of the Indian Hotels Company Limited (IHCL)

CHARLES M. ELSON & LAURENZ LANKES Charles is Director of the John L. Weinberg Center for Corporate Governance. Laurenz is a Fellow of the Weinberg Center for Corporate Governance NANCY FALLS Chief Executive Officer of The Concinnity Company TORBEN FISCHER & SANDRA SÖBBING Torben is a Forensic, Risk & Compliance Partner in the Hamburg office, and Sandra is Tax Advisory Partner in the Frankfurt main office of BDO AG Wirtschaftsprüfungsgesellschaft ALISON GAINES Global CEO, Gerard Daniels DR ASHRAF GAMAL EL DIN Chief Executive Officer, Hawkamah BARBARA A. HELLER & CHRISTOPH WENK BERNASCONI Barbara is a Managing Partner and Christoph a Senior Partner at SWIPRA Services Ltd

DR AMI DE CHAPEAUROUGE Founding Partner, de Chapeaurouge + Partners

DUNCAN HERRINGTON & MARLA SHIPTON Duncan is a Managing Director and Marla is an Associate at Raymond James

BRIAN CHRISTENSEN Executive Vice President, Protiviti

MATHEW JOHN Board Practice, Amrop India

DOUGLAS CLARE Vice President, Fraud, Security and Compliance Solutions, FICO

HELLE BANK JORGENSEN Chief Executive Officer, Competent Boards

TIM J. LEECH Managing Director, Global Operations at Risk Oversight Solutions SIMON LOWE Chair, Grant Thornton Corporate Governance Institute GREG MATTHEWS Partner at KPMG CHRIS McCANN Founder, Resilient.World GREG MICHAELS & IMRAN JASWAL Greg is the Managing Director and LATAM Practice Leader for Cyber Risk, and Imran is the Managing Director for CyberClarity360 at Duff & Phelps LUCY NUSSBAUM Research analyst at the Council of Institutional Investors FIONA LE POIDEVIN Chief Executive Officer, The International Stock Exchange Group CHRIS ROBERTSON UK Chief Executive Officer, Creditsafe TURID ELISABETH SOLVANG Founder and CEO, FutureBoards AS KERRIE WARING CEO, International Corporate Governance Network ANNA WITHERS Founder and Director, Mightywaters Consulting Ltd

EDITOR Claire Woffenden DEPUTY EDITOR Spencer Cameron EXECUTIVE EDITOR Miles Hamilton-Scott 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.

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Autumn 2019 | Ethical Boardroom 9

Commentary | WeWork

WeWork for Adam Neumann WeWork, the shared workspace real estate company, may work for its billionaire founder Adam Neumann, but will it work for anyone else? Despite recent changes to the soon-to-bepublic company’s structure, the governance of the operation ultimately works against the interests of its shareholders.

There are two major governance-related problems with WeWork that should give any potential investor pause. The first is the dual class structure, which, regardless of recent events, remains in place, enabling Neumann to retain significant control over the company, despite a lessened and disproportionate economic interest. The second, an outgrowth perhaps of the first problem, are the numerous conflicts of interests that Neumann had created over time and that, in the face of serious concern from investors, the company has sought to reduce. Initially, the company proposed to go public with an equity structure that would give its founder, Neumann, stock with a voting ratio of 20 votes per share while most other investors were entitled to one vote for each share. This structure would have given Neumann complete control over the organisation for his lifetime, and beyond. This approach raised serious concerns for investors whose capital was eagerly sought, but whose opinion was as eagerly rejected. The outcry over this seemingly eternal allocation of voting rights produced such outrage in the investment community that the company was forced to revise the structure. Instead of 20 votes per share for Neumann, he would then be entitled to ‘merely’ 10. Of course, this change was cosmetic at best as Neumann would remain entirely in charge of the company and its board by controlling more than half of the vote necessary for any corporate action. The resulting structure left investors with few, if any, options should management take either inappropriate or ill-advised action inimical 10 Ethical Boardroom | Autumn 2019

Without change, shareholders are powerless to deal with any kind of mismanagement

the agency problem that tends to reduce the value of, and is the main corporate governance challenge facing, widely held companies in the United States. For outside investors in US public companies, the bluntness for the market for control as a disciplinary mechanism and the difficulties inherent in disaggregated shareholders’ Charles M. Elson & Laurenz Lankes use of formal power through proxy voting, Charles is Director of the create an inability to effectively monitor the John L. Weinberg Center officers and directors of such companies. for Corporate Governance. Laurenz is a Fellow of In this sense, the directors and officers of the Weinberg Center for US companies have de facto control, and the Corporate Governance agency concern in such cases is thus about management opportunism. In controlled to the general welfare of the company. companies, by contrast, the controlling This approach is contrary to managerial shareholder has an economic incentive to interests as well – as an executive who is monitor management because it stands held accountable for their actions will, to capture a significant proportion of ultimately, create long-term value for any increase in share value that results themselves and their fellow shareholders. from such monitoring. For this reason, Through the dual class structure, a controlling shareholder has at least the Neumann completely controlled the potential to be a more effective monitor company. A controlling shareholder in and of corporate management than is possible of itself is always problematic. There is with the mechanisms available in the often a misalignment with the widely held model. goals of the non-controlling So, in a controlled company, Through the shareholders. And controlling then, management opportunism dual class shareholders cannot monitor is, again, at least in theory, much structure, themselves to prevent selfless likely to be a significant dealing or poor management, problem. But there is another Neumann while minority shareholders kind of agency problem that completely have little, or in the case of can arise in such companies this particular structure with controlled the – namely, opportunism by the Neumann in complete control, controlling shareholder at company. A nothing to say. The problem is the expense of the minority exacerbated here by the fact shareholders. The incentive for controlling that his economic interest is such opportunistic behaviour shareholder disproportionately lower than arises from the fact that not all of in and of itself the costs borne by the company his voting interest. Neumann may argue that his controlling are ‘internalised’ by the is always position gives him the ability controller because the controller problematic to operate the company does not own 100 per cent of the effectively for the long-term to equity. This creates the potential the benefit of all shareholders. Unfortunately, for direct diversions of pecuniary benefits for various reasons, this is unlikely to occur, from the company to the controller through as we will explain. But, more importantly, self-dealing transactions. In addition to such there are fundamental agency issues arising pecuniary ‘private’ benefits that come at the out of his control. expense of the minority shareholders, there The nature of the agency problem that may also be non-pecuniary, or what might affects controlled companies differs from be referred to as ‘psychic’-private benefits www.ethicalboardroom.com

Illustration by Brendon Ward www.inkermancreative.com

WeWork | Commentary associated with the position of control over an enterprise. As one example, the prestige and status associated with being at the helm of a large enterprise may weigh more heavily with some controlling shareholders than the increase in their wealth resulting from a higher share value. To the extent that this is so, some controllers are likely to pursue goals other than the maximisation of profitability and firm value. Agency problems of this non-pecuniary type can be especially pernicious. To be sure, the top managers of widely held public companies may have a similar predilection for activities such as empire building, but there is at least some constraint on inefficient behaviour from markets and the shareholder franchise. In the case of controllers, though, that constraint is entirely lacking. Controllers are immune from proxy contests and can ‘just say no’ to any takeover offer. They are, in large part, free to set the company’s strategy largely as they wish, subject only to a different, much less demanding set of constraints. Finally, the courts, as the final backstop, are almost completely ineffective as a restraint on this type of behaviour because the concept of self-dealing is not elastic enough to encompass actions such as deciding to expand into new markets, and the deferential business judgement rule would shield this form of conduct from judicial scrutiny. Of seminal importance to the WeWork story, coincident and even evolving from the dual class control, as discussed, comes the problem of the conflict of interest transactions, beneficial to the controller but, at the expense of the company and the remaining shareholders. This is the second central problem in the WeWork situation. In the very recent past, the company has had its share of questionable conflicted transactions between Neumann and the corporation. First and foremost was Neumann’s purchase of valuable properties to be leased by the company, to his individual benefit. These purchases were ultimately reversed in most part prior to the IPO but remain a problematic depiction of his sense of corporate responsibility. Secondly, as first disclosed in the IPO filing, the company paid Neumann $5.9million to acquire the ‘We’ trademark, which arguably belonged to the company all along; although ultimately, responding to investor concern, Neumann www.ethicalboardroom.com

returned the money. Thirdly, in a very questionable relationship to the primary business of the real estate leasing company, an elementary school servicing the Neumann children, among others, was formed. It was reportedly embedded in the WeWork structure both physically and philosophically, labelled with the obviously related moniker ‘WeGrow’. Finally, and perhaps most concerning to any long-term investor, is the fact that initially in the IPO, Neumann’s wife Rebekah, was solely empowered to designate his successor as CEO. Succession driven by a spouse is no way to run a $15billion operation. Even though some of these conflicts have recently

been addressed by the company, it is hard to imagine that the corporate atmosphere that allowed such conflicts to occur has been completely dissipated. On a side note, in addition to his pre-IPO liquidation of $700million in holdings, Neumann’s initial expression of interest following the IPO in selling a further significant portion of his investment would not suggest to others comforting confidence in his view of the long-term viability of the enterprise. In summary, as long as the managerially protective dual class structure remains in place, investors have little reason to believe that Neumann would be effectively incentivised to avoid further conflicted transactions. The use of the dual class structure combined with a history of conflicted transactions sets the stage for ultimate investor disappointment. Hence, investors should thoughtfully consider the significant risk associated with investing in such an enterprise. While the structure clearly works for Neumann, it likely won’t work for anyone else.

FORMER WEWORK CEO Adam Neumann co-founded office space company WeWork, alongside Miguel McKelvey in 2010 Autumn 2019 | Ethical Boardroom 11

Commentary | Stewardship

Investing in sustainability The announcement by the Business Roundtable in August that it was abandoning the doctrine of shareholder primacy it has advocated for more than 20 years in favour of a commitment to ‘lead their companies for the benefit of all stakeholders’ attracted a lot of attention. This is understandable. Taken at face value, it represents a notable shift in position from the US corporate community. It follows on from the debate in the UK over directors’ duties to their different stakeholders, which resulted in new regulations requiring the boards of listed companies to explain how they take account of the impact on those stakeholders when taking decisions. Similar debates are happening in many other jurisdictions. Some of the media reporting on these developments has sought to paint investors

Shareholders are allies, not enemies, in creating sustainable value Kerrie Waring

CEO, International Corporate Governance Network as the villains, pressuring management to see the share price as the only measure of success or to put dividends before research and development, and investment in the future. Some commentators also seem to believe that the interests of shareholders and stakeholders are fundamentally opposed and that never the twain shall meet. Both of these views are misplaced. Yes, there are some investors who seek to extract

as much value as they can as quickly as possible, but they are not representative of all investors – increasingly less so, in fact; and there are many issues on which the interests of shareholders and society are entirely aligned. This should come as no surprise. After all, the individuals down at the end of the investment chain are not just savers but stakeholders in many companies as well, whether as employees, suppliers, customers or members of the local community. This alignment of interest is most obviously the case when it comes to the long-term systemic risks facing us all, companies, investors and individuals alike.

Action on climate

Take, for example, climate change. The World Economic Forum’s most recent Global Risks Report identified the failure of climate change mitigation as the top two global risks in terms of likelihood. Millions of people took part in the world-wide

SHARED VISION Only by working together can we secure a sustainable future

12 Ethical Boardroom | Autumn 2019

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Stewardship | Commentary

‘climate strike’ in September, demonstrated the level of public concern. Attracting less attention, but important in their own right, are the actions being taken by investors to tackle the causes of climate change. The International Corporate Governance Network’s (ICGN) investor members, who between them control more than $34trillion in assets under management, are at the forefront of many of these developments. Examples include Climate Action 100+, an investor initiative launched in late 2017 that aims to ensure the world’s largest corporate greenhouse gas emitters take necessary action on climate change. Another is the shareholder campaign at Exxon led by Edward Mason of The Church Commissioners for England, for which he received the ICGN’s inaugural Stewardship Champion award last December. For the ICGN and its investor members, this is part and parcel of looking after the interests of clients and beneficiaries. Tackling long-term systemic risks is essential if we are to meet our collective need for sustainable value creation upon which current and future generations or savers depend. As we make clear in the ICGN Global Stewardship Principles, investors ‘should prioritise the mitigation of system-level risk… over short-term value’. These Principles, currently under review for updating in 2020, provide a global investor perspective on stewardship obligations and practices.

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Becoming vocal

focus on the long-term health of the planet, The recognition among institutional the economy and individual companies, investors that their duty extends they are helping in a positive way to beyond generating immediate financial align shareholders’ and stakeholders’ returns is not new – the ICGN Principles long-term interests. were first introduced in 2003 – but it has Not all regulatory developments have undoubtedly gained momentum over the been constructive, unfortunately. In some last decade. More and more are joining the markets the ability of shareholders to hold ‘stewardship movement’. management to account has been damaged In large part this is due to client demand – for example in Italy, the Netherlands, from ‘saver-stakeholders’ making their Hong Kong and Singapore where the rules voices heard. Sustainability themed now encourage dual-class shares, in effect investing is experiencing rapid growth reducing the voting rights of external and now accounts for around $1trillion investors. Some high-profile flotations in according to the 2018 Global the US and elsewhere have Sustainable Investment Review, There are some done the same. while Morningstar estimates The justification given for investors who these that there was a 40 per cent actions is that they seek to extract protect management from increase in the assets in sustainable funds in Europe alleged excesses of as much value the between 2014 and 2018. short-term traders, and that as they can This has been accompanied by doing so they are in some by increased expectations from as quickly as way protecting the interests clients, and from the media, as of other stakeholders. to the level of scrutiny to which possible, but This is a false argument. shareholders should subject This is not a zero-sum game. they are not their investee companies. the rights of representative Reducing The actions of regulators and shareholders does not lead to stock exchanges have also been of all investors an increase in the influence of influential. Many understand stakeholders; quite the opposite. the important role than investors can play It potentially damages both by enabling in engaging with companies to hold them to poor management to resist their combined account for creating long-term value. This is efforts to bring about a change of approach evidenced by a swathe of investor where it is needed. stewardship codes around the world, a We need to stop promoting the idea proliferation of ethical investing indices, that investors are the enemies of either such as the FTSE4Good index, and, in some companies or other stakeholders. When markets, by legislation (for example, the it comes to securing a sustainable future, revised EU Shareholder Rights Directive). we are all allies and will only achieve The ICGN welcomes policy initiatives that objective by working together. of this sort. By encouraging institutional investors to be active stewards and

Autumn 2019 | Ethical Boardroom 13

Commentary | Leadership

A NEW DIRECTION Companies need strong leaders to survive and thrive

Who’s gonna drive you home? Board directors are in the driving seat, making the final judgement calls on behalf of the companies they are appointed to serve – decisions that not only affect the shareholders, but also the wider ecosystem of stakeholders. But are our business leaders on top of new realities in the corporate world – or just hanging in there? The last few years, digitalisation has been the hottest topic for boards, while focus is

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Times of uncertainty and rapid change call for a new approach to leadership Turid Elisabeth Solvang

Founder and CEO, FutureBoards AS now shifting towards the company’s purpose and role in society, corporate culture, values and ethics. Driving this change are the UN Global Compact Sustainable Development Goals (SDGs), which are at the heart of ‘Agenda

2030’ – a plan adopted by all 193 UN member states for achieving a better future for all. The SDGs aim to end extreme poverty, fight inequality and injustice, and protect our planet. Businesses play a crucial part in achieving these ambitious goals.1

The heat is on — corporate directors

Larry Fink, CEO of BlackRock, the world’s largest institutional investor, is among those calling for action at the top floors of the corporate world. He’s asking CEOs of BlackRock’s investee companies ‘to demonstrate the leadership and clarity that

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Leadership | Commentary

will drive not only their [clients’] investment returns, but also the prosperity and security of their fellow citizens’. Large asset managers, such as Norges Bank Investment Management – better known as Norway’s oil found, puts it this way: “We aim to identify long-term investment opportunities and reduce our exposure to unacceptable risk.”2 Companies that do not comply with the oil fund’s investment policies are quickly removed from its portfolio. Echoing these trends, the US-based not-for-profit Business Roundtable recently launched its new Statement on the Purpose of a Corporation signed by CEOs of the 181 largest companies in the United States. 3 They commit to lead their companies for the benefit of all stakeholders – customers, employees, suppliers, communities and shareholders. Some say it’s sweet talk and window dressing but, instead of looking for answers in the rear window, it’s always a better idea to watch out for bumps and turns on the road ahead,4 such as the armada of Millennials out there, demanding that companies stop operating at the cost of the environment, human rights, child labour and so forth. On top of that, consumers are becoming more discerning and have the power to influence regulations affecting a company’s operating model directly. Which implies that reality is not what it used to be, and the business of business is no longer just business. Long gone are the days when board directors’ responsibilities were only to the company’s shareholders. Today, corporate leaders are expected to be accountable to the society in which they are licenced to operate. This is a mega shift that requires a whole new set of skills and, even more important, a shift of mindset on the part of those in charge. The fundamental question is how and by whom should our companies be governed in the future to ensure long-term value creation for all?

Boardroom overload

Board agendas are already packed, and a large number of issues are fighting to be on top. An article last year by Erik Kutcher, senior partner and a global leader of hi-tech in the media and telecoms practice at McKinsey, indicates that boards suffer from flaws; time constraint, lack of diversity and expertise, including lack of comprehension of the companies they were appointed to serve. 5 Kutcher holds that: “These flaws limit the effectiveness in the board and often lead management to limit interactions with their board by trying to manage through meetings, rather than viewing the board as a

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helpful source of new ideas and expertise and a sanity check on strategy.” Furthermore, a recent survey among European board directors, conducted by Board Agenda and Mazars concludes that sustainability is high on the boards’ agendas and that the risks and opportunities are well understood.6 However, board directors are not up to speed with regards to integrating sustainability thinking in their overall strategies, and they have a hard time measuring and communicating the results. And, even more worrying, a gap seems to exist between what board directors think they are doing and what they actually do.

company’s stakeholders. This requires new perspectives on the board of directors’ role and responsibilities, as well as the way they operate. As an example, is the Norwegian corporate governance model with entirely non-executive directors sustainable? Will a group of people that meet for a couple of hours once a month or less, be able to comprehend the rapid changes that are taking place inside and outside the company? Or will they be back-seat drivers?

New people in power

Back in the day, board directors were generalists, whether they were recruited on the basis of their good sense, or their So, how do we fix it? good connections. Lately, the need for While national rules and regulations, specific expertise have resulted in more ownership structures as well as culture specialist appointments to boards of and traditions shape our perceptions of directors. Digital disruption and other what is to be considered good corporate developments are seen to add to the urgency, governance, change is imminent. Most as have government regulations that place business activities are reaching across specific responsibilities on specific board national borders and so should our committees and their members. And even understanding of good business conduct. if the gender balance on corporate boards According to the to the rock star of is improving, most boardrooms worldwide corporate governance, are still filled with men professor Mervyn E. King, aged 60-plus, most of them Most business the answer lies in integrated previous CEOs, because activities are thinking. As chair of experience is regarded a the King Committee on key qualification for board reaching across Corporate Governance members. But, we know that national borders individuals with too much for Southern Africa, and an international thought and so should our shared background and leader in this field, the experience – AKA ‘the old understanding good professor has boys’ network’ – may lead strongly influenced of good business to groupthink, which in corporate governance turn may lead to disastrous conduct around the world.7 consequences for your The 4th edition of the company, as well as society. King Report on Corporate Governance While there is no silver bullet, nor a magic for South Africa, which has been cited wand, it’s quite clear that we need new as ‘the most effective summary of the people in the drivers’ seat: wise women and best international practices in corporate men – both young and experienced – with governance’, was published in November insight and foresight, diversity of minds and 2016. King holds that: “It’s a question of perspectives, as well as the courage to speak value creation. If you have scarce natural up to ensure that your company will survive resources and you just focus on short-term and thrive in the 21st Century. profit and concentrate on trying to get more So: ‘You know you can’t go on thinking dividends to shareholders, you’re going to nothing’s wrong. Who’s gonna drive you destroy the company.” home tonight?’9 His visionary ideas led to the creation 1 https://www.unglobalcompact.org/sdgs 2https://www. of the International Integrated Reporting nbim.no/contentassets/67c692a171fa450ca6e3e1e 3a7793311/responsible-investment-2017---governmentCouncil – of which he is now the chair pension-fund-global.pdf 3https://www.businessroundtable. emeritus – and the development of the org/business-roundtable-redefines-the-purpose-of-aIntegrated Reporting (IR) framework. 8 The corporation-to-promote-an-economy-that-serves-allidea is to help boards see the bigger picture americans 4https://www.ft.com/content/fff170a0-e5e011e9-b8e0-026e07cbe5b4 5https://www.linkedin.com/ and to better detect risks and opportunities pulse/corporate-boards-need-facelift-eric-kutcher/ by seeing the company’s financial and 6 https://boardagenda.com/resource/leadership-innon-financial capitals in unison. corporate-sustainability-european-report-2018/ 7http:// www.accaglobal.com/zw/en/member/member/accountingCorporate leaders must rethink their business/2016/09/insights/king-revolution.html 8https:// responsibilities, to whom they are integratedreporting.org/ 9Lyrics from ‘Drive’ by The Cars, accountable, and how they can ensure which reached number three on the Billboard Hot 100 in 1984 and the band’s biggest international hit. that the business is understood by all the

Autumn 2019 | Ethical Boardroom 15

Commentary | Family Business

Keeping it in the family After years of working on governance for all sorts of companies and government institutions, I can claim, with a great deal of confidence, that applying good governance in family-owned businesses is one of the most challenging tasks.

There are many reasons why I came to that conclusion, all of which are based on the practices and issues facing families who are running businesses in the Middle East and North Africa (MENA) region. In other regions, this might not be such a significant problem. But in a region that is dominated by large, family-owned conglomerates, operating in all sorts of industries and employing hundreds of thousands of employees, the risk becomes too high to ignore. If the business case for good governance is well-established, if the benefits are known almost to everyone, and if the risks have been proven many times from different parts of the world, why is it that difficult to sell the concept of good governance to family-owned businesses? To be able to answer this question, we need to go back to basics; what is governance all about? One cannot help but refer back to the definition of corporate governance by Sir Adrian Cadbury, a system by which companies are directed and controlled. The commonly agreed structure of corporate governance is the one in which we have shareholders, who have the ultimate power, an elected board of directors, composed of professional directors, who act on behalf of the shareholders in appointing the management, motivating and supporting it, evaluating its performance, and dismissing it, if so needed.

16 Ethical Boardroom | Autumn 2019

Can we have good governance in family â&#x20AC;&#x201D;owned businesses? Dr. Ashraf Gamal El Din

Chief Executive Officer, Hawkamah When shareholders elect directors, they make sure that they are qualified, have diverse experiences and knowledge, have the time and commitment, and are loyal to the company. Ideally, directors are free from any biases and take decisions that maximise the long-term success of the company. In doing so, the management is accountable to the board and the board is accountable to the shareholders. In other words, shareholders evaluate the performance of the board and, if not happy, they can dismiss the entire board or some of its directors. Boards, being accountable to shareholders and having full control over the management, assess the performance of the CEO and have the right to reward, or fire, him/her. This system of hierarchical accountability is key to the success of any organisation. We always remind ourselves of the wisdom that says: â&#x20AC;&#x2DC;power corrupts, absolute power corrupts absolutelyâ&#x20AC;&#x2122;. How does the system work in family businesses?

Many of these businesses now are either in the first generation, where the patriarch is still in power, or in the second generation. Those who are on the third generation are either facing serious challenges or were divided into smaller organisations or have been sold out or closed down. Focussing on companies governed by first and second generations will help us shed the light on the challenges to good governance. The model we have seen in most of the families we interacted with is almost the same; the founder (usually male), either alone or along with, usually, the eldest son, are the ones in control. They manage the business closely and control its operations. The board, if there is one, is the family. The father, sons and daughters, sometimes the mother, are the directors. In a few cases you may find one non-family member, usually a family friend

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Family Business | Commentary or trusted advisor, on the board. Needless to say that the ‘shareholder’ function is practised either by the patriarch alone or in partnership with his sons and daughters. In such a model, it is quite difficult to establish the concepts of responsibility, fairness, accountability and independence. One might think that it is the founder or patriarch who resists good governance. The assumption might come from the perception that he would like to remain in control and be the ultimate decision-maker. This is partially true. The founder perceives the company as his empire; he built it, made it successful and hence must remain in control. In some cases, it is his main source of the social status and prestige. Losing control over the company means that the founder loses his social status. While interacting with families, however, we found that in many cases, it is the second generation that resists establishing good governance in their companies. This is because they are either in control or they are enjoying many privileges that they would lose under good governance. Examples of such privileges include exaggerated packages, access to corporate money and assets, unlimited corporate cards, and the like. In other cases, the family as a whole perceives the company to be part of the ‘family legacy’. In this case, the family and the company represent a sort of one, inseparable structure. Does this mean that we cannot have good governance in family-owned businesses? The answer is no, but we need to start somewhere else; with the family. Good governance starts from the family, because that is where the problems are. The family, led by the founder or the second generation, needs to answer one key

question; do we need the company to be a source of wealth for us or do we prefer to have it as a source of jobs for family members? The answer to this fundamental question makes a huge difference. If the family decides that it wants the company to be a source of wealth, then it needs to be run on a professional basis. That does not prevent family members from working in the company and leading it, but this is to be based on merit, not family name. In this case, the family will establish a professional employment policy for the company that applies even to family members. If, on the other hand, the family wants the company to be a source of jobs for its members, this must come with the realisation of the cost of such policy. The family will be paying from its own wealth to make sure that family members

The family acts as the ‘shareholders’; it appoints a board of directors who then appoints a CEO and works with the management towards fulfilling the vision of the shareholders must find jobs in their business. However, this is a destructive policy in the long term. There are no guarantees of the quality of all family members who aspire to work in the company, and while some might be really clever, it might be hard to convince those who are not that clever that they do not qualify to work in the business. This is like setting a series of time-bombs, hoping that none of them will actually explode. Family businesses cannot

flourish under this system and the family will sooner or later lose its business. If the family decides to have its company as a source of wealth, it needs to go back to the classical governance structure we mentioned earlier. The family acts as the ‘shareholders’; it appoints a board of directors who then appoints a CEO and works with the management towards fulfilling the vision of the shareholders. Nothing prevents one or two of the family from being board members, and nothing prevents family members from joining the company, but based on the regular employment policy of the company, that is approved by the board, who acts on the best interest of the shareholders. But for the shareholders to act as a professional general assembly, the family needs to put some rules for its functioning. These family-agreed rules will keep the family from conflicts between its members and from manipulation by some members. Patriarchs are best advised, to have wider roles in the society and many non-business engagements that help maintain their status, even if they leave their businesses. Needless to say, that in fact they do not need to leave their businesses; the patriarch can continue to be the chairman of the board or the head of family assembly. This suggested system does not mean that the family loses control, it rather means that the family will practise a different type of control than managing the daily operations of the company. A final word on regulation. While governments may perceive family businesses to be a family business, it is not. As mentioned earlier, they operate in all industries, employ loads of employees, and generate income for thousands of families. It might be a good idea that once a family business reaches a certain threshold, it needs to be regulated differently and made to adopt a governance structure that protects the interests of the economy and society at large.

CONTEMPLATING THE FUTURE Family-agreed rules can ensure a business practises good corporate governance

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Autumn 2019 | Ethical Boardroom 17

Commentary | Good Governance EMBRACING CHANGE Boards need to ensure a culture of innovation and value creation to thrive

Governance 4.0

We are living in the fast-changing world of the 21st Century – evolving at such a neckbreaking speed that it is resulting in a so-called VUCA world, that is volatile, uncertain, complex and ambiguous. Due to these disruptive elements, corporate leaders are required to refocus their strategic vision and direction in order to remain relevant. The lifespan of a S&P 500 corporation today is significantly shorter; in the 1980s it was 75 years, but now it’s down to 15 years and declining. No industry is immune to this disruption. At the 2016 World Economic Forum, the Fourth Industrial Revolution or ‘IR 4.0’ was etched into the lexicon of the corporate world. Governments and private sectors of first world and developing nations have 18 Ethical Boardroom | Autumn 2019

Embracing integrated thinking is key to sustainable corporate practices Paul W. Chan

President of the Malaysian Alliance of Corporate Directors embraced IR 4.0 as the strategic thrust for their economies. But, what is IR 4.0? Industry 4.0 refers to a new phase in the Industrial Revolution that focusses heavily on interconnectivity, automation, machine learning and real-time data. While every company and organisation is unique, they all face a common challenge – the need for connectedness and access to real-time insights across processes, partners,

products and people. From board governance perspectives, silo thinking is obsolete; to survive and remain competitive, boards must embrace a new framework based on integrated value-creation thinking. Board oversights of the holistic, digital-driven business ecosystem in our disruptive environment is what we aptly term ‘Governance 4.0’. The fiduciary duty of the board has gone far beyond the traditional supervision of the company’s financial performance as overseen by external auditors. It is imperative that directors appreciate the market-led, changing definitions of the resources entrusted to them. These include a redefiniton of assets, capitals, future workforce, digital disruption, paradigm shift in corporate reporting, and so on. Assets as reflected in financial statements are transactional tangible assets only. As such, the significant value of data that www.ethicalboardroom.com

Good Governance | Commentary battle for relevance. As an industry, we have not kept up with a world where 75 per cent of market capitalisation is now driven by intangibles assets.” The board would have failed to duly discharge its fiduciary duties if it did not clearly disclose the limitation of the financial statements to the investors vis-à-vis the market value of the company. No one disputes the importance of investing in human capital and R&D; yet by today’s accounting standards, such investments are considered expenses. The more we allocate resources to such investments, the more the company’s bottom-line is adversely impacted. Yet, the company would surely perish were it not to invest in its human capital. The board’s duty of care goes beyond the traditional reliance on outsourced expert opinion. Being aware of the limitation of audit assurance that is guided by established accounting and auditing standards, it is incumbent on the board to raise pertinent questions regarding the scope of the audit vis-à-vis the market value of the company. If the audited financial assets is significantly less than the company’s market value, there needs to be a rational, analytical basis to explain the difference.

is viewed as ‘intangible’ is simply ignored in these statements. Yet in today’s economy, markets view data as one of the most prized assets. In 2014, it was reported that WhatsApp, a messaging app company, recorded an accummulated loss of $232million. Yet, it was acquired by Facebook for $22billion. What did Facebook see that financial experts failed to account for? It is data… 300 million messages exchanged daily at the time, which has now grown to more than 1.5 billion active users texting over 65 billion messages daily, yet this incredible value is still not reflected in any financial statement! Studies consistently prove that more than 80 per cent of the market value of S&P 500 companies today comprise of intangible assets, especially in technology sectors. Even the risk industry is confronted with the onslaught of ‘intangibles’ that often distort the basis and validity of pricing the risk elements. As Greg Case, Aon CEO, said at the company’s Q3 2018 earnings call: “The risk industry has to keep up with a constantly evolving environment in a daily www.ethicalboardroom.com

frameworks. In today’s highly disruptive environment, one should question the value of such an exercise that tends toward a mindset of short-termism. The constantly changing business landscape also demands greater disclosure in areas such as the company’s strategies regarding the environment, sustainability and climate change, to name a few. So, with the increasing demand on the board for greater disclosures in corporate reporting, what should the board focus on? The board as a whole is a strategic asset to the company with fiduciary duties to safeguard, add and create value of the assets and capitals entrusted to it. While the importance of regulatory compliance should not be underestimated, these are already delegated to qualified professionals, such as external auditors, corporate secretaries, corporate counsels, etc, to keep the company’s business activities and the board on the straight and narrow. However, the board’s fiduciary oversight responsibilities still remain and cannot be delegated. As strategic assets operating in a VUCA environment, boards need to oversee their organisations’ capacities to do a better job of assessing disruptive risks, whether Reporting decisions internally or externally driven. These From a big-picture perspective, the risks could have significant economic, governing purpose of a corporate audit operational, and/or reputational impact report is to give assurance to investors that should they occur. The task is not an the financial performance of the company optional undertaking for directors: it is a is true and fair. The robust regulatory critical imperative because these types of framework for financial reports ensures risks are often ambiguous, complex, and the interests of investors are safeguarded difficult to identify. To assess and respond by the independent assurance to these risks will require of external auditors. However, building proficiency in what A culture of do we know how much investors is called ‘adaptive governance’ innovation rely on the financial reports – as a necessary response to a to make forward, informed and a culture world in continuous disruption. investment decisions? A A culture of innovation and of value well-documented research by a culture of value creation are Prof Baruch Lev and Associate creation are the two-prong approach for Prof Feng Gu in their book in a world of change. the two-prong thriving The End of Accounting indicates Regardless of market approach that investors rely on financial disruptions, the board’s top reports less than five per cent priority is to create value for thriving of the time when making with the capitals and assets in a world investment decisions, which entrusted to it – conveying is understandable because by to investors a more holistic of change the time any audited financial message on the output of its report is published, it’s already outdated. fiduciary responsibilities. A trending More than 70 per cent of the time investors corporate strategy is the adoption of lean on unaudited sources, such as an integrated value creation-thinking media reports, market intelligence, framework on how the board creates industry insights, government statistics, value with the essential capitals under analyst forecast, and so on. Investors, its care. The output-focussed integrated being pragmatic and judicious, rightfully reporting (IR) framework, developed by raise questions regarding the value the International Integrated Reporting of audits beyond merely fulfilling Council (IIRC), is gaining traction toward a compliance requirements. paradigm shift in the traditional financial The board is often pressured to file the corporate reporting to holistic Integrated company’s quarterly financial report in Reporting. This will redefine and reinvent compliance with established regulatory the governance framework as we know it. Autumn 2019 | Ethical Boardroom 19

Global News Asia Pacific

Auckland supports women on boards Auckland Airport has become the only company in the New Zealand stock exchange to have a majority of female directors. Liz Savage has been elected to the board of Auckland Airport, making it the only company in the NZX top 10 to have a majority of female directors. Elected at Auckland Airport’s annual general meeting in

October, Savage is the fifth woman to join the board, which is made up of eight directors. “We strongly believe in the benefits of diversity and inclusiveness and while we still have a way to go, we are pleased that we are on the right track and are making progress,” said Adrian Littlewood, Auckland Airport’s chief executive.

Hedge fund targets poor governance A new hedge fund launched by private bank Union Bancaire Privée will target poor corporate governance in Japan, according to reports. The Japan Times said the yet-tobe-named hedge fund will be run by Zuhair Khan, who was recently head of research at Jefferies Japan. The long-short fund will seek out about 30 undervalued companies with good governance, while shorting roughly 60 richly valued businesses with weak oversight. “Valuations in Japan are very low as future improvements in governance are not priced in, and this creates tremendous upside,” Khan told the Japan Times. “A few years ago, it may not have been possible to have a fund like this.”

Australia has diversity ‘wake-up call’ Australian businesses have lost momentum in improving gender diversity with the percentage of women on ASX 200 boards falling, a report has found. The latest Gender Diversity Report released by the Australian Institute of Company Directors (AICD) reveals that the percentage of women on ASX 200 boards has fallen to 29.5 per cent, down from 29.7 per cent in July. The number of male-only boards in the ASX 200 also increased this year to seven.

In 2015, the AICD called for ASX 200 companies to achieve 30 per cent women on boards by the end of 2018. AICD CEO and managing director, Angus Armour said the results should serve as a wake-up call to directors, investors and shareholders across the ASX 200. “Australia is not lacking for talented and experienced women. Boards struggling with gender diversity must challenge themselves and make commitments to do better.”

Sport Australia boss steps down Kate Palmer has announced she is to step down from one of the most important roles in Australian sport after electing not to seek to renew her contract as chief executive of Sport Australia. Sport Australia is the Australian Government’s lead sport agency and is in charge of funding elite sports in the country and promoting physical activity. Palmer has been in the role since February 2017 after joining from Netball Australia but will step aside when her contract expires on 31 January 2020. “Kate has led an ongoing process of building capability and of governance reform among national sports organisations and put in place important safeguards to protect children in sporting environments,” said chairman of Sport Australia, John Wylie.

20 Ethical Boardroom | Autumn 2019

Gupta stars on CEO list Piyush Gupta (below) is the only CEO in South-east Asia on Harvard Business Review’s list of the top 100 best-performing CEOs in the world. Gupta, chief executive of DBS Bank, is also the first Singaporean CEO to feature on the annual list, which measures performance for the entire length of a chief executive’s tenure. Harvard Business Review said leaders on its 2019 list have ‘prospered by outperforming their peers over the long term – both financially and on increasingly important environmental, social, and governance measures’. “Being the first Singapore CEO to be featured on this list, Gupta has done us all proud by flying the Singapore flag high on the global stage once more,” said DBS Chairman Peter Seah.

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CMY

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 & Australasia | Japan THERE’S STILL A LONG WAY TO GO Japan needs to stay committed to corporate governance reformation

Japan’s unfinished reforms In 2013 and 2014, Prime Minister Abe’s cabinet put in place a ‘growth strategy’ based in part upon a white paper that I had led in 2010.

The core theme in both was that the enhancement of productivity and profitability of corporations was essential for Japan’s future, and the central ‘pillar’ of the growth strategy was to improve corporate governance. A stewardship code and corporate governance code1 were put in place, and other reforms followed.

Progress is slowing

So far, so good. On the one hand, enough of a base of ‘best practice’ concepts and new mindsets now exists that if shareholders ask for specifics, more and more Japanese companies will heed their reasonable requests. As I wrote a year ago, at this point the pace of change is mainly up to investors. But in a country where many modern corporate governance practices were avoided for 40 years, change does not come easily. Many institutional investors are still getting their engagement ‘legs’. They do not know what is changing on Japanese boards and what is not, what exactly to ask companies for, and how to get it. At the same time, many companies are resisting change or just sliding by with superficial motions, and their defensive ‘wall’ of cross-shareholders and other yes-man ‘allegiant holders’ remains high – or has even increased in size. On average for non-financials in the TSE First Section, 22 Ethical Boardroom | Autumn 2019

Dear Prime Minister, don’t give up yet! Nicholas Benes

Representative Director of the Board Director Training Institute of Japan (BDTI) more than 55 per cent of net assets is stuck in non-core holdings and cash. Unsurprisingly, in 2018, for a variety of reasons the Asian Corporate Governance Association (ACGA) ranked Japan seventh out of 12 countries in Asia in its overall CG rankings2 (see Figure 1, opposite).

Reform is losing steam

Thus, is it essential that the Tokyo Stock Exchange (JPX/TSE) and the various regulatory agencies keep up reform momentum. However, one senses a desire from these groups to ‘declare victory’, and they have a tendency to not fully coordinate with each other. If Prime Minister Abe’s cabinet did more to make the key players coordinate their efforts in key areas, meaningful governance change (and protection of investors) would accelerate. Japan’s goal should not be to come close to, or equal, other major markets. It should be to exceed the quality and trustworthiness of other major markets. As the most developed economy and largest stock market in Asia, it has the potential to do this. Prime Minister Abe has pledged to ‘continue to advance corporate governance reforms in line with global standards,

including appointment of external directors and disclosure of officer remuneration’. 3 Now is the time for him to realise that vision (see Figure 2, opposite).

The unfinished business

Detailed rules for an independent committee Despite its numerous exhortations to ‘fully utilise’ independent directors, Japan’s Corporate Governance Code (CGC) still doesn’t set forth clear and consistent rules for a fully independent ‘nomination and compensation committee’, the one place where their independence could be best leveraged to improve governance. Obviously, a minority of three independent directors on a 10-person board will have limited sway. But if appointed to a committee, they can control the most important levers of governance where independence is essential. In fact, it was precisely in order to subsequently require such a committee, that I insisted on ‘multiple’ independent directors when I first proposed the key items that I thought should be in the CGC. The next revision of the CGC should set forth clear requirements and best practices for such a committee. It should also require the independent committee to advise the board not only on nominations and compensation matters, but also on any other matter with respect to which more than two directors or a related party may have an inherent conflict of interest or special interest, in the opinion of a majority of the independent directors. www.ethicalboardroom.com

Japan | Asia & Australasia

the role and responsibilities 3 Codifying of executive officers

Japan has to deal with an impending problem that the Governance Code itself has created, by amending the Company Law so as to create legally valid ‘executive officer’ (shikko yaku) roles at all Japanese public companies. This is an area that shows that not everything can be handled by ‘soft law’ (non-mandatory principles, such as the CGC), and that some issues can only be addressed by changing the Company Law (the ‘hard law’) itself.4 In the two legally permitted governance structures that are utilised by 99 per cent of Japanese companies, the more independent directors are added to a board, the smaller becomes the number of directors who can be appointed as legally valid ‘executive directors’, and in particular, are eligible to be appointed as the CEO at any time. Thus, the positive trend to appoint more independent directors is at the same time creating a situation where the pool of persons who can be considered as a replacement CEO when one is quickly needed is becoming smaller and smaller. This is not a healthy situation, especially since the CGC itself appropriately stresses the importance of a timely process for replacing the CEO when and if necessary. To make matters worse, at these companies (99 per cent of listed companies), persons who are non-director ‘officers’ not only cannot be appointed to serve as CEO without an AGM, but also carry no fiduciary duties and therefore cannot be sued by shareholders for violation of duties of due care, reporting and the like. Thus, now there is not only less ability to flexibly select the most senior executives, but also less legal accountability for executives overall. www.ethicalboardroom.com

of overlapping 4 Consolidation disclosure reports

As ACGA and many others have pointed out, Japan needs to consolidate its myriad disclosure reports so that they are much more convenient to use. This will require strong political leadership from the top, because it can only be done by abandoning the separate bureaucratic silos of Ministry of Justice (MOJ), Financial Services Agency (FSA) and TSE/JPX-required disclosure. Japan needs to integrate financial reports, business reports, and governance disclosure into a single document (the yuho, or annual financial report, submitted to the FSA). Next, it needs to require this document to be

published prior to the AGM so that information can be used by shareholders on a timely basis. To give just one example of the problem, currently less than one per cent of Japanese public companies release their annual financial reports, which contain all disclosure required by securities law, before the AGM has been held. Investors also need to keep in mind that business reports in the proxy statement, ‘kessan tanshin’ earnings reports, and JPX/TSE corporate governance reports are not subject to potential liability under securities law in case of misrepresentations or material inaccuracies. This is the major reason there is so much sloppy, vague and meaningless disclosure language in TSE/JPX governance reports: they entail no legal liability. Notably, the proliferation of so many different disclosure reports, and the burdens that imposes on investors, was a principal reason why the ACGA lowered Japan’s corporate governance rating in its 2018 report. FSA, MOJ and the Minisry of Economic Trade and Industry (METI) have had initial discussions on the concept of combining different reports, but progress is very slow.

FIGURE 1: TOTAL ALLEGIANT SHAREHOLDINGS ■ Allegiant Share Holdings ■ Topix 1000 Index*

35 30

Trilion Yen

A separate principle, clearly requiring a majority of independent directors, needs to be set forth in the CGC, regardless of the presence of such a committee. Otherwise, one cannot have full confidence that the selection of directors or committee members will be made on an objective and neutral basis. By global standards, the CGC only encourages a choice between (a) a half a loaf: a majority of independent directors, but no committees are required, and (b) a weak and vague loaf: a nomination or compensation committee that has ‘substantial participation’ by independent directors on it, but is chosen by a board dominated by executive directors, and the chair of which may be an executive director (even the CEO). The loose wording of this section would not pass muster in most other developed nations.

If Prime Minister Abe’s cabinet did more to make the key players coordinate their efforts in key areas, meaningful governance change (and protection of investors) would accelerate

25 20

30.0

29.1

26.5

26.2 126.9

112.1

100.0

118.1

15 10 5 0

2016

2017

2018

2019 to date

FIGURE 2: ALLEGIANT SHARES HOLD BACK FIRM PERFORMANCE 30%

R2 = 0.012 P=0.0001

20% 10%

ROIC

clear requirement for a majority of 2 Aindependent directors on the board

-10% -20% -30%

10%

15% 20% 25% 30% 35% Allegiant Shares / Total Assets

Non-financial companies suffer a 0.12% drop in return on invested capital (ROIC) for every % increase in allegiant holdings/total assets, ceteris paribus.

40%

45%

50%

Average ROIC for firms with: A) <10% allegiant holdings/total assets 6.34% B) >=10% allegiant holdings/total assets 3.21%

Source: BDTI Corporate Governance Database, preliminary data.

Autumn 2019 | Ethical Boardroom 23

Asia & Australasia | Japan of minority 5 Protection shareholder rights

FIGURE 3: FEMALE DIRECTORS: JAPAN STILL LAGS BEHIND ■ Japan (All listed) ■ Canada (TSX) ■ UK (FTSE 350) ■ US (Russell 3000, ex. S&P500) 35

Trilion Yen

To come closer to the global standard that the Prime Minister has promised, Japan 30 will need to address the protection of 29.1% 26.7% minority shareholder rights and ‘fairness’ 25 24.5% 23% in M&A transactions not only by means 21.9% 20 of non-compulsory METI ‘guidelines’, but 19% 17% 16% 15 also by amending the Company Law (the 15% 14% 14% 13% 13% 12% 12% hard law) and compulsory stock exchange 10 listing standards. 5 5% As things stand now, not only a 51 per cent 4.3% 3.5% 3.8% 2.9% parent company but a holder of merely 25 0 2015 2016 2017 2018 2019 per cent or so can do all sorts of things to Source: Japan — BDTI Database; Canada — Osler; UK — Hampton-Alexander Report; US — Harvard/ISS. destroy value that should accrue to minority holders, whether it be by pushing through that perpetuate narrow-mindedness and not stop at meekly ‘encouraging’ corporate unnecessary dilutive capital increases, stymie creativity and dynamism. pension funds to sign the SC, but should stopping takeover bids or beneficial merger The benefits of diversity do not come from take more meaningful steps to serve the proposals in their tracks, self-servingly merely increasing the number of women on interests of the pensioners it is charged pushing through their own underpriced corporate boards. They arise from changing with protecting. Specifically, it should deals, or ‘tunneling’ of all sorts, including corporate ingrown cultures so that different require corporate pension funds to include simply requiring excess cash to be deposited opinions and perspectives are more easily a description of their policy towards with the large holder rather than paid back tolerated and even ‘stewardship’ in their formal investment to shareholders. encouraged, management policies, and should require them to disclose This is an area where so Japan is viewed innovation can more easily to employees and pensioners whether their much has not been done by global investors occur, and practices and pension fund has signed the SC or not. 8 yet that listing everything allegiances of the past are would require another as one of the So far, only eight defined-benefit pension quickly abandoned when article. Therefore, I will markets that has funds of non-financial companies have they are no longer effective. only mention the two policy the most to gain signed the SC, out of a total universe Japan should require changes that I think would numbering more than 700 funds. It is clear disclosure of the number of help the most. First, the from greater that neither MHLW, corporate pensions, women and foreigners (a) on JPX/TSE listing standards diversity and nor their corporate sponsors are very serious the boards and (b) among should require shareholder about stewardship, even though Japanese the executive ranks from approval for capital inclusiveness at companies pride themselves on the strength the middle level upwards. increases that dilute of their covenant to employees. Yet, asset In addition, if directors shareholdings by more than all levels in many owners such as corporate pension funds (CEO or otherwise) are hired 20 per cent. Second, in the companies are one of the most important players as ‘advisors’ (soudanyaku or case where a shareholder in the investment chain, because they komon) after their retirement from the board, sues a director who voted for a transaction decide which asset managers are awarded their compensation amount and general job affecting ownership or capital structure or mandates (or not), the amount of funds responsibilities should also be disclosed in involving a related party, the Company Law allocated to them, and the proxy voting the yuho financial report6. should reverse the burden of proof unless and other stewardship practices that are the board had obtained the advance Strengthening stewardship required of them. approval of the fully independent committee throughout the investment chain Here again, strong political leadership mentioned earlier in this article. Japan’s Stewardship Code (SC), which is a is essential. Sound familiar? Here again, only strong political completely voluntary code but is successful leadership can bring about the coordination Opinions are my own. 1I myself was lucky enough to get in the sense that most asset management between different agencies and the stock the governance code ball rolling, by proposing it to key fiduciaries in Japan have signed it, needs to exchange that is needed. 5 lawmakers and making a presentation to the committee in charge. 2Asian Corporate Governance Association, CG be strengthened in the following important Watch 2018 3Policy Speech by Prime Minister Shinzo Abe Enhancing transparency respects: (a) clear rules are needed to to the 198th Session of the Diet, January 28, 2019, https:// to reduce entrenchment countenance collective engagement as long japan.kantei.go.jp/98_abe/statement/201801/_00003.html. 4 and enhance inclusiveness as the collective action is unconditionally Last year, I was able to convince METI of the need to do this, and METI formally suggested amendment of the law to Japan is viewed by global investors as one of ‘opt out’ in nature, and these rules must the Ministry of Justice. However, the MOJ council ignored the markets that has the most to gain from apply even in the case of ‘making this suggestion, showing that political leadership is needed. greater diversity and inclusiveness at all recommendations’ to companies; (b) public See the link below (Japanese only): http://www.moj.go.jp/ content/001237422.pdf. 5Regarding protection of minority levels in many companies, and the reduction disclosure of per-item votes should not be shareholder rights, see my public comment submission of ‘old boy networks’ and other practices that voluntary (but rather, mandatory) if an to METI. https://bdti.or.jp/en/blog/en/metipubcomnb/. 6 tend to lead to entrenchment of management. institution has signed the Code; and (c) the Regarding advisors, as background see: https://bdti.or.jp/en/ blog/en/advisorg/. 7See: The Unfinished Business of Japan’s Here, I am referring not only to the need to FSA should create a system to standardise Stewardship Code, https://academiccommons.columbia.edu/ appoint more female directors and managers the format of such per-item vote disclosures doi/10.7916/D8D79PTM. 8This is what I proposed in (see Figure 3, above). Rather, many Japanese and make them freely available to investors 2018, which was not put in place but led to an inter-agency study group, the new CG Code principle on stewardship, companies need to promote diverse thinking in fully machine-readable format.7 and a MHLW web page to encourage pension funds. At the same time, as the regulator of in general, by appointing more foreigners See article: https://www.top1000funds.com/2019/04/ corporate pension funds, the Ministry of and facilitating market pressure (via japans-governance-conundrum/. See also: Health, Labour and Welfare (MHLW) should https://bdti.or.jp/en/blog/en/ishinoueni3nen/. transparency) to abandon outdated practices

24 Ethical Boardroom | Autumn 2019

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Asia & Australasia | Board Performance

On the road to effective Board evaluations in India The corporate governance story in India over the last two decades has been one of promise, path-breaking initiatives and occasional heartbreak.

On the regulatory front, governance reforms are taking place at a breakneck speed. The most recent tend to display greater focus towards instituting checks and balances that are designed to enhance overall company governance structures and addressing the agency problem prevalent in India. That is characterised by the omnipresence of promoter-run,

26 Ethical Boardroom | Autumn 2019

Unlike the US or the UK, board evaluation in India is still an emergent concept. Mathew John

Board Practice, Amrop India promoted-owned companies in both the listed and the unlisted space (i.e. potential conflict between promoters and minority shareholders). While this is certainly a cause for celebration and optimism, the frequency of governance failures and instances of fraud continue to be status quo with major institutions like the Punjab National Bank (PNB) and Infrastructure Leasing and Financial Services Limited (IL&FS) leading the race to the bottom in 2019.1 In this context, board evaluations are

seen as an important element in a firmâ&#x20AC;&#x2122;s strategy for improving the quality of its top-level decision-making and for developing its operations. Over the last few years, the Indian regulatory environment has transitioned from merely encouraging voluntary adoption of evaluation of the board of directors of a listed company to a regime that strongly mandates listed and public entities (with paid-up capital of INR 250million or more) to undertake periodic evaluations of the board and its various committees. While the intent behind mandating periodic evaluations is commendable, the actual implementation is fraught with many challenges.

How evaluations contribute to board effectiveness

Spurred on by waves of technological disruptions and corporate crises across the globe, reforming governance structures, including novel ideas on improving the performance and effectiveness of boards, now takes centre stage in academic and professional discourse focussing on corporate governance. Strengthening board effectiveness is a high priority for many leading companies and their shareholders. Consequently, it is no longer sufficient to have directors who are only â&#x20AC;&#x2DC;good enoughâ&#x20AC;&#x2122;. Globally, corporate boards conduct regular evaluations to assess their strengths and weaknesses, with the objective of building high-performing boards capable of anticipating and overcoming the challenges ahead. Well-structured evaluation processes provide an important conduit for reform as companies require new skills, perspectives and strategies over time. For this reason, evaluation of board behaviour, effectiveness and its disclosure are increasingly being

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Board Performance | Asia & Australasia regarded by investors as a key opportunity to enhance shareholder value. An OECD study published in 2018 notes that boards in countries with more detailed principles and guidance adopt a ‘more substantive and accessible board evaluation practice than their peers in jurisdictions with little or no detailed requirements’.2 The jury is still out on whether or not evaluations mandated by legislation are actually effective in encouraging companies to move beyond a ‘box-ticking’ compliance exercise. It goes without saying that meeting compliance standards is not the single qualifying criteria determining board effectiveness. An effective board is characterised by having the right skill diversity in composition and an innate desire among members to work together to improve the quality of decision-making to ensure equitable benefits to all stakeholders. In many leading companies, robust board evaluation and honest undertaking of consequent remedial measures often turn out to be the key ingredients that enable the transformation of a good board into an effective board.

Board evaluations in the Indian context

Unlike the US or the UK, board evaluation in India is still an emergent concept. It was only in April 2014, with the enactment of the Companies Act 2013 and the SEBI Listing Obligations and Disclosure Requirements Regulations, 2015 (SEBI LODR) that India mandated periodic evaluations for the board of directors of listed entities and its various committees. However, diving deep into the mechanics of mandated evaluations reveal a tangled mess. Section 178(2) of the Companies Act 2013 necessitates the boards of directors of listed entities to form a nomination and remuneration committee (NRC), which is tasked with establishing criteria; and, finally, making for the evaluation of

performance of independent directors and the board of directors; carrying out these evaluations based on the established criteria and finally; making the determination to continue or revise the term of appointment of the independent director based on each of their assessment reports.3 Meanwhile, Schedule IV of the Act requires review of the board and the chairperson to be done in a ‘separate meeting’ of independent directors without the attendance of other board members. In the same breath, Schedule IV also stipulates that the performance of each director is to be evaluated by the board. So finally, the question arises: who is really supposed to conduct the evaluations? When it comes to the practice of board evaluations, in a study conducted by one of the three proxy advisory firms in India, it became fairly apparent that very few Indian companies recognise the value of conducting credible evaluations beyond fulfilling compliance obligations.4 Since the first iteration of the mandatory evaluation exercise issued in March 2015, many companies are content to follow oversimplified processes to conduct evaluations and the range of compliance varies wildly between them.5 Evaluations are being conducted in an arbitrary manner with some companies relying on questionnaires with Likert style rating scales, some relying on one-to-one interviews and peer reviews and others relying on in-house processes and/or external consultants.

While the main goal of any review process is to identify areas for improvement that can potentially improve board effectiveness, the fact remains that almost no Indian company discloses areas for improvement flagged by the board during the evaluation process. In an attempt to address these issues, in January 2017, the Securities and Exchange Board of India (SEBI) released a ‘guidance note’ with the objective of providing clear directions to listed entities on the various aspects and nuances involved in the evaluation process.6 The SEBI note says that in addition to the aforementioned statutory requirements, listed companies can voluntarily opt to provide additional disclosures, including the outcome of the evaluation, actions taken, and current status of the outcomes that require engaging various stakeholders. For SEBI, the guidance note is a departure from the standard practice of establishing norms and procedures to one that recognises the need for encouraging a board culture that fulfils its perceived moral obligations towards all stakeholders.

EFFECTIVE BOARDROOMS Robust evaluation can transform good boards

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Autumn 2019 | Ethical Boardroom 27

Asia & Australasia | Board Performance While it remains a truism that adherence to the ‘guidance note’ is not mandatory, it would be difficult for companies to claim good corporate governance performance without it. Ongoing reforms in India prove that the quality of performance of Board of Directors in India is under greater scrutiny than ever before. They are a response to the growing importance of effective Board evaluations internationally as a key instrument for assessing board effectiveness and efficiency.

Way forward

industry practitioners has developed a robust ‘3-phase’ process that goes beyond a cursory compliance exercise. The process achieves this by holistically assessing all aspects influencing board effectiveness in the 21st Century, ranging from composition and individual board members’ contributions and results, to ethical conduct, sustainability and stakeholder communications. In the Summer 2019 edition of Ethical Boardroom, Andrew Woodburn, managing partner at Amrop South Africa, recommended a ‘Multi-year Sustainable Evaluation Programme’ approach designed to generate actionable insights on the key determinants of board effectiveness over the short, medium and long term.8 Rather than following a specific template of evaluation every year to meet compliances, Sustainable Evaluations encourage Boards to take an in-depth look

With the board rising in prominence as a key determinant of a company’s destiny, it is all the more important that it should be dispassionately assessed. Evaluation is to be a formal, closed-door, comprehensive process which considers all issues faced by the board, including the hard ones. When measuring performance, it must be in the context of alignment with strategic objectives of the company and fiscal performance without compromising the principles of stakeholder democracy. A good evaluation exercise is also underpinned by its nuanced understanding of the social dynamics of board interactions and, as David Nadler reflects in the May 2004 issue of the Harvard Business Review, ‘in the competence, integrity, and constructive involvement of individual directors’.7 Just as a robust evaluation exercise can contribute to strengthening board effectiveness, poor evaluations can lead to governance failures. It goes Reluctance of board members to accept their shortcomings when without highlighted should not result saying that in the board shying away from working on areas for improvement success of any in the interest of preserving any evaluation collegial atmosphere within. An exercise is external evaluator in this context can be very useful in facilitating contingent an honest, objective assessment on ensuring in terms of board roles, dynamics and individual performance. feedback is Following a clear articulation of given to all every year to measure their the objectives and scope of the performance at specific exercise, and a careful selection those who levels and also to figure of parameters and tools used for have been out exactly what works and evaluation, external consultants evaluated what doesn’t when it comes can also be leveraged to drive the to following through on the process of adequately apprising the on the action items covered in the preceding board before the implementation phase itself. year. Paraphrasing Andrew’s reflections in the Once the board evaluation process Indian context and considering the issues reaches its conclusion, any specific enumerated earlier, this model of sustainable recommendations for implementation evaluation will go a long way towards should be brought up. It goes without saying promoting investor confidence by extending that success of any evaluation exercise is stakeholders the opportunity to observe and contingent on ensuring feedback is given to measure the board’s commitment to active, all those who have been evaluated. ongoing evaluations and improvements in Sustainable evaluations board practice. At Amrop, our global board practice in It is worth reiterating that no amount concert with leading academicians and of legislation can ensure ‘good corporate 28 Ethical Boardroom | Autumn 2019

governance’. It has to come from an innate desire to maximise shareholder value while at the same time fulfilling the company’s moral obligations to all stakeholders. Evaluation can serve as a powerful tool towards mapping the governance landscape with the objective of correcting any deficiencies, but success of any such exercise is contingent on the board buying in on the idea and viewing it as a constructive initiative. Exhaustive studies done over the years demonstrate time and again that good corporate governance leads to superior firm value and is consistently associated with lower cost of capital, effective capital allocation and risk management, among other benefits. Echoing the views of global experts and trend observers, it would not be long before investors begin placing a GETTING THE RIGHT ANALYSIS Evaluations done poorly will lead to governance failures

premium on evaluation reports – which means a well-designed process which includes actionable reporting is paramount. In this context an effective, sustainable evaluation exercise contributes positively towards improving efficiency of the board as a whole and should be seen as such. https://economictimes.indiatimes.com/industry/ banking/finance/banking/scam-exposes-managementlapses-at-pnb-say-experts/articleshow/62934503. cms 2https://www.oecd.org/daf/ca/Evaluating-Boardsof-Directors-2018.pdf 3http://www.mca.gov.in/Ministry/ pdf/CompaniesAct2013.pdf 4http://www.ingovern.com/ wp-content/uploads/2016/05/Board-Evaluation-Practicesin-India-26-05-2016.pdf 5https://www.icsi.edu/media/ webmodules/companiesact2013/Final_LODR.pdf 6https:// www.sebi.gov.in/legal/circulars/jan-2017/guidance-note-onboard-evaluation_33961.html 7https://hbr.org/2004/05/ building-better-boards 8http://www.amrop.in/wp-content/ uploads/2019/09/EB_Summer2019_AMROP_DPS.pdf 1

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Corporate Governance Awards | Introduction

AWARDS 2019 ASIA & AUSTRALASIA WINNERS

The need for ensuring strong governance Implementing good corporate governance ensures organisations conduct their business in a fair and ethical manner, considering the interests of all its stakeholders to achieve long-term and sustainable growth. The focus on establishing strong corporate governance frameworks has intensified in the face of changing capital markets and megatrends, such as climate shifts and pressures, digitalisation and population change. In Australia, new regulatory guidelines established by the Australian Securities and Investments Commission (ASIC) aim to drive accountability and corporate governance standards across the country. ASIC’s supervisory initiative – the Corporate Governance Task Force – was established to ‘conduct targeted reviews into corporate governance practices of large listed entities to gain an insight on actual governance practices’ and its first report focusses on director oversight of non-financial risk. The report highlights the standard the corporate regulator expects from organisations when governing for non-financial risks, such as conduct, operational, compliance and strategic risks. Based on the work of the Taskforce, ASIC will also release a follow-up report later this year that will deal directly with the relationship between conduct risk management and executive variable remuneration.

30 Ethical Boardroom | Autumn 2019

In Japan, the push for improved corporate governance has seen organisations under pressure to align their management goals of hitting financial targets with their responsibilities towards industry analysts, years of corporate governance reforms by the Japanese government may finally be resulting in improvements, with companies more eager to return money to shareholders, and activism more acceptable to conservative investors. Japanese focus on governance in recent years has elevated the status of shareholders,

The focus on establishing strong corporate governance frameworks has intensified in the face of changing capital markets and megatrends

putting shareholder interests higher than they have been in the past. In Malaysia, the government believes that a culture of integrity and ethics is central to good governance and that it must be put into practice in every aspect of a company’s operations. This year, Malaysia’s Securities Commission issued its inaugural Corporate Governance Monitor, revealing that 70 per cent or 841 of listed companies have adopted the 27 best practices listed in the Malaysia Code on Corporate Governance. Malaysia’s Finance Minister Lim Guan Eng has called upon the nation’s corporate leaders and captains of industry to set a tone of anti-corruption and integrity at the top level to ensure good governance in their respective organisations. 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 Asia and Australasia.

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The Winners | Corporate Governance Awards

INDIVIDUAL WINNERS 2019 BEST CEO LEISURE & HOSPITALITY Mr Puneet Chhatwal The Indian Hotels Company Ltd (IHCL)

FMCG Dabur Ltd Financial Services HDFC Ltd

BEST COMPANY SECRETARY LEISURE & HOSPITALITY Mr Beejal Desai The Indian Hotels Company Ltd (IHCL)

IT Services Tata Consultancy Services (TCS) Leisure & Hospitality The Indian Hotels Company Ltd (IHCL) (India)

Insurance AIA Group (Hong Kong)

Food & Beverage Nestlé Malaysia Construction Sunway Construction Group (Malaysia)

Conglomerate Keppel Corporation Real Estate Investment Trust (REITs) Capital and Commercial Trust Airlines Singapore Airlines (Singapore)

INDIVIDUAL WINNERS 2019 BEST CEO BIOTECHNOLOGY Mr Paul Perreault CSL Limited BEST COMPANY SECRETARY TELECOMS Ms Sue Laver Telstra Corporation Ltd

BEST CEO FOOD & BEVERAGE Mr Juan Aranols Nestlé Malaysia BEST CEO AIRLINES Mr Goh Choon Phong Singapore Airlines

Holding Ayala Corporation

Mining BHP

Telecoms Globe Telecom (Philippines)

Transportation & Logistics Brambles Biotechnology CSL Ltd Construction Lendlease Group Insurance Insurance Australia Group Ltd (IAG) Telecoms Telstra Corporation Ltd

Food & Beverage The a2 Milk Company Real Estate Investment Trust (REITs) KIWI Property Group Electric Power Generation Meridian Energy Ltd (New Zealand)

Retail Woolworths Supermarkets (Australia)

BEST CEO CONSTRUCTION Mr Steve McCann Lendlease Group BEST COMPANY SECRETARY TRANSPORTATION & LOGISTICS Mr Robert Gerrard Brambles www.ethicalboardroom.com

Autumn 2019 | Ethical Boardroom 31

Cover Story | The Indian Hotels Company Ltd

AWARDS

WINNER 2019 ASIA LEISURE & HOSPITALITY Historically, sustainability has referred to an approach that protects or conserves the environment. This has now expanded to include the aspect of social sustainability and economic sustainability practices. These three pillars of sustainability are required to ensure social, economic and environmental equality.

However, this concept of sustainability is not new for the Tata Group, which has embraced the challenges of addressing many developmental challenges by contributing to growth and jobs, reducing poverty, mitigating climate change, ensuring food security and environmental sustainability, while successfully running businesses. Since inception, a sustainable soul has been at the heart of the 150-year-old Tata group, with the visionary founder, Jamsetji Tata sowing the seeds of corporate conscience that are today visible in

Indian Hotels Company Limited is raising standards in hospitality and ensuring a brighter global future Puneet Chhatwal & Beejal Desai

Puneet is the MD & Chief Executive Officer and Beejal is the Senior Vice President and Legal & Company Secretary of the Indian Hotels Company Limited (IHCL)

initiatives taken by the different arms of the group. At the Indian Hotels Company Ltd (IHCL), the Tata Group’s way of doing business finds expression not just in the business of hospitality but also in how it explores new frontiers in sustainability. The Tata values are at the core of IHCL’s operations with initiatives across the value chain and in local communities to share the values created with all stakeholders. As one of Asia’s leading hospitality companies with more than 190 hotels across 80 locations worldwide, IHCL has always adopted the path of sustainable growth. Taking advantage of its multilocational business presence, IHCL takes a 360-degree view of sustainability, addressing not just the environment, but also the community to shape a common future through environmental stewardship, social

responsibility and business performance. From maximising renewable energy to developing skills in local communities, and initiatives for employee wellbeing, the aim is to ensure a shared future of sustainable growth for all stakeholders in a global atmosphere of unprecedented challenges and countless opportunities. The challenge is in bringing together disparate efforts and diverse stakeholders to create a meaningful, sustainable impact. IHCL supports the UN Sustainable Development Goals, with particular emphasis on Goal 12 for resource consumption and optimisation towards environmental sustainability and Goal 8 for decent work and economic growth towards social sustainability. The Group also participates in the United Nations Global Compact (UNGC), a voluntary pact to adopt sustainable and socially responsible business policies through a principle-based framework.

Caring for the environmental soul

The hospitality sector is seeing discussions on the impact on the environment of energy and water consumption, waste creation and disposal. These issues are at the fore when it comes to formulating inclusive business strategies for environmental sustainability. Today’s IHCL guests make active choices in making the world a better place and prefer an environmentally friendly hotel that is ‘green’ conscious. IHCL’s operations cover several places of cultural and historical importance, across different geographies that range from major cities to protected forests, from the mountains and hills to the coastal beaches.

Luxury with a

32 Ethical Boardroom | Autumn 2019

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The Indian Hotels Company Ltd | Cover Story The potential environmental impact arises from the creation of waste, the use of plastics, discharge of sewage, energy and water usage, as well as CO2 emissions from operations. Its presence in remote locations may have implications for the environment due to the high tourist footfall. To combat these, IHCL makes environmental stewardship the basis of its operations and strives to assimilate a ‘green’ thought process into the daily operations and thinking of all stakeholders. As the international drive towards renewables continues to accelerate and discussions about water security gain prominence across industries, IHCL has taken a proactive stance to these global concerns by phasing out single-use plastic, exploring renewable energy and strengthening water security. Its business ecosystem focusses on sustainability with a continuous pursuit of excellence in the operation of facility management systems and priority to procuring local, sustainable materials. IHCL has seen significant results from initiatives to eliminate plastic across its hotels. Just the elimination of plastic straws has led to a reduction in emissions. It is estimated that more than two million straws have been eliminated from the ecosystem avoiding 3,410kg CO2-eq emissions. Another initiative is the Waste To Innovation challenge that was launched during the annual Earth Hour event. It has other plans to create a sustainable environment, including an advanced laundry system. With the rationalisation of costs of renewable energy, economically viable environment-friendly options have

begun to be widely available for the hospitality industry. IHCL has begun integrating renewable energy into its ecosystem, with fuel consumption from renewable sources showing a big jump. Energy conservation measures and usage of alternate fuels such as biogas, PNG and CNG, has helped reduce emissions. Expansion of the renewable energy quotient has led to avoiding 65,200kg CO2-eq of IHCL’s total greenhouse gas (GHG) emissions. Progress is evaluated by continuous measurement of energy and water consumption, GHG emissions and renewable energy adoption. IHCL has collaborated with EarthCheck since 2008 for benchmarking of its environment and social performance. EarthCheck Certification is the world’s leading environmental certification and benchmarking programme for the travel and tourism industry. Since 2008, 78 IHCL hotels have achieved EarthCheck Certification and generated significant savings. Eight are Platinum Certified, 63 Gold Certified and EITHT hotels are Silver Certified, cementing the company’s position as a world leader in responsible tourism.

Nurturing the social soul through affirmative action

Enabling local cultures and communities to thrive is necessary for social sustainability to be effective. IHCL has historically contributed towards the betterment of the underprivileged and socially disadvantaged communities, providing support to livelihoods, art and culture, with efforts to

integrate the community as distributors, suppliers of goods and services, or employees. A good example of the practice of preserving the culture of Indian traditions while supporting communities is what IHCL does at its Taj palaces – Taj Lake Palace in Udaipur; Umaid Bhawan Palace in Jodhpur; Rambagh Palace in Jaipur and Taj Falaknuma Palace in Hyderabad – weave in a taste of Indian tradition mixed with authentic experiences by working with local artisans and non-government organisations (NGOs). At Umaid Bhawan Palace, guests are welcomed with the signature Rajasthani Khama Gani greeting, ‘Khamaghani’ followed by a grand Maharaj welcome –they are welcomed by a fleet of horses from the royal stables, a symphony of war drums and trumpets, followed by a shower of rose petals and rose water and the traditional Indian aarti and tikka garland. Guests are then treated to performances by local dance troupes known as Langa, followed by a group who perform the traditional Ghoomar dance. With opportunities for livelihoods expanding in the travel and tourism industry, IHCL works to build capabilities and further livelihoods of the economically weaker sections and low-income groups of women and young people, communities from scheduled castes and scheduled tribes, the differently-abled and traditional artisans. IHCL is aligned with the Skill India movement and has training programmes that help disadvantaged youth people find employment in the hospitality sector.

sustainable soul www.ethicalboardroom.com

Autumn 2019 | Ethical Boardroom 33

Cover Story | The Indian Hotels Company Ltd IHCL has skilled and certified more than 20,000 less privileged young people who have dropped out of school since 2008, by providing more than 90 per cent of such job placement opportunities across the Indian hospitality industry. Each year, the programmes enable livelihoods for more than 3500 people including youth who have dropped out of school, women, artisans and differently-abled beneficiaries. The Taj Tata Strive Programme is a tripartite collaboration between Taj, Tata Strive and CII which aims to provide financial, infrastructural and skill support to the underprivileged to achieve a sustainable livelihood. IHCL enables communities in the areas it functions in, creating opportunities where the skills of the local communities can be put to best use, supporting the revival of local art and traditions to ensure a win-win situation for all concerned. To take one example, Varanasi is one of the oldest living cities in the world and an integral part of its rich historical and cultural heritage is the intricately woven handloom Banarasi silk saree. IHCL is facilitating social change, which not only promotes the centuries-old traditional art of weaving Varanasi saris but also increases entrepreneurship opportunities for the

Shaping a common future through excellence in business performance, customer delight, environmental stewardship, and social responsibility is at the core weavers who have been involved in handloom weaving for generations. Taj has spearheaded a Livelihood Support Programme for the handloom weavers. The company commissions these weavers to create silk sarees. These sarees are worn by the front office and housekeeping staff at all of its luxury and palace hotels in India and abroad. In a game-changing move, Taj it has also initiated a female weavers’ training programme in Sajoi village to facilitate sustainable livelihood opportunities in Varanasi since December 2016. In a historic first, Taj is breaking the mould of what is considered a male-dominated industry, heralding the first time that women have become involved in the Varanasi handloom sector. Additionally, more than 100

indigenous artisans, craftsmen and culture troupe members are supported year on year through the provision of exhibition spaces Initiatives to enable other communities include efforts such as ‘Walk with the Pardhis’ for Taj Safaris in Panna National Park in the central state of Madhya Pradesh. This one-of-its-kind collaboration with Last Wilderness Foundation and Panna Forest Department is an inclusive tourism model for enabling alternative livelihood opportunities for the Pardhi community. Panna National Park, a wildlife reserve, had suffered devastating effects of poaching wherein the Pardhi community, known for their jungle knowledge, was used for the unlawful activities. Strict anti-poaching laws led to a significant increase in tiger numbers but left

IHCL: Ensuring good governance The Tata Group is recognised globally for its ethical and transparent business practices, as well as exemplary corporate governance across the board. An embodiment of the idea of ‘leadership with trust’, the Tata brand has, for years, signified the creation of long-term stakeholder value. IHCL is driven by the Group’s core values of integrity, responsibility, excellence, pioneering, and unity in all aspects of its functioning and organisational priorities. The core of IHCL’s service ethos is TAJ-ness, based on the three broad pillars of: ■■ Trust – that its guest bestow on it ■■ Awareness – of what is happening around it and its responsibility to the Indian hotel industry ■■ Joy – that IHCL takes in providing service At IHCL, disclosures and transparency form the cornerstone of good governance. IHCL has adopted the Tata Business Excellence Model (TBEM) to drive excellence and track progress on the 34 Ethical Boardroom | Autumn 2019

LEADING THE WAY Senior Vice President, Legal & Company Secretary

company’s strategic objectives. The model aims to enhance fairness and accountability in delivering the IHCL promise. The board periodically reviews the TBEM update, offering its valuable suggestions on how best to achieve functional excellence. IHCL abides by the Tata Code of Conduct (TCOC), in line with its philosophy of adhering to governance standards of responsibility, transparency, integrity and desire to preserve the human rights of every individual and the community. TCOC covers various aspects, such as being an equal opportunity employer, treating people with dignity and respect, prohibition of bribery and corruption, gifts and hospitality, conflict of interest, financial reporting and records, among others. The board of directors has a key responsibility to establish the ‘tone from

the top’ through the right attitudes, actions, and communications to promote ethical behaviour. This is communicated and reinforced through IHCL’s policy and procedure manuals, systems of internal controls, hiring practices, as well as through a highly proactive approach towards handling grievances and identification of key fraud risks. The IHCL board of directors is active, well-informed and independent. It is responsible for the overall conduct of the company and has the powers, authorities and duties vested in it respectively pursuant to the relevant laws of India and the articles of association of the company. IHCL ensures quality leadership by following a rigorous screening process for appointment of members to the board. While it ensures diversity of backgrounds www.ethicalboardroom.com

The Indian Hotels Company Ltd | Cover Story

THE HEIGHT OF LUXURY The lobby at IHCL’s Taj Dubai hotel

ROOM WITH A TOP VIEW The Presidental Terrace at IHCL’s Taj Cape Town hotel

through experience, talents, competencies, characteristics like independence, integrity, high personal and professional ethics are a top priority. At IHCL, the board: ■■ Has final responsibility for the management, direction and performance of the Hotel Group and its businesses ■■ Is required to exercise objective judgement on all corporate matters, independent from executive management ■■ Is accountable to shareholders for the proper conduct of the business ■■ Is responsible for ensuring the effectiveness of and reporting on the hotel group’s system of corporate governance The board has a formal schedule of matters reserved to it for its decision and these include: ■■ Group strategy ■■ Annual budget and operating plan ■■ Major capital projects, acquisitions or divestments ■■ Group financial structure, including tax and treasury ■■ Annual and half-yearly financial results and shareholder communications ■■ System of internal control and risk management ■■ Senior management structure, responsibilities and succession plans The board is consistently evaluated on its efficacy through a process that is bespoke in www.ethicalboardroom.com

the Pardhis to look for alternative sources of income. This initiative will offer an alternative to poaching and a new livelihood for future generation of Pardhis by channelling the community’s age-old knowledge of the forests into promoting wildlife conservation. IHCL’s Taj Public Service Welfare Trust was founded in the aftermath of the Mumbai terror attacks in 2008. The objectives of the Trust are to extend assistance to victims of terror, natural disasters, members of the armed forces and other services who demonstrate bravery in their line of work, and family members of all these affected persons. The Taj Mahal Palace Mumbai hosted a Black Tie Charity Ball on the eve of its anniversary on 15 December 2018. A similar event was held at Delhi as well. The galas brought together well-known members of the Mumbai community for a charitable evening coupled with jazz, music and fine food. All the proceeds from these events were donated to the Taj Public Service Welfare Trust (TPSWT). Recently, IHCL has also begun supporting Heritage Sites through the promotion of cleanliness in more than 30 public spaces across locations in India. These include the Gateway of India in Mumbai, the National Rail Museum in New Delhi and Dashashwamedh Ghat in Varanasi. its formulation and delivery, going beyond the processes mandated by regulatory authorities setting out clear objectives aligned to the provisions of the Act, guidance note on board evaluation issued by the Security and Exchange Board India (SECI) and the corporate governance requirements prescribed by listing regulations. The nomination and remuneration committee (NRC) maintains its oversight on it. IHCL engages with stakeholders prior to the implementation of policies or actions that could impact them. It interacts regularly with the community, through public hearings and meetings with various groups, such as senior citizens groups, and local leaders. The forums of the annual general meeting, analyst meetings and investor roadshows serve to interact with investors and are used to address issues of performance, long-term strategy and growth plans. At IHCL, stakeholder democracy is an essential part of corporate governance. The corporate governance framework ensures the equitable treatment of all shareholders, including minority ones. The company has constituted a stakeholder’s relationship committee that assists the board of directors in servicing and protecting various aspects of interest of shareholders, debenture holders and other security holders, having the mandate to review and redress stakeholder grievances. A robust system of internal controls exists to ensure efficacy, integrity, and quality of

Strengthening the economic soul At IHCL, the aim is to create shared value practices that balance resources and rewards to ensure long-term benefits in the community. It is about embracing social and environmental change and using the business and using that integration to drive economic value. IHCL’s associates are the core of the business and the most valuable assets. There is immense importance placed on fostering their growth through various programmes for employee development. Industry-leading steps, such as including fertility treatments under medical cover, eliminating break shifts and providing daycare centres in the hotels for the children of staff, are all part of a commitment to employee wellness. Shaping a common future through excellence in business performance, customer delight, environmental stewardship, and social responsibility is at the core of all employee efforts. As sustainability goals evolve in a constantly changing world, IHCL’s commitment to creating shared value for stakeholders, communities and the planet remains the foundation of all its efforts to ensure ‘luxury with a sustainable soul’.

financial reporting. All operating hotel units and corporate office functions are audited annually to evaluate areas of weakness and scope of improvement; compliance with policies and TCOC, safeguarding of assets and risk management. The company has an enterprise risk management process in place and the audit committee is assisted in its oversight role by the internal audit team. A whistle-blower policy enables employees to report concerns about unethical behaviour, actual or suspected fraud or violation of the TCOC. IHCL’s coporate social responsibility (CSR) thrust is building on the Group’s legacy of ‘giving back to society’. It is skilling India’s underprivileged youth towards improving their employability. It is actively involved in promoting unique traditional heritage through arts and handicrafts, through partnerships with local organisations around its various properties. It is also involved in disaster relief and rehabilitation programmes. IHCL has been proactive in strengthening corporate governance at the company. It embraced the Kotak Committee recommendations as approved by SEBI in March 2018, ahead of time, taking governance practices at India Inc a step further. It is among the first and only Indian hospitality brands to have adopted integrated reporting – a more strategically driven shift from compliance-based reporting to a governance-based one. Autumn 2019 | Ethical Boardroom 35

Global News Middle East

Push for ‘greater equality’ in UAE

Webinars on good corporate governance The Pearl Initiative, the non-profit organisation promoting a culture of corporate transparency and accountability in the Gulf region, has launched educational webinars on corporate governance. The webinars will focus on how organisations can best adopt anti-corruption best practices, promote diversity in leadership and become more efficient by embracing corporate governance practices. Its first webinar discussed how micro, small and medium enterprises (MSMEs) can efficiently use corporate governance structures to maximise their investment and funding strategies. Yasmine Omari, executive director of the Pearl Initiative, told ZAYWA: “These educational webinars are our latest offering to deliver on our mission to communicate the importance of corporate governance for better business results across the region. It is an extremely rewarding educational journey that regional businesses should embark on for their continued growth and stability.”

Sheikha Shamma bint Sultan bin Khalifa Al Nahyan is supporting an initiative to promote gender equality in the UAE workplace. The great-granddaughter of the United Arab Emirates’ founding father, Sheikh Zaye, has called for 20 competent women on 20 UAE company executive boards by 2020. Sheikha Shamma told The National newspaper: “This year we are launching the 20 for 2020 initiative where we aim to increase female participation on UAE boards and to create an environment that allows them to succeed. “I hope to see a future that is gender-balanced and where initiatives like my own will no longer be necessary, simply because it will be the norm.”

Saudi Aramco kicks off IPO

Saudi Aramco has moved forward with its plan to list on the Riyadh stock exchange, in what could be the world’s biggest initial public offering (IPO). The company supplies 13 per cent of the world’s oil — this year it has revealed half-year profits of $46.9billion. The milestone market debut could value Saudi Aramco at $1.5trillion – although that is significantly below initial expectations of up to $2trillion. The Saudi government initially discussed floating five per cent of the company in 2018 in a deal that would raise as much as $100billion. It is now expected that shares in the range of one to three per cent of the total stock will be released on to the Riyadh market.

Mashreq elects new chair and CEO

Sharia index to drive ethical investments Dubai’s main stock exchange, the Dubai Financial Market (DFM), has launched an Islamic index to measure the performance of Sharia-compliant securities. According to the DFM, the Dubai Financial Market Sharia Index (DFMSI) is a significant initiative that caters to investors’ growing appetite towards ethical investments in Islamic countries and beyond. Essa Kazim, chairman of DFM said: “The Index enables Sharia-compliant investors

36 Ethical Boardroom | Autumn 2019

and international institutions a trajectory of the historical and current performance of DFM’s Sharia-compliant shares compared to other Islamic or conventional indices at the local, regional and international levels.” At launch, the DFM Sharia Index consists of 40 listed companies, including 30 UAE companies and 10 dually listed companies, with the weightage of any company capped at 10 per cent.

Dubai-based bank Mashreq has appointed its former CEO Abdul Aziz al-Ghurair as its new chairman to replace Abdullah Ahmed al-Ghurair, who will be stepping down from his role. Mashreq — the oldest local bank in the United Arab Emirates — has named Ahmed Mohamed Abdelaal, head of its corporate and investment banking section, as the new CEO. Abdul Aziz al-Ghurair said: “For over 30 years I have had the privilege to serve as the leader of UAE’s oldest financial institution. It is with great humility I will be taking up the new role, building on the legacy of my father’s work.” Earlier this year, Mashreq unveiled plans to close 50 per cent of its branch networkin 2019, with some offices to be turned into digital branches. www.ethicalboardroom.com

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Board Leadership | Agility RETHINKING THE BOARD AGENDA Agile boards are more adaptable and innovative when facing change

Building an agile board in a disrupted world The world of business is a world disrupted. Digital advances are changing the way we communicate, the way we work, the way our organisations deliver products and services. Capital allocation is shifting toward technology, away from physical and human capital.

Companies are faced with complex and evolving choices around how to utilise new technologies while protecting themselves from cyber risk. The shifting sands of globalisation, market instability, geopolitical 38 Ethical Boardroom | Autumn 2019

Help organisations succeed by transforming the way leadership teams work together Nancy Falls

Chief Executive Officer of The Concinnity Company and cultural shifts, regulatory imperatives and new investor criteria, such as ESG (environmental, social and governance), make it apparent that not only is the playing field shifting, but so are the goalposts.

Boards cannot afford to do what they’ve always done and stay ahead of this level of disruption and innovation. The only way forward is to become an ‘agile board’.

Defining the agile board

The Oxford English Dictionary defines agile as ‘able to move quickly and easily’. But what does ‘agile’ really mean to the board responding to the wake-up call of disruption? What characterises the agile board, enabling it to govern well in an age of disruption?

The agile board embraces disruption to drive winning strategies, risk management and improved performance. www.ethicalboardroom.com

Agility | Board Leadership on our board. We literally gave the future a seat at the table and built a forward-thinking perspective into every conversation. This is the kind of thinking an agile board builds into its DNA. The agile board often chooses change as a way of being proactive, staying in front of change that is always coming. agile board values change 2 The over fear in its own work. We know

that growth and improvement require organisations to change. We expect management to embrace this. Agile boards demand it from themselves. This means looking at things like board composition, board agendas, board processes and tools with an open mind. The director afraid of change and retooling will get in the way of progress eventually, no matter how profound the wisdom they impart. Carefully chosen leadership, responsibilities, activities and tools will make board work more efficient, effective and safer, even as it inevitably asks us to shift our habits and perspectives. The agile board has a healthy fear of not changing, rather than a fear of change itself. agile board prioritises 3 The collaboration and dialogue. The role

of a board has long been to advise, support and challenge management with a focus on strategy, risk and performance. This will not change. Agile boards are always focussed on oversight, not getting in the weeds with management. But in a world of disruption, they prioritise collaboration, with To build agile management and with boards, we must each other. This means communicating frequently fundamentally – and differently. The shift how we ‘flipped classroom’ model in education, which advocates think about for using classroom time what board for problem solving and homework time for reading work is, how and watching presentations, that work gets is just as powerful in board work. We see strong results done, and what when CEOs ‘flip the script’ it means to sit on the classic boardroom on a board The agile board values flow, using 80 per cent of forward motion, separating the meeting time to listen and productive risk from reckless risk and problem solve rather than 80 per cent of the over-cautious avoidance. Many boards get time making a presentation. The agile board comfortable with letting someone else be the likewise leaves most if not all administrative first mover. This often feels safer but can in activities to pre and post meeting, ideally fact be a choice that misses opportunities. handling those things via technology to Waiting for others to move first today often make room for expertise and strategy to means being late to the party, getting left take centre stage when everyone is together. behind. The agile board fears being disrupted How to build an agile board and embraces being the disrupter. Bringing To build agile boards, we must fundamentally advisors, if not directors, to the table who are shift how we think about what board work is, expert at seeing around the bend can make how that work gets done, and what it means divining the difference between recklessness to sit on a board. We must be willing to ask and over-caution easier, more comfortable. questions. Do classic tools like the board book At one of my companies, we had a futurist sit www.ethicalboardroom.com

and the quarterly meeting cycle still serve us in a disrupted, always-on world? What does it mean to support the management team that is facing fresh disruption almost daily? How can we create boards that are up to the challenges of today’s business world? All this means thinking deeply about the people, processes and systems we choose to do our work. Here’s how:

PEOPLE

Modify your mindset. Everyone’s area of expertise is affected by disruption, which makes everyone responsible for agility, for considering disruption. This is a new mindset, not a new department. This is a thing that everyone needs to include in how they think about their board work from now on. Next step? Make ‘becoming agile’ a priority discussion for the next board meeting, possibly bringing in a dedicated facilitator, and create space to talk through everyone’s opinions and generate concrete next steps. Are you already thinking to yourself about how that feels a little sudden and disrupts your plans, even while you acknowledge it is necessary? That’s what disruption feels like, and what an agile response looks like. Don’t put it off. Shift your mindset now and take action. Embrace education. Ongoing learning is critical. This means every board director, even those who are experienced, long-term directors, should be learning how to improve at their work. Disruption will not let anyone ride out their term! Next step? Require everyone on the board to pursue board director education as part of what is required to be a director on your board. Be specific. Organisations, such as The American College of Corporate Directors, The National Association of Directors and Private Directors Association all offer good ongoing education, but it’s fine to get creative about what this means for your board. The point is not to get the certification for its own sake – the point is to cultivate the agile mindset of ongoing learning so that the board keeps growing. Continually improve board composition. The data show that board diversity can have a positive social and financial impact for those who embrace it.1 But board diversity is also a way to incorporate more agile thinking into your board makeup. Fresh thinking moves everyone forward. Next step? Make agile thinking part of your next board director search. Look for directors with experience in industries that have successfully navigated disruption as well as directors who embrace 21st Century governance practices and systems. Prioritise how new candidates approach problems and how important they think this new, agile direction is to the future of the board and the company. Autumn 2019 | Ethical Boardroom 39

Board Leadership | Agility

PROCESS

Elevate your engagement. Elevated engagement is a core facet of the agile approach. This requires redefining the rules of good engagement. Spread the consumption of information, interactions and collaboration more evenly across the year. Cultivate ongoing conversations, ongoing research and reading. Find ways to nurture ongoing thinking about how to move the company forward. Next step? Put redefining engagement expectations on the agenda. This can start with the CEO and chair or with a small committee. Consider how to prioritise ongoing engagement over sporadic interaction. Add a line item for ‘engagement’ to the board scorecard and define what that means in terms of collaboration between board members or communication with company management. Measure, learn, and adjust! Come together with communication. Historically, boards are in touch in the time leading up to a meeting, but not much in between. This is changing in many companies and needs to change in all of them. The agile board communicates before, during, after and in between board meetings. Next step? Shift the expectations around communication for everyone on the board by creating and agreeing on some shared guidelines. To begin, this might mean discussing guidelines for information sharing between meetings and communication expectations. Ask what the management team can do to smooth information consumption for directors and look into making more real-time information and communications available. Also, begin discussing how your team might automate the routine to make room for the urgent. Choose a committee for disruption. A few years ago I was at a conference for public company audit committee members. The subject of where to house ‘risk’ was on the table. While everyone agreed that boards needed more focus on risk management, the debate was about whether or not risk needed a committee home, at least initially to elevate attention to it. Many boards had lumped risk into the audit committee, but audit committee agendas are already packed. The reality is that risk should have a seat not only at every discussion but on every committee. But creating a separate risk committee can help shepherd the issue into everyone’s consciousness and jumpstart bringing more focus on risk at the discussion, committee and full board level. Disruption is now often ‘housed’ in the audit committee. Should it be? Next step? Have the board hold ‘disruption’ up and talk through how you want to make it more visible across the board. Should it have a committee home? 40 Ethical Boardroom | Autumn 2019

If not, ask each committee to look at their protocols through the agile lens, create a plan for shifting how they work, and share it with the rest of the board. These can be sleek, single page documents that focus on a few targeted actions that will move the needle, not bulky PowerPoint decks that will gather dust in a folder somewhere.

SYSTEMS

Take advantage of technology. Utilising emerging board technology is essential for the Agile Board. While electronic board books have been considered sufficient, today technology solutions can and should provide far more support to the critical work of the board and the leadership team. Board technology should give directors access to all historical and current information. It should facilitate real time, fulsome and secure communication. It should automate

FILLING THE GAPS Fitting together people, processes and systems must all shift to make a board agile

recurring board tasks to free up time for the urgent and important. It should be able to measure progress toward outcomes as defined by the board. A software that is SOC II certified and is the dedicated place for board conversations means that things are documented, safe from outside threats, and help build the habit of elevated engagement. Next step? Start looking for a real-time communication hub that is secure. We strongly suggest that you eliminate email and texting about board matters outside of your board tool. Does this sound extreme and anti-agile? It’s not. It’s a way to focus attention on what everyone needs to do and where they need to be doing it. It will make board work nimbler in the face of disruption. Make time for measurement. Agile does not mean random. Agile is proactive, not reactive. Accountability requires measuring and elevating transparency of outcomes. This means utilising company and board

dashboards to create transparency across the team and keep everyone focussed on a plan, benchmarks, and goalposts that everyone understands. Next step? Find a good company dashboard that gives everyone real-time visibility, has a risk or disruption metric, and helps hold management accountable to shared objectives. In parallel, implement a board scorecard that helps hold the board accountable to its stated mission in a way that goes beyond the annual board self-assessment survey, digging deeper to tie board work with company performance and stakeholder concerns. None of this is about judging each other – it is about creating focus and holding ourselves accountable. Implement integration. The agile board finds concinnity by pulling it all together. People, processes, information, communications, and outcomes measurement can, and should, all happen in one place. This builds the agile muscle and makes things easy to access and track. Remember, disruption doesn’t wait for meetings, so you won’t always have time to spend pulling resources from widely dispersed sources, tracking down different people. Next step? Simplify, centralise and automate. Create rhythm and routine for what is repeatable, leaving more room for the agile thinking required for breakthrough strategy, exceptional risk management, and performance accountability. Technology is a huge asset to make this happen, and often an ally for the behaviour changes that need to occur.

CONCLUSION

These suggestions are the beginning of the path to becoming an agile board, shifting how we think about people, processes and systems from the ground up and the top down. Becoming an agile board does not mean moving beyond the oversight role. Agile boards understand that good governance requires an abundance of deliberative, far-reaching, creative and critical thinking. But they do not confuse this with slow moving. It is perilous when an agile CEO hits a wall of directors who are caught flat footed or still focussed on yesterday’s issues, something I have seen far too often in my work with boards. Becoming an agile board is a journey. Start or prioritise having fulsome board discussions about your journey now. The main points in this article are good starting points for the necessary dialogue you and your leadership must have. By taking time to re-examine the people, processes and systems of your board work, your path to becoming an agile board will become clear. 1 https://hbr.org/2019/03/when-and-why-diversityimproves-your-boards-performance

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Board Leadership | Gender Diversity

Women in the workforce Let’s rewind to the 1950s – it was unusual for women to go to university; most left school and went straight into work until they got married. Once hitched, the majority of women would stay at home, raising children and carrying out general domestic duties.

The Good Wife’s Guide, published by Housekeeping Monthly in 1955, highlights how women were expected to freshen up before their husband returned home from work and to have dinner ready on the table.1 His needs would always be put before hers – women were told not to greet their other half with complaints or problems and to let him talk first as ‘his topics of conversation are more important’.

42 Ethical Boardroom | Autumn 2019

Attitudes to gender equality in the boardroom may be shifting, but there’s still work to be done Chris Robertson

UK Chief Executive Officer, Creditsafe In most modern societies, this archaic attitude towards women as inferior beings has changed significantly since then. Fast forward to today and more than two-thirds (71 per cent) of UK women aged 16-64 are employed, the highest percentage since the Office of National Statistics (ONS) began recording this data in 1971. 2 By comparison, the figure is 80.3 per cent for men. Many

women are choosing to put their careers before starting a family – with 28 being the average age of a first-time mother in 2017, compared to 25 in 1949. 3 However, search for gender diversity in the workplace and particularly in the boardroom, and you will realise that gender equality remains a contentious issue. How has gender equality improved? It’s clear that significant progress has been made when it comes to women at work. Here are just some of the ways in which we can see demonstrable improvement.

Greater female participation in the workforce

If we look at the numbers over the past few decades, it’s easy to see the strides that have been made in female workplace participation. Back in 1975, a mere 57 per cent of ‘prime

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Gender Diversity | Board Leadership

working age’ women were employed, but this soared to a record high of 78 per cent in 2017.4 Nowadays, women are also far more likely to remain in employment after the birth of their first child – for women born in 1958, only 41 per cent were still working two years after giving birth, whereas for those born in 1970 this rises to 58 per cent. 5 Today, around 72 per cent of working-age mothers are in paid work.

Greater protection against gender discrimination

The UK’s Equal Pay Act 1970 gave everyone the right to be treated equally in terms of pay when compared to a member of the opposite sex, but the Equality Act 2010 extended this protection to cover ‘allowing claims for direct gender pay discrimination where there is no actual comparator’.6 Legislation was also introduced in 2017, which forced companies with 250-plus employees to publish their gender pay gap information, providing greater transparency and facilitating further conversation around the topic.7

The Time’s Up movement

While the Time’s Up movement may have begun in Hollywood, its ripples have been felt around the world. Focussed on harassment in the professional realm, Time’s Up has helped to start conversations about systemic inequality and to begin to reduce gendered power imbalances in the workplace. The momentum achieved by this campaign has empowered women around the world to speak up in their own workplaces, with 69 per cent of women and 59 per cent of men saying that it will result in progress in workplace relations between men and women. 8 And it’s about time. In 2017, the European Institute for Gender Equality (EIGE) published its Gender Equality Index, which reported that there had in fact been little improvement in gender equality at work across the EU between 2005 and 2015.9 This was also the case for gender equality as a whole, not just in the workplace.

The gender pay gap

The gender pay gap is a contentious subject. Some people claim that it is no more, or even that it was always a myth. While equal pay for equal work at first seems like it would solve the problem of gender inequality in the workplace altogether, this is simply not the case. While laws have been introduced to protect against gender discrimination in situations where men and women are doing the same amount and level of work, the impact of this has been limited. In fact, of the companies that were forced to publish their gender pay gap figures under UK legislation, nearly eight in 10 companies pay men more than women10 and some companies were paying them as much as double the salary11 of their female employees. And, if we look by age group, the pay gap is relatively slim for those under 30 but widens significantly as we get older – which lines up fairly well with the average age of a first-time mother.12

MORE WOMEN IN EMPLOYMENT Today in the UK, a record high of 71 per cent of women are employed

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Autumn 2019 | Ethical Boardroom 43

Board Leadership | Gender Diversity

Social attitudes

Mothers in particular still face challenging social attitudes regarding their choice of whether to work or not. If a woman has a child aged less than five years old, only a tiny seven per cent of people believe she should have a full-time job.13 This rises to 38 per cent agreeing that part-time work was ‘acceptable’, but a third of people felt she should be a stay-at-home mum. It is hard to imagine that these people would say the same about fathers and this view also discounts the fact that some mothers need to work to be able to support their families.

The glass ceiling

When we speak about ‘the glass ceiling’, we are referring to the ‘sometimes-invisible barrier to success that many women come up against in their careers’. The phrase was coined in the late 1970s by management consultant Marilyn Loden, but more than 40 years later it is still as relevant a term as ever.14 Factors, such as psychological differences between men and women, as well as the additional unpaid labour women are still expected to undertake, are often cited as reasons that women are still held back in many workplaces designed by and for men.15 Businesses should speak to their female employees to identify any concerns or barriers they face when looking to progress through the ranks, which will allow you to remove any obstacles and to provide additional training on any challenging topics.

The confidence gap

For every 100 men that are promoted into a managerial position, only 79 women receive the same promotion.16 While equal pay for equal work is all well and good, if women are not receiving the promotions they need, then this remains unattainable. The fact that women tend to have lower levels of self-confidence can have a significant impact on whether women will push for a promotion they deserve, or whether they are seen to be as deserving compared to an equally qualified but more self-confident man.17 For instance, men have been found to apply for a promotion when they meet only 60 per cent of the requirements, whereas women tend to apply only if they tick every box.18 Until significant changes are made in the way we raise boys and girls in their developmental years, as well as improving the opportunities and feedback we give them as they reach adulthood, it is difficult to see how this can be addressed properly.

Poor representation

Ultimately, no matter what your personal opinion is, the figures speak for themselves – just under a third of the world’s senior business leaders are female.19 There is also the infamous statistic that, in the United States, there are fewer women among chief 44 Ethical Boardroom | Autumn 2019

THE IMPACT OF GENDER EQUALITY Research has shown that diversity improves productivity and peformance www.ethicalboardroom.com

Gender Diversity | Board Leadership executives of Fortune 500 companies than there are men named John.20 Some companies are more guilty than others, of course, with Google being one of the worst offenders. In its most recent annual diversity report, the tech giant’s leadership was found to be 74.5 per cent male, with female employees making up only 30.9 per cent of their staff.21 A recent study also found that none of the top 20 searched-for company directors on Google were women. 22 While these searches are largely influenced by the wider media, Google does have something to answer for

MORE VISIBILITY Companies need to reflect and elevate their diverse workforce

in how it shapes our perceptions of leaders. The image results it delivers for the term ‘CEO’ were found to be heavily skewed in favour of men, even in countries where the percentage of women in management roles was higher than men. 23

Where do we go from here?

You may have heard the phrase ‘if she can see it, she can be it’. In other words, once women have a role model to look up to, they can visualise attainable goals and have increased confidence to dream bigger. So, in a way, it is a chicken and egg situation, as it is much easier to get women inspired to break the glass ceiling and enter the boardroom after other women have already done it. This can raise a conundrum for businesses who then aren’t sure how to approach improving gender diversity in the boardroom in the first place. But, especially considering that research has shown that diversity improves productivity and financial performance, the onus is nonetheless on businesses to lead the way with encouraging female employees to seek out new challenges and to reward them appropriately when they do so.24 Here are just some of the ways that companies can combat gender inequality in their own teams.

Flexible working

Nowadays, flexible and/or remote working is a must-have for nearly all modern companies. This has been a nice-to-have for generations entering the workforce for some time, but, www.ethicalboardroom.com

given the advances in technology and changes in job roles, both millennials and Gen-Z workers see it as an absolute priority.25 Flexible working can aid gender equality in your workplace by making it easier for your employees to plan each day as it comes, and to accommodate other commitments outside of work. This is especially attractive to working mothers (and fathers!) and can help to retain your female workforce during and after pregnancy, allowing them to continue their development rather than having to take an extensive career break.

in your photos. You should also make sure that your image descriptions and alt text refer to any women in senior management roles where possible, as this helps both visually impaired users and Google to understand the content of your images.

Offer a creche or childcare vouchers

Some women will delay having a family to prioritise their career. Others won’t. Both choices are perfectly fine, businesses should respect both decisions and take steps to accommodate them. Companies sometimes fear women taking time out to have children, as they worry that they will not come back to work afterwards. But if you offer a welcoming work environment, which gives parents options to arrange suitable childcare, this will rarely be the case. You’ll likely also find that this benefits the working fathers in your team, too. The bottom line is that people need to see diversity in their role models, otherwise it can be challenging to imagine yourself breaking into that space. It is important that businesses encourage and invest in the development of their female employees, as well as rewarding their hard work with a visible position of responsibility. Only Flexible working can aid gender then will we make significant equality in your workplace by progress in the fight against making it easier for your employees workplace gender inequality.

to plan each day as it comes, and to accommodate other commitments outside of work

Set up a mentoring scheme

If you ask the women who are currently in senior positions within your company, the chances are they would love to have the opportunity to mentor another woman to achieve the same levels of success they have had. Plus, they’ll also have insight on the barriers they had to overcome to achieve their current role and will be able to help remove these barriers for future women to reach management roles. Be aware that some women may be more hesitant to put themselves forward for such initiatives, due to a lack of confidence or even imposter syndrome. 26 So if you feel that there is someone who would benefit from the scheme, approach them directly to see if they are interested.

Be conscious of your website imagery

If you want to attract women to work for your company, having a website which makes a good first impression is crucial. If your site is full of imagery of men, don’t be surprised when you only get men replying to your job postings! Be sure to include a fair representation of all your employees

1 https://www.littlethings.com/1950sgood-housewife-guide 2https://www. catalyst.org/research/women-in-theworkforce-uk/ 3 https://www.ons.gov. uk/peoplepopulationandcommunity/ birthsdeathsandmarriages/livebirths/bulletins/ birthcharacteristicsinenglandandwales/2017 4https://www. ifs.org.uk/uploads/BN234.pdf 5Ibid 6https://www.gov.uk/ guidance/equality-act-2010-guidance 7https://www.gov. uk/guidance/gender-pay-gap-reporting-overview 8https:// hrdailyadvisor.blr.com/2018/04/04/timesup-movementmeans-employers/ 9https://eige.europa.eu/publications/ gender-equality-index-2017-measuring-gender-equalityeuropean-union-2005-2015-report 10https://www. theguardian.com/money/2018/apr/04/gender-pay-gapfigures-reveal-eight-in-10-uk-firms-pay-men-more 11https:// www.theguardian.com/world/2019/mar/28/women-earn50p-for-1-made-by-men-at-some-multi-academy-trusts 12 https://www.ons.gov.uk/employmentandlabourmarket/ peopleinwork/earningsandworkinghours/datasetsannual surveyofhoursandearningsashegenderpaygaptables 13 https://www.bbc.co.uk/news/education-44767657 14 https://www.bbc.co.uk/news/world-42026266 15https:// www.studyfinds.org/study-glass-ceiling-women-workplacestill-exists-hurting-economy/ 16https://www.mckinsey. com/featured-insights/gender-equality/women-inthe-workplace-2018 17https://www.forbes.com/sites/ jackzenger/2018/04/08/the-confidence-gap-in-menand-women-why-it-matters-and-how-to-overcome-it/ 18 https://www.forbes.com/sites/jackzenger/2018/04/08/ the-confidence-gap-in-men-and-women-why-it-mattersand-how-to-overcome-it/ 19https://www.catalyst.org/ research/women-in-management/ 20https://www.nytimes. com/interactive/2018/04/24/upshot/women-and-mennamed-john.html 21https://diversity.google/annual-report/ 22 https://www.creditsafe.com/gb/en/more/hub/newsroom/ most-searched-companies-and-directors-2018.html 23 https://www.creditsafe.com/gb/en/more/hub/newsroom/ women-management-around-the-world.html 24https:// hbr.org/2019/02/research-when-gender-diversity-makesfirms-more-productive 25https://www.forbes.com/sites/ heidilynnekurter/2018/11/15/5-ways-millennials-are-shakingup-the-workforce-from-the-bottom-up/%231cd85f6c2415

Autumn 2019 | Ethical Boardroom 45

Board Leadership | Diversity

Ageism within the workplace Governing organisational culture, age discrimination and unconscious bias Alison Gaines

Global CEO, Gerard Daniels

Boards are increasingly interested in organisational culture. They realise that it is a key enabler of enterprise performance. Infact, it is one of the key organising principles for performance – along with governance, strategy, leadership, sufficient resources and good processes.

Although management is responsible for the levers that drive the day-to-day culture of the organisation, the board has stewardship of the culture and should give direction to management about the preferred norms for the workplace. Employers find themselves well placed to create great cultures and there is perceptible goodwill toward good employers. The well-regarded 2019 Edelman Trust Barometer – the largest global survey and foremost authority on trust in business, government, media and NGOs – found a loss of faith in the system, with less trust in government, the media and non-government institutions. The relationship that has bucked this trend is the growing trust in ‘my employer’. A trusted employer is often identified as an employer whose values align with the employee and provides a sense of meaning and purpose for employees. Trusted employers provide employees with certainty. For employees, their priority is a sustainable career – with access to well-designed jobs and preparation for the jobs of the future. They also seek a fair workplace where opportunities are equally accessible, work design is flexible and there is fair pay and proper recognition for performance. Good leaders and managers are critical to the quality of the workplace. A dimension of organisational culture 46 Ethical Boardroom | Autumn 2019

candidate screening and interviewing. is fairness. Fairness in the workplace is a Employment branding can project an age great driver of legitimacy for leaders and imaging that promotes ‘youthful brand’ organisational culture. Organisations or at least a brand that does not present that behave unfairly run the real risk of visually a diverse workforce by age. losing the commitment of employees. Examples of practices that can prompt Fairness implies a workplace culture of complaints are job adverts that hire for inclusion and free of corrosive bias. recent graduates or use words like ‘high Age discrimination is a dimension of energy’ or ‘innovators’ or ‘challenging’ or bias. Workplaces are accommodating ‘strong media skills’, which are often seen as five generations of workers (spanning code for ‘young workers’. Often an emphasis traditionalists, baby boomers, Gens X, Y and on ‘cultural fit’ in the recruitment process Z). The millennials are approaching their can reinforce an age monoculture. forties. Many, but not all countries, have age During employment, older workers discrimination laws. Age discrimination in the complain that they are not given the workplace complaints are on the rise, usually same investment in training and career involving older workers and usually related development to prepare for changing jobs. to recruitment practices and layoff decisions. They see employers exhibiting a bias for Common examples are complainants reporting developing younger workers, ostensibly that they are unsuccessful in a recruitment because the investment has more years process because the employer wanted a to deliver a return to the younger worker; or an employer employer. Employers refusing job applications from Age bias can can be slow to adapt the older workers because they be found in all workplace to the different can’t learn new skills or aren’t aspects of HR needs of older workers, a good cultural fit. While including offering job flexibility age discrimination is fairly decisions. It and modifying physical tasks common, few employers include can commence or redesigning jobs. age diversity among their Layoff decisions can involve workforce diversity initiatives. with the overt age discrimination – where The recent OECD report employment there is a deliberate decision Working Better With Age to layoff the oldest workers or identifies many examples of branding and have a forced retirement policy workplace age discrimination. recruitment – or can be more subtle where a Principal among them is a advertising, voluntary retirement package reluctance of employers to hire and retain older workers and through to the is offered to older workers as a key layoff strategy; or jobs are to invest in skills and improve job description, redesigned to make redundant employability of older workers. the skills of older workers It recommends that the key to candidate an offer to reskill. older worker participation is screening and without While targeting older workers flexible working hours and new is a legacy HR strategy, it interviewing investment in employability ignores the phenomena of – especially to improve the workers staying in the workforce for longer digital awareness of older workers. Employers than the last generation. should also address poor recruitment, promotion and retention practices. What is unconscious bias? The inattention to age discrimination Unconscious biases are social stereotypes arguably allows unconscious bias in human about certain groups of people that we resource decisions to prevail unchecked. form outside our conscious awareness and Age bias can be found in all aspects of HR happen outside of our control. It occurs decisions. It can commence with the automatically and is triggered by our employment branding and recruitment brain making a quick judgement. advertising, through to the job description, www.ethicalboardroom.com

Diversity | Board Leadership WHATâ&#x20AC;&#x2122;S AGE GOT TO DO WITH IT? Some older workers say they are not able to enjoy all work opportunities

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Autumn 2019 | Ethical Boardroom 47

Board Leadership | Diversity As Daniel Kahneman posits in the resume does not include date of birth, Thinking, Fast And Slow this occurs because photo, graduating year for qualifications we tend to be over-confident in our and irrelevant early career experience. Some own investment in decisions. We like to employers have gone further and rather think of ourselves as rational. We like to than ask for a chronology of a candidate’s make fast decisions that feed into our career they request the candidate address self-confidence, as winners rather than the key criteria with examples of their losers when we make judgements. experience and qualifications. Some also Moving fast brings into play cognitive anonymise the candidates for the screening biases we use to sift our choices – often process to ensure old-fashioned names called intuition, gut reaction or reliance on don’t disadvantage candidates (this archetypes. There are a few archetype biases technique is also successful for gender – confirmation bias, affinity bias, attribution diversity recruitment). bias, group think – that tend to dominate Bias in the workplace can be corrosive. human resource decisions. Interesting An insidious dimension of age research from McKinsey (McKinsey discrimination is the fear of being left out Quarterly June 2019) shows that of the office in-crowd. In the neuroscience CEOs and HR practitioners of leadership, we learn that are the most likely to membership of the group An insidious exhibit over-confidence is very important to most dimension of age employees. A challenge bias in their own talent management processes. all leaders is to shape discrimination is for Confirmation bias is a workplace where we can the fear of being optimise the number of where the decision-maker undertaking the analysis people who feel included. left out of the wants to prove a There is evidence that older office in-crowd predetermined assumption. workers can feel excluded Affinity bias is where the from the ingroup. A recent decision-maker unconsciously prefers ‘people comparative study between perceptions of like us’. Attribution bias is where the decisionNew Zealand and Australian older workers maker uses a simple attribution to make (aged 55 to 64) found that Australian complex judgements (for example assuming workplaces didn’t place the same value older workers are overqualified or older on age diversity as their New Zealand workers won’t have digital skills). Group think counterparts and older Australian workers is where a dominant approach to decisionseem to standout more and are treated making, usually by the leader, overwhelms differently by colleagues and management. rational decisions. Poor HR practices allow The authors concluded that many managers these biases to leak into decision-making. are not supportive of new ways of thinking, The risk of bias dominating such as flexible work hours, and have decision-making occurs where there is one outdated views on the value of older decision-maker or one dominant workers to their organisation (Bentley, decision-maker. Sharing decision-making Teo Factors influencing leave intentions for hiring, retention and layoff decisions, policies and processes with a wide range A VALUABLE of participants from diverse backgrounds DEMOGRAPHIC INITIATIVE who have received unconscious bias training A gold miner analysed the downtime is a practical step to improving process. in the use of mine machines during Some employers have responded to the the 12-hour daytime shift of machine problems of human bias by employing operators. Management redesigned automated recruitment systems. However, the shift and offered to train artificial intelligence (AI) may create its unskilled workers in the nearby own risks. While management hoped that country town to take up shorter day predictive AI recruiting systems (algorithmic job platforms that source and time shifts. The new workers were screen applications) would reduce the bias overwhelmingly older women who of human decision-makers there is now a needed flexible roles. The outcome real risk that machines will learn their own changed the age and gender diversity bias by reinforcing what they’ve learned of the mine and was a standout from past success. Regulators are now result in the mining industry. showing interest in how AI can cause discrimination. Some large users of AI have abandoned flawed products, and some are subjecting the AI to fairness audits. Proactive employers have introduced blind recruitment methods that strip out any age-related information on the resume. This includes ensuring that 48 Ethical Boardroom | Autumn 2019

among older workers: a moderatedmediation model’ 2019). One of the best tactics to maximise the size of the ingroup is to practise fairness, which inherently challenges biased behaviours.

What practical steps can the board take to shape an organisational culture free of bias? First, the board can ask for a demographic profile of its workforce. It can also ask for an audit of the age diversity strategy of the organisation and the internal rules about anti-discrimination and the fair process guiding human resource decisions. It should enquire about the unconscious bias documentation and training that accompanies HR processes (not only recruitment but also promotions, training and development, remuneration, job design and redundancy). It can ensure that management pays attention to age discrimination on its job sites and in human-based and AI recruitment decisions. The board should also assess the risk and monitor the outcomes of poor process – including litigation with employees based on allegations of aged bias; complaints to anti-discrimination regulators by employees based on age bias; feedback gathered from exit interviews; and turnover and the impact of layoff programmes measured by workforce age. The board can also have a positive agenda for management that captures the proven initiatives that help workers participate in the workforce:

■■ Encourage age diversity as an employment brand and organisational outcome ■■ Measure outcomes for older workers ■■ Insist on unconscious bias process improvement and training for all decision-makers ■■ Improve the workplace for older workers – provide job flexibility; design ways of working (especially manual work) so that it is safer and more comfortable for older workers ■■ Give equal access to training and development to ensure all workers can keep up with jobs of now and the future ■■ Avoid age-based layoff programmes Of course, the board cannot lead where it does not follow its own advice. The board should be alert to its own biases in the decisions it makes about recruitment to the board and recruitment of the CEO and influence over the succession pipeline. More broadly, unconscious bias can lead to flaws in broader decision-making and board interaction. A well-functioning board will always reflect on the possibilities that the unconscious can undermine the conscious decision. www.ethicalboardroom.com

We help you navigate complex situations. Abernathy MacGregor is a strategic communications firm that helps corporate leaders bridge stakeholder concerns from Wall Street to Main Street to Washington and beyond. We create communications and engagement strategies for pivotal business events from crisis management and litigation to M&A and shareholder activism to CEO transitions, both planned and unexpected. We also help clients create and maintain day-to-day, best-in-class communications and engagement practices. These include reputation management, investor relations and media relations counsel, government affairs and governance support. Our seasoned counsel can show you the way forward.

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Board Leadership | Board Effectiveness

DOES YOUR BOARD HAVE UNTAPPED POTENTIAL? A board effectiveness evaluation that gets under the skin of what’s working well and what’s getting in the way of peak performance is the perfect vehicle to help boards unlock this potential. But what does an effective board evaluation look like?

An effective board is essential to every organisation but, however well yours is doing, every board has untapped potential

In this article I set out why and how to conduct a board evaluation and the conditions for success. In the UK, as with many other countries, it is now mandatory for the board of listed companies to undertake a formal and rigorous annual evaluation of its own performance and that of its committees and directors. For FTSE 350 companies, this evaluation should be facilitated externally through independent evaluation every three years. For unlisted companies, public bodies and charities/ not-for-profits it has become a matter of good practice to evaluate board effectiveness and it is often expected by regulatory bodies. In the narrow pursuit of fulfilling this legal requirement, or simply complying with good practice, lies the danger of treating a board effectiveness evaluation as just another tick-box exercise. All too often, such a purely compliance-motivated approach jeopardises the great opportunity board effectiveness evaluations present in gaining valuable and insightful feedback.

Anna Withers

Warning: narrow remit of traditional board effectiveness evaluations

The need to avoid a narrow board evaluation remit was highlighted by research into board effectiveness presented in the March 50 Ethical Boardroom | Autumn 2019

Founder and Director, Mightywaters Consulting Ltd 2017 Harvard Business Review (and backed up by earlier research published by the search firm Spencer Stuart). This research found inadequacies in many board evaluations that stem from focussing primarily on policies, structure and processes. Such a narrow approach gives an incomplete picture and has limited value. This is also true too of ‘quick and dirty’ online board self-assessments.

Winning approach: consider the board’s internal context

Value adding board evaluations are broader than this narrow remit and take the board’s internal context into account. At their heart, they focus on the human dynamics that support or hinder effective working relationships. They therefore address directly those areas that typically get in the way of board effectiveness: interactions between board members; levels of trust; how the chair, CEO and senior independent directors create the environment for performance; how well the board looks outwards and engages with stakeholders; and, crucially, how differences of opinion and diversity of views are accommodated. If a board is to perform its three core functions of direction setting, assurance and advising, it is critical that the board is able to have open, uninhibited discussions that enable it to make the best decisions. An effective board evaluation should enable the board to identify its strengths

SCOPE OF BOARD EVALUATIONS — GIFT® How policies, systems and structures align to enable the board to make effective decisions, take action Governance and be accountable

How well the quality of relationships and behaviours between board members support critical Interactions conversations and effective decisions

Board evaluation

How the board is selected, organised, resourced, developed and run

Team

Focus

How the board ensures its work delivers impact for the benefit of the organisation and its stakeholders

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Board Effectiveness | Board Leadership as well as uncover shortcomings and identify how best to close these gaps.

So, what should the scope of a good board effectiveness evaluation be?

Board evaluations should address four areas: governance, interactions, focus and team (GIFT®). After all, a well-run board is a GIFT to the organisation (see graphic opposite)! Assessment is typically achieved through a combination of: ■■ Observation of the board at work ■■ Diagnostic seeking feedback on key areas of board performance ■■ Interviews with board members and critical stakeholders to get under the skin of the diagnostic ■■ Review of board processes, papers, self-assessments, etc

So, what needs to happen to deliver a successful board evaluation?

Boards should not be the passive recipients of a board effectiveness evaluation. A good process combines the following five ingredients:

Board leadership: When a board commits to an evaluation, the chair must be prepared to lead the exercise as the primary sponsor. The board (and potentially other stakeholders) must be prepared to invest time to ensure that the process is delivered in a way that leads to action. Typically, at least one other senior board member is actively involved in sponsoring and overseeing the evaluation. Inclusive approach: The approach 2 must give all board members and key

stakeholders a voice. This typically involves gathering both quantitative (formal diagnostic) and qualitative (interviews and desk research) feedback as part of the evaluation. For people to feel their voice is heard, it is also essential that the external facilitator is independent and able to build trust rapidly with board members. A process fit for purpose: 3 Boards come in different shapes

and sizes and the process must be fit for purpose. A relevant and appropriate process builds trust and enables evaluation to get to the heart of what is working or not. A board effectiveness evaluation should occur within the rhythm of board meetings, ideally allowing for observation of one or more meetings of the board and its committees as part of the evaluation. www.ethicalboardroom.com

Depending on the cycle of board meetings, a board evaluation is usually completed within two to three months. Partnering with the 4 right organisation:

Finding the right partner to provide independent evaluation is key. Important criteria are: ■■ Genuine independence… so that existing or future commercial relationships don’t get in the way of evaluation and recommendations ■■ Listening skills… so that your partner understands your organisation, leadership and governance needs and is able to shape an approach that will be most relevant to you ■■ Holistic approach... so that board dynamics and the human dimensions of board effectiveness are fully understood, as well as systems, structures and processes ■■ Evidence and research-based recommendations… so that commitment to proposals can be built, ensuring evaluation becomes a springboard for action ■■ Continued support to improve performance… so that you are supported, beyond the evaluation stage, in improvement areas that require skilled facilitation or specific coaching A commitment to follow up and 5 review: Board effectiveness evaluation

should be run as a cycle to sustain improvements in board effectiveness and not seen as a one-off, tick-box exercise. The actionable outcomes from a board evaluation should be reviewed regularly so that board performance becomes one of the key indicators of organisational health.

Effective boards are essential to all organisations and all boards have untapped potential. As boards come under increasing scrutiny, making time to reflect intentionally and purposefully on board effectiveness is no longer a ‘nice to do’ exercise, but a must. At the heart of effective board evaluations is a focus on the human dimension, the dynamics between board members that enable difficult decisions concerning strategy, risk, accountability and the like to be worked through in a constructive and generative way. In this article I have set out the scope of what meaningful board evaluation looks like and the key factors for success. If taken forward, this approach will help boards really get under the skin of what is working well and what needs to happen to improve board performance. Autumn 2019 | Ethical Boardroom 51

Global News Europe

Renault ousts Bolloré as CEO Thierry Bolloré (right) has described the decision to remove him as chief executive of French carmaker Renault as brutal and completely unexpected. Renault’s board of directors decided to end the mandate of Bolloré with immediate effect in October, saying it was launching a process to appoint a new CEO for the longer term. The company’s financial director Clotilde Delbos has taken over the role of CEO on an interim basis with sales executive Olivier Murguet and José-Vicente de los Mozos, senior supply chain chief, named as deputies. According to the Financial Times, Bolloré was considered by Renault’s alliance partner Nissan to be a ‘disruptive force’ and didn’t do enough with regards to former CEO Carlos Ghosn’s arrest over financial misconduct allegations last year. “The brutality and the totally unexpected character of what is happening are stupefying. This coup de force is very worrying,” Bolloré told Les Echo newspaper.

Italy tops female CEO list Italy is leading the way for having the most women as CEOs, according to a new report by the Credit Suisse Research Institute (CSRI). With 15 percent of female CEOs, Italy is on a par with Singapore, topping the CSRI Gender 3000 report globally. The Gender 3000 report provides unique research on the gender diversity mix within the leadership teams of more than 3,000 companies across 56 countries. The 2019 report identifies a link between firms with more female leaders and stronger share price performance over time. It also shows that family owned companies, with at least 10 per cent women executives, have out-performed male-only companies by around 410 basis points per year since 2014.

Auditors must report better to ‘improve trust’ The UK’s Financial Reporting Council (FRC) has called for improvements to corporate reporting in an open letter to all audit committee chairs and finance directors. According to the FRC, investors and other stakeholders expect greater transparency of the risks to which companies are exposed and the actions they are taking to mitigate the impact of those uncertainties. Paul George, executive director of corporate governance and reporting at the FRC, said: “Investors and the general public rightly expect financial reports to be fair, balanced and understandable. This is particularly important in periods of uncertainty where heightened transparency is expected. “High-quality reporting by companies, including candid disclosure of the risks they face, supports trust in business.” The FRC has told companies to improve the quality of reporting of forward-looking information, the potential impact of emerging risks on future business strategy, the carrying value of assets and the recognition of liabilities.

52 Ethical Boardroom | Autumn 2019

EPGC raises stake in Metro AG Czech businessman Daniel Kretinsky and Slovak partner Patrik Tkac will raise their stake in German wholesaler Metro AG following a failed takeover bid earlier this year. EP Global Commerce (EPGC), the investment vehicle of Kretinsky and Tkac, will see its stake grow from 17.52 per cent to 29.99 per cent – just below the 30 per cent threshold that would require it to launch a full takeover bid. In August, EPGC failed with a €5.8billion bid for the German cash and carry group after failing to agree a valuation with shareholders Meridian Stiftung and Beisheim Holding, which hold a nearly 21 per cent stake in Metro. EPGC said the increase ‘underlines its commitment’ as a responsible strategic investor and it will be seeking appropriate representation on the supervisory board of Metro AG.

Management shake-up as job axe falls Deutsche Bank has moved the head of its wealth management division into a new role, helping the German lender push through a radical overhaul that will eliminate a fifth of its workforce. Fabrizio Campelli, who has led Deutsche’s wealth management division since 2015, will join the management board as chief transformation officer. Former Credit Suisse private banking chief Claudio de Sanctis will replace Campelli as the bank’s global head of wealth management. In July, Deutsche Bank announced its intention to pull out of global equities sales and trading, scale back investment banking and slash thousands of jobs as part of a sweeping restructuring plan to improve profitability.

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Europe | Advertorial DISCLOSE & ENGAGE SWIPRA puts a focus on constructive dialogue

SWIPRA Services: A holistic view on corporate governance SWIPRA Services is a Swiss corporate governance specialist providing services to listed companies and their boards of directors as well as to institutional investors. Our holistic approach and integrated view on corporate governance and corporate social responsibility guide the identification and management of relevant governance risks. We advise boards of directors and executive management in creating sound and modern corporate governance frameworks for the long-term benefit of the company and its stakeholders and support institutional investors in their stewardship activities and dialogue with Swiss investee companies and, in particular, with Swiss institutional knowledge. In our work with clients, we integrate our personal practical knowledge and experience with principles 54 Ethical Boardroom | Autumn 2019

Barbara A. Heller & Christoph Wenk Bernasconi

Barbara is a Managing Partner and Christoph a Senior Partner at SWIPRA Services Ltd

of value-based management and empirically relevant findings.

Recent milestones in corporate governance developments in Switzerland

The development of corporate governance in Switzerland is characterised by a few key events presenting significant challenges to the boards of directors of Swiss-listed companies. In 2002, the Swiss industry organisation Economiesuisse introduced the first version of the Swiss Code of Best Practice for Corporate Governance (Swiss Code), a self-regulatory code for Swiss corporates to establish a best practice corporate

governance framework. The Swiss Code is amended from time to time and based on a â&#x20AC;&#x2DC;comply or explainâ&#x20AC;&#x2122; principle. A next milestone occurred on 1 January 2007 when Swiss corporate law was amended with the requirement that public companies would have to disclose information on the remuneration of boards of directors and executive management. Subsequently, the Directive Corporate Governance (DCG) of the Swiss Stock Exchange, applying to all companies listed on the Swiss Stock Exchange SIX, was amended, specifying the details regarding the disclosure on remuneration schemes effective for the reporting period 2008. For the first time, listed companies were obliged to disclose individual compensation amounts for each board member, the total compensation amount for the executive management, and the individual compensation amount of the executive committee member with the highest pay. www.ethicalboardroom.com

Advertorial | Europe This new transparency eventually triggered an increasingly engaged political debate on management pay, resulting in a public, constitutional initiative, often referred to as the ‘anti rip-off’ or ‘Minder initiative’. This initiative was ultimately accepted in a public referendum and transferred into the Ordinance against Excessive Compensation (OaEC) in 2013. The OaEC was at the time a unique and internationally widely observed piece of legislation, shifting significant powers from the board of directors to the annual general meeting (AGM) of shareholders within a short transition period of only one year. The OaEC requires shareholders to elect individually and annually: ■■ Each board member ■■ The board’s chairperson ■■ Each member of the compensation committee On an annual basis, shareholders bindingly vote on the maximum compensation amount for each of the company’s governing bodies: ■■ The board of directors ■■ The executive committee ■■ The advisory board (if established) Depending on the provisions of the articles of association as approved by the shareholders, the AGM can either vote on these amounts ex-post (retrospectively), once the actual performance of the company is known, or ex-ante (prospectively) as a maximum budget that the board of directors is allowed to pay out for a specified current or future period. In case of direct shareholdings, Swiss pension funds have to cast votes at the AGMs of their investee companies and disclose their voting behaviour, including a rationale in case they reject proposals from the board of directors. Interestingly, these requirements have not been extended to Swiss fund and asset managers. Importantly, market standards in Switzerland have been increasingly influenced by governance and stewardship developments in other major capital markets, such as the US and the UK. Due to large holdings of non-Swiss investors in Swisslisted companies, corporate governance in Switzerland has been exposed to spillovers from international regulatory developments, such as the EU Shareholder Rights Directives as well as self-regulatory initiatives of the industry, such as the UN PRI.

shareholders, and in particular proxy governance-related thought-leadership advisors, it was unclear how to deal in Switzerland, and 4) independent and with these newly allocated rights and practically relevant research and PR activities obligations, in particular, the binding supporting the Swiss market, regulatory votes on compensation amounts. At the processes and the public, with objective views time, institutional shareholders relied on corporate governance and corporate social heavily on ‘tick-the-box’ proxy advice that responsibility (see Figure 1, below). largely followed a stringent one-size-fits-all At the core of SWIPRA’s approach is the blueprint into which these new firm belief that corporate governance is the company-specific votes did not fit well. overarching principle of corporate businesses. At the time, it was becoming more evident Corporate governance is not a short-term ‘we that there are rarely any ‘one-size-fits-all’ against them’-story, but rather one of mutual solutions, but rather best possible solutions understanding and trust over the long for companies on an individual level. term, a view that has by now also received When SWIPRA was founded, it was support by independent research. When based on the understanding providing advice on governance that there was a substantial structures of companies, At the core value proposition behind an it is and has always been of SWIPRA’s individual, company-specific SWIPRA’s principle to interact approach is corporate governance with issuers and investors framework and the importance the firm belief to enhance the mutual of an objective view on how understanding of individual that corporate businesses, to create wellcompanies can execute a sustainable strategy. SWIPRA’s governance is fitting and broadly accepted corporate governance services frameworks, the overarching governance build upon findings of modern and to clarify issues that academic research, an objective may have gone uncommented principle of analysis as well as a substantial or were misunderstood corporate market experience, combined by the market. SWIPRA business with a deep understanding of is promoting disclosure corporate structures and (one-way communication) and processes. SWIPRA was one of the first engagements (two-way communication) market participants in Switzerland to as suitable and efficient complementary recognise that a constructive dialogue tools for the boards of directors to address between companies and their stakeholders their stakeholders. on corporate governance topics, so-called SWIPRA governance cycle ‘engagements’, are an important foundation SWIPRA has developed a holistic on which to build sustainable businesses. approach to assess corporate governance Today, SWIPRA’s operations are based and corporate social responsibility on four pillars: 1) corporate governance (CSR) frameworks of companies (see consulting services for issuers, 2) engagementthe pillars of the SWIPRA Governance based stewardship support for investors, 3) Cycle, Figure 2, page 56). SWIPRA’s think tank, providing corporate

FIGURE 1: SWIPRA’S FOUR KEY AREAS OF SERVICE

ISSUERS

INVESTORS

THINK TANK

INSIGHTS & NEWS

SWIPRA’s origin and market position today

At first, the Minder Initiative and the implementation of the OaEC created a high level of uncertainty in the Swiss market. To www.ethicalboardroom.com

Autumn 2019 | Ethical Boardroom 55

Europe | Advertorial responsibility, SWIPRA provides its clients with advice that is uniquely positioned in the market. With its inside-out approach, SWIPRA starts with the premise that, in general, it should be a company’s management and board of directors that know best how to create value with the assets in place, while a continuous and transparent dialogue with the company’s stakeholders provides important guidance on expectations. Building on this, SWIPRA proposes governance structures and disclosure strategies with an adequate system of checks and balances that is supported by the company’s largest shareholders and stakeholders and that will ultimately also help to prevent unfriendly activism. Hence, SWIPRA is using corporate governance as a dynamic toolbox allowing for a broad range of structures that should ultimately result in a sustainable business.

co mp ens ation

s ge pon m sibi en lity t :

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

e tiv en Inc

56 Ethical Boardroom | Autumn 2019

E rectors CL of di CY oard

Value creation & pa FIGU Reporting & eng yout RE ag po 2 em li en cy t

A CORPORATE GO VE IPR lder & sta W keho RN S reho l E d a AN e h rs S TH C

The company’s shareholders elect their board of directors. However, increasingly, various other stakeholders gain influence on the selection process of board candidates. The election of board members is the key channel for investors to influence the sustainable long-term development of their investee companies. By demanding and, ultimately, electing specific individuals as board members on an annual basis, and requesting specific skill portfolios for boards, shareholders can take an active role to influence strategy, corporate culture and corporate social responsibility. By electing the members of the executive committee, setting strategic targets and defining a company’s financial and non-financial (CSR) priorities, the board sets the course for the company’s success, not only in terms of governance, but also in terms of E (environmental) and S (social) aspects. It is further the board’s decision on how to structure compensation and incentive frameworks. It is not sufficient to define challenging strategic goals. Employees need appropriate financial and non-financial incentives to actively pursue these strategic goals. Value-based reporting and engagements provide issuers with the possibility to inform their stakeholders, assessing the value-creation during the reporting period and, based on this and linked to the corporate strategy, how value-creation shall be assured over the longer term. This will be the basis for shareholders to take their decisions at the upcoming AGM, to either elect or re-elect their board members, to either approve or disapprove compensation-related agenda items and to take payout decisions. It is this holistic and dynamic approach that forms the basis for SWIPRA’s identification process of relevant governance risks and the development of potential measures to be implemented over time. A direct consequence of this approach is how SWIPRA thinks about ESG (environmental, social, governance) or, as it should rather be put, CSR. In SWIPRA’s view, corporate governance, strategy, corporate social responsibility and incentive schemes need to be aligned and integrated for companies to be able to create a sustainable, value-creating business in the long term. Focusing on certain individual aspects of E and S without anchoring relevant targets fondly in the overall strategy, governance and compensation framework is certainly allowed as part of a philanthropic activity, but not sufficient for developing a sustainable business, neither from a shareholders’ nor from a social welfare’s point of view. Based on this progressive view of corporate governance and corporate social

e lr a cia an o s m gy & sk Strate als/ri go

With this inside-out view, SWIPRA has been able to successfully provide support to companies undergoing significant changes in the structure and organisation of their board of directors, changing their compensation system to realign the incentives with the intended culture, solving conflicts of interest in their board, or looking to better integrate CSR, including cultural efforts, in their disclosure.

SWIPRA – Switzerland’s think tank for corporate governance and CSR

To exchange intelligence and support a wider dialogue on corporate governance in Switzerland, SWIPRA has established a think tank for the Swiss market. This think tank consists of two advisory boards: A panel of experts with high-level representatives, generally board members or board chairmen from Swiss-listed or large private companies, and a panel of investors, with high-level

representatives from the investor community. With these two panels, SWIPRA provides thought leadership directly to the market participants with a significant impact on the Swiss market. The think tank further supports important research in the field of governance and CSR. Annually, SWIPRA conducts the SWIPRA Corporate Governance Survey. Providing concurring views from companies and institutional shareholders, this survey has proven to be highly valuable to foster a more efficient and better-informed dialogue in the market, to increase the public’s understanding of corporate governance topics, and to support regulatory processes. SWIPRA further conducts a thorough annual AGM analysis to track developments in voting behaviours of shareholders of Swiss-listed companies. Moreover, SWIPRA provides the market with an outlook to the upcoming Swiss AGM season and its expected key topics. Based on the findings and outcomes of its proprietary market research, SWIPRA organises events and discussion roundtables with market participants in Switzerland and abroad. A key event is the Swiss Corporate Governance Dialogue ‘SCGD’, bringing together public companies and institutional investors for a day of discussions on current governance and CSR topics, combined with the opportunity for one-on-one engagement meetings. The next SCGD is taking place on 20 November 2019 in Zurich.

SWIRPA Services: experienced, competant, well-networked

SWIPRA has longstanding experience as an independent Swiss corporate governance specialist and consults with an inside-out view and from the perspective of a variety of stakeholders to create broad acceptance for companies’ governance frameworks and CSR efforts. SWIPRA is well-networked and respected in Switzerland and internationally. The SWIPRA Think Tank includes leading personalities from the investor and corporate issuer community, providing thought leadership based on SWIPRA’s objective market analyses. SWIPRA maintains a comprehensive proprietary knowledge database and conducts international market research to ensure professional support.

SWIPRA Services AG Claridenstrasse 22 8002 Zürich +41 55 242 60 00 www.swipra.ch info@swipra.ch

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ENVIRONMENTAL SOCIAL

GOVERNANCE

SUSTAINABILITY

MORE AND MORE GREEN PERFORMANCE, FOR A SUSTAINABLE GROWTH Our performance is the result of a combination of financial choices, respect for the principles of accountability, and an active approach to environmental, social, and governance issues.

Company of

This document is for Institutional Investors only and should not be relied upon by private investors

www.eurizoncapital.com

Europe | Green Finance

Fiona Le Poidevin

Chief Executive Officer, The International Stock Exchange Group

Sustainable listings and good governance A stock exchange listing is a mark of authenticity â&#x20AC;&#x201D; itself a sign of good corporate governance, especially in the green and sustainable investment market Heading up a stock exchange group, I often come into contact with business owners or their advisers who are considering accessing the capital markets as a route to fundraising, whether simply for working capital or to take their company to the next stage of its development, for example via mergers and acquisitions (M&A) activity.

What I always suggest is that executive and non-executive teams give early consideration to the listing rules, which include adhering to both general principles and specific listing requirements. For example, a company wishing to list equity on The International Stock Exchange (TISE) is required to provide three years of audited annual accounts and, as such, undergoing a proper review and planning process prior to the point of seeking admission to the exchange not only has strategic but very practical benefits. A company wishing to list on TISE must appoint a listing sponsor, which is responsible for helping the company with the listing application process. This includes demonstrating that the company meets the 58 Ethical Boardroom | Autumn 2019

minimum conditions of listing, completion of the listing document, disclosure requirements and responsibility statements. The sponsor is also required to assist the company in meeting its continuing obligations, post admission. This includes notifications to the market and the ongoing preparation of audited financial statements to internationally recognised standards (e.g. International Financial Reporting Standards, or IFRS, the UKâ&#x20AC;&#x2122;s and the USâ&#x20AC;&#x2122;s generally accepted accounting principles, or GAAP). The audit provides third-party scrutiny and review of the financial position of the company, which allows investors and the wider public to be able to make an evaluation of the performance of the company. As such, the listing rules not only demand, but also reinforce, transparency and good corporate governance.

Attracting investors

This makes (both primary and secondary market) investment in listed companies more attractive for investors. Indeed, some investors, such as large institutional investors like pension funds and insurance companies, are mandated to only invest, or invest a certain proportion of assets, in listed companies. This is because they know that the company in which they

are investing is adhering to specified standards of transparency and governance. It means that when I am talking to companies about listing, I can point to the benefit of attracting more and quality capital by virtue of adhering to the standards of transparency and good governance. However, this does not diminish the fact that this is the more ethical way to do business in any case and that, aside from the immediate financial benefits that listing may bring, companies should be aiming for the highest standards of good governance as it, in turn, promotes long-term sustainability.

ESG

On the note of sustainability, of course, allied to this is the growing focus on corporate environmental, social and governance (ESG) attitudes, policies and practice. There is a feeling that corporates have historically only paid lip service in this regard and, as such, now face pressure from two directions: on the one hand, governments, regulators and supra-national bodies are beginning to impose standards on the corporate world; on the other, a new (millennial) generation of investors is providing the catalyst to demands for better regard to ESG factors, which are www.ethicalboardroom.com

Green Finance | Europe

HIGHLIGHTING YOUR GREEN CREDENTIALS It is time to focus on investments that enhance or protect the environment

feeding their way through, often via institutional investors and asset managers, to investee companies. There are reports that question both which generation has the most appetite for ESG investing and the extent to which it is being followed through in practice. Yet, even if it does remain more aspirational, there is no doubt that the pressures from both governments and regulators (‘above’) and investor groups (‘below’) are building, and the narrative is only heading in one direction.

This means that both investee companies and institutional investors face increased demands (one way or the other) to demonstrate their ESG credentials. As a result, there has been significant growth in ESG-specific training and qualifications, consultancies and technology with a view to providing more detailed reporting. However, especially while this remains in its infancy and relatively immature, standards continue to be varied and, as such, it remains difficult to draw

There has been significant growth in ESG-specific training and qualifications, consultancies and technology with a view to providing more detailed reporting www.ethicalboardroom.com

comparisons and conclusions. Nevertheless, there is still demand for more general ‘products’ with labels and badges, which clearly articulate the merits of an investment.

A TISE product

At TISE, we have built on our core listing offering, with the transparency and good corporate governance that entails, to also offer a specific product for green and sustainable investments. We have launched a green market segment, TISE GREEN, to encourage greater flows of capital into investments that protect or enhance the environment. TISE GREEN has been established to enable those seeking investment into environmentally beneficial initiatives to highlight their green credentials while, at the same time, providing easier access for investors who are looking to allocate towards those investments that have been verified as meeting globally recognised standards in green finance. Autumn 2019 | Ethical Boardroom 59

Europe | Green Finance TISE GREEN is open to investments – bonds, funds and trading companies – from any jurisdiction. An appropriate third-party needs to provide verification both initially, and ongoing annually, that the investment meets an internationally recognised standard of green finance.

Verification

An appropriate third party verifier includes firms that have been specifically endorsed by those who have initiated global standards, audit firms, rating agencies and other niche specialists in assessing environmentally sustainable initiatives. The recognised standards on TISE include the Green Bond Principles published by the International Capital Markets Association (ICMA) or the Common Principles for Climate Mitigation Tracking published by the Multilateral Development Bank (MDB) and the International Development Finance Club (IDFC). Having this third-party verification measured against a recognised global

TISE GREEN IS OPEN FOR BUSINESS Green market segment enhances the visibility of investments that impact the environment

standard at the outset and annually is hugely important in doing as much as possible to protect the integrity of the market and enhance the value of the product. Other exchanges do not necessarily have this stipulation for their green markets but we wanted those on TISE GREEN to be able to showcase that fact, safe in the knowledge of the credibility of the ‘badge’. Indeed, that ‘badge’ is intended to provide potential investors with a shorthand way (compared to detailed, granular ESG reporting) of knowing that they are investing their and/or their clients’ money in a manner which is consistent with globally recognised standards of green and sustainable finance. Any investment must first be admitted to TISE’s Official List but beyond the usual fees for listing, there is no additional charge for the subsequent entry to, and presence on, TISE GREEN. This is not only in recognition of the likely additional expenditure in obtaining third-party verification but also because we don’t want to be accused of 60 Ethical Boardroom | Autumn 2019

profiteering from the demand for green finance. We see TISE GREEN as part of our own corporate social responsibility. It builds on the fact that the Exchange provides a mechanism for the flow of capital by specifically providing an offering to facilitate investment into initiatives that will protect or enhance the environment and, as such, help to save the planet. To that end, we have been delighted to welcome our first investments onto TISE GREEN. Faro Energy, which specialises in solar energy projects in Latin America and other emerging markets, has had four bonds successfully admitted to TISE’s Official List and subsequently approved to enter TISE GREEN. The bonds are certified green bonds under the Climate Bonds Initiative (CBI) Climate Bond Standard & Certification Scheme, with the proceeds intended to be used to finance solar energy projects in Brazil.

Impact investing

There used to be a time when the conventional wisdom was that if an investor

comparable traditional investments. This is on both an absolute and risk-adjusted basis, across asset classes and over time’. On the flipside, it also points to the fact that there is nothing wrong with making financial returns from investments which also have a positive impact. Indeed, profit and positive purpose are not mutually exclusive and it is instructive for all companies to consider how, with investor appetite shifting towards a more purposeled approach, they are performing, not just financially but in terms of the way in which they conduct their business and what that says about the culture of the organisation.

Conclusion

Leadership teams need to be aware that investors are increasingly demanding that companies not only perform well financially but that they are conducting their business affairs in a more broadly positive manner. However, they also need to recognise that they can’t simply apply the thin veneer that in the past used to pass as corporate lip service to those ideals. Today, investors demand more authenticity and in any case, leadership teams need to recognise that they need to conduct themselves in this way because it is the right thing to do in and of itself. The standards of transparency and good corporate governance demanded, and reinforced, by a listing can assist in this process. This is especially the case when the exchange listing is accompanied by a position on a specific segment which has further in-built standards of transparency and governance that enable

THE INTERNATIONAL STOCK EXCHANGE (TISE) TISE provides a responsive and innovative listing and trading facility for companies to raise capital from investors based around the world. TISE offers a regulated marketplace, with globally recognisable clients and a growing product range, from within the European time zone but outside the European Union (EU). Headquartered in Guernsey and with offices in Jersey and the Isle of Man, it offers a convenient and cost-effective service wanted to invest in a way that was positively impactful – for, say, the environment or for society – then they would have to forgo an element of financial return in comparison with a conventional investment approach. While this may remain open to debate, advocates of impact investing would point to a 2015 study by Morgan Stanley. It evaluated more than 13,000 US-based funds and managed accounts and concluded that ‘investing in sustainability has usually met, and often exceeded, the performance of

for listing a wide range of products, namely trading companies, investment vehicles (including funds), and debt (including bonds). With a business established in 1998, the Exchange now has more than 2,800 securities on its official list with a total market value of more than £300billion. companies to demonstrate the credibility of their green, sustainable or impactful credentials to investors. What strikes a chord with me at the moment is that this is reportedly seen as a ‘new’ approach to doing business. In fact, green and sustainable finance has at its heart the principles of accountability, responsibility and transparency which have long been, and continue to be, central to the concept of a publicly quoted company, listed and traded on the capital markets. www.ethicalboardroom.com

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Risk Management | Advertorial

Managing third party risk Leading practices in third party risk management risk segmentation Greg Matthews Partner at KPMG

KPMG has observed three major evolutions of organisations’ third party risk management risk (TPRM) segmentation programmes over the past five years in the financial services sector.

Initial focus on obtaining buy-in and design of the programme

Implementation of the programme 2 (addition of headcount and increased

effort dedicated to TPRM activities both pre and post contracting)

The recalibration and 3 optimisation of the programme This third phase of recalibration and optimisation of the programme is largely a response to the need to be more efficient and more effective, in the face of both increased public reputational impacts caused by third party failures and continued business pressure for cost reduction and reduced cycle time for onboarding third parties. REDUCING RISK Apply due diligence to keep your organisation safe

62 Ethical Boardroom | Autumn 2019

Key activities for right-sizing and rebalancing the risk segmentation and risk assessment processes include: ■■ Strengthening third party relationships and reducing third party costs through third party rationalisation efforts and establishing preferred-provider agreements ■■ Reducing the number of questions being asked of the business in inherent risk questionnaires (IRQs) and of third parties in due diligence questionnaires (DDQs) ■■ Re-thinking internal roles and responsibilities to focus risk subject matter experts on the highest value components of the risk assessment process ■■ Tailoring programme requirements for specific types of third parties that share distinct characteristics that are different from traditional third parties (e.g. affiliate service providers, law firms) ■■ Fine tuning the requirements for the TPRM programme to expedite onboarding of third parties (e.g. fintechs), so that they are quickly on-boarded to support business needs ■■ Determining which risk categories should be assessed at a service level v. legal entity level, as well as determining the periods in which an assessment is deemed valid in order to rationalise assessment activities (e.g. financial viability assessment to be performed at legal entity level and would be valid for one year)

■■ A rebalance away from point-in-time risk assessments to an initial deep dive scan with more emphasis on continuously monitoring the nature of the third party service (e.g. volumes, types of data shared, etc) and risk profile of the third party (e.g. negative media, breaches, etc) ■■ Exploring third party support or involving TPRM utilities (e.g KY3P, TruSight) to facilitate on-site reviews. The combined result of these efforts is a reduction in both the effort required for individual risk assessment and the volume of third-party risk assessments that are conducted overall Recalibration and optimisation activities must be in accordance with the TPRM risk appetite and support the organisation’s continued ability to comprehensively identify, monitor and manage third-party risk.

Guiding definitions and strategy for the TPRM programme Definition of third party TPRM programmes must have a clear definition for a third party documented within the TPRM policy. This definition drives the requirements for the third party inventory at the service level (rather than the third party entity level). The reason for this is that different services have different risk profiles and one third party may provide many services to an organisation.

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Advertorial | Risk Management A good generally accepted definition of a third party is provided by the US Financial Services Regulator, the Office of the Comptroller of Currency (OCC), which defines a third party as: ‘any business arrangement between a bank and another entity, by contract or otherwise. Third party relationships include activities that involve outsourced products and services, use of independent consultants, networking arrangements, merchant payment processing services, services provided by affiliates and subsidiaries, joint ventures and other business arrangements where the bank has an ongoing relationship or may have responsibility for the associated records. Affiliate relationships are also included. Third party relationships generally do not include customer relationships.’ Critical third party services The OCC also has a good generally accepted definition of critical activities as: significant bank functions (e.g. payments, clearing, settlements, custody) or significant shared services (e.g. information technology), or other activities that have the potential to: ■■ Could cause a bank to face significant risk if the third party fails to meet expectations ■■ Could have significant customer impacts ■■ Require significant investment in

resources to implement the third party relationship and manage the risk ■■ Could have a major impact on bank operations if the bank has to find an alternate third party or if the outsourced activity has to be brought in-house Having a large volume of third party services classified as ‘critical’ can reduce management’s ability to dedicate the requisite attention on overseeing the truly critical third party services. The expectation is that both risk and performance of a critical service are assessed and continuously monitored with significant attention, focus and expenditure of organisational resources. It is important to note that irrespective of the control environment, when a service is designated critical it remains as such with the greatest amount of oversight provided.

The expectation is that both risk and performance of a critical service are assessed and continuously monitored with significant attention, focus and expenditure of organisational resources

For global organisations in particular, it is crucial to apply discipline in rating third party services as critical. We have observed a tendency for individual business or regions to rate business/region-specific third party services as critical, when these services are not critical for the enterprise as a whole. In some cases, a particular business or region may choose to shoulder the additional cost and effort for overseeing a region-specific service as critical and TPRM programmes can tag these exceptions as ‘region’ critical (rather than ‘enterprise’ critical). In many cases, the service would remain ‘high’ risk (rather than ‘critical’) for the enterprise rating. Outsourcing strategy and TPRM risk appetite In addition to defining third parties and criticality within the TPRM policy, leading TPRM programmes are further codifying an outsourcing strategy and TPRM risk appetite. The outsourcing strategy moves beyond a traditional sourcing strategy (that is largely focussed on achieving specific commercial outcomes) by articulating risk-based parameters for the use of third party outsourcing. The outsourcing strategy might include a preference to limit direct third party contact with customers and limited off-shoring of data to maintain consistent branding and preserve the organisation’s reputation.

FIGURE 1: ESTABLISHING A COMPLETE AND RISK-SEGMENTED THIRD-PARTY INVENTORY Risk segmentation begins with determining the level of assessment required for the third party service. Many organisations have 40 to 80 service categories that are used as the baseline to determine whether a service falls into one of three buckets: standard TPRM process, speciality programmes, or nominal risk. The use of services categories also helps to manage what information goes into the TPRM inventory; all third parties (including nominal risk) are captured for inventory completeness. Map third party service requests to service categories

Example risk segmentation process

Business identifies a need to request a third party service and selects from the catalogue of service types as part of the sourcing intake process ‘Front door’ sourcing intake module has service categories that are mapped to three buckets: l Standard TPRM process l Speciality programme l Nominal risk Which category does your requested service fall under?

Standard TPRM process l Third-party services that

present a requisite level of third-party risk and are effectively-managed through the standard five-phased TPRM lifecycle. The risk-based approach is tailored for each third-party service, so that due diligence is only conducted for applicable risk categories Examples include: l Consultants l Marketing l Software l Technology infrastructure l Support l Payroll services with building access

Speciality programme

Nominal risk

l Homogenous groups of

l Third-party services that

third-party services that share a common risk profile, similar fee arrangement, is being used by similar groups within the organization, etc. Speciality Programmes may have a less extensive or more extensive process than the Standard TPRM Process, based on the type of speciality programme Examples include: l Affiliates l l Distribution l channel l Industry l utilities

Law firms Agents Trading counterparts

do not present the requisite level of third-party risk, do not support key functions/products, and are easily-replaceable. Nominal risk categories re-evaluated and risk-accepted annually

Examples include: l Landscaping l Charitable contributions l Catering l Car service l Employee l General office travel supplies

Guiding principles/activities include: centralised TPRM programme governance and policy, annual refresh of service category mappings, quality assurance for the accuracy of service categories selected by the business, complete and comprehensive third party inventory 2019 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Co-operative (KPMG International), a Swiss entity. All rights reserved.

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Autumn 2019 | Ethical Boardroom 63

Risk Management | Advertorial The TPRM Risk Appetite articulates the organisation’s level of comfort with third party risk in alignment with applicable components of the enterprise-wide risk appetite. This might include low tolerance for downtime of certain applications and services. Based on these two documents, the TPRM programme established limits and thresholds for individual third party services and the broader third party portfolio. An example of risk limits might be that critical third party services cannot have more than two consecutive quarters of ‘red’ performance score cards or that a business line can be no more than 20 per cent concentrated in one third party provider. It is crucial to document limits and thresholds to verify that the third party inventory, risk segments and risk assessment activities are appropriate to provide senior management with the right information to determine if the TPRM programme is designed and operating effectively in alignment with both the outsourcing strategy the TPRM risk appetite.

Three segments within a complete third party inventory

Risk segmentation begins with determining the level of assessment required for the third party service. Many organisations have 40 to 80 service categories that are used as the baseline to determine whether a service falls into one of three categories: (1) standard TPRM process, (2) speciality programmes, or (3) nominal risk. The use of service categories also helps to manage what information is required to be captured within the TPRM inventory; all third

parties (including nominal risk) are captured for inventory completeness.

Standard TPRM process Third party services, such as critical services, key suppliers, data storage and management, technology platform providers, etc, will follow the standard TPRM lifecycle that is articulated within the TPRM policy and procedure, from initial planning through termination. A key hallmark of effective TPRM programmes is that they are risk-based, with the energy and expertise dedicated to onboarding and overseeing third party services being directly proportional to the risk of the third party service. programmes 2 Speciality Increasingly, TPRM programmes are

identifying homogenous third party services that are more efficiently managed in a separate segment of the TPRM programme, rather than adhering to the standard TPRM process. Common examples of speciality programmes include law firms that provide opinions and outside counsel or affiliate

Risk segmentation begins with determining the level of assessment required for the third party service. Whether a service falls into one of three categories: standard TPRM process, speciality programmes or nominal risk

service providers. In these examples, the speciality programme has a common risk profile, similar payment arrangement, is being used by specific function (e.g. legal) within the organisation, etc. The speciality programme generally allows a ‘lighter-touch’ risk assessment than the standard process, but speciality programmes may also have more strenuous requirements for certain risk assessment and ongoing monitoring, such as when interacting with the organisation’s customers. risk 3 Nominal Third party services that do not present

the requisite level of third party risk for the standard TPRM process may fall within a nominal risk segment. These third parties do not support key services/functions/products and are easily replaceable. Nominal risk services are captured within the third party inventory; nominal risk categories are re-evaluated and risk-accepted annually. Examples of nominal risk third party service categories may include: charitable donations, landscaping services, catering and employee travel. It is important to note that limited checks are still performed, such as sanctions screening and conflicts of interest.

Risk assessment process

Inherent risk assessment After determining that a third party service is in-scope for the standard TPRM process, the next step is to conduct the inherent risk assessment via the inherent risk questionnaire (IRQ) to ascertain the inherent risk rating (IRR) and due diligence questionnaire (DDQ) applicability.

FIGURE 2: RISK ASSESSMENT PROCESS – WHAT ARE THE POTENTIAL AREAS OF THIRD PARTY RISK? COMPLIANCE RISK ■ Regulatory requirements ■ Theft/crime/dispute risk ■ Fraud, anti-bribery and corruption/sanctions ■ Compliance with internal procedures and standards

CYBER RISK ■ Information security ■ Data privacy/data protection ■ Cybersecurity

STRATEGIC RISK ■ Service delivery risk ■ Expansion/roll-out risk ■ Mergers and acquisitions ■ Alignment to outsourcing strategy ■ Intellectual property risk

OPERATIONAL RISK ■ Business continuity ■ Disaster recovery ■ Physical security ■ Operational resilience ■ Performance management (inc. SLAs) ■ Financial viability ■ Model risk ■ Human resources risks (conduct risk, etc) REPUTATIONAL RISK ■ Negative news ■ Lawsuits (past and pending) ■ Brand of the third party ■ Key principals/owners of the third party ■ Workplace safety

SUBCONTRACTOR RISK ■ Applicable across all risk areas CONCENTRATION RISK ■ Supplier concentration across critical services ■ Industry concentration (inc. subcontractor) ■ Concentration of critical skills (tech support) ■ Geographic concentration ■ Reverse concentration

CREDIT RISK ■ Financial risk from lending to a third party ■ Liquidity risk

COUNTRY RISK ■ Geopolitical risk ■ Climate sustainability

LEGAL RISK ■ Jurisdiction of law ■ Terms and conditions of the contract

2019 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Co-operative (KPMG International), a Swiss entity. All rights reserved.

64 Ethical Boardroom | Autumn 2019

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Advertorial | Risk Management

FIGURE 3: DILIGENCE — ILLUSTRATIVE VIEW OF RISK ASSESSMENT FOR THE STANDARD TPRM PROCESS Risk assessment determines which risk categories are applicable to the third party service and, on a risk-based approach, assesses these risk categories at the service and/or entity level 2. Use IRQ to confirm applicable risk categories for due diligence

Example risk assessment process

1. Determine inherent risk rating Business owner requesting the third party service fills out the inherent risk questionnaire (IRQ) to determine which risk categories are applicable and the overall inherent risk rating (IRR) Inherent risk questionnaire 1. Reliance on third-party service? 2. Recovery time objective? 3. Data shared with third party? 4. Number of records? 5. Systems/network access? 6. Customer interaction? 7. Location of service delivery? 8. Offshoring of data? 9. Use of the cloud? 10. Regulatory requirements? 11. Reliance on subcontractors? 12. .... Inherent risk rating

■ High

Inherent risk rating

3. Conduct due diligence, determine overall control effectiveness ■■ l Thirdparty responses to

due diligence questionnaires evaluated and onsite reviews completed to determine control effectiveness

l Higher risk categories,

■ ■ ■ ■ ■ ■ ■

assessment /due diligence (DD) required ■ Compliance risk ■ Operational risk ■ Strategic risk ■ Cyber risk ■ Subcontractor risk ■ Reputational risk ■ Concentration risk

l Minimal risk categories, further

■ ■ ■ ■ ■

assessment/DD NOT required

Overall risk effectiveness

■ High ■ Strong

■ Moderate

Inherent risk rating of high, driving ongoing monitoring requirements and re-assessment frequency for applicable risk categories

Operates only in the US ■ ■ Credit risk

Overall risk effectiveness

Inherent risk rating

Residual risk

Compliance risk Subcontractor risk Operational risk Cyber risk Reputational risk

■ ■ Country/geopolitical risk

No extension lending to third party ■ ■ Legal risk Minimal as legal proceeding under US law

4. Assign residual risk rating

■ Strong

The IRQ covers areas such as cyber, compliance, business continuity and disaster recovery. We have also seen organisations include questions around the use of subcontractors, whether the provision of service directly interacts with the organisation’s customers and where geographically the service will be delivered. There are often no more than 10 to 20 questions within the IRQ that drive the IRR and determine criticality. These questions are completed by the first line service sponsor who is engaging the third party and subsequently reviewed by the TPRM programme (or other QA function) to validate the comprehensives of the responses and perform data validations to check for anomalies. IRQ questions that determine the IRR generally include: ■■ Will the third party service be relied upon to deliver critical business objectives? ■■ What is the recovery time objective of the service? ■■ What type of data will you have access to? ■■ How many records? ■■ What systems will the service provider have access to? ■■ Will the service provider directly interact with our customers/clients? ■■ What location will the services be provided in? ■■ Will data be offshored? ■■ Will it be stored in the Cloud? www.ethicalboardroom.com

■■ Will service involve the use of subcontractors to perform critical aspects of service delivery? ■■ Does the service support regulatory requirements?

2 Diligence Organisations generally evaluate the

following topics, as applicable, for third party services on a risk-based approach. Certain risk areas (like cyber risk) may require specialised skillsets for evaluation on the individual service/contract level, whereas other risk types (like financial viability) can often be evaluated once at the third party legal entity. Organisations are experimenting with which risk areas can be evaluated via data feed or reviewed by the TPRM support function (rather than requiring risk area expertise). There are three main approaches for calculating risk scores. Organisations may: (1) use a ‘high water mark’ approach for determining the overall residual risk score; (2) average the scores across all risk categories equally; or, (3) use a weighted calculation that places more emphasis on certain risk categories than others (generally when there are differences in the TPRM risk appetite for different categories). Overall service scores drive the reassessment of the service while individual risk component scores (such as cyber) drive when that component of the risk is monitored from an ongoing stand point. It is the review of DDQs that can drive

significant effort and duration into the TPRM programme, both at the front end, asking hundreds of questions and waiting for the third party to send adequate responses, and at the back end, reading and assessing the responses. Leading practices for rationalising TPRM due diligence include: ■■ Use of market utilities (e.g. KY3P and TruSight) to gather responses to assessment questions ■■ Use of industry standard question sets (e.g. National Institute of Standards and Technology [NIST], Standardised Information Gathering (SIG)) ■■ Rationalising proprietary DDQs for fewer questions on each questionnaire ■■ Use of automated reports for publicly available data when possible (vendors for financial viability, negative media screening, review of shareholders or board members, sanctions or financial crimes screening, etc) effectiveness rating 3 Control Once the due diligence questionnaires

have been completed by the third party, appropriate TPRM or risk category subject matter professionals review the responses to determine the scoring for the control environment for the risk category. Controls may either be located/performed at the third party or as a compensating control at the organisation.

Autumn 2019 | Ethical Boardroom 65

Risk Management | Advertorial An example of common organisationowned control would be a complementary user entity controls (CUEC) that would remove a third party from access to a file sharing system or data feed once the third party engagement has been terminated. It is crucial for the subject matter professionals across risk categories to harmonise control effectiveness rating scales so that risk categories can be compared consistently. This ‘convergence’ in risk scoring is a top focus area for leading TPRM programmes. risk scoring 4 Residual The control effectiveness scoring, in

combination with the inherent risk of each risk category, determine the residual risk rating for each risk category and the overall residual risk of the third party service. Residual risk scores (both individual third party services and across the third party portfolio) are incorporated into TPRM management reporting to validate the programme is operating within prescribed risk tolerances. Firms are still determining how residual risk scoring may be appropriate for determining TPRM programme requirements, such as reassessment frequency and ongoing monitoring requirements. Such a model would reduce the frequency of reassessments and volume of ongoing monitoring activities, which would reduce costs. At this point in TPRM evolution, however, the majority of organisations are still using the inherent risk rating to drive ongoing monitoring requirements.

Ongoing monitoring

There are two primary components to ongoing monitoring:

Service reassessment schedule TPRM programmes generally repeat risk assessment and due diligence process on a risk-based cadence (with higher risk third party services being reassessed more frequently than lower risk third party services). KPMG recommends that TPRM programmes require the business owner of the third party service re-attest the validity of the IRQ annually, as the risk profile of third party services may change over time. Depending on the inherent risk of the third party service, due diligence may need to be re-performed annually or every few years. That said, leading TPRM programmes are currently re-examining their reassessment cadence to rationalise these activities – especially for due diligence activities that require an on-site assessment and 66 Ethical Boardroom | Autumn 2019

what activities can be assessed for the entity versus the service, bearing in mind that many third parties deliver multiple services to clients. Various industries are also exploring the use of industry utilities that seek to gather information once from third parties and reuse multiple times as members perform their reassessments.

Continuous risk and performance monitoring of the service and associated risks The primary focus of TPRM risk assessment and due diligence processes has been point-in-time, deep-dive assessments around the service and its associated risks. These

Leading TPRM programmes are making a more fundamental shift in mindset to emphasise continuous monitoring of risk and performance in a manner similar to transaction surveillance or other real-time monitoring assessments require business and risk domain subject matter professionals with deep risk category knowledge to review evidence provided by the third party and make a determination on the control effectiveness and residual risk of the third party service. In addition to improving the process for point-in-time risk assessments, leading TPRM programmes are making a more fundamental shift in mindset to emphasise continuous monitoring of risk and performance in a manner similar to transaction surveillance or other real-time monitoring. Currently, this is possible for aspects of reputational risk, geopolitical risk, negative media and other publicly available data streams. Internally, organisations can establish service level agreement (SLA) adherence reporting to track whether or not third party services are being performed in accordance with established expectations and contract terms. For critical third party services that include high volumes of transactions on a daily basis, there is an expectation that organisations will test a sample of the transactions on a daily basis. It is not difficult to imagine a future in which the entire volume of transactions would be continuously monitored for anomalies or issues using AI, for example. Organisations are determining how to ingest continuous monitoring information into the third party service

risk profile within their TPRM technology platform to accurately reflect the inherent risk, control effectiveness and residual risk of the third party service on a real-time basis.

Where to focus for maximum potential benefit in risk segmentation rationalisation

Risk segmentation drives an organisation’s risk assessment activities, which are often the most time-consuming and expensive components of the TPRM lifecycle. We recommend clients focus on the following aspects of risk segmentation and risk assessment to streamline their processes, reduce third party onboarding cycle time and cut programme costs: ■■ Map third party service categories to three risk segments: standard TPRM process, speciality programme and nominal risk ■■ Pursue third party rationalisation and establish preferred-provider agreements ■■ Reduce the number of questions being asked of the business (in IRQs) and third parties (in DDQs) ■■ Revise programme requirements to allow flexibility for applicable risk categories to be assessed at the legal entity level (v. the service level) and rationalise the cadence of reassessment activities for services performed by the same legal entity (as appropriate) ■■ Focus risk subject matter experts on the highest value components of the risk assessment process ■■ Explore how automated, continuous monitoring can augment point-in-time risk assessments The KPMG name and logo are registered trademarks or trademarks of KPMG International. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation.

KPMG LLP 345 Park Ave, New York, NY 10154, United States +1 212 954 7784 gmatthews1@kpmg.com www.kpmg.com www.ethicalboardroom.com

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Risk Management | Third-Party Cyber Risk Management FOCUSSING ON THIRD-PARTY RISK The pressure is on companies to better manage their third parties security posture

Tackling third-party cyber risk The spectre of what can go wrong with third parties is never far from the minds of many directors and executives. Companies have long grappled with these risks, particularly in the context of anti-bribery and anti-corruption laws. Cyber risks that come with third parties, however, are in a class of their own. The growth of digital business and exponential rise in cyberattacks demand a much more adaptable approach to third-party cyber risk. The August 2019 findings of a survey conducted by Gartner on third-party risk management reveal that ‘the standard point-in-time approach to risk management is no longer effective in today’s landscape of fast-paced, rapidly changing business relationships’, with 83 per cent of organisations identifying third-party risks after initial due diligence.1 The issue becomes even more challenging when accounting for the ever-evolving nature of cyber risks and the multitude of threats and vulnerabilities uncovered on a daily basis. 68 Ethical Boardroom | Autumn 2019

Cyber has changed third-party risk: are you addressing the challenge? Greg Michaels & Imran Jaswal

Greg is the Managing Director and LATAM Practice Leader for Cyber Risk, and Imran is the Managing Director for CyberClarity360 at Duff & Phelps Digital connections – either directly to your company or within the third party itself – can become a conduit for data theft/loss and malware infection. Sometimes, the threat manifests directly through malicious insiders or careless employees. For example, a Fortune 100 global financial services firm engaged in litigation discovered that privileged case-related information was exposed on the dark web. The ‘source’ turned out to be a paralegal at the firm’s external counsel who was inadvertently disclosing this data while accessing free media on peer-to-peer file-sharing networks. Public companies are facing greater pressure to address third-party cyber risk as regulatory mandates – and penalties for noncompliance – expand and evolve. 2

For example, two years ago, the New York State Department of Financial Services (NYDFS) released its cybersecurity requirements for financial services companies. The requirements devote an extensive section (500.11) exclusively to third party service provider security policy. 3 The guidance includes requirements that covered entities must perform periodic (i.e. ongoing) risk assessments of against their third parties. Then, this past May, the NYDFS created a cybersecurity division and appointed a former cybercrimes chief in the US Attorney’s Office as its leader.4 This development takes on greater significance, given that the two-year grace period that delayed compliance with the NYDFS cybersecurity requirements expired earlier this year.

Holistic third-party cyber risk programme key to customised risk mitigation and compliance

Mitigating third-party cyber risk can seem overwhelming, given the intricacies of third-party relationships, including data sharing, in today’s global economy. However, doing nothing or merely engaging in ‘check-the-box’ activities is unacceptable. Establishing a holistic third-party cyber www.ethicalboardroom.com

Third-Party Cyber Risk Management | Risk Management risk management (TPCRM) programme can help organisations protect themselves from the most common types of related cyber incidents. A TPCRM programme can also demonstrate an authentic commitment to addressing this challenge and capturing the organisation’s efforts for a defensible narrative, should a security event or data breach occur. 5 In order to completely understand and combat its unique risk, an organisation should develop a TPCRM programme that concurrently addresses the challenge from two vantage points: ■■ Looking outward, employ a blend of advanced technology and human insight to assess and risk-rank third parties against industry-accepted standards ■■ Looking inward, and acknowledging the fact that a third party’s defences can fall short, put in place the policies, controls and technology to anticipate threats and mitigate harm

Technology indispensable for knowing, assessing and risk-ranking third–parties

Advanced, purpose-specific technology becomes indispensable to streamline and centralise all data gathering, documentation and reporting related to third parties. Aside from creating and maintaining a dynamic inventory of third parties, an effective technology solution will also analyse the data it gathers and generate an independent measurement or ‘risk score’ on each vendor. Another important feature to look for in a technology platform is its ability to scale to size as the numbers of third parties can fluctuate and likely continue to grow.

Plan for the best, prepare for the worst to anticipate and pre-empt third-party cyber risk A third party can expose an organisation to a security event, despite the most careful vetting. It is incumbent upon the board to inquire of its chief information security officer (CISO) or information security leader how the organisation has anticipated this exposure and the internal measures in place to pre-empt effects of third-party security shortcomings. As a board member, you will want to ask your CISO how (or if) the organisation implements the following best practices:

■■ Least-privilege policies and access methods Each third party should be provided with the least access necessary to deliver its services to your firm. Also, systems should be segmented to help prevent an intruder from moving throughout the network ■■ Controlled access permissions Dual-factor authentication (i.e. 2FA or www.ethicalboardroom.com

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Effective third-party cyber risk management technologies can facilitate oversight of large sets of vendors and help with prioritisation

MFA) provides an extra layer of protection in the event that usernames and passwords are compromised. Whitelisting the IP address of the person/system with authorised access is another effective strategy ■■ Sophisticated endpoint threat monitoring Many of today’s malware variants can evade traditional anti-virus solutions. Endpoint threat monitoring, however, is designed to continuously scan for and detect anomalous network activity and raise an alert that enables timely intervention ■■ Deep and dark web monitoring Monitoring for the presence of your data on the deep and dark web provides visibility into data compromises, which may have occurred in the supply chain/vendor universe, unknown to you, and the opportunity to remediate harm

Third-party cyber risk management programme brings everything together

While technology solutions and wide-ranging security measures are individually valuable, their collective benefits are amplified in the context of a comprehensive TPCRM programme, which provides the organisational framework for: ■■ Ensuring third-party risk is being captured and measured properly ■■ Identifying and addressing security gaps in a timely way ■■ Allocating appropriate levels of resources and expertise ■■ Coordinating efforts throughout the enterprise ■■ Conducting meaningful testing and monitoring to validate the effectiveness of policies and controls in place

Boards should require an annual assessment and testing of the TPCRM programme by independent cyber risk professionals to support stakeholder confidence in the programme or to identify areas for improvement.

TPCRM programme optimising

Addressing third-party risk is taking on greater urgency for companies as government agencies and regulations mandate companies better manage their third parties and related security controls. Kroll, a division of Duff & Phelps, provides a wide range of TPCRM services that bring unrivalled insight and ground-breaking technology to optimise, validate and strengthen your company’s TPCRM programme: ■■ Programme design, implementation, and governance: fuelled by experienced leaders and the unique capabilities of CyberClarity360 TM, our proprietary TPCRM platform ■■ Third-party cyber audits and reviews ■■ Virtual CISO advisory ■■ Managed detection and response ■■ Dark web monitoring Footnotes will be run in full online.

Kroll – A Division of Duff & Phelps 55 East 52nd Street, New York New York 10055 +1 212 593 1000 www.kroll.com/en cyberresponse@kroll.com

For Greg Michaels: +1 201 978 1546 gregory.michaels@kroll.com For Imran Jaswal: +1 858 231 4948 imran.jaswal@duffandphelps.com

Autumn 2019 | Ethical Boardroom 69

Risk Management | Third-party risk

Third-Party Risk: The dark corner of cybersecurity For many years – and for far too long – organisations have paid too little attention to cybersecurity risks. A key reason is that boards of directors and senior management simply were not consistently equipped to understand cyber risks or their remediations.

Smart boards recognise that an increased focus on third-party risk is essential

Cyber risks are inherently technical, involving much more than the basic understanding of computers that most of us acquire as users through our interactions with technology at work or at home. Networking protocols, the intricacies of machine-to-machine communications, and the inherent flaws in the design of the internet are simply beyond the technical capacities of most people in corporate leadership. These topics are the realm of engineers, not executives. But large breach events and increasingly large compliancerelated fines are working to shift the attention of management teams and requiring executive leaders to ramp-up their security knowledge and quickly. The technical challenge in managing cyber risk is compounded by the fact that the security of our networks is increasingly dependent upon the security of the infrastructure of those we are connected to. Understanding cyber risks within our own companies is difficult, but the challenge in understanding them in our supply chain is an order of magnitude more so. This is due to the scale and complexity of networked operations as well as the fact that it is inherently difficult to see into other organisations. These are the dark corners of security risk. Suppliers have natural incentives to minimise the exposure of those risks to others, as well as a duty to protect themselves by keeping their vulnerabilities

as concealed as possible. So, assessing third-party risk is not easy. That said, managing supply chain risk has necessarily become a front-of-mind topic for risk managers and corporate leadership, not least because a large proportion of security incidents experienced by businesses are the result of third-party relationships. According to Ponemon Institute’s 2018 Data Risk In The Third-Party Ecosystem report, more than 60 per cent of US chief information security officers indicated that their company had been a victim of a third-party breach incident. The same survey cites that 75 per cent of companies believed that their risk of third-party security incidents is increasing. The complexity and scale of the modern supply chain further complicates the task. Some firms have a few critical suppliers; but as the economy becomes more information-driven, most of us are sharing data and creating technical connections with an increasing number of firms. Many mid-sized and larger firms have thousands – and in some cases, tens of thousands – of suppliers. Understanding and managing this risk requires not only insights, but process and method. Risks are inherently differentiated and relative. It quickly becomes a measurement task, and risk quantification becomes important. Such methods and processes have already been adopted by more sophisticated firms, or those subject to specific regulations

70 Ethical Boardroom | Autumn 2019

Douglas Clare

Vice President, Fraud, Security and Compliance Solutions, FICO

regarding the management of third-party risk. Headline-making breaches, a general increase in awareness of cyber risk, as well as emerging and evolving compliance frameworks, such as the European Union’s General Data Protection Regulation (GDPR), are driving medium-sized and even small firms to adopt formal supply chain risk programmes as well. Cyber risks are one of many risk categories that need to be assessed in the evaluation of an organisation’s supply chain. Cyber risk assessments are performed within a larger framework of supply chain risk management, which frequently encompasses multiple components of governance, risk and compliance (GRC) strategies. Financial and trade credit risk are front of mind. Knowyour-vendor, Office of Foreign Assets Control (OFAC), and supply chain anti-money laundering compliance are also increasingly important aspects of GRC programmes. Formal third-party risk programmes are likely to include processes for assessing many different aspects of risk, both at the inception of the supplier contract and on a planned cadence thereafter. Some aspects of risk may be subject to continuous monitoring, providing the supply chain risk professional with the ability to recognise and address risks as they emerge or increase. This allows firms to actively participate in risk mitigation with critical suppliers in an ongoing effort to avoid the cost of disruption, preserve important business relationships, and forestall the costs involved in changing suppliers. There are many ways to approach the problem, but the following can serve as a general framework for shedding light on third-party cyber risks. It consists of four key components.

Categorisation of supply chain participants

Suppliers play different roles in terms of www.ethicalboardroom.com

Third-party Risk | Risk Management what they bring to your organisation, and how they are connected to it. The first step is understanding your potential for risk exposure. Building this understanding will typically require consideration of the way a supplier is utilised by the organisation, as well as factors inherent to the partner. The first objective of categorisation is to determine which suppliers require deeper assessment and of what character? Does this supplier deliver pencils, or are they intimately involved in the delivery of services to your customers? The goal is to categorise suppliers in order to implement risk and impact-appropriate management processes. This in turn enables organisations to allocate resources for in-depth scrutiny where supplier impacts are greatest, with a view to the combination of inherent risk and supplier criticality. To determine the criticality of a supplier, companies should develop a set of criteria that reflects their risk management goals, resources and programme capacity. Things that might be considered include: the nature of the supplier relationship, the size of the supplier, their financial strength, the technical connections required with the supplier, the nature and amount of shared data, the certifications held by the supplier, the potential difficulty in replacing the supplier, the tenure of the supplier (what level of trust has already been established?), and what risk-transfer backstops are in place (i.e. insurance)? The answers to these and similar questions will allow an organisation to build a process that allocates resources to risk management that are aligned with risk exposure.

Defining and refining a cyber risk workflow

The categorisation framework serves to determine which branch of the workflow is appropriate for a given supplier. Some will not require any scrutiny, while others may require only an infrequent or light-touch evaluation, and still others a full measure of in-depth scrutiny. Cyber risk scoring tools are available on the market today that allow users to assess the cyber risk of an organisation from the outside, with little or no involvement from the third-party subject of the score. (Full disclosure: the author of this article works for FICO, which provide such a tool in the FICO Cyber Risk Score.) Using such a tool, the supply chain risk manager can get a reasonable, objective view of cyber risk that can further inform the workflow. The key here is to document and establish a differentiated workflow based on the intersection of risk and criticality. This allows the organisation to base decisions not only on the absolute risk enumerated by cyber assessment (qualitative and/or quantitative), but also based on supplier criticality and impact to the business. Supply chain risk www.ethicalboardroom.com

managers will then be able to develop a strategy for supplier engagement and embark upon an impact-appropriate plan of action for remediation, improvement, or termination (and replacement) of a supplier. Utilising a cyber risk scoring tool, the firm may set a score threshold (or multiple thresholds, depending on categorisation) which can be used to determine whether more aggressive information collection is warranted, and what the next steps might be. This may be used in combination with adjacent risk factors, such as financial strength to understand organisational health/maturity and any impact on cyber risk. The cyber risk workflow might include: a decision to perform an on-site audit, request for standards reporting (e.g. SOC II), issuance of one or more cyber questionnaires, prescribed actions for remediation, or a requirement for compensating controls. Decisions may also be taken here to terminate a relationship, seek alternative suppliers, or alter the timing of subsequent planned reviews. Where a supplier is both high-impact and high-risk, high-touch, high-frequency scrutiny can be applied. Where impact and risks are low, the intensity and frequency can be reduced, conserving resources for the management of high-risk suppliers.

Cyber risk scoring assessments can help an organisation keep track of supplier performance against a number of critical cybersecurity KPIs on an ongoing basis Documentation and consistency are key to ensuring that the necessary diligence is always applied. They are also increasingly key in demonstrating compliance with both established and emerging regulatory guidance regarding supply chain risk diligence. Having a documented policy and being able to show that you are consistently operating against it can provide some effective air cover when something does go wrong in your supply chain.

Continuous monitoring

For many suppliers, continuous monitoring of cyber risk may be a logical next step. Again, based on the combination of criticality and risk, the supply chain risk manager may establish a cadence for re-evaluation, or put the supplier into a continuous monitoring model. Cyber risk scoring assessments can help an organisation keep track of supplier performance against a number of critical cybersecurity KPIs on an ongoing basis. While not a substitute for in-depth security audits, these tools can serve to point out

critical changes in risk exposure or security performance between in-depth reviews. Most such tools include alerting mechanisms that will provide an early warning of escalations in risk. Such tools can also help supply chain risk managers by enabling a more elastic response to risk. The most well-run organisations still suffer from unexpected projects, resource constraints, and the need to respond to crises. Continuous monitoring of critical suppliers through cyber risk scoring allows supply chain risk teams to adjust the timing of in-depth reviews based on up-to-date information. They allow a more informed pivot when circumstances dictate changes of plan. Cyber scoring tools also allow organisations to quickly establish comparative benchmarks as well. By looking at the average scores of the suppliers in a given category, the supply chain risk manager can determine whether a given supplier presents more or less risk than a comparable supplier, or whether a new prospective supplier represents more or less risk than the incumbent or the benchmark average across the category. While more criteria are necessary to fully establish the risk of a given supplier, scores can be valuable in informing decisions at the margins, or as a catalyst for communications with a failing supplier.

Transferring residual risk

Effective and responsible supply chain risk programmes increasingly include insurancebased risk transfer. A firm might require insurance for suppliers where the combination of risk and criticality requires additional protection. The amount of coverage that a supplier is required to carry can be ascertained in part based on information collected in the categorisation process, including things like the amount and type of data shared with the supplier. Many data protection regimes include defined penalties for data loss, and there are published estimates available for recovery costs for different types of breach events. These can be useful in defining coverage requirements for suppliers. Organisations may require that they be named as additional insureds in supplier policies for specific coverage areas. Finally, many cyber insurance carriers are leveraging cyber risk scoring as part of their underwriting and pricing processes. Knowing and managing your own score may help your firm cost-effectively secure the coverage you need. Efficiently assessing third-party cyber risk has become a critical priority for many firms, and the emerging and evolving data privacy directives of various jurisdictions and regulatory bodies are likely to ensure that improved management of third-party risks remains a focus for management and boards of directors for the foreseeable future. Autumn 2019 | Ethical Boardroom 71

Board Governance | Risk Management

A February 1, 2016 letter from Larry Fink, CEO of BlackRock the largest money manager in the world with over $5.1trillion assets under management, to CEOs of the biggest companies in the world is a good indicator of a growing institutional investor sentiment.

He wrote:“We are asking that every CEO lay out for shareholders each year a strategic framework for long-term value creation. Additionally, because boards have a critical role to play in strategic planning, we believe CEOs should explicitly affirm that their boards have reviewed these plans. BlackRock’s corporate governance team, in their engagement with companies, will be looking for this framework and board review.”1 The International Corporate Governance Network (ICGN), a global not-for-profit that represents companies with assets under management totalling more than $26trillion, calls on investors to start by focussing their attention on the boards of investee companies: “The risk oversight process begins with the board,” it says. “The unitary or supervisory board has an overarching responsibility for deciding the company’s strategy and business model and understanding and agreeing on the level of risk that goes with it. The board has the task of overseeing management’s implementation of strategic and operational risk management.”2 On the long-term value preservation front, Institutional Shareholder Services (ISS), the leading proxy advisory firm, has also laid out its position quite clearly: “ISS will recommend voting ‘against’ or ‘withhold’ in director elections, even in

Directors need better information to meet rapidly escalating expectations Tim J. Leech

Managing Director, Global Operations at Risk Oversight Solutions uncontested elections, when the company has experienced certain extraordinary circumstances, including material failures of risk oversight. In 2012, ISS clarified that such failures of risk oversight will include bribery, large or serial fines or sanctions from regulatory bodies and significant adverse legal judgments or settlements.” 3 The most powerful institutional investors in the world are signalling quite clearly that they want boards to better oversee strategy and value creation; as well as the effectiveness of the company’s risk management processes linked to value preservation. Two main findings from the American Institute of Certified Public Accountants (AICPA)/North Carolina State 10th annual 2019 risk oversight survey provide insight on the limited progress made to date in integrating strategic planning and enterprise risk management (ERM):4

increasing for large organisations and public companies, particularly ■■ Few organisations perceive their approaches to risk management as providing important strategic value. Less than 20 per cent of organisations view their risk management process as providing important strategic advantage. Only 26 per cent of the organisations report that their board substantively review top risk exposures in a formal manner when they discuss the organisation’s strategic plan (See Table, opposite) The harsh reality is that strategic planning, the annual/semi-annual ERM risk register update processes, and internal audit in the majority of companies around the world are largely standalone silos with very limited real integration. Since the globally accepted definition of the word ‘risk’ is ‘affect of uncertainty on objectives’, why are ERM frameworks, internal audit and strategic planning frameworks not better integrated?5

Really big reason #1

Heavy focus on risks and internal controls, not objectives, impedes integration. The majority of ERM frameworks in the

■■ External stakeholders expect greater senior executive involvement in risk management. External parties (59 per cent) are putting pressure on senior executives for more extensive information about risks, and 65 per cent of boards are calling for ‘somewhat’ to ‘extensively’ increased management involvement in risk oversight. Strong risk management practices are becoming an expected best practice. These pressures are

Board oversight of strategy & risk 72 Ethical Boardroom | Autumn 2019

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Risk Management | Board Governance world today are risk centric, focussed on building and maintaining risk registers; not objective centric, focussed on assessing the certainty that top value creation and preservation objectives will be achieved. The majority of internal audit work done today, largely because of its external audit roots, is control centric, compliance centric, and process centric; not objective centric. The diagram below shows the 10 main assurance methods in use today. For those that want to better understand the evolution of thinking and methods, a longer explanation of the 10 main assurance methods is available.6 The largest percentage of internal audit work done in the world today is done from the left side of the diagram. Internal auditors, most often using some combination of what is labelled traditional methods in the diagram, provide opinions on whether internal controls are effective. Internal auditors receive little, or sometimes no training at all on the full range of risk treatment methods in spite of often claiming to do ‘risk-based internal audits’ (i.e. risk transfer, risk share, risk finance, risk avoid, risk mitigate and risk accept). The focus is on evaluating internal controls, linked

AICPA/NORTH CAROLINA STATE 10TH ANNUAL RISK OVERSIGHT SURVEY Percentage of respondents saying ‘mostly’ to ‘extensively’ Extent that Existing risk exposures are considered when evaluating possible new strategic initiatives

Largest organisations Full Public Financial Not-for-profit sample (Revenues >$1B) companies services organisations 40%

39%

42%

46%

35%

Organisation has articulated its appetite for or tolerance of risks in the context of strategic planning

28%

26%

28%

40%

20%

Risk exposures are considered when making capital allocations to functional units

30%

32%

29%

38%

21%

mainly to traditional value preservation objectives, such as reliable financial statements, data security, continuity of operations and asset safeguarding. Following the 2008 global financial crisis, public companies, particularly companies in the financial sector, were pressured by regulators to create ERM frameworks. The majority of ERM frameworks in the world today are risk centric. The focus is on building risk registers and showing boards of directors the company’s ‘risk

profile’ and risk maps. Direct links to strategic objectives and current performance are rarely made. Few risk functions or internal audit departments analyse the composite effect of multiple risks that effect achievement of top objectives. The current risk oversight survey done by North Carolina State and the AICPA, now in its tenth year, still assumes most organisations are using risk centric/risk register-based ERM frameworks, not objective-centric ERM.

STRATEGY & VALUE OVERSIGHT ERM/AUDIT OVERVIEW Audit approach options Business objective starting point Traditional methods Risk starting point Business process focus

Control criteria evaluation Compliance/ inspection focus

Traditional product:

Audit of management’s assessment

Opinion on whether management’s key objectives, risks, risk treatments, performance and overall risk status is complete, reasonable and accurately reported

Strategy/value management product:

Audit’s v. report/ Audit’s opinion on report on risk/control management effectiveness self-assessment

Regulatorsto The board of directors Risk sources: Business Objectives Universe Finance/ Events, activities economic Business unit or circumstances that can affect an organisation and Sub Sub Sub Environmental liability the achievement of CertintyStatusLine business objectives End result objective Missing (implicit or explicit) objectives Customers Internal/External context Suppliers Employees Competition Product/ service liability Natural events Political influences

Threats to achievements/risks Risk treatment strategy Risk mitigators/controls Risk transfer, share, finance Residual Risk Status/Certainty No Re-examine risk Acceptable? treatment strategy Yes and/or objective and develop action plan Risk treatment

optimised? Yes – move on

Fraud/ corruption Equipment/ technology Control design

Management self-assessment approach options Self-assessment report: management/ work units

Commercial /legal

Assurance functions/activities External audit Health & safety Environment Legal Quality Internal audit Risk & insurance Regulatory & compliance

Traditional methods Risk starting Point

Analysis of risks, risk treatment and performance, linked to key business objectives

Business process focus Control criteria evaluation Compliance selfassessment

Human behaviour Public perception

Business objective starting point

Strategy/value management product:

Traditional product:

Management’s report on risk v. status linked to Management’s key business assessment of objectives risk/controls

The majority of ERM frameworks in the world today are risk centric’, focussed on building and maintaining risk registers; not objective centric, focussed on assessing the certainty that top value creation and preservation objectives will be achieved www.ethicalboardroom.com

Autumn 2019 | Ethical Boardroom 73

Board Governance | Risk Management

Really big reason #2:

Use of the word ‘defence’: While I like the notion of ‘lines’ in the name of the framework, I am strongly against retaining the word ‘defence’. It implies that the primary purpose of all the lines, particularly risk specialists and internal audit, is defence. This marginalises the role of all the lines and implies the framework has no role in value creation or strategic planning. This is not consistent with the direction of COSO ERM 2017 for risk management or what Richard Chambers, IIA CEO/president sees for the IA profession. A LinkedIn post where I comment on this issue is available.10 The June ED mentions the issues raised by the word ‘defence’ but does not address the huge damaging impact of the word ‘defence’. Recommendation: Replace the word ‘defence’ with ‘accountability’ or ‘assurance’. Role of management – the first line: Page eight of the ED describes the role envisioned for management. It does not indicate that management is/should be responsible for learning how to self-assess the acceptability of the current state of risk, linked to top value creation and preservation objectives. It also does not state that the first line should be responsible for regularly reporting on the state of risk-linked top objectives upwards to the CEO and board. This suggests to me that the working group has accepted/endorsed a weak first line governance model and described the roles of all other lines assuming a weak first line that is not responsible for assessing and reporting on the state of risk linked to top objectives. This is very akin to endorsing manufacturing operations decades back that relied on the inspection department to

identify and correct flaws from production. The framework should distinguish between weak first line models and strong first line models and provide an overview of what the roles of all the lines are in a weak first line model, and the quite different role of all the lines in a strong first line model. More comments on the weakness are available on my LinkedIn post.11 Recommendation: Provide readers with an overview of the roles of all the lines, assuming a strong first line model where management is the primary risk assessor/reporter linked to top value creation and value preservation objectives. The current draft provides the role descriptions of the lines for a weak first line model. The guidance could describe the differing roles of the lines to illustrate the differences between a strong first line model and a weak first line model. Assurance method(s) being used: There are five primary assurance methods organisations use to get assurance. These

THE THREE LINES OF DEFENCE MODEL Governing body / Board / Audit committee Senior management

1st line of defence

2nd line of defence

3rd line of defence

Financial control Security Internal Management control controls measures

Risk management Quality

Internal audit

Regulator

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the current model has strengths that can be extended and enhanced to serve organisational needs even more successfully. My top criticisms of 3LoD and recommendations made to the IIA working group in September 2019 to increase integration of strategic planning, ERM, and internal audit follow:9

External audit

The three lines of defence model works against integration of strategy and ERM. Following the 2008 global financial crisis, there was enormous regulatory pressure globally on financial institutions to create risk management departments. Risk functions, not surprisingly given regulatory focus and expectations, focussed on identifying risks and creating risk registers, risk maps, risk profiles and risk appetite statements. Internal auditors continued to focus on providing subjective opinions on internal control effectiveness, primarily linked to traditional value preservation objectives. The assessment methods and terminology used by the two groups, with the full endorsement of regulators, were quite different. As a result of growing confusion, the IIA in Europe started to popularise what has become widely known as the three lines of defence (3LoD) model to try to explain the role of risk groups and role of internal audit. A visual of the original European Confederation of Institutes of Internal Auditing (ECIIA)/Federation of European Risk Management Associations (FERMA) framework is shown in The Three Lines of Defence Model Table below. Financial regulators around the globe quickly seized on the IIA framework and popularised it by legislating/regulating the use of the framework.7 The IIA accelerated the adoption of the 3LoD model with the release of a guidance paper in 2013. This 2013 development had the effect of further emphasising that risk functions (part of the ‘second line of defence’) should focus their attention on risks; and internal audit (the 3LoD) was to report on the first line of defence’s use of management controls and internal control measures. How an organisation creates value and exploits opportunities is not discussed. The governing body/board/audit committee and senior management are depicted and described in the framework as process oversights, not active participants/’lines. In June of 2019, the IIA announced its intention to update the 2013 3LoD guidance. To kick-off the process, the IIA published an exposure draft for comment.8 The comment period closed on 19 September 2019. The authors made it very clear that, in spite of strong criticism from multiple expert sources, significant changes should not be expected. The model has attracted criticism over the years, highlighting its limitations in addressing the complexity of modern organisations. In addition, the familiar graphic, developed and promoted to illustrate the model, is seen as reinforcing these limitations. A number of variations to the model have been proposed, but none has gained significant adoption. Rather than needing a complete overhaul,

Inspection Compliance Adapted from ECIIA/FERMA Guidance on the 8th EU Company Law Directive, Article 41 www.ethicalboardroom.com

Risk Management | Board Governance DRAWING THE LINES A strong first line with five lines of accountability is the best model

assurance methods are broadly defined as objective centric, risk centric, process centric, control centric, and compliance centric. These methods can be done by the second and third lines directly or performed by management and quality assured by the second and third lines. These different assurance methods are described in an overview.12 There are significant differences between the different methods. When a company uses an objective-centric assurance method applied to top value creation and value preservation methods, it significantly elevates the role and stature of the second and third lines and helps governing bodies meet escalating expectations that boards oversee the company’s strategic planning process. The ED makes no reference to the technical assurance method(s) being used by an organisation, in spite of the fact that roles of all the lines are significantly impacted. For example, in most organisations that use a risk-centric/risk register-based ERM framework, few internal audit departments today provide much formal assurance to the board that the information it is receiving from the second line/risk group is reliable. Recommendation: Provide an overview of this issue in the guidance, which describes the impact on the lines when different combinations of assurance methods are used. Number of ‘lines’: The ED is about three lines of defence but introduces a fourth line – governing body. It isn’t clear if the current three lines in the IIA three lines of defence model is going to become four lines in the final guidance document. The ED does not www.ethicalboardroom.com

envision the CEO and C-Suite as a line in spite of the fact that, in my experience, the role of the CEO is absolutely key to the long-term success of an assurance framework. Recommendation: Endorse the five-line approach that many have advocated since the IIA 3LoD was introduced that elevates the roles of the CEO and C-Suite and the board of directors. It is ironic that the IIA, when it popularised 3LoD to try to define the roles of overlapping assurance groups, has consciously or unconsciously popularised and reinforced what I regularly call ‘a weak first line risk governance framework’. Even more ironically, regulators around the world have picked up on the IIA 3LoD model and further reinforced and encouraged the use of a weak first line model that depends heavily on the second and third lines (risk and other second line groups and internal audit) to identify and report areas of major weakness and excessive risk emerging from the first line. In simple terms, the IIA and regulators have endorsed and elevated a framework that is much like the auto production lines of the 60s and 70s in North America; an approach that relied heavily on inspection departments at the end of the line to identify and correct production flaws from the main production line. The IIA is now considering the feedback that it has received to date on the June 2019 3LoD exposure draft. I am not optimistic the IIA will make major changes to this badly flawed model.

Really big reason #3:

CEOs and boards don’t think risk groups or internal audit have much to offer in the area of strategic planning.

As a direct result of really big reasons #2 and #3 described in this article, CEOs and boards, quite naturally and rationally, see risk functions (one of the second line of defence), and internal audit (third line of defence) as being primarily about defence, with little to contribute to the strategy development and implementation process. Risk oversight surveys done in the US by the AICPA and North Carolina State for the past 10 years, and in Canada most recently by Conference Board and CPA Institute continue to confirm this fact. Risk groups focus on building and maintaining risk lists with an emphasis on value preservation. Internal audit focusses on giving opinions on internal control effectiveness with a heavy focus on value preservation objectives. In the majority of organisations, neither group starts the process by agreeing a set of the organisation’s top value creation and value preservation objectives, including top strategic objectives. Management (the first line) is rarely responsible for learning how to assess and report on the state of risk/certainty linked to top strategic value creation or the more traditional value preservation objectives. Few chief risk officers or chief audit executives or their staff are asked to participate directly in the strategic planning process or oversight of its implementation.

Going forward

If I am correct that the IIA has little appetite for radical change and quite likes internal audit’s regulatory endorsed role as ‘defence specialists’ and that the associations that represent the risk profession (e.g. IRM, GARP, PRIMIA, RMA) are largely silent and content with their role as second line ‘defence specialists’, the onus will fall on CEOs/senior management (what I and many others label ‘the fourth line’) and boards of directors, (what I and many others label ‘the fifth line’) to demand change.13 The fourth and fifth lines responsible for oversight of strategic planning, ERM and IA must demand that the companies they oversee transition from the seriously flawed 3LoD model, a model focussed heavily on value preservation that depends heavily on inspection and rework identified by the second and third lines, in favour of an objective-centric/strong-first-line/five-line accountability model with active roles for senior management and the board. Boards, and the associations that represent them, also need to clearly signal to the IIA and regulators around the world that at least some boards of directors want major changes in the deliverables from risk groups and internal audit to better meet what boards, society and powerful institutional investors need in today’s fast-changing, disruptive world. Footnotes will be run in full online.

Autumn 2019 | Ethical Boardroom 75

Board Governance | Internal Audit

Thinkingdifferently differently When you consider the technology that we have at our disposal, there has never been a more exciting time to be an auditor. Given the analytical and technology skills that many in the profession possess, internal audit is uniquely capable and positioned to embrace digital transformation while providing exceptional risk assurance in this rapidly changing world. In order to take advantage of this thrilling potential, audit leaders need to commit to transforming into a nextgeneration internal audit function. The journey may not be quick or easy, but if they can push through the challenges and overcome human reluctance to change, 76 Ethical Boardroom | Autumn 2019

Are you embracing the next generation of internal audit? Brian Christensen

Executive Vice President, Protiviti the transformation will reap tremendous rewards for internal audit teams and their stakeholders, including the board of directors. Protiviti’s white paper The Next Generation Of Internal Auditing – Are You Ready? details why and how internal audit functions need to perform their work in a more agile manner and how to leverage the proliferation of data combined with technology-enabling auditing solutions to deliver on transformational objectives.1 The white paper concludes that leaders must fundamentally rethink the design and capabilities of the internal

audit function in order to be more forward-looking and help improve the business. The board can play a significant role in this transformation process. This mandate is also underscored in the results of the Executive Perspectives On Top Risks For 2019 survey conducted by North Carolina State University’s ERM Initiative and Protiviti.2 According to this global survey of board members and C-suite executives, the top risk for organisations is concern about existing operations (of which internal audit is a key part) not meeting performance expectations and competing against ‘born digital’ organisations. Audit and compliance professionals need to understand how these risks can affect the audit function’s imperatives. A commitment to the following priorities is a great starting point:

Focus on strategic risk In recent years, organisations have evolved beyond just www.ethicalboardroom.com

Internal Audit | Board Governance

NEXT-GENERATION INTERNAL AUDIT Organisations need to acknowledge the need for change and establish a clear game plan

taking the ‘wash, rinse and repeat’ approach to audit and begun to think about effective strategic risk management. Think beyond the scope There’s an old audit joke that auditors show up after the battle has been fought. To avoid reactive functionality, audit professionals need to better anticipate how the information they capture during audits can help them make better, more forward-looking decisions across the organisation. Share your point of view Auditors have the ability to look at a process and understand it, but they can share a perspective on it as well. Auditors should use their perspective to help the organisation identify the latest and greatest solutions it can use to push forward. Be facilitative and communicative In the last 10 to 15 years, the expectation of what auditors and compliance professionals can do has changed. If they are able to facilitate change and communicate with the organisation, they can now add significant value to their function. Be risk-oriented Risks may change from day-to-day, so audit functions need to consider a dynamic risk profile. Can

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audits adapt to the risks of the organisation, or does the audit team chisel away at them during November and December? The results of the Protiviti 2019 Internal Audit Capabilities And Needs Survey, in which the firm takes an in-depth look at the adoption of next-generation internal audit competencies such as agile auditing, artificial intelligence (AI), machine learning (ML), robotic process automation (RPA) and continuous monitoring, among many others, provide a detailed assessment of how internal audit groups are progressing on their next-generation journeys. 3 Here are some additional highlights and key takeaways from this internal audit study:

Three out of four internal audit groups are undertaking some form of innovation or transformation effort While this finding is expected, given what we’ve observed in the market, it also sends a clear message to the significant number

of internal audit functions that have yet to begin their next-generation journeys: it’s time to get started. Overall, the adoption of nextgeneration internal audit capabilities is in its early stage The implementation of the governance mechanisms, methodologies and enabling technologies that comprise the next-generation internal audit model has so far occurred in a predominantly ad hoc manner. Internal audit groups within organisations that are digital leaders have made substantially more progress with their innovation and transformation initiatives. Chief audit executives need to take the lead in getting the function’s transformation on the audit committee agenda Fewer than one in five organisations report that their audit committee is highly interested in the internal audit group’s innovation and transformation activities. Chief audit executives (CAEs) must convey the internal audit function’s commitment to innovation and transformation to audit committee members through effective and efficient information-sharing practices and persuasive presentations.

Autumn 2019 | Ethical Boardroom 77

Board Governance | Internal Audit cybersecurity risks, vendor 4 ERM, and third-party risk management,

and fraud risk management are top audit plan priorities Internal audit groups have been highly focussed on these areas in their 2019 audit plans.

It’s encouraging to see that most internal audit functions have begun to launch innovation and transformation activities, key first steps in their next-generation journeys. Some internal audit groups are ahead of the game, including most of those that sit within companies considered ‘digital experts’ and ‘digital leaders’. Digital leaders are far more likely than other organisations to appoint internal audit innovation/transformation champions. However, more substantive progress is needed in several areas if early-stage, next-generation internal audit models are to mature and fulfil their massive potential. Undertaking this journey requires a recognition that transformation consists of more than a collection of discrete activities; becoming a next-generation internal audit function requires a commitment to continual evolution. It also demands a holistic mindset focussed on governance, methodology and enabling technology, as true digital transformation involves more than just implementing technologies.

leveraging early warning systems using risk thresholds. The mixture of big data, process automation and data analytics offers interactive visualisations and business intelligence capabilities and can help to make time for more strategic analysis to convert data and information to real insights and enable creation of impactful reports. Automated processes Robotic process automation is a powerful means of eliminating manually intensive tasks, allowing auditors to focus sharply on key business risks and areas requiring the exercise of professional judgment. Examples of processes that could be automated include reviewing large volumes of contracts to identify high-risk terms or clauses requiring further review and advanced monitoring techniques that drive greater audit coverage, efficiencies and early alerts.

populations for risk-based analysis. They also can be used to perform predictive modelling to provide intelligent continuous process auditing. These digital activities and tools enable internal auditors to translate an increasingly overwhelming amount of data into meaningful, impactful analysis. Coupled with divergent and critical thinking, these capabilities have the potential to steepen the value-delivery curve significantly for internal auditors. The annual audit planning process so familiar to directors has become a relic of the past. Rarely will an audit plan be executed in its entirety before fresh insights and developments emerge, creating the need for changes to it. The above digital pathway will lead to the observations and

Why should the board care?

What does this mean to the board? Next-generation internal audit functions have three essential objectives – improve assurance by increasing focus on key risks; make internal Digital activities audit more efficient; and provide deeper, more valuable and tools enable and timelier insights from internal auditors audit activities and processes. to translate an These objectives are easy increasingly Process mining to understand. But the insights Process mining mechanisms to implement overwhelming extracts data easily from such changes vary across amount of data within the company’s systems a range of innovative approaches, tools and into meaningful, to discover and monitor how a process actually functions. governance processes and impactful It enables auditors to analyse are intertwined with the process data earlier in the innovative culture created by analysis audit cycle to quickly identify the chief audit executive risks, potential control breakdowns and (CAE) and his or her vision of what nextinefficiencies. This analysis also directs audit generation internal audit looks like. focus to those issues and opportunities that For those internal audit functions that truly matter, delivering significant efficiency have not yet begun their next-generation gains and a more impactful audit process. journey, we recommend the board considers AI and machine learning These the following technology activities and advanced capabilities increase the tools that are commonly implemented in effectiveness and efficiency of complex next-generation transformations: testing and provide intricate analysis in Ubiquitous data analyses and real time. Examples include the application advanced analytics These capabilities of classification and clustering algorithms access a broad swath of data to develop a to data. These purpose-specific algorithms holistic view of risk. This includes analysis of are designed to identify outlier and high-risk full samples, data-driven flowcharting and transactions and to better stratify

78 Ethical Boardroom | Autumn 2019

WORKING FASTER AND SMARTER Automation tools bring powerful capabilities to the auditing process

recommendations that board members, senior executives and other stakeholders will value and can act upon quickly in the digital age. Directors cannot be indifferent to the CAE’s level of awareness of digital techniques and tools available for next-generation audit. The reality is that companies are moving to cloud computing and adopting artificial intelligence, machine learning and other digital practices to conduct business at the speed of innovation. As they do so, an agile methodology enabled with the right skills, resources and technology helps the CAE sustain internal audit’s relevance by providing assurance to the board and other stakeholders on the risks that matter in the most efficient manner. The board should accept nothing less. 1 www.protiviti.com/auditnextgen 2www.protiviti.com/ toprisks 3https://www.protiviti.com/US-en/insights/ internal-audit-capabilities-and-needs-survey

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Board Governance | Pay

Executive compensation in the US Guidelines for non-US multinational companies on establishing and managing programmes Marsha Cameron & Paul McConnell

Marsha is the Co-Founder and Managing Partner of Paradox Compensation Advisors. Paul is the Co-Founder and Managing Director of Board Advisory

Since about 2010, labour market dynamics in the US have increased pressure on non-US based multinationals to ‘up the ante’ regarding executive compensation for their US operations, especially in the areas of annual and long-term incentives.

There is often frustration expressed on both sides (multinational ownership and US management) and there is natural tension between those responsible for approving programmes and potential recipients. Multinational entities with US operations have experienced the same issues with attracting and retaining top talent as their US-based counterparts. When the issue is ignored, executives can become frustrated to the point of resignation, which may impact the ability of the company to execute upon its strategy. A study by executive outplacement firm Challenger, Gray & Christmas, found that a total of 1,452 CEOs left their companies in 2018, which is the highest number since 2008. Just in the fourth quarter, 425 CEOs departed, a 45 per cent increase over the same time in 2017. Of course, not all these departures were voluntary, and compensation may not have even been a factor, but rising executive turnover does place companies in the position of managing the risks related to turnover and attracting and retaining key talent more continuously. Boards of organisations with operations in the US must pay attention to this topic as they bear responsibility for managing the risks of global performance. Those organisations with an expatriate in one or two key positions are not immune to 80 Ethical Boardroom | Autumn 2019

the pressure, given that executive compensation programmes generally apply to the CEO, his or her direct reports and frequently, two to three levels down in the organisation. Even those public multinational companies that provide equity awards to top-level executives in their US operations are often challenged by the value of the awards and the organisational depth of participation. Some of the questions and concerns expressed by multinational management and boards about higher levels of incentive compensation for US-based executives include: ■■ Why doesn’t our home country philosophy work? ■■ What does this ‘extra pay’ accomplish? ■■ What’s the right programme for our US operations? ■■ How do we know we are not under or overpaying? ■■ How can we be sure that we are getting a return on our investment? ■■ Who should participate? ■■ Where do we start and what are the pitfalls? This article examines foundational issues behind some of these questions and presents case studies that summarise the approach two companies took in implementing executive compensation programmes that ultimately met the concerns of both US management and multinational ownership.

Status of US executive pay programmes

For at least two decades, large public US companies have continued to shift more executive pay into incentive compensation,

LONG-TERM INCENTIVES Companies may need to be more flexible if they are to attract the best talent www.ethicalboardroom.com

Pay | Board Governance both annual bonuses and long-term incentives (e.g. restricted stock or units, stock options, long-term cash programmes). Over the past 10 years, partly due to the pressure of shareholders and shareholder advisory groups, incentive plans in large public companies have become increasingly formulaic, and there has been a striking shift from the use of stock options to restricted stock or units and, in particular, to performance-based equity or units. Compensation committees of boards spend an enormous amount of time benchmarking total compensation (salary, annual bonuses, long-term incentives and any other executive benefits or perquisites) for top management, defining incentive programmes that align with creation of shareholder value, and disclosing to shareholders both the intent and the results of executive compensation decisions. Mid-size public companies and private companies soon began to follow suit. In our experience, the dynamics that have influenced mid-size and private companies include (again) the tight market for executive talent, the need to satisfy their shareholders through greater pay for performance, and ongoing cost-consciousness â&#x20AC;&#x201C; i.e. the desire to â&#x20AC;&#x2DC;self-fundâ&#x20AC;&#x2122; post-recession executive pay increases through meeting key objectives. As a result, while executive compensation has increased, most of the growth is due to amounts allocated to incentive pay. Boards and management of multinational companies should note that long-term performance cash plans have fallen out of favour among US public companies. These plans operate much like a bonus with multi-year measurement and, historically, have been used by companies headquartered outside the US to fill the gap due to lack of equity awards for US management. Also, long-term performance cash awards are generally capped at 150 to 200 per cent of target opportunity and do not provide the perceived unlimited upside of equity awards. Though trend data is less available among private companies, surveys that Over the past 10 have been conducted indicate that most years, partly due private companies in the $100million-plus revenue category are providing to the pressure annual bonuses, while slightly more than half award long-term incentive of shareholders for key positions. A and shareholder opportunities survey conducted by Vivient Consulting advisory groups, on behalf of WorldatWork indicates that among private companies, more incentive plans formulaic approaches to annual in large public incentives are currently being used or are being considered. This is in line with companies a general trend of less discretion and have become greater transparency of measurement, which has become an important increasingly incentive compensation feature to formulaic both executives and shareholders. www.ethicalboardroom.com

Autumn 2019 | Ethical Boardroom 81

Board Governance | Pay Of the private companies awarding long-term incentives, unlike public companies, about half are in the form of long-term performance cash or stock options. Given the historical preference of private equity firms to award stock options, their continuing popularity in private companies is not surprising. However, in our experience, an increasing number of these companies (now about 25 per cent) are using restricted stock units, both time and performance-based, for the following reasons: more competitive with public companies, ability to base all or a portion of the amounts vested on key performance metrics, potential for cash pay-outs rather than equity, ability to separate vesting and pay-out and thus, tailor executive liquidity to align with shareholder liquidity. Among US public companies, participation in incentive compensation, both annual and long-term incentives, tends to be deeper in the organisation than what would be typical elsewhere. Participation in annual incentives is common down through the manager level and even lower, though the percent of total compensation targeted in annual incentive is not substantial until an employee reaches the senior director or vice president level. Where long-term incentives are concerned, participation down through the vice president level (or third organisational tier) is common. Below the vice president level, there are significant variations across industries and the proportion of total compensation granted in long-term awards is not typically significant. Given the desired motivational value of these programmes and the cost, organisations now perform extensive benchmarking and pay for performance analyses to understand: ■■ Positions that should be eligible for both annual and long-term incentives ■■ Competitive target values of awards ■■ Accruals for annual and multi-year cost of incentives at target values ■■ Total investment in incentives and ROI at varying levels of performance. Effective goal setting (for both annual incentives and performance-based, long-term plans) should underpin any expectation of return on investment. In the past 10 to 15 years, goal setting has evolved from linking strictly to a company’s budget and internally generated strategic plan to sophisticated stress testing, understanding/tracking peer performance, industry outlook, macroeconomic factors and, in long-term plans, focus on relative achievement. Further, where top executives are concerned, the compensation committee of the board (or the overall board in many private companies) should expend significant time and energy discussing the appropriate metrics for annual plans and 82 Ethical Boardroom | Autumn 2019

performance-based, long-term plans and ensure alignment with company-specific strategy and shareholder expectations.

Challenges for non-US based companies

Once the US executive compensation landscape is understood, non-US based companies continue to face questions and challenges. Some of the core points we hear in these discussions include:

‘Our 50th percentile, pay-forperformance executive compensation philosophy is tied to a global business strategy; how do we align with this philosophy while achieving and maintaining competitive positioning in the US?’ In general, a company can implement the same broad philosophy globally, but the mix of pay (fixed versus variable) may be different and 50th percentile pay in the US will likely be higher than that of peers in other countries. ‘How do we select among all of the different types of long-term incentive plans used in the US?’ First, if your company already has a long-term incentive plan, explore how competitive the methodology is in the US. If it is simply not competitive, work through the pros and cons of various methods, considering advantages to both shareholders and executives, complexity to communicate and maintain, ability to implement at the business unit level, and fit with overall compensation philosophy. ‘What if we don’t track measures that are common in our industry at the business unit level (e.g. total shareholder return)?’ Offering a competitive executive compensation programme for US operations does not necessarily mean that metrics will be defined solely at the business unit level. Most US plans include a blend of corporate and business unit metrics for annual plans and corporate metrics (and/or share or unit value) in the long-term plan. If desired, plans specific to the business unit can be defined, but this should be determined based on business need. ‘How do we manage incentive pool competitiveness versus cost?’ Generally, a benchmarking exercise can be used to ensure that the scope of participation, award levels and overall incentive costs are within competitive range.

Case studies

As the case studies below demonstrate, even when a plan is set in place, executive compensation programmes in US-based operations need to be assessed periodically for competitiveness of both award values and other practices. Energy company owned by European private equity firm. When a European

private equity firm acquired a mid-sized energy company in the US, it was its first US investment in the industry. Both the private equity firm and management bought into a strategy shift, focussing on acquisitions and profitable growth, with the necessary capital being supplied by the private equity firm. There was also agreement that the executive compensation plans, specifically the long-term plan, needed to be altered to align with the new strategy. Both sides expected a larger award pool and negotiated award amounts and frequency of grants prior to closing the transaction. These agreements were reached before any benchmarking was conducted. A benchmarking study subsequently educated the board that its potential restricted stock unit pay-outs would be a much higher proportion of company earnings than the competition unless performance triggers were introduced. This led to a significant amount of financial analysis being conducted in order to determine performance objectives that would deliver an appropriate return on investment and, simultaneously, be credible to executives. Mexican-owned consumer packaged goods. Initially, the US subsidiary of a Mexican company gained approval to implement a long-term performance cash plan for top executives. The plan assumed that there would be a three-year performance period with no new grants for on-going participants until the performance cycle had concluded. About a year later, it became obvious to the Mexican parent that a new CEO with larger company experience was needed as well as talent upgrades in a few other key positions. Attempting to recruit externally with the existing plan was not successful. A study of industry practices led to a shift to annual grants with overlapping performance cycles and substantially larger target award amounts. The US subsidiary also committed to providing regular executive compensation benchmark information to the Mexican parent.

Conclusion

A key component of managing strategic risk is to ensure the attraction, motivation and retention of the executive talent required to implement and advance strategy. For a multinational company, this may mean being flexible enough to use methods that are unique to the US and granting target awards that exceed those for peers in other countries. Data and analyses should be used to educate parent company management and the board about executive compensation practices in the US. Special attention should be paid to industry peers in the US, but slavish adherence to average practice is not necessary or appropriate. Ultimately, a successful programme should help to support and advance a company’s specific talent and strategy objectives. www.ethicalboardroom.com

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Board Governance | Responsibility

Where was the board? The question ‘where was the board?’ is often asked when an unethical issue has made its way into the news. With the speed at which information is delivered through social media, news can quickly proliferate and, as a result, judgement can make or break a company in a short period of time.

A reputation that has taken years to build can be destroyed in minutes when a company is deemed to be unethical. Many of the issues that are now hitting the news are related to sustainability, ESG (environmental, social and governance) and climate. These are precisely the issues that talent, customers and increasingly investors are valuing, making the need to manage and govern a company’s impact in these areas more and more important. This begs the question: do board members have the insight needed to provide oversight when it comes to sustainability, ESG and climate? Do they have the insight needed to make the ethical decisions that more and more shareholders, as well as stakeholders, are expecting? “I think a board member who can’t articulate the most material environmental, social, and governance factors for their own company is in breach of fiduciary duty,” said Erika Karp, founder and CEO of Cornerstone Capital Group and contributor to the Competent Boards Certificate Program.

Boards are feeling the pressure In a 2019 survey conducted by the National Association of Corporate Directors (NACD), 73 per cent of directors reported that board leadership is more challenging now compared to what it was three years ago, and 84 per cent reported that performance expectations have gone up for all board members. As the stakes for boards of directors continue to rise, so does the uncertainty of whether the director’s insurance policy will protect the director and when the director is in breach of the fiduciary duty/duty of care. So, in a time where a company’s actions and decisions are watched closer than ever, boards must understand the positive and negative

84 Ethical Boardroom | Autumn 2019

Boards are at risk of being in breach of their fiduciary duty Helle Bank Jorgensen CEO, Competent Boards

impacts of their business decisions in order to earn their own licence to operate as a board member. We are often backward-looking when it comes to identifying problems and solving them. Instead of being only problem solvers, we might want to look upstream, mitigate risks and utilise opportunities. As stated by Paul Dickinson, CEO of CDP, in one of Competent Boards’ interviews: “There are Kodak moments looming across practically every area of our industrial and commercial system. And the opportunities are great, and the risks are great and it’s tremendously exciting. I think the leaders that embrace the future and don’t deny its existence are the ones that are going to do well.’’ As we continue to see sustainability as a means to identify current and future material risks, it is important to consider how these areas can better inform board decisions and ensure future-fit businesses.

Investors want to see more than just a sustainability report; in fact, they often want to see more than an integrated report. They are requesting ongoing engagement with board members. With the positive and negative impact that ESG considerations can have on a company’s financial performance and shareholder value, investors are increasingly looking to better understand a company’s long-term plan and

how sustainability, ESG and climate will impact the strategy. As there continues to be a gap in the information that companies are disclosing, and the information shareholders seek, investors are seeing the value of entering an ongoing dialogue with the companies they invest in. And they increasingly want to talk directly to the board members. Further, as we’ve heard from many of the more than 60 global leaders we interviewed for our Certificate Program, investors are and will increasingly be evaluating board members and the degree to which their ESG expertise is up to date. So, if a board member isn’t able to articulate the company’s long-term ESG strategy, the information gap will remain, resulting in a seemingly higher risk profile from an investor’s perspective.

What is the value of a well-informed decision?

Being able to understand ESG risks and engage in discourse will not only reduce risks, but it will also allow board members to understand the changing needs of investors and prepare for ESG-focussed shareholder proposals. According to a 2019 Nasdaq study, a majority (80 per cent) of S&P 100 companies highlighted environmental and sustainability issues as priorities in proxies this year. When it comes to climate change, there are a growing number of demands from other stakeholders who want to see climate action and commitment from companies. It is becoming increasingly difficult to ignore the signs from customers and employees who are dissatisfied with business’ inaction. Climate strikes have become an international phenomenon and employees are taking a stance. Earlier this year, Amazon employees walked out in protest over the company’s climate change policies or lack thereof. Moreover, inaction can translate into legacy issues. Much like asbestos or companies involved in sweatshops, the companies (and those making decisions) that remain complacent, while aware of their impacts and emissions, will be remembered. And for those companies that survive, the accumulated costs of the consequences of uninformed and unethical decisions are significant.

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Responsibility | Board Governance

ARE YOU AWARE? Investors are and will increasingly be evaluating board members and the degree to which their ESG and climate expertise is up to date

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Autumn 2019 | Ethical Boardroom 85

Board Governance | Responsibility It’s a cost that will be paid not only by the shareholders but also by the board of directors. So, the costs of the question ‘where was the board?’ can be very high, both in financial and legacy terms.

More than reputational risks

Climate risk goes beyond reputational risk and can impact the long-term viability of the business and society. If your company is not able to access its raw materials because of climate change, then your business is at risk. If a company and its board do not have a climate change action plan, they will be left behind, lose investors, and in some cases cease to exist. Being climate competent and understanding ESG principles will enable boards to look at risk through a different lens and map out current and future risks. With this knowledge, companies will have the foresight needed to be ahead of the curve on not only stakeholder demands, but also stock exchange requirements and regulatory demands. A sentiment that has been echoed in many of the interviews we have conducted with global business leaders is the prediction that we will see regulatory frameworks expand in the area of sustainability, and those businesses that have started acting will be the ones leading the way. According to the Governor of the Bank of England, Mark Carney, major corporations will have two years to agree on rules for reporting on climate risks before global regulators develop their own and make them compulsory. Further, the leader of the UK Labour party stated that companies will be delisted from the London Stock Exchange if they fail to meet environmental criteria.

Boards that can have a candid discussion about purpose, build their strategy, and set a tone from the top around that purpose, will increase stakeholder trust and their ability to be seen as relevant Take advantage of the opportunity before it is too late

Being knowledgeable on sustainability aspects of your business, industry and market will allow you to help your business take advantage of the opportunities presented by ESG, climate change, diversity, the Sustainable Development Goals (SDGs), etc. Boards that can have a candid discussion about purpose, build their strategy, and set a tone from the top around that purpose, will increase stakeholder trust and their ability to be seen as relevant. This can provide endless opportunities to attract investors, customers and talent. In addition to increasing productivity, companies are looking to invest in opportunities that will solve global sustainability issues such as climate change. For example, the SDGs can be seen as a long-term forecast for what is coming in future decades, which leading companies view as a directory for business opportunities to invest in. In an interview with Torben Möger Pedersen, CEO,

PensionDanmark, he specified that by looking into national SDGs programmes ‘it’s like looking into a big catalogue of investment and exporting opportunities for investors and companies.” Paul Polman, Former CEO Unilever and a contributor to the Competent Boards Certificate Program said: “Competent Boards will share knowledge, experience and insight to help train board members on how to capitalise on the opportunities the SDGs present”.

Five questions boards should ask themselves

An ill-informed decision cannot only cost a company, but also the board of directors its reputation and licence to operate. To ensure that the board avoids such damaging decisions, here are five questions boards should ask themselves: Do we, the board, have the insight 1 needed to provide proper oversight? Do we, the board, understand what 2 can disrupt the business or how the

business can be a disruptor? Do we, the board, understand scenario planning in relation to sustainability, ESG and climate-related issues and opportunities? Who on the board has the competencies related to sustainability, ESG, climate, diversity, human rights, supply chain, SDGs, anti-corruption, data use, cybersecurity, tax, investment, pay, engagement and disclosure? Are we, as the board, fit for the future, or do we need education in these areas?

4 5

TOUGH QUESTIONS ilI-informed boards can cost a company its reputation and licence to operate 86 Ethical Boardroom | Autumn 2019

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Board Governance | Best Practice

The hidden value of governance

GOOD GOVERNANCE DOES PAY OFF Strongly governed companies deliver double the shareholder value

If you were to invest £1million, what return would you prefer in 10 years’ time: £4.5million or £8.5million? Surely, it’s a no brainer? And yet, there are many boards and investors who would rather go out to their local DIY store and purchase a tall ladder than reach up for the low hanging fruit! But more of that later.

The purpose of governance is strongly hinted at in the first principle of the 2018 UK Corporate Governance Code where Principle A clearly reminds us that ‘a 88 Ethical Boardroom | Autumn 2019

Why it’s time for boards to look again at their corporate governance practices Simon Lowe

Chair, Grant Thornton Corporate Governance Institute successful company is led by an effective and entrepreneurial board, whose role is to promote the long-term sustainable success of the company, generating value for shareholders and contributing to wider society’.

Key words in the first principle, such as ‘entrepreneurial’, ‘generating value’, ‘long- term success’, are strong signposts to the overarching objective of governance. But when it comes to implementing effective governance practices, many companies have lost sight of the purpose of governance. Perhaps it is not surprising, given the more singular agendas of: ESG reporting, currently the topic of the moment for institutions; Section 172 of the Companies Act, the favoured topic of the former Prime Minister, and its emphasis on the need to respect stakeholder interests; and diversity with its almost singular focus on gender alone. At times, www.ethicalboardroom.com

Best Practice | Board Governance Governance) being owned, refined and promoted by the companies’ regulator, the Financial Reporting Council (FRC), whose remit most would see as being to police and enforce rather than promote and encourage. The net result has been that the majority of the UK’s largest publicly listed companies have come to see corporate governance as a compliance exercise, despite the principle to apply and the option to ‘explain’. Such a compliance focus is evident in the results of the soon to be published Grant Thornton 2019 Annual Corporate Governance Review, which reports that 73 per cent of the FTSE 350 now claim compliance with the Code, compared to 29 per cent in 2005. At first sight, that’s encouraging but closer analysis highlights that when it comes to how companies choose to interpret and then apply the principles of the Code, only 32 per cent appear genuinely to embrace them. Regularly, when discussing our analysis of an individual company’s governance practices with the management, I get push back that it’s not what they disclose in their annual accounts that matters; even though to the majority, if not all, of investors and, indeed, wider stakeholders, the annual accounts Investors (analysts represent the primary working together, source of reliable data. as opposed to It is from this data that they can judge independently, with the effectiveness of their governance the decision-making environment, its teams) and other performance interested parties, such associated and the leadership quality of its directors as, lenders should and senior management. be more engaged in Frequent excuses are understanding and ‘we do it but we just challenging companies’ don’t see the point in shouting about it’ or, governance practices more frequently, ‘it’s the profit that really matters; without profit there’s no return for shareholder, never mind the wider stakeholder community’. But new, seminal research, shows they it seems that the objective of the UK’s are missing a trick. Stronger governance is Corporate Governance Code is in danger the leader to greater performance. of being hijacked. Recent research undertaken at Grant Back in 1992, Sir Adrian Cadbury, the Thornton on the applied governance father of modern-day corporate governance, practices of the FTSE 350 over 10 years, summed up governance up as ‘the system found that the strongest governed by which companies are directed and companies, as defined by being in the top controlled’. And, while said with the best quartile of their Corporate Governance of intentions, it perhaps set the mould by Index (CG Index), delivered double which governance would be seen by the the shareholder value of the weakest majority of companies for the next quarter (bottom quartile) governed companies. of a century as an exercise of control and Looked at from a value creation compliance. This perception has been perspective, this stronger performance further compounded by the main UK Code (defined as having probabilities of greater (there are many others but they all take than 70 per cent) was particularly evident in their lead from UK Code of Corporate areas of operational efficiency, cash flow and www.ethicalboardroom.com

return on capital where it was found that the strongest companies: ■■ Generate 3.4 times more cash flow from their operations ■■ Are 43 per cent more efficient in their operations (as defined by their percentage EBIT) ■■ Provide 29 per cent more return on capital ■■ Generate double the return for shareholders When looked at from a value retention perspective, it was found that the top quartile perform better across a range of indicators. The strongest companies: ■■ Are 15 per cent more solvent ■■ Have 25 per cent more liquidity. ■■ Are more than twice as likely to stay in the FTSE 350. In each case, these findings hold for most of the 10 sectors covered by the research. Further, the findings hold when the population is stratified into groups of 50 by market cap to eliminate the influence of greater resources. The notion that the less accountable, the more flexible a company can be is shown to be flawed. The evident conclusion, based on the research, is that boards of companies who choose to dismiss or down grade the value of governance are holding their companies back. In light of these findings, boards should be asking how they can strengthen their practices. For example, do they really believe the embedded culture, processes and systems are what they expect throughout the organisation to deliver strategic objectives and purpose. Investors (analysts working together, as opposed to independently, with their governance teams) and other interested parties, such as lenders, should be more engaged in understanding and challenging companies’ governance practices and holding boards to account for more than the remuneration report. For example, if customers are increasingly demanding more sustainable business practices, why isn’t the executives’ remuneration explicitly linked to relevant KPIs (statistics from 2019 indicate 13 per cent cited non-financial KPIs)? Even if they are not yet happy about introducing, what many see as the ‘softer targets’, then how about challenging the 85 per cent that have no specific linkage between remuneration and clear strategic objectives? Then there’s the proxy voting agencies that could do with changing their models in order to recognise what makes sense for a company, rather than focussing on every act of non-compliance. Of course, improving practice takes time to filter through to decision-making, which impacts financial performance. Autumn 2019 | Ethical Boardroom 89

Board Governance | Best Practice Perhaps more telling, the referred research shows there is a compelling financial impact for companies that progressively strengthen their corporate governance practices – moving from the bottom quartile in the CG Index – the research identifies a strong link between improved governance and subsequent value enhancement. Each step up between quartiles is associated with an average: ■■ 44 per cent increase in operating cashflow ■■ 10 per cent increase in EBIT margin And governance isn’t just for public companies. ‘In the words of James Wates, Chairman of the Wates Group, in introducing his large company code, boards should use the Wates Principles as ‘a tool to help.... companies look themselves in the mirror, to see where they have done well and where they can raise their corporate governance standards to a higher level. This can, in turn, result in better engagement with their stakeholder base and, ultimately, build trust’. Given the clear evidence of this research, now seems a good time for at least 75 per cent of the FTSE boards to reappraise their governance practices. Viewing the Code as a compliance exercise that has been imposed by a regulator in order to appease market criticism is to misunderstand the genesis of the Code. The reality is the opposite: the regulator merely distils what it sees or hears are the practices that successful companies have evolved over time and incorporates this into a lexicon, aka the Code, which is then a blueprint available for everyone. To get real value, it is a huge mistake to see the Code as a regulator-driven, compliance exercise. Much better to look on it as the go-to source of best practice in the full knowledge that it has evolved from the cumulative experiences of the most successful companies (coupled with the lessons of a few who have failed). But, as the saying goes, it takes two to tango.

FRC introduction to the 2018 Code:

“Investors should engage constructively and discuss with the company any departures from recommended practice. In their consideration of explanations, investors and their advisors should pay due regard to a company’s individual circumstances. While they have every right to challenge explanations if they are unconvincing, these must not be evaluated in a mechanistic way. Investors and their advisors should also give companies sufficient time to respond to enquiries about corporate governance.”

For at least the past four years and, despite the introduction of a stewardship code and tiering, the level of quality engagement 90 Ethical Boardroom | Autumn 2019

between companies and their investors, as reported in the annual accounts, has been on the decline, dropping from 55 per cent in 2015 to 31 per cent. The FRC is currently once again in consultation with the investor community with intention of refreshing the Stewardship Code and perhaps adding more teeth. But this will take time. It will come as no surprise that it is the larger investors who have the resources to pursue this goal of active engagement on matters of governance but, even for them, the attention is more on the largest companies in their portfolios. And yet the research shows that, whatever the size of the company, there are opportunities to enhance value if there is positive (rather than passive) engagement. The benefits of greater challenge and engagement on matters of governance are not limited to investment managers, as, for example, for banks and pension trustees, a greater focus on the quality of the investee operation’s governance practices has the potential to further de-risk their investment

execute decisions. In terms of these key areas it is interesting to see that while, for example, risk management and internal control were a focus of the Code at the turn of the century and board effectiveness only came into focus at the end of the decade, culture, succession and purpose are only now emerging as key areas of governance in the new Code. Of course, success is not guaranteed, even for a well-governed business – events can change the fortunes of any company. However, this research indicates that companies that have a healthy respect for applying the principles of governance have a far greater chance than those whose decision-making is founded on weak governance structures. With new governance codes being introduced around the world and across different sectors, this research should encourage organisations globally to refresh their attitude to their governance frameworks, processes and practices. Further, it ought to encourage investors, lenders and stakeholders to be clearer and

SIX PRIORITY AREAS FOR CORPORATE GOVERNANCE TOP PERFORMERS Looking more closely at the common governance attributes of companies in the Grant Thornton Corporate Govenrance Index, we found that companies in the top quartile achieve high scores in six key areas:

Business Model Clarity & Connectivity

Culture & Value integration

90 41

89 33

Board effectivness evaluation

Succession planning

92 41

88 21

Risk management

Internal controls

96 49 % Top-quartile companies

decisions: does the espoused culture of the organisation stack up with their experience of dealing with the employees in everyday life? Is there a clear skills gap analysis and do the existing skills of the board truly address the emerging risks and challenges? Do management incentives align with what the companies promote to the public? But what are the drivers of success? Are there any particular aspects of governance that will move the value dial straight away? Governance is bespoke; the research does not find a ‘one size fits all’ set of good governance practices that are being applied consistently across the top-performing companies. However, it does identify six attributes that show a strong distinction (see table above) in performance between top and bottom quartile companies: These areas should come as no real surprise as they provide organisations freedom within a strategic framework to

95 38 % Bottom-quartile companies

more forthright about the role governance should play in their engagement with companies and in their investment decisions. Returning to my opening question, and no, it’s not a trick, it would seem that, the majority of the UK’s largest companies, wittingly or unwittingly, are currently opting for the lower end of the returns spectrum. At a time when the economy is showing signs of stalling and retaining value (never mind creating it) is likely to prove elusive, now would seem like a good time for boards to revisit the strength of their governance practices and consider how they frame and communicate them. Equally, investors, rather than cutting back and outsourcing to the voting agencies, should be looking to increase their engagement; challenging companies about the quality and purpose of their governance activities. After all, when low hanging fruit is so readily available, why wouldn’t you reach up and pick it? www.ethicalboardroom.com

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Board Governance | Dual-Class Shares

ONESHARE, ONEVOTE Many prominent companies made high-profile initial public offerings in 2019, including Lyft, Peleton and Pinterest. A point of commonality among these companies, often buried in the headlines, is their dual-class equity structures.

Recent developments at WeWork and Endeavor show that investors are starting to shine a spotlight on such governance problems at companies looking to go public. In dual-class, a superior class of common stock, often held by founders and their families, has significantly more votes per share than the inferior class available to public shareholders. While companies may thrive for some period with dual-class structures in place, the misalignment between control and equity presents a substantial risk to long-term company performance. Board members at the pre-IPO stage have a special responsibility because many of their decisions will carry impact throughout the public company’s life. One of the most important is whether to adopt an equity structure that protects the company’s owners equally according to their equity stake. The term ‘dual-class stock’ is used to encompass a variety of equity structures that are defined by unequal voting rights; some companies opt to have a triple-class structure or even a single-class structure with additional voting rights granted to founders through special arrangements. The most commonly adopted voting ratio among dual-class companies is 10 votes per superior share to one vote per inferior share. Even more alarming is the

92 Ethical Boardroom | Autumn 2019

Why we alert investors on dual-class structures with differential voting rights Lucy Nussbaum

Research analyst at the Council of Institutional Investors growing number of companies that adopt more disparate structures, including Lyft, Peloton and Pinterest, where each of the shares held by their founders has 20 times the voting power of those held by its public shareholders. Some companies have gone even further, creating a class of non-voting shares, where management has absolutely no mechanism of accountability to that class of shareholders. Dual-class structures can enable founders to maintain voting control despite having a minority interest in the company. Of course, the extent of misalignment depends not only on votes per share for each class, but also the number of shares outstanding. Investors can compare misalignment across companies by focussing on ‘the wedge’, which is the difference between the superior class shareholders’ control of total voting power and their equity stake. Among US multi-class companies, the wedge averages around 40 per cent but can be as high as 72 per cent for some of the more egregious structures, such as Domo’s 40:1 vote ratio.1 As a result of this disparity, public shareholders’ influence is diluted. This significantly erodes a company’s accountability to shareholders, the principle that underpins good corporate governance.

History of dual class

While dual class is a highly debated, somewhat commonly adopted feature of the securities market today, in the past, multi-class structures were uncommon and, at times, even stigmatised. From the 1940s until the 1980s, the New York Stock Exchange (NYSE) had a one share, one vote rule, turning away most dual-class companies that wanted to list on the largest US exchange. 2 Exceptions were granted for certain founder-centric companies, such as the Ford Motor Company, and for media conglomerates, including the New York Times, that used the guaranteed control of dual-class to maintain independence from the market. 3 Even after the NYSE reversed its rule in 1984, due to pressure from companies seeking anti-takeover protection, most dual-class companies remained in these categories.4 It wasn’t until Google went public in 2004 with a dual-class structure that the concerning trend came back into style, particularly among the Silicon Valley crowd. 5 Today, approximately nine in 10 publicly traded companies have a one share, one vote structure.6 However, a quarter of IPOs in the first half of 2019 went public with dual-class structures with unequal voting rights, the vast majority of which have no sunset to phase out this structure.7 Index providers have begun to take this issue

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Dual-Class Shares | Board Governance

very seriously and directors should follow suit. For example, in 2017, the S&P Dow Jones Indices announced it would no longer add dual-class companies to its S&P Composite 1500 index and its components. 8 Around the same time, FTSE Russell also agreed to include a minimum requirement on their indexes for the percentage of a company’s voting rights available to public shareholders.9

CII’s role

The Council of Institutional Investors (CII) has supported the principle of ‘one share,

one vote’ in its member-approved policies since its founding in the 1980s. CII is a non-profit, non-partisan association of US asset owners, primarily pension funds, state and local entities, charged with investing public assets and endowments and foundations, with combined assets of $4trillion. Our associate members include non-US asset owners with more than $4trillion in assets and a range of asset managers with more than $35trillion in assets under management. CII members share a commitment to healthy public capital markets and strong corporate governance. We believe that companies looking to raise money from public investors should protect the right for these investors to vote in proportion to

their holdings. While we believe a company should go public with equal voting rights, if that is not the case, we support sunset provisions of seven years or less to achieve alignment of voting rights and ownership rights. Both of these paths allow companies to protect long-term shareowners and promote long-term firm value.

The allure and the consequences

Dual-class structures are appealing to founders because they provide an obvious mechanism to maintain control for those who see themselves as the company’s ‘special sauce’ or who want to continue acting like a private company. To the extent that companies commit to adopt a ‘one share, one vote’ structure within a reasonably limited period of time following the IPO, a company may be able to reap some of these benefits, however debatable, without presenting agency costs to longterm investors for decades down the road. Capital markets work best when decision-makers have ‘skin in the game’ that is proportionate to their influence. With dual-class structures, managers decide on the company’s strategy with shareholders disproportionately bearing the financial consequences of those decisions taken by management.

NOT SO EQUAL VOTING RIGHTS? Holding the most powerful shares allows insiders to control the board

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Autumn 2019 | Ethical Boardroom 93

Board Governance | Dual-Class Shares A growing body of research supports the idea that unlimited dual-class structures are bad for long-term company performance, which in turn affects all stakeholders and shareowners, insiders and boards included. In 2008, researchers from Harvard Business School, Stanford Graduate School of Business and Yale School of Management found that the wedge between equity ownership and voting rights created by dual-class structures strongly and significantly impacted firm value.10 They showed that a widening wedge decreased firm value, while aligning equity and voting rights for the superior class increased firm value.11 More recent research supports the idea that the risks associated with dual-class structures can be tempered if they are adopted with a time-based sunset provision that would convert the dual-class structure to one share, one vote within a reasonable amount of time. In 2018, researchers at the European Corporate Governance Institute found that while dual-class firms initially have valuation premiums over similar single-class companies, these turn into discounts somewhere from six to nine years after the IPO.12 That same year, SEC Commissioner Robert Jackson found that in the long-term, multi-class firms with sunset provisions significantly outperformed their counterparts without such provisions by the seven-year mark after going public.13

adopted at more than 90 per cent of S&P 500 companies and recently eclipsed plurality voting as the market norm for Russell 3000 companies, yet less than 10 per cent of 2019 IPOs had a majority vote standard in their governing documents. Another mechanism of entrenching insiders, supermajority requirements to amend the charter or bylaws were present at 87 per cent of 2019 IPOs. By contrast, only 47 per cent of S&P 500 companies and 60 per cent of Russell 3000 companies have these requirements.16

The pivotal role of the board leading into the IPO

When a company is preparing to go public, the board of directors, as the nexus between a company’s management and its shareowners, is uniquely well-positioned to

of companies that went public with a dual-class structure extending more than seven years.17 The list also shows the other public company boards on which these directors sit, giving investors an avenue, albeit indirect, to bring accountability to those individuals. Because companies with dual-class structures essentially silence the voices of their public investors, some investors may use this list to vote against directors of single-class companies who chose to adopt elsewhere dual-class structures without reasonable sunsets. When it comes to the critical question of voting rights, directors should be aware that the decisions they make in their role at one company may follow them to other boards and use this information to better prioritise the principle of equal voting rights.

DIRECTORS UNDER THE SPOTLIGHT The CII identifies directors of companies with dual-class shares

Broader governance concerns at IPO companies

Dual-class shares are just one of the numerous governance areas in which IPOs significantly lag behind public market norms of accountability to owners. According to a CII review of 2019 IPOs to date, IPOs are also far more likely than existing public companies Investors are to have classified boards, beginning help steer the company in the non-independent board to ramp up direction of good governance leadership, plurality vote standards and super-majority their scrutiny and a capital structure that will promote long-term performance requirements to amend of directors by mitigating agency problems. key provisions in their with the Directors should be actively governing documents. involved in crafting good While nearly 80 per cent opportunity governance policies and of 2019 IPOs surveyed had to stand up reasonable sunset provisions classified boards, yearly board on features that undermine elections are a widely accepted against dual to owners. governance feature, with only class when it accountability Rejecting or placing a time limit 14 per cent of S&P 500 and 43 per cent of Russell 3000 matters most on dual-class structures should be a core priority. As a practical companies staggering their matter, for as long as they remain in place, boards.14 Even more concerning is that more than one-third of 2019 IPOs did not report dual-class structures negate the possibility of independent board leadership, either through reforming other weak governance practices. an independent chair or through a lead Investors are beginning to ramp up independent director. By contrast, only seven their scrutiny of directors with the companies in the entire S&P 500 in 2018 did opportunity to stand up against dual not have independent board leadership.15 class when it matters most. In August, Further, a majority vote standard in CII launched the ‘Dual-Class Enablers’ list, uncontested director elections is widely which provides information on directors 94 Ethical Boardroom | Autumn 2019

1 https://www.cii.org/files/June%202019%20Dual%20 Class%20List%20Upgrade%20w%20Lucy%20 edits(2).pdf 2https://cpb-us-w2.wpmucdn.com/sites. udel.edu/dist/f/506/files/2012/10/Dual-Shares-Q3-20121. pdf 3https://cpb-us-w2.wpmucdn.com/sites.udel.edu/ dist/f/506/files/2012/10/Dual-Shares-Q3-20121.pdf and https://corpgov.law.harvard.edu/2018/04/07/unequalvoting-and-the-business-judgment-rule/ 4https:// cpb-us-w2.wpmucdn.com/sites.udel.edu/dist/f/506/ files/2012/10/Dual-Shares-Q3-20121.pdf 5https:// cpb-us-w2.wpmucdn.com/sites.udel.edu/dist/f/506/ files/2012/10/Dual-Shares-Q3-20121.pdf 6https://www.cii. org/dualclass_stock 7https://www.cii.org/files/issues_and_ advocacy/DualClassStock/2019%20Dual%20Class%20 Update%20for%20Website%20FINAL.pdf 8https:// www.spice-indices.com/idpfiles/spice-assets/resources/ public/documents/561162_spdjimulti-classsharesandvot ingrulesannouncement7.31.17.pdf?force_download=true 9 https://research.ftserussell.com/products/downloads/ FTSE_Russell_Voting_Rights_Consultation_Next_Steps. pdf 10https://papers.ssrn.com/sol3/papers.cfm?abstract_ id=562511. 11https://papers.ssrn.com/sol3/papers. cfm?abstract_id=562511. 12https://papers.ssrn.com/ sol3/papers.cfm?abstract_id=3062895 13https://www. sec.gov/news/speech/perpetual-dual-class-stock-caseagainst-corporate-royalty 14https://www.activistinsight. com/governance/ 15https://www.spencerstuart.com/-/ media/2019/july/ssbi_2018_new.pdf 16https://www. activistinsight.com/governance/ 17https://www.cii.org/ dualclassenablers

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Global News The Americas & Caribbean

McDonald’s sacks CEO McDonald’s has fired its chief executive Steve Easterbrook after he had a consensual relationship with an employee. The US fast food giant said Easterbrook, who became chief executive of McDonald’s Corporation in 2015, had violated company policy and shown poor judgement. Its board of directors voted on Easterbrook’s departure after ‘conducting a thorough review’. McDonald’s did not provide other details on the relationship but said Easterbrook would be replaced by its USA president, Chris Kempczinski, immediately. Easterbrook wrote in an email to employees: “This was a mistake. Given the values of the company, I agree with the board that it is time for me to move on.”

Slow diversity progress across the Americas Women are largely under-represented on corporate boards in South America and progress to change this trend continues to be slow, a study has found. Only 7.9 per cent of board seats in Latin and South America are held by women (up from 7.2 per cent in 2016), the Deloitte Global’s sixth Women in the Boardroom: A Global Perspective report has shown. According to Deloitte, the numbers ‘underscore a now-familiar challenge: women are largely under-represented on corporate

boards, and progress to change this trend continues to be slow’. The report also revealed that the percentage of board seats held by women in Canada has grown to 21.4 per cent, a 3.7 percentage point increase since 2017, and in the US, 17.6 per cent of board seats are held by women, up from 14.2 per cent two years ago. “These statistics illustrate an urgent need for organisations to take action to drive more positive and dramatic change,” said Dan Konigsburg, senior managing director at Deloitte’s global centre for corporate governance.

Boeing makes boardroom changes Boeing has separated its chairman and CEO roles to ‘strengthen the company’s governance and safety management processes’. The aviation company’s chief executive officer, Dennis Muilenburg, lost his title as chairman with company directors electing David L. Calhoun, to serve as non-executive chairman. “The board has full confidence in Dennis as CEO and believes this division of labour will enable maximum focus on

96 Ethical Boardroom | Autumn 2019

running the business with the board playing an active oversight role,” Calhoun said in a Boeing statement. The board’s move to split the CEO and chairman roles came the same day as a new report from the Joint Authorities Technical Review faulted both the Federal Aviation Administration and Boeing for failures in the overall certification of its grounded 737 Max jets. Boeing 737 Max was taken out of service following two crashes in vwhich 346 people were killed.

AT&T to sell Puerto Rico business

AT&T has unveiled plans to sell its Puerto Rico and US Virgin Islands business to Liberty Latin America (LLA) for almost $2billion. The deal is part of AT&T’s larger initiative to divest non-core business lines, which activist investor Elliott Management expressed support for in a recent letter to the company’s board. AT&T has been trying to pay down its debt and find more cash after it purchased Time Warner last year for around $85billion. LLA recently announced that its chief operating officer, Betzalel Kenigsztein, will relocate from Denver to its new operations centre in Panama City as part of its drive to ‘to deliver value for customers and shareholders’.

SEC sued by proxy adviser ISS

Proxy advisory firm Institutional Shareholder Services (ISS) has filed a lawsuit against the Securities and Exchange Commission (SEC) over new disclosure rules the regulator issued earlier this year. In late August, the SEC voted to adopt a new guidance urging proxy advisers to take more steps to disclose and explain shareholder recommendations. But ISS says the guidelines are an abuse of the agency’s power. In a filing in the federal district court in Washington, ISS said that the SEC’s guidance is ‘arbitrary and capricious’ and that it ‘inappropriately altered the regulatory regime’ over proxy advice. According to Reuters, SEC is also considering new rules that would require proxy adviser firms to give companies two chances to review proxy materials before they are sent to shareholders.

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Activism & Engagement | Proxy Season

Duncan Herrington & Marla Shipton Duncan is a Managing Director and Marla is an Associate at Raymond James

DEAL OR NO DEAL Shareholder activism and deal opposition campaigns in the 2019 proxy season The trends in shareholder activism each proxy season are driven, at least in part, by changing investor sentiment and, perhaps more importantly, the prevailing public market conditions. Traditionally, merges and acquisitions (M&A) related demands are a common tactic employed by activists seeking a quick takeover premium by forcing a target company to be broken up or sold. However, in a softening but still vibrant M&A market, this year has seen a significant increase in deal opposition campaigns; in other words, where an activist campaigns against an announced M&A transaction, in order to either have the deal terms improved or prevent the deal from closing altogether – often in favour of an alternative transaction. This year has seen several headline-grabbing deal announcements, and with that there have been several notable campaigns by activists pushing to block announced M&A transactions. Deal opposition campaigns can occur on either the sell-side or the buy-side. More common are campaigns on the sell-side, called ‘bumpitrage’, where a shareholder of the seller threatens to oppose approval of the deal unless the buyer improves its price.

98 Ethical Boardroom | Autumn 2019

Shareholders may also criticise the company’s sale process and push the company to expand the process, in the hope that another buyer with a higher bid will emerge. Alternatively, shareholders can also attempt to block campaigns on the buy side. These campaigns can arise for a combination of reasons, including: ■■ Deal terms, i.e. arguing that the buyer is paying too much ■■ Strategic rationale/execution risk, i.e. questioning the merits of the deal or believing the execution risks are excessive ■■ Conflicts/process, for acquisitions where certain shareholders may receive different benefits than others, ensuring the deal was agreed on arms-length terms

The numbers

Looking at data from z, so far in 2019 activists have opposed 44 deals globally, a 42 per cent increase from the 31 deals targeted in 2018. Sell-side campaigns made up 80 per cent of these and buy-side campaigns, typically less common, made up the remaining 20 per cent. Though there was an array of industries targeted, natural resources (e.g. oil and gas, metals and

CLOSING THE DEAL Deal opposition campaigns could put your M&A plans at risk

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Proxy Season| Activism & Engagement mining) was one of the most active sectors. The US comprises the largest percentage of deal opposition campaigns by geography, accounting for 48 per cent and 55 per cent in 2019 and 2018, respectively; however, there were many notable campaigns in Europe this year as well. 2019 saw a surge in deal opposition in Europe, which made up 32 per cent of all campaigns, doubling from 16 per cent in 2018 and largely driven by an increase in campaigns in the UK. This year, UK-headquartered Acacia Mining was targeted by both Odey Asset Management and Legal & General for its announced sale to 64 per cent majority shareholder Barrick Gold. Although previously open to the transaction, Acacia subsequently acquiesced to these shareholders and put pressure on Barrick to raise its takeover bid. Barrick did increase its offer and Acacia shareholders approved the improved deal. However, the geographical breakdown can vary year-to-year. For example, offsetting the increase in deal opposition campaigns in Europe this year was a decrease in campaigns against Asian companies. In 2018, deal opposition campaigns in Asia accounted for nearly 13 per cent of all deal opposition campaigns, yet in 2019 none of the deal opposition campaigns so far have targeted an Asian company. As with many other activist tactics, deal opposition has not been confined to use by only the most experienced activists this year. Increasingly, traditionally ‘non-activist’ shareholders are using activism to influence companies, including in contested M&A. Wellington Management, one of the world’s largest independent investment management firms and typically considered to not be an activist shareholder, publicly sided with activist fund Starboard Value and came out against Bristol-Myers Squibb’s $74billion acquisition of Celgene Corporation, arguing in a press release that the deal was too risky and expensive. Activism, as a whole, is becoming more common among a range of shareholders, but deal opposition campaigns may represent a more accessible form of

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activism to shareholders with less experience of leading public campaigns. Deal opposition campaigns can be easier to run than campaigns for board seats since a shareholder does not need to comply with a company’s bylaws or even file a proxy statement, making them not only simpler but also cheaper. Shareholder opposition to a deal can be as straightforward as publicly releasing a letter against the announced transaction. Though more involved, a shareholder could potentially escalate by running a campaign for board seats to pressure the target company to call off the deal. However, some deal opposition campaigns can also present hurdles not often encountered in a typical proxy fight for board seats. At the announcement of a deal, a target’s shareholder base may significantly change as merger arbs (i.e. investors who buy stocks of companies involved in M&A transactions, speculating on the successful completion of a deal) buy up shares. Any shareholders buying in post-announcement would be more likely to vote for a transaction, absent a compelling competing offer. Because of this, bumpitrage campaigns can be an easier battle than campaigns to call off a deal completely.

Activism, as a whole, is becoming more common among a range of shareholders, but deal opposition campaigns may represent a more accessible form of activism to shareholders with less experience of leading public campaigns Even with these obstacles, activists have been successful in 11, or 25 per cent of deal opposition campaigns so far this year, by either forcing the target to call off the transaction, or by securing improved deal terms or other concessions. On the buyer side, Paulson & Co and VanEck, two of Newmont Mining Corporation’s largest shareholders, opposed the company’s proposed $10billion acquisition of Goldcorp, arguing the purchase price was too high and the compensation packages for Goldcorp’s chairman and CEO were ‘outrageous’. In order to gain shareholder support, Newmont announced a $0.88 special dividend, its largest in three decades, and both Paulson and VanEck moved to support the deal.

Autumn 2019 | Ethical Boardroom 99

Activism & Engagement | Proxy Season On the seller side, Mangrove Partners shares. Both ISS and Canyon Capital publicly opposed Denbury Resources’ supported the revised offer. $1.7billion acquisition of Penn Virginia. Most activism happens in the middle Mangrove, a Penn Virginia shareholder, felt market, with the vast majority of campaigns the proposed acquisition price was too low targeting companies with a market and solicited shareholders to vote against capitalisation of less than $1billion. Yet the deal. Penn Virginia and Denbury targets of deal opposition campaigns this Resources terminated their merger, and less year were generally larger: more than half of than a month later Penn Virginia announced all companies targeted in such campaigns the appointment of a Mangrove Partners had a market capitalisation of greater than representative to its board of directors. $1billion, and almost 20 per cent had a A key factor in almost any market capitalisation greater contested shareholder vote than $10billion, showing that As with is the vote recommendations size is clearly not a deterrent. any activist released by Institutional Leading the charge against campaign, Shareholder Services (ISS) these mega-deals were a handful and the other proxy advisors, of experienced, well-known fighting a including Glass Lewis. ISS has activists who attracted public battle issued recommendations on wide-scale media attention. 18 contested deals so far this A day after United requires year, 16 of which were in favour Technologies Inc.’s ($112billion significant of the deal, and the remaining market capitalisation) two of which were against. attention from announcement in June of its The influence ISS holds over proposed merger with Raytheon a company’s the success of a contested Company to form one of the management world’s largest aerospace and deal was seen in Bristol-Myers’ acquisition of Celgene. defence companies, Bill team and is ISS recommended that Ackman publicly opposed the a distraction Bristol-Myers shareholders deal, arguing it had no strategic vote for the transaction, rationale. Third Point, which from the concluding that the deal had had previously targeted United business at ‘sound strategic rationale’ and Technologies and pushed that the acquisition was better for a three-way breakup of any time than any other stand-alone the company, also criticised the path. Starboard Value withdrew its deal for similar reasons. Both Pershing solicitation against the deal on the same Square and Third Point seem to have day the recommendation was released, withdrawn their campaigns, however, as and shareholders later voted to approve both have since exited their positions in the acquisition. United Technologies. Shareholders are In January, ISS recommended that Rowan scheduled to vote on whether to approve Companies shareholders vote against its the transaction later this year. proposed all-stock, at-market merger of Several activists publicly opposed equals with Ensco. In its recommendation, Centene’s ($20billion market capitalisation) ISS sided with activist Canyon Capital $17billion acquisition of WellCare Health Advisors, noting that while the logic of Plans. Corvex Management, Sachem Head the deal was sound, Rowan Companies Capital Management, and Third Point, all shareholders were not being properly Centene shareholders, urged the company to compensated for taking on more consider a sale instead of undertaking such incremental risk than Ensco a large acquisition. Despite the activists’ shareholders. Following the hopes for Humana to submit a bid for recommendation, Ensco increased the exchange offer on the deal from 2.215 to 2.75 Ensco shares for each Rowan Companies

Centene, such an offer never surfaced, and, without an alternative, Centene shareholders ultimately voted to approve the merger. Another attention-drawing campaign was Carl Icahn’s opposition to Occidental Petroleum’s takeover of Anadarko Petroleum. T. Rowe Price had initially opposed the acquisition when it was first announced and Icahn later acquired a stake in Occidental, stating that the deal was ‘hugely overpriced’ and that shareholders should be given the chance to vote on the transaction. Occidental completed the Anadarko acquisition, despite opposition from shareholders, and Icahn has since initiated a campaign to replace several members of the Occidental board (pending).

Conclusion

The increased scrutiny surrounding M&A and the willingness of shareholders to publicly express opposition to transactions create additional execution risks for public company deals. Activists of all types are playing a more prominent role in M&A and seeing some success, as companies improve deal terms and call off transactions in the face of opposition. As with any activist campaign, fighting a public battle requires significant attention from a company’s management team and is a distraction from the business at any time, not to mention when working to close a deal. To mitigate a negative market reaction to a newly announced transaction, companies should take a few important steps to prepare. First, companies should analyse a deal from the market’s perspective to assess any potential for an activist to oppose the transaction (whether on strategic, financial or other grounds) in order to plan and communicate to shareholders pre-emptively. Second, in the event of a deal opposition campaign, it is important that companies are well advised on the process and how to win the support of shareholders, as well as the proxy advisors, whose recommendation can be vital to winning a contested vote. Ultimately, effective shareholder communication and engagement must be a key part of the process, and preparedness in advance of announcing a transaction can help to avoid additional risks to closing the deal.

CALLING THE DEAL OFF Companies need to be prepared for shareholder opposition 100 Ethical Boardroom | Autumn 2019

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POWERHOUSE PRACTITIONERS

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– THE LEGAL 500 US “… Schulte Roth & Zabel partners … have established themselves as go-to lawyers for activist investors.”

– THE AMERICAN LAWYER “With offices in New York, Washington D.C. and London, Schulte Roth & Zabel is a leading law firm serving the alternative investment management industry, and the firm is renowned for its shareholder activism practice.”

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Schulte Roth & Zabel LLP New York | Washington DC | London www.srz.com The contents of these materials may constitute attorney advertising under the regulations of various jurisdictions.

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Activism & Engagement | Future Trends

What you need to know heading into the 2020 proxy season How will 2019 trends shape the next proxy season?

With another proxy season in the books in the US, it’s helpful to look at the trends that dominated 2019 and are likely to continue into next year. As you gear up to meet with your investors, knowing what’s on their minds can help you better engage, set your strategy and prepare for any activism or challenges that may come your way.

My team at D.F. King examined the data and identified several prevailing themes – here’s what we found:

Shareholder proposals: Social issues were out in front Social issues took the lead. Approximately 60 per cent of shareholder proposals in 2019 were related to environmental and social requests. The number of social proposals submitted in 2019 increased by approximately 45 per cent over the previous year, buoyed by submissions

Zally Ahmadi

Director, Corporate Governance and Executive Compensation, D.F. King, an AST Company including campaigns for lobbying and political contribution disclosures and human rights – likely due to the current political climate – as well as board diversity. Submissions regarding political contributions and lobbying requests have increased by 14 per cent, and more than half of proposals that went to a vote received more than 30 per cent support. We also saw a significant increase in human capital management-related (HCM) proposals in 2019; for example, 82 per cent of all employment diversity-related shareholder proposals went to a vote this year, compared to just 30 per cent in 2018. Gender pay gap proposals that went to a vote increased by almost 250 per cent as well, and proposals related to sexual harassment were newly introduced this year, with almost all of them making it onto ballots. Notably, when it comes to E&S disclosure, the largest increases of disclosure provided by companies typically

fall under HCM, covering topics including employee diversity and training, pay/benefits and employee feedback. The topic of greater board diversity also continues to gain momentum, with large asset managers increasingly articulating their support for it. More than 80 per cent of the increase in the number of female directorships in the past decade occurred during the past five years, with annual growth of female directorships exceeding seven per cent in each of the past three years. This is likely to increase in light of the emerging regulation of board diversity, which certain states are in the process of implementing, as well as the updated voting guidelines that many institutional investors have published to emphasise their focus on board diversity (See Figures 1 and 2, below). Only a quarter of environmental proposals actually made it onto ballots, likely driven by increased transparency and collaboration with shareholders

FIGURE 1: TOP SOCIAL PROPOSALS 56

Number of proposals

● Average support level

FIGURE 2: POLITICAL CONTRIBUTIONS/ LOBBYING PROPOSALS 58

43 36

33 26

35.6% 30.2% Political contributions

Lobbying

13.3% Board diversity

102 Ethical Boardroom | Autumn 2019

31.1% Human rights

21.7% Gender pay gap

14 22.9%

Link Exec pay to social

26.7% 38.6%

28.7%

34.2%

EEO 2017 2018 2019 Number of proposals ● Average support level

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Future Trends | Activism & Engagement Issuers are increasingly willing to engage with investors, which has likely led to more of these proposals being absent from ballots – in addition to the fact that nearly 50 per cent of challenged environmental proposals were provided no-action relief by the Securities and Exchange Commission (SEC) this year, the highest percentage in more than three years. Proposals with the highest support levels typically requested greenhouse gas goals or climate change reporting. There were fewer submissions and reduced levels of support, also likely due to increased disclosure across all industries as well as efforts to discuss environmental initiatives with investors. One hundred proposals were submitted (down 28 per cent from 2018), and average support for all environmental proposals decreased to approximately 26 per cent in 2019 from 31 per cent in 2018. The largest sub-category, representing 40 per cent of these proposals, continues to be climate change. Notably, no proposals passed this season, while four climate change proposals passed in 2018 (See Figure 3, below). Governance and, specifically, board composition continue to capture attention Governance-related shareholder proposals remained the most common type to be voted upon, though they were surpassed in submissions by proposals with social requests. Investors are keeping a close eye on boards, continuing to scrutinise them for issues such as a lack of diversity and overboarding – many of the largest asset managers have recently updated policies regarding these two topics, and this year we saw those policies impacting vote results for directors. In addition, board-related shareholder proposals on topics such as independent board chair, board declassification, majority voting for director elections, and seeking to adopt or amend proxy access constituted nearly half of all governance-related shareholder proposals. There were significant increases in requests to adopt majority voting for the election of directors as well as requests to reduce supermajority voting; the submission levels for these proposals increased by 222 per cent and 50 per cent, respectively. Although average support for majority voting for directors dropped to approximately 42 per cent, average support for proposals requesting to reduce supermajority requirements remained high at approximately 65 per cent. Although requests for independent chair took the lead in submissions, none passed. Shareholders are typically satisfied when a sufficiently empowered lead independent director is appointed as an alternative to mandatorily separating the CEO and chair roles. When it comes to governance-related shareholder proposals, overall pass rate www.ethicalboardroom.com

continues to decline. This is due in large part to a reduction in the relative number of proposals relating to proxy access, majority voting and board declassification, a result of these measures becoming market practice among larger companies. In 2019, 13.8 per cent passed, compared to 17 per cent in 2018 (See Figure 5: Spotlight on Board Diversity Initiatives by US State, on page 104).

Shareholder proposals regarding executive compensation increased over previous years, with proposals requesting to tie environmental and social proposals to executive compensation taking the lead. These kinds of proposals didn’t pass but did receive increased support, with proposals requesting to tie drug pricing to executive compensation at healthcare companies receiving the highest levels of support (approximately 27 per cent). The average vote result for companies that received an ISS ‘against’ recommendation is 30 per cent lower than those that received a ‘for’ (See Figure 4, below).

While the overall number of shareholder proposal submissions declined in 2019, the proportion of environmental- and socialrelated proposals grew

Fewer shareholder proposals, fewer votes In 2019, 703 shareholder proposals were submitted, down five per cent from the previous year. Not only were fewer proposals put forward, but even fewer went to a vote. Only 52 per cent of proposals submitted went to a vote, compared to 70 per cent in 2017, due in part, again, to the withdrawal of environmental and social proposals following engagement with proponents. Half (52 per cent) of shareholder proposals in 2019 received more than 30 per cent of shareholder support, on par with what we saw in 2018. Moreover, shareholder proposal proponents continued to focus on large-cap companies, with almost 75 per cent of proposals being voted on at S&P 500 companies.

Support remained high for say-on-pay and equity plan proposals Say-on-pay results remained in line with 2018 levels, with average support remaining high at approximately 90 per cent. Equity plan approvals remained uneventful, with only two failures recorded for 2019. The number of equity plans placed on ballots decreased from previous years, likely due to the elimination of the 162(m) provision that required shareholder approval of performance goals in incentive plans every five years.

FIGURE 3: TOP ENVIRONMENTAL PROPOSALS 45

70%

■ Number of proposals submitted ● Average support level

60%

35 50%

40%

25 31.1%

28.2%

28.5%

22.6%

30% 20%

10 10%

5 0

0% Climate change /GHC

Sustainability report

Community/ environmental

Renewable energy

Recycling

FIGURE 4: AVERAGE SUPPORT (SAY-ON-PAY & EQUITY PLANS) 93%

Say-on-pay average support level ■ 92% 91%

Equity plans average support level ■

91.4% 90.9%

90.85%

90% 89%

89%

88% 87%

2017

89.11% 88.8%

2018

2019 Autumn 2019 | Ethical Boardroom 103

Activism & Engagement | Future Trends Requests to reduce supermajority thresholds typically have the highest levels of shareholder support. Although historically the top 10 has been dominated by governance proposals, over the past few years, the landscape has evolved to focus primarily on environmental and social initiatives. Updates on SEC no-action relief In 2019, companies challenged nearly 30 per cent of shareholder proposals through the SEC no-action process. The two most commonly challenged kinds of proposals were environment-related requests (15 per cent) and requests to eliminate supermajority voting (10 per cent). The most successful categories for exclusion were proposals to reduce special meeting thresholds as well as animal rights proposals, which both currently have a 100

NEARLY 50%

of challenged environmental proposals were provided no-action relief by the SEC, the highest percentage in over three years

per cent success rate. These were followed by human rights proposals and proposals to eliminate supermajority voting, which both had success rates near the 80 per cent mark. ■■ Conflicting management proposals: Although the SEC has historically granted no-action relief under Rule 14a-8(i)(9) on the basis of a conflicting management proposal (for example, the exclusion of a proposal to reduce the ownership threshold for special meetings due to its conflict with a management proposal to ratify the existing threshold), there is a new approach by ISS and Glass Lewis when it comes to seeking these types of exclusions. (And we at D.F. King recommend considering this approach.) In their 2019 voting guidelines updates, both ISS and Glass Lewis have stated that they may recommend against board members at companies that have excluded shareholder proposals as a result of conflicting management proposals. ■■ Ordinary business exemptions: In late 2018, the Division of Corporation Finance

issued Staff Legal Bulletin No. 14J (SLB 14J), which provided guidance on the exclusion of shareholder proposals on the basis that they seek to ‘micromanage’ the company. SLB 14J detailed that, under the ordinary business exception, a company may exclude a proposal for micromanaging if it ‘involves intricate detail or seeks to impose specific timeframes or methods for implementing complex policies’. As a result, nearly two-thirds of climate/greenhouse gas proposals have been challenged and the SEC has provided no-action relief to more than 45 per cent of these proposals, which is the highest percentage we’ve seen over the last three years. As you speak with shareholders this fall, expect to see a lot of attention on human capital management and board and management composition, as well as a continued focus on executive compensation. Keep in mind, for governance teams at today’s largest investors, value and values increasingly go hand in hand.

FIGURE 5: SPOTLIGHT ON BOARD DIVERSITY INITIATIVES BY US STATE California made headlines in 2018 following the passage of its board diversity mandate. As a result, a number of other states have introduced legislation regarding board diversity targeting and reporting. Here’s a look at some notable updates.

CALIFORNIA

SB 826 requires companies headquartered in California to have at least one woman on boards that have four members or fewer, two women on boards of five people, and three women on boards of six or more. California companies, 89 per cent of which fall under the law’s parameters, have until 2021 to implement these changes.

on boards. Effective as of October 2019, domestic stock and nonstock corporations with sales and operating budgets exceeding $5million must include the number of women serving on the board and the total number of members on their annual reports to the State Department of Assessments and Taxation. The comptroller will ultimately make female board representation data publicly available on its website.

NEW JERSEY

NJ S2469, not yet passed, seeks to implement requirements for proportional female board membership. This would require all companies to have at least one female director by the end of 2019.

ILLINOIS

HB 3394, not yet passed, would require an annual reporting component to collect information about board member diversity, which would be published online by the Secretary of State.

MICHIGAN

By the end of 2021, additional female directors would be required, depending on the size of the board.

NEW YORK

S. 4728, not yet passed, proposes amending the state’s Business Corporation Law in order to conduct a Women On Corporate Boards Study, to be published by February 2022.

PENNSYLVANIA

PA HR0114, not yet passed, would allow companies until 2021 to have a minimum of three women on boards with nine or more seats, a minimum of two women on boards with five to eight seats, and a minimum of one woman on boards with five or fewer seats.

Michigan

New York Pennsylvania

California Illinois

SB 115, not yet passed, mirrors California’s SB 826. It would allow companies until 2023, however, to meet requirements.

New Jersey

Maryland

MARYLAND

HB 1116 and cross-filed SB 0911, both approved in May 2019, institute new annual reporting requirements regarding the number of women serving

104 Ethical Boardroom | Autumn 2019

Up to date at time of writing

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Engagement | Germany

Strategic battles in German boardrooms How informal negotiations have shaped the ‘new normal’ in activist engagement in Germany Dr Ami de Chapeaurouge de Chapeaurouge + Partners

Aside from cases of bumpitrage – extracting a higher price for a minority holdout position in the aftermath of a public takeover by exploiting certain loopholes in German legislation – and activist short-selling, ‘traditional’ shareholder activism has been strong.

In Germany, equity shareholder activism stands for non-control minority investments in undervalued or poorly managed public companies by one or several investors, investment partnerships or activist funds, based on strategic objectives and tactical measures that are carefully formulated in advance, such as value restoration to the benefit of all shareholders, enhanced corporate governance monitoring and increased operative efficiency as outcomes. An additional emphasis is on the process of persuasion of target leadership and fellow shareholders about the superiority of an activist strategic plan for the company, compared to the roadmap of the incumbents, to demonstrate alignment, culminating in the threat of a proxy fight and lending such an activist campaign some bite in the event of a breakdown of negotiations with target 106 Ethical Boardroom | Autumn 2019

management. The credibility of the threat of a possible proxy contest has been given a boost by the success of the Active Ownership Capital (AOC) v. STADA Arzneimittel AG (STADA) campaign in August 2016. The success of this intervention notwithstanding, a negotiated style of creating value by bridging differences in target strategy analysis between activist and incumbent management is thus far more prominent tactical route in the German marketplace.

Two styles of shareholder activism: negotiated (Germany) v. escalation (US/UK) There are two styles of shareholder activism prevalent in the world today, on one hand, the US escalation model of a crescendo of ever more aggressive tactical steps as part of an activist intervention strategy, culminating in a proxy fight and litigation against the incumbent board, also known as disruptive activism. While many such confrontations end up in settlements or other forms of compromise, the threat of winning a long-slate proxy fight whereby the entire board is replaced by an insurgent slate remains a powerful and intimidating activist tool. In the US, activism revolves around seeking board representation or a change in corporate control via proxy fight (without an accompanying takeover bid) and promoting what activist investors consider a more shareholder-friendly composition of the board of directors; hence a proxy contest occurs when shareholders believe managerial slack and flawed strategic vision by the current leadership have served as the catalysts for lack of performance and undervaluation (Crawford and Zaramian 2018, de Wied 2018). From 2013 through the 2018 proxy season, there were 700 US-based

contentious activist situations. Out of 700 activist situations, approximately 520 were settled or withdrawn, leaving more than 150 proxy contests. In Germany, by contrast, a heavily negotiated, behind-the-scenes style has proved effective, also known as collaborative activism. The singular AOC v. STADA test case evidences for Germany that after almost 20 years of trying, an individual supervisory board member can be removed via a proxy contest in Germany after all – the first success out of eight attempts to date in a total of 450 activist campaigns, where 200 public companies were targeted by approximately 100 mostly foreign activist funds. However, over the years, about 20, or more similar, albeit negotiated, successes and outcomes of replacing supervisory board members or even management board members are a reminder that a discreet, informal persuasion and negotiation strategy with the incumbent management board and supervisory board proves a more effective activist approach. Once a critical letter to the management board or white paper is published (examples are Elliott Advisors UK Limited 26 July 2019 letter to Scout24 AG, Petrus Advisers 12 September 2017 and 27 February 2018 letters to Commerzbank AG, its February 2018 White Paper, and its AGM questions to comdirect Bank AG, published in May 2018), a negotiated outcome becomes virtually impossible as target leadership will circle the wagons (see Chart 2, p109).

Significant adjustments of activist tactics and strategy

In Germany, activist hedge funds as protagonists of the engaged shareholder movement proved adaptive to the sceptical legal culture and became effective minority www.ethicalboardroom.com

Germany | Activism & Engagement investors. Most campaigns have not come to light in the press since target company management and supervisory boards preferred to compromise and activists themselves have shunned the public limelight, press or social media so as not to risk undermining their efforts of translating informal influence in favourable negotiated outcomes, which is in contrast to more robust activist practices in the US and in the UK. They pursue the following twin objectives: first, they play a role as fiduciaries of the rate of return interests of their own investor base, such as pension funds, banks, and insurance companies; second, in their self-understanding that all boats should rise in a tide, they also represent the interests of passive retail investors who, without the support of their zeal, presumably would fall through the cracks. Their operating philosophy has become increasingly conversational and focusses on seeking early influence on the market valuation reflected in the stock price of the respective companies they are invested in. Their methods have become quite subtle, with nuanced demands (see Chart 1, below). In reality, it is mostly the supervisory board that interfaces with shareholders, even though shareholder dialogue is deemed the sole prerogative of the management board, pursuant to section 76 of the German Stock Corporation Code (AktG). This increasingly informal aspect of the dialogue between shareholders and corporations has been addressed recently (in 2017) by both the ‘Guidelines for the Dialogue between Investor and supervisory board’ by

the German Corporate Governance Code (GCGC) and on part of the Shareholder Rights Directive to be transposed into German law via ARUG (II). GCGC section 5.2 reads: “The chairman of the supervisory board should be prepared – within reasonable boundaries – to discuss topics related to the tasks of the supervisory board.”

Elucidation of Chart 1

Point of departure of a five to 10 per cent minority investment and activist campaign is frequently that an institutional investor is dissatisfied with the governance record or value of a portfolio company and contacts an activist hedge fund to do something about these deficiencies; or an activist fund by itself reaches similar conclusions and may be joined informally by other funds (wolf pack). Our findings suggest that in 80 to 90 per cent of their campaigns, activists pursue a compromise within informal channels of communication outside an AGM. Targets are receptive to protect their reputation. Only when activists fail to be heard will they turn to publicity, coalition building for AGM voting purposes, and a proxy fight, or litigating against a company. Seeking information concerning the target by meeting informally, frequently and with greater intensity with management board and certain supervisory board members, which have to abide by equal treatment-of-all-shareholders (section 53a German Stock Corporation Act (AktG)) and insider trading rules (Articles 7, 14 MAR); persuasion of target to embrace activist investment thesis and follow demands,

such as an activist nominee supervisory board seat; conclusion of an investment agreement concerning entire catalogue of activist demands; a more aggressive posture of convincing target leadership to go along with activist demands by merely threatening (rather than going public and actually going through with such plan) to build majority coalition to replace supervisory board members (section 103, paragraph 1, 2nd sentence AktG) or to decline exoneration and hold vote of non-confidence for a management board member (factually subverting her/his ability to serve); an activist seeks publicity in only 20 per cent of the cases; even rarer is the escalation of an AGM vote via proxy fight (one successful precedent out of eight attempts) or suing the target company in court. Activists attempt from the very start to communicate meaningfully with the corporate leadership, regardless of being management or supervisory board members, in order to exert informal influence. The reason is their preference for a unitary board line of communication, supported by the growing debate as to the legitimacy for the chairman of the supervisory board and audit committee chair, in consultation with the management board, to engage in investor dialogue. It is through personal relationships that they attempt to influence the management board and supervisory board composition and value creation strategy. This informal approach is the standard or ‘new normal’ in activist attempts to gain influence over German public portfolio companies (Turu (2015).

CHART 1: Parties, communication lines or actions in modern German equity activist campaigns — informal persuasion and influence-seeking minority stakes investment in preponderance (80 per cent) of up to 450 events/cases US/UK institutional investor (such as X, Y, X) Seeks discussion with and help from activist to monitor and launch a value-enhancing intervention improving target performance, governance and value Activist hedge fund A Informal arrangement with other activists (wolf pack) below the threshold of Insider Trading Art. 14 MAR (§14 old WpHG) or Acting in Concert (§§ 34 WpHG, 30 WpÜG) Activist hedge funds B and C

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(Unhappy) Investor invested in underperforming German public portfolio company Seeks engagement with both management and supervisory board

Additional information

Annual review of GCGC

Strictly internal white paper Special dividend or stock buyback Other capital allocation

Supervisory board A performs in-depth due dligence and acquires German public portfolio 5 – 10% company (AG) over time to engage company leadership B+C may likewise invest in portfolio company in support of activist A

Sale of assets- strategy change Value enhancing measures the result of informal negotiations between activist and company outside AGM

Management board Breakdown of negotiations – publicity and formal legal activist action by A, B + C (during AGM and thereafter) to Preserve value of their investment campaign

Business model changes Monetise other assets Supervisory board seat Management board seat Governance matters, executive comp Induce company to sell itself Frustrate or push for an M&A deal Bumpitrage Publicity, litigation coalition building, proxy fight

Autumn 2019 | Ethical Boardroom 107

Activism & Engagement | Germany Informal or factual influence is every act by a shareholder not tied directly to the weight of their formal shareholding position that bears some influence on certain formal corporate decisions and corporate strategy of a public portfolio company. With their usual average shareholding range between five and 10 per cent, by resorting to informal tactics predicated on personal relationships with members of both boards, activists enjoy the advantage of influencing corporate decision-making directly, with a built-in timing and flexibility advantage, independent of an AGM setting, and their actual weight expressed in the percentage of their stock position in the company, and defy easy classification. Any communication between company and activist is subject to the mandatory equal treatment of all shareholders, pursuant to section 53a AktG. This only means that if other shareholders do so demand during an AGM, management is compelled to disclose to them any information shared with activists beforehand so long as the piece of information conveyed to such activist investors was tied to their being shareholders of the company, pursuant to section 131, paragraph 4 first sentence AktG. From this may be inferred that informal one-on-one discussions are admissible with the result that all other shareholders have no general right to find out the contents of such meetings outside an AGM. Management and supervisory boards are prohibited from sharing inside information with activists pursuant to Articles. 7, 8, 10, 14 MAR unless there are overriding justifications. It is permissible to explain the business model and deepen an activist’s understanding of company strategy– below the threshold of giving away company secrets.

Informal nomination or replacement of supervisory/ management board members

In the event that an activist harbours the plan to assume a supervisory board position (such as Cevian did with respect to Demag Cranes and Bilfinger Berger), it will commence informal negotiations with the company. The members of the supervisory board are nominated, elected and placed in position (‘bestellt’) by the AGM (according to sections 101, paragraph 1; 119, paragraph 1 No. 1 AktG), if there are not certain rights of shareholders to have a supervisory board member representing their interests appointed or supervisory board members are being selected pursuant to the rules of labour codetermination. As a practical matter, both informal suggestions as well as formal AGM nominations of new supervisory board candidates are usually agreed upon behind 108 Ethical Boardroom | Autumn 2019

the scenes with the management board, the chairman of the supervisory board or at least an important supervisory board member beforehand behind closed doors, especially in the event of a formal nomination (Bader and Georgieff (2015). The right to make nominations about supervisory board membership is vested in the supervisory board itself, pursuant to section 124, paragraph three, first sentence AktG. It is decidedly not the management board that may make such proposals to the shareholders before an AGM vote; in this way, the management board has no influence on the nomination or election of those persons that are called upon to supervise the management board in its discharge of management duties pursuant to section 111, paragraph 1 AktG. The supervisory board may not enter into a contractual arrangement with a third party, such as an activist investor, before it has met its own set of due diligence obligations towards nominating an appropriate candidate for the membership spot.

It remains noteworthy that in Germany most activist interventions never become public since target company leadership and activists both prefer to settle and conclude non-disclosure agreements If these negotiations and conversations do not lead to the desired result preferred by the activist, it will – in Germany – rarely seek a public forum to express its displeasure. They lend a certain punch to their requests by setting forth a scenario of supporting alternative candidates for both boards. If a fund has accumulated sufficient voting power with the help of other, like-minded investors, the mere threat of such a scenario may sway reluctant supervisory boards and prompt a change of mind and help realise the desired outcomes. Since activists only have indirect, structural voting power to remove or replace supervisory board members, once they can convey the impression of marshalling sufficient votes they may make the supervisory board think. The AOC proxy fight success plays a significant role as to the necessary credibility of such a threat. As far as removing and replacing unwelcome management board members, activists in Germany dispose of even less, purely informal, influence. We know of about 20-plus such similar events in Germany, at times involving the management board, however mostly attaching to successful informal, negotiated

nominations or replacements of supervisory board members (Thamm 2013). So, under German law, activist shareholders may not instruct the management board with regard to how they run the company and its business; yet they are still indirectly in a position to exert influence and secure the appointment of a management board member with more accommodating views and disposition towards their own plans, by first selecting supervisory board members whom they know to vote with them in crucial matters and who, no doubt, will appoint new management board members according to the preferences of the activist. Such removal of a management board member by the supervisory board before the end of their term (section 84, paragraph 3 AktG) depends on a dismissal for good cause. When it comes to vital disagreements as to strategy and policy, a supervisory board that is heavily influenced by an activist hedge fund is placed in the position to recall a management board member for cause. Activists increase the pressure by withholding confidence or refusal to discharge such management board members during an AGM vote; which would damage their standing at first with the supervisory board. Thereby activists attempt to increase the pressure on those management board members to withdraw or risk being removed by the supervisory board. The activists signal to such board members that a majority of the shareholders disagree with his/her philosophy and wish to see them resign or removed from their positions should they refuse to support the activist strategy for the company. In the past, the position of the management board was at risk of falling for a bluff as they often did not fully know who their shareholders were and needed to rely on surmise and voluntary disclosure to gauge the actual voting power of an activist fund, given the lack of transparency before the adoption of the Shareholder Rights Directive. This dimension of indirect replacement power as to management board members, i.e. effectively having them recalled before the end of their regular term due to deep-seated differences of opinion about the appropriate future strategic course of a company, rests on the alleged intolerable atmosphere (Unzumutbarkeit) of their continued position and is a corollary of the growing influence of activism on German public corporations, as evidenced empirically in the doctoral dissertation by Thamm (2013) and Thamm/ Schiereck (2014) – and borne out also by experience. It has further been studied capably by Stefan Brass in a 2010 PhD thesis supervised by Professor Theodor Baums, and analysed by Schockenhoff (2015, 2017). In summary, the preconditions of the revocation of the appointment as a member of the management board are much more www.ethicalboardroom.com

Germany | Activism & Engagement CHART 2: Shift from informal negotiations to adversarial posture to protect activist investment — publicity, formal legal remedies in only 20 per cent of reported German interventions — rare proxy fights Published, external white paper critique

Activist hedge fund A

Seeking publicity to sway public opinion Lobby analysts, ISS and Glass Lewis

German public company

Breakdown of informal persuasion and negotiations — publicity and formal legal activist action by A, B + C (before, during and after AGM) to preserve value of their investment campaign

Outreach to employees, suppliers and customers Tough questions earning calls, conferences Public letter attacking board Forging coalitions / majority building Nominating own slate of directors Aggressive assertion AGM minority rights Proxy contest AGM or special meeting Litigation against management and supervisory board Appoint special auditor to examine both boards

Activist hedge funds B and C

complex than a simple activist demand for recalling her/him before they served their full term and activist pressure on the supervisory board. While it is true that the final determination about such premature dismissal rests with the supervisory board and the threshold of such independent judgment is quite high, the impact of a no-confidence vote and withholding of discharge during an AGM can be quite devastating to the standing of a management board member with the supervisory board so as to sway the decision in direction of the preferences of the activist hedge fund.

Elucidation of Chart 2

It remains noteworthy that in Germany most activist interventions never become public since target company leadership and activists both prefer to settle and conclude non-disclosure agreements; and that only about 20 per cent of the activist campaigns become public knowledge because a controversy flares up, spilling into the public domain. Escalation and publicity are usually synonymous with loss of activist influence that structurally relies on persuasion and subtle forms of pressure in view of high shareholder population concentration, where only sound reasons will sway controlling shareholders or dominating blockholders to go along with activist value ideas. Once activists get the impression that www.ethicalboardroom.com

Appoint special representative to bring claims

target management and supervisory boards block communication or do not adequately consider their value propositions, a checklist of assertive-aggressive methods can be activated and launched. These moves are self-explanatory. It is counterintuitive that the German legal literature is almost exclusively focussed on those activist fights where publicity is sought and a confrontation such as a proxy fight or litigation are in the offing (Chart 2), whereas in 80 per cent of all cases, in reality, informal persuasion is the predominant approach to seek changes to corporate strategy, value creation, governance, and compensation as focal points of activist dissent (Chart 1). The first successful proxy fight (STADA August 2016) resulted in replacing the chairman of the supervisory board; six prior attempts (Babcock Borsig (2002), Volkswagen (2006), CeWe Color (2007), Ehlebracht (2010), Infineon (2010), Balda (2012), and one subsequent attempt (Grammer 2017) had failed. In spite of only 450 public companies in Germany being listed on the Regulated Market segment of the Frankfurt Stock Exchange (and another 250 corporations being listed on the German OTC segments such as Scale of the Frankfurt Stock Exchange and other regional German exchanges); and although about 60 per cent of all listed German companies are controlled

by corporate groups or families or dominated by large blockholders, Germany has, over the past 20 years, emerged as a relatively active market for shareholder activism. A principal reason for a certain ignorance in New York or London (but even in the local German press and in professional circles) about the relatively widespread occurrence of activist campaigns in Germany is twofold. The rather solid empirical research and published evidence of about 20 teams of economists in the 2008 – 2017 timeframe has been largely ignored; second, public disputes between activists and companies rarely escalate into a proxy fight, a preoccupation of English and US-American activists – we know of just eight cases since 2002, with only one insurgent success (AOC v. STADA); there are also technical legal origins (no right to obtain the actual shareholder list to reach out to them, a muddled approach to voting representatives and proxy cards), as well as cultural reasons and a still existing old-boys-network which render proxy contests an exception.

Flipping perspectives: activist interference with management board authority

Any compromises or settlements between management and activists will raise suspicions from institutional investors for failing to articulate some of their key concerns in public, say, lack of responsiveness to ESG challenges, managerial slackness and value destruction. Management boards may enter into legally binding investment agreements with activists, in particular, if and when the activist shareholders convince them of the superiority of their ideas as compared to the incumbents’ own plans. In such scenario, they would not surrender their independent business judgement, autonomy and authority. As an alternative, they may prefer a détente that likely will take the form of an unwritten, informal understanding if they feel that an all-out confrontation would be lethal to the corporation. The relevant question is whether the ‘prohibition of pre-commitment’ or equivalent restrictions from fiduciary duties extend to promises made to placate shareholders who threaten to wage a proxy fight (Engert (2019). Overall, the management board may be ill-advised to give in to poor activist ideas not in the interest of the corporation and its stakeholders: They will perceive it in their reputational interest to observe their fiduciary obligations and oppose, say, paying out a special dividend at the expense of and on the back of mass dismissals, slashing long-term R&D investments, or shelving a well-planned acquisition to grow the business rather than caving in to pressure; even if they run the risk of being defeated by the insurgents and eventually replaced. Sources will be run in full online.

Autumn 2019 | Ethical Boardroom 109

Activism & Engagement | Advertorial

Maximise shareholder support for your AGM and don’t be a victim of the wolf pack

KNOWLEDGE With institutional investors ever more engaged with their investee companies and activist investors increasingly on the hunt for shareholder value to unlock, AGMs are no longer a routine event. Without the necessary preparation, AGM resolutions may lay themselves open to overt criticism from your shareholders or, even worse, fail to obtain the minimum level of support altogether. As if the rise of shareholder activism in recent years was not enough to warrant particular attention when tabling proposals at each year’s AGM, in our 2019 European Proxy Season Review we found that, across the seven major markets, the overall proportion of resolutions that received more than 10 per cent opposition has increased by 6.67 per cent.1 At the same time, proxy advisors continue to hold great influence on voting outcomes with a vast majority of resolutions opposed by proxy advisors receiving high levels of opposition from investors. This highlights how important it is for companies not only to address investor concerns but to proactively engage with proxy advisors as well. In particular, executive remuneration continues to remain a key focal point for investors and proxy advisors alike, with remuneration-related resolutions being among the most contested resolutions in the majority of the markets surveyed by Georgeson. This focus on remuneration will have further resonance in 2020, when the revised

110 Ethical Boardroom | Autumn 2019

Domenic Brancati

CEO UK/Europe at Georgeson European Shareholder Rights Directive will introduce annual remuneration votes across the EU. Our analysis shows that the major markets that are most unprepared for this change are Germany and the Netherlands (where only a minority of companies held votes on executive remuneration in 2019). Director elections also continue to attract investor scrutiny and negative votes. The considerable growth in negative votes on discharge resolutions in certain markets shows an increased investor willingness to oppose board members directly when they consider that there have been corporate governance failings. Moreover, as investor and proxy advisor guidelines become stricter on dilution in continental Europe, proposals to issue shares have also been subject to greater scrutiny by investors, confirming a multi-year trend across European markets. Lastly, regardless of shareholder proposals failing to pick up pace in Europe as fast as in the US, increased investor focus on ESG makes for an additional hurdle for companies trying to woo investors to their side.

Activism goes mainstream

Shareholder activism is on the rise and has been for some time. As activism goes mainstream, an important distinction to be drawn is that between shareholder activists and active investors. Shareholder activists are value investors whose strategy is to unlock shareholder

value by pushing for strategic, financial or governance changes at their investee companies, often by employing pressure tactics and seeking board representation. Active investors, on the other hand, may or may not be value investors and rather employ active holding strategies with the aim of taking advantage of profitable conditions and realise above-market average returns by actively managing their holdings. Engagement with companies and pushes for change are not necessarily part of the latter investment strategy. Notwithstanding this meaningful difference, institutional investors – both active and passive – have come under rising pressure to provide voting disclosure in a public format, especially with regard to the number of times they choose to oppose certain resolutions at their investee companies. With external pressure building up on investors from regulators and stakeholders alike, AGMs are the perfect opportunity for them to exercise their fiduciary duties and hold companies accountable on their environmental, social and governance (ESG) issues. Heightened stewardship duties upon institutional investors and the rising tide of activism have helped create an environment where the spectrum between traditional hedge fund activism and institutional investor stewardship is much narrower than it used to be. With institutional investors increasingly pressured to act as stewards of their investee companies, especially with regard to corporate governance, AGMs often set the table for shareholder activists and institutional investors to join forces

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Advertorial | Activism & Engagement

KNOW THY INVESTOR Establish early what motivates your investors to be ready to engage

IS POWER and activists are quickly learning how to compel investors to join their ranks. To top this all off, the rise of the occasional activist investor is an additional warning sign for companies. With excess liquidity in the markets, an ever-increasing number of active investors have turned to employing activist tactics when returns are lagging.

Engaging with your investors year-round becomes paramount to building strong relationships with your shareholder base and establishing trust in the company’s management team With increased attention to stewardship from institutional investors and additional actors making their debut onto the stage of activism, the triple threat is real. Demands can come from unexpected activists and even traditional activists’ demands will gain momentum with support from a wide array of institutional investors who may be drawn to join forces with the activists with the aim of fostering corporate governance.

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An additional level of complexity comes from ESG activism. As institutional investors step up their focus and efforts on ESG-related issues, activists are likely to find increased leverage to push their demands on the board’s agenda from the business sustainability front. Be it business ethics issues, fractured community relations or environmental concerns related to a company’s activities, a multi-layered activist campaign leveraging on themes dear to ESG-focussed institutional investors will help the activists win the support they need to push forward their agenda. In such an environment, engaging with your investors year-round becomes paramount to building strong relationships with your shareholder base and establishing trust in the company’s management team. Being activist-ready used to be a short-term, campaign-focussed effort, but with institutional investors actively pursuing their stewardship role and ever increasing and more sophisticated activists tailoring their demands to gather institutional support, continuous engagement with – and in-depth knowledge of – your shareholders will soon have to become the norm.

Year-round engagement

In order to avoid unpleasant surprises at your AGM, year-round engagement starts right after the AGM in order to build that long-term relationship with your institutional investors and is key to ensuring that your AGM resolutions are protected from falling short of investor expectations.

Autumn 2019 | Ethical Boardroom 111

Activism & Engagement | Advertorial ANNUAL CORPORATE GOVERNANCE CYCLE FISCAL YEAR END

PR Proxy advisor engagement

AN RN

N CO CE

Investor outreach Reporting & tracking

Board composition benchmarking Perception studies

Proxy advisor report Post-AGM voting analysis

CORP

OV E

112 Ethical Boardroom | Autumn 2019

Vote forecasting

Proxy distribution

TIN G SU L

Governance roadshows

RA TE G

To make any campaign a success – be it an AGM campaign or an activist defence effort – it is important to understand your shareholder base and their voting patterns. Before even starting to think about engaging with your investors, you should review and understand what type of investors are in your stock, how did they vote in the past (at your AGM or those of your peers), what are their staples when it comes to corporate governance and whether they heavily rely on proxy advisors to carry out their proxy voting obligations. You need to profile your investors and be ready to tailor your engagement efforts to their idiosyncrasies. Many companies often have different touch points to investor engagement. While investor relations functions normally take the lead on discussions about strategy and economics with fund managers, company secretariat and/or the lead independent director normally engage with the corporate governance functions at the same institutions. Once you have done your homework and are ready to engage, it then becomes imperative that you understand who in your company is taking charge of the governance talk and ensure consistency across all different streams of communications. When did an approach with an investor occur and what are the main takeaways after each of the investor engagements is key to maximising the outcomes of your engagement efforts.

Agenda & voting risk analysis

Q4 Q1 Q3 Q2

Remuneration advisory

Sustainability (ESG) disclosure analysis

OX Y

T IO ITA

Be prepared

Governance roadshows

IC OL

If you have an activist voicing dissent in your register, a wholesome relationship with your shareholders becomes even more paramount. As you have worked hard on your strategy throughout the year and built a business for all stakeholders, it is essential that your AGM does not taint a bleak picture of your management and board. Uncertainty on whether your resolutions will pass, the rising influence of proxy advisors and the smoke and mirrors surrounding shareholder identity pose a great challenge when it comes to gauging your shareholders’ sentiment and exerting influence over their voting decisions. The run-up and post-announcement period is often a nail biting time for the board. There is a lull, until just days before the AGM, when the major investor vote arrives (anonymously, of course, in registered holder name). So how do you influence your shareholders positively in advance? Working out where your institutional investors’ voting power rests is the first step. Is it with the fund managers or with the governance teams? Does it rest with the beneficial owners? How much reliance is placed by your institutional investors onto the recommendations of increasingly influential proxy advisors?

ANNUAL GENERAL MEETING

Anticipate governance issues

Is the level of disclosure in your annual report adequate? Is your board sufficiently independent, skilled and diverse? Are your remuneration resolutions clearly articulated and simple to calculate? Do they align interest between investors and management? By conducting a full governance health assessment you will be prepared for what your investors may already have on their radar as issues for your upcoming AGM. There may be some quick fixes in order to appease your shareholder concerns while others may take longer. Regardless of whether a particular issue can be quickly fixed or not, building awareness around your vulnerabilities and identifying targeted actions that will mitigate your investor concerns within reasonable timeframes will go a long way in building the support you need. If you are engaging early and you understand the governance issues of your investors, you are in a better position coming into a shareholder vote.

Understand how the proxy advisor has recommended on your agenda items in the past, which member of your board of directors has been given a negative recommendation in the past and at which company. Understanding when to engage and how to engage is very important to ensure you are providing timely and accurate information in order for the proxy advisors to complete their analysis. Access is key and you need to understand that it may not happen when you are ready to engage but only when the proxy advisors are ready to engage.

Engage early, do not be caught off guard

Be sensitive to the institutional investors’ workload and resource constraints in judging how and when to engage and on what topics. This year, SRD II will see more pressure put on investors during the proxy season and an increase in remuneration votes to be assessed and voted on. In most cases, it is all about cultivating long-term relationships with the governance teams at each institutional investor. With careful relationship management and preparedness, you can learn a lot about how and when each investor will vote and which proxy advisor, if any, they rely on. It cannot be stressed enough: before engaging with each investor, you need to be well prepared and have developed consistent messaging, or all your efforts may be in vain. As Sun Tzu said on the art of war: “The greatest victory is that which requires no battle.” 1 Georgeson’s 2019 Proxy Season Review analyses the seven major European markets where Georgeson has a widespread client base, thorough investor engagement and deep market expertise. Available for download at https://www. georgeson.com/ uk/2019-seasonreview

Assess proxy advisors’ influence

Make it a priority to know which investor uses which proxy advisor and how. Remember these key influencers change their policies every year. You should understand what those changes are and how they will affect your company and agenda items being put up to a vote at the next AGM. Identify the key agenda items that each proxy advisor may take issue with. Proxy advisor recommendations will have a big influence on your AGM. It is important that you have the right tools to engage with this community and to be prepared for the types of questions that proxy advisors might ask.

Georgeson

Moor House, 120 London Wall London, EC2Y 5ET +44 (0) 207 019 7003 www.georgeson.com domenic.brancati@georgeson.com

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Global News Africa

Nigeria oil sector needs to ‘support women’ Women operators in the Nigerian oil and gas industry have been promised ‘gender friendly policies on access to funding, award of contracts and support for research and development’. According to the Nigerian Content Development and Monitoring Board (NCDMB), gender diversity decreases with seniority in the sector, with only a tiny proportion of women in executive positions.

The percentage of women in the industry drops over time from 36 per cent to 24 per cent between the middle and executive level. Executive secretary of NCDMB, Engr. Simbi Kesiye Wabote, called for special initiatives to encourage women participation in the sector. “Access to finance is very important and we will look at our policy to see how we can support women who are serious to do business,” Wabote said.

PIC questioned for firing whistleblower

Gunvor fined over bribes in Africa Gunvor, one of the world’s biggest energy traders, has agreed to pay Swiss prosecutors almost $100million to settle a long-running corruption case. Swiss federal prosecutors found oil trading firm Gunvor Group criminally liable for corruption in the Congo Republic and Ivory Coast. “The Geneva commodities trader has been convicted of failing to take all the organisational measures that were reasonable and necessary to prevent its employees and agents from bribing public officials in order to gain access to the petroleum markets in the Republic of Congo and Ivory Coast,” a statement from the Swiss Attorney General’s Office said. Gunvor said it maintains that ‘there was absolutely no conscious or desired involvement of employees or members of management in these activities’ and said that no current employees or businesses of Gunvor Group are involved in any related ongoing litigation or investigations.

114 Ethical Boardroom | Autumn 2019

Africa’s biggest fund manager, the Public Investment Corp (PIC), has been slammed for dismissing an assistant portfolio manager who ‘spoke out’ over governance failings. Earlier this year, Victor Seanie testified that the fund’s former CEO, Dan Matjila, used his authority to push through transactions with a little-known technology company, allegedly ignoring due process. Seanie was suspended amid an enquiry but, in October, the PIC said in a statement that Victor Seanie had been dismissed after a disciplinary process found him guilty of charges of ‘breaching the PIC’s internal policies in investment decisions’. Asief Mohamed, chief investment officer at Aeon Investment Management, commented to BusinessTech that: “It looks like the PIC is trying to recover what it can from investments that appear to not have followed proper process. This decision to fire Victor Seanie does leave me wondering why it didn’t wait for the commission’s final findings before making this move.”

Ngugi named as new Kenya Power CEO The Kenya Power board of directors has appointed Bernard Ngugi as the company’s new managing director and chief executive officer. Ngugi, who is the former general manager in charge of supply chain at the company, takes over from Eng Jared Othieno. Othieno has been the interim managing director and CEO at Kenya Power since July 2018 after Ken Tarus was ousted over graft allegations. “We believe that Mr Ngugi will see the company through an important stage of its development and growth as we work to diligently implement all our plans to strengthen the company and the commercial aspects of our business,” said Kenya Power’s chairman Amb (Eng) Mahboub Maalim.

Aker Energy appoints Zubairu to its boardroom Samaila Zubairu, president and chief executive officer of the African Finance Corporation, has joined the board of directors at Aker Energy. The company has aims to become the offshore oil and gas operator of choice in Ghana but the venture has hit delays due to regulatory challenges. Sverre Skogen, chair of the board of directors at Aker Energy, said: “AFC is an important partner to Aker Energy. We are therefore honoured to welcome Samaila Zubairu to the board, as he brings extensive experience with innovative infrastructure development and financing across the African continent, as well as geopolitical and industrial insight.” Zubairu has previously served as CEO of AfriCapital Management Limited and as chief financial officer of Dangote Cement Plc.

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Regulatory & Compliance | Advertorial

Designing a tax compliance management system Now is the time to act, particularly for businesses operating internationally In the last issue of Ethical Boardroom, we reported on the changed environment in German tax law and the criminal code for tax offences. Now, we should like to focus on designing a tax compliance management system (TCMS) based on Practice Note 1/2016 of the Institute of Public Auditors in Germany (Institut der Wirtschaftsprüfer in Deutschland e.V), in order to discuss how the risks of liability and criminal prosecution that we described could be minimised. Although we’re dealing here with a German standard, it could be worthwhile for non-German group companies to take this standard on board so as to achieve a more transparent, secure and efficient tax compliance management system. The fact that Practice Note 1/2016 makes reference to OECD framework concepts, such as Cooperative Tax Compliance: Building Better Tax

GETTING TAX COMPLIANT It is important to be transparent and secure 116 Ethical Boardroom | Autumn 2019

Torben Fischer & Sandra Söbbing

Torben is a Forensic, Risk & Compliance Partner in the Hamburg office, and Sandra is Tax Advisory Partner in the Frankfurt main office of BDO AG Wirtschaftsprüfungsgesellschaft Control Frameworks, as the basis for a TCMS makes this particularly possible. In Cooperative Tax Compliance: Building Better Tax Control Frameworks, the OECD states that there are no suitable, universally applicable approaches to a functioning tax control framework, but puts forward six building blocks as parameters for such a framework, namely: ■ An established tax strategy ■ A strategy that is applied comprehensively ■ A strategy that is responsibly assigned ■ A strategy whose governance is documented ■ A strategy on which testing is performed ■ A strategy for which assurance is provided As both Practice Note 1/2016 and the OECD publication take a generic approach, it is distinctly possible to combine these frameworks and use them as a basis for designing a TCMS that is suitable for the new environment. What is more, the Practice Note

dispenses with rigid requirement criteria, constructing instead an indicative framework based on seven basic elements, which gives a company structural and substantive scope for designing and operating an individually appropriate TCMS. This ensures that the design is substantially geared to the complexity of the company’s particular business environment and processes, while also complying with OECD requirements.

Practice Note 1/2016

The Practice Note is based on seven mutually interactive basic elements (See tax wheel graphic, opposite): ■ Tax compliance-culture ■ Tax compliance-objectives ■ Tax compliance-risks ■ Tax compliance-programme ■ Tax compliance-organisation ■ Tax compliance-communication ■ Tax compliance-monitoring and -enhancement Tax compliance-culture provides the basis for the appropriateness and effectiveness of the TCMS. It is characterised, inter alia, by the basic attitude and behaviour of management (‘tone at the top’ and ‘tone from the top’)and communication of the importance of tax compliance. What also characterises the tax complianceculture of an enterprise is the early and comprehensive engagement of the tax function in tax-relevant issues and the principles behind penalising tax compliance infringements. The corresponding values and desired behaviour patterns can be communicated and documented by, for example, a code of conduct and/or written (tax) guidelines or tax strategies. In this way, the culture is crucial in defining how seriously the company’s employees regard compliance with tax rules and the proper fulfilment of tax obligations. The systematic identification and evaluation of key areas and the setting of www.ethicalboardroom.com

Advertorial | Regulatory & Compliance tax compliance-objectives takes place in out – is an important component of accordance with the general objectives of the compliance-program. the company. The tax compliance-risks, The tax compliance organisation basic i.e. the risk of infringing regulations, can then element frequently poses a particular be identified and classified into risk classes. challenge in practice. Tax complianceThis involves evaluating how likely they are organisation is concerned with rules to occur and their possible consequences. for the organisation of structures and Analysis of the objectives and risks is processes. What matters here, therefore, particularly important, given their is to integrate the TCMS and the tax fundamental nature. In particular, it should function into the company-wide compliance be noted that tax risks often arise within management system as far as possible. the context of operational processes that The tax compliance-communication are not controlled or supervised by the tax basic element concerns whether the function or often not even monitored by it. It relevant employees and, if necessary, is therefore crucial also to involve the relevant third parties are adequately informed. departments other than the tax department This includes the relevant requirements, in the consideration of tax risks. obligations and elements of the tax The tax compliance-program introduces compliance-program, as well principles and takes measures based on the assessment of tax compliance-risks and is The OECD states that there aimed at minimising those risks and thereby are no suitable, universally avoiding tax compliance infringements. Control and minimisation of identified risks applicable approaches to takes place within this framework. a functioning tax control Ideally, the corresponding risk management measures will have a preventive framework… it is time for effect and one that thus avoids errors. As German companies to take even this is no guarantee of absolute security, appropriate (detective) measures that detect action. But not only for infringements of the rules in a timely manner German companies should also be put in place. Finally, the tax compliance-program will include methods as defined roles. In addition, tax compliance for identifying so-called red flags, i.e. -communication must define reporting indicators of possible compliance channels and frequency and the infringements, and criteria and contents and recipients of measures for carrying out reports. Furthermore, the internal investigations. It is TAX TAX opportunity to report within the remediation COMPLIANCE indicators of regulatory phase, i.e. the MONITORING & COMPLIANCE ENHANCEMENT OBJECTIVES infringements should identification of be provided. weaknesses in the In the light of preventive measures current German that have opened the TAX TAX TAX way to the identified COMPLIANCE COMPLIANCE COMPLIANCE legislation, it is also COMMUNICATION CULTURE RISKS essential that the infringements, that executive board or preventive measures management can in the critical areas be assured that the are tightened up. TAX TAX COMPLIANCE COMPLIANCE TCMS is effective. This The connection ORGANISATION PROGRAM is the nucleus of the tax between the results compliance- monitoring of an investigation and and -enhancement basic the consequent effects on element. Among the requirements the design should be regulated for the TCMS to be effective, are sufficient in the TCMS. monitoring of compliance with the It can be said in conclusion that the measures of the TCMS, process workflows, compliance programme consists of awareness of necessary training and preventive, detective and investigative continuous professional development measures which, in the ideal case, programmes and the interface with external significantly reduce the likelihood of service providers. This also demonstrates infringements by means of preventive the link with the other basic elements. measures. As the occurrence of infringements Efficient monitoring and retrospective cannot, however, be excluded entirely assessment of the effectiveness of the by preventive measures, the conceptual system as a whole is possible only if design of an investigation – in particular concrete rules for design and control have establishing in what circumstances and been made known to all relevant employees. by reference to what internal decision-making The design of such rules in turn requires processes an investigation is to be carried www.ethicalboardroom.com

that the relevant risks have been fully identified and, building on this, that the measures most appropriate and effective for the company concerned have been identified, designed and also implemented. These objectives must be aligned with the overarching tax compliance objectives and it must be made clear to employees by the appropriate signals within the framework of the tax compliance-culture that compliance with the adopted rules and regulations is essential and that infringements of these rules and regulations may lead to consequences. In the absence of any one of these steps, not only is systematic compliance impossible but the consequences in the event of an actual infringement for the persons concerned, especially the company’s management organs, which in the worst-case scenario can lead to severe personal penalties, are also left to chance.

Conclusion

The requirements in Germany for a management system that ensures compliance with tax rules and regulations have significantly increased, leading to similarly increased legal and financial risk for companies and their management organs. As many other countries have also introduced requirements for a tax control framework, now is the time to act, particularly for internationally operating businesses. As well as thereby reducing the civil and criminal consequences, this would also provide further advantages associated with the implementation of a tailor-made tax compliance management system: ■ Increased transparency (at company headquarters) and thus the opportunity of designing more efficient processes ■ Enhanced cooperation with the tax authorities, possibly thereby speeding up decision lines and ensuring problem-free tax audits ■ Enhanced quality of reporting and thereby a better basis for decision-making In this respect, it is time for German companies to take action. But not only for German companies.

BDO AG Wirtschaftsprüfungsgesellschaft Fuhlentwiete 12 20355 Hamburg, Germany +49 40 302 930 hamburg@bdo.de www.bdo.de Autumn 2019 | Ethical Boardroom 117

Regulatory & Compliance | Contracts RETHINKING HOW COMPANIES WORK Automation can help free up legal teams

Reimaginethefuture Organisations today are operating in a challenging environment of change and digitisation, along with a risk and regulatory landscape that is becoming fast-moving and ever more demanding.

Within this, the role of the general counsel (GC) is also changing and so are the demands on the legal team. The GC role is increasingly evolving from being a technical legal specialist to a strategic advisor to the business. GCs need to be able to take a wider view and deliver commercial but legally robust insight. They need to ensure that the work of the legal team is aligned to the strategic objectives of the business â&#x20AC;&#x201C; providing a proactive, internal clientcentric service. In short, GCs need to lead their legal functions in a transformation 118 Ethical Boardroom | Autumn 2019

Empowering the legal team to take control of contracts Nicola Brooks

Head of Legal Operations and Transformation Services, KPMG of their working practices that sees them operate like a business, for the business. An increase in complexity and volume of work is often creating an unsustainable workload for legal teams, who are finding themselves overstretched and struggling to manage demand. It becomes essential to manage the peaks and troughs by adopting the right resourcing strategy, reassessing processes and workflows to drive greater efficiencies through standardisation and adopting the right technology solutions.

Only in this way can GCs ensure that the right task is delivered at the right time and with the right mix of people, processes and technology. Recent statistics from Gartner succinctly underline the size of the challenge facing GCs and their legal teams: there is an 85 per cent projected increase in demand for legal services by 2020 â&#x20AC;&#x201C; but 53 per cent of GCs are being asked to cut or hold budgets flat. Clearly then, the way that legal functions operate must change. This is why KPMG has launched its Legal Operations and Transformation Services (LOTS), designed to help teams rapidly reset how they work and leverage smarter, more digital solutions.

The contract management challenge

One concrete and practical area where GCs can begin to transform operations is contract management. Most businesses www.ethicalboardroom.com

Contracts | Regulatory & Compliance will have hundreds if not thousands of contracts in place with different suppliers and customers, with these being instigated by many different parts of the business. Creating, authoring and managing these can therefore be a difficult task that often puts a significant burden on the legal team. Many GCs say it is a priority to achieve an optimised and repeatable approach to the contract management lifecycle wherein the business is empowered to increasingly self-serve more and members of the legal team are freed up to concentrate on higher value activities. Many legal and procurement teams find their time monopolised by manually intensive tasks such as document creation, contract assessment and data abstraction; and ongoing supplier obligation management. Additional complexities, such as non-standardised contract templates, multiple, non-integrated contract management tools and contract metadata that is often inaccurate or unavailable, impact the ability for organisations to capitalise on contract opportunities. The reality is that in many businesses today, contract management is still ad-hoc and reliant on ‘management by spreadsheet’. According to the State of Contracting (SpringCM) 2018 survey, some 59 per cent of in-house teams manage contracts on Microsoft Excel. Nearly one in 10 teams said it had ‘no process’ at all. Perhaps it was not surprising then that nearly three quarters of GCs believe human error is often or very often a factor in contracting. Just four per cent of GCs were confident that human error never creeps in. To overcome these challenges, we have developed a contract lifecycle management service as part of our LOTS offering that uses AI and cognitive technologies sourced from leading technology providers to help organisations gain far more effective control. KPMG Contract Lifecycle Solutions service helps to simplify, standardise, centralise and automate the contracting process. We leverage our subject matter expertise across process improvement, legal insight and key automation technologies to help clients digitise the entire contracting process, as well as build in continuous improvement for the future. This is done through the implementation of advanced contract management software that creates a platform through which existing contract data can be analysed and structured, new contracts can be consistently created through approved templates, a central storage solution can be created, and ongoing amendments can be managed. We help move the dial for businesses, improving processes, speeding up contract turnaround times, and increasing the ability of the business to safely self-serve. This includes helping clients with: www.ethicalboardroom.com

■■ Instruction – move from an adhoc process with no centralised data capture or audit trail, to a single point of access through a business portal with automated triage and comprehensive data tracking ■■ Authoring – move from manual drafting with heavy dependence on the legal team, disorganised (or no) templates and limited knowledge sharing, to a standardised drafting process that reduces error, moves work to junior resource and automates the selection of in-house v. outsourced resource to assist with the matter ■■ Negotiation – move from inconsistent application of contracting rules with a lack of structured negotiation taking up significant internal time, to a digitised, automated and consistent process with enforced back-stop positions that mitigate risk with automated escalation for approvals if deviating from the standard position ■■ Execution – move from physical signatures, poor storage of executed documents and a lack of ongoing obligation management to digital execution, a clear audit trail and key data extraction stored centrally for ongoing obligation management

The reality is that in many businesses today, contract management is still ad-hoc and reliant on ‘management by spreadsheet’ If you recognise any of the following challenges with contract management, then our Contract Lifecycle Services could help: ■■ Do you find that there is no standard process for preparing your contracts and you lose a lot of time searching for the right templates? ■■ Is communication and the exchange of data between the business unit and the legal department cumbersome and inefficient for all parties involved? ■■ Do you find it is difficult to adapt documents reliably in the case of legal and regulatory changes? ■■ Would centralised storage and administration make it much easier for you to work with the large quantities of contracts and templates? ■■ Do you find that often different departments aren’t equipped with the legal knowledge to prepare contracts and the legal department is overwhelmed with FAQs? ■■ Is there a high rate of error and/or a variety of other risks arising from the fact that a diverse range of entities are involved in contract processes?

A host of benefits

The KPMG Contract Lifecycle Solutions team review processes, workflows and help to automate documents onto a contract lifecycle technology platform. By doing this we help businesses uncover a range of benefits. It dramatically increases the speed of the contract management process, reduces risk and improves compliance. By reducing staff time, it lowers labour costs and means more time can be devoted to higher value generating activities – increasing legal team motivation and job fulfilment. In addition, the business will see P&L improvement through standardisation of key financial and risk terms which helps build a case for investment. More broadly, it enables greater commercial insights to inform decision-making and planning.

KPMG’s suite of legal operating transformation solutions We have a team of specialists with deep legal, consulting and technology expertise that work alongside clients to bring a fresh perspective to legal services. Leveraging KPMG’s extensive experience in designing and implementing transformation programmes across other functions of the business, we help you reimagine legal service delivery excellence. Our teams can work with you to create a model where the function contributes measurable value to the business. We will support you every step of the way, from design to implementation, and can be part of the ongoing solution. Our LOTS services cover a wide range of key areas:

■■ Sourcing models – are you utilising an optimal mix of in-house and external resource? Does the balance need to shift, and where? We help you to achieve the right balance within your sourcing model ■■ Legal intake – is the legal team being used to best effect on areas where it can add most value? Are there matters where business areas could increasingly self-serve? We can work with existing organisational-wide technology or with leading technology providers to help route legal requests into the function ■■ Standardisation – does the legal team have multiple, discrete processes that aren’t joined up? We help you assess where standardisation can be introduced to increase efficiency and speed

Mapping where you are

We also offer a diagnostic tool to check legal team performance and conduct a thorough gap analysis for you, identifying areas where you may get the highest return, most quickly. Whether it’s redesigning your contract management system or focussing on another priority area, we can help and support you in the journey. Autumn 2019 | Ethical Boardroom 119

Regulatory & Compliance | Climate Change

The great challenges we face in the 21st Century (of climate change, resource depletion, exploitation, food security, etc) are not insurmountable. Not by a long shot. They are, however, driven by particular views of the world that are no longer fit for purpose – that equate prosperity with growth, the failure to acknowledge that the planet has finite boundaries, and the heedless use of natural capital (‘the tragedy of the commons’). My brilliant colleague Kate Raworth makes this point very convincingly in her book Doughnut Economics (and, if you can’t spare the time to read, listen to her YouTube performance). It is fortunate that we are at a period in history where we see the emergence of alternative models, such as ecological economics. That’s not to say that we, across the planet, are not in serious trouble. It turns out that Malthus was right, albeit a little delayed (and Deming, too), when he made the observation that ‘it is not necessary to change. Survival is not mandatory’. However, climate change and other 21st Century ills are not a crisis, in the same way that putting a shotgun to one’s mouth is not aggravated assault. Behaviours are not set in stone and anyone who has experience of handling a four-year-old understands the importance of teaching impulse control. The United Nations acknowledges this and in recent years has appointed behavioural advisors to ensure its their insights are

Climate change is not a crisis — it’s a matter of behaviour Chris McCann

Founder, Resilient.World efficiently mainstreamed in various UN programmes and activities. These two ideas, that of ‘seeing things as they really are’ (ecological economics) and behavioural alignment, are the jumping-off point in the development of an effective sustainability programme (both social and environmental). Behavioural alignment in the boardroom becomes a little easier, of course, as legislators step up, and as The Guardian newspaper recently reported: “Mark Carney, governor of the Bank of England, has warned major corporations that they have two years to agree rules for reporting climate risks before global regulators devise their own and make them compulsory.” How to square the circle of profitability and sustainability? Far from dropping into some dystopian nightmare, there are those who have crunched the numbers and argue that what lies in the very near future is a new Golden Age (or, more accurately, a Green Age). An age of sustainable living, the good life, driven by revised values and technological innovation. Carlota Perez is a Venezuelan scholar with an impressive résumé. She researches the concept of techno-economic paradigm shifts and the theory of great surges, a further development of political economist

Joseph Schumpeter’s work on the Kondratieff waves theory. Sounds like heavy stuff… but, in a nutshell, she lays out a history of five technological revolutions that follow a similar pattern of bang, bust and, hopefully, renewal. What she says about the current revolution and where we’re headed next is inspiring and offers a tremendous vision of possibilities. Perez has examined the work of Soviet economist Nikolai Kondratieff, best known for proposing the theory that Western capitalist economies have long-term (50 to 60 year) cycles of boom followed by depression. These business cycles of expansion, stagnation and recession have today been expanded into four periods, with a turning point (collapse) between the first and second phases. Termed Kondratieff waves, they were first brought to international attention in his book The Major Economic Cycles (1925), and modern versions of his work credit technology and/or credit cycles as the driving force behind these waves. Perez is one of those who hold the view that technology shifts are the key driver, with five technological cycles over the past 240 years: The Industrial Revolution – 1771 1 Typified by machines, factories and canals The Age of Steam and Railways – 1829 2 Typified by coal, iron and rail The Age of Steel and Heavy 3 Engineering – 1875 The Age of Oil, Electricity, the 4 Automobile and Mass Production – 1908 The Age of Information and 5 Telecommunications – 1971

Beyond Kondratieff’s Hill 120 Ethical Boardroom | Autumn 2019

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Climate Change | Regulatory & Compliance

Each cycle takes approximately 40 to 60 years to spread across the world and to reach maturity. Why revolutions? Because, and this is the key point, these technologies transform the whole economy. In each cycle there is the potential for enormous new wealth creation, requiring a new direction of change across all industries and, eventually, across society. Perez gives the example of the USA at the dawn of mass production. Charles Erwin, President of General Motors, famously made the observation that ‘what is good for our country is good for General Motors, and vice versa’. And, in many ways, he was correct – the automobile was at the centre of that technological wave, enabling the development of suburban housing, the creation of Fannie Mae (to fund federal housing), the innovation in electrical appliances to equip new housing as a result of huge demand, and spawning a thousand products and industries. The same effect was seen in each of the other four technological cycles, in each case driving change not just in the industry of origin, but acting as an enabler for change throughout society. Perez understands that each technological revolution propagates in two different periods. The first half (known as ‘installation’ and taking 20 or 30 years) establishes infrastructure and allows the market to pick the winners. It’s a period of ‘creative destruction’, a period of ‘out with the old and in with the new’, and is led by financial capital that always ends in a crash, because financial capital is speculative in nature – a lot

of the wealth creation is false ‘betting’, with no real increase in productivity in the ‘real’ economy. Witness canal mania and canal panic, the same for rail, the same in the roaring Twenties and the 1929 crash and, most recently, in the Age of Information (the NASDAQ crash of 2001, which followed the establishment of new

Charles Erwin, president of General Motors, famously made the observation that ‘what is good for our country is good for General Motors, and vice versa’

technologies during the internet and dotcom bubbles, and the 2008 crash following the period when finance innovated using software and internet technologies, developing a global reach but creating a globalisation bubble). The second half (known as ‘deployment’ and again taking 20 or 30 years) reaps the full economic and social potential. This is the period of ‘post-crash’, where painful lessons from the crash produce a better understanding of its causes and prompts institutional change – business and government come together to begin understanding how to create a true wave of wealth creation. It is this period that comes to be known as the Golden Age, where the new technology has been fully installed and can act as a catalyst to help the rest of industries to innovate. In this second period, the alliance between production and the state serves as a driver and innovator, and finance takes a service and facilitator role. So, what will this new revolution look like? It will be a Green Age enabled by information and technology, augmented by the implementation of circular economy strategies and, most particularly, the redesign of value chains through the application of business transformation methodologies. We will begin to see a move away from mass production, and mass consumerism. The future will be less about buying the same thing 17 times in a lifetime and more about living the good life using less materials, less energy, more communication, more creativity, more social living.

INSPIRING TIMES AHEAD Moving out of the crash phase and heading into a golden future www.ethicalboardroom.com

Autumn 2019 | Ethical Boardroom 121

Regulatory & Compliance | Climate Change

We will see sustained efforts to reduce enormously the amount of materials needed to make the good life, and a greater emphasis on making the good life aspirational – a move back to durable products but with greater emphasis on maintenance, and elimination of planned obsolescence. In the fabrication industries, for example, we will see custom-designed materials, minimum energy and materials use, zero defects, zero waste, planned upgradability instead of built-in obsolescence, disassembly and recycling. In the process industries, we will see an emphasis on energy saving, on intelligent process controls where by-products are seen as a source of value (waste valorisation). In freight transport we will see a full awareness of environmental impact and full costing, optimising routes by bulk and weight, innovation in packaging and distribution. In the energy sector, we will see multiple energy sources, local production, interactive users that buy and sell. And in urban development we will witness the ushering in of integrated cities where living, work, education and leisure all take place in close proximity and in environmentally intelligent buildings to reduce the need for transportation and maximise natural capital. A shift to technologically enabled green consumption patterns is possible, but only through using desire and aspiration as drivers and not fear and guilt. What was the luxury life/good life under the mass production paradigm? Brand new is better than old; bigger is better than smaller; more is better than less; fabricated is better than handmade; keep up with the Joneses or fall behind. Under the new paradigm, it will become increasingly vulgar to be a consumerist and instead the aspiration will be high quality and durability. At the same time, as Verisio’s Chris Riley points out, the consumer will have a keen interest in the provenance of products, not only of where they are made but that the conditions in which they are made are just and fair. For us

today the exciting news is that, at precisely the moment we face some of the greatest challenges of our time, we’ve also been bequeathed the potential for transformative (and disruptive) solutions. Viewed through the lens of history, we are standing at the precipice of a new, sustainable moment. It’s something of a myth to suggest that sustainability and profitability are mutually exclusive. In fact, in the not-too-distant future we’ll find that the two concepts are joined at the hip. We’re already witnessing the emergence of a new breed of billionaire exploring investments in renewable energy or using their existing wealth to develop ‘cleantech’ solutions. Elon Musk and Tesla

A shift to technologically enabled green consumption patterns is possible, but only through using desire and aspiration as drivers and not fear and guilt may be the most well-known of these, but the list also includes energy trader John Arnold and Bill Gates who, together with others, launched the $1billion Breakthrough Energy Coalition, and the world’s first ethanol billionaire Rubens Mello (net worth $1.4billion). Why the focus on renewable energy? Well, we’re an energy-based civilisation – energy powers everything from the food we eat, to the clothes we wear, and the homes in which we live. And, we’re heading into a fossil fuel-constrained future. More particularly, though, there are fortunes to be made as the world begins to transition to a new energy reality – to be precise, an annual investment in the order of $1trillion from now until 2050, according to DNV GL’s Energy Transition Outlook (ETO). Savvy investors and the capitalist imperative will, ironically, prove to be the catalyst for sustained and sustainable change. For the

entrepreneurial-minded, change is the lifeblood of success. It’s at the boundary of ‘what is’ and ‘what will be’ where visionaries and futurists thrive and, in the process, take others with them.

Technological advances

The information revolution is not just about ‘bits’ and ‘bytes’, however. There will be those players in value chains, of course, that will seize upon latest technologies but, without any accompanying context, will be unlikely to maximise their utility. In fact, without not only operational but also strategic application of technology it’s likely that many organisations won’t prosper: 20th Century thinking won’t address 21st Century problems. The information revolution allows not only the rapid deployment of technology, but also, more particularly, the rapid dissemination of ideas. We will reimagine our products with their end-of-life in mind; we will reconstruct not only our supply chains but also our value chains (and in the process, create wholly new revenue streams); and re-evaluate our business operations to take advantage of the new energy/resource reality. Instead of a linear economy that converts raw materials to waste at the fastest rate possible, our economy and our thinking will become circular and regenerative. And, as always with these things, we’ll ask ourselves why we never operated in this fashion from the start. Resilient.World is a pioneer of this three-step methodology – that an effective sustainability programme requires a process of behavioural alignment (at board level and cascading down through an organisation), the deliberate development of an organisational circular economy strategy encompassing that organisation’s value chain, and implementation of that strategy through a structured business transformation approach that incorporates both operational and organisational design. Beyond Kondratieff’s Hill, the view is becoming not only clearer, but brighter.

BRIGHTER OUTLOOK Can technology innovation lead to a time of prosperity?

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KEEPING IT ABOVE BOARD “Essential reading for boards who want to stay ahead of the governance curve”

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