Last week the EU conference gathered together experts representing various fields, including policy-makers, investors, academia, trade unions and environmentalists, with the aim to reflect on how to foster more sustainable governance in line with the Action Plan on Financing Sustainable Growth. The key message emerging from the event points out that if we want sustainable finance, we need sustainable corporate governance.
For the last few months the European Union has been setting the tone of public debate focused around the need of building a more environmentally and socially sustainable financial system in Europe. As strongly highlighted by the EU, financial sector is critical in the transition process to a low-carbon, more resource-efficient and sustainable economy. At the same time, the EU has pointed out that far-reaching reform is needed to build a financial system that supports European environmental and social objectives. It has also become clear that the reform cannot take place without a closer look at corporate governance standards.
Driven by the concept of sustainable finance, the wider investor community contributed to a debate on the role of responsible investing, fiduciary duty and short-termism versus long-term value creation, among other issues. The important milestone in those discussions was a report published by the so-called High-Level Expert Group on Sustainable Finance (HLEG) in early 2018 followed by a concrete ‘Action Plan on Financing Sustainable Growth’ towards reforming the entire investment chain and building a sustainable finance strategy.
And it is the HLEG work that brings the sustainable corporate governance on the agenda recognising the fundamental role of the boards in the transformation process delivering the EU’s commitments related to the Sustainable Development Goals and the Paris agreement on climate change. In its Action 10, the EU’s Action Plan gives a special attention to fostering sustainable corporate governance through redefining corporate board duties. Further, it also examines an undue short-term pressure from capital markets on corporations as opposed to the long-term value creation crucial for the sustainability transition.
Beyond considerations at the EU level, 2018 also saw a number of initiatives undertaken to revise the existing corporate governance laws and regulations both in the EU and worldwide. The UK Corporate Governance Code and the US Accountable Capitalism Act are the examples. The newly adopted regulations indicate a shift in the boards’ focus from shareholders to stakeholders as well as a stronger emphasis on preservation of the business success in the longer-term. The trend coincides to a great extent with the objectives of the EU sustainable finance concept and the role of the financial sector.
To date, responsible investors have also been an important voice in strengthening corporate governance practices mostly through active ownership. In responsible investments, material ESG factors remain a key driver in delivering the positive long-term investment outcomes. Notwithstanding the fact that, responsible corporate leadership integrating sustainability risks and opportunities into governance is a key to create more stable performance in the capital markets. As such, it is important that investors, fulfilling their own fiduciary duties, take a clear position on corporate governance and effectively engage with the investee companies on the associated issues.
Typical corporate governance engagement process covers the topics related to the board independence, board skills and diversity and board effectiveness, executive pay, risk oversight, accounting and integration of environmental and social risks and opportunities into board’s considerations. In addition, Corporate Governance is a priority engagement issue in relation to the incidents where the companies are complicit in bribery and corruption allegations. However, despite those efforts, corporate governance known today is still very much focused on the good governance within the company and less on the inclusiveness of sustainability into the governance structures and practices. In other words, the corporate governance model focused on maximising shareholder returns continuous to dominate the economy.
The EU, discussing the future of corporate governance in support of the environmental and social commitments, has now raised the questions whether the existing corporate governance rules and frameworks fit for purpose and how can governance contribute to addressing socio-economic and environmental problems with a view to fostering long-term value creation. Again, it appears that the HLEG’ framework will guide the direction for corporate governance transformation going forward.
HLEG lays an emphasis on the role of the boards in incorporating sustainability and the view has been once again highlighted during the most recent EU’s conference on Sustainable Corporate Governance. There should be a clear understanding at the board level of sustainability drivers and ability to translate the arising risks and opportunities into the business models. Whereas promoting long-term value creation and integration of sustainability factors remains a core element of the investor stewardship activities.
On the way to the sound corporate governance practices, following the HLEG recommendations, investors could encourage the companies to embed an overarching commitment to sustainability into the duty of the company directors as well as to the governance rules related to management, supervision and incentive systems. Strengthening of directors’ duties related to sustainability and composition of governance and supervisory bodies are essential. Furthermore, measurable sustainability targets should be implemented into the business planning process. While the remuneration policy and the incentive schemes should be consistent with the sustainability goals, last but not least, providing transparency of sustainability impacts in financial terms is pivotal.
Although there is no consensus yet on the cross-border regulatory frameworks in the European Union, more changes in the corporate governance world can be expected in the future. Ahead of the coming sustainable financial system, investors can already take immediate actions to steer corporate governance to being more sustainable.