Navigating the EESG Cross-Currents
A practical approach to sustainable stakeholder corporate governance.
The top five issues for 2020 are:
There is no delaying. Climate accountability means taking action now.
The climate crisis, with rising sea levels, more frequent extreme weather events and apocalyptic fires, is the most important issue of our times. Urgency to take action is intensifying.
In November, a letter signed by more than 11,000 scientists warned that the Earth was clearly and unequivocally facing a climate emergency.
The global movement led by Greta Thunberg and students around the world saw an estimated 170,000 people march in New Zealand as part of the September school climate strike in September.
Boards have a critical role to play in responding to climate-related issues to ensure the long-term sustainability of their organisations. In the 2019 Director Sentiment Survey we saw a lift in the number of boards that said they were engaged and proactive on climate change, but it was still only 35%.
If you are in business, the impacts and risks – such as business disruption, physical and financial risks – are becoming clearer.
A legal opinion published in October by the Aotearoa Circle’s Sustainable Finance Forum says directors have legal obligations in relation to climate risk. It considers directors’ duties under the Companies Act 1993 and other obligations. Key findings include:
The past 12 months have seen climate change mitigation and the “purpose” of businesses cement themselves as the key challenges that boards must grapple with as they strive to ensure the long-term sustainability of their organisations.
The Forum also published Financing the Future, which looked at how the financial system in New Zealand may be redesigned to meet sustainability challenges. It explores the purpose, role, and responsibilities of business and finance in society and sets out potential pathways for achieving a sustainable system.
The Climate Change Response (Zero Carbon) Amendment Act passed into law in November, amending the Climate Change Response Act 2002. Its long-term 2050 emissions reduction target will:
The government is consulting on Climate-Related Financial Disclosures — Understanding Your Business Risks and Opportunities Related to Climate Change and is considering adopting mandatory climate-related disclosures (on a comply or explain basis) for listed issuers, banks, general insurers, asset owners and asset managers.
The Task Force on Climate-related Financial Disclosures (TCFD) reporting framework is proposed as a default framework. Although mandatory assurance is not proposed at this stage reporting would be required in annual reports. This will be a significant focus for 2020.
I don’t want your hope. I don’t want you to be hopeful. I want you to panic and act as if the house was on fire.
Purpose beyond profit is the key to remaining competitive and sustainable in the long term.
That purpose is critical to governance is not a new concept. Determining purpose is, after all, the first pillar of the IoD’s Four Pillars of Governance Best Practice for New Zealand Directors. Recently, however, it has been getting much greater attention as the effectiveness and value of capitalism and corporate governance are questioned.
In recent years, Larry Fink, chair and CEO of the world’s largest investment company, BlackRock, has been exerting increasing influence on corporate governance through his annual letter to CEOs. He highlights particular areas from an investment perspective and the 2018 and 2019 letters place organisational purpose firmly up front.
In August, the US Business Roundtable gained global attention with its new Statement on the Purpose of a Corporation, which committed its 181 signatories to leading their companies for the benefit of all stakeholders – customers, employees, suppliers, communities and shareholders.
Previous versions endorsed principles of shareholder primacy (ie, that corporations exist principally to serve shareholders).
The shareholders-versus-stakeholders debate was reignited in New Zealand this year by the FMA CEO Rob Everett in a speech to the New Zealand Capital Markets Forum.
Changes in listed company ownership and a move towards greater institutional investor holdings have altered the relationship between investors, boards and management.
The issue is not whether a company should account for stakeholder interests but, rather, the extent to which it should.
In the decade since the Global Financial Crisis, corporate governance regimes around the world have been reformed and strengthened. The pendulum has swung away from shareholder primacy towards giving more recognition and weight to stakeholder interests (including in risk management and corporate reporting).
Purpose is the driving force to remaining competitive and sustainable in the long term and needs to be led by the board. We expect to see greater focus on purpose as companies continue to adapt to shareholder and stakeholder expectations.
This is also evident in a significant focus on environmental, social and governance factors. In the Director Sentiment Survey, 70% of directors say these were very important to their boards.
The British Academy’s Principles of Purposeful Business notes the need to reform business around purpose, trust, values and culture including to “profitably solve the problems of people and planet”.
Although purpose is getting greater attention in the corporate sector, it has always been the raison d’être for not-for-profit (NFP) organisations.
The Centre for Social Impact’s report What is the Future for NGO Governance says that NGOs generate $20 billion in annual income in New Zealand and employ around 100,000 people (nearly 5% of the workforce). Good governance in charities and other community organisations is critical to a thriving and sustainable society and economy.
The NFP sector is in the midst of the most significant changes in over 100 years. A new Trusts Act 2019 has been passed, the Incorporated Societies Act 1908 is due to be replaced, and work to modernise charities legislation includes considering the need for governance standards or a code for charities. Social enterprise and impact investing are also on the rise.
It’s all about purpose.
In a world of data and digital dependency it is no surprise that data governance features again in our annual Top Five Issues.
Technology continues to reshape companies, and the business and social environment. Giant tech companies are dominating new and traditional industries in ways that demonstrate the opportunities and disruptive risks of technology. These include new ways of doing business, the impact of data privacy scandals and cyberattacks.
Artificial intelligence, the Internet of Things, big data, data analytics, data privacy, ethics, and security all fall under a board’s role in data governance. It means leading to stay on top of new and emerging technologies, risks, opportunities and innovation.
This includes understanding your organisation’s value and how to protect and maximise it. Up to 80% of company value is made up of intangible assets such as brand, data, IP and organisational/social capital, but they are still massively under-represented on the balance sheet.
Having good knowledge of your critical assets is vital for any board member. More than a third of New Zealand businesses have been subject to a cyberattack in the past 12 months (Aura’s Cyber Security Market Research Report 2019). Cyber-attacks and data breaches are a real and continuous threat, and it really is a matter of not if but when it will happen.
Despite potential consequences of a cyberattack or incident, only 50% of boards (in our 2019 Director Sentiment Survey) reported discussing cyber risk and that they were confident their company has the capacity to respond to a cyberattack or incident. Only 41% said that their boards were getting comprehensive reporting from management about data risks and incidents (down from 47% in 2018).
It is critical that boards receive comprehensive reporting from management about cyber risks and incidents, and actions taken to address them. The IoD and Aura Information Security guide on reporting cybersecurity to boards includes guiding principles and outlines some important questions to ask when developing cybersecurity metrics and dashboards.
Data privacy and protection is a core concern for customers and citizens across the globe and New Zealand will have a new privacy act in 2020. It’s more than a quarter of century since the Privacy Act 1993 was introduced and in that time the rise of the internet and the digital economy have transformed organisations– and how we use personal information. See IoD webcast with the NZ Privacy Commissioner held 5 May 2020 for more information.
The new Privacy Act is focussed on modernising the privacy landscape and will introduce mandatory privacy breach reporting, bringing increased responsibilities and liabilities. Boards should be able to say what they have done to ensure the organisation and its people know how to treat data and privacy.
Again it is concerning that only 33% of directors in the Survey said that their board has the right capability to lead their organisation’s digital future. This statistic has been stubbornly stagnant since 2016.
Directors do not need to be digital experts but digital literacy and savvy is essential, including being able to ask the
right questions and hold management to account.
Trust and accountability underpin reputation and brand.
In a world of fake news in which “talk” is cheap, opinions can be overwhelming and the speed of sharing them is just a click away, it is hardly surprising that public scrutiny for businesses and individuals is on the rise. Trust needs to be earned – it can take decades to build – and just a moment to destroy. The media is a hungry machine with more and more channels on offer and negative stories are newsworthy. Cast your mind back – even
just one year – it’s easy to name a host of very public failures and scandals that have, rightly or wrongly, violently rocked reputations. And some will never recover.
The 2019 Edelman Trust Barometer revealed that the most trusted institution is now “my employer”. Globally, “my employer” (75%) is significantly more trusted than NGOs (57%), business (56%), government (48%) and media (47%). Building and retaining trust should be front of mind for boards.
And this trust is what underpins your brand and reputation. The value of reputation is dynamic, intangible and hard to quantify. In fact there are whole organisations who exist solely to value a brand. And Forbes publishes an annual summary of the top brands by value. All of this provides a very big pointer for boards that protecting brand and reputation should be top of mind and feature as a key risk on the board risk register.
Transparency is a key opportunity to help foster trust, showing what businesses are doing, how they’re doing it, and their impact on the environment and society.
Public attention and the power of social media, active regulators and the rise of litigation funding and class actions all add to an operating environment of heightened accountability for directors.
There are many issues that can impact on reputation and ESG (environmental, social and governance) matters are particularly important in today’s business environment.
A key issue for boards is executive pay and allowances which are major governance issues globally and were in the spotlight during 2019. Issues include the size of executive remuneration packages, use of company assets, inconsistent alignment between executive pay and company performance, and pay disparity between executives and employees. Boards should expect increased attention on these matters and be prepared to be held to account on them.
Organisational culture and conduct should, if not already, be high on the board agenda following a raft of enquiries and reviews in New Zealand and Australia, particularly in the financial and sports sectors.
Some risks to reputation and trust can be mitigated proactively but there will be times when unexpected incidents occur such as a viral social media incident. Being prepared is critical. In the 2019 Director Sentiment Survey, 65% of directors said their boards had discussed crisis management plans in the last 12 months. Crisis preparedness is something for the 2020 board plan, if it is not already on it.
This is even more critical given the rise of deep fake video technology (which is very difficult to identify) and synthetic media, where what you see and hear may appear real but is actually digitally fabricated.
As stewards for their organisations boards have a critical leadership role.
If you’re a director you are a leader, one that has an important role to play in transforming the future of your organisations, which will in turn help build
our communities and drive the nation’s prosperity and wellbeing.
Serving on a board gives directors an opportunity to make a difference and have positive impact. It is rewarding, exciting, and definitely challenging. Governing today for tomorrow means being across a vast array of complex and diverse issues and being responsive to increasing stakeholder expectations. It’s also about kaitiakitanga – guardianship and stewardship. The majority of directors (81%) in the 2019 Director Sentiment Survey said their boards had in the past 12 months discussed long-term value creation and their roles as stewards.
The expectation, and need, for directors to be across so many things means they are increasingly spending more time on board work. The 2019 Directors’ Fees Report showed a 10% increase in time spent on board work since 2018. The 2019 Director Sentiment Survey also showed time had increased for directors over the past 12 months on risk oversight (for 71% of directors) and on compliance activities (for 80% of directors).
A key challenge for boards is balancing time spent on risk and compliance with sufficient focus on strategy, opportunities and innovation.
Time is not the only challenge, information overload definitely holds a prime position. The right information is crucial to drive strategy and to ensure that directors can discharge their responsibilities. Decisions have to be based on sufficient, accurate, relevant and timely information. It’s up to boards to define the information they need – and raise any gaps with management as a priority.
Board leadership in a dynamic and complex operating environment requires continuous learning and development. You need to understand the business, the industry and the wider operating environment. You will need to move beyond the boardroom and connect with the business and its people. And you will also need to embrace change in the way the board operates, for example optimising the use of committees to support the board and asking how technology and innovative practices can help transform the way your board works.
Putting people at the forefront is key to effective leadership and relationships, including between directors, and with management, shareholders and
stakeholders. Leaders don’t just need IQ and EQ, they also need CQ and AQ – cultural intelligence and adaptability.
Directors set the tone and lead through high standards of ethical conduct, commitment, candour and integrity. They are curious and they challenge. They embrace new competencies and diversity of thought and capability. They are proactive about strengthening professionalism and embrace continuous improvement. This includes regularly evaluating board performance and capability, having robust succession planning and director development to ensure the board has the skills needed for today and the future.
The IoD and MinterEllisonRuddWatts publication Always on Duty: the Future Board explores board leadership and innovation in more depth, including how to manage increasing demands on directors’ time.
This article is featured in Boardroom issue December January 2020