- January 30, 2020
Revised Stewardship Code sharpens the focus on ESG factors
The UK Stewardship Code forms part of the FRC’s mission to promote transparency and integrity in business. The 2020 version of the Code was published by the FRC earlier this month. Under the Code, it is incumbent on asset owners and asset managers to disclose how they have prioritised ESG factors when assessing investments.
The introduction to the 2020 Code recognises that, in addition to governance, environmental and social factors have become material issues for investors to consider when making investment decisions and carrying out their stewardship role. The revised Code sets out 12 principles for asset owners and managers. Principle 7 requires asset owners and managers to explain in their Stewardship Reports, which will be public documents, either:
• how integration of stewardship and investment has differed for funds, asset classes and territories and the way they have ensured that tenders have included material ESG factors as part of a requirement to integrate stewardship and investment, or
• the processes used to integrate stewardship and investment, including material ESG issues, to align with the investment time horizons of clients and beneficiaries and to ensure service providers have received clear and actionable criteria to support integration of stewardship and investment, including ESG factors.
The Stewardship Code is not the only set of principles urging corporates and investors to concentrate on sustainability and ESG factors. The Sustainable Development Goals and Principles of Responsible Investment, published under the auspices of the UN, have a similar purpose. Corporates are under increasing pressure to incorporate ESG factors into their executive remuneration policy and practice. And there is evidence that corporates are taking positive action. Interestingly, however (and, perhaps, counter-intuitively) whilst many ESG factors are long term in nature, research indicates that those corporates which have included ESG metrics in their remuneration policies have done so in connection with their short-term incentives.
Whilst corporates have been required to address a range of Governance issues for some time, under various corporate governance codes, now they are paying closer attention to Environmental and Social factors. One of the difficulties is that ESG is likely to mean different things to different companies. For example, research indicates that oil & gas companies place greater emphasis on employment conditions, safety and physical damage to the environment, whilst financial services companies are more likely to be concerned about customer service.
Larger companies have established ESG/Sustainability teams or departments and committees. One of the first questions to consider is: what does ESG mean for us? Other important initial questions are: what are we going to do about it? and who is accountable? For a multi-national company, what it is going to do about ESG may well differ for each of the territories in which it operates.
Not all companies will have the resources to establish a department dedicated to ESG. However, there can be a positive financial advantage for corporates that have developed a coherent ESG policy, as increasingly lenders offer finer rates to corporates with a clear ESG policy.
To comply with the Stewardship Code, asset owners and managers must ask themselves and address questions similar to those asked of the Boards of the corporates in which they invest. In addition, they must understand the action corporates have taken (or intend to take) to address ESG factors and the reasons for taking such action. That understanding can only be achieved through constructive engagement, as encouraged by the Stewardship Code and a willingness on all sides to listen and to be clear and open. Corporates and their investors will need to start on their respective sides of the bridge and walk to the centre. That will require a good deal of co-operation and commitment (both of time and thought) and flexibility. If the Stewardship Code, adherence to which is voluntary, can help to bring that about, it will have made a stride towards breaking down the antipathy, which has sometimes existed between corporate Boards and their investors, for the benefit of all stakeholders globally.
For further information about the issues raised in this article or to discuss any questions you may have, please contact Paul Norris.
- January 29, 2020
2020 MM&K / GECN Global Research
In 2019 MM&K, together with our partners in the GECN Group (Global Governance and Executive Compensation Group) researched the Global Trends in Corporate Governance – investors perspective. The outcomes of this research are present in the Executive Summary (click here to request a copy).
25 global investors were interviewed to understand the key issues for them and to identify upcoming trends in Corporate Governance around the world. Board effectiveness appears to be a key issue for investors from Australia and Asia. To the EU, UK and US investors the ESG (environmental, social, and governance) is the main concern.
The G – Governance is currently one of the most regulated aspects of ESG in the UK. There are two codes published, that companies could adopt:
• 2018 UK Corporate Governance Code (applies to accounting periods beginning on or after 1 January 2019);
• 2018 QCA Corporate Governance Code (update of the 2013 QCA Corporate Governance Code).
The E and S – Environmental and Social aspects are less defined at the moment. The 2020 UK Stewardship Code is addressing the whole ESG issue. However, the 2020 Code does not define Environmental and Social measures, only mentioning the climate change issue.
Based on the interviews conducted, climate change is in the lead for the majority of respondents. Some respondents suggest that there will be no material change unless the relevant metrics are incorporated into pay structures.
However, for companies to successfully tackle the whole of the ESG issue, they will need to defining the E and S aspects beyond climate change – “What does ESG mean for us?”. To help our clients and to find out what is the current practice around the world, we will focus our 2020 Research on the ESG being addressed around the world.
For further information contact Margarita Skripina.
- January 28, 2020
The FRC’s annual review of reporting, following 2018 changes to the UK Corporate Governance Code shows the quality of reporting has been mixed.
In this article we analyse key elements of the FRC review
The 2018 UK Corporate Governance Code that applies to accounting periods beginning on or after 1 January 2019, is designed to build on the relationships between companies, shareholders and stakeholders and make them key to long-term sustainable growth of the UK economy.
The new Code focusses on the application of the Principles and reporting on outcomes achieved. For the Code’s Provisions, companies should disclose how they have complied with these or provide an explanation appropriate to their individual circumstances.
Key elements of 2018 UK Corporate Governance Code and summary of the Annual Review of Corporate Governance by FRC are provided in the table below:
Key Elements 2018 UK Corporate Governance Code requirements Early adoption of the 2018 Code (according to FRC)
Company purpose The board should establish the company’s purpose, values, and strategy, and satisfy itself that these and its culture are aligned’ (Principle B) Around half of the sampled FTSE 100 companies provided purpose statements. However, the quality of these varied greatly. There was a tendency to conflate mission and vision with purpose.
Too many companies substituted what appeared to be a slogan or marketing line for their purpose or restricted it to achieving shareholder returns and profit. This approach is not acceptable for the 2018 Code. Reporting in these ways suggests that many companies have not fully considered purpose and its importance in relation to culture and strategy, nor have they sufficiently considered the views of stakeholders in their purpose statements.
Evaluating and monitoring
The board should monitor culture and
any seek assurance that management has taken corrective action (Provision 2)
A handful of companies included culture as a key risk; these companies recognised the importance of ensuring the right culture to retain staff, engage with stakeholders effectively, and respond to requests for information from investors.
In some cases, boards either had a committee or planned to delegate to a committee the role of leading on culture. In these cases, this responsibility was often combined with other issues such as sustainability or health and safety.
Overall, there was limited discussion of assessing and monitoring culture. Of those that did, the main tool used appeared to be employee engagement surveys, with the main metric being completion rates of such surveys. While these are beneficial, they only provide a snapshot of information and should not be used in isolation.
Workforce Engagement For engagement with the workforce, one or a combination of the following methods should be used:
• a director appointed from the workforce;
• a formal workforce advisory panel;
• a designated non-executive director (Provision 5)
Analysis of the FTSE 100 showed that this area continues to be one that companies are carefully considering, with around half commenting on their current engagement with the workforce or detailing their preparation ahead of full reporting in 2020.
The reporting on current approaches to engagement was wide-ranging, with companies explaining that many different approaches were used, from staff surveys and employee AGMs to inviting employees to attend board meetings to discuss specific issues.
Practical Law’s What’s Market practice? report notes that 171 FTSE 350 companies included a statement on which workforce engagement method they have adopted or will adopt; having a designated NED was the most popular choice (at c.60%).
Succession planning Review existing disclosure of succession planning procedures and policies to determine whether
they are sufficiently robust and cover both the board and senior management pipeline, including
diversity. (Principle J)
The reviewed reports lacked detail on succession planning, with many companies focussing more on their appointment process (including usage of external recruitment agencies) rather than providing information on how they plan for the various types of succession that exist. Some did set out development plans for current board members and progression plans for those looking to move to board level, but this was not something that most companies reported. Several companies only highlighted succession planning as an outcome of an external board evaluation in terms of an area to improve, including linkage to increasing diversity. Maximum tenure of the chair Consider whether the tenure of the chair exceeds (or is close to exceeding) the new nine year
maximum set by the Code and needs to be explained/justified. (Principle 19)
When the Code was published in July 2018, there were 28 chairs in FTSE 100 with tenures of nine years and over; for the FTSE 250, it was 73. As of October 2019 these numbers decreased to 25 for the FTSE 100 and 49 for the FTSE 250 respectively. Diversity If not already provided elsewhere in the annual report, the new Code calls for detail of the policy
on diversity and inclusion and a breakdown of the gender split of the direct reports to the senior
management team. (Provision 23)
Almost all the annual reports stated that the company had a diversity and inclusion policy, and included statistics for females at board level and senior management levels. Some companies chose to include elements of the policy within the annual report. However, there was limited reporting of diversity beyond gender. Remuneration Remuneration policies and practices should be designed to support strategy and promote long-term sustainable success. Executive remuneration should be aligned to company
purpose and values, and be clearly linked to the successful delivery of the company’s long-term
strategy. (Principle P)
All sampled companies used financial KPIs to measure their annual bonus and LTIP awards. There is some movement towards the use of additional non-financial metrics, such as diversity, culture and health and safety targets. Better practice examples included strategic or individual non-financial KPIs that align with long-term horizons and specified the use of vesting periods for incentives. Remuneration committee should review workforce remuneration and related policies, and the alignment of incentives and reward with culture, taking into account when setting the policy for executive director remuneration. (Provision 33) A clear majority of companies sampled have yet to provide any information in their annual reports about engagement. Very few committees have reported early on their engagement with the company’s workforce; of those that did comment, a handful explained that they engage with the workforce through dedicated forums. The pension contribution rates for executive directors, or payments in lieu, should be aligned with those available to the workforce. (Provision 38) Many FTSE 100 companies have adopted this Provision early for new appointments. For current executive directors, this was unlikely to be an immediate change due to contractual obligations.
To conclude, the new Code applies to premium listed companies for accounting years beginning on or after 1 January 2019. Therefore, reporting will be part of the annual reports published in 2020. However, many listed companies noted in their annual reports published in 2019 the actions that they were planning to take in preparation for full reporting.
In relation to early adoption of the 2018 Code, according to Annual Review of Corporate Governance the quality of reporting has been mixed. Corporate culture and workforce engagement were the most frequently discussed areas. Also, many companies would be proposing new remuneration policies to their 2020 AGMs. Therefore, the 2018 Code changes to remuneration committee oversight will become evident in this year’s reports.
For further information about the issues raised in this article or to discuss any questions you may have, please contact Natalie Cherkas.
- January 23, 2020
What insights into effective business practices are coming out of the QCA review of Good Governance on AIM?
MM&K are members of the Quoted Companies Alliance (“QCA”) and sit on both the Corporate Governance and Share Schemes experts group. Here are four insights coming out of the recently published AIM Good Governance Review.
1) There is an increasing trend for more disclosure in the year-end financial reports of AIM companies. This trend towards more detailed reporting, which we think is likely to continue, is expected to create a situation where low levels of reporting and the use of “boiler plate responses” – even perhaps in private companies – will start to be commented on unfavourably by shareholders and proxy agents.
2) There is still a low level of reported engagement with employees as a distinct “stakeholder” group. It is surprising that companies are not taking the opportunity to self-regulate in this area and show more openness on this point. We suspect that, if this does not show improvement during 2020, this may be an area for fresh intervention from the government.
3) Board Experience and Evaluation is seen as an increasingly key issue for investors – although some of the attitudes highlighted remain very “traditional” in that sector expertise in Non-Executives is seemingly prized above ability to challenge and develop the business.
However, as work with our partner organisations in the Board Evaluation space is beginning to show more and more, the effectiveness of Boards is less about industry knowledge and more about having all the right skills in the Boardroom.
4) Succession planning is starting to get the attention it deserves. The review showed that companies which included a statement on succession planning had increased from 20% to 48%. However, it does still look like many of the statements made are generic in nature. Good succession planning can act as an effective antidote to the pressure of bringing in new Directors in the future on high remuneration packages.
For further information about the issues raised in this article or to discuss any questions you may have, please contact Stuart James.
- January 22, 2020
European PE Activity in 2019
It appears that 2019 was another very good year for the European Private Equity Industry. The year set a new annual record for European PE fundraising with €86bn raised across 89 fund entities.
The year was also a good year for PE deal activity which in value terms was the second highest on record. However, the number of deals was some way down on previous years. One consequence of this was the fact that the median PE deal size in 2019 was the largest ever (by some margin), just exceeding €30m.
The whole thrust of what we are seeing in this sector seems to be that it is becoming more mainstream and more accepted as mainstream. Those investors who once shied away from the asset class cannot afford to do so anymore. It is particularly interesting to observe that a not insignificant number of PE investors who used to rely on the GP community or the fund of funds community to manage their PE allocation, have started to invest directly themselves. Good examples of these are family offices, pension funds and sovereign wealth funds.
This has meant that the competition for deals has become greater as has the competition for talent.
One area that has not performed so well is exits. The value of PE exits in 2019 was well down on 2018 and 2017 and was in fact the lowest it has been since 2013. When looking at the exit routes used, secondary buyouts still account for a significant proportion of them although trade buyers were also pretty active. The IPO markets however were not a happy hunting ground for exits. 2019 saw only 29 companies exit to public markets, registering the lowest IPO value and volume figures since 2012.
We have referred in the past to the seemingly ever-increasing demand for talent in this sector which shows no signs of abating. This can only push up the salaries and the packages generally of the investment professionals, particularly at the senior associate and investment director levels. Our 2019 survey indicated that salary and bonus levels were again on the rise, particularly for the middle and more junior ranking professionals and the expectations were that this would be happening again come 2020.
But one other area that PE fund managers may need to be looking at is the way that their long-term incentive plans are structured. There does seem to be evidence that the industry is moving towards a longer typical holding period for their portfolio investments than used to be the case. This is particularly true for those pension funds, sovereign wealth funds and family offices who have chosen to become direct investors in their own right. These types of investors tend not to be so concerned about internal rates of return (“IRR”), but more about cash on cash money multiples and in some cases yield as well.
We have heard about some, and seen one or two first hand, carried interest plans that have been adopted recently, that have set their hurdle as a money multiple hurdle rather than an IRR hurdle. This type of hurdle we believe is better suited to a PE investing business where the expectation is for longer term hold investments. There are other attractions to this type of hurdle in a carried interest plan. The methodology of calculating the hurdle and its likelihood of being achieved is more transparent and easier to communicate to participants. The way the catch up mechanism works is also much more straightforward with this structure of hurdle. We are envisaging that more and more carried interest plans will have this type of hurdle going forward.
For further information contact Nigel Mills.
- January 13, 2020
Annual Conference sees the GECN emerging as a stronger independent global compensation and governance adviser
The sixth Annual Conference of the Global Governance and Executive Compensation Group (GECN) took place in Zurich from 6 to 8 January, hosted by Swiss-based group member, HCM International.
The GECN is a group of five independent advisory firms specialising in executive compensation and corporate governance. It comprises 95 professionals operating from nine offices globally (www.gecn.com). GECN member firms have offices in Los Angeles, New York, London, Kiev, Geneva, Zurich, Singapore, Melbourne and Sidney. MM&K represents the GECN in the UK.
Key topics discussed were how to co-ordinate and optimise leverage of the wealth of knowledge and consulting experience that resides within the GECN to add value to clients globally. Good progress has been made over the past year, as evidenced by the increasing number of global projects won by GECN member firms working together.
The GECN adds value globally through objective, tailored advice and implementation provided by high-quality independent professional firms. The advice provided by GECN is supported by the Group’s data collection, research and analysis facilities.
In 2019, GECN interviewed 25 institutional investors and their advisors globally to gather information about the areas of corporate governance behaviours which are of most concern to them. Perhaps not surprisingly, ESG factors appear high on the list. The report of this research is available from Margarita Skripina
This year, GECN will look at the ways in which corporates globally have been tackling the issues raised by investors.