Corporate Governance 2023

Governance: Balancing Good Regulation Against Excessive Regulatory Interference 

In order for any market to function efficiently and to operate properly for those who use it, there must be well designed, proportionate, clearly drafted and consistently applied regulation. Too little regulation fails to protect market users and risks undermining the reputation of the market as a stable investment environment. Too much regulation and an excessive governance burden stifle growth and may damage the market’s appeal, driving both existing and new companies to list on alternative markets or to seek alternative sources of investment.   

Achieving a balanced regulatory regime is a key issue for governments and their appointed regulators, and how they try to strike the right balance can be seen in the regulatory approaches adopted in different jurisdictions. Whatever approach individual regulators decide to take, the occurrence of seismic events, such as the COVID-19 pandemic and the Russian invasion of Ukraine, and existential threats, such as climate change, can fundamentally disrupt this balancing act.   

Climate Change: Assessing Companies’ Preparedness  

So long the elephant in the room, few can now credibly deny the threat presented by climate change. Corporates are expected to play a significant role in the drive to lessen the impact of climate change and regulators across the globe continue to work on initiatives to increase engagement by companies in the move to a greener future.  

The recommendations and recommended disclosures of the Taskforce on Climate-related Financial Disclosures (TCFD) have been endorsed by regulators in a number of jurisdictions. The work of the TCFD forms part of the basis for the new standards being developed by the IFRS’ International Sustainability Standards Board (ISSB), which have the potential to drive this harmonisation programme to the next level. This is providing a uniform platform against which companies’ contributions to climate change, their commitments to address this contribution, and progress against these commitments, can be assessed across jurisdictions.   

Measures, such as the UK government’s intention to introduce the mandatory disclosure of transition plans by companies and the EU’s adoption of the Corporate Sustainability Reporting Directive, highlight the importance of understanding the risks faced by, and the opportunities presented to, companies as they prepare for a more sustainable economy. Better quality disclosures help companies, investors and the broader community evaluate the contribution of companies to the climate crisis and the potential scope of their role in addressing this crisis.   

Embracing transparency in relation to green credentials however must not inadvertently encourage greenwashing by companies ‒ the misleading marketing of their environmental impact. In this regard, the work to create comprehensive "green" taxonomies to support sustainability disclosure requirements is of key importance. 

Diversity and Inclusion: Breaking Away From Groupthink 

For a number of years, conventional wisdom has been that diversity improves economic performance. See for example, the study by Boston Consulting Group published in 2018 which concluded that companies with above-average diversity amongst their management teams reported 19% higher innovation revenue as compared with companies with below-average diversity in their teams. Recognising the value of diversity in theory however is different from effecting diversity in practice. Regulators have been exploring in recent years how best to drive diversity and inclusion. Some jurisdictions have adopted formal quotas ‒ a recent example of this approach being the EU’s Gender Balance Directive (2022/2381), which was adopted in November 2022. The Directive requires member states to put in place implementing measures under which large EU companies listed on EU regulated markets will be required to have met prescribed targets by 30 June 2026 for the percentage of director and non-executive director positions occupied by the "underrepresented sex". 

The UK has adopted an alternative approach, seeking to achieve balanced boards through voluntary targets for gender and ethnic diversity. Previously, the attainment of these targets was monitored and reported on by two review boards but, with effect from financial years starting on or after 1 April 2022, listed companies themselves need to report against prescribed targets on a comply or explain basis in their annual reports and also include prescribed data relating to diversity. 

Russian Sanction Regime: Measures to Drive Compliance 

A number of jurisdictions (including the UK, USA and EU) have over the last year reinforced the sanction regimes adopted in respect of Russian entities and individuals in response to the ongoing Russian invasion of Ukraine. Ensuring compliance with these regimes is crucial to their effectiveness. Understanding who owns the economic benefit of trading counterparties is a vital tool for companies seeking to comply with the regimes and for governments seeking to enforce such compliance. To enable this understanding, in jurisdictions such as the EU and the UK, companies have been required to disclose the identity of those who exercise significant control over them. The UK has taken these transparency obligations a step further and now requires the beneficial ownership of overseas entities which own land or property in the UK to be disclosed on a register at the companies registry, Companies House.  

It is possible that, in contrast to sanction regimes which have been in place for some time with respect to other jurisdictions, the sustained spotlight on Ukraine (both in the media and in society as a whole) has helped keep companies focussed on the need for vigilance and continued monitoring of whom they are interacting with. The risk of penalties for breach being imposed on a strict liability basis, as is the case in the UK and the USA, also helps to reinforce the need for this vigilance and adds weight to arguments against attempts to circumvent the restrictions. 

Cost of Living Crisis: Are We All in This Together? 

Another issue which has dominated news coverage over the last year and which is, at least in part, linked to the war in Ukraine, is the global cost of living crisis. One of the many aspects which companies need to consider as part of their response to the crisis is directors’ pay. Whilst investors in an increasing number of jurisdictions are regularly involved in the process of setting executive remuneration (including for example through consultation on, and approval of, remuneration plans and share schemes), there is heightened attention on awards being made to directors. Against the backdrop of levels of inflation not seen in some countries since the 1980s, and associated calls for, or enforcement of, general pay restraint by governments and/or central banks, companies need to be mindful of how any increases in executive remuneration compare to pay rises being offered to the wider workforce. Companies have been called on by investor bodies to show restraint when setting executive pay and should anticipate dissent where they fail to do so. This in turn can create challenges in filling leadership roles where real global competition for talent applies.

Enhancing the Attractiveness of Public Markets 

As noted at the outset, the public markets in any particular jurisdiction are competing to attract investment against not only overseas public markets but also private capital markets. Various factors including the impact of the COVID-19 pandemic, the economic turmoil of the last 12 months and, in the context of the UK, Brexit, have led regulators to investigate how to enhance the attractiveness of public capital markets. Issues explored have included how to improve the speed, ease and costs involved in accessing public markets, without exposing investors to unnecessary risks or introducing obscurity in place of transparency. The UK government in particular has been engaged in a lengthy review process, with numerous workstreams being taken forward. This is often looked at through the prism of international competition between public markets. The bigger competition may in fact be between public and private market access to capital.

The activities in this area are reflective of the broader tension for governments to ensure that regulation in their jurisdiction operates effectively and does not create too great a regulatory burden. The goal should always be to embrace quality of regulation over quantity. It should be recognised that it is not the role of regulation to eliminate all investment risk but rather to create a fair and transparent market in which investors can participate. Good corporate governance is central to this aim and has the capacity to contribute significantly to flourishing markets, accessible to all.