What should we be looking out for as we embrace the new year?
After a year nobody could have predicted, 2021 promises more change. Corporate governance professionals need to be prepared to tackle post-Brexit issues for registrars, issuers and their EU resident shareholders, as well as its impact on intermediation and dematerialization. COVID-19 will continue to have implications for the way AGMs are managed, and ESG governance will come increasingly under the stewardship spotlight.
Here, I've rounded up some of the key areas governance teams need to look out for in 2021.
The Impact of Recent Changes: Brexit
We are just a month on from the 31 December 2020 Brexit date, and the only material impact so far has been to the way some regulated products are marketed. The removal of passporting rights means that UK firms' ability to market to EU customers has been removed.
Active promotion of share-dealing services and dividend reinvestment plans to those in the EU, therefore, has had to stop; firms can no longer offer these services in their literature to EU clients. What they can continue to do, is to invite non-UK shareholders to view potential choices (not all of which may be available to them, depending on jurisdiction) online, from where they can make their own choices without being actively marketed to.
Looking ahead, the fact that companies based in Ireland can no longer use Crest in London as their central securities depository will impact businesses there, with a new replacement product due go live in mid-March.
COVID Impacts
AGMs ' which have already seen huge changes in 2020 due to the pandemic ' also need consideration in 2021. The Corporate Insolvency and Governance Act expires on 30 March 2021 and cannot be extended further. Any change to continue to allow virtual or hybrid meetings without a change in company's articles would therefore demand new legislation ' something there is probably little government appetite or capacity for at the moment.
The question then arises; should organizations future-proof their articles to allow digital or hybrid meetings, or changes in processing, in future?
Companies face lots of decisions on this in 2021, and what happens beyond 30 March is currently unclear. Whether meetings are held via Zoom, behind closed doors, as webinars, or as a hybrid is something companies need to consider, with shareholder ' as well as business ' preferences needing to be considered.
A recent survey carried out in conjunction with the UK Shareholders Association found that 81% of shareholders are in favour of hybrid meetings, while 89% are against fully virtual ones. This significant support for hybrid meetings and those making some use of digital attendance ' in part driven by the ESG considerations of institutional holders ' is something companies need to consider.
The willingness of investors to get involved in AGMs via proxy appointments is increasing; figures show that in 2019, 50.1% of capital voted, while in 2020 this rose to 64%.
Proxy volume by digital channels has also increased, with 39% of proxies voting digitally in 2019, and 53% in 2020. Shareholders are becoming more engaged with issuer companies, and the potential to get involved electronically facilitates this.
The voice of the shareholder ' retail as well as institutional ' is therefore increasingly being heard when it comes to the evolution of the AGM. Companies that haven't changed their articles to allow hybrid meetings already may therefore want to consider this in 2021, even without legislative imperatives to do so.
Demat and Intermediation
Brexit will also have an impact on dematerialization. The original timeline for change would have seen any new security coming to market needing to be in dematerialized form by 1 Jan 2023; for existing securities, the planned deadline was 1 Jan 2025.
But since Brexit, the conditions contained within the Central Securities Depositories Regulation have not been implemented, and the implications of this are not yet fully known.
With the new central securities depositories coming into play on 12 March and the need to dematerialize from Ireland, the UK is still looking to have fully dematerialized system in place for 1 Jan 2023 ' although this will require significant work.
On intermediation and shareholder rights, the industry is awaiting findings of the intermediation study being carried out by the Law Commission, brought about by questions around:
Dormancy requirements may therefore be something else for companies to think about when considering how they might future-proof their articles.
Board Oversight of Climate and ESG Considerations
Brexit is one top-of-mind issue for governance teams. Climate and ESG considerations are another, with the Board increasingly interested and involved in decisions here. Disclosures around climate-related matters is a topic of increasing focus ' with board-level oversight of climate and ESG strategy central to this.
Key Drivers for the Focus on Climate and ESG
There are four main drivers for the momentum around climate and ESG:
The TCFD encompasses 11 reporting recommendations grouped under four themes: governance, strategy, risk management, and metrics and targets. It requires organizations to set out how climate change considerations have been embedded into strategy and systems, as well as into board and management roles and responsibilities.
On a related theme, in December 2020, the UK Financial Conduct Authority (FCA) published reporting requirements for commercial companies with premium listings on the London Stock Exchange; these companies now need to confirm in their annual report whether the report includes climate disclosures in line with TCFD; where these are published if not; or why they have not published them.
The FCA requirements operate on a 'comply or explain' basis; the Authority generally expects companies to comply immediately. In 2021, it is considering whether to move from this approach to mandatory disclosure.
In fact, many companies already need to consider these disclosures under existing rules, because the FCA recognizes that climate change risks and opportunities are considered financially material to many issuers' assets.
The rules do not currently apply to AIM companies, investment companies or standard segment companies ' but we expect to see consultations this year around extending similar disclosure obligations to a wider range of investors, including pension providers, asset managers and life insurers from 2022-25, with the scope extended to other listed and large private companies by 2022.
The first annual reports to comply with these rules aren't due until spring 2022. But that's no reason for complacency; climate-related reporting will be a key focus for the Financial Reporting Council in the meantime.
The FRC's thematic review on climate change, published in 2020, showed that more needs to be done on climate change reporting; while narrative reporting is common, it can be unclear how climate considerations inform strategy, decisions or the business model. And there can be a lag between this narrative and any consideration/disclosures in the related Financial Statement or notes.
The FRC is therefore encouraging companies to voluntarily report against TCFD and Sustainability Accounting Standards metrics this year, to meet the needs of investors and other users of annual reports.
The Council is also asking companies to make sure that where climate risks and uncertainties are material, these are clearly flagged in narrative reporting and properly considered in the financial statements and notes.
Investors provide a further area of pressure; pension funds and asset managers have been asking for improved climate disclosures for some time to reflect their own obligations, and have therefore been pressing for more information on climate considerations.
A paper and letter published by the Institutional Investors Group on Climate Change in November 2020 sets out investor expectations for accounts to be aligned with the Paris Agreement, reflecting the impact of net zero emissions by 2050, and outlines ways that investors can hold companies to account on this.
BP, Shell and some of the other companies that will be most impacted have started to do this; boards need to be prepared for this focus to extend to all companies, beyond only the largest polluters, before too long.
The IIGCC is also demanding auditor reassurance that accounts include this climate risk and are Paris-aligned. This connects to the last key driver here; audit reform. Action to implement the reforms proposed by the Kingman and Brydon reviews might see a requirement for enhanced viability and risk disclosures over the immediate, medium and long term.
What Does this Mean for Boards?
So, how prepared are Boards and CoSecs to deal with these climate-related requirements?
A recent Eversheds/KPMG report on corporate response to climate change showed that many are still on a steep learning curve. While 87% of executives surveyed understand climate-related risks, 74% believe board and management need some or considerable skills improvement to deal with these threats.
The 2020 Sustainability Board Report, meanwhile, analysed the boards of the 100 largest public companies from the Fortune 200. It found that the prevalence of sustainability committees and sustainability directors is growing ' but that still only 17% of directors have explicit sustainability credentials in their biographies.
This, it suggests, reflects either poor disclosure at best or, at worst, a paucity of sustainability knowledge at board level and a lack of desire or urgency when it comes to changing this.
Preparedness will differ from business to business, of course, and because the approach needs to be different for all company structures and circumstances, every organization would need to adapt any recommendations to their own needs. Nonetheless, there are some steps all organizations can take to sense-check their compliance with climate and ESG governance.
Sense-checking Governance Requirements
There are a few questions all organizations can ask themselves to check their own governance:
And pressure to comply is increasing; in 2021, Glass Lewis Proxy Advisory Reports for FTSE100 companies will flag a concern if the annual report doesn't clearly disclose board level oversight of ESG. In 2022, this will escalate to a recommendation to vote against chairs of boards that do not do this.
What Does Each Code Committee Need to Do?
Each of a company's committees should play a different role in supporting organizations' ESG approaches.
Any gaps in climate competence need to be addressed as a matter of priority, and every organization should consider what this means for them. Does this mean new recruits to the board? If so, what skills do they need? Does the board need a specific subject matter expert or should all board members look to increase their climate competence? What training is needed? Do you need an advisory committee, comprised of internal and/or external experts?
NomCos should think about building climate competency into their longer-term succession planning, for NEDs and board committees, as well as for the exec committee and pipeline. This is particularly important if one person is relied on as the main source of climate competence.
An incentive scheme based on Paris-aligned accounts might be one way to achieve this ' although this is recognized as being ambitious at the moment for most companies.
The Audit Committee Chairs' Independent Forum has produced a draft paper on this, which is worth looking out for once the final version is published.
The role of Directors
Of course, while these committees play a vital role, the onus shouldn't sit entirely with any one of these committees, or their Chairs; instead, Directors need to take responsibility for upskilling themselves on climate and ESG matters. Chapter Zero, a network created by NEDS for this purpose, is a good resource offering toolkits, thought leadership and webinars to help NEDS engage with the climate challenges they need to address.
Conclusion
Climate change financial matters have not always been high on board agendas; in the main, companies have reacted to external stimuli rather than being proactive, and have done the minimum required to comply.
But these demands are not going away ' they are growing, and will only continue to do so, as investors and regulators recognize that there is substantial Value at Risk from a failure to address climate and ESG challenges.
Hopefully the tips I've included here will help you not only to meet your obligations, but also to achieve real value by improving performance and reporting around ESG and climate change.
After a year nobody could have predicted, 2021 promises more change. Corporate governance professionals need to be prepared to tackle post-Brexit issues for registrars, issuers and their EU resident shareholders, as well as its impact on intermediation and dematerialization. COVID-19 will continue to have implications for the way AGMs are managed, and ESG governance will come increasingly under the stewardship spotlight.
Here, I've rounded up some of the key areas governance teams need to look out for in 2021.
The Impact of Recent Changes: Brexit
We are just a month on from the 31 December 2020 Brexit date, and the only material impact so far has been to the way some regulated products are marketed. The removal of passporting rights means that UK firms' ability to market to EU customers has been removed.
Active promotion of share-dealing services and dividend reinvestment plans to those in the EU, therefore, has had to stop; firms can no longer offer these services in their literature to EU clients. What they can continue to do, is to invite non-UK shareholders to view potential choices (not all of which may be available to them, depending on jurisdiction) online, from where they can make their own choices without being actively marketed to.
Looking ahead, the fact that companies based in Ireland can no longer use Crest in London as their central securities depository will impact businesses there, with a new replacement product due go live in mid-March.
COVID Impacts
AGMs ' which have already seen huge changes in 2020 due to the pandemic ' also need consideration in 2021. The Corporate Insolvency and Governance Act expires on 30 March 2021 and cannot be extended further. Any change to continue to allow virtual or hybrid meetings without a change in company's articles would therefore demand new legislation ' something there is probably little government appetite or capacity for at the moment.
The question then arises; should organizations future-proof their articles to allow digital or hybrid meetings, or changes in processing, in future?
Companies face lots of decisions on this in 2021, and what happens beyond 30 March is currently unclear. Whether meetings are held via Zoom, behind closed doors, as webinars, or as a hybrid is something companies need to consider, with shareholder ' as well as business ' preferences needing to be considered.
A recent survey carried out in conjunction with the UK Shareholders Association found that 81% of shareholders are in favour of hybrid meetings, while 89% are against fully virtual ones. This significant support for hybrid meetings and those making some use of digital attendance ' in part driven by the ESG considerations of institutional holders ' is something companies need to consider.
The willingness of investors to get involved in AGMs via proxy appointments is increasing; figures show that in 2019, 50.1% of capital voted, while in 2020 this rose to 64%.
Proxy volume by digital channels has also increased, with 39% of proxies voting digitally in 2019, and 53% in 2020. Shareholders are becoming more engaged with issuer companies, and the potential to get involved electronically facilitates this.
The voice of the shareholder ' retail as well as institutional ' is therefore increasingly being heard when it comes to the evolution of the AGM. Companies that haven't changed their articles to allow hybrid meetings already may therefore want to consider this in 2021, even without legislative imperatives to do so.
Demat and Intermediation
Brexit will also have an impact on dematerialization. The original timeline for change would have seen any new security coming to market needing to be in dematerialized form by 1 Jan 2023; for existing securities, the planned deadline was 1 Jan 2025.
But since Brexit, the conditions contained within the Central Securities Depositories Regulation have not been implemented, and the implications of this are not yet fully known.
With the new central securities depositories coming into play on 12 March and the need to dematerialize from Ireland, the UK is still looking to have fully dematerialized system in place for 1 Jan 2023 ' although this will require significant work.
On intermediation and shareholder rights, the industry is awaiting findings of the intermediation study being carried out by the Law Commission, brought about by questions around:
- Where we are on demat
- What intermediation is
- What SRD2 has delivered since it came into force in September 2020
Dormancy requirements may therefore be something else for companies to think about when considering how they might future-proof their articles.
Board Oversight of Climate and ESG Considerations
Brexit is one top-of-mind issue for governance teams. Climate and ESG considerations are another, with the Board increasingly interested and involved in decisions here. Disclosures around climate-related matters is a topic of increasing focus ' with board-level oversight of climate and ESG strategy central to this.
Key Drivers for the Focus on Climate and ESG
There are four main drivers for the momentum around climate and ESG:
- New Taskforce on Climate-Related Financial Disclosure (TCFD) reporting requirements
- Existing requirements and encouragement to act on this
- Paris alignment; and
- Audit reform
The TCFD encompasses 11 reporting recommendations grouped under four themes: governance, strategy, risk management, and metrics and targets. It requires organizations to set out how climate change considerations have been embedded into strategy and systems, as well as into board and management roles and responsibilities.
On a related theme, in December 2020, the UK Financial Conduct Authority (FCA) published reporting requirements for commercial companies with premium listings on the London Stock Exchange; these companies now need to confirm in their annual report whether the report includes climate disclosures in line with TCFD; where these are published if not; or why they have not published them.
The FCA requirements operate on a 'comply or explain' basis; the Authority generally expects companies to comply immediately. In 2021, it is considering whether to move from this approach to mandatory disclosure.
In fact, many companies already need to consider these disclosures under existing rules, because the FCA recognizes that climate change risks and opportunities are considered financially material to many issuers' assets.
The rules do not currently apply to AIM companies, investment companies or standard segment companies ' but we expect to see consultations this year around extending similar disclosure obligations to a wider range of investors, including pension providers, asset managers and life insurers from 2022-25, with the scope extended to other listed and large private companies by 2022.
The first annual reports to comply with these rules aren't due until spring 2022. But that's no reason for complacency; climate-related reporting will be a key focus for the Financial Reporting Council in the meantime.
The FRC's thematic review on climate change, published in 2020, showed that more needs to be done on climate change reporting; while narrative reporting is common, it can be unclear how climate considerations inform strategy, decisions or the business model. And there can be a lag between this narrative and any consideration/disclosures in the related Financial Statement or notes.
The FRC is therefore encouraging companies to voluntarily report against TCFD and Sustainability Accounting Standards metrics this year, to meet the needs of investors and other users of annual reports.
The Council is also asking companies to make sure that where climate risks and uncertainties are material, these are clearly flagged in narrative reporting and properly considered in the financial statements and notes.
Investors provide a further area of pressure; pension funds and asset managers have been asking for improved climate disclosures for some time to reflect their own obligations, and have therefore been pressing for more information on climate considerations.
A paper and letter published by the Institutional Investors Group on Climate Change in November 2020 sets out investor expectations for accounts to be aligned with the Paris Agreement, reflecting the impact of net zero emissions by 2050, and outlines ways that investors can hold companies to account on this.
BP, Shell and some of the other companies that will be most impacted have started to do this; boards need to be prepared for this focus to extend to all companies, beyond only the largest polluters, before too long.
The IIGCC is also demanding auditor reassurance that accounts include this climate risk and are Paris-aligned. This connects to the last key driver here; audit reform. Action to implement the reforms proposed by the Kingman and Brydon reviews might see a requirement for enhanced viability and risk disclosures over the immediate, medium and long term.
What Does this Mean for Boards?
So, how prepared are Boards and CoSecs to deal with these climate-related requirements?
A recent Eversheds/KPMG report on corporate response to climate change showed that many are still on a steep learning curve. While 87% of executives surveyed understand climate-related risks, 74% believe board and management need some or considerable skills improvement to deal with these threats.
The 2020 Sustainability Board Report, meanwhile, analysed the boards of the 100 largest public companies from the Fortune 200. It found that the prevalence of sustainability committees and sustainability directors is growing ' but that still only 17% of directors have explicit sustainability credentials in their biographies.
This, it suggests, reflects either poor disclosure at best or, at worst, a paucity of sustainability knowledge at board level and a lack of desire or urgency when it comes to changing this.
Preparedness will differ from business to business, of course, and because the approach needs to be different for all company structures and circumstances, every organization would need to adapt any recommendations to their own needs. Nonetheless, there are some steps all organizations can take to sense-check their compliance with climate and ESG governance.
Sense-checking Governance Requirements
There are a few questions all organizations can ask themselves to check their own governance:
- Do we have a specific committee with capacity and skills to take on climate/ESG matters? Or should our board take on this responsibility? Or should we create a new separate committee for ESG or risk? Only 22% of the FTSE 350 currently have a risk committee, and while this is mandatory for certain financial services companies, and of varying importance by sector to others, it is something that should be considered by all organizations. It's worth remembering that all directors have a duty to consider ESG as part of their responsibilities under section 172 of the Companies Act.
- Do committee terms of reference need to be updated to ensure they're clear on ESG/climate oversight?
- How will different committees stay aligned? ESG and climate matters span all Code Committees; co-ordination is therefore vital.
- Is sufficient time allocated to these matters in committee/board meeting agendas in 2021?
- Are responsibilities clearly set out?
And pressure to comply is increasing; in 2021, Glass Lewis Proxy Advisory Reports for FTSE100 companies will flag a concern if the annual report doesn't clearly disclose board level oversight of ESG. In 2022, this will escalate to a recommendation to vote against chairs of boards that do not do this.
What Does Each Code Committee Need to Do?
Each of a company's committees should play a different role in supporting organizations' ESG approaches.
- The Nomination Committee should consider whether climate risks and opportunities are sufficiently material to the business to be included in the directors' skills matrix. If there is no skills matrix, the committee should consider designing an appropriate one, tracking any gaps and using this to help with succession planning. Directors and CoSecs should ensure that their climate change/ESG skills and the contributions they can make are visible in their biographies.
Any gaps in climate competence need to be addressed as a matter of priority, and every organization should consider what this means for them. Does this mean new recruits to the board? If so, what skills do they need? Does the board need a specific subject matter expert or should all board members look to increase their climate competence? What training is needed? Do you need an advisory committee, comprised of internal and/or external experts?
NomCos should think about building climate competency into their longer-term succession planning, for NEDs and board committees, as well as for the exec committee and pipeline. This is particularly important if one person is relied on as the main source of climate competence.
- The Remuneration Committee should explore the place of ESG metrics in exec incentive schemes. Few companies have introduced this approach to date, and where they have, this can be short term. Although this could be seen as counter-intuitive to the long-term nature of climate change risks and responses, this short-termism can reflect the practical challenges in setting realistic targets ' challenges that have only been exacerbated by Covid.
An incentive scheme based on Paris-aligned accounts might be one way to achieve this ' although this is recognized as being ambitious at the moment for most companies.
- The Audit Committee currently does most of the heavy lifting in terms of ESG/climate reporting, partly as they tend also to be responsible for risk oversight, which climate reporting falls under. There are a few questions all Audit Committees should be asking themselves around the process:
- Are they satisfied that arrangements are in place for the company to meet new disclosure requirements on a timely basis?
- Do their monitoring/review activities show that the company's risk management systems are effective in identifying/assessing material climate risks?
- Has the resilience of the business to material climate-related threats been considered?
- Have climate risks, operations and strategic discussions been disclosed, and are they adequately reflected in the asset and liability valuations? What scenarios have been developed?
- Is the committee satisfied with the metrics and targets that have been chosen?
- And are they satisfied with the level of assurance they have over the integrity of reporting and data on climate matters?
The Audit Committee Chairs' Independent Forum has produced a draft paper on this, which is worth looking out for once the final version is published.
The role of Directors
Of course, while these committees play a vital role, the onus shouldn't sit entirely with any one of these committees, or their Chairs; instead, Directors need to take responsibility for upskilling themselves on climate and ESG matters. Chapter Zero, a network created by NEDS for this purpose, is a good resource offering toolkits, thought leadership and webinars to help NEDS engage with the climate challenges they need to address.
Conclusion
Climate change financial matters have not always been high on board agendas; in the main, companies have reacted to external stimuli rather than being proactive, and have done the minimum required to comply.
But these demands are not going away ' they are growing, and will only continue to do so, as investors and regulators recognize that there is substantial Value at Risk from a failure to address climate and ESG challenges.
Hopefully the tips I've included here will help you not only to meet your obligations, but also to achieve real value by improving performance and reporting around ESG and climate change.
