Is the European Commission planning to regulate European corporate governance practices? Last week, we highlighted the on-going sustainable corporate governance initiative, which is exploring options at the EU level. Karen Wauters of the Luxembourg Directors Assocation (ILA) believes its members must have a strategy in the face of this process.
While a key section of the EU’s current work to promote sustainability is around the greening of investment practices, the next phase toward the middle of this decade, will target social and governance considerations. The work on making boards act in a more sustainable fashion was kicked off in July with a consultation period, accompanied by the publication of a study by EY* ordered by the Commission.
This report caused a stir after it drew conclusions such as ‘there is a trend for publicly listed companies within the EU to focus on short-term benefits of shareholders rather than on the long-term interests of the company.’ It identified key problems, such as: ‘companies lack a strategic perspective over…sustainability risks and impacts’ saying this is reinforced by prevailing remuneration and board composition practices.
The report went on to list possible policy choices. Options A and B are non-legislative ‘soft’ measures such as awareness raising, communications, green papers, or going further by fostering national regulatory initiatives driven by recommendations. Yet option C would see ‘minimum common rules to enhance the creation of long-term value while ensuring a level playing field through EU legislative interventions’.
ESG aware
There has been criticism of EY’s methodology regarding how they sought to prove empirically that European businesses work in a short-term fashion. Yet Wauters said this is almost beside the point. ‘We need to focus on the issue at hand, and demonstrate that we support the goal of targeting long-term sustainability,’ she said. Indeed, she noted that businesses themselves recognise that there is a problem. She mentioned a recent intervention by Paul Polman, the former CEO of Unilever, who stated that only about 15% of boards are sufficiently ESG aware.
As for the way forward, Wauters calls for patience from decision makers. ‘This is a new area for businesses and it is taking time to build the competencies internally,’ she said. Yet the desire to make these changes is clear, given the shift in consumer demand towards the desire for greater sustainability from the businesses they buy from.
Regarding the discussion of whether soft measures or hard legislation is required, she called on legislators to consider how law can be overly prescriptive ‘rather than allowing businesses to react and deal with market pressures in a normal fashion.’ She pointed to examples of countries where codes of conduct are helping to drive change, such as the increase in diversity on boards.
Similar pressure could work in other directions too, she argued, particular regarding increasing transparency about board practices and policies. ‘We need to ensure that ESG is on the board agenda and questions are being asked of executives about this,’ she said. As well, having a dedicated sustainability subcommittee on a board would send a strong internal and external message about how seriously the company takes these matters. ‘Few entities have ESG committees, so this is something to be considered,’ she noted.
Ultimately Wauters believes boards need to be honest about the current situation, and then create effective, transparent processes as knowledge is acquired internally about this relatively new challenge. ‘It’s about building awareness, and then creating a linkage between that awareness and the specific risks faced by every company,’ she said. This message of building sustainability competencies can then be taken to EU and national policy makers, as well as customers. ‘Ultimately it is about transparency. If the processes and policies are in place, and we are open about this, then the public can decide,’ she said.
*Study on directors’ duties and sustainable corporate governance, DG Just/EY