Did you miss this year's edition of our ILA Directors' Day? You participated in one of the break out sessions but will like to know a bit more about the others?
We invite you to read the summary articles of the different sessions. Make sure you keep up with the latest news on corporate governance!
Social responsibility: how to make it happen
Becoming a demonstrably socially responsible businesses is the next frontier of the move towards sustainable business practice. Directors have a central role in setting the tone, argued Jaap Winter, a Visiting Professor of Corporate Governance at INSEAD in his presentation “The Duty of Societal Responsibility of the Board”.
Customers, employees and regulators are pushing back on the long-held teachings of Milton Freedman that maximising shareholder value is the key social responsibility of a corporation, Jaap argued. To some extent, embracing environmentalism now goes with the grain of these traditional nostrums of profit enhancement, because consumers and investors are increasingly demanding these safeguards. But how to approach the often less tangible goal of building socially responsible businesses?
“We need to understand and react to the consequences of our actions for society, for our staff, for our communities, for the climate,” Jaap said. He indicated three elements which could drive this process: a change in the director’s role, changing the company’s articles of association, and increased reporting on societal impact.
Executive and non-executive directors have a clear role to explicitly take societal concerns into account he said. “I think we need to ensure personal responsibility has its place in the boardroom, ensuring we are not just making analytical financial judgments, but including reflections on what we as human beings find important,”Jaap argued. In other words, the influence of human values has to gain weight on board culture by changing the outlook of key decision-makers.
Rewriting the purpose clause in articles of association clearly expresses the desire for a new view, and this can have an impact in how decisions are considered, he said. By setting the tone, it could change the nature of boardroom discussions, and may even have an effect on the composition of the board, leading to a need to bring in new expertise. “Ideally there should also be consequences on our executive remuneration systems,” he said.
When positive impacts on society result, these should be communicated, ideally after having been quantified. Jaap recognises that it is “hard to measure, and definitely hard to compare with others.” He suggests “qualitative reporting, as well as narratives about impact as we see it as a corporation.”The potential trap is that this could be reduced to corporate happy talk, so he recommended experimenting to increase the credibility of these messages. For example, “the opinions could be sought of those who actually feel the impact of what the corporation has done, and let them talk about it.”
Yet while recognising the difficulty of these avenues, a cultural shift among directors will help change trajectories. The coronavirus has demonstrated how corporations are part of society, particularly after state budgets and central banks were mobilised to keep businesses afloat. To reciprocate the favour, “the purpose of the corporation can be made much more explicit, to really integrate that with the concerns of society,” Jaap said.
Digital innovation: A vector of business sustainability?
Just as smart systems driven by artificial intelligence are revolutionising the efficiency of supply chains and production techniques, the same logic is being turned to achieving environmental sustainability. Martha Crawford, Dean of Welch College of Business and Technology pointed out that boards need the knowhow to align strategy to these changes.
Real time analytics of vast data sets producing valuable, instant insights enable practitioners to make better decisions in the real world. This is the essence of the move to the next generation “Industry 4.0” paradigm, Martha explained. “We're shifting from static to smart systems, and the key to this is big data,” she said.
Data collection and storage have become cheap and accurate, enabling the collection of substantial quantities of information. This can be analysed and visualised with ever greater levels of sophistication. “The machines actually communicate, and we're using advanced analytics to provide visualisation in real time,” Martha explained.
The impact on supply chains and production systems can be considerable. McKinsey has estimated that switching to automated, smart production can boost productivity in industry by a half. These techniques can be applied to nearly every activity in the public and private sectors.
There is also great potential for environmental sustainability. If by improving quality control, process control, upgrading supply and demand matching we reduce wasted raw materials and transportation effort, we take a clear step forward to reducing our environmental footprints.
Yet Martha had a warning. “If we are capturing new value from these technologies, then we also have to assume new risks and monitor them,” she said. Digital transformation brings in major operational and reputational risks. The technology can break down, it could not live up to its promise, and it gives greater opportunities for hackers.
Boards’ role then is to guide and advise management to anticipate, mitigate and manage these risks. To achieve this “boards must have a strategic view of how technology convergence and digital transformation will shape the company’s future,” she said.
“It doesn't mean that everybody on the board has to have the necessary technical ability, but in my experience, ideally you need two people,” Martha said. She noted that having one voice can be tricky as the technical person might find it difficult to fit the board culture, making it more difficult to start a conversation about these unfamiliar topics. Having herself a PhD in engineering and an MBA she can see both sides of this question.
Martha highlighted her experience on an audit sub-committee. She was appointed specifically to work on technical risk, yet this discourse ran counter to the experience of the rest of her colleagues who were finance specialists. Managing this culture is key to ensuring effective strategy.
Insurance governance up to the mark
“Do you agree that governance expectations in the insurance sector have trailed requirements in the banking and finance industry?” was the provocative audience question asked during the break-out session dedicated to insurance. Four experienced local professionals explained how this old perception is no longer relevant.
While recognising that some of the formal regulatory structures are not in place in his sector (there is no equivalent of the CSSF’s 12/552 circular for example), “the governance principles at most insurance companies are at the same level as the banking sector,” said Fernand Grulms, chair of Liberty Mutual Insurance Europe. Aude Lemogne, board member of AXA Wealth Europe agreed: “I can only speak from my personal experience, but at AXA governance is extremely well established, and this is driven by the parent company.”
Some context was provided by Jean-Michel Pacaud of EY and chair of the ILA Insurance working committee. “Insurance used to lag behind banking and investment funds in terms of corporate governance, but now in practice, all sectors are about to be at the same level,” he said. Pressure from stakeholders and peers had made up for the lack of formal requirements had been important. “So do we really need to have an equivalent of 12/552 for the insurance sector? Personally, I'm not so sure,” he added.
That said, Jean-Michel outlined how regulations do influence corporate governance practice in the sector. Although there is not even a recommendation in the insurance law about the need for independent non-executive directors, the law on the audit profession requires for a majority of the board audit committee to consist of independents.
Marc Hengen managing director of the Association of Insurance Companies (ACA) added that the main EU regulation for the sector Solvency II has a range of governance requirements. “For example, each board member has to sign a risk and solvency assessment of the company, as well as a solvency and financial condition report of the company,” he said. He also pointed to the increased prevalence of specialised board committees, for remuneration, audit and compliance. He also mentioned ACA’s governance code which was first published in 2010, and was updated this year to include social and environmental criteria.
Fernand pointed to the advantage of an approach which is not too prescriptive and burdensome. “Roughly 90% of our time is dedicated to monitoring, but directors also need to look forwards to the many challenges that lie ahead,” he said. He noted that he attended about 50 meetings last year, of which five were board meetings. “We get a lot of briefings on different subjects, like cybersecurity, climate change, and the launch new products.”
So does Luxembourg have what it takes to provide a couple of independent directors for each of the 85 or so insurance firms in this country? “We need a reservoir of people with the technical knowledge, but also others who can be outspoken and think outside the box,” said Aude. “I think we can definitely achieve that.”
Channelling startup innovation
For the innovation and drive of startups to produce long term value, often the steadying hand of an independent director can help. A breakout session chaired by Franck Willaime looked at these relationships from both ends, with a discussion between Ilana Devillers, CEO of the startup Food4All, and the experienced corporate governance practitioner Luc Sterckx of MTJA bvba.
Founded in 2017, the Luxembourg-based startup Food4All is making great strides in Luxembourg, and has international ambitions. Their app cuts food waste and helps less well-off shoppers find bargains. Retailers post information about their cut-price nearly-out-of-date food online, which results in them having to dump less old food. Food4All now works with seven supermarket clients and employs 15 people.
Early growth was driven by youthful enthusiasm and idealism, but Ilana came to realise she could benefit from some experience. “At first there weren’t too many processes, which worked fine at the start, but in the end we realised we needed more structure,” she noted. There was a need to process constructive feedback between the company, clients and end users, and internal roles and responsibilities also needed to be defined. They now have board advisers in Luxembourg and San Francisco, and their experience and networks are helping.
Making an early start to get systems in place is key. “Establishing good relationships between the founders and investors is very important,” Luc said. In particular he highlighted to need for quality reporting and other communication, as well as taking into account the points of view of the full range of stakeholders.
It is also important to mentor the entrepreneur to ensure they understand their priorities. “You can’t do everything you want to do at the same time,” Luc said. “Sure, keep developing and perfecting your product, but this can’t come at the expense of ensuring your innovations are generating cash. Cash isn’t king, as is often stated. Cash is emperor!” he insisted. Not only is it needed to keep the wheels turning, but it demonstrates the business promise required for subsequent funding rounds.
“I see many, many business plans and financial plans, and I always look for the sections detailing the cost for marketing and sales,” Luc noted, adding “but too often this has insufficient prominence”. He also mentioned how conflicts can arise between founders who often want to stay true to their vision, and investors who came in late. These days, it is also increasingly important to embed ESG into the startup’s operations from the beginning, as this too will assist with sales and financing over the short and longer term. A non-executive can provide this wider view, and Luc believes it is often best if they chair the startup board.
As for remuneration, the independent director will have more experience than the CEO, so Luc said it is reasonable that they should be paid more. This payment can come through share options, an annual fee or an attendance fee. However, for institutional investors, representatives of venture capital firms are most often paid by their employer.
ESG Considerations for Investment Fund DirectorsGreen investing is being embraced by Europe’s asset managers at a high pace, driven by regulatory and market pressure. Directors have been rushing to acquire the knowledge they need to ensure they can ask the right questions on compliance and meeting investor demands. A breakout session chaired by Daniela Klasen-Martin of Crestbridge took the temperature.
Decision time is just weeks away regarding the sustainable finance disclosure regulation (SFDR), noted Nathalie Dogniez of PwC Luxembourg, with the first deadline regarding reporting set for 10th March 2021. “The consideration of ESG risk is no longer an option, it is part of the asset manager’s duty,” she said.
Boards will need to be involved in the conversation of how to categorise funds. Article eight products are those where environmental or social considerations are an important element of the investment policy, while article nine products have the principal objective of delivering positive impact on environmental or social objectives. Alternatively, funds will take the article six approach of having no explicit green investing ambitions.
Once these decisions are taken then information about how these objectives are to be achieved will need to be communicated, as well as the likely impact of these choices on the value of the portfolio. These considerations will then need to be posted online and in the prospectus. Ensuring these assessments are correct and consistent could have long term implications on marketing and carries a degree of reputational risk.
“It is really important how the industry applies SFDR to ensure there are no problems passporting products into other European countries,” commented Laurent Van Burik of the CSSF. To help, given the short time-frame, the CSSF will implement a fast track procedure for the approval of revisions to fund prospectuses. Laurent mentioned a self-certification process, and a CSSF template which is due for publication soon.
As for future regulation, he said “it will be a topic which will keep us busy for the next couple of years.” Industry players and regulators will be watching closely and working to adapt over this period. “So the only advice I can give is watch this space,” said Laurent.
While noting the necessity of understanding the technical regulatory details, Jane Wilkinson of Ripple Effect pointed to the need for directors to get to grips with the nature of the ESG-investing mindset. She mentioned the plans at the University of Luxembourg for a certified executive education programme on sustainable finance, which is due to launch early next year. This accompanies the sustainable finance options which have recently been incorporated into the University’s finance and economics master’s programme. Jane also mentioned ILA’s sustainability training options.
This upskilling is necessary, because change is coming quickly. Natalie mentioned a recent PwC study which estimated that up to 57% of European funds will have ESG criteria by 2025. In this scenario, she noted that legacy products will have had to be repositioned. As well, a total of 77% investors said they intended to stop investing in non ESG European funds over the coming two years. “Do not underestimate the opportunity! Europe is ahead of the rest of the world. Let's capitalise,” she said
Communication the key for boards experiencing crisis
For many of us, Covid is the first major crisis of our professional lives, but for Luc Frieden it “is not that much different from others I have gone through.” He was Luxembourg’s finance minister during the September 11 attacks and the global financial crisis. Then as now, he said the key was to focus on the important decisions. Amongst other things, Luc is chair of the Chamber of Commerce and local bank BIL, and he stressed the need for internal and external communication and reassurance.
Crisis brings to the fore the eternal question of the extent to which boards should intervene with management, noted the session chair and ILA board member Monique Bachner. Luc said the first step was to hold sufficient meetings to ensure that every board member has full access to the information they need. This was a particular concern for the BIL, with questions such as whether and how to grant moratoriums on loans; decisions which are of potentially systemic significance. But Luc is clear about this personal view on this matter: “I'm a chairman who has an expansive view of my role as chairman, which involves being a coach and a strong supporter of the CEO, and this is because I feel responsible.”
“It's human nature at the beginning of a crisis to want to step in,” noted Karen Wauters chair of the ILA Board Organisation and Effectiveness Committee. As a board member herself she “appreciated that we had more frequent meetings, with information which was often particularly well prepared.” She found the result to be productive, concise and clear discussions, the nature of which took away some of the pressure to intervene with management. Rather, the board felt better able to provide the necessary mentoring role for under-stress executives.
Communication with other stakeholders is equally important. Luc pointed to greater intensity of dialogue with the regulator, and the need to work with the main Chinese shareholder when discussing support to the Luxembourg economy. He was satisfied with how this worked. This contrasted with the not-for-profit sector, where Karen said the lack of ability to meet the full range of stakeholders at events could not be compensated for online.
As for the future, the pair believe that we will be living with the after effects for a while to come, and that boards will need to react. Luc forecast that it would take four to five years before life fully returns to normal, hence the importance of ensuring strategy is adapted accordingly. Karen agreed there would be change, and she called for a realistic approach. “It's important to look at things as they are and base our plans on that reality, and not on what we hope it would be.” In an online poll of the Directors’ Day audience, 40% said they have changed strategy in light of the crisis, but to the 20% who said they had not even discussed the matter, these words should be a wake-up call.
Claude Marx, Director General of the CSSF, on Covid 19, Brexit, the regulatory outlook and more
A review of the state of the financial sector and its regulatory situation, given by Claude Marx, Director General of the CSSF, in interview with Carine Feipel and John Li brought the conference to its traditional conclusion. Mr Marx touched on the following topics impacting the Luxembourg financial sector:
• COVID 19 Pandemic
• Key findings from on-site inspections:
o the importance of having robust and well documented governance procedures,
o strong minute taking,
o the need for on-going training
o board attendance
• The board’s role on AML
• Plans for the reform of the 12/552 circular
• The importance of having independent directors on boards, and the role of specialised board committees such as audit, risk, nomination, and innovation
• On-going work to reform the long form report
• CSSF’s stance regarding European ESG regulations