It’s the end of another pandemic year. As it closes, we face the daunting prospect of managing a third year overshadowed by Covid-19 and its cost to lives and business.
There has been huge upheaval for populations across the world as governments struggle to combat infection. Economies have been damaged, taken to breaking point, and continue to be undermined. That will go on into 2022, as administrations and health authorities adjust their thinking to deal with the omicron variant, almost certainly leading to more personal tragedy and greater economic trauma.
Business will have to continue; economies depend upon it. And it too will be transformed. But the pandemic will not be the only cause of evolution.
Governance in 2022 will see shifts to accommodate a range of other issues. Regulation, here in Europe, the US, and even the Far East is moving to embrace ESG (environmental, social and governance) factors. In the UK, 2022 should at last see significant reforms for auditors, and the London Stock Exchange will move to embrace dual-class shares.
Elsewhere, digital business models, cybersecurity, gender and ethnic minority representation, business and human rights, will make their mark. The 2022 governance agenda is brimming with issues to resolve.
EU regulation
Perhaps a good place to start is the much talked about regulation that should at last see some form of resolution in the coming year. Look at any jurisdiction around the world and it’s easy to find new laws waiting to hit the statute books, if only the policymakers can find agreement. From New Zealand to Japan and back to the US, codes or laws are under scrutiny and set to remould governance landscapes.
Among the most significant are moves underway in Brussels with the Corporate Sustainabilit Reporting Directive (CSRD) and Sustainable Corporate Governance Directive (SCG).
CSRD will bring non-financial reporting requirements to vastly more companies than before—up to 50,000—and impose mandatory assurance for those disclosures; a major change for many companies.
Alexia Perversi, a director at Mazars, says: “The CSRD contemplates common European sustainability reporting standards and mandatory limited assurance of reporting. Previously only some countries in the EU, including France and Spain, had implemented this requirement. What we are expecting is to see is for this to become mandatory across Europe.”
SCG is, perhaps, the more controversial piece of policymaking, introducing mandatory human rights and environmental due diligence for companies as they manage supply chains. Already delayed three times in 2021, campaigners have called on EU politicians to push ahead with the new laws, insisting they are urgent.
According to Johannes Blankenbach of the Business & Human Rights Resource Centre, SCG remains a “key ask” for the coming year. “One big hope is the trends towards mandatory human rights and environmental due diligence and corporate accountability legislation. It can be a game change for better outcomes for people and the planet across globalised value chains, if the legislation is bold enough.”
Mandatory climate reporting
In the UK political leaders have staked much on the mandatory use of the TCFD climate disclosure framework, set to become mandatory this year for listed and large private companies. Companies will also need to begin preparing their plans for transitioning to a “net zero” economy, expected to become mandatory in 2023.
Sarah Dunn, a corporate reporting expert at accountancy body ICAEW, says: “While some companies will already be reporting under TCFD, for example premium listed companies in accordance with FCA listing rules, the upcoming year represents a step-change and will be the start of a longer-term shift toward increased reporting on sustainability matters.”
The story of climate disclosures doesn’t end there. COP26 in Glasgow saw the launch of the International Sustainability Standards Board (ISSB), a project to develop global standards for non-financial disclosures. Chancellor Rishi Sunak has already pledged to adopt the standards—expected to take TCFD as a baseline—for UK companies when they’re ready. Next year will see a watching brief on those.
While sustainability policies grab the headlines, more mundane but no less controversial measures are planned in other areas. Companies, and especially their audit committee members, can expect 2022 to bring audit reform to a head after years of discussion following the collapse of Carillion in 2018. An audit white paper containing hundreds of proposals has been in circulation and hotly debated for much of the past year. It could bring a restructuring of audit regulation and the audit market, new rules for audit content and potential sanctions for audit committee members deemed to have fallen short. Most significantly, a new audit regulator should be properly launched (work has been underway for most of the year).
With the scope of audit reform potentially vast, experts, among them Maggie McGhee, executive director at ACCA, have been calling for a “phased approach” to change. But they also want the work be “stepped up” this year. She says that “getting the pace of change right is important because audit’s role is central to instilling confidence to the UK as a capital market. These are huge areas of business reform that need to be implemented with care.”
One other item to watch out for: the introduction of dual-class shares for premium listed companies on the London Stock Exchange. The Hill Review, published in March, recommended pushing ahead with differential shares as a means of encouraging big tech companies to list in London (Hong Kong, Singapore and the US) have all proved more attractive as destination for tech leaders). The debate has surged back and forth ever since but it looks as if 2022 will be the year when the measures will see resolution.
Board diversity
The end of 2021 brought some optimism on one key issue: the number of companies in the FTSE 350 with at least one board member from an ethnic minority has increased year-on-year from 59 to 123. That is good news, but it is still less than half of the membership, and most of those members are likely present in the FTSE 100. Even Sir Alan Parker, chair of the Parker Review examining ethnic minority board membership, said earlier this year that there was much work to be done.
Some have taken an aggressive stance. Investors have warned they will vote against nominations committee chairs that fail to improve ethnic diversity. But looming this year is the Financial Conduct Authority’s consultation on new disclosure rules for listed companies to report on the gender and ethnic composition of their boards and senior management as well as progress against diversity targets. (The targets, not mandatory, are 40% women on boards and at least one director should be “non-white”, following Parker.) Rules were expected this side of Christmas, but it looks like the timetable might slip to the New Year.
Many observers detect an increasingly closer link between diversity in the boardroom and the pursuit of a rock solid ESG agenda. As COP26 launched, campaign group the Sustainability Board Report revealed research that concluded women were driving the ESG agenda in many companies through chairing key committees.
This has not gone unnoticed elsewhere. Fiona Hathorn, chief executive and co-founder of Women on Boards, says it’s becoming clear that a good performance in one area of ESG, such as environment, is underpinned by a solid performance in areas such as culture, of which diversity is a core component. 2022 will see these lessons “embedded” in corporate governance requirements, she says.
“Investors are increasingly interested in diversity data, due to its close correlation with strong business performance,” says Hathorn. “We have seen in the past two years more countries, including the US, introduce and strengthen quotes for diversity on boards. I believe there will be more to come.”
And while there is some concern boards continue to struggle with acquiring the right knowledge to tackle climate change, many governance experts see 2022 as the year sustainability beds in as a core board discipline.
“Stakeholders will expect sustainability to be fully built into business models, product and service offerings with concrete evidence of action not rhetoric,” says Helena Wayth, founder and MD at consultancy A Bird’s Eye View. “Companies on the front foot will continue to mitigate risk while shifting investment to innovation and adaptation.”
She adds management should be expecting more challenge on their sustainability performance, bringing us back to diversity and boardroom skills. “Boards will be assessing whether they have the right composition, information, structure and oversight mechanisms in place to ensure sustainability is integrated across the board function, company strategy and short and long-term performance evaluation.”
And boards can expect investors to feel more confident across a range of issues, including ESG. According to Ali Saribas, an engagement expert with Squarewell Partners, ESG is now “better understood” by investors and “increasingly” integrated into investment and stewardship activities. Boards unresponsive to ESG concerns can expert more shareholder proposals and traditional activist investors could begin to “leverage” the issue in their campaigns.
However, complete understanding between boards and investors is not without its challenges. Boards may find it difficult to gauge their investors concerns because it is best understood through one-on-one engagement, says Saribas—even though it is “increasingly difficult to get airtime due to increased demand to engage”—or through voting policies which are kept intentionally “vague”.
Technology and cybersecurity
Whatever happens in the coming year, technology will play an increasingly important part: whether blockchain, artificial intelligence or simply using web platforms to connect with customers and suppliers, the pandemic has made sure of that. But business driven by IT raises its own concerns. Indeed, according to Andrew and Nada Kakabadse, professors of governance at Henley Business School, current forms of corporate governance may be rendered “inadequate”.
“Due to a widespread lack of knowledge concerning these technologies, information-based newcomers will largely escape market regulation and will instead exercise governance for their own benefit. This will ultimately end to exploitation of markets and people. The outcome will be greater insecurity, inequality and increased shareholder dominance.”
The solutions, they say, are improved boardroom knowledge and the “willing exercise of stewardship”.
Add to that concern cybersecurity. Early summer 2022 should see publication of the National Cyber Strategy, which should stress the need for government, business and academia to work together on cybersecurity.
Kamal Bechkoum, a cybersecurity expert at the University of Gloucestershire, says: “Cybersecurity is set to become an even greater governance issue in 2022 as many parts of the UK government begin tightening respective controls, while the courts are likely to set fresh precedents in terms of fines and penalties.”
US governance trends for 2022
No survey of the coming year is complete without casting an eye across the Atlantic to developments in the US. After the Trump years a markedly different approach has settled on the country under President Biden, not least with a consultation on the introduction of mandatory ESG reporting measures.
But there is much else in the world’s largest economy to occupy governance watchers. For Richard LeBlanc, a close of observer of US governance from his position as a professor at York University, Canada, improved reporting of a path to “net zero” is just one element. He’d also welcome mandatory diversity quotas for all listed companies, not just NASDAQ; mandatory engagement between boards and large shareholder with agenda’s publicly disclosed; sunset clauses on all dual-class shares; term limits for listed company directors; and measures to address executive pay through regulation of pay consultants and the highly contested area of “peer benchmarking”.
These are just a few issues. There are others. But LeBlanc is not holding his breath.
“What I would like to see, and what will happen are two different things,” he says. “The problem in the US is lobbying, that corporates can donate money to politicians and that states rather than the federal government control election laws.
“President Biden has a slim majority in the Senate and a majority in the House, but is still challenged by politicians at the edges who can hold up legislation. The US is a very different country than it was five years ago.”
Governance 2022: a multidimensional landscape
The ranks of governance issues queuing up for consideration in 2022 are numerous and diverse. And we haven’t touched on the ongoing and energetic campaign to establish “corporate purpose” and stakeholder governance as the dominant frame of thought for governance practitioners. In many ways, along with an associated drive to reform directors’ duties, they deserve an article of their own.
It’s no great insight to say governance is no longer dominated by questions of “compliance” with a few rules. That world has long since faded from view. It remains a feature but the governance landscape has become multidimensional, demanding new skills and knowledge. Adapting to ESG is seen by many as a paradigm shift in capitalism itself.
Climate, diversity in boardrooms and workforces, executive pay, dual-class shares, the role of technology and its associated risks, human rights and the long running thorny issue of audit will all play significant roles in the coming year. As will the uncomfortable process of adjusting to considering all stakeholders, not just shareholders.
Board members should make the most of the holiday season. Next year’s agenda may be the most exhausting yet.