Podcast transcript: Demystifying Stewardship for corporate boards

Hello and welcome to the podcast from EY’s UK Centre for Board Matters for Non-Executive Directors. I’m Justine Green, and our focus this time is Stewardship.

Investors’ expectations are changing fast and businesses must make important decisions to survive. To discuss the action needed now, we have a distinguished panel all joining the conversation remotely.

First, Catherine Howarth, CEO of ShareAction who promote responsible investment.

Hello Catherine.

Hello. Good to be here.

And Will Hutton Political Economist, former Principal of Hertford College, Oxford and co-chair of the Purposeful Company.

Hello Will.

Hello there.

Now Catherine set the scene for us. We are living in a time when investors’ priorities are changing.

Catherine Howarth

We certainly are. They are changing both because of the pandemic, which has kind of created a need for realignment and reassessment right across the global economy and certainly in Capital Markets. But that builds on sort of 10 years since the last great financial crisis of growing expectation not only by investors of companies, in terms of long-term focus on risks including environmental, social and governance related risks, but expectations of investors to be active owners, to be responsible holders of corporate bonds and shares and other asset classes such as infrastructure and property.

And in the UK, we’ve obviously just seen, at the beginning of the year, the launch of the new Stewardship Code. The UK was the first country in the world to launch a Stewardship Code 10 years ago. And 10 years on, the new code significantly ramps up the requirements on investors that sign up to the Code, and there is a much stronger focus, this time round, on environmental and social stewardship and oversight of companies’ performance, alongside governance which was always strongly in focus in the first code.

Justine Green

Will, what has been the UK’s record to date when it comes to stewardship and responsible investment?

Will Hutton

Well I think there has been some fantastic protocols and many C-Suites, but not all of them, talk this language. But actually, until quite recently, the kind of behaviours that you would want to see associated with all this talk were not really happening. I mean when push has come to shove in the end the old maxims about show the value maximisation above any other stakeholder interest and actually although it is nice to do things that are sustainable, or towards the community, a kind of genuflect towards a multi-stakeholder approach has been more conspicuous in the talk than the action.

But this last year or two or three, there has undoubtedly been a change. Unilever, for example, report that their brands committed to sustainability outsell their brands that don’t do that by 70%.

So, you know, people are picking up the marketplace and the workplace are reinforcing what the Corporate Governance and Stewardship Codes are requiring. And there is beginning to be, I think, a real change in the way British business certainly, and some European business, operates.

Justine Green

Catherine, you are a member of HM Treasury’s Asset Management Taskforce. What is the Government expecting in terms of Stewardship?

Catherine Howarth

Well the government obviously oversees the Financial Reporting Council for which it has issued the new Code. My observation is that multiple government departments have suddenly realised that this Stewardship business is actually very positive and they need to get behind it. So, the Department for Work and Pensions is really acting very strongly, within the government, to press this agenda and is requiring much stronger policies from pension schemes in this space, and then that filters down in terms of the pension schemes requiring stewardship policies of their own asset managers.

But Treasury is also deeply behind this now and they oversee the Financial Conduct Authority, which is the financial regulator with real teeth overseeing the Asset Management industry and the Insurance industry and other large institutional investors.

So my sense is that the government recognise just how important it is that institutional investors are taking a close interest in what companies get up to, that good stewardship can help to prevent, although will never completely eliminate the risk of embarrassing corporate catastrophes where large companies go bust and huge numbers of people are cast adrift in the economy and unemployed. The government are clearly very keen to avoid that but also sees the longer term upside.

Justine Green

And Will, when it comes to decision-making at board level, how much do you think the UK Stewardship Code 2020 will raise standards?

Will Hutton

I think that that very much depends on how the asset management and asset owner community, how kind of how seriously they take it. And signing the Code is voluntary not mandatory. You have to hold yourself to account. It is self-regulatory in framework so you’ll be reporting at the end of March 2021 to the replacement body of the FRC what you’ve done. All hangs in the balance I have to say. There are a number of asset management groups that take this very seriously. But I think if Charles Randall of the FCA was on the line I think he would back up everything that Catherine has said but he’d would say look you know there is a big gap still. There is a lot to be done and there are a lot of people, who frankly, talk the talk but don’t actually do it. But to re-emphasise, Boards are moving in the right direction. A lot depends on the Chair/CEO relationship and their willingness to bind as agenda. Once they do you get a long way.

Justine Green

Okay thank you both for the moment.

Stay with us and we’ll meet our remaining guests next.

So, joining us now is Jessica Fries Executive Chair of Accounting for Sustainability, who works with the finance community on creating a more sustainable economy.

Hello Jessica.

Jessica Fries

Hi.

Justine Green

And Loree Gourley, EY’s UK Regulatory and Public Policy Director.

Hello Loree.

Loree Gourley

Hello.

Justine Green

Jessica, looking outside the UK what response are you seeing to stewardship in other parts of the world?

Jessica Fries

What we see from the work we do with investors and companies globally are some very similar trends. So, the first one is that sense of values driving value. And you’ve really seen that happening globally. And I’d have said that a lot of other parts of the world are potentially behind Europe in terms of really shifting the focus and the pandemic has, if anything, reinforced that focus from the work that we have done. So that focus on purpose-driven decision-making. Trying to find a way that stakeholders, and a stakeholder mindset, is influencing and driving both strategy and decisions. And the investor community increasingly putting companies in the spotlight in terms of how they are managing to balance that full set of stakeholder interests in the decisions that they take.

Two other areas worth thinking about. One is absolutely around net zero emissions. You are seeing globally more and more governments committing to net zero emissions by 2050 in the build up to the COP26 Climate Agreement next year, in 2021. You’ll see more and more corporate and investor action. If I think of the asset owners we work with, more and more pension funds and indeed banks and others are thinking about what it means to commit to net zero emissions.

The third area that companies really should be thinking about on Boards is reporting. Again, you’ve seen globally more and more focus on the kind of information that companies need to report to their investors and huge global traction around a shift towards mandatory. So you’ve got the Taskforce on climate related financial disclosures that is going to be mandatory in most jurisdictions around the world in the pretty near future, inclusive of the UK.

Justine Green

And Loree would you say that the role of the Non-Executive Director has become even more important now?

Loree Gourley

Absolutely. I think even more important but also even more challenging. Because as Jessica has just spoken about these new disclosure requirements are much more strategic in nature. So, the Stewardship Code that came into effect has really encouraged us as managers and assets owners to move away from activity-based requirements, whether that be reporting disclosures of their investee companies or whether that be engagement. So, I think from a Non-Executive Director perspective they need to be able to challenge their respective Boards on what the outcomes are.

And one example that we have seen recently comes from Legal & General. And so they published an expectation. They wrote to all of their FTSE 100 company boards around an expectation relating to governance, so the ‘G’ of ESG. And that is an expectation and outcome that relates to appointing and hiring one non-white director by 1 January 2022. So this is the outcome that investors are seeking to see their Boards achieve, and I think from an NED perspective, they really need to be on top of these outcomes and the strategy that a Board is trying to achieve.

Justine Green

So Jessica, how important is it right now for companies to focus on ESG, Environmental Social and Governance, particularly Environmental?

Jessica Fries

It’s fundamental. So, in spite of some of the challenges that we are currently facing through the pandemic, or maybe even in part because of it, the focus on ESG has not gone away. If anything, for the investors we work with and I think across the whole investment chain, there has been increased focus. The ‘S’ of ESG, we’ve really seen an upping of the agenda across all different sectors. I think Loree has touched on a great example there. You’ve seen Black Lives Matter and a fundamental shift in expectations on what companies are doing on the Diversity and Inclusion side of things.

Recent focus from investors responding to a real societal shift means that you really can’t afford to sit back, and tackle one thing at a time. You really need to be getting to grips with the breadth of the different impacts and issues and, of course, there is that connection to performance. So you are seeing more and more investors releasing analysis that does underline that they see continued outperformance from funds that have stronger ESG characteristics and companies that have stronger ESG characteristics.

Justine Green

Loree, what are you hearing in terms of how Stewardship is now challenging Boards?

Loree Gourley

Well I think from a challenge perspective it’s that Boards understand not only these outcomes relating to the disclosures but also how they are going to engage with their investors, so the dialogue. So, those corporate boards that are able to articulate their purpose, as Will says, their strategy and their long term value creation activities, I think will be vitally important.

And I guess the second challenge from my perspective would be the Here and the Now. On this podcast we are talking about ESG issues and opportunities. But a challenge for Boards will be the Next and the Beyond. So, ESG are the first three, issues and opportunities and key priorities that are being accelerated.

Again, as Will said, by the external market, by regulation, etc, but it’s also about Boards understanding what next area of priority is. We know from investor disclosures of late, and expectations, that those relate to corporate strategy, capital allocation as well as human capital. So I think, in summary, the challenge for any Board, at this moment in time, is to satisfy the ESG Here and the Now but also be prepared for the Next and the Beyond and the emerging priorities of the investors.

Justine Green

Well thanks to both of you and do stay with us as we round off by looking at what needs to happen next.

Catherine Howarth and Will Hutton are still with us, along with Jessica Fries and Loree Gourley.

So looking ahead, what should Boards be doing now to prepare for the new post Covid investor? Let’s get your thoughts.

Catherine, start with you.

Catherine Howarth

Well I would encourage all Boards to take a very good look at the 2020 Stewardship Code, because if you want to anticipate what your big investors are going to be looking to you for, that is a really helpful piece of guidance. And you will see in the new Stewardship Code that you can fully expect more questions from investors on your company’s social and environmental performance, but also on innovation and other areas where investors increasingly need to understand the company’s resilience and potential for long term success.

Justine Green

And Will your thoughts on this.

Will Hutton

I think there is going to be a couple of litmus tests, post Covid. When we get back to some semblance of normality which will probably not be until the second half of 2021, and maybe even that is kind of optimistic, I think that people are going to take really hard looks at companies. They are going to want to know that they are walking the talk. I think it’s going to be very, very clear in some product markets. It’s going to be very, very clear when you take hiring decisions. And I think people are going to look at pay quite closely. We at the Purposeful Company have been advocating moving away from annual bonuses and long term incentive plans to actually paying over a five or seven year period in deferred stock, closely related to metrics, the kind of metrics that are going to be introduced which are really around long term value generation and respecting the agenda of this podcast.

Justine Green

And finally what the priorities right now for Boards to minimise risk when it comes to responsible stewardship? Loree?

Loree Gourley

To minimise risk, I think I’d go back to my point earlier that Boards need to be agile to respond to the current issues of today. The ESG, that we have discussed, but equally to respond to the emerging risks of tomorrow, particularly as companies respond and adapt to the radically changing economic regulatory and stakeholder environment.

I think the other risk that I would pose to Boards is that investors really have three levers to pull to drive change and Boards need to be prepared for this, Board members and NEDs alike.

Increasingly, the investors will name and fame good practices. So, they will publicly disclose good practices. Equally they will name and shame poor practices or those that are demonstrating insufficient disclosures or outcomes. So, that’s the first lever.

The second lever, the investors will actively exercise their votes. They will vote against re-election of Board members, again, if they are insufficient or inadequate in driving the outcomes desired.

And thirdly, and lastly, investors will move capital. We have seen that in the UK already when companies are not adequately responding to modern slavery and/or supply chain issues. So, I think that Boards need to prepare not only for today’s risks but also the risks of tomorrow and beyond.

Justine Green

And Jessica, your view on the priorities for reducing risk?

Jessica Fries

I’d agree with the points that Loree just raised there and maybe just underline one that even in the passive space we are seeing more and more of the asset owners really putting pressure on asset managers, inclusive of passive and indeed debt finance, to really think about what active stewardship in those areas might mean, albeit where there is a very different relationship between the fund manager and the company. So, using things like those routes on the reappointment of the Chair as a lever in that kind of space. So, almost making it personal as a way to exercise and have influence on the company and whether or not they are taking decisions towards this purposeful, sustainable direction.

The other thing that I would like to underline is that it is not just about the risk. So, if you are failing to think through what the opportunities are then that is of itself a risk. So, do think about the upside of these trends. Things like access to finance. We see more and more companies really looking at how they can issue sustainable fixed income, so bonds or indeed looking at debt, and ways to embed sustainability into some of their capital raising decisions. And there is a real opportunity there, as well as building an investor base that is may be broader than the current one, where you really are thinking about how you can demonstrate that sustainable value story, and having deeper longer term relationships with investors as a result.

Justine Green

Okay well thank you very much all of you for taking part in our podcast and for sharing with us your insight on this important topic. And if you found our discussion useful and you’d like to find out more please email neds@uk.ey.com.

So join us again soon for another episode and in the meantime from me, Justine Green, and all our guests thanks for listening and goodbye.

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