This update presents our predictions, based on the current governance environment, and our recommendations on issues that should be important when preparing for the upcoming proxy season. This year's update takes into account comments made by representatives of institutional investors and governance organizations at a webinar we held recently, and provides guidance to help issuers navigate turbulent times.
Purpose: A meaningful umbrella?
When the Statement on the Purpose of a Corporation1 was released by the Business Roundtable a little over a year ago, its signatories could not have predicted that a once-in-a-century global pandemic was looming on the horizon. And yet, the timing of its statement could not have been more fitting, as in the context of the multi-faceted crisis, corporate directors will most likely have to demonstrate how, through executing a clearly stated purpose, they took into account the interests of various stakeholders.
This year, many clients are considering adopting their own statements of purpose, often in response to shareholder proposals. In thinking about their approach, issuers point out it is not always simple to translate their corporate purpose into words.2
Two main reasons underlie the "challenge" of drafting a statement of purpose. First, purpose is wide-ranging and variable notion – an umbrella – that encompasses broad subject matters such as environmental, social and governance topics (ESG), stakeholder engagement, business strategy, policy, and much more. Purpose statements should be adequately tailored to a corporation's specific industry, business and unique characteristics. The second challenge is that one must be wary of unexpected consequences when drafting a statement of purpose. Such a statement could be a powerful means to create an impact, but it can also generate liability if a corporation is unable to live up to its commitments.
Some authors and institutional investors have raised doubts about the real impact of statements of purpose.3 Some of them question the motivations of issuers and how serious they are about implementing such statements. They point to vague and boilerplate language used by some issuers, as opposed to customized, well-thought-out statements.
We understand that when considering how to vote on a shareholder proposal requesting an issuer to adopt a statement of purpose, most institutional investors and proxy advisors will look at existing policies and practices of the issuer. The fact an issuer has or has not adopted a statement of purpose will not in itself be determinative to the outcome of a voting recommendation. An issuer that can show there is substance behind its ESG policies and it is committed to implementing them will get shareholders' endorsement more easily than issuers with boilerplate statements.
Recommendation: Take the opportunity of the pandemic to re-assess your purpose or ESG policies, consider adopting meaningful objectives, and – most importantly – ensure they can and will be translated into concrete actions.
ESG becoming bigger and bolder
2020 will be remembered as a year of turbulent shocks that accelerated the focus on ESG issues. For many investors, a myopic focus on stock price and shareholder returns no longer suffices to gauge the overall value of a corporation. Rather, a more holistic conception of value is being favoured, with stakeholder governance increasingly viewed as central to an issuer's ability to compete and succeed in the long run.4
Employees Get Their Own Pillar – EESG
Many influential initiatives, including the Global Reporting Initiative,5 the Business Roundtable,6 the Sustainability Accounting Standards Board,7 and the Embankment Project for Inclusive Capitalism have identified human capital as a key driver of long-term value.8 Although already a growing focus for stakeholders under the ESG framework, the pandemic may have permanently enhanced the emphasis on employee concerns and human capital management (HCM), warranting its own pillar under an "EESG" rubric.
Against this backdrop, and coupled with the major impact the pandemic had on human capital, investors have increasingly been asking issuers to provide additional HCM disclosure through shareholder proposals. Once merely considered an HR or management issue, HCM is becoming well entrenched within the board's oversight responsibility with nearly 40 per cent of boards consistently discussing the topic at every board meeting and 79 per cent of directors saying their boards spend more time discussing talent strategy than they did just five years ago, according to recently published findings from a US-based survey spearheaded by the EY Center for Board Matters.9
In its 2020 stewardship priorities, BlackRock said that "[g]iven most companies identify their employees as their greatest asset, we expect boards to oversee human capital management strategies. [...] BlackRock will hold board members accountable absent some disclosure about the board's role in overseeing the company's HCM efforts."10
In this context, boards should make or reaffirm oversight of HCM and talent as a strategic priority. They should help their companies strategize for HCM challenges beyond the near horizon, and integrate information about human capital and talent across company communications. As investors increase their integration of EESG matters into investment processes, failing to effectively communicate your human capital strategy and progress may affect the reactions of investors and other stakeholders.
Recommendation: Review the HCM procedures and policies at your company and ensure oversight of HCM and talent is a strategic priority. Review your external reporting so as to adequately communicate your HCM initiatives and strategies.
Environment still central to ESG
While recent events may have permanently enhanced the focus on HCM and temporarily overshadowed other considerations, climate change and environmental sustainability issues remain a cornerstone of the ESG rubric warranting robust disclosure and corporate action. In fact, the increasingly pervasive climate and sustainability risks have become a tangible investment risk and investors have heightened expectations for their management and associated disclosure:
- In his January 2020 letter to CEOs, BlackRock's Larry Fink recognized climate change as a "defining factor in companies' long-term prospects" and further observed that "climate risk is investment risk." Fink emphasized that the asset manager would be "increasingly disposed to vote against management and board members when companies are not making sufficient progress on sustainability-related disclosures and the business practices and plans underlying them." According to Fink, "Climate change is invariably the top issue that clients around the world raise with BlackRock," often asking how they should modify their portfolios in response.11 Similar sentiments were expressed by State Street CEO Cyrus Taraporevala in his annual letter to board members.12
- ISS has recently clarified its 2021 Canadian and US voting policy guidelines making it clear that board members may face adverse voting recommendations should the proxy advisor determine, on a case-by-case basis, that the directors failed in adequately overseeing environmental and social risks. Not taking meaningful steps to increase the resilience of companies to climate change-related risks may be considered as an oversight failure.
- An examination of voting statistics among Russell 3000 companies reveals that climate-related investor concerns have had a meaningful impact on the 2020 proxy season. Not only has there been increased support for climate-focused shareholder proposals, but climate-related concerns are influencing the degree of support in director elections.13 We believe the same trend will be observed in 2021.
- During the 2020 proxy season, issuers listed on the S&P/TSX60 Index received 40 shareholder proposals related to ESG matters,14 with some companies having multiple ESG-related shareholder proposals on the ballot at the same AGM. Fifteen per cent of those proposals related to environmental matters. We expect to see an uptick in this trend.
- In response to investors, policymakers and other stakeholders' increased focus on economic and business risks posed by environmental threats, ISS published in March 2020 new climate-centered thematic voting guidelines for investors who wish to integrate a particular set of factors into their voting decisions. The guidelines apply globally (with a separate policy applicable to US issuers) and include a number of voting recommendations based on issuers' disclosure and climate-related performance.15
Recommendation: Keep yourself up to speed with climate change risks facing your organization and how these risks are being managed. Focus on your climate change risk disclosures.
Spotlight on Social Issues
During the 2020 proxy season, many shareholder proposals related to social issues. Among the S&P/TSX60 companies' proposals, seven (17.5 per cent) focused on these issues, including four pertaining specifically to human rights. We believe this trend will continue in 2021.
Overseas, the European Commission recently took the first steps towards a mandatory human rights due diligence law, by launching a public consultation on a sustainable corporate governance initiative requiring companies to, among other things, monitor, identify and assess whether their operations and business relationships cause or contribute to any human rights, environmental or governance risks. Companies would also have various reporting obligations. If formalized, this initiative could eventually apply both to companies incorporated or domiciled in a European Union member state and to foreign companies selling goods or services in the European Union market.
Recommendation: Review your company's supply chain and human rights risks oversight and get ready for more scrutiny.
Let's Compare Apples to Apples: Standardizing ESG Metrics
With ESG issues increasingly incorporated into investors' decision-making, it is only natural there have been ongoing efforts to develop standardized ESG reporting metrics to facilitate some degree of comparability. In recent years, several frameworks have been developed to disclose relevant data in a structured manner; many public companies worldwide currently disclose this information using frameworks developed by the Global Reporting Initiative, the Sustainability Accounting Standards Board and the Task Force on Climate-related Financial Disclosures, among others. Moreover, many institutional investors have publish`ed their own metrics or scorecards that they use to assess ESG strengths and weaknesses of the issuers in which they invest or have endorsed other frameworks in an effort to push for a consensus approach.16
However, most recently, the World Economic Forum's International Business Council, in collaboration with the Big Four accounting firms, spearheaded an effort to identify a core set of ESG metrics. The ultimate objective is to determine the basis for generally accepted standards that are akin to an ESG version of GAAP, so as to ensure reporting consistency across all industries and countries. The white paper published in late September 202017 draws from existing frameworks and includes 22 well-established metrics organized into four pillars, namely governance, planet, people and prosperity, alongside 34 expanded metrics that seem to be less well established in existing practice.18
Recommendation: Monitor "best practices" in terms of disclosing ESG data. If this is not already the case, familiarize yourself with the major voluntary reporting frameworks and consider their implementation, in light of the standardization trend.
Manage virtual and cyber opportunities and threats
Virtual AGM or Not... That Is the Question (and will be in a post-pandemic world)
While the number of "virtual-only" shareholder meetings (VOSM) has steadily increased in the United States over the past decade, the format has had a remarkably slow adoption in Canada until this year. Indeed, between 2017 and 2019, a total of six VOSM and seven hybrid shareholder meetings were held in Canada. Against this background, 2020 stands out with 312 VOSM and 21 hybrid shareholder meetings being held as at June 1. This represents a 7,800 per cent annual increase in VOSM, evidently prompted by concerns related to the COVID-19 pandemic.
Until the pandemic is fully under control, similar figures are to be expected. Looking ahead, however, it is likely these figures will initially decrease, albeit with an upward trend after a few years, as familiarity with virtual platforms grows among issuers and shareholders and as the offering of VOSM platforms facilitating such meetings expands (driving down cost in so doing). Statistics reported by Broadridge reveal that, on average, VOSM are shorter (the average length of a VOSM in the United States was 22 minutes in 2020) and more accessible to participants (59 shareholders and guests, on average).
This foreseeable upward trend will put pressure on regulators and other stakeholders to take a more cooperative and pragmatic stance on the issue. Historically, proxy advisory firms and many institutional investors have opposed VOSM out of concern they disenfranchise shareholders and unduly protect management and boards from addressing underperformance or other controversies.
Institutional investors and proxy advisors have, however, moved towards greater acceptance of VOSM in response to the pandemic, often under the condition that VOSM would be accompanied by adequate disclosure regarding how the issuer will safeguard shareholder participation rights. Glass Lewis has, for instance, indicated that VOSM occurring after June 30, 2020, should be preceded by robust disclosure on shareholder participation. This includes:
- addressing the ability of shareholders to ask questions during the meeting, including providing guidelines around what types of questions are allowed, and rules for how questions and comments will be recognized and disclosed to meeting participants;
- providing procedures, if any, for posting appropriate questions received during the meeting and the company's answers, on the investor page of a corporate website as soon as is practical after the meeting;
- addressing technical and logistical issues related to accessing the virtual meeting platform; and
- procedures to obtain technical support to assist with any difficulties accessing the virtual meeting.19
ISS in turn confirmed in November 2020 that its April 2020 COVID-19 Policy Guidance20 will continue into 2021 and be amended in due course. This means notably that ISS will not oppose VOSM, provided that issuers disclose the rationale behind choosing this format (social distancing requirements, etc.) and efforts are made to ensure full shareholder participation, including being able to ask questions and engage in dialogue with directors and senior management. Nonetheless, the guidance continues to encourage issuers to return to in-person or "hybrid" meetings (or to put the matter to shareholders to decide) as soon as safe and practicable.
Recommendation: As expectations regarding VOSM are formalizing and a set of ground rules is falling into place, issuers should consider adopting clear guiding principles for their VOSM.
Cyberthreats Not in Quarantine
Cybersecurity risks represent grave threats to investors and to capital markets.21 With more corporate activities such as annual shareholder meetings and board meetings beginning to shift into the digital realm, as well as the growing dependence on technology that permeates all aspects of business, board oversight responsibilities in relation to preventing, detecting, and responding to cyber incidents are more scrutinized by stakeholders. Disclosing the consequences of a cybersecurity incident and managing cybersecurity risks will increasingly be put under a microscope.
According to Canadian Securities Administrators (CSA) staff notices, cybersecurity risk disclosure should, as a general principle, focus on material and entity-specific information, and avoid>22 Readers should be able to distinguish one issuer from another, within the same industry or across industries, in terms of the level of exposure, the level of preparedness and how the risk impacts the issuer.
Regarding cybersecurity incident disclosure, the CSA recognizes there is no bright-line test and the quantitative or qualitative threshold at which a cybersecurity breach becomes material may vary between issuers and industries. However, issuers should address in any cyberattack remediation plan how materiality of an attack would be assessed to determine whether and what, as well as when and how, to disclose in the event of an attack>23
Recommendation: Periodically monitor and review management's cybersecurity risk assessment, mitigation strategies, as well as related corporate disclosure.
Diversity and inclusion: The road ahead
Since January 1, 2020, all public companies incorporated under the Canada Business Corporations Act (CBCA) must disclose, among other things, if they have a diversity policy for their board of directors and senior management, if the policy includes targets for the representation of four "designated groups" (i.e., women, Aboriginal peoples, persons with disabilities and members of visible minorities) and statistics on the representation of these groups.24 Our review of the "enhanced" diversity disclosure of 199 CBCA-incorporated issuers – 21 of which are listed on the S&P/TSX 60 Index – reveals a number of interesting findings.
Whether they are governed by the CBCA or not, companies are increasingly coming under pressure to develop and disclose effective diversity and inclusion policies, with stakeholders such as institutional investors and other investor groups clarifying their positions on the topic.25 More recently, ISS also updated its voting guidelines on board diversity and, in doing so, significantly raised its standard. Thus, effective February 1, 2022, ISS will generally withhold votes for directors responsible for board nominations if (i) the issuer's board gender diversity is sub-30 per cent and (ii) the issuer has not disclosed a formal written gender diversity policy, or the issuer's formal written gender diversity policy does not include a commitment to have at least 30 per cent women on the board over a reasonable timeframe.26
Moreover, as of February 2022, ISS will generally recommend voting against the chair of the nominating committee (or other directors as appropriate) of companies in the Russell 3000 or S&P 1500 indexes where there are no identified ethnic or racially diverse board members. The presence of a racial and/or ethnic minority member on the board at the preceding annual meeting and a firm commitment to appoint at least one racially and/or ethnically diverse member may constitute mitigating factors under the policy.
A paradigm shift will likely be seen in 2021 as companies' efforts in fighting racism and investing in visible minority talent are increasingly valued by investors. Initiatives in this area are numerous and include:
- In June 2020, Business Roundtable chairman Doug McMillon established a Special Committee to Advance Racial Equity and Justice to promote broad economic opportunity and mobility, focusing on public policy solutions and corporate initiatives in areas such as health care, education and finance.27
- In July 2020, the Canadian Council of Business Leaders Against Anti-Black Systemic Racism launched the BlackNorth Initiative, "challenging senior leaders of Canadian companies to sign a CEO pledge and committing their organizations to specific actions and targets designed to end anti-Black systemic racism."28 To date, over 300 organizations have signed the pledge, including 30 per cent of the issuers listed on the S&P/TSX 60 Index.29
Beyond the diversity imperative lie the crucial issues of inclusion. Hence the idea that corporations should not strictly focus on statistics, but also on ways to make diverse employees and board members feel their opinions are heard and result in specific actions.
Recommendation: Provide extensive and accurate disclosure on your diversity practices. Partner with management to ensure the company's goals, culture and actions are consistent with principles of inclusion.
Compensation in the spotlight (and even more so during the pandemic)
We have been regularly reminding clients to keep in mind the "5Ps" of executive remuneration when designing or reviewing their compensation mix. While all these remain as crucial as before, with the COVID-19 disruptions, the necessity to render the compensation package "Pandemic-adapted" has expanded our list.
Our initial "5Ps" can be summarized as follows:
1- Policy infrastructure (use a mix of compensation tools that support your strategy, implement minimum equity requirements for executives, double-trigger provisions for change-of-control payouts, clawback policies, etc.);
2- Performance-based awards (align total compensation with performance);
3- Peer-adjusted package (take into account horizontal benchmarking – i.e., compare compensation figures to companies of similar size and scope, or related industries);
4- Proportionate (do not lose sight of vertical benchmarking and internal pay equity perceptions – i.e., CEO compensation is not disproportionate compared to its direct reports and average compensation of employees);
5- Problematic awards (i.e., avoid paying overly generous severance packages and special awards, especially if recurrent; justify any special payment).
The sixth "P" requires a careful balancing act:
6- Pandemic-adapted practices (you will be judged by how you adapted to the pandemic).
Boards of many issuers are expected to materially revise executive short-term incentive plan performance metrics applicable to upcoming financial years in light of the pandemic and the possible ensuing recession so as to make these better adapted to issuers' new realities. ISS has been encouraging issuers since April 2020 to progressively disclose the rationale behind any such adjustments, so as to permit investors to assess these in their context.30
Long-term performance plan adjustments may be more problematic as their performance periods span longer periods of time and midstream changes are often not viewed favourably by proxy advisors. Long-term incentive plans typically provide directors with the power to exercise their discretion and waive or revise certain metrics for unvested grants. Undoubtedly, such discretion is essential to boards in times of crisis. However, complete and timely disclosure explaining the reasons motivating its exercise is crucial and will guide proxy advisors in their voting recommendations in that respect.
Recommendation: Don't lose sight of the 6Ps in your compensation design and policies. Bear the increased scrutiny in mind and ensure any changes are reasonable and appropriately and accurately explained.
CBCA amendments – current status
The following table provides the current status of various governance requirements set forth in recent amendments to the CBCA applicable to "distributing corporations" (reporting issuers):
Fiduciary Duty of Directors & Officers
|Status||New Requirements Applicable to "Distributing Corporations" (Reporting Issuers) Pursuant to Amended CBCA||Comments|
|In force since June 21, 2019||
|Status||New Requirements Applicable to "Distributing Corporations" (Reporting Issuers) Pursuant to Amended CBCA||Comments|
|In force since January 1, 2020||
Well-being & Remuneration Disclosure and Mandatory Say-on-Pay Vote
|Status||New Requirements Applicable to "Distributing Corporations" (Reporting Issuers) Pursuant to Amended CBCA||Comments|
Election and Appointment of Directors
2 See for instance our bulletin: https://www.nortonrosefulbright.com/en/knowledge/publications/c49f77f5/directors-fiduciary-duty-in-a-pandemic-you-need-a-protocol
3 See for instance: L. Bebchuk and R. Tallarita, Was the Business Roundtable Statement Mostly for Show? – Evidence from Corporate Governance Guidelines, available at: https://corpgov.law.harvard.edu/2020/08/18/was-the-business-roundtable-statement-mostly-for-show-2-evidence-from-corporate-governance-guidelines/
4 The world's 120 largest companies CEOs stated in the 2020 Davos Manifesto of the World Economic Forum that "[a] company is more than an economic unit generating wealth. It fulfills human and societal aspirations as part of a broader social system. Performance must be measured not only on the return to shareholders, but also on how it achieves its environmental, social and good governance objectives" (https://www.weforum.org/agenda/2019/12/davos-manifesto-2020-the-universal-purpose-of-a-company-in-the-fourth-industrial-revolution/)
See BlackRock, BlackRock Releases 2020 Stewardship Priorities for Engaging with Public Companies, https://www.blackrock.com/corporate/newsroom/press-releases/article/corporate-one/press-releases/stewardship-priorities See also https://corpgov.law.harvard.edu/2020/06/30/human-capital-management-the-mission-critical-asset/#more-130679, https://corpgov.law.harvard.edu/2020/05/24/human-capital-key-findings-from-a-survey-of-public-company-directors/
14 We compiled a total of 27 proposals related to corporate governance and executive compensation, 6 proposals pertaining to environmental matters and 7 proposals on social issues.
22 See CSA's Staff Notice 51-347. See also Staff Notice 11-326 Cybersecurity, Staff Notice 11-332 Cybersecurity, Staff Notice 33-321 Cybersecurity and Social Media, Staff Notice 11-336, and Staff Notice 11-338.
23 See Staff Notice 11-332.
25 See for instance: https://www.cdpq.com/sites/default/files/medias/pdf/fr/politique_exercice_droit_vote_fr.pdf;
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