The new German Corporate Governance Code will increase the focus on corporate sustainability.

Background to the new Code

The German Corporate Governance Code was first published in 2002. It already included sustainability elements, but not as comprehensively as in the current drafts. The new Code, published following an extensive consultation process, will only come into force when it is published by the Ministry of Justice. Until then, the previous version of 16 December 2019 remains valid.

Key changes

The focus of the revised draft Code is ESG: environmental, social and governance. In addition, adjustments have been made based on the Financial Market Integrity Strengthening Act (FISG) and the revised Leadership Positions Act (FüPoG II).

The main changes are set out below.

ESG for the Executive Board

The focus on sustainable and social, ESG-compliant, corporate governance is already clear in the preamble. The executive board and supervisory board should take social and environmental factors into account in their management and supervision. This is in the interest of the company, because social and environmental factors have an influence on the company's success.

Recommendation A.1. of the draft 2022 Code shows how this can be achieved. The executive board, it says, should systematically identify and assess the opportunities and risks for the company associated with social and environmental factors, as well as the ecological and social impacts of the company's activities.

In addition to long-term economic goals, ecological and social goals need to be adequately taken into account in corporate strategy. Corporate planning should also include financial and sustainability-related goals. The aim of this is to ensure appropriate consideration of sustainable interests alongside economic interests. This is a weaker formulation than the previous consultation version of the Code, which still gave the impression of requiring an equal balance between sustainable and economic interests.

ESG for the supervisory board

The focus on sustainable and social corporate governance is also found in the recommendations for the supervisory board. Here, the government draft of 17 May 2022 is also more restrained. The comprehensive recommendation on the supervisory board's oversight and monitoring of sustainability aspects, included in the previous consultation version, has been removed. However, the supervisory board is also held responsible in the current draft 2022 Code:, which includes monitoring and advice by the supervisory board on sustainability.

Supervisory boards should have expertise on sustainability issues that are significant for the company in question (recommendation C.1 sentence 3).

The 'qualification matrix' (recommendation C.1 sentence 5) is new. The status of the implementation of concrete objectives for supervisory board composition members' competence profile must be disclosed in a qualification matrix in the corporate governance statement.

Finally, the supervisory board report should indicate how many supervisory board meetings and committee meetings have taken place virtually and how many on site (recommendation D.7).

ESG for internal auditing

Principle 4 of the draft 2022 Code provides for internal control and risk management systems and supplements these with internal monitoring for adequacy and effectiveness.

Sustainability will also become an issue for internal auditing in the future. The internal control and risk management systems should also include sustainability-related objectives (recommendation A.3). The internal control and risk management systems should be described in the management report (recommendation A.5) and include a compliance management system geared to the company's risk profile (Principle 5).

Adjustments for the Financial Market Integrity Strengthening Act

Principle 14 provides for the establishment of an audit committee (a new requirement added to the Financial Market Integrity Strengthening Act requires listed companies must establish an audit committee).

The audit committee members should include at least two financial experts: one accounting and one auditing expert. Here again there is an ESG impact: knowledge and experience in the audit of financial statements include knowledge of sustainability reporting and auditing (recommendation D.3).

Gender balance on board

For the composition of the boards, Principle 9 of the 2022 draft Code now also includes a minimum gender participation (as provided for by the Leadership Positions Act. According to Principle 9, the supervisory board must ensure the legally regulated minimum gender participation or set targets for the proportion of women on the board within the framework of legal requirements.

Recommendations for action

The 2022 Code is still in draft, but is not expected to change significantly now. As the comparison with the consultation version already shows, the focus is on ESG-compliant corporate governance.

Sustainable corporate governance is right and important: numerous investors have already recognised this. As envisaged in the last draft version, the 2022 Code will probably enter into force in the near future. The focus on ESG-compliant corporate governance will come, and so will the next compliance declaration, so if listed companies do not already have ESG-compliant corporate governance, these changes should be examined immediately and implemented internally.

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