The Institute’s latest Corporate Governance Conference, held at the JW Marriott Hong Kong on 14 September 2018, explored the need for a new governance model for a changed world.

‘Nothing,’ as the Keynote Speaker at the Institute’s latest Corporate Governance Conference (CGC) put it, ‘is what it used to be.’ The Keynote Address by Professor Mervyn King, Chairman, International Integrated Reporting Council (IIRC), set the tone for the day’s proceedings. This is the 20th year that the Institute has been holding its bienniel CGCs and over the last two decades the context within which businesses operate has changed dramatically. Most obviously, businesses are subject to much higher expectations of their environmental and social track records. Meanwhile, emerging technologies are rapidly transforming the way we live and work, disrupting many traditional business models but providing opportunities for start-ups in most sectors of the economy.

Under the theme ‘Corporate Governance – The New Horizon’, the Institute’s CGC 2018 looked at the impact of these changes on companies locally and globally.

Milton Friedman is dead

Milton Friedman, economist 1912–2006, famously believed that the only social responsibility of businesses is to increase profits for shareholders. These views landed him the Nobel Prize in 1976, but Professor King pointed out in his Keynote Address that markets globally have turned away from the Friedman approach, in particular renouncing the shareholder primacy model of corporate governance.

His presentation took aim at a number of assumptions underpinning shareholder-centric capitalism. Firstly, shareholders are not the owners of the company; they own shares in the company but the company, since the creation of the limited liability company in the 19th century, remains a sovereign person. The creation of the ‘ltd’ brought with it the assumption that directors should act in the interests of the putative owners of the company – the shareholders – and this myth of ‘shareholder primacy’ led to a business culture which equates corporate success with a rising share price, and which prioritises short-term profit for shareholders, often at a cost to society and the environment.

In this century there has been a growing recognition that the duty of directors is ‘to the company’s health not shareholders’ wealth,’ as Professor King put it. In tandem with this has been the emergence of a different approach to corporate reporting. Corporate performance and activities, in the traditional corporate reporting model, were seen solely through a financial lens. Corporate reporting was therefore only concerned with the financial health of the corporation over the previous year. He compared this backward-looking, myopic approach to driving a fast car with only rear view mirrors and no windscreen.

Since the financial crash of 2008, there has been growing momentum behind integrated reporting (IR). The IIRC was formed in 2010 and it published its IIRC Framework in 2013. The fundamental concept behind integrated reporting is that all organisations depend on a variety of resources and relationships for their success. These resources and relationships can be conceived as different forms of ‘capital’. IR encourages companies to report on six capitals – financial, manufactured, human, intellectual, natural and social.

Summing up, Professor King argued for a new approach to corporate governance focused on ensuring the creation of value in a sustainable manner. ‘The vision must be to have a company-centric governance model which moves away from yesterday’s primacy of the shareholder,’ he concluded.

Keynesian resurgence?

The first speaker in Session One of the conference, David Simmonds FCIS FCS, Group General Counsel, Chief Administrative Officer & Company Secretary, CLP Holdings Ltd, addressed the theme – Financial Performance: The Holy Grail? His presentation highlighted some positive role models for companies looking to adopt a more stakeholder-inclusive approach. The food company Danone, for example, has specifically renounced the shareholder primacy approach. Mr Simmonds quoted Emmanuel Faber, CEO Danone as saying: ‘The purpose of this firm is not to create shareholder value… it is to get healthy food to as many people as possible’.

Danone is not alone. Mr Simmonds highlighted the launch of the ‘B Corporation’ movement, which encourages firms to formally amend their constitutional documents to include responsibility to the community and planet in their objects clauses. He also looked at the proposed Accountable Capitalism Act in the US. US Senator Elizabeth Warren is proposing this new law that would require very large companies to acquire a federal charter (as opposed to the current state charter arrangements), which would come with specific obligations – in particular, the need to consider the interests of all corporate stakeholders, including workers.

So is the ghost of Milton Friedman well and truly buried? Are we seeing a resurgence of the ideas of Friedman’s arch nemesis – John Maynard Keynes (economist 1883–1946)? While there is a lot of evidence for this globally, Mr Simmonds was cautious about the extent of change here in Hong Kong. For example, despite supportive words in favour of including environmental, social and governance (ESG) issues in the corporate agenda, the reality on the ground for most firms is still very much in the old mode – the pursuit of profits for shareholders without much attention paid to the external costs to society and the environment.

He added, however, that corporate risk horizons are lengthening and this will be a powerful driver of change. ‘There is a clear advantage for companies who take a long-term approach. Once you take a long-term approach, the interests of stakeholders tend to align’, he said. Answering the question raised in the theme of his presentation, he suggested that as long as financial performance is ‘long-term and sustainable’ it can be considered the holy grail.

The rise of ESG

The disconnect between words and deeds when it comes to ESG was also addressed by the second speaker in Session One of the conference – Andrew Weir, Senior Partner, Hong Kong/Vice Chairman, KPMG China. Mr Weir highlighted the findings of a collaborative research project by the Institute, KPMG and CLP which surveyed 212 business executives of Hong Kong listed companies on their ESG strategies and practices. The resulting report, ESG: A view from the top, released on 13 September 2018, found that 88% of respondents to the survey agreed that ESG is relevant to their business, but only 41% of surveyed companies considered ESG to be a board-level discussion. Even more worrying, only 37% of surveyed companies have integrated ESG issues into their strategic planning. The report recommends that improving board oversight of ESG issues should be a top priority for firms.

‘Given that mandatory ESG reporting requirements for general disclosure and environmental key performance indicator (KPI) disclosures were enacted within the past two years – which are still at an early development stage – it is understandable that it will take time for companies to move further along the ESG learning curve and integrate ESG issues into their core business strategies,’ Mr Weir said.

In the meantime, he warned however, investor pressure for improved ESG performance will only increase. In the context of the growing sustainable investment market, for example, companies with a poor ESG performance are increasingly deemed to be ‘toxic assets’ by the market.

Shareholder engagement

In the context of the changes highlighted above, businesses’ relationships with shareholders are changing. Despite the shift away from shareholder primacy, shareholders remain a key stakeholder for companies and shareholder engagement expectations and requirements have extended beyond the responsibility of companies to maintain an appropriate level of disclosure. This was the focus of discussion in Session Two of the conference. The first speaker, Professor Frederick Ma Si-hang GBS JP, Chairman, MTR Corporation Limited, shared his views on how to get the dialogue with shareholders right. He put forth that the starting point should be a recognition that this needs to be a two-way dialogue and companies need to be conscious about changing shareholder expectations.

‘Shareholders are much more active than in the past and, in addition to financial returns, they are looking for good governance and social responsibility in companies,’ Professor Ma said. He also made reference to the 2018 annual letter to CEOs of public companies by Larry Fink, Founder, Chairman and CEO of BlackRock Inc, the world’s largest asset manager, that companies should know their own purposes, bearing in mind the good of the society as a whole. ‘To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society. Companies must benefit all of their stakeholders, including shareholders, employees, customers and the communities in which they operate,’ the letter states.

One of the toughest challenges in shareholder engagement, however, is how to balance the interests of different shareholders. Since the Hong Kong Government is a majority shareholder of the MTR Corporation, Panel Chair Professor CK Low FCIS FCS, Associate Professor in Corporate Law, CUHK Business School, asked Professor Ma how the company balances the interests of the government and retail shareholders. Professor Ma acknowledged that this is a tough challenge since those interests can be conflicting, for instance, in relation to the setting of and control over fares.

The tech challenge

As mentioned above, the dramatic changes to the social contract for businesses comes at a time of equally dramatic changes to the business environment brought about by new technologies. High-profile cyber attacks together with large-scale data breaches have made the market more knowledgable about rising IT risks, but how many businesses are taking the necessary precautions?

The second speaker in Session Two, Franklin Chen, Sales Director, Diligent Corporation, looked at some of the ways in which board practices are failing to keep pace with rising IT risks. He quoted the recent APAC Survey of Board Communications & Cybersecurity Practices which found that 80% of directors use personal email to communicate with fellow directors and management. The survey, which conducted 118 online interviews with board directors in October 2017, also found that 52% of directors keep confidential company information stored on their personal computer or devices.

These practices subject companies to high levels of IT risk, such as hacker intrusions, as well as malware and ransomware attacks. Mr Chen recommended that companies create a board-secure communication policy, implement secure governance software and secure all director communications. He also highlighted the importance of ensuring that the board has the necessary IT knowledge and expertise.

These issues were further explored in Session Three of the conference. Kenneth Wong, Partner, Risk Assurance Cybersecurity & Privacy, PwC, argued that there can often be a degree of naivety about what emerging technologies can achieve for companies. Adopting Cloud technology, for example, can reduce IT costs but can also open companies up to data residency, data security and access rights risks. Similarly, artificial intelligence (AI) is increasingly used by businesses, and while it may represent a game changer in some sectors of the economy, it is by no means error free. Mr Wong looked at some recent examples of where AI has been shown to be bias-prone and subject to unintentional and intentional manipulation.

New and emerging technologies are also transforming the regulatory sector and the conference was fortunate to have Julia Leung SBS, Deputy Chief Executive Officer and Executive Director, Intermediaries, Securities and Futures Commission, to discuss the key issues in ‘RegTech’. She started her Session Three presentation with a look at some of the ways in which technology is transforming the financial sector. The first virtual banks, for example, are set to open in Q1 2019 in Hong Kong. As new technologies are implemented, she stressed, maintaining high data governance standards becomes all the more important. She also emphasised the fact that regulation should remain technologically neutral. Since Hong Kong’s codes and rules date back to a face-to-face and paper-based era, they will need to be revised but the principles will not change. ‘The fundamental principles that underpin regulation will be the same in the new economy as they were in the old,’ she said.

The Institute’s Corporate Governance Conference 2018 was held at the JW Marriott Hong Kong on 14 September 2018.