By Mak Yuen Teen

On August 26, SGX Regco released two consultation papers, one on enhanced rules on climate and diversity, and the other on a common set of core environmental, social and governance (ESG) metrics to be disclosed by companies as a starting point. My overall view is that the enhanced rules on climate and diversity are a positive step forward but may simply result in fancier boilerplates, and the common set of core ESG metrics proposed may be counter-productive.

Let me first touch on the issue of diversity. SGX Regco is consulting on the following questions:

  • Do you agree that issuers must set and disclose their board diversity policy in their annual reports?
  • Do you agree that gender should be an aspect of diversity encapsulated within issuers’ board diversity policy? What other aspects, if any, must be mentioned?
  • Do you agree that issuers’ disclosure in their annual reports on their board diversity policy must contain targets for achieving the stipulated diversity, accompanying plans, and timeline for achieving the targets?
  • Apart from targets, accompanying plans and timeline for achieving the targets, what other component, if any, must be part of the issuers’ disclosure on their board diversity policy?
  • Do you agree that issuers should be required to disclose in their annual reports as part of the board diversity policy, how the combination of skills, talents, experience and diversity of directors on the boards serve their needs and plans?

Another small step forward on diversity

SGX Regco is essentially taking up a notch what is currently in the 2018 Code of Corporate Governance on board diversity, by making certain disclosures mandatory.

Principle 2 of the 2018 Code currently states: “The Board has an appropriate level of independence and diversity of thought and background in its composition to enable it to make decisions in the best interests of the company.”

Provision 2.4 expands on the principle and says: “The Board and board committees are of an appropriate size, and comprise directors who as a group provide the appropriate balance and mix of skills, knowledge, experience, and other aspects of diversity such as gender and age, so as to avoid groupthink and foster constructive debate. The board diversity policy and progress made towards implementing the board diversity policy, including objectives, are disclosed in the company’s annual report.”

Practice Guidance 2 fleshes this out further as follows: “The Board is responsible for setting the board diversity policy, including qualitative and measurable quantitative objectives (where appropriate). It may charge an appropriate committee (such as the NC) with the task of setting these objectives for achieving board diversity, and reviewing the company’s progress towards achieving these objectives.”

Process is more important than diversity targets

I have long been an advocate for improving diversity on boards, including gender diversity. A report in the Business Times on June 21, 2008 titled “Board Makeup of Singapore Companies Lack Diversity” quoted me as saying that “companies here have not tried hard enough to look for women directors. It cannot be that there are no women with the required skill sets, just that the board hasn’t tried hard enough or have used the usual network to recruit directors.”

I added: “I wouldn’t start with diversity from the perspective of gender/race… [but] if boards have proper processes for searching for the best candidates, then I don’t see why more boards should not have more women and other minorities…I wouldn’t necessarily rule out an all-male, all-Chinese board if there is a proper search process. …But most companies don’t have proper search processes, and end up with all-male, all-Chinese boards.”

In 2008, as then chairman of the committee for the Singapore Corporate Governance Awards organised by the Securities Investors Association (Singapore), I recommended  the introduction of a new board diversity award. I said: “We didn’t specifically identify gender as a criterion but I wouldn’t expect a board with no female to win the award.”

In an article “Ad-hoc Way in Picking Directors Keeps Women Out” (Business Times, March 11, 2011) I wrote: “The most important reason [for lack of female directors], in my view, is the ad-hoc approach followed by many companies when it comes to appointing directors. When recruiting managers and employees, companies often go to great lengths to identify potential candidates and find the best one. They often have little hesitation in spending money on advertising or head-hunting. Few companies would ask their managers to just use their personal networks – perhaps bring in their mahjong kakis – to fill positions. They know that doing so will ultimately harm the performance of the company. Not surprisingly, we find much better gender diversity in the general workforce, and increasingly even in fields that used to be dominated by men.”

I went on to say: “But when it comes to the boardroom, the incentives for finding the best talent are not so clear. An important role of the board is to provide oversight and safeguard the interests of the company – and to provide checks and balances on the actions of controlling shareholders and senior management. Controlling shareholders and senior management may not see this as in their best interests, even if this is in the best interest of the company. How else can one explain the disparity between the way companies appoint directors and the way they recruit employees?”

I added: “Because companies may not necessarily have the incentives to ensure an effective board, I believe that without some kind of external intervention, nothing much will change. As a start, we should remind boards to consider not only the independence, competencies and commitment of directors, but also diversity that includes gender diversity. We should incorporate this into our code of corporate governance as many of the more developed economies have done. There should be greater onus placed on companies to explain their process for identifying skills and experience gaps on the board, putting together the desired attributes of directors, and doing proper searches for directors. Shareholders, including institutional shareholders, should scrutinise the resolutions proposing the appointment of directors, and ask companies to disclose the process that they have followed to identify the candidates proposed for election. If shareholders are not satisfied with the transparency or the robustness of the process, then they should seriously consider voting against the appointment of these directors.”

SGX Regco is now proposing to require all companies to have in place and to disclose a board diversity policy, targets, plans and timelines, and disclose “how the combination of skills, talents, experience and diversity of directors on the boards serve their needs and plans.” Having read hundreds of corporate governance reports over the years, all I can see is more work for consultants and advisers in helping companies craft cleverly worded policies, targets, plans and timelines, and make disclosures that are still boilerplates.

Without proper processes in place for identifying skills and experience gaps and searching for directors, boards may over time improve demographic diversity but not cognitive diversity. The SGX proposals do not address the adequacy of these processes. Bolder steps would be to require companies to implement and fully disclose comprehensive board competencies and diversity matrices, disclose how competencies and diversity of existing and proposed directors align with these matrices, disclose search and nomination processes used, and if no external searches are done, to explain why.

Mandating external searches for independent directors and subjecting the election of all independent directors to two-tier votes, including a separate vote by minority shareholders, would be another step up.

I believe that only if the above processes are in place, will we realise diversity in thought, rather than just diversity in demographics. Otherwise, we may end up like one company which has five female directors who make up more than 40% of directors on the board, but two of the female independent directors succeeded their fathers as independent directors of the company and one is the spouse of the founder.

As I advocated ten years ago, investors should be prepared to vote against directors if they are not satisfied with the transparency and robustness of the processes used by companies, rather than just vote based on whether companies have achieved some diversity targets.

“G” should come first

This brings me to the broader “ESG” thrust of the two consultation papers. There is no dispute about the importance of “E” and “S” but  there is a significant risk that “G” becomes an afterthought, perhaps exemplified by “G” being put at the end of “ESG”. Without good governance, “E” and “S” are likely no more than lip service.

While many companies here are speaking the “ESG” and “sustainability” language, and producing nice sustainability reports, there is little evidence of any significant changes in “G”. We are not seeing many changes in the composition of boards and management of companies here that incorporate the necessary skills and experience related to “E” and “S”. We read a lot about companies “pivoting” but see many boards and management teams remaining stationary. Transforming from the oil and gas business to a renewables business, for example, is arguably the most significant change management that a company has to go through, and must start from the top.

I also have reservations regarding the proposal that internal auditors, or external auditors or other external service providers, provide independent assurance on sustainability reports. Internal audit in many companies here currently lacks maturity and extending the internal auditor’s responsibilities to providing independent assurance on sustainability reports may be no more than another box-ticking exercise, giving investors a false sense of assurance about the sustainability report. My concern also applies to external auditors and other external service providers as competencies and cost may result in little more than superficial assurance. At this point, I would rather leave independent assurance on sustainability reports as voluntary – and if done, to be substantive.

On the proposal to make it mandatory for directors to attend training on sustainability, the concern is whether this will be mere recital of rules on sustainability reporting which will have little impact on board decision-making in practice. Many directors are currently failing on the most rudimentary tasks such as ensuring proper due diligence in acquisitions and investments, and disclosure of material information. Perhaps we should send them for remedial training in such areas before we move on to training on sustainability.

TCFD disclosures are about governance

The recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) are organised into four pillars of governance, strategy, risk management, and metrics and targets. They are all part of what I would consider to be corporate governance. On governance, TCFD recommends that companies describe “the board’s oversight of climate-related risks and opportunities” and “management’s role in assessing and managing climate-related risks and opportunities”. On strategy, companies are recommended to describe “the climate-related risks and opportunities the organization has identified over the short, medium, and long term” and “the impact of climate-related risks and opportunities on the organization’s businesses, strategy, and financial planning”. In the area of risk management, companies should “describe the organization’s processes for identifying and assessing climate-related risks” and “the organization’s processes for managing climate-related risks”. Finally, on metrics and targets, companies should disclose “the metrics used by the organization to assess climate-related risks and opportunities in line with its strategy and risk management process” and “Scope 1, Scope 2, and if appropriate, Scope 3 greenhouse gas (GHG) emissions, and the related risks”.

The recommended disclosures of the TCFD on board oversight; management execution; consideration of risks and opportunities in strategy setting; risk management; and setting of metrics and targets, are all part of corporate governance.

Enough ESG ratings

Finally, I am not enthused about the proposal to start with a common set of core ESG metrics. There are 15 categories of metrics proposed under “Environmental” (4 categories), “Social” (5) and “Governance” (6), with 27 specific metrics proposed. They come across as ad hoc and selective. For instance, on “Social”, metrics such as gender pay gap and top management remuneration relative to average employee remuneration, are not proposed  – perhaps reflective of our reluctance to address greater transparency and equity in remuneration. Similarly, on “Governance”, there are many areas that are not included among the proposed metrics.

I can understand the reasoning for the proposal. It would be wonderful if investors have a simple way to assess the “ESG” of companies. However, an overly simplistic dashboard is more likely to mislead than illuminate. The proposed core set of ESG metrics may simply add to the already crowded market of conflicting ESG ratings.

An article by Robert Armstrong in the Financial Times “Team ESG fights back” (August 26, 2021) cited a tweet by Duncan Lamont of Schroders which showed that the correlations among ESG ratings by MSCI, S&P and Sustainalytics ranged from just 0.3 to 0.6 for both “Environmental” and “Social”, and 0.4 to 0.6 for “Governance”.

We see the inconsistency in ESG ratings for the 34 companies shown on the SGX website. Up to five ESG ratings are disclosed for these companies – FTSE Russell, MSCI, Sustainalytics, S&P and V.E. For example, Keppel Corp scores 3.2/5, AAA, High Risk, 61/100 and 57/100 respectively for the five ratings; Sembcorp Industries scores 3.4/5, A, High Risk,  59/100 and 39/100; and ST Engineering scores 2.5, A, High Risk, 32/100 and 32/100.

My suggestion is that SGX holds off on introducing the common set of core ESG metrics and wait for further progress on the current effort to harmonise reporting frameworks on sustainability-related disclosures, particularly the work of the International Financial Reporting Standards (IFRS) Foundation and its proposed establishment of an International Sustainability Standards Board.

Regulators, investors and companies should not allow the focus on sustainability and diversity to take their eyes off governance.