From Competitor to Collaborator

Dealing with the S in ESG 

Rare it is to hear business call for more government regulation. Yet this is the plea heard in private conversations with some of the largest financial companies in the UK, as they face undeliverable expectations to be at the forefront of solving rising inequality, racism and environmental disaster.

“The To-do list for corporates will continue to grow. We are having to deal with issues like racial injustice [because] governments aren’t,” says the CEO of a FTSE-100.

The financial crisis led to an upsurge in regulation, ranging from capital adequacy to conduct rules. Regulators like the Financial Conduct Authority in the UK and the Securities and Exchange Commission in the US became ever more powerful. An unwelcome outcome for financial institutions, but one they fully understood and accepted, even as their compliance departments doubled and tripled in size.

Meanwhile, the E in Environmental Social Governance (ESG) became a major risk and reward factor for companies – consider the plummeting market capitalisation of coal companies and the general proliferation of environmental ratings. In this area, the change makers are the institutional shareholders rather than the regulators or government.

Covid-19 allied to Black Lives Matter has swung the spotlight onto the ‘Social’ aspect, ranging from the safety of employees in the pandemic, to key workers without proper contracts, to the minimal numbers of BAME executives in the City and Wall Street.

The backdrop to this is changes to the decades-old emphasis on an ‘efficient’ international economy.  Its weaknesses – gig economy workers who live pay check to pay check and an international supply chain too dependent on political goodwill – are now fully exposed. The shareholder-first approach is being subsumed into a multi-stakeholder approach.

The increased complexity of the new corporate model means that firms look more like universities, balancing the interests of a wide range of interest groups with the constant threat of a hostile social media campaign.

What happened at the London School of Economics a few years ago is a salutary warning. The union highlighted the appalling employment conditions of the prestigious university’s outsourced cleaners. The support of students and academics gathered pace. A couple of years later, in 2018, the cleaners won the battle to be taken on as employees of the LSE.

Interestingly, hedge fund Chanos is shorting gig economy comp­anies such as ride-hailing app Uber and online food-delivery platform Grubhub. It is betting that there is going to be a greater political focus on low-wage, precarious workers.

Boards of directors would prefer to have clearer regulation on ‘Social’ issues, such as outsourced workers. For instance, gender pay gap reporting, while not exactly welcomed with open arms by business in 2017, is now a regular part of the corporate landscape for all medium and large firms, helping highlight the continual need for action on diversity and inclusion. 

FTSE100 financial companies continually review and upgrade how they treat their permanent employees. In fact, boards at several banks have appointed designated Non-Executive Directors responsible for workforce relations in line with the revised UK Governance Code. More mental health support and flexibility on working from home are other measures implemented on the back of Covid-19 – with a decent salary as a starting point. Yet these benefits do not touch the outsourced workers like cleaners and security guards.

And yet one prescient FTSE-100 board director believes the rules are already clear: “The Board is accountable for the supply chain.” Speaking at a recent Oliver Wyman Forum event, where top executives and senior policy makers share experiences, she noted that issues related to multi-stakeholder capitalism had moved from sub-committees to main board level.

That includes tax avoidance schemes, with the most newsworthy instituted by Big Tech, yet just as prevalent at other large, global companies. Minimising tax through the use of complex schemes leads to jaw-dropping anomalies. Over 50% of the subsidiaries of foreign multinational companies report no taxable profits in the UK, for instance.

Paul Polman, the former head of Unilever, is not alone in believing that companies should embrace having to pay their fair share of tax on the back of a crisis which has seen massive spending by governments to avoid a 1929-style depression. This must include unlisted capital, such as private equity and hedge funds.

Building a level playing field and a sustainable economy means governments imposing tax reform and coordinating with other jurisdictions. The verdict so far: nul points.

Yet there are a few possible indicators of change: an OECD global tax rules blueprint might prosper if Joe Biden wins the US presidential election; the morally dubious sight of private equity firms accessing government cash could explode in a social media campaign; visionary CEOs are beginning to consider that a company’s approach to tax should be part of the ESG metrics by which investors judge them. 

Ensuring the heightened role of technology makes for an inclusive economic recovery is one of the biggest challenges facing financial services. Deepening social inequality, with Covid-19 disproportionately affecting women, BAME and those from poorer socio-economic backgrounds, sits uncomfortably alongside the accelerating digital take-up benefitting a small pool of winners. Many financial services companies are looking to cut their real estate footprint due to the permanent shift to increased home working, presaging waves of redundancies for their outsourced frontline workers.

Economist Noreena Hertz, in her recently published book The Lonely Century, writes about the neoliberal  mindset which dominated for four decades, leading to societies of unparalleled loneliness and the rise of right wing populism: “40 years of seeing ourselves as competitors not collaborators, takers not givers, hustlers not helpers.”

The effects of the pandemic have made even the most fervent small government activists mutate into advocates of big spending to stave off mass unemployment and depression. If that reversal is possible, so is the probability of legislation for the hidden workforce and international tax coordination. 

The future will involve collaboration, consensus and communication between government and the corporate sector to an unparalleled degree.  Not an easy way forward, but the only one to solve our societal problems.

Power to the People

The merging of business and politics

GLOBAL TRENDS AND WHAT THEY MEAN FOR BOARDS OF DIRECTORS

This column was first delivered as a webinar to Z/Yen Group and the Financial Services club, which you can listen to here

Firstly, many thanks to my dear friend, Alderman, Professor and Sheriff Michael Mainelli for asking me to share some thoughts with you.

INTRODUCTION

Covid-19 and its economic effects are not going away anytime soon. We will be seeing a reconfiguration of our systems, ranging from geopolitical relations to the power of national governments, from company accounts to working patterns.

Some say the new paradigm is but an acceleration of existing trends. I wouldn’t disagree, but there is a point at which acceleration leads us into a new world, one where we must change our outlook. One where the responsibilities of Boards of Directors broaden out into the wider world. THAT is what I will focus on today.

For simplicity’s sake, I have divided this speech into three.

• THE RISK COMMITTEE

• THE NOMINATION AND REMUNERATION COMMITTEES

• THE AUDIT COMMITTEE 

What I am saying for each one equally applies to executives and entrepreneurs and, naturally, to the main Boards. 

RISK COMMITTEE

Black Swan Events

That famous phrase used by author Nassim Nicholas Taleb. Arguably a pandemic is not a Black Swan event when Bill Gates publicly – publicly! – talked about how unprepared governments were in a video a few years ago. But let us not quibble about definitions.

What matters is that Risk Committees need to expand the subjects on their agenda.

There will be other pandemics. There will be unseasonal flooding and bush fires like those in Australia. Climate change is a given and its effects on natural resources and economies are key. Take a recent catastrophe in Russia where the thawing permafrost lead to 20,000 tons of diesel spilling into the Norilsk River.

Geopolitically we are in a world of increasing nationalism and maverick leaders where the web of US-led, post-war institutions no longer function. Where does the dialogue and the negotiating happen now?

I will just mention three key countries.

RUSSIA. President Putin’s poll numbers are plummeting; Covid-19 deaths are more than the government’s corrupt statistics office will reveal; the oil-dependent Russian economy has been battered by record-low oil prices. Putin will need to engineer a distraction, this year or in 2021 – another invasion, perhaps Belarus? Or cutting off electricity supplies in some small corner of the West? Or a cyberattack in a port area…they (or perhaps another country like North Korea or Iran) have done it before in Rotterdam. 

CHINA – it is too large a subject to deal with in this webinar! Let me just say that China was never the West’s best friend, an assumption held by the government of David Cameron, but neither is China our worst enemy, President Trump’s current assumption. Bringing those supply chains back from China, the new ‘localism’, ain’t that easy!

THE US – Trump is embattled. There are major doubts that he can win the November election. Creating more division inside the US – the enemy within - isn’t enough. I would expect some new narrative and action around “the enemy without” – new tariffs, new trade wars, take your pick.

Rising Inequality

Pope Francis in his Urbis & Orbis Easter homily spoke about a “dignified life”. We are going to have millions…and millions… and millions… of unemployed. Whether the US unemployment rate is 13% or higher – you are all aware of the recent controversy about the numbers - it is bound to head up vertically. As will our numbers.

And the so-called full employment we had in much of the West was a lie, with zero-hour contracts, no ability to save, no margin for error. We left too many people behind on the back of globalisation and automation. Re-incorporating them (plus all those who falling headlong into unemployment now) into working society and a dignified life is an enormous challenge. If the corporate sector is not part of the solution, it will be perceived as part of the problem.

The divide on economic policy between left and right is fast disappearing. The evidence? President Macron of France spoke about the need to transform our capitalist societies due to their environmental and social inequality failures. A discussion about the Universal Basic Income is now mainstream. British trade union Unison saw a net increase of 16,000 in their members, which is 18% higher than in the same period last year.

I urge you to read a dystopian 1952 novel by Kurt Vonnegut, Piano Player.

Government

After the financial crisis, the pendulum of power for financial services and banks swung back towards government and the regulators. Even more so now. Big government is back.

To keep businesses like airlines going they will be forced to turn loans into equity stakes. After all loans, even at low rates, don’t do the trick when the revenues aren’t there.

Circumstances, not ideology, have put government in the ascendant at the expense of the private sector. With the best will in the world, they won’t be able to sell those shareholdings anytime soon, and so they will influence how companies are run, how they interact with their suppliers, how they deal with their financials.

Of course, the biggest risk and opportunity is Quantum Computing. I am no expert, but as a shareholder in a quantum computing company, I have been exposed to some of the mind-blowing possibilities and would urge any board to be constantly updated on advances.

THE NOMINATION AND REMUNERATION COMMITTEES

People

This section is really about people. How do you attract the most talented people? Speaking mainly to a City audience, let me point out we have a problem – and this is relevant for financial and professional services in other OECD countries.

The City was where the best and the brightest in my generation headed. Now, they more generally head to Google or start-ups, they join NGOs or set up their own.  Former City Minister Mark Hoban chaired a Financial Services Skills Taskforce which found a skills and talent crisis in the sector, issues with purpose and culture and not enough continuous education.

Attracting the best and the brightest is one problem. But the unemployed are also your problem. The deprived are your problem. Racism is your problem. There is no longer a separation between politics and business.

In the words of Martin Luther King: “In the end we will remember not the words of our enemies but the silence of our friends.”

From Larry Fink of BlackRock to UK CEOs, companies have spoken out on the back of the Black Lives Matter movement. Some have announced special schemes or are looking anew at their recruitment. Those that haven’t are probably making a mistake. Because if you consider the demonstrators, and those who have spoken up on social media – all races, including a lot of whites.

A larger proportion of companies’ workforces are made up of millennials and Generation Z, and they CARE. They look for work/life alignment, where they can be the same person at work and at home, and they want to be proud of the company they work for.

Diversity & Inclusion

Look at it like ESG (Environmental Social Governance). That ‘E’ no longer sits in some far-off office and is trotted out once a year. Mark Carney, the former Governor of the Bank of England first highlighted the financial risk from stranded assets and, in parallel, the opportunities. The Norwegian Sovereign Wealth Fund recently sold its Glencore shareholding for breaching it guidance on coal use.

Similarly, the ‘S’ in ESG, or Diversity & Inclusion, is now central. It is about risk and it is about innovation. To mitigate risk and think laterally we need diverse opinions which are encouraged and listened to.

That is why I am the Co-founder of the newest institute at the London School of Economics, The Inclusion Initiative, which uses behavioural science and data to improve innovation and the bottom line. My Co-Founder Professor Grace Lordan and I are in conversation with financial and professional firms about their becoming partners in this endeavour.

Do please get in touch if you think it might be of interest to you.

A few last words on people. Communication and collaboration are key skill sets. Empathetic leadership and the ability to understand what drives your many different stakeholders is something that no leader can do without. Chose them wisely.

“Build back better” is a phrase you may have heard. Understand what the impulse behind it is, for it will affect the future of companies.  

THE AUDIT COMMITTEE

Resilience

In the financial crisis, the banks were bailed out by the government. The regulators then forced them to increase their capital and work on changing their culture. That is why we are not facing a financial sector crisis, at least at the moment.

The corporate sector is different. Companies are being run in an “efficient” way. Cut costs to a minimum, carry as little capital as possible, get that ROE up.

That’s finished.

For two reasons. One, the realisation that the Black Swan world we live in demands higher capital sums and more focus on cash, or cash equivalents. The amplitude of the events we are facing is such that this is necessary.

Two. Treating employees as contractors, or outsourcing to India, and then focusing excessively on shareholders, is a discredited model. It now turns out to be a very risky one. One bank CEO said to me she thinks differently about employees in India whose circumstances mean lockdown and isolation aren’t possible.

And, as mentioned earlier, government and regulators will be much more powerful and involved in the private sector than before. They also don’t like that model. The new Stewardship Code, for instance, calls for more high-quality integrated reporting.

Costs still need to be cut, but automation, robotics and AI are now the focus, plus having 30% or more of your workforce on agile working, depending on your business, which will also save on real estate fixed costs – with  huge implications for commercial real estate.

Fraud

I have only one word. It’s going to be HUGE. I presume accountants are more than aware of this. Anecdotally I already know about one private equity-held company that took government furlough money in a month when it had no right to. When you have convulsions in funding, opportunities for misbehaviour increase.

Taxes

Look out for windfall taxes on some of the corporate sector. Governments are desperate for funds. They will hit individuals – a wealth tax perhaps, getting rid of the vestiges of the Non-Dom regime, a rise in income tax – but they can’t raise VAT as consumption needs to come back. That leaves the corporate sector in their crosshairs.

I hope, and perhaps this is more hope than reality, this crisis will lead to the proper taxation of the Googles and Amazons of this world. And not just taxes. Elon Musk, the Tesla and Space X entrepreneur, recently called for the break-up of Amazon. And I just read a convincing case for a digital advertising monopoly suit against Google, co-written by a Yale professor who’d been in the Anti-Trust unit of the US’s Department of Justice a few years ago.

Maybe, just maybe, the employees of the Facebooks and the Twitter’s will be the impulse behind proper corporate taxes on their employers? It is far-fetched as a theory, I will grant you that, but they aren’t afraid to be heard. In 2018, for instance, 20,000 Google employees – yes, 20,000 – walked out in protest at their company’s handling of sexual harassment.

CONCLUSION

In 2015 a client for the Robinson Hambro CEO Advisory service who was the Executive Chairman of a bank asked me to give a talk to his Global Advisory Board. My theme was that globalisation had peaked. Very prescient, if I say so myself, coming before Trump and Brexit. In case you think I have a crystal ball, let me say I also predicted Putin would be out of power in Russia. You can’t win them all!

The point of this story is that we cannot predict the future. But executives and non-executives can consider trends and responsibilities within Boards, within the Risk Committee, the Nominations and Remuneration Committees, and the Audit Committee, and act accordingly.

Thank you for listening. And now, the fun bit for me, I much look forward to your comments and questions.