7 Themes for PLC Directors for 2022

Many business folk will look back on 2021 with little affection. Yes, the economy has recovered (7 per cent UK GDP growth), the FTSE 100 was up 14.3 per cent and there was an exciting burst of M&A, with $5.8trn of deals done worldwide.

But Covid cast a long shadow over a year when jollity was supposed to return. It started with raging Covid-19 and lock-down and finished with, well, raging Covid-19 and a “stealth lock-down”.

So, we must hope for a more upbeat 2022. As we look forward to the year and, in the words of Bob Seger, Turn the page, I discuss below 7 Themes which I believe will be relevant for PLC Directors to keep in mind.

1. Ongoing pandemic fallout

Many would say that the world of business and commerce has recovered from the acute shock of the first Covid wave in 2020 faster than feared. The speed with which vaccines were developed and rolled out was tremendous testament to human ingenuity and endeavour and the facility with which we adapted to remote working was pretty amazing. It turns out that being “in the office”, however desirable in human terms, is not a prerequisite to doing deals, having efficient board meetings or recruiting talent.

But the ongoing ripple effects of the pandemic - beyond hospitality, travel and events which continue to feel the direct pain - are not to be underestimated and will surely command the attention of PLC Boards this year. I am thinking here particularly of the great resignation and supply chain challenges.

Great resignation

Over recent months much has been written about tightness in the jobs market and it does seem that the pandemic has caused many people to reassess their working lives. As Ian King pointed out in a recent article for The Times, 400,000 Britons switched jobs in the third quarter of 2021 and a stunning 8.6 million Americans quit their jobs during September and October. Something big is going on in the jobs world and it is happening across sectors. The legal services market, for example, is at daggers drawn in the war for talent.

There are two important takeaways for Boards:

• The more obvious one of course is that employment costs, from recruitment expenses via retention bonuses to wage inflation, are set to rise materially. How much of this can realistically be passed on to customers (my restaurateur son tells me that that he has had to raise the price of a Bad Kitty cocktail), how much can be compensated by cutting other costs and how much is going to hit the margins?
• The other key question is how can we ensure, money aside, that our business is a really attractive environment within which to work and build a career, particularly for A-Players? There are a number of factors here:

1. In a world where young people are increasingly motivated by ESG performance, do we walk the talk on purpose and sustainability?
2. Are we smart in engaged career development for our stars, moving them between roles to keep them motivated? Have we thought of establishing some form of shadow board to tap into the zest and ideas of the digital natives?
3. Are we genuinely differentiated and fast-moving in the recruitment market?

Supply chain challenges

Stories of supply chain issues such as component shortages and logistical bottlenecks have been legion over the last few months and will surely only be compounded by the surge of the Omicron variant. If you wanted a new VW Golf today you would have to wait 40 weeks for it. The second-hand Golf which you might have bought for £13,500 in November 2020 would now cost you £17,360, according to Auto Trader. I know that I over-index on cars, but that is quite some statistic.

There are some business winners here (used car retailers) but the distortion in supply and demand has manifold implications for businesses, consumers and, of course, inflation.

So, many PLC Boards will be very focussed on supply chain issues as they contemplate 2022. In that context it is worth taking a look at this piece from McKinsey https://www.mckinsey.com/business-functions/operations/our-insights/how-covid-19-is-reshaping-supply-chains. The key thesis of the article is that companies “have only partly addressed weaknesses in global supply chains exposed by the coronavirus pandemic. In the face of new challenges, finishing the job is even more important.”

Two particularly striking findings from the two surveys which underpin the piece:

• companies have tended to increase inventories of critical products and components rather than diversify supply bases or regionalise the supply chain; and
• “significant blind spots” remain in most companies’ supply-chain risk management arrangements.

2. Climate

2021 was the year of COP 26 in Glasgow and that has brought (even) greater focus on efforts to speed up the carbon transformation of business and the financial system. These matters are front of mind for investors and will necessarily be high on the PLC Board agenda in 2022.

I would highlight two aspects here: disclosure and “Say on Climate”.

Disclosure

I’m afraid that this is a topic which calls for a lot of cold towels. Here is the Ladybird version:

• premium listed companies have been required to disclose climate related information in line with the TCFD framework, on a comply or explain basis, for financial periods beginning on or after 1 January 2021 - so, this applies to financial statements published from now on;
• this requirement will extend to standard listed companies for financial periods beginning on or after 1 January 2022;
• in respect of financial periods beginning on or after 6 April 2022, this disclosure will become mandatory in the UK (so, just comply) and be extended to all publicly quoted companies, large private companies and LLPs;
• those in scope will also then be required to provide “an analysis of the resilience of the company’s business model and strategy, taking into account different climate-related scenarios” which will be a significant future-focussed disclosure; and
• the UK’s proposed Sustainability Disclosure Requirements (“SDR”) will mean, probably from 2023/24, that listed companies will need to report their impact on climate and thus develop systems to look both outward and inward when assessing climate impacts (so-called “double materiality”). Climate transition plans will also probably become mandatory under the SDR.

All of this is without considering the potential implications of global disclosure standards to be developed by the recently announced International Sustainability Standards Board.

PLC Board Audit Committees will, of course, be working on this disclosure framework with the close involvement of auditors but the big takeaway for all PLC Directors is that the disclosure burden around climate is headed on a steep upward incline from now on.

Say on Climate

There has been a growing trend, over the last year, for companies to offer their shareholders an advisory vote on the company’s climate transition plan. We have seen this at Unilever, Shell and HSBC and others, such as Barclays and National Grid, have committed to offering a climate vote at this year’s AGM. Some of these (for example at HSBC and Glencore) are, unsurprisingly, stimulated by shareholder activism but presented by management.

The pertinent question for PLC Directors is whether “Say on Climate” votes should be embraced or resisted? A few thoughts:

• there is clearly some attraction to taking control and presenting a plan with which management and the Board is content rather than being caught on the hop with an activist-requisitioned resolution. It is noteworthy that the resolution put at last year’s BP AGM by activists Follow This received a 20% vote in favour - less than totally comfortable for the BP Board;
• on the other hand it may be difficult to craft a fully convincing resolution. BHP received criticism for theirs because it did not set a target for Scope 3 (customer) emissions, which are 96% of total emissions, instead saying that it would partner with its steel customers to accelerate the transition to carbon neutral steel making. This seemed like an understandable approach but Glass Lewis recommended voting against the resolution (although it did pass with only a 15% vote against); and although the 10 resolutions put by UK companies’ Boards have received strong support (all but two passing with higher than 90% majorities) some investors are becoming uneasy with these votes which may over-simplify and rubber-stamp complex issue. CalPERS for example prefer the notion of holding the Board accountable and voting against directors who fall down on their oversight of environmental issues. And, of course, the success of Engine No 1 in putting directors on the Exxon Board suggests that investors may increasingly focus on the climate competence of directors - note, for example, that Elliott is calling for the appointment of two independent directors with renewables experience at SSE.

Clearly a huge amount will depend on the sector which the company is in and the views of its influential shareholders. All other things being equal, however, I can see meaningful benefit to getting on the front foot and seeking shareholder endorsement of the company’s preferred transition plan. Shareholder pressure on climate is only going in one direction and, for the moment at least, the fans of the advisory vote seem to outweigh the doubters.

I say this with a heavy heart as it is another brick in an already complex governance wall - but I think it can be a smart approach.

3. Diversity

Progress continues to be made on Board diversity and we should celebrate that. But the pace is slow. Although things will have improved since then, the Spencer Stuart Board Index 2021 (the “Index”) reports that, at 30 April 2021, only 61% of FTSE 150 companies had at least one minority ethnic director sitting on their board. We will know soon how many FTSE 100 companies met the Parker Review target of “One by 21”.

According to the Index, women occupied 36% of board roles in the FTSE 150 which marks steady progress since 2011, when it was 12%. More concerning is that only 14% of executives on those boards were women, no increase on the previous year.

The FCA has consulted recently on changes to its Listing Rules that would require UK listed companies to disclose annually, on a comply or explain basis, whether it has met targets that (i) at least 40% of the board should be women; (ii) at least one of the senior board positions (Chair, SID, CEO, CFO) should be held by a woman and (iii) at least one board member should be from a non-white ethnic minority background. Other disclosures would be mandated by the changes, such as data on the composition of senior executive management by gender and ethnicity.

It is generally assumed that these changes will be brought into force early in 2022.

It follows that diversity, at and below board level, will need to continue to be a major focus for PLC Boards in 2022.

In that context I have three thoughts:

• every effort should be made to ensure that Nomination Committees are as diverse as possible and are accountable for the meaningful deployment of diversity policies through the organisation and the monitoring of appropriate KPIs;
• the Chair should be pro-active in probing the networks of board colleagues for potential diverse candidates. Too little is made, I fear, of the rich range of connections which many directors and senior executives will have (and conflict concerns will often be manageable); and
• the Board, and the organisation, should be noisy and generous in their support of charitable initiatives which offer real opportunities to young people from diverse backgrounds (such as 10,000 Black Interns (https://www.10000blackinterns.com/ and Royal Springboard (https://www.royalspringboard.org.uk/). These initiatives change lives.

4. The Digital World

It is axiomatic that the pandemic accelerated the pace of digitisation in business. According to a McKinsey global survey of executives in 2020 their companies accelerated the digitisation of customer and supply chain interactions and their internal operations by 3 to 4 years. And the share of digital or digitally enabled products in their portfolios advanced by 7 years.

Now, more than ever, digital is a key competitive differentiator - not just for tech companies but for “traditional” businesses like Unilever and John Deere. Part of the runaway success of Tesla is down to the cleverness of its software. And in a world where “working from home” is suddenly much more the norm digital communications and processes need to be fast, secure and intuitive.

There is opportunity but there is also, of course, risk. According to Security magazine the total number of data breaches up to 30 September 2021 exceeded by 17% the total number of events in 2020. There were 48 compromises in manufacturing and utilities (48m victims) and 78 compromises in healthcare (7m victims).

In just one example the personal data of 700 million LinkedIn users was on sale online.

In addition, ransomware attacks are growing rapidly, both in number and in their financial and reputational cost to business. According to a Deloitte survey, 65% of business leaders see it as the greatest threat to their organisation over the next 12 months, whilst only 33% have prepared for such an attack. Cybersecurity Ventures estimates that, by 2031, there will be a new attack every 2 seconds, with total costs reaching $265 billion.

Many PLC managers and directors will already be very focussed on the rewards and risks of the digital world but early 2022 might be a moment for the Board, in its oversight role, to take stock and suggest a session with senior management to run through a few key topics:

• What is our digital strategy and, given its competitive importance, how does it differ from that of our competitors?
• How does our recruitment strategy support our digitisation ambition and (for manufacturers) how are we thinking about robotics - noting that in 2020 the UK installed 2,200 robots which is a rate of growth less than a tenth of that seen in Germany?
• What are the weaknesses in our defences against data breach, ransomware attack and other cyber security risks?

5. Corporate Governance

FRC Annual Review

The Financial Reporting Council (“FRC”) published its Annual Review of Corporate Governance on 25 November 2021 https://www.frc.org.uk/getattachment/b0a0959e-d7fe-4bcd-b842-353f705462c3/FRC-Review-of-Corporate-Governance-Reporting_November-2021.pdf. It finds that there has been a general improvement in reporting against the UK Corporate Governance Code (the “Code”) but that there is room for significant improvement and “a number of areas where the same issues persist” as identified in its 2020 report.

In its research the FRC looked at a random sample of Annual Reports of 100 FTSE 350 and Small Cap companies. Headline points are:

• there was less erroneously claimed compliance and more reporting of non-compliance against specific Provisions of the Code. The top 2 Provisions where non-compliance was declared were Provision 38 (alignment of executive pension contributions with those of the workforce - a perennial challenge) and Provision 19 (Chair independent on appointment). But the FRC is looking for improvements in explanations for non-compliance, with more information about the reasons for departures along with any support offered by shareholders;
• there has been a step up in relation to s.172 and stakeholder engagement reporting but room for improvement in relation to suppliers, communities and modern slavery reporting. For example, only 37% of companies that identified their suppliers as a key stakeholder group reported on a clear dialogue between that group and the company; and
• diversity and inclusion and succession planning at board level and through the pipeline remain a concern and more focus needs to be given to the work of the Nominations Committee (and see my comments above on this).

A great deal of work has gone into the Review and a real effort has been made to call out Key Messages and to give Examples of good disclosure. Careful reflection on the more detailed points made in the Review is recommended. Three which caught my eye are:

• some companies still do not address compliance with the Principles of the Code and focus solely on the Provisions. As I mentioned last year, it is useful to look at how Astra Zeneca approach this;
• purpose statements are getting clearer but some still confuse purpose with mission and others are limited to marketing slogans; and
• the FRC believes that most companies in their sample which received 20% votes against a resolution at their last AGM did not sufficiently address their shareholders’ concerns in the following Annual Report. The FRC “intends to look more closely at shareholder engagement and 20% votes against in the coming year”.

BEIS White Paper

We await, of course, the UK Government’s feedback in relation to the consultation on “Restoring Trust in Audit and Corporate Governance” which closed last July and garnered, I understand, over 600 responses. Here is my article discussing the White Paper : https://1drv.ms/b/s!AiNiB_DAS8su8RR7Clfl8La1y19n?e=JOrv5m.

PLC Directors will be very interested in which proposals get taken forwards and which don’t.

Those which seem likely to be pursued include:

• Clarification of distributable profits;
• Resilience Statements and Audit and Assurance Policies (whether or not the latter become the subject of a shareholder vote);
• Stronger supervision of corporate reporting; and
• Additional reporting on activities undertaken to detect fraud.

Areas where there may be more analysis as to the way forward include:

• attestation of internal controls (UK SOX);
• the definition of Public Interest Entities, although we must assume that large private companies which have a listed PIE parent will not be caught; and
• minimum standards for Audit Committees.

We must passionately hope that the Government does not pursue its suggestion to give ARGA additional powers to enforce directors’ duties. Finally, the managed shared audit proposal received very negative feedback and it seems that other options, including (interestingly) the use of a market share cap, are being considered.

6. Shareholder Activism

The UK has seen some high profile activist campaigns over recent months. Elliott are targeting GSK and SSE, Cevian has a stake in Aviva, Trian has been focussed on Janus Henderson and Third Point is pursuing Shell - and, in an ironic twist, is itself the subject of activist attention at its London listed investment company.

Traditional activist campaigns designed to bring about the board or management change (GSK), the return of more capital (Aviva) or a split of the company (Shell) are increasingly supplemented by climate campaigns (Follow This at BP and Shell and ShareAction at HSBC). Moreover, we saw in the summer that shareholders in UK companies were prepared to challenge board recommendations to accept a bid and drive higher offers (St Modwen and UDG Healthcare).

So, the “addressable market” for activists (and bolder long investors) is growing.

Looking forward, Alvarez & Marsal, in their interesting Activist Alert (https://www.alvarezandmarsal.com/sites/default/files/2021-12/A&M Activist Alert (AAA) Forecast and outlook for 2022.pdf) surmise that Europe is set to enter a “Golden Age for Activism” with a surge in activity during 2022. Some key takeaways from the Alert are:

• their analysis indicates 58 European companies at imminent risk of a public campaign (and another 90 companies on the Amber list). The predictive accuracy of their model is around 50%;
• UK corporates will continue to be the preferred target for activists (21 companies at imminent risk, 34 Amber) given their decline in relative performance compared to other European peers and relatively low PE ratios; and
• preferred sectors will be industrials, consumer (as economies continue to open and savings are high), IT and healthcare.

What does all this mean for PLC Directors?

It’s obvious of course, but it will be particularly important to be on the front foot in analysing where the risk of activist attack sits and to engage pro-actively with shareholders, listening attentively to their views. Might now be the moment, moreover, to organise a separate Board session, facilitated by a “Devil’s Advocate” third party who really understands the business and the sector, to brainstorm areas of potential exposure?

As my first Principal, Thomas Buckley, said to me when I was an articled clerk - “Time spent in reconnaissance is seldom wasted Christopher”.

7. If you were a city…

I don’t know if you have been watching the Spanish series, La Casa de Papel (Money Heist), on Netflix. If you haven’t you must - it’s essential viewing. The various protagonists are each called by the name of a city in order to protect anonymity (apart from the mastermind of the plan who is El Profesor). All the names, you come to realise, suit the individual. So, the stolid older man in charge of digging tunnels is Moscow, his slightly gadabout son is Denver, the narrator with some sense of Triad about her is Tokyo and the smartly dressed and organised leader of the team is Berlin.

So, here’s the thought.

At the next Board Dinner - and hopefully they will start to occur again in the coming months - the Chair might invite each Director to identify which city they would be and why. It could be quite illuminating and good for ongoing relationship building. And then maybe existing names could be dispensed with in Board and Committee meetings.

Just an idea.

Christopher Saul

Christopher Saul provides independent trusted advice to senior executives and key stakeholders within publicly quoted and privately owned businesses and professional service firms. His areas of focus are governance, succession and the moderation of differences.

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