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The Sustainability Story
Leena Linnainmaa: Corporate Governance and due diligence in the EU: a step in the right direction?
00:25:27
Josina Kamerling and Leena Linnainmaa, Secretary General of Directors' Institute Finland, and Chair of ecoDa’s Advocacy Committee, have a conversation on the impact of the proposed new EU rules on corporate governance and due diligence on European...
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Hello everyone and welcome to the Sustain Story Podcast. This podcast focuses on sustainability stories around the globe and I'm Josina Kamling, one of the three co hosts focusing on the EMEA region and specifically what has been happening in the EU in today's podcast. Today I have as my guest Lena Binmaimer, who's Secretary General of the Directors Institute in Finland and Chair of the ICODA Advocacy Committee ECOda. For those of you that don't know, this organization is an independent actor and is the voice, the European Voice of Board members. It covers about 50,000 individual directors across 21 countries and sitting across in boards across all different sizes and sectors of the companies. So again, of course the voice of directors and boards is incredibly important in today's topic, which is about the new piece of legislation that has been hotly debated at the EU level on corporate due diligence, the famous or infamous CS3D. In short, it's taken quite a while to get through the different political processes. It's a very important piece of legislation as it touches on corporate governance and also on due diligence of the supply chain, both topics crucial for companies, especially as sustainability is now really focus and center stage in global policy conversations. And it's really a challenge for how companies are needing to approach their environmental, social and governance responsibilities. The new proposed rules, which are still not completely final as we speak end of March these are going to come, probably will be voted on in the European Parliament in their plenary session in April and then they should come into EU law, but they will take a long time in coming into effect. It is likely that they will only come into effect in round 26 to 27 in the EU and even longer for companies outside the EU, it will be 2029 by the time they will have to start applying. So there is quite a bit of time. However, even though the rules in this new piece of legislation have been watered down quite significantly and I'll be asking Lena for her opinion on that. The initial rules were really far more ambitious and looking at companies, many more companies than the current, which has watered down to about one third of the companies initially in the scope of the Directive. But still, it's a first step and the first step is important. And we know in the eu, for those of you that listen in from other regions of the world, the EU may take some steps forward and some steps sidewards, but it does get there in the end. It's a process and it has to be done by consensus. And we need to take into account, specifically, of course, for corporate governance issues, the culture of all the member states that are in the European Union. And that is not an easy topic, especially when you touch to the hard bone of the local economies, which is companies. So, Lina, EU legislators are getting close to that final agreement. What are the implications for companies regarding the due diligence rules that will be mandated by this legislation?
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Well, the implications will be huge. I have often heard, and I already heard now, that the project has been watered down. But looking at it, there are very large things coming. And also, although it is being said that it only covers the largest European companies and later on global companies, actually, because the chain of activities is also covered, it will have an impact on SMEs also. And when we consider that there are different business sectors and to make the transitional plan for combating climate change to reach the 1.5 target of the Paris Agreement, that is a huge thing and it is not easy. Companies will need resources, they will need expertise. Where does this expertise come from? These are not simple things. And of course, what is important in, for example, in heavy industry is something very, very different in, for example, in a consultancy. So to understand that how to work risk based, this is something important. During the legislative process, there was in the early stages, the risk based due diligence was not so much talked about. But luckily the final version of the Directive will, as I believe, include that the work shall be risk based. So identifying what is important also all the adverse impacts, organizing engagements with stakeholders and consultations, what does that actually mean in different sectors, in different countries and how to do it so that it is useful how to organize the complaints procedure and is covering the chain of activities. Also, the European Commission is promising guidelines and single help desk, et cetera. But how high expertise will those actually have? How helpful will that be? And one worry of course, is that is this more a bureaucratic exercise or is it more engaged in how to make plans and this and that, or how to actually act for a better world? Because the sanctions, if something goes wrong, can be huge, even 5% of net global turnover. That's a huge sanction. Of course, I don't say that it would be likely used something like that. But also when the national supervisory authorities will be involved in this and they are often having sanctions, it's often quite strict. Will they be able to turn to help desk model or something that this is something we need to do together to reach the goals and not to emphasize the sanctions. There is lots and lots of needs to learn on every party, companies, stakeholders, authorities, and it will be very interesting to follow it. But also we need to be humble and understand that everything will not go right in the beginning. And of course what worries us on the company side and the directors that will there be litigation? So because some countries in the EU have already legislation like this and some of them are experiencing lawsuits and is this something that there will be more lawsuits against companies about some bureaucratic planning and this and that. So will be very interesting to follow how all of this works out. And hopefully the European Commission and Parliament will also be interested in seeing does this work out or not and will be ready to make changes if needed. Because I said this is not a simple exercise.
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I agree with you. It's not a simple exercise. And you know, when I look back to the last 10 years, corporate governance and the engagement of shareholders, stakeholders in companies, and that interaction between the company and its shareholder and the stakeholders around it, the way it's portraying information has been changing enormously already. I recall conversations back in 2015 when CFA Institute was researching on the Shareholders Rights Directive revision and how we started to see, as we worked together with the London Business Corp and we interviewed shareholders, we started to see that institutional investors, shareholders were already aware that they needed to engage on behalf of other stakeholders, not just for themselves. And I think that was that first awareness coming through. Of course, sustainability, esg, its whole sort of bundle of laws have meant enormous amount of changes also within compliance departments of, for example, the asset managers and institutional investors. And it's difficult to keep track of all the companies they're investing in. So again, as you said, this is a work in process. It will need to be tweaked. But we're good in the EU on tweaking. Sometimes we tweak too much. As laws go on, we may change it a little bit too much, which is also a problem because people are of course developing their due diligence processes. So again, the new EU rules on due diligence, how do you see that fitting and aligning with what is happening for companies globally? Because this is going to be very complex.
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Yes, this will be very complex. And if you think of an EU company under this new directive, they may have 10,000 suppliers all over the world. And how about the knowledge in the different countries, the attitudes, the assurances? And how can you trust it that. That surely the large European companies will do whatever it takes in their power to try to do well. But is it really possible in the chain of activities among the huge amount, amount of suppliers, to get relevant information, to get information that you can trust? That is a big, big issue. And surely, of course, the understanding in the other countries will increase because eu, it's a large partner in the global market, so it's not insignificant what the European Union companies are doing, but it does not change overnight. And although there is still some time before the Directive has been implemented and enforced, but the time really flies. And how will the information go to the foreign partners in the supply chain? That is a very big question. And I hope there is understanding also from the supervisory authorities and the European Commission that it will not be easy. And also in the global connections, the European Commission needs to be active, disseminate information, engage in talks, because of course, the ideal would be that other countries, especially industrialized countries elsewhere, would engage in similar procedures. It would make it so much easier. The understanding would be wider and of course, that the impact would be much larger. Because if it's only an EU exercise, I'm not sure, as said, if it can always be trusted, what the information flow contains. And can you trust the contractual assurances? The directing will, as I understand, require the companies, these large companies, to require contractual assurances from their direct business partners. But what kind of assurances do you get and can you trust them? This is the big question.
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Yeah. And, you know, you mentioned the word trust and assurance. Those two words are going to be key. Of course, you know, what is happening within the sort of global context. And I, I look at sort of iosco, the International Organization of securities Regulators, we look at the ifrs, we look at the Sustainability Board. You know, there are all sorts of organisms. The un, of course, we, you know, we're going to need to cohabit in this global space with all of us. I remember Sean Berrigan, Director General of DG FISMA and the European Commission, when we were talking about sustainability legislation, saying to me, you know, we are the front runners. We know that other people then are looking at us and they might follow us, but they might also tweak. And of course they learn by experience. So, yes, the EU is a front runner and that is good, but it's also going to be complex because it will require TWEAKING as other regions look at what we're doing. And we will need to keep very agile on this piece of legislation. And I think what is really important and I coming back here to the word assurance, it's really that seamlessness of the same information coming out the same way and how the companies, whether it's the boards to the middle management, who is working with the assurance preparers and the auditors to give that information is giving it correctly. The auditors are going to have to understand and ask the right questions. Again, that is also a training ground. One of the things that probably also is going to be very important in the coming years is the upscaling of knowledge and training at the audit firms within companies. Going down from the boards all the way down to the middle management to the juniors. The upscaling and training of understanding what it is we're trying to do with the information we have is going to be one of the huge challenges, I think, and an interesting challenge. We all need to grow with this, but it is going to be a challenge. I'm sort of coming here saying, you know, that realizing these challenges of how we have to educate ourselves and also understanding that corporate governance is actually a crucial linchpin of capital markets. Again, we come to that word trust. We come to that word of understanding the companies when you invest in them. Do company boards, to your mind in the eu, believe that by really looking at corporate governance and trying to attempt an EU wide lens of looking at corporate partners, that we are actually delivering value and that we can help develop the capital markets for the eu? We know of course, we're reaching the end of the legislative period. There have been a lot of different supervisory authorities, think tanks, companies that have given already high level statements of where they would like the next five year period to go. What is your belief that with what has been happening now on this piece of legislation and others, that we are helping to build that capital markets union and making Europe a sort of more homogeneous investing place.
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There are many sides to this story and of course corporate governance and this directive, it's a part of promoting the European market. But on the other hand, if we look at the global situation, Europe is not leading in the field of innovations, AI and what is happening. So we need to be humble here and look what is going on. Why, why aren't we, with all the education, all the advantages that we have, resources, et cetera, why is it so that we are lagging behind actually in this? So, so one of the things is to have the corporate governance we saw the directives and companies doing this, but, but the other story is that we, we need the entrepreneurial mindset that many other countries overseas have. They have the hunger for innovations than making things in a new manner. And maybe we are not having the same kind of hunger. And of course the question is, is there regulatory barriers here regarding, for example, divide, developing, AI et cetera, et cetera. We need to look into this that are there simple reasons that we could learn on. But as said, I'm not trying to diminish the meaning of corporate governance, but it's part of a larger picture.
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I think you very rightly re put that within the larger picture and that we're lagging on innovation. I mean, there have been, I've been seeing discussions in the press and with think tanks that the European budget is overly focused perhaps on regional and cohesion funds and the agriculture and that we're lagging a little bit, taking some of that budget maybe to innovation. And when institutional investors look at companies in Europe, they see that a lot of the capex is not on innovation. And again, this is a crucial point. What investors are looking for is indeed seeing, you know, are the companies moving forward, are they innovating, are they going to become the next, you know, whatever company? And I think in the sustainability sphere this is really, really important. If you had to give some pointers, let's say, you know, Lena, you, you are there and you're going to tell the next European Commission, what should you be focusing on to make European companies really develop that to be a lynchpin of the capital markets? Because it's not enough, I think, to reform capital markets, the financial services, we actually need to make the financial services match what companies want. And companies need to find themselves in that CMU project. What would be your pointers for the next Commission on this?
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Yes, first of all, the European Commission and we all need to keep in mind the competitiveness of Europe. So when we are doing new projects, is this promoting the competitiveness of Europe or is it not then? The second thing is that we have received lots of new legislation and this corporate sustainability due diligence Directive is now coming. So there is a lot of new rules coming. And the thing is that we need a regulatory pause next. So what we would like to advise the next Commission not to do is to give increasing numbers of new regulations. It is now time to see how the latest and the forthcoming directive, how will they work out? Are there flaws? Is there more guidance needed? Impact assessments, reviews, etc. So how does this all Work out. And if there is a need for new regulation, I would like to emphasize the necessity and importance of impact assessment. And regarding the project of this directive that we're talking about, impact assessment was not the strong point. It even got a red flag at least once from the European Regulatory Scrutiny Board and some of the latest additions to the text were not assessed as for the impact which caused some of the mayhem towards the end. So impact assessment is the pointer and then maybe also this, that we have now enough rules for the compensation of company boards. Gender rules are being implemented in different member states because there is a quota directive. Previously we already had the directive regarding the need of a financial expert on board. Also what is coming now is cyber security expertise. So if we keep adding that you need this and that and that expert, are we sure that politicians and public authorities are the right ones to understand what kind of expertise is needed for a company board? Shareholders, owners of the company should be the ones who decide the board composition and whether it's certain expertise is on the board or is it bought from outside. So this is something that. Okay, let's stop now with, with all the regulatory processes and let's have a look what is going on. Remembering that investors are very demanding. They don't accept any kind of negative behavior from companies if they want to invest them. They look at the board compositions, they, they look at the corporate governance. And so the investors are also kind of an assurance that companies need to have good corporate governance as well as. Of course. And the final pointer is to remember that corporate governance codes are the most flexible and the quickest way to change things compared to lengthy years and years long legislative processes. And in many countries corporate governance codes are binding, so it's not actually very soft tool. So let's remember the corporate governance codes and use them where appropriate. So there's quite many wishes towards the European Commission.
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No, that is wonderful. I very much like your statement that we have to touch base with competitiveness and you know, put it as a sort of a framework. We need to make sure that we're competitive. That needs to be, you know, and it's, it's no use being best in class if there's nobody else in the class.
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Yes, nobody else. The products.
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Yeah, exactly. So, you know, I think this, this makes total sense and very good of you to remind our listeners that in fact the impact assessment in the CS3D was not, not, not a good one and that the last changes weren't really incorporated. And again, the impact assessment is an important part of new legislation in the eu when it came out, it was, it was seen as a good tool, but it's still not to the role where it should be. And also I think people are not reading and commenting enough on it because if think tanks and stakeholders are reading the impact assessments and comment on it, then actually the commission is going to have to up its game on the impact assessment. So I think this, this is what democracy and exchange is all about. And stakeholders are becoming more vocal. They're going to have to become even more vocal. We're going to have really a task ahead of us at the EU for the next legislative five year period of making sure that our companies are competitive to play in the global market, that that in turn opens up our EU capital market. So we have work cut out for us. But it's going to be a very interesting and challenging time. Lena, I thank you very much for your openness and frank discussion with me. Thank you very much indeed. And to the listeners, look forward to the next podcast. And thank you very much.
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Thank you, Josina. I really enjoyed our discussion and I'm very enthusiastic to see how will things work out in the future regarding this directive. Thank you.
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Lovely. Thank you very much.