Herbert Smith Freehills' Financial Services Regulatory (FSR) team surveys the regulatory landscape in 2020 and identifies some themes that we expect to be at the core of regulatory priorities globally in the next 12 months.
The wider "stakeholder" in a new era of purposeful corporate culture
Global regulators are increasingly setting their sights on the wider meaning of "company purpose", including Environmental, Social and Governance (ESG) criteria, and non-financial risk.
This change in focus reflects a societal shift in attitude, with individuals becoming more conscious of the need to contribute to the well-being of society. As a consequence, companies, including financial institutions, are coming under pressure to realign their corporate purpose for the benefit of their shareholders, employees and the communities within which they operate.
In the UK, attention has turned to the meaning of section 172 of the Companies Act 2006. This requires company directors to consider a non-exhaustive list of factors when decision making, including having a regard for employees, the community in which the company operates and the environment. At the request of the UK Government, the GC 100 (the association of general counsel and company secretaries working in the UK FTSE 100 companies) has recently published guidance on section 172, providing practical steps for directors in the areas of strategy, director training, the content of board papers, use of policies and processes, flow of information and stakeholder engagement, to better enable directors to make decisions with regard for wider stakeholders. This aligns with a recent speech given by Jonathan Davidson, Director of Supervision at the Financial Conduct Authority (FCA) on purposeful leadership to promote progression.
Reporting obligations, imposed as part of a new wave of statutory changes to the UK corporate governance framework, require all large private and public UK incorporated companies to include a statement in their strategic reports describing how their directors have had regard for their section 172 duties. The statutory changes are part of the growing trend towards the expanding definition of the "company purpose", the need for increased transparency and a pressure for organisations, including financial institutions, to develop culture, and operate for the benefit of society as a whole.
In the USA, 181 CEOs of American companies (Business Roundtable CEOs) have signed a new statement on the purpose of a corporation. They have committed to leading their companies for the benefit of all stakeholders - customers, employees, suppliers, communities and shareholders - demonstrating a wider global shift towards investment in employees and communities.
We expect that this focus on the accountability of corporates and financial institutions will only increase and diversify with time. In a recent speech, Christine Lagarde promoted the building of a safer, more sustainable and ethically sound financial sector, with the aim of creating an industry where the "everyday magic" of finance is restored. Lagarde identified innovation, regulation and a broadening of corporate responsibility as key to creating an industry more aligned to society's needs, and in the interests of all stakeholders.
We anticipate that, with the growing demand from consumers for large corporates to take their social responsibilities seriously (including for future generations), global regulators will become increasingly interested in the steps that should be taken by corporate and financial institutions to curtail the effects on climate change. Mark Carney, the Governor of the Bank of England (BoE), recently spoke of his desire to bring climate risks and resilience into the heart of financial decision making, and for sustainable investment to go "mainstream".
In Europe, the Commission will draw up a Sustainable Europe Investment Plan, hoping to unlock 1 trillion of sustainable investment over the next decade. A new Non-Financial Reporting Directive will require information on sustainability risks and opportunities.
In the UK, the FCA issued a feedback statement as part of a wider set of communications from UK financial regulators seeking to direct the evolving conversation around climate change and green finance. The FCA is targeting three priority outcomes: an increase in climate-related disclosures to the market; integration of climate change considerations; and an increase in the availability of green finance products and services for consumers. In early 2020, the FCA will consult on new 'comply or explain' rules for climate-related disclosures, with the objective of bringing UK corporate disclosure in line with the Financial Stability Board's (FSB) task force on climate-related financial disclosures (TCFD) recommendations by 2022.
With 80% of over 1100 G20 companies already disclosing in line with TCFD recommendations, it is expected that, like the FCA, financial regulatory authorities in other jurisdictions will also implement changes to promote increased corporate reporting on, and accountability for, climate-related considerations and products.
In Australia, we have observed moves by regulators to expand corporate governance awareness to encompass both the wider community, and climate change. Following on from the 2019 Final Report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Royal Commission), the expression "community standards and expectations" has entered the financial services regulatory lexicon, and we expect that trend to continue. For example, the release of a 4th edition of The ASX Corporate Governance Principles and Recommendations (ASX Principles) to take effect on 1 January 2020, was "fuelled by recent examples of conduct by some listed entities falling short of community standards and expectations". ASX Principle 3 - that a listed entity should "instil a culture of acting lawfully, ethically and responsibly" - underwent a shift in focus, to openly promoting the values of a listed entity and instilling a culture of ethics. ASX Principle 7 - that a listed entity should "recognise and manage risk" - has extended to environmental and social risks, such as climate change. Listing Rule 4.10.3 obliges listed entities to disclose the extent to which they have or have not followed the ASX Principles.
The findings of the Royal Commission have also prompted emphasis on "community standards and expectations" with respect to financial institutions' management of non-financial as well as financial risk. In its 2019 report on "Director and officer oversight of non-financial risk", the Australian Securities and Investments Commission's (ASIC) Corporate Governance Taskforce found that broad oversight of non-financial risk, and of its "very real financial implications", has been lacking. ASIC's view is that the approach to board oversight of non-financial risk has been one of form over substance, overly reliant on frameworks and policies and deficient in compliance with these policies.
Regulators have shown themselves to be increasingly responsive to public pressures for greater corporate awareness of wider social issues, non-financial risk and climate change. Corporates and financial institutions will need to re-think the factors relevant to board decisions; adjust their internal processes, policies and reporting practices to meet the expectations of their regulators and wider stakeholders; and align themselves with a new age of globalised social awareness for sustainable business practice, which will, inevitably, become the new mainstream.
Protecting vulnerable customers
In the same way as regulators are requiring financial institutions to consider social criteria in their "company purpose", we also see them looking to firms to ensure that vulnerable customers receive appropriate protection. This is part of a wider debate which also draws in other industry sectors, including in particular power, water and telecommunications. The dial has moved away from the principle of "buyer beware" - and there has been much discussion about the definition of vulnerability, the extent of financial institutions' responsibilities with regard to vulnerability, and whether regulatory action alone can deliver a good outcome for the vulnerable or the excluded in society.
In the UK, in July 2019 the FCA launched its consultation on draft guidance for firms on the fair treatment of vulnerable customers, setting out its expectations about how firms should:
understand the nature and extent of vulnerabilities in their target market, and the potential needs that therefore arise; ensure that staff have the skills and capability (and are empowered) to meet those needs; and integrate that understanding through practical steps in designing products and services, delivering good customer service that responds to customers' needs and situations, and communicating clearly with vulnerable customers. Critically, the FCA's definition of "vulnerability" includes potential vulnerability, as well as actual vulnerability. Research cited by the FCA suggests that half of UK adults display one or more characteristics of being potentially...