Client Intelligence > Dollars and sense > Charting the GC response
Dollars and sense – charting the GC response as sustainability hits the boardroom
A tougher risk environment is taking sustainability from PC fad to board-level concern... and onto the agendas of GCs. We teamed up with Linklaters to chart the client response in a world of 'not quite legal' risks.
In his 1962 work Capitalism and Freedom, the economist Milton Friedman complained that 'the view has been gaining widespread acceptance that corporate officials and labour leaders have a "social responsibility" that goes beyond serving the interest of their stockholders.' This 'fundamental misconception' about how markets work, argued Friedman, ought to be replaced by the consensus that the only social responsibility of business was to increase profits 'so long as it stays within the rules of the game'.
In recent years, and particularly since the financial crisis, businesses have found the Friedman doctrine increasingly wanting. Satisfying shareholders has become more difficult than ever and the once-dominant cult of maximising shareholder value that Friedman helped to start has come under sustained assault from serious business academics and some chief executives, who criticise it for engendering short-termish and risky behaviour.
As Richard Buchband, general counsel (GC) at US-based employment consultancy ManpowerGroup, puts it: 'Shareholders have always expected a profit from the corporation, but their focus on how the company is governed, and the nexus between that governance and their economic return has tightened. Institutional investors have sharpened their focus on corporate governance and everything from the composition of the board to the philosophy behind compensation decisions will be scrutinised.'
Even playing by the rules has become a challenge. A swathe of new legislation on tax, gender pay, carbon emissions and supply chains has added to the reporting burden companies face, and as businesses go in search of growth markets, they are encountering new and often conflicting rules. The problem of complying with the letter of the law is that, these days, there are an awful lot of letters.
As a result, corporate sustainability – defined in the UN Global Compact as the delivery of 'long-term value in financial, social, environmental and ethical terms' – is coming to be seen as the new rules of engagement for businesses and their advisers. Alison Kay, GC of UK gas and electricity transmission operator National Grid, sums up this change in focus: 'When I first moved in-house the topics covered by corporate sustainability were issues that didn't have an awful lot to do with legal counsel, but it's getting a lot of airtime in our peer group discussions now. We are more and more often discussing "not quite legal" questions relating to corporate governance or the effectiveness of our controls and risk management systems.'
Or, as Tom Shropshire, a corporate partner at Linklaters and co-head of the City giant's operational intelligence group, puts it: 'Corporate sustainability and corporate strategy are becoming more or less interchangeable, and there is a real need for GCs to understand corporate sustainability as part and parcel of corporate strategy.'
To better understand the ways in which the growth of corporate sustainability is shaping the GC role, we teamed up with Linklaters for an Insight report, gathering responses from 250 senior counsel and speaking to a number of senior GCs globally for in-depth perspectives.
Goodbye quarterly capitalism
The march of sustainability from corporate fad to near mainstream business thinking has been decades in the making, linked to mounting criticisms of post-1970s orthodoxies of governance and the dramatic (and related) shift in the risk equation facing sizeable companies.
Increasingly vocal calls for corporate transparency, declining trust in business, rising need to access new markets and a higher level of engagement among politicians – as seen in the use of UN/OECD remedy mechanisms to leverage campaigns – have all brought sustainability to prominence.
It is attracting powerful backers too. Michael Bloomberg, founder of Bloomberg and former New York mayor, now agitates against 'quarterly capitalism' and hosts a yearly sustainable investing summit, while Unilever chief executive Paul Polman has been so vocal on the topic of sustainability that The Economist in 2012 wryly noted that he sounded like a spokesman for anti-capitalist movement Occupy Wall Street. Iconic business thinkers like Peter Drucker and Warren Buffett have likewise frequently railed against corporate myopia.
And consider the dramatic shift in investing towards churning stock portfolios – the average time that a stock was held on the New York Stock Exchange has plunged from eight years in the 1960s to just four months in 2010. There has been ample evidence that a narrowly-applied model of maximising shareholder value is prone to short-term behaviour, often slashing investment and leading to a tendency to downplay operational risk while, perversely, avoiding the commercial risk-taking that can unlock dramatic gains.
But then ignoring risks is getting harder, even for the most venal of corporate executives. The fallout from a wave of US corporate scandals in the wake of the 1990s boom and the 2007/08 banking crisis was a major force in overturning complacency about corporate culture. Add in the intersection of tougher regulation and the border-straddling complexity of modern markets and it is easy to see how notions of sustainability have merged with risk.
Shropshire summarises the shift: 'If you were to compare corporate strategies across the largest companies ten years ago, you wouldn't see the same diversity of approaches you see today. The complexity of the issues that companies have to deal with has risen exponentially. From dealing with different markets, a more diverse stakeholder universe, increased regulatory pressures and different societal expectations, business is operating in a different world. The way in which companies execute strategies and the range of factors that inform that strategy have all become more complex.'
Buchband has a similar take. 'The world only becomes more complex. The demands upon a public company director and the expectations around the board are considerably higher than they used to be, and it is part of my job as GC to support the company's efforts to meet those pressures.'
Indeed, responses from the 250 in-house counsel respondents highlight growing awareness of such issues among the client community.
While only a small number (4%) of legal teams directly own sustainability in their organisations, 64% of GCs said sustainability had become more important to their activities advising the business compared with just two years ago. And GCs are playing a substantive role in their companies' sustainability strategies, whether they are leading them or not: 74% of legal teams had taken steps to raise awareness of sustainability within the organisation.
In addition, 72% said that sustainability was a 'top priority' for senior management, while two thirds of respondents thought a credible sustainability strategy improved access to capital. Perhaps most relevant to in-house counsel, 78% believed it was a good way of managing regulatory and compliance risk globally, while 83% believed that such policies improved the company's 'brand or reputation'.
Almost all the GCs contacted for this article emphasised that such concerns were pushing them to work across functions more frequently, allying with compliance, communications, and even research and development to help address governance concerns. Notably, the GCs who felt they were making a significant and direct impact on their business' sustainability strategy were those whose official responsibilities extended beyond legal matters.
Linklaters' global environmental head and co-head of the operational intelligence group Vanessa Havard-Williams comments: 'It is becoming common for businesses to encounter governance, ethical and regulatory issues that cut across legal disciplines and jurisdictions. Issues like corrupt payments, social and environmental compliance, and antitrust problems are becoming more interwoven, and it is increasingly obvious that the most effective way to deliver strong corporate governance is to ensure that the controls in place for one set of risks is as strong as for all others.'
Respondents emphasised that the greatest concerns to their boards were the ones that could destroy personal reputations (or put them in prison). As Clovis Torres, GC of Brazilian mining giant Vale, notes: 'For a very large company, poor governance and improper oversight can be extremely damaging. When you've got operations globally, managing thousands of employees, these things can go right to the heart of the company and threaten your ability to operate.'
The shift in legal, financial and operational risks is leading to a change in the core skills required of GCs, asserts Shropshire. 'Crisis management, which used to be thought of as a dispute-focused skillset related to investigations, now bleeds into a whole range of issues. Even on the M&A side we are seeing big changes.'
Fatima Wolff, senior director of legal and compliance at Boston Scientific Corporation, echoes the point: 'Boards were always worried about doing a bad deal, but when you raise reputational and compliance stakes it becomes a critical issue. You buy a company and find that it has legacy issues. That can blow up and go right to the boardroom. This definitely changes the calculus you make as a lawyer and companies are genuinely prepared to walk away from good business if it might present issues in future.'
As many we spoke to pointed out, finding effective ways to manage regulation is no longer just a legal issue; as broader compliance costs continue to rise at a global level, it is increasingly a question of remaining profitable.
For example, The Better Regulation Commission (now The Better Regulation Executive), the non-departmental public body, calculated that 10-12% of UK GDP is spent by business on compliance each year. That is roughly equivalent to the amount collected in income tax. And these are just the costs of complying with local laws. Increasingly, businesses are expected to comply with US, EU and UK law, even when their activities are conducted elsewhere.
Tina Smith, vice president of EMEA group legal at Japanese manufacturing conglomerate Ricoh, comments: 'It doesn't matter where your headquarters are – as a global business you are expected to comply with the laws of what might be called the dominant jurisdictions and these jurisdictions are increasingly mandating requirements that are blind to borders.'
The rapid churn of regulations also means GCs are having to move closer to their businesses' operating models. 'Conversations around governance models involving the GC are happening more often and you can understand why,' says Laura Stein, GC of The Clorox Company. 'For companies to grow they need to move into new markets. New markets have new norms, new laws, new regulations and new risks. All of these things need to be layered onto the environment in which the company is already operating. And these issues no longer stay in one place. If you're a reporting company or a listed company you've got to worry about the [US anti-bribery laws] globally. These are the sorts of things that make directors nervous and they want to know they are being managed properly.'
The realities of overlapping regulation presents two obvious challenges for companies: agencies tag-teaming across borders or, equally problematic, actively competing with each other. As Havard-Williams notes: 'If a regulator investigating an issue in one jurisdiction finds that there are people outside their jurisdiction implicated, they now may engage with the regulators in that jurisdiction. The risk of contagion across jurisdictions is therefore much greater and legal departments have to engage with these issues much more fluidly than in the past.'
One response to the regulatory onslaught, particularly for companies with substantial operations in high-risk markets, has been to develop company-wide standards for global operations. Advocates of this approach concede that it frontloads the work for legal and compliance professionals, but say it saves much time and cost down the line.
'Meeting the strict minimum in any given location might intuitively feel like the easiest form of compliance, but in the long run it is the most difficult, and the most expensive, to maintain,' says Vale's Torres. 'By establishing single, global frameworks we can operate much more efficiently, even if those frameworks are more demanding than the local laws. We keep an eye on the so-called soft laws that are developing around the world and incorporate them into our global standards because these are often a reliable guide to the regulation of the future.'
Seth Jaffe, GC of Levi Strauss & Co, strikes a similar note: 'When you deal with dozens of markets, it's difficult to [manage] the thousands of different rules that will result across the supply chain. It is far simpler to have a single standard that sets out how you expect suppliers to operate.'
This approach also has the advantage of meeting soft law standards of conduct that are often far more stringent than local laws and, increasingly, the subject of stakeholder attention. Havard-Williams observes: 'The growth of soft law in relation to ethical standards has still not been fully appreciated by the business community and it can be difficult for companies to understand that the commitments they make in CR [corporate responsibility] reports can have consequences. GCs need to make it clear to their boards that the social contract between the company and its stakeholders is changing, and there is an expectation that you will be held to account on commitments you make.'
Licence to operate
The notion of a social 'licence to operate' has gained a lot of traction in recent years. As Rui de Oliveira Neves, GC at Galp Energia, puts it: 'There has been a shift recently toward an approach that is not compliance in the narrow sense. It is still about the law and rules, but it is also concerned with how you engage with societies and communities, and to what extent your legitimacy or licence to operate comes from that engagement. Compliance and the licence to operate more generally is the biggest issue for in-house lawyers when it comes to sustainability.'
Licence to operate has become a popular term in sustainability circles, though it remains vague. As one critical study points out, between 2007 and 2012, almost every corporate member of the various major international mining councils referred to 'social licence to operate' in its corporate communications. However, a considerable number of companies are having to take it seriously and there are practical issues underpinning it.
Mohamed Adam, GC of ArcelorMittal South Africa, says that the concept reflects a pragmatic change in the nature of risks companies face. 'You can't just look at financial issues in isolation because that will inevitably lead you into huge dangers that can jeopardise the organisation's viability. Corporate citizenship and stakeholder engagement is a big part of that. A lot of organisations are starting to look at how they run their businesses and are looking to move to a new mode of governance.'
National Grid's Kay sees it as an even more fundamental shift in business thinking. 'There is no longer a God-given right for a company to just keep doing what it has always done. We are constantly being challenged on how we do things and being pushed to recognise that the licence to operate comes with a pay back. For us to be able to be out in a community on a day-to-day basis we have to ask: what is the community going to want in return?'
While there is no physical licence to operate, a growing number of companies are using their environmental, social and governance (ESG) disclosure statements as a proxy. Not only are more companies looking to report on such risks, but a growing number of investors are pushing for it. A number of private equity funds have now started including ESG criteria to inform investment decisions. As Erika Karp, founder and chief executive of investment house Cornerstone Capital, puts it: 'There has been a growth in interest in sustainable investment and that growth is accelerating. The reason is obvious – why would you not want more information as an investor? Many empirical studies show ESG integration is additive to a portfolio's performance precisely because it gives a broader view of the company's activities.'
Some have gone further still and incorporated ESG reporting into their financial disclosures. However, Havard-Williams says GCs could push their organisations to use these disclosures more effectively. 'Sustainability reporting is still too focused on good news – it's still too fluffy. CR teams tend to write aspirationally, but it's not in the interests of the organisation to be that upbeat about it. There is scope to explain why it isn't straightforward to take responsibility down the supply chain and what measures you have in place to manage corruption risk without pretending it is possible to eradicate it. Governments and NGOs both have an interest in putting responsibility onto the multinationals. But it's not only the multinationals' responsibility.'
A growing number of GCs are seeing things the same way. As former GC of Total, Maarten Scholten, says: 'NGOs tend to focus on [multinationals] in the sector and forget that national players are often much bigger. In the oil industry, the five largest multinationals account for 5% of daily oil production but get 95% of the attention from NGOs. There is only so much multinationals can do by themselves.'
Adam agrees: 'Ethical sourcing is always a trade-off. How far do we impose our requirements about anti-corruption and safe working standards on contractors and suppliers? We can only push the boundaries so far before it becomes unrealistic.'
These challenges aside, the number of GCs who point to the growing role that sustainability has in their day jobs is rising, and the 'not quite legal' matters key notes are become increasingly core to in-house teams. Some may recoil from the clunky jargon but, one way or another, such concepts and wider risk disciplines are forcing their way onto GCs' agendas.
As Buchband concludes: 'There is plenty of complexity to running a sustainable global enterprise, which means sustainability is central to my role. GCs are always involved in sustainability whether we use that label or not.' LB
Staying power – meet the GCs driving boardroom sustainability
Richard Buchband, ManpowerGroup (US)
'ManpowerGroup has always been concerned with sustainability in that it has been contributing to society by providing meaningful employment,' says Richard Buchband, general counsel (GC) and company secretary of the US employment consultancy. 'That focus has evolved to encompass a wider range of environmental and social issues.'
Buchband's role sees him leading Manpower's ethics and compliance programme, which he has helped to re-engineer over the past two years to include a company-wide training programme – both online and in person – that covers 29,000 people. He notes: 'The focus of the programme is around our code of conduct, the expectations we have about how our people operate in the business community, and the integrity and behaviours that are important to us. We were very conscious of making it understandable, realistic and relevant to situations our people face every day.'
Addressing internal stakeholders is only half the challenge of developing a credible strategy. Finding new ways to communicate with key investors is often just as important. Buchband frequently contacts Manpower's larger shareholders, offering to meet them in person to explain the company's approach to corporate governance.
'We've got a great story to tell as a company and this creates another opportunity to tell it. Investors can meet members of the c-suite and check that our approaches align with their expectations. Getting the right governance structures is central to the role of GC, and the decisions the board and management make need to be completely visible.'
Buchband says the GC's unique place within an organisation makes the role extremely important to developing a sustainability strategy. 'The GC position comes with access to the board of directors, access to shareholders, to departments and to operating units within the company. My advice is to use that access. A good GC can build bridges between the stakeholders and functions that form the company.'
Clovis Torres, Vale (Brazil)
In November 2015, Brazil suffered one of the largest environmental disasters in recent history. The collapse of a dam near the city of Mariana led to 19 fatalities and affected a 600km stretch of water, from river to ocean. The company responsible for the disaster, Samarco, is a joint venture between FTSE 100-listed BHP Billiton and Brazil's Vale, one of the largest mining concerns in the world. Vale spent billions dealing with the communities surrounding the affected area and, says GC and head of sustainability Clovis Torres, was fortunate to escape intact.
Vale has built up its sustainability strategy as a response to the complexity of its operations, which in Brazil tend to focus on areas where indigenous rights are heavily protected. 'If you bring 20,000 construction employees to a municipality you will definitely make a huge impact,' says Torres. 'In this situation the GC plays a very important role. You need to do a whole range of things, none of which are technically legal matters but all of which contain legal issues one way or another.'
'We bring in anthropologists, environmental scientists, sociologists – world experts in their field – to mitigate these risks and report to these communities, but as a lawyer, my reading of a risk is much more careful. What may to an environmental specialist look like a simple statement of our good faith needs to be checked carefully, because to the outside world these are commitments we are expected to meet.'
Building up this approach, Torres is now focused on Vale's operations outside Brazil. 'There are places where health and safety standards do not match our model, but by following a global best-practice standard we are able to protect the communities we work with, and our own reputation, regardless.'
As part of these efforts, Torres helped introduce a series of mobile courts to assist Vale's mining operations in Mozambique. 'There were fewer than 200 judges in the country when we arrived and the legal structures were not robust enough to offer protections. We saw that as a huge risk to the company. The mining project involved us investing $10bn on a long-term basis, so the stability of the jurisdiction was of great concern to us. Helping Vale's operations be a success and raising standards more broadly are one and the same thing.'
In early 2017, Vale hired former World Bank deputy GC Alberto Ninio to work alongside Torres as sustainability director. 'Our role as lawyers is helping to draw in the various teams of experts and ensuring all potential risks are adequately covered. It becomes a virtuous circle: lawyers have a depth of knowledge and are good at helping other functions address risks, and by engaging with sustainability issues this understanding is deepened, which helps us become better at spotting risks.'
Mohamed Adam, ArcelorMittal South Africa
ArcelorMittal has enjoyed a near-monopoly in South Africa since it acquired the former state-controlled steel producer ISCOR in 2004. In 2016, longstanding tensions between the company and the ruling African National Congress came to a head when it was handed the largest competition law fine in the country's history, amounting to around 5% of turnover. The issues the case introduced, says GC Mohamed Adam, took him far away from his legal training.
'Though it was a competition law contravention, my role advising the chief executive had very little to do with the legal aspects and a lot to do with helping the company plan a strategic response. We did not want to shirk our responsibility, but to undo the wrong and make sure we were able to avoid a similar situation in future we needed to have a conversation with the authorities so we could deal with these issues in a manner which would not be prejudicial to the steel industry in South Africa.'
This, says Adam, shows the value a focus on sustainability can bring to the GC role. 'If we had approached the case in a pure legalistic manner we would have got nowhere. It would have been a question of taking defensive positions or arguing whether we were wrong or right. The sustainability approach was abandoning that to say: "Look, this is the way the government thinks the industry should be regulated, this is what we think they're overlooking – can we have a conversation and reach a compromise position that is better for both sides?"'
As a result, a new pricing methodology on steel was agreed with the competition authorities. A similar approach, says Adam, can be used to help business, governments and communities reach compromises that avoid unproductive horse-trading. 'It is no good having rules and penalties if companies cannot reasonably comply with them. At the same time, we must accept responsibility to go beyond bare-minimum compliance. Long-term stability demands we think about stakeholders, ethics, and about the relationship between what we do and the communities we operate in. The world is much more uncertain so lawyers have to become more comfortable dealing with ambiguity.'
Seth Jaffe, Levi Strauss & Co (US)
In 1854, Levi Strauss gave $5 to an orphanage in his adopted city of San Francisco. This established a tradition of social responsibility at the company that now bears his name. In recent years, however, the company's focus has widened from corporate social responsibility (CSR) to sustainability. Notes GC Seth Jaffe: 'Our customers, particularly Millennials, think more about the companies they are buying from and what those companies' values are. Developing a sustainability strategy is about aligning with those expectations.'
Along with his responsibilities for legal, security and the chair's office, Jaffe oversees the Levi Strauss Foundation, a corporate trust which has for more than 60 years been focusing on the communities with which the company engages. 'The Foundation's recent work is a great example of how sustainability initiatives can generate opportunity,' says Jaffe. 'We did an assessment and determined the areas our workers needed help in before working with our vendors to incentivise them to provide this type of education. The data we collected showed that for every $1 vendors invested, they got back $4 due to reduced absenteeism and increased turnover. That is how I think of sustainability. Doing the right thing generally gives you a better business outcome in the medium term than focusing only on the bottom line.'
Jaffe has also seen a big change in the relationship between sustainability and the role of GC. 'The involvement of legal teams in CSR used to be confined to advising the supply chain on how to interpret and contract certain decisions the company had made. Nowadays it is important for a board to be aware of what's going on in terms of market expectations, regulations and a host of other things. Frankly, boards expect GCs to bring these issues to their attention, and we have the ability and the duty to shape those conversations. That is not going beyond your legal mandate, it is simply advising properly on risks.'
Laura Stein, The Clorox Company (US)
Consumer goods group Clorox is well known for its sustainability initiatives. It was the first major consumer packaged goods company to lead in ingredient transparency in cleaning products, the first such company to launch an environmentally-friendly household cleaning line into mainstream retailers across the US, and one of the first listed US companies to release integrated financial and CSR reports, which it has done since 2011.
Integrated reporting, says GC Laura Stein, who also co-sponsors the company's social responsibility and enterprise risk management programmes, was a response to changing expectations Clorox is facing in the market. 'We found our CSR strategy and business strategy overlapped on so many key indicators that it no longer made sense to treat them as independent documents. In giving a total company narrative, we are outlining to stakeholders the entire set of issues we face, backed up by external auditing across several ESG [environmental, social and corporate governance] metrics. We treat the ESG portion of our report with the same care and legal diligence as we treat the financial report. Both are documents outlining risks investors can expect to face and, from a legal perspective, both should be just as accurate.'
This shift toward monitoring sustainability has led Stein to partner with parts of the business that GCs rarely encounter. 'A successful sustainability strategy requires you to ignore silos and work across business lines. I sit with our R&D teams to look at how we can make our products more sustainable. This isn't about telling our people how to comply with laws – it's going far beyond the law to address the future of our business. It's in these areas that I really see how a sustainability strategy is good for driving innovation.'
This, says Stein, is a lesson that all GCs should learn. 'Almost all aspects of sustainability will trip into the legal field and if you set a standard or a code of conduct as a company, you need someone to drive that forward in a realistic way. One of the reasons our CEO and board entrusted me with this role is that there are many things in the GC's background that are helpful in driving a sustainability strategy.'