ESG in Asia Pacific

For a number of years now, investors have encouraged companies around the world to adopt ESG metrics into their executive incentive plans. The argument is that ESG metrics – that is, metrics tied to concerns around environmental, social and governance issues – will help make companies more resilient and sustainable. It is an argument that has gained significant traction around the globe as the risks posed by climate change move from theory to the lived experience of millions of people, as the psychological and economic costs of gender and racial discrimination mount, and significant financial mistakes and irregularities fill the business press.

European companies are being prodded by their customers and governments to focus on environmental and climate issues. In North America, George Floyd’s murder, the #MeToo movement, and the Securities and Exchange Commission’s new rules on human capital disclosures, are pressuring companies to focus on social issues, including gender and racial diversity in the board room and C-suite. In Asia Pacific, while less directly impacted, companies have not ignored these environmental or social issues, and many companies are working diligently to upgrade their governance policies, especially with regard to HR and compensation issues.

This governance focus in Asia Pacific is being driven by several trends, including updates to stock exchange listing rules, regulator pressure and investor concerns.

Asia Pacific regulators are focused on governance issues

A number of regional stock exchanges have proposed upgrades to board governance rules, including those in Japan, Singapore, Malaysia, and Hong Kong. The updates are generally focused on several key issues, including:

• Director independence, to ensure appropriate oversight of management
• Board and management diversity, in order to improve decision making
• Enhanced disclosure of governance issues (including ESG), to ensure stakeholders are fully informed in a timely manner
• A more powerful role for the nominating committee, in order to ensure Independent Non-Executive Directors (INEDs) better control the process of hiring and onboarding new directors

In addition to the updated listing rules, banking and financial services regulators in Asia Pacific continue to expand and refine how financial services firm are governed, with particular attention given to pay and pay governance issues.

One example is Australia, which is combining its banking and insurance regulators into a single entity and revamping a number of rules that will, for instance, expand disclosure of governance processes and policies, expand the role and responsibilities of the board, more closely dictate how material risk takers and key roles in control functions can be compensated, and mandate longer vesting periods for deferred compensation.

Investor governance concerns

Recent accounting scandals from some high-profile Chinese companies like Luckin’ Coffee, along with continued poor disclosure from many companies in the region have led many investors to become wary of investing in Asia Pacific. As noted above, regulators and stock exchanges are hoping to improve governance, but there is clearly hesitation from many investors to devote money to Asia Pacific due to a perception of poor corporate governance and higher investment risk.

Perhaps in response to these issues, JP Morgan reports that ESG investment funds focused in Asia Pacific doubled in size to US$25 billion in 2020. And 57% of investors in the region expect to have “completely” or “to a large extent” incorporated ESG issues into their investment analysis and decision-making processes by the end of 2021, according to an MSCI survey.

How boards are responding to these changes

Executive remuneration is perhaps the most visible aspect of corporate governance and serves as an important indicator of how the board conducts business, manages company resources, and is aligned with shareholder interests. Due to this visibility, as well as the increased regulator and investor attention on governance generally, boards are working to ensure pay practices and reward outcomes are based on a robust governance framework.

As with the adoption of any ESG-related goals, the approach taken by each board should reflect that company’s specific circumstances and support the company’s overall business strategy and objectives.

Some of the actions taken by boards that we are seeing include the following:

1. 01

   Reviewing incentives and compensation programs to ensure they are aligned with the company’s risk profile and appetite

   • The board needs to ensure it offers competitive pay packages, including incentives, in order to attract and retain necessary talent; losing capable talent is also a business risk.
   • Ensuring careful design of the remuneration framework to incorporate multiple, holistic performance measures: incorporating incentive payout caps, balancing short-term performance goals with achievement of long-term goals, using appropriate levels of deferred compensation and building clawback mechanisms, etc.

2. 02

   Reviewing board committee structures

   • As their workload expands, boards are looking at their committee structure and adding committees or revising their duties and responsibilities. For instance, nominating committees are being asked to take a more active role in evaluating current directors rather than just looking for new board members. Given the global interest in sustainability, companies are establishing ESG committees and expanding the remit of remuneration committees to include broader employee and HR issues.
   • In particular, risk committees are beginning to be seen in industries other than financial services. Over the past 7 years, the percentage of Hong Kong-listed companies with a risk committee has doubled, with nearly 20% of companies now having a formal, board-level risk committee. Among its many tasks, the risk committee typically works with the remuneration committee to ensure risks are appropriately weighted and rewarded in incentive plans and that the company’s overall risk profile is appropriately reflected in incentive payouts.

3. 03

   Upskilling the board/hiring new independent directors

   • Board workloads are increasing. Boards need members with both the motivation to meet the demands of today’s fast work pace, while also bringing significant work experience and compelling backgrounds to the board room.
   • Diversity by itself can create a competitive advantage – studies show diverse organisations are more creative and tend to have better outcomes – and Asia Pacific boards are increasingly looking to add diverse new talent.
   • For leading companies, diversity is not being measured along a single dimension but at least eight: gender, age, tenure, independence, culture/ethnicity, domain expertise, industry experience, and geographic expertise.

4. 04

   Implementing malus and clawback language

   • These basic protections – which allow boards to cancel or reclaim incentive awards following financial restatements, executive misconduct, and other events – are increasingly being incorporated into both short-term and long-term incentive plans.

5. 05

   Internal governance

   • The roles of management, the board, board committees and other stakeholders should be clarified.
   • Even where companies are not creating a new risk committee, they are still reviewing their processes to ensure that all relevant and appropriate voices, including management, HR, legal, finance, remuneration committee, board chairman, and outside advisors such as compensation consultants, are part of the compensation decision process – from pay program design, metric selection, goal setting, to incentive payout and vesting.
   • Companies are clarifying and documenting processes for pay decisions, ensuring that pay decisions are made at the proper level in the organisation and with appropriate input, to avoid biases and to focus on pay equity.

6. 06

   Assess plan performance and risk

   • Some companies have qualitatively assessed the risk embedded in incentive plans and the pay program as a whole. The common approach is to review key plan design features, identify the associated risk mitigators and aggravators, and assess overall risk by ‘grading’ each plan feature.

Leading remuneration committees understand that effective compensation program governance is a cyclical process that requires the periodic assessment of all plan design features and processes, and includes revisions to stay aligned with external conditions and company strategy.

Author

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Trey Davis

Senior Director, Executive Compensation and Board Advisory (Charlotte)

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