There is much still to do if the European Union is to meet its obligations under the Paris Agreement on climate change. Last week, the European Commission’s High Level Expert Group (HLEG) on Sustainable Finance published a report with wide-ranging recommendations that should help to move the EU closer to achieving its ambitious targets. As well as suggesting that fiduciary duties should be clarified for institutional investors and fund managers, including private equity and venture capital fund managers, so that they clearly require “sustainability” issues to be taken into account in decision-making – a suggestion that is already being taken forward by the Commission – a number of other recommendations are also likely to influence the Commission’s reform agenda.
But in one area the proposals need more thought: the HLEG’s suggestions for the duties of company directors may look like a tweak to existing rules but, if applied as widely as envisaged, would actually require more fundamental change.
In the same week that the UK government announced the chair of the working group it has tasked with producing a corporate governance code for large UK private companies, to sit alongside the Code that already applies to publicly traded companies, the HLEG also looked at the role of corporate governance in delivering better outcomes for a company’s stakeholders. But the HLEG took a different approach: it rejected the idea of a “fully-fledged” European corporate governance code, in favour of explicitly including sustainability in a director’s duties.
The formulation suggested for this newly articulated duty looks similar to the statutory duty already applying to directors of UK companies – whatever their size and impact – but with some very important differences. The HLEG adopts the UK formulation of a director’s core duty of loyalty: a director’s duty is to act in the way that the director considers most likely to “promote the success of the company”. However, unlike its British counterpart, the HLEG approach is to give equal weighting to “shareholders and other stakeholders” when specifying how a company’s “success” is measured. The list of factors that directors are supposed to take into account also closely follows a similar list in the UK law, but in the UK it is clear that shareholder interests dominate. No such shareholder primacy appears to be envisaged in this EU-wide duty.
The HLEG report also proposes a rewriting of the duty of care for company directors and specific duties for non-executives (or supervisory board members for companies with two-tier boards). These would include a duty to ensure that management developed a climate strategy, had remuneration structures consistent with that strategy and reported regularly on sustainability. It is not specified whether these changes would apply to all companies, to companies in specific sectors, or only to large companies or those which are publicly traded. Perhaps the most likely outcome, if this proposal is taken forward, would be for it to apply to all companies, public and private, above a certain size threshold.
But any such changes would be hard to implement across the EU because the law on directors’ duties is not harmonised in Europe, and countries come from varying starting points. It may seem odd that the HLEG has started with the UK formulation, given that the UK will probably not be a member of the EU for much longer, and other countries have already adopted different ways to protect outside stakeholders (especially employees). For example, some European countries already have a “pluralist” approach to defining a company’s interests – taking into account stakeholders more broadly than just shareholders – but generally the duties are owed to the company, and enforceable by the company. That means that shareholders – who appoint the board, or at least usually a majority of the board – are still effectively in the driving seat.
More fundamentally, the HLEG proposal remains very sketchy and does not deal with some very basic objections to this pluralist conception of the company’s interests. What about, for example, where the interests of shareholders and other stakeholders are in conflict? How are directors supposed to resolve these conflicts? Who will enforce the duties? Will stakeholders be given rights to bring claims against directors for failing to properly consider their interests, or will shareholders be in charge of enforcement (in which case it seems likely that their interests will continue to dominate)? Will an outside regulatory body be needed to resolve disputes and enforce duties and what effect will that have on shareholders’ willingness to invest in European companies and the cost of capital? Will these changes be mandatory for all EU companies, or default rules that shareholders can override? And will they only apply to companies incorporated in the EU, or to any company doing business in Europe, wherever established?
It is, perhaps, for these reasons that many countries and stock exchanges – including the UK – have chosen to develop “comply or explain” codes, to spread best practices but without mandating a particular set of rules. In apparently embracing a different approach, the HLEG raises a whole series of questions that, if the Commission decides to take them forward, it will need to answer.
Or it may decide that this (relatively small) part of the overall report is one that belongs in the “too difficult” pile, at least for now. In this regard, it is perhaps noteworthy that the Commission’s highly positive press release that accompanied publication of the report mentions sustainability disclosure by companies, but is silent on directors’ duties.