Governance, in simple terms, is how a governing entity, regardless of its size, interacts and makes decisions to accomplish a goal. You may find dozens of definitions of it, more or less sophisticated, but they all come down to the same idea.
Corporate governance is gaining traction in financial services, as expectations for director performance are increasing and the scope of board oversight continues to grow in complexity. The degree to which businesses formalise governance practices depends on the vision of the board of directors, a business’s internal rules and how much business partners or stakeholders require it.
Until now, Luxembourg’s asset management and banking industries are subject to strict corporate governance that the Commission de Surveillance du Secteur Financier (CSSF) regulates. However, businesses focused on alternative investments – Private Equity, Real Estate, Insurance, Hedge Funds, etc.– aren’t yet required to have corporate governance in place.
Organisations often fall into the “governance trap”, namely, governance becomes a “compliance with regulations” game. Well performing organisations are making more than compliance.
There isn’t a one-size-fits-all corporate governance model; on the contrary, it takes many forms driven by different motivations. Its non-obligatory nature in alternative investments makes it even more varied. But because a sound corporate governance influences investor trust positively, it can be the secret sauce that leads to better business results, and to stay a step ahead of the competition.
This article advocates the need for businesses to embrace corporate governance, walks you through its advantages and certain nuances to consider, and reflects on the challenge Luxembourg financial services face when implementing it.
Why Corporate Governance is the secret sauce
Why do you do business the way you currently do it?
Why do you do this business, anyway?
Sure, one can argue that the busy nature of financial services has little or no time for this type of reflection; however, the technology labyrinth we all are wandering through, and increasing governmental and societal scrutiny for businesses to behave responsibly and sustainably (among other megatrends shaping the world) don’t offer another option other than taking the time to rethink business.
A new approach to governance, with directors more engaged with topics such as corporate culture, cybersecurity, social issues and the environment, is emerging. This change is timely because the current global realm invites financial services institutions to redefine how they function today and how they will do it tomorrow. However, if there is still a certain reluctance to this fresh thinking, it’s because of the perception that it’ll require a financial trade-off.
The five pillars of corporate governance (Source: PwC)
This new approach comes in part from external pressures. Investors are increasingly vocal about what they want from their boards. Following the ostrich strategy is always an option, but if efforts to change or any costs this new fresh thinking incurs are what you are worried about, the price of ignoring corporate governance is probably more expensive.
Defining clear governance helps diminish risks, brings agility and stronger resilience and can leave more space for thinking innovatively. Governance is ESG’s G spot because decisions made on the environmental and social variables of the equation greatly depend on financial services boards’ sensitivity to them, their careful reading of changes in investors interests and their understanding of what’s at stake under this new frame.
Corporate governance drags clarity to decision systems, and brings legitimacy and efficacy too. In turn, clarity leads to having decision-making structures that help boards not only to react timely –a virtue much needed nowadays – but also to anticipate new waves of change in technology and regulation, to mention some.
But, most of all, it adds trust to the investment equation, a precious value in times when skepticism towards businesses and governmental institutions is on the up. For Alternatives, betting on sound corporate governance adds the accountability layer to their organisational leadership’s decisions, and, therefore, a healthier relationship with investors.
Key corporate governance issues can range from highly-strategic topics like corporate strategy, IT oversight and innovation, board composition and risk oversight to more real-time topics like crisis management and shareholder activism. Yet there are new technology-related subjects that will make the list longer. For example, the data governance, investors privacy and responsible artificial intelligence.
Thinking Governance (or how to get started!)
Business culture and the personalities of board members can influence the definition of governance criteria.
The exercise invites them to think of “who they are and what they stand for” and “where they want the business to be.”
For directors to cope with what’s expected from corporate governance under the new investors’ needs and increasing scrutiny, participative exercises – workshops for instance – where boards reflect on the future business, are helpful. This reflection leads to defining a benchmark or baseline (the current reality), what are the actions to take so as to change certain business practices, and the design of metrics and evaluation criteria that also calls for thinking of data sources.
Boards need new blood anyway
Embracing corporate governance or coping with increasing requirements linked to it – in the case of regulated industries – all these changes translate into a mindset change as well.
Business’s strategies change and business models evolve, so board composition needs to be evaluated on an ongoing basis. Evaluating board composition means thinking of what skills and attributes are critical to providing effective oversight of the company and answering to new or upcoming societal, investor and shareholder needs. Does the current board members have them?
Forward-looking boards expand the universe of potential qualified candidates by looking outside of the C-suite, and considering investor recommendations. For instance, they can start by broadening the approach to diversity.
Many boards conduct a gap analysis that compares the attributes its directors have with those the board thinks are critical for effective oversight. Gaps can be filled either by recruiting new directors, or by consulting external advisors.
Governance is hot, but communicating on it is even hotter
Somewhere above, we discreetly mentioned “data”. The word is short but its implications and influence are sizeable.
Data, indeed, is AI (artificial intelligence)’s favourite meal, and kryptonite to gut-based decisions.
What if tomorrow a financial services board has an AI-powered technology sit down right next to the members, to improve decision-making? AI can help streamline decision-making processes, and support them with data-driven knowledge. Better yet, it can help predict the future outcome of such decisions.
However, if AI may be the secret weapon of financial services boards nowadays, it will be as common as holding a smartphone tomorrow. What will make the difference, then?
While corporate governance is a differentiation factor, it is just a silent spectator if it isn’t made known. In the upcoming era of robots and AI, communication will be less a cosmetic action and more an important driver to keep business alive and make it grow.
Many financial services businesses are falling short on communicating with investors and shareholders.
It’s a board’s primary task not only to comply with corporate governance – in case of regulated industries – or to embrace it for competitive, reputational and investor relationship improvement but also to identify where the company is on the spectrum of investor-related communications with shareholders and to take the necessary actions to make it better.
The Luxembourg governance challenge
Corporate governance in Luxembourg faces a challenge.
Although the country is a global fund centre for both collective investment funds and other unregulated and alternative investments, it is mainly an operations hub, with sound expertise in distribution.
Because headquarters are frequently elsewhere, branch governance is the most common requirement, namely, local boards’ decisions for the branch to perform properly.
This situation requires well-defined hierarchical lines, clear guidelines for reporting, defining the responsibilities both the Luxembourg entity and the parent have, and establishing what the latter expects from the branch (responsibilities and goals).
Once again, communication proves to be key as well as alignment.
What we think
Raphael Docquier, Director at PwC Luxembourg
Undeniably, sound corporate governance influence investor trust. Companies and fund managers more and more are required to add sustainability criteria, build digital trust and think of the ethical impact of an investment in a company or business. The increase of investors’ demands for transparency and accountability is here to stay and financial services want to keep up with it. One can simply deny them, but the cost of neglecting may result in negative financial and reputation impact with unforeseen consequences. For alternative investments corporate governance isn’t yet regulated but until that comes, it is a clear differentiator factor that builds trust, improves relationships with investors and influences business sustainability.
