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The Master CFO Series - A tale of two markets - EY - Deutschland

Klug geteilt - Die Rolle des CFO bei der Abwägung von Investitionen in entwickelten und stark wachsenden Märkten

Roger Barker, Head of Corporate Governance, Institute of Directors

Roger Barker, Head of Corporate Governance at the Institute of Directors, discusses with Ernst & Young the role of the non-executive board in striking the balance between developed and rapid-growth markets.



EY: What are some of the governance issues that companies are likely to encounter when investing in rapid-growth markets?

Roger Barker: When companies invest in emerging markets, one of the common issues they face is that it's often not possible to enter without forming a partnership with a local enterprise. Companies may have to form a joint venture, an alliance, or enter into a distribution agreement with a local firm in order to gain access. This may require some kind of formal corporate arrangement or it may simply mean that you need to work through intermediaries in the local market.

This can create all sorts of governance issues. If you're investing through your own company, you can transfer a certain corporate culture and an understanding about behavior, conduct, and what is appropriate. But if you are working with another company in a joint venture arrangement, for example, that is more difficult. You're therefore in a novel situation where you have less control, and where all sorts of difficulties can arise.

Another issue is the whole challenge of bribery and corruption. Even if you are operating through intermediaries or agents of some kind, you can potentially be held responsible for their behavior if it transpires that you haven't put adequate procedures in place to ensure that they don't operate in a corrupt way.

How should CFOs interact with the board when outlining their rationale for investments across developed and rapid-growth markets?

I think it's absolutely right that a key executive in the organisation like the CFO brings strategic ideas to the board based on their expert knowledge of the business and all the information that they're getting about the growth prospects in different markets. The board then plays a key role in challenging those strategic ideas and has to somehow find a way to form a judgment about how viable those ideas actually are.

What are the obstacles that boards face in reaching that judgment?

One may be a lack of expertise in those markets among the non-executive directors. The composition of the board may not reflect the new markets into which the company is planning to invest. In those circumstances, it is very important for the board to seek external advice, rather than rely exclusively on the proposals and justifications coming from the CFO and other executives.

In the longer term, if the strategic direction of the company is likely to involve a major shift towards rapid-growth markets, then the board may want to think about the skills and experience it needs in future to reflect that new international mix. There has been a significant trend towards greater international diversity on non-executive boards over the past decade or so, in the UK and elsewhere.

What are the challenges that can prevent board members from getting the information they need to evaluate a particular strategy, particularly in rapid-growth markets?

The big challenge that faces a non-executive director is getting hold of information about what's happening on the ground in a way that doesn't undermine the executive management who are actually managing the operation. This is always a tricky balance to strike.

Non-executive directors have to develop those information flows and that will involve them going out to visit these countries. It will involve establishing contacts with various individuals in the management structure, people they can speak to directly, and utilizing the internal eyes and ears of the company from functions like internal audit.

They also have to utilize external sources of information. This might include consultants and analysts who are looking at these markets and assessing how the company is performing in those countries.

How should CFOs communicate with investors about their investments in rapid-growth markets and what are the challenges associated with that?

Most investors recognize that these markets have tremendous growth potential. So the key thing for CFOs is to demonstrate to investors that they are capable of exploiting that potential. Often, the key issues in terms of being able to get a return out of that strategy are related to corporate governance. We all know that these economies will be an important part of the investment mix, so the question is whether a company's corporate governance is going to be robust enough to extract the financial return for getting involved in those markets.

It's also very important in the eyes of investors that the non-executives, particularly independent non-executives, appear to be fully persuaded that the chosen strategy is the right approach. Because after all, those independent non-executives are the people on whom the shareholders are relying to exercise independent judgement on what is being proposed by the management. It's fine for the CFO and CEO to say that these are great plans, but investors will find it much more convincing if the Chairman and the other non-executives are also behind a particular strategy.

 

Vanessa Jones, Head of Corporate Governance, Institute of Chartered Accountants in England and Wales

Vanessa Jones is Head of Corporate Governance at The Institute of Chartered Accountants in England and Wales (ICAEW). Here, she talks to EY about the challenges of managing risks in rapid-growth markets from a governance and reporting perspective.



EY: Companies increasingly consider rapid-growth markets to be their key source of future growth. As they increase their exposure to these markets, what are the issues that CFOs and other business leaders need to think about from a disclosure perspective?

Vanessa Jones: Companies have always invested in new markets but the difference today is the speed and the extent to which they are doing it. Rapid-growth markets pose particular challenges because they are more complex and often less transparent. This highlights the importance of putting in place relevant internal controls and then being able to articulate to external and internal stakeholders how they are managing risks across these markets.

When a company straddles developed and rapid-growth economies, it will inherently be running multiple business models, each of which has a different risk profile. From a governance perspective, it is a real challenge for companies to provide clear and transparent information about those different business models, particularly now that disclosure requirements are much more stringent in many countries.

A lot of the governance frameworks that have been in place for years need to be reassessed. When a company enters emerging markets, it may need to manage risks that it has never encountered before or that are inherent to that particular jurisdiction. If I were a director, I'd be looking for assurance that the information flows were as best as they could be and that there were continuous efforts being made to improve them.

How do companies balance the need for greater disclosure with the desire to protect their own competitiveness?

There is a consensus in public policy circles, stemming from the financial crisis, that what we need is greater transparency. Yet everybody recognizes that lack of transparency was not the cause of the financial crisis. In fact, most of the businesses that failed were incredibly transparent. There's nothing wrong with having more transparency but we shouldn't be fooled into thinking that greater transparency is going to prevent another crash, because it won't.

There is also a contradiction at play here. Policy-makers want greater disclosure and transparency. Yet, at the same time, they are asking companies to produce annual reports that are shorter, tighter and more succinct. Those pressures pose significant challenges to companies.

Obviously, policy-makers would argue that companies need to report more smartly, and most focus on disclosing the key and major risks. But the problem is that what's a key and major risk is in the eye of the beholder. And if companies make decisions that turn out to be wrong, then there are implications for them not to have disclosed those decisions to stakeholders.

How do companies ensure that they have internal controls that are effective and embedded in the business?

There is a danger that you put policies and procedures in place, but they sit in splendid isolation and they're not lived and breathed. If I was a CFO, I'd want to make sure that the company had an iron grip on these risks, particularly those related to the Bribery Act and the Foreign Corrupt Practices Act in the US. Even then, you can never legislate for everything, but at least you can say that you did everything that you could.

The problem with internal controls is that once you start writing rules, it is human nature to find ways around those rules. So when internal controls are too prescriptive, there is a danger that they run the risk of being circumvented or do not cover all the eventualities. That's why assurance is so important because these controls need to be constantly monitored and updated. Good companies do this by embedding the controls within their employees' behavior and making them part of their incentives through key performance indicators.

 

Colin Melvin, Chief Executive, Hermes Equity Ownership Services Ltd

As companies diversify their footprint across rapid-growth and developed markets, investors are increasingly seeking assurances that the executive team takes environmental, social and governance (ESG) issues seriously. Here, Colin Melvin, CEO of Hermes Equity Ownership Services, outlines the process for engaging with companies on ESG.


EY: What is the role of an organization like Hermes Equity Ownership Services?

Colin Melvin: At Hermes, we act on behalf of 24 pension funds and advise our clients on environmental, social and governance (ESG) issues. We recognize that many pension funds today are interested in their stewardship of the companies in which they invest. Stewardship describes the relationship between the end owner of an asset, such as a pension fund, and the company. The idea here is that the long-term shareholder as a steward has a responsibility and an opportunity in its interaction with companies to raise their long-term value through dialog.

How do you interact with companies on ESG issues?

Every year, we have between 550 and 600 engagements with companies. What we mean by engagement at Hermes is a face-to-face conversation with a senior officer or director of the company, such as the CFO. Normally what happens is that we will contact companies where we have a concern and where we think that our concerns can be addressed through that contact or engagement.

Unlike a normal investment meeting, we're not seeking information or trading advantage in any sense. Instead, what we're doing is challenging and supporting companies to promote their long term value. It's not our role to second-guess strategy or micro-manage companies but where companies have a stated strategy and they seem not to be following it then that would be a concern. Alternatively, there may be something in the company's recent past that suggests their risk management is not as effective as it could be. That would also lead us to engage.

As companies rely increasingly on rapid-growth markets as sources of revenue growth, does that change the types of issues around which you are engaging with companies?

It does to some extent. Bribery and corruption is one issue that we might need to address more frequently and that clearly affects certain companies more than others. In extractive industries, for example, it's common for companies to have to deal with this when they have operations in difficult or sensitive territories. We'd also look for assurance that there is good-quality risk management and reporting processes in firms.

How do you gain reassurance that a company's operations in rapid-growth markets have robust ESG procedures and performance?

We will visit companies' operations to see how things are wor

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