2023 proxy season: ESG remains center stage amid market uncertainty

This update summarizes current trends in governance and executive compensation. It also includes recommendations on key issues in view of the upcoming proxy season. This update considers not only key corporate legislation and proxy advisory firm guideline developments, but also comments made by representatives of institutional investors and governance organizations at a webinar we held recently.

ESG in action

ESG operationalization: All eyes on the “how”  

In last year’s update, we discussed the fact that many investors and proxy advisors intend to keep boards accountable on environmental, social and governance (ESG) matters. Some intend to vote against the chair or members of the board or its committees who fail in this respect, and Glass Lewis (GL) has announced that, for meetings held in 2023, it will recommend voting against the governance committee chair of companies included in the S&P/TSX Composite Index that fail to adequately disclose the board’s role in ESG oversight. 

However, beyond attributing responsibilities for ESG to the board or its committees, issuers should operationalize their ESG oversight. As further described in our update on ESG operationalization, there is no “one-size-fits-all” approach. “How” oversight is performed must be tailored to each company. 

ESG-related risks may cover a wide spectrum, including climate change impacts, health and safety conditions, human rights protection, diversity, equity and inclusion, and ethical business conduct, to name a few. Issuers should identify potential risks (and opportunities) for their business, and generally allocate resources accordingly. This analysis may extend to an issuer’s supply chain. 

As a best practice, issuers may use materiality matrices¹ or ESG heat maps to identify important ESG topics and adopt work plans to coordinate reporting and oversight by the board and board committees on these topics. 

Recommendation: Review your board and committee charters and consider using materiality matrices, heat maps and work plans to identify and manage ESG-related risks.

Diversifying diversity 

Expectations of proxy advisory firms on the rise

One of the key changes for the 2022 proxy season was the coming into force of revised voting guidelines of Institutional Shareholder Services (ISS) and GL on diversity. These guidelines were renewed and enhanced for the 2023 and 2024 proxy seasons.² 

As previously announced, GL will now generally recommend voting against the chair of the nominating committee of TSX-listed companies with less than 30% “gender diverse”  directors, and against all members of the nominating committee of a board with no “gender diverse”³ directors. This is a change from the fixed numerical approach it previously applied, i.e., requiring at least two women for boards with at least seven total directors. GL may choose not to make a negative vote recommendation if the company has a diversity policy with non-boilerplate language and clear targets or disclosure around the board's timeline for increasing its gender diverse membership. 

Likewise, ISS moved to a 30% minimum threshold in 2022 for the representation of women on the board, though only for S&P/TSX Composite issuers. For TSX-listed companies with more than four directors that are not part of the S&P/TSX Composite Index, ISS will generally recommend a withhold vote for the chair of the nomination committee if there are no women on the board. The exemption for companies that have a formal diversity policy will no longer apply except in particular circumstances, such as recently falling below the minimum requirement or a recent transition to the TSX or Composite Index. 

ISS recently amended its voting guidelines such that effective February 1, 2024, S&P/TSX Composite Index constituents will be expected to have at least one racially or ethnically diverse director. Under the new policy, ISS may recommend voting against the chair of the committee responsible for director nominations, or where no such individual is identified, the chair of the board of directors, when an issuer does not comply with such guideline.

New data on gender diversity representation in Canada

On October 27, 2022, the Canadian Securities Administrators (CSA) released their eighth annual review of Canadian issuers’ disclosure regarding women on boards and in executive officer positions.⁴ Based on a sample of 625 issuers, the report includes year-over-year comparisons of key trends:

While the CSA has not yet published amendments to securities regulations regarding diversity disclosure beyond gender (as was done by the federal legislator for companies incorporated under the Canada Business Corporations Act [CBCA]), it is considering expanding the scope of diversity disclosure.⁵ 

In preparing meeting materials for the upcoming proxy season, issuers should note that both the CSA and Corporations Canada have released guidance on how to disclose diversity-related data (CSA guidance begins on page 10 here and Corporations Canada guidance is available here).

Recommendation: Consider how the content and disclosure of your diversity policies and renewal mechanisms align with evolving expectations voiced by regulators, shareholders and proxy advisory firms.

ESG reporting: climate and beyond 

In 2023, the main ESG priority for many institutional investors will still relate to climate change and environmental protection. Many will thus support proposals seeking disclosure on carbon emissions, energy and natural resource use, and waste and pollution management.⁶  

ISS and GL have issued new climate-related disclosure policies for companies that are “significant” greenhouse gas (GHG) emitters listed on the TSX (ISS) or any issuer whose GHG emissions represent a “financially material risk” (GL).⁷ Beginning in 2023, both ISS and GL will generally recommend against the chair of the responsible committee in cases where such company has not adequately disclosed climate-related risk information in line with the Task Force on Climate-related Financial Disclosures (TCFD). For ISS, these companies must also have either medium-term GHG reduction targets or net-zero-by-2050 GHG reduction targets for at least the company’s operations (Scope 1) and electricity use (Scope 2). For GL, boards should have explicit and clearly defined oversight responsibilities for climate-related issues and issuers should provide adequate disclosure of such. 

Standardization of climate disclosure is very much top of mind. In October 2021, the CSA proposed National Instrument 51-107 – Disclosure of Climate-related Matters. Largely based on the TCFD’s recommendations, the proposed CSA regime focuses on four areas: (i) governance, (ii) strategy, (iii) risk management, and (iv) metrics and targets. A total of 131 comment letters were submitted during public consultations, which were concluded in February 2022. A second iteration of the proposed regime is expected in 2023, most likely after the US Securities and Exchange Commission (SEC) and the International Sustainability Standards Board finalize their respective instruments. 
ESG disclosure is generally made with good intentions but is often broad and vague, with a marketing twist. Such language may attract the attention of competition and securities law authorities. In their recent continuous disclosure review report, the CSA specifically warned against making misleading, unsubstantiated or otherwise incomplete claims about business operations or the sustainability of a product or service that may constitute greenwashing.⁸ When it comes to forward-looking statements, it is important to provide realistic expectations and include proper cautionary language.

Recommendations: Proactively prepare for new disclosure requirements. When releasing ESG-related statements, consider potential liability and include cautionary language regarding forward-looking information.

Cybersecurity as part of risk portfolio  

GL has introduced a new section to its voting guidelines, stating that cybersecurity oversight and cyber risk disclosure is material for all companies. GL now expects issuers to provide disclosure on the board’s role in overseeing issues related to cybersecurity and the steps taken to properly educate directors on the topic. ⁹  

This reflects the increasing prevalence of incidents, which are now seen successfully targeting larger public companies from a broad range of industries. The costs related to these cyber attacks are also heightened, from remediation costs and ransom demands, to operational, reputational and potential litigation costs.  

As a result of this increased risk, the SEC sought comments in March 2022 on its proposed amendments to its rules on incident disclosure, with the aim of enhancing and standardizing disclosure pertaining to cybersecurity governance, risk management and incident reporting by issuers.¹⁰ These proposed rules reflect the SEC’s stance that investors should be made aware of issuers’ efforts to prepare against and react to cybersecurity incidents in order to make well-informed investment decisions, as these incidents can have significant consequences on an issuer’s operations. 

Against this background of increased disclosure requirements regarding both cybersecurity programs and incident reporting, boards should seek to understand the cyber risks associated with their company. Companies should invest in building their security infrastructure and securing service providers and vendors to assist them. Cybersecurity training at all levels of the company and a clear internal protocol in case of an incident can also mitigate both the risks and the impacts associated with cyber incidents.  

Recommendation: Review board and board committee charters to ensure cybersecurity oversight is properly addressed. Consider cybersecurity as part of the risk portfolio on which your board has oversight, and disclose accordingly.

Overboarding: What’s the tipping point?

The pandemic has highlighted that in times of crisis, it may be demanding to sit on many boards. Both ISS and GL have updated their guidelines on overboarding.

Note ISS will generally not count a board seat if it has been publicly disclosed in the proxy circular that the director will be stepping down from that board at its next annual meeting. On the other hand, it will count as a board seat a nomination even if the shareholder meeting for the election of that seat has not yet taken place.

Recommendation: Review your directors’ list of directorships in light of ISS and GL guidelines. 

Reviewing majority voting policies 

Amendments to the CBCA on director elections came into force on August 31, 2022. Such amendments require an individual and annual election of directors. Shareholders of CBCA issuers are now required to vote “for” or “against” each nominee director (instead of “for” or “withhold”), and each nominee director must receive a majority of “for” votes to be elected.¹¹ 

Consequently, a company subject to the CBCA should review its majority voting policy and, if applicable, its by-laws, to remove inconsistent provisions. The TSX has confirmed that a CBCA company, even without a formal majority voting policy, will be considered to have satisfied TSX requirements on majority voting as the CBCA now provides a comprehensive regime in that respect. Likewise, GL has confirmed that a CBCA company will be deemed to have adopted a majority voting policy.

Recommendation to CBCA companies: Revise or repeal your majority voting policy to comply with the new CBCA requirements.

Virtual shareholder meetings: Looking beyond the pandemic

In 2023, many issuers will continue to hold virtual or hybrid (virtual and in-person) annual meetings. As described in a recent update,¹² there are various potential benefits and concerns with holding virtual meetings: 

Both ISS and GL encourage issuers to ensure shareholders have the same rights and opportunities to participate as they would at in-person meetings. GL will recommend withholding votes for the governance committee chair where an issuer holds a virtual meeting and does not provide disclosure addressing shareholder safeguards.¹³  

In February 2022, the CSA published guidance on conducting virtual shareholder meetings.¹⁴ It reminds issuers that: 

• meeting materials should provide shareholders with clear and comprehensive disclosure on logistical considerations, including how to access, participate in and vote at a virtual meeting;
• they should provide complete explanations on the registration, authentication and voting procedures for both registered and beneficial shareholders;
• they should disclose how shareholder questions will be received and addressed, and any other actions that will be taken to accommodate and manage shareholder participation; and
• they should provide shareholders with contact information where they can obtain assistance with registering for, accessing, or attending a virtual meeting.

Finally, please remember that certain corporate statutes require the company’s by-laws to include provisions allowing virtual-only meetings.

Recommendation: Make sure your AGM is free from problematic practices and review corporate by-laws as needed.

Shareholder proposals: Be aware of changes

CBCA companies should take note of recent changes regarding the deadline to submit shareholder proposals for inclusion in a company’s circular. Shareholders are now allowed to submit their proposal 90 to 150 days before the anniversary of the previous AGM.¹⁵  

Further, we have noticed strong efforts by activist shareholders recently to mobilize support for certain proposals. Shareholders with relatively small portfolios of shares are reaching out to traditionally passive shareholders to garner support for their proposals, offering to submit proposals on their behalf. Companies should remain aware of such developments and tailor their shareholder engagement efforts accordingly. 

Recommendation: Take into account new CBCA rules on proposals and be cautious of activist shareholders reaching out to passive shareholders to advance their cause.

Compensation still in the spotlight 

Pay for performance is key in challenging markets

At our recent webinar, representatives of institutional shareholders mentioned that a strong link between executive pay and company performance is critical during challenging markets. For many, executives should not benefit from underperforming markets (through generous grants of options or other equity awards) when shareholders suffer losses. In order to align pay and performance, GL has increased from 33% to 50% its threshold for the minimum percentage of a long-term incentive grant that should be performance based.¹⁶ 

When noticing a misalignment between pay and performance, ISS may review indicators based on a company’s peer group and perform a qualitative analysis, looking at factors such as change in executive management, as well as financial and operational performance. 

Recommendations: Consider using incentive mechanisms that correlate pay and performance, and benchmark against peer companies to reward relative performance.

New clawback rules

Clawback policies can take different forms and include various triggering factors. Some policies link the claw back of incentive compensation to a financial restatement or to executive misconduct, while others require both a restatement and misconduct. ISS and GL encourage adopting clawback policies, without identifying a particular type of clawback as “best practice.”

On October 26, 2022, the SEC issued new rules requiring national securities exchanges (such as the New York Stock Exchange and NASDAQ) to incorporate enhanced clawback requirements into their listing standards. According to these new rules, a listed issuer generally must claw back incentive compensation when it restates its financials, regardless of executive misconduct. The rules will also require each listed company to disclose its policy and all events of clawbacks. The new rules apply to all issuers listed on US exchanges (with limited exceptions), including foreign private issuers.

Recommendations: Consider reviewing your clawback policy, taking into account SEC rules and best practices.

The 6Ps: still a good checklist

Generally speaking, issuers should keep in mind “6Ps” when designing or reviewing their compensation mix:

1- Policy infrastructure (use a mix of compensation tools that support your strategy, implement minimum equity requirements for executives, double-trigger provisions for change-of-control payouts, clawback policies, etc.); 

2- Performance-based awards (align total compensation with performance, including ESG performance¹⁷);

3- Peer-adjusted package (take into account horizontal benchmarking – i.e., compare compensation figures to companies of similar size and scope, or related industries);

4- Proportionate (do not lose sight of vertical benchmarking and internal pay equity perceptions – i.e., CEO compensation is not disproportionate compared to direct reports and average employee compensation); 

5- Problematic awards (i.e., avoid paying overly generous severance packages and special awards, especially if recurrent; justify any special payment); and

6- Post-pandemic recalibration (you will be judged based on how you adapt your practices to the economic reality post pandemic). 

Recommendations: Don’t lose sight of the 6Ps in your compensation design and policies. Ensure any adjustments are reasonable and appropriately and accurately explained.