Making corporate governance more sustainable in Germany – Corporate Governance

The new German Corporate Governance Code will put more emphasis on corporate sustainability.

Context of the new Code

The German Corporate Governance Code was first published in 2002. It already included elements of sustainability, but not as completely as in current drafts. The new Code, published after an extensive consultation process, will not come into force until it is published by the Department of Justice. Until then, the previous version of December 16, 2019 remains valid.

Key changes

The revised draft code focuses on ESG: environmental, social and governance. In addition, adjustments were made on the basis of the Financial Markets Integrity Strengthening Act (FISG) and the revised Management Positions Act (FüPoG II).

The main changes are presented below.

ESG for the Management Board

The focus on sustainable and social corporate governance, ESG compliant, is already clear in the preamble. The management board and the supervisory board should take social and environmental factors into account in their management and control. It is in the interest of the company, because social and environmental factors have an influence on the success of the company.

Recommendation A.1. of the draft 2022 Code shows how to achieve this. The board, he says, should systematically identify and assess the opportunities and risks for the company associated with social and environmental factors, as well as the ecological and social impacts of the company’s activities.

In addition to long-term economic objectives, ecological and social objectives must be duly taken into account in the company’s strategy. Business planning should also include financial and sustainability goals. The aim is to ensure appropriate consideration of sustainable interests alongside economic interests. This is weaker wording than the previous consultation version of the Code, which still gave the impression of requiring an equal balance between sustainable and economic interests.

ESG for the Supervisory Board

The focus on sustainable and social corporate governance is also reflected in the recommendations to the supervisory board. Here, the government project of May 17, 2022 is also more sober. The overall recommendation on monitoring and follow-up by the supervisory board of sustainability aspects, included in the previous consultation version, has been deleted. However, the Supervisory Board is also held accountable in the current draft 2022 Code: , which includes monitoring and advice from the Supervisory Board on sustainability.

Supervisory boards should have expertise in sustainability issues that are material to the company in question (recommendation C.1 sentence 3).

The “qualification matrix” (recommendation C.1 sentence 5) is new. The progress of the implementation of concrete objectives for the composition of the supervisory board competence profile of the members must be disclosed in a qualification matrix in the corporate governance statement.

Finally, the supervisory board report should indicate how many supervisory board and committee meetings were held virtually and how many on-site (recommendation D.7).

ESG for internal audit

Principle 4 of the draft 2022 Code provides for internal control and risk management systems and supplements them with internal control of adequacy and effectiveness.

Sustainability will also become an issue for internal audit in the future. Internal control and risk management systems should also include sustainability-related objectives (recommendation A.3). Internal control and risk management systems should be described in the management report (recommendation A.5) and include a compliance management system adapted to the company’s risk profile (principle 5).

Adjustments for the Strengthening Financial Markets Integrity Act

Principle 14 provides for the establishment of an audit committee (a new requirement added to the Strengthening Financial Markets Integrity Act requires listed companies to establish an audit committee).

The members of the audit committee must include at least two financial experts: an accountant and an audit expert. Here again, there is an ESG impact: knowledge and experience in auditing financial statements includes knowledge of reporting and auditing in terms of sustainable development (recommendation D.3).

Gender balance on board

For the composition of the boards, principle 9 of the 2022 draft code now also includes a minimum participation of women (as provided for in the law on management positions. According to principle 9, the supervisory board must ensure the minimum participation of women legally regulated or set targets for the proportion of women on the board within the framework of legal obligations.

Recommendations for action

The 2022 Code is still in draft, but is not expected to change significantly now. As the comparison with the consultation version already shows, the focus is on ESG-compliant corporate governance.

Sustainable corporate governance is fair and important: many investors have already recognized this. As envisioned in the latest draft, the 2022 Code will likely enter into force in the near future. The focus will be on ESG-compliant corporate governance, as will the upcoming compliance statement. Therefore, if listed companies do not already have ESG-compliant corporate governance, these changes should be considered immediately and implemented internally.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

Helen D. Jessen