Sustainability Policies and Practices for Corporate Governance in Latin America

8. Key policy recommendations

Abstract

This chapter provides eight key policy recommendations around sustainability disclosure, shareholder rights and the responsibilities of the board addressed to regulators and policy makers in the seven major Latin American markets.

This report presents the main trends and issues related to sustainability and corporate governance in seven major Latin American countries and globally. The main goal is to provide useful information for policy makers, regulators, and market participants to assess whether their national corporate governance frameworks adequately respond to investors’ and companies’ demands related to sustainability.

Capital markets are less developed in Latin America than in other regions. For instance, while Brazil and Chile have market capitalisation to GDP ratios close to 50%, OECD and G20 economies stage an average ratio of close to 150% (Figure 2.1). The global transition to a low‑carbon economy offers the possibility for Latin America to further develop its capital markets. In the region, companies have access to immense natural resources, and global institutional investors have increasing assets under management to invest in sustainable businesses. If public capital markets can efficiently connect both parts, Latin America’s economy and the environment will both benefit.

While green, social and sustainability (GSS) bonds have been the focus of some sustainability‑related initiatives in Latin America, the relative importance of these debt securities is low. For instance, whereas non‑financial corporations issued less than USD 15 billion in GSS bonds in either Chile or Mexico between 2013 and 2022 (Figure 2.6), the market capitalisation in these countries was USD 150 billion and USD 453 billion, respectively, in 2021 (Table 2.1). The evidence presented in this report shows a strong demand for corporate sustainability disclosure from asset managers investing not only in GSS bonds but in all types of securities, including equity. Companies have been responding to this demand, and probably the most relevant gap is the adoption of a single sustainability accounting standard accepted by both local and non‑domestic investors.

This chapter introduces eight key policy recommendations to serve as an initial agenda for discussion in the region, including in the OECD‑Latin America Roundtable on Corporate Governance, as well as in other fora. The effective implementation of the recommendations in this chapter would demand a more detailed analysis of all relevant policies in a jurisdiction, as well as a more nuanced understanding of specific capital market practices and needs. Importantly, the review of the G20/OECD Principles has not yet been finalised, and its new version is expected to contain new guidance on corporate sustainability and resilience.

The eight key policy recommendations can be classified into two categories: (i) sustainability disclosure; and (ii) shareholder rights and the responsibilities of the board.

8.1. Sustainability disclosure

1. Argentina and Mexico may consider the development of more detailed regulation on sustainability disclosure to enhance their consistency, comparability, and reliability.

As presented in Figure 3.2, Latin American companies representing 83% of the region’s market capitalisation already disclose sustainability reports (the relevant share is somewhat lower in Argentina with 58% and higher in Colombia with 95%). Notably, companies representing 76% of market capitalisation in the region report their scopes 1 and 2 GHG emissions (Figure 6.3). While requiring sustainability disclosure may not necessarily be the best policy at present in all markets, the fact that more than four‑fifths of Latin American listed companies would support mandatory sustainability disclosure is revealing of market trends (Figure 3.8). A relatively high number of board committees responsible for sustainability in the region (44% of the companies by market capitalisation have such a committee), as shown in Figure 5.4, is also a proxy of companies’ interest in improving their management and disclosure of sustainability risks and opportunities.

From the investors’ perspective, there is also a clear demand for high‑quality sustainability information in Latin America. The assets under the management of ESG or Climate Funds have been increasing globally, but especially in the region since 2020 (more than USD 4 billion in 2021, as presented in Figure 2.8). More important, even among small sized asset managers, more than 80% reported that sustainability matters affect their decision when making investments (Figure 6.1). Indeed, less than 20% of asset managers investing in the region declared that they do not review the sustainability disclosure of their portfolio companies (Figure 3.1). This may explain why more than three quarters of asset managers investing in Latin America would support mandatory corporate sustainability disclosure (Figure 3.7).

2. Argentina, Brazil, Chile, Costa Rica, Mexico, and Peru may contemplate the adoption of a high‑quality and internationally accepted sustainability disclosure standard that facilitates the comparability of disclosure across markets.

Non‑domestic institutional investors are an important source of funding for listed companies in Latin America. For instance, non-domestic institutional investors hold a larger equity share than domestic institutional investors in Argentina, Brazil, Chile, and Mexico (Figure 2.3). The use of a local disclosure standard or the freedom for companies to choose different standards may be a barrier for the increase of non‑domestic investments.

Different sustainability accounting and reporting standards are currently in use in Latin America. As presented in Figure 3.9, GRI Standards and SASB Standards are among the most often used, but some other frameworks are also a reference for a non‑negligible number of listed companies. At the same time, asset managers investing in the region indicate a relatively clear preference for GRI Standards, SASB Standards and TCFD’s recommendations with a negligible top priority for other standards (Figure 3.11). Notably, asset managers investing in Latin America strongly support the adoption of a common international sustainability disclosure standard for listed companies (71% among large‑sized asset managers, as shown in Figure 3.12), so as a majority of companies also do (70% of large listed companies, as presented in Figure 3.13). In the region, Colombia’s financial markets regulator has already adopted SASB Standards as the mandatory sustainability reporting standard, in addition to TCFD’s recommendations for climate‑related disclosure (Table 7.2).

Specifically, in the cases of Argentina, Brazil and Costa Rica, the adoption of a specific sustainability disclosure standard would also involve the clarification of who are the primary users of sustainability information. Particularly, the SASB Standards and TCFD’s recommendations, as well as the soon‑to‑be‑enacted IFRS Sustainability Standards, have investors as their primary users, while the GRI Standards are aimed at a larger main audience of investors and multiple stakeholders (see ‎Annex A for more information on these standards).

3. All Latin American countries should consider requiring or recommending annual assurance attestations by an independent, competent and qualified assurance service provider to deliver an external and objective assessment of a company’s sustainability disclosure.

Sustainability disclosures reviewed by an independent assurance service provider may enhance investors’ confidence in the information disclosed and the possibility to compare sustainability reports between companies. The frequent use of executive compensation linked to sustainability matters also adds a potential conflict of interest for executives responsible for accounting and reporting sustainability information (Figure 5.3).

In Latin America, companies representing 60% of market capitalisation already hire a third party to review their sustainability information, which is above the global average, but there are significant differences between countries (Figure 3.4). For instance, companies representing 84% of market capitalisation in Colombia provide third party assurance, while companies representing only 25% of market capitalisation in Peru do so.

4. Mexico may assess whether to embrace more flexibility in its sustainability disclosure requirements in relation to the size of listed companies, especially if developing more detailed regulation on sustainability disclosure.

The disclosure of sustainability information represents a cost for companies, which may be relatively fixed regardless of their size. In the case of smaller companies, therefore, the costs of accounting and reporting on sustainability information may not be compensated by the benefits a company will have in attracting more funding from sustainability focused investors. This is probably the reason why the support for mandatory sustainability disclosure in Latin America is lower among smaller companies (Figure 3.8).

5. Argentina, Chile, Costa Rica, and Mexico may consider prioritising, in their regulatory activities, the most salient sustainability matters in their respective markets. All Latin American regulators may prioritise their supervisory activities in a similar way.

Companies and their service providers, as well as regulators themselves, may encounter a learning path in their understanding of sustainability matters and might need time to develop adequate processes and good practices. This may justify prioritising disclosure requirements of some of the most relevant sustainability matters or phasing in other requirements such as for assurance. In Latin America, the key sustainability matters currently are water and wastewater management, climate change, human capital, data security and customer privacy, and human rights and community relations (see Table 4.1 for the perspective of asset managers, Table 4.2 and Table 4.3 for the practices in companies, and Table 4.4 and Figure 4.1 to view how industry distribution may be relevant for such a prioritisation).

8.2. Shareholder rights and the responsibilities of the board

6. All Latin American countries may choose to provide guidance on the fiduciary duties of the board of directors, and how boards may consider stakeholders’ interests.

Chile, Colombia, Costa Rica, Mexico, and Peru have adopted a “shareholder primacy” view of the fiduciary duties of directors. Directors in those countries would typically need to consider only shareholders’ financial interests while complying with the applicable law and ethical standards. In the case of Brazil, the company law arguably adheres to an “enlightened shareholder value” approach where directors would have to consider stakeholders’ interests, but the absence of court precedents brings uncertainty on how to best interpret directors’ fiduciary duties.

While the debate on “shareholder primacy” has been mostly restricted to the academia, listed companies face changing expectations from shareholders. For instance, 56% of the large‑sized asset managers investing in Latin America would be willing to accept a lower rate of return as an investor in a company in exchange for societal or environmental benefits (Figure 5.2). Moreover, 13% of large companies in the region reported that their articles of association would allow a trade‑off between long‑term shareholder value and societal or environmental benefits, which would go even further than what an “enlightened shareholder value” approach would permit (Figure 5.1).

7. Argentina, Chile, Colombia, and Costa Rica may consider the adoption of the Business Judgement Rule – or of a similar safe harbour – either in statutory law or in a reinterpretation of existing legal provisions.

Protecting board members and management against litigation, if they made a business decision diligently, with procedural due care, on a duly informed basis and without any conflicts of interest, will better enable them to assume the risk of a decision that is expected to benefit the company, but which could eventually be unsuccessful. Such a safe harbour would apply even if there were clear short‑term costs and uncertain long‑term cash inflows, as long as managers diligently assessed whether the decision could be reasonably expected to contribute to the long‑term success and performance of the company. The Business Judgement Rule is widely adopted in developed capital markets, as well as in Brazil, India and Mexico (Table 5.1), and it may be especially important for board decisions considering long‑term social and environmental trends.

Nevertheless, cautious in the adoption of the Business Judgement Rule would be warranted in Latin America. The combined holdings of the top three shareholders at the company level ranks from an average of 57% in Brazil and Mexico to a 73% average in Argentina, Chile, Colombia, and Peru (Table 2.2). Such a degree of ownership concentration may give rise to a number of conflicts of interest for directors who might be themselves controlling shareholders or be closely affiliated with a substantial shareholder. If most directors approving a transaction are interested parties, the court should not uphold the presumption in the Business Judgement Rule and the board members would need to demonstrate that the transaction is fair to the company.

8. Argentina and Brazil may consider requiring listed companies to disclose verifiable metrics to allow investors to assess the credibility and progress toward meeting voluntarily adopted sustainability‑related goals or targets.

In Latin America, 58% of companies by market capitalisation have a publicly disclosed GHG emissions reduction target (Figure 6.5). Likewise, more than 70% of asset managers of all sizes investing in the region would consider filing an ESG‑related shareholder resolution, which may include establishing long term sustainability‑related targets or goals (Figure 6.2).

Sustainability‑related goals, such as net‑zero GHG emissions targets, can strongly affect an investor’s assessment of the value, timing and certainty of a company’s future cash flows. Both from a market efficiency and investor protection perspective, if a company publicly sets a sustainability‑related goal or target, policymakers may decide to require sufficient disclosure of consistent and verifiable metrics. This would allow investors to assess the credibility of the announced goal and management’s progress toward meeting it. The disclosure may include, for instance, the definition of interim targets when a long‑term goal is announced and annual consistent disclosure of relevant sustainability metrics.