Report from the May 2018 CDN

Meeting

The Canadian Directors Network (CDN) met on 15 May 2018

in Toronto. We prepared this summary to highlight key

themes that emerged during the meeting on the following

topics:

► Regulatory matters: cybersecurity, climate change

reporting ► Canadian investment climate ► Governance considerations ► Artificial intelligence

This document reflects the Network’s use of a modified

version of the Chatham House Rule whereby comments are

not attributed to individuals or their firms. Participants are

listed at the end of the document.

Regulatory matters

During recent conversations, members cited two recent

regulatory developments that boards are following: the U.S.

Securities and Exchange Commission’s cybersecurity

guidance, and the CSA’s recent report on climate change

reporting.

Cybersecurity

In February 2018, the SEC issued interpretive guidance

instructing companies to include specific disclosures about

cybersecurity risk management, and how the board of

directors engages with management on cybersecurity issues.

The guidance stresses the importance of cybersecurity

policies and procedures and discusses the application of

disclosure controls and procedures, insider trading

prohibitions, and Regulation FD selective disclosure prohibitions.1

Members discussed the following:

1. Regulatory focus on cybersecurity is intensifying. Members agreed that much of the SEC’s recent

cybersecurity focus stemmed from the 2017 Equifax

breach, which exposed sensitive personal

1 U.S. Securities and Exchange Commission, “Commission Statement and

Guidance on Public Company Cybersecurity Disclosures,” 26 February 2018.

information of 143 million Americans. That breach—

and the subsequent response from Equifax’s

management and board—contributed to a “feeling [at

the SEC] that not everyone had proper governance

structures in place.” Moreover, the magnitude of

companies’ cyber-risk appears to be increasing. As

one member said, “A year ago, [it seemed] there

was a breach every six months. Today [there is one]

almost every day.” Some members were concerned

that the SEC felt the need to provide specific

guidance, particularly given the differences in cyber-

risk across sectors. As one said, “We shouldn’t have

to be told what do to. It’s just about good

governance.” Another asked rhetorically, “If you

have to provide guidance on this, where do you

stop?” Still, there may be benefits: “The SEC

guidance gives [boards] a good checklist.”

2. Boards are evolving their cyber oversight

practices. Members noted that many boards are

deciding how best to oversee cybersecurity risks.

One member said management is increasingly

engaging in tabletop exercises (i.e., simulated

breaches), and wondered how many directors

participate in these exercises. After all,

“management [often] looks at a breach differently

[from the board]. … Getting everyone on the same

page is difficult. Reputational risk comes up time and

time again.” Of course, some companies (e.g.,

financial institutions) face greater exposure than

others. Their cyber defence strategy may include

“educating customers, [cyber] insurance, training

your employees, and having policies in place.”

However, some said their companies are reverting to

older processes—including phone calls and faxes—to

mitigate cybersecurity risks. As one member said,

“In some cases it feels like we are stepping back [in

time].”

Climate change reporting

On 5 April 2018 the Canadian Securities Administrators

released the results of a year-long review of climate change

risk reporting by large Canadian publicly traded companies.

The study found that “substantially all of the users we

consulted are dissatisfied with the current state of climate

Canadian Directors Network

Meeting notes

change-related disclosure, and believe that improvements are

needed.”2 The report found significant disparities in practices

across companies and industries, but did not recommend any

immediate action.

Members discussed the following:

1. Boards might encourage greater disclosure of

climate change risks. One member noted that Sarah

Keyes of CPA Canada recently spoke to their board

about climate change disclosure: “The takeaway was

that there was more to do.” Unfortunately, many

companies don’t know where to start. What is an

appropriate risk threshold? According to one member,

“it’s very hard to start with [a] blank sheet and

highlight risk factors. You want to include everything,

but [when you list] everything, [it] almost equates to

nothing.”

2. Most stakeholders value action more than

disclosure. Members generally agree that the broader

consequences of climate change are “very important,”

and that the risks—and opportunities— go well beyond

disclosure. One member said that “investment funds

are forcing companies to focus on climate change.”

However, another said that few investors are willing to

pay a premium for granular climate reporting, and

“buyside analysts are not asking about sustainability

or green policies.” Still, boards recognize that an

emphasis on green practices and transparent

reporting may yield ancillary benefits in time:

“Younger people want to invest [their careers] in

sustainable enterprises.”

Canadian investment climate

Before the meeting, several members expressed concern with

the Canadian business climate. And they highlighted the

Trans Mountain Pipeline project as a “litmus test” for many

foreign investors.

The first Trans Mountain Pipeline was built in the early 1950s

to carry crude and refined oil from Alberta to the west coast

of British Columbia. In 2013, the pipeline’s owner, Kinder

2 CSA Staff Notice 51-354, “Report on Climate change-related Disclosure

Project,” 5 April 2018. 3 In a timely postscript to our meeting, the Canadian federal government

announced on May 29 that it would buy the Trans Mountain pipeline from Kinder Morgan for C$4.5 billion. Finance Minister Bill Morneau explained:

Morgan, applied to build another pipeline roughly parallel to

the existing one to transport diluted bitumen. The Canadian

government indicated in late 2016 that it supported the $7.4

billion project, whose construction would create 15,000 jobs.

Despite the approval, the project has been challenged by the

municipalities of Vancouver and Burnaby, as well as several

First Nations.

On 8 April Kinder Morgan suspended “non-essential”

activities, as the company did not want to “put our

shareholders at risk on the remaining project spend.” The

company seeks assurance that the project will not be delayed

by political and legal wrangling and has given the federal

government a 31 May deadline to resolve the impasse.

Members discussed the following:

1. The pipeline will probably be completed; Kinder

Morgan is unlikely to own it. Most members expect

the Trans Mountain pipeline to be completed

eventually. However, there was broad agreement that

Kinder Morgan’s 31 May deadline will be of little

consequence, as the final project will likely require a

change in ownership. Some thought the Province of

Alberta would assume a more direct financial stake,

since “[Alberta Premier] Rachel [Notley] needs to

show she’s resisting forces that oppose [the project].”

Members expressed concern that the project had been

derailed by a “vocal minority,” and some thought the

pipeline would have to be re-positioned as “an

indigenous project” using “Aboriginal investment

funds.”3

2. The consequences of Trans Mountain are a threat

to Canadian business regardless of the final

outcome. Some worried about the precedent set by

Trans Mountain as companies pursue strategically

important infrastructure projects. After all, as one member said, “Ian Anderson, [president] of Kinder

Morgan [Canada], is the poster child for how to do this

with the buy-in of interest groups. The message to and

for Canadian investors is that it sends a signal of

uncertainty as regards the Canadian investment

climate. Everyone should be concerned about [the

“When we are faced with an exceptional situation that puts jobs at risk that puts our international reputation on the line, our government is prepared to take action.” The federal government says it does not intend to own the project for the long term.

government’s] interest [in supporting] foreign

investors [that want] to invest in Canada.”

Others agreed. As one member said, “[Prime Minister

Justin] Trudeau has to pass the pipeline deal. His

reputation with [the] business community is at stake.”

Some wondered whether the federal government had

the courage to assert its legal authority, particularly

on interprovincial trade. Another member lamented

the federal government’s “limp-wristed submission.”

Moreover, “If BC can block this, it puts the federal

government in a position of weakness [going

forward].” Members recognize that political solutions

can be messy; as one quipped, “Those that love laws

and sausages shouldn’t watch either being made!”

3. Regulatory uncertainty is a significant risk to the

Canadian business community. Some members say

Canadian competitiveness is being impacted by the

renegotiation of NAFTA—particularly in the auto

sector—and changes to the US corporate tax system.

However not many members worry too much about

those issues. As one said, “Yes, we lost [a tax rate]

advantage. But for [a tax difference of 2%], why would

I move [the company] to the US? [In Canada], there is

less absenteeism, and better quality.” Still, many are

worried about Canadian “regulatory uncertainty,”

which is a “predominant concern.” For example, one

observed that regulatory approval for projects in

Canada routinely takes 18 months longer than for

projects in the US.

4. Canadian companies can no longer assume their

most attractive growth opportunities are at home. Several members said concerns about the Canadian

business environment were causing their companies to

more aggressively explore growth opportunities

abroad, particularly in the “red-hot US economy.”

Some worried about a flight of Canadian talent to US

companies, and said Canadian companies needed to

“hedge [their] bets” given the more favorable business

climate in the US. Still, even though tax and regulatory

considerations make the US “more attractive,” some

pointed out that investing outside of Canada can

present challenges too. As one said, US executives

4 Alex Morrell, Business Insider, “Larry Fink, CEO of $6.3 trillion manager

BlackRock, just sent a warning letter to CEOs everywhere,” 16 January 2018. 5 Eric Roston, Bloomberg, “Fink's Letter to CEOs Upends a Half-Century of Business Thought,” 17 January 2018.

often command higher compensation than their

Canadian peers, so that “compensation structure

cross-border becomes an issue.”

Governance considerations

Several members wanted to discuss BlackRock CEO Larry

Fink’s 2018 Annual Letter to CEOs, A Sense of Purpose. And

it’s no wonder. One reporter described the letter as a

“warning shot,”4 and Bloomberg said it “upends a half-

century of business thought.”5 In stark contrast with Milton

Friedman’s assertion that “the social responsibility of

business is to increase its profits,” Fink argued for “a new

model of shareholder engagement” in which investors and

managers align their interests with evolving societal needs.

As Fink wrote: “Society is demanding that companies, both

public and private, serve a social purpose. To prosper over

time, every company must not only deliver financial

performance but also show how it makes a positive

contribution to society. Companies must benefit all of their

stakeholders, including shareholders, employees, customers,

and the communities in which they operate.”6

Members discussed the following:

1. Fink’s letter will prompt greater focus on a

company’s purpose. Members appear to generally

support Fink’s vision of a “new model of shareholder

engagement.” One said Fink described “a new social

contract,” and argued that the market would favour

“purpose-driven organizations.” Members said that

boards and executives need clarity on a critical

question: “Why does the company exist?” After all,

“it’s good when there is alignment between purpose

and profitability. It’s difficult when there is a gap.”

Five years from now, members expect “more

reporting with consequences. Sustainability

reporting will be standard.” Moreover, members said

Fink foreshadowed a looming talent risk: “If you

don’t pay attention to these things, you won’t attract

the next generation of employees.”

Some also noted that evolving corporate ownership

structures will also impact governance practices.

Over time, the “massive shift from public to private

6 Larry Fink, BlackRock website, “Larry Fink’s Annual Letter to CEOs: A Sense

of Purpose.”

[equity] markets” will be a “major influencer” in the

management and oversight of leading companies.

We had planned to discuss a number of governance topics at

this meeting (e.g., board composition, onboarding,

committees, board dynamics, self-assessment, succession).

However, there was not enough time cover these issues, so

we will defer them to the next meeting. Members did offer

several observations about effective board governance that

will provide context for our conversation at the next meeting.

These included:

1. Great chairs lead great boards. Members stressed

the chair’s important role in board effectiveness.

Values are critical, and the chair leads the board in

reinforcing these core values. Asked how an

observer would distinguish between a board with a

great chair but average directors, and a board with

great directors but an average chair, one member

said it was a false choice: “A great chair would never

tolerate average members!” Members noted that

while some US companies still have a combined

CEO/board chair, the vast majority of Canadian

companies now split those roles.

2. Management presence can stifle board

discussions. Before the meeting, several members

observed that the most productive board discussions

often took place during dinner. During the meeting,

most agreed that it was actually the presence of

management—rather than the setting—that stifled

discussion. One member said, “There are more

management showing up at board meetings.

Communication is not as open [when they are

present].” Some boards routinely vary dinner and

meeting format—sometimes including management,

and sometimes not. Others leave it to committees to

engage with operating key executives; for example,

the audit committee will meet for breakfast with the

finance team, while the compensation committee

meets with senior HR staff. Members said the chair

and/or CEO will typically poll fellow directors as part

of a “long, drawn-out negotiation” to agree on board

meeting participation and structure.

7 Michael Chui et al, McKinsey Global Institute, “Notes from the AI Frontier: Insights from Hundreds of Use Cases,” April 2018.

3. Management wants the board to dig deeper into

the substance of the business. Some members

have observed that management’s expectations of

the board are changing. As one said, management

wants the board to have “more direct industry

experience. It’s a great benefit [for them]. The ability

to dig into issues with deeper questions.” Others

agreed, though one said, “The challenge is the pace

of change. Industry experience must be kept

current.” Consequently, boards need to focus more

on evaluation and succession processes—topics we

plan to explore in greater depth during our next

meeting.

Artificial intelligence

A recent McKinsey report described artificial intelligence (AI)

as “a transformational technology of our digital age.”7 The

authors noted that “while much of the public discussion of AI

focuses on science fiction-like AI realization such as robots,

the number of less-noticed practical applications for AI

throughout the economy is growing apace and permeating

our lives.”8

To offer some perspective on the opportunities and risks

associated with these emerging technologies, we invited

Elissa Strome to join the network for this part of the meeting.

Elissa is Executive Director, Pan-Canadian Artificial

Intelligence Strategy at the Canadian Institute for Advanced

Research (CIFAR), where she works with research leaders

across the country to implement Canada’s national research

strategy in AI.

Members discussed the following:

1. Canada is a pioneer in AI. Ms. Stromme said that AI

technologies strive to model the learning and

information processing architecture of the human

brain. While research is being done globally, Canada

has played a “pioneering role in AI research” for

more than 35 years. The country currently has three

centres of excellence, which support and coordinate

university research and industry collaboration. Many

of these efforts have spawned new businesses, and

there was a 28% increase in Canadian AI start-up

activity in the last year.9

8 Ibid. 9 Jean-François Gagné, Canadian AI Ecosystem 2018.

2. Many industries are well-suited for cutting-edge

AI applications. Examples included:

a. Healthcare. The use of AI with endoscopic

imaging offers “a tremendous increase in

the ability to diagnose [patients].” This

leads to lower costs and improved

outcomes.

b. Transportation. Uber is working with the

University of Toronto to develop algorithms

that will support self-driving vehicles. These

solutions aspire to be safer, less expensive,

and more environmentally friendly than

traditional vehicles.

c. Energy. Researchers are using AI to

discover new materials that could be used

in renewable energy applications and the

smart grid uses AI to better manage our

existing energy delivery infrastructure.

d. Retail. Many retailers manage complex

supply chains with “massive amounts of

data.” AI can help retailers better predict

“what you [should] put on shelves.”

e. Auditing. Many internal and independent

audits involve repetitive processes that can

be automated (e.g., optical scanning and

analysis of lease documents). Over time,

advanced modeling will allow auditors to

more accurately predict financial results

based on multiple input factors (e.g.,

weather patterns). Auditors can then

initiate deeper dives when actual results

vary from those predictions.

f. Human resources: One member said that,

“the HR side of organizations is ripe for AI.

How do we evolve talent? And how does

effective collaboration drive results?”

3. Boards need to learn and help management

determine strategic implications. As one member

asserted, “data is the new oil.” As such, “people

expect greater control and compensation for their

data.” This profound observation will likely impact

many strategic decisions. As one member said, “Our

companies are going to be disrupted [by AI and other

technologies]. We may as well disrupt them

ourselves.”

10 Christina Larson, Science, “China’s massive investment in artificial intelligence has an insidious downside,” 8 February, 2018.

One member described how their company had

made significant investments in AI, viewing the

technology as a key strategic enabler. Many

companies will have to decide how best to develop

and deploy AI. Some may decide to outsource these

technologies; however, “if it’s central to future

development, it should be in-house.” Since many AI

start-ups are underfunded, there may be

opportunities for larger companies to invest in—or

acquire—these technologies.

To fully appreciate the opportunities afforded by AI,

many boards will have to seek out education and ask

many more questions of management. After all,

“management is focused on driving the bottom line

today. AI can be pushed from the board down.”

Members agreed AI is a business priority, not a

technology priority; as such, it should be owned by

“senior leaders, business unit leaders, functional

leaders, not the CIO.”

4. China is investing aggressively in AI, and the

West may be unable to keep up. Several members

were surprised to learn about the magnitude of

China’s investment in AI. Many expressed concerns

that Western advances in AI may pale in comparison

over the long term to those of the Chinese

Government. For example, China is building a

US$2.1 billion AI technology park in Beijing's

western suburbs. In contrast, the US Government's

total spending on unclassified AI programs in 2016

was about $1.2 billion.10 As a Stanford University AI

pioneer observed, "China is investing heavily in all

aspects of information technology [from quantum

computing to chip design]. AI stands on top of all

these things."11

The Chinese Government’s motives may not be

entirely benign though. While some AI advances may

provide consumer benefits (e.g., digital payments by

facial scan, confirming identity at airports), others

can easily be used to stifle political dissent.

11 Ibid.

Appendix – Meeting attendees

CDN members

Ray Bromark

Cynthia Devine

Sarah Kavanagh

Alice Laberge

David LeGresley

John Manley

Eileen Mercier

Kathleen O’Neill

Janice Rennie

Barbara Stymiest

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