The Role of Boards in ESG
Environmental, social and governance (ESG) considerations are gaining more traction in tandem with the increased demand for greater corporate transparency and accountability to stakeholders. The scope of ESG is wide, ranging from issues like climate change and income inequality, to gender diversity, ethical practices, and greater stakeholder participation or input in decision-making. Investors are becoming increasingly concerned with how ESG factors affect the value of their investments, and the term “sustainable investing” is finding its way more frequently into stakeholder conversations, positioning ESG as a factor in decision-making that may have an impact on value creation.
Board members therefore need to understand the ESG impacts on business strategy, and the risks and opportunities these present, as a host of challenges confronts their organisations today. Increasingly dynamic market trends, rapidly evolving technology, even climate change, are some of the factors driving how shareholders and stakeholders are making investment decisions. As companies progress, they will need to respond to demands for greater disclosure and more information on how they operate – and this may translate directly into their ultimate competitiveness. This implies greater Board oversight of ESG issues, and greater accountability on matters pertaining to ESG.
In the near future, Board members are likely to have larger roles in communicating the organisation’s perspective on these matters to stakeholders. Choosing to do otherwise may no longer be an option as it may cause long-term competitive loss and the opportunity of maintaining a favourable public profile of the firm. The company has to decide whether it can risk damage to its brand and reputation. Boards are bound by fiduciary duties, and these have now grown to include ESG factors as they become linked more strongly to the creation of business opportunities and the risks which arise in parallel.
In its efforts to include ESG in its strategies, the Board will have to understand the risks that come with it, and the management and supervision of these to the satisfaction of stakeholders including shareholders, employees, and the communities they operate in. But ESG risks are not the easiest of risks to identify and mitigate. They are dynamic and interrelated, sometimes manifesting only in the long term, and almost always slipping under the radar of traditional risk identification systems. More sophisticated, longer and further reaching systems are necessary.
It is worth noting that stakeholders today want to see evidence of Board involvement in ESG, among many other things. This can be attributed to the less-than-transparent operations that resulted in many financial scandals and economic hardship globally in the past two decades. It is imperative, therefore, that the Board works with management to develop corporate strategies that encompass ESG which can effectively drive the organisation’s performance. But this is easier said than done. In many companies, ESG is seen as an exclusively social or CSR activity, not something that is linked to its long-term sustainability and competitiveness.
As it moves to incorporate ESG into organisational strategy, the Board should ask itself pertinent questions like which ESG-related risks (or opportunities) are significant to the current business, and which may directly impact the balance sheet. Members should continually seek information about ESG-related matters, and stay abreast of trends, standards and the continuously-evolving terminology. This will go a long way in supporting their expanded oversight responsibilities. They may also want to establish a special committee for ESG, and consult with subject matter specialists, to ensure core issues are identified, addressed and benchmarked against industry or international standards, if necessary.
Being “woke” where environmental and social issues are concerned, is no longer considered altruistic in the corporate context. It has become a key responsibility for Boards and management; there is a growing need to engage more concertedly with stakeholders to understand their perspectives of ESG, and what they perceive as effective management of ESG-related issues. Boards need to constantly review their effectiveness in addressing ESG risk, and should work with management to identify which ESG issues will impact the business most significantly. Risks and opportunities in these areas should be integrated into the formulation of strategies and operations.
Boards should have regular briefings on these matters as part of the Board’s role in strategic planning. Management will have to identify emerging ESG risks that could negatively impact the firm’s value in the long term and discuss how to mitigate them. While management works at supplying the necessary information, the Board must continue to look at ways of empowering them to ensure that ESG will remain part of corporate strategy, and be integrated into the roles and responsibilities of management and the Board of Directors.
Why should this be a consideration? ESG issues are long-term; organisations need Board members who are forward-thinking and focused on the next challenge. One way of managing ESG issues is to continuously add to the talent and skill sets of both Board and management; the tone at the top can be the difference between driving the company forward and lagging behind the competition. The pressure on companies – and by extension, Boards – to perform, is relentless. Stakeholder expectations increase by the day, in parallel with regulatory restrictions and greater public scrutiny. Companies that broaden their horizons on ESG matters now, and incorporate these into their long-term strategies, will be ideally positioned to continue maintaining and creating value into the future.