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ESG and the Board

02 September 2020 by Peter Swabey

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On 13 August, we held a discussion panel to develop the thinking for the third in our series of papers on ‘Building Board Resilience’ on which The Chartered Governance Institute is partnering with Diligent Corporation

In this third study, we wanted to focus on the board’s responsibility for, and focus on, ESG issues. Increasingly, ESG is at the heart of stakeholder engagement with companies; no longer is it enough for a company to point to profitability as evidence of its good to society, a whole host of other, sometimes conflicting, issues must be considered.

Has the board’s oversight of ESG issues changed in recent years and, if it has, how?

Our virtual panel agreed that boards are increasingly interested in sustainability. This is the result of both internal and external factors. To some degree it is a function of changes in boardroom composition, with many boards having younger members, and members with different social interests. But it is also a function of changes outside the boardroom – the impact of the press and social media commentary on ESG issues, coupled with the activities of activist investors.

Back in July 2016, the Financial Reporting Council published its report on Corporate Culture and the Role of Boards. The FRC has come in for some criticism in recent years, but this report was an excellent piece of work which focussed corporate minds on some of these issues. We have also seen thought leadership from a variety of industry bodies, not least the Institute’s own report, with the Investment Association, on the Stakeholder Voice in Board Decision Making, published in September 2017. Our panellists agreed that in the last few years the board has built on this wider corpus of guidance and thought leadership to oversee management activities in the ESG space more effectively.

Another point on which our panellists agreed was that in many cases it is the board driving sustainability, setting the tone from the top, although it was accepted that the executive team need little persuasion. It does, however, focus executive minds if they know that they have to present to the board. One panellist gave a very specific – and topical – example where the CEO had mentioned the Black Lives Matter campaign and had been challenged by the board on what the company was doing, rather than saying, about it.

Boards want to be ahead of the curve, but ultimately, what they are trying to do is crystal-ball gaze. How will their business model be impacted by ESG changes and pressures, and how can they get ahead?

Does the board look at the E, S and G issues differently and, if it does, how?

Our panellists were unanimous that boards generally take a more holistic view, rather than looking at environmental, social and governance issues in isolation. Indeed, they went further, arguing that although there may be individual elements of the work which play to one of those themes, it is far better to think in terms of the sustainability of the organisation, in which each of these elements will play a part; a part, moreover, which will vary dependent on the company concerned and the issues that it is currently facing.

It is often easier to tackle a large task through a variety of smaller projects and many companies have established committees, at board level or below, to study specific issues. In many cases, we were told, the board sees its primary role as ensuring that these disparate activities are drawn together. As one panellist explained it, “our chair’s focus is on bringing perspective”, whilst another took the view that “the board is trying to work out what is material to the company, and getting confirmation that management is engaging appropriately on those issues.”

What is the path to really operationalising ESG across an organisation? Is it possible or realistic?

So how can a company embed sustainability? In part, as with so many other similar issues, this comes down to culture; making sustainability part of the thought process of people at all levels of the company.

And the central point to which our panellists returned was that this is an area where one size definitely does not fit all. Boards need to identify the appropriate responses for that company at that particular stage in its development and then integrate the response into the operation through its normal management and measurement systems – including training and development, recruitment, procurement and design – and not as a separate set of initiatives. They also need to remember that that response will not necessarily be the same across the whole company. It may vary by business unit and by geography amongst other variables.

Sustainability must be an integral part of the organisation’s work, with specific initiatives linked to the company’s strategy and customer focus. Reporting must be integrated into the organisation’s normal reporting sequence. The right ESG initiatives for an organisation ought to improve efficiency, increase customer focus and reduce costs. The question for the board is really to what extent ESG initiatives ought to be initiatives, and to what extent they ought to form part of business as usual. If they are the right initiatives ought they not to be part of the re-framing of the way the organisation operates?

What do governance professionals view as their role in board awareness and adoption of ESG?

One of the challenges is that there are so many disparate views. One of the principal functions of a board is to take decisions and, while some decisions may be a ‘no-brainer’, others involve balancing two or more options, each of which may have their own supporters. This will be the case with sustainability metrics too.

In addition to internal advocates, there will also be external ones, be they investors, advisers to investors or specific lobbyists. There is no shortage of advice and it is not always consistent. Our panellists felt that one of the major contributions of the governance professional is to understand the various metrics and the reasons for them advocated by their supporters, to help the board identify the key issues for the company. This is not easy.

The governance professional has a key role in maintaining the relevant board awareness, curating their information flow and introducing information and training onto the board agenda. They can also discuss agendas with the chair to ensure that the board gets relevant briefings from key influencers and regulators, and encourage board sponsorship of appropriate networks and committees.
But having identified the key issues for the company, it is important that companies then have the courage to explain this to their investors. This is another key aspect of the role of the governance professional – raising awareness, both amongst the board and with management, of investor and market expectations, leading on the relevant reporting project and driving executive responsibility. In some ways this is both an education and facilitation role. As an institute, we often refer to the company secretary as a bridge between the executive and non-executive, and here the role includes helping directors identify the questions that they should be asking but at the same time counselling and mentoring executive colleagues about what the board’s legitimate expectations will be and on how this tallies with the investor and customer view.

If the main change in recent years has been the board’s focus on sustainability, then one of the changes in the role of the governance professional has been to ensure that the board’s desire to remain on the front foot remains on the agenda of the executive team and, in particular, those in the one or two levels immediately below ExCo.

Does COVID-19 present an opportunity for boards to further ESG initiatives and ‘emerge stronger’?

How has all this work been affected by the COVID-19 pandemic? Has it slowed the work already in development, or has it, as crises often do, presented opportunities for change? For some of our panellists, COVID-19 has made little real difference to this work, although they recognised that the change from physical to virtual site visits is likely to make them less rich. But much depends on context. A site visit to familiarise a new NED with an aspect of the company’s business can very well be made virtual; one where one or more NEDs have been sent because ‘something smells funny’ will be much less effective without feet on the ground.

The pandemic is, however, creating some new issues. Many companies may now be introducing structural and operational changes that they might perhaps have been delaying. It has also raised into stark focus some questions about how the company treats its workforce, its customers and its suppliers and about how the company can respond to such a significant challenge. For example, if a company behaves towards its suppliers so that they go out of business, it may struggle to get supplies to enable it to restart after the pandemic. We are all learning and innovating. 

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