Is the board on board with ESG? If not, what, if anything, should be done?
Despite new European Union legislation governing ESG disclosure and due diligence beginning to take effect for many companies, the acronym, and how companies should respond, is the subject of some controversy. GoodCorporation invited business leaders to debate these issues under the Chatham House Rule at the House of Lords.
Our host, Baroness Kingsmill, opened the debate by suggesting that while the term ‘ESG’ sounds easy to discuss, the simple acronym can disguise the importance and complexity of the issues it encompasses. ESG relates to corporate sustainability, not simply from an environmental perspective, but to the wider sustainability of the business as a whole. Emerging ESG regulation, however, may shift the focus away from analysing and addressing ESG issues, towards reporting ESG data, with the risk that it becomes another tick-box exercise.
To avoid this, businesses and their boards may need to make some substantive changes, possibly shifting the emphasis away from ‘growth at any cost’, towards a focus on developing sustainable, resilient businesses that proactively minimise any negative impacts of their operations.
The board has a substantial role to play in delivering resilient and profitable businesses with a long-term future. Focusing on ESG reporting alone is not enough to do this and it was suggested that boards should have a legal duty to manage businesses sustainably. This should come with penalties for organisations with a poor sustainability record and a correlation between sustainability performance and executive remuneration.
Are boards on board with ESG?
While most debate participants agreed that their boards were on board with ESG, a number of challenges relating to board engagement and understanding of ESG issues and recent regulation were highlighted as potential barriers to effective management of ESG issues.
Too broad for the board?
Though boards may say they are on board with ESG, the reality is that the time they have to discuss ESG and wider sustainability issues is limited, making it impossible to discuss the complex issues involved in sufficient depth. It is often easier for boards to approach ESG from a compliance perspective, focusing on reporting and ticking boxes rather than evaluating risks and resilience accurately to develop a long-term strategy for sustainability.
Boards need to devote sufficient time to understanding and managing their risks and impacts, developing the mitigating actions needed. This may mean redeveloping their business model to ensure that sustainability becomes integral across all operations, with real board accountability for the long-term sustainable performance.
The need for an expert sustainability group reporting to the board was discussed, however the key to ensuring that sufficient time is allocated to board discussions is to have a formal sustainability committee on the board, comprising the chief executive and other board members. This ensures that sustainability is elevated beyond a function report and is discussed at the most strategic level.
The E, the S and the G
Different companies and industries are at varying stages in their journey toward understanding and addressing the risks associated with environmental, social and governance issues. For some businesses, the social and governance aspects have already become operational and are embedded within their strategies. Others have made significant progress on environmental issues whilst social and governance components lag behind.
Social issues can be particularly challenging for many boards. Although there is usually a desire to do the right thing, acquiring the necessary resources and building internal capacity to address concerns can be challenging. Ensuring equitable working conditions, addressing diversity and managing community impact often require long-term commitments and a significant allocation of resources, which can stretch the capabilities of companies still trying to balance these priorities with environmental and governance goals and other business pressures. Ultimately, while progress may vary across companies and sectors, addressing all three pillars of ESG holistically is the key to sustainable business growth.
Measuring progress
When making sustainability operational, businesses should establish clear metrics that will make it easier to track progress and meet reporting requirements. This enhances transparency and provides a concrete framework for evaluating how well a company is managing its sustainability efforts, together with assurances that the actions taken are having the desired impact. Ideally this should come with some form of independent auditing for additional verification.
Demonstrating progress through consistent measurement of metrics is also beneficial from an investment standpoint, as investors are increasingly well-informed on ESG issues and are using their own research and data to assess risk and resilience. Companies that can demonstrate their success at measuring and managing their own material issues can benefit from the preferential rates often associated with ESG funding.
Sustainability, SMEs and the supply chain
While current regulations may not directly target small and medium-sized enterprises (SMEs), many of these businesses form part of the supply chains of larger corporations subject to regulation and will find themselves under pressure to demonstrate how they manage their own ESG risks.
Supply chains contribute significantly to the overall impact of a business, so supporting sustainable practices throughout the supply chain will become increasingly important. This may lead to a shift in practice, and in some situations, companies may even need to work collectively to drive meaningful change, particularly with some of the social issues surrounding human rights. Businesses will need to engage directly with their suppliers on the ground, fostering transparency and collaboration to ensure sustainability goals are met.
Understanding risks
Boards must understand the risks that adverse impacts on rightsholders pose to their businesses. When it comes to analysing ESG matters, boards do not always have a clear understanding of what is material to their operations. Without this understanding, it is impossible for boards to manage their sustainability risks and opportunities effectively. Alongside this, scenario modelling can be helpful in evaluating the effectiveness of proposed ESG strategies.
It is therefore vital that companies understand and integrate double materiality into their risk management strategies, assessing not just the risks to planet and people but the extent to which those risks might affect the financial performance of the business.
Some felt this shift should be integral to the licence to operate, marking a transition towards responsible capitalism, establishing businesses as positive contributors, accountable to all stakeholders, including investors, customers, employees and wider society.
ESG Challenges
Educating the board on ESG can help address the say-do gap and ensure appropriate board oversight of material issues. Enhancing the financial literacy of sustainability teams can also help, ensuring clearer communication and a more comprehensive understanding of ESG risks and opportunities at board level.
Achieving net-zero was also identified as a challenge. In particular, the growing tension between the expectations of shareholders, who are focused on returns, and the demands of customers, who may need to bear some of the transition costs. Reaching net-zero will therefore require difficult decision-making that must balance these conflicting priorities.
For companies to meet net-zero targets, governments must also play a more active role through regulatory support, ensuring there is enough capacity, guidance and incentive to achieve net-zero targets. Carbon offsets alone cannot solve the problem as damage control is effectively outsourced rather than mitigated against. Companies, governments, regulators and civil society groups must therefore collaborate more effectively to identify the most effective solutions.
The challenge remains in making ESG a non-negotiable standard integral to every corporate decision and action. Until such level of integration is achieved, the full potential of ESG to transform businesses and industries may not be realised.
The GoodCorporation view
It is important that ESG does not become performative or focused solely on legal compliance. While reporting on material ESG issues alone may seem tempting considering time and financial constraints, this will not be enough to ensure strong performance and business sustainability in the long-term.
Boards should focus on strategic planning, ensuring that ESG is embedded throughout the organisation and that all functions in the organisation are aligned with these wider sustainability goals. Minimising negative impacts arising from ESG risks will help build resilience and sustainability into business models and give businesses a competitive advantage. Doing so will not only future-proof businesses, ensuring they operate within the limits of the world’s resources, but also help them increase long-term value for shareholders, enhance trust with stakeholders and attract and retain the best talent.
To ensure effective future-proofing, the board must be on board with ESG and dedicate adequate time and resources into embedding ESG strategy into operations. GoodCorporation is working with companies to evaluate their ESG risks and how best to address the impacts arising from these. We not only provide environmental and human rights due diligence services covering the ‘E’ and the ‘S’, but also tailored ESG board training to assist boards in thinking about compliance alongside strategic resilience building.