As investors turn to ESG analysis to bolster their reconnaissance of target companies, Senior Manager for Board Services, Veena Pydiah reflects on the rising influence of ESG factors in corporate decision making and why board members should understand how they affect their risk oversight roles.
Environmental, social and governance (ESG) is a broad concept with no standard definition, but most can agree on the scope of the issues it covers; how a company performs as a steward of nature, how a company manages relationships where it operates and ultimately, how ethically it acts.
Driven by well publicised natural disasters such as Australia's bushfire crisis and campaigns led by high profile individuals such as Greta Thunberg, sustainability initiatives and ESG continue to gain significant momentum - global socially responsible investments grew by 34 percent to $30.7 trillion 2017-19.
Unsurprisingly, ESG is also quickly rising to the top of board agendas. The rippling effects on the globalised economy caused by natural disasters have reiterated the vulnerability of businesses to natural events. As emphasised by BlackRock CEO, Larry Fink, climate change is driving a fundamental reshaping of finance as "climate risk" becomes widely recognised as an "investment risk". As a result, stakeholders are expecting information on a company's ESG practices and susceptibility to ESG risks to be readily available, particularly given the impact not acting has on a company's reputation, hiring opportunities and long-term viability. Brendan Dowling, Managing Director of Ocorian's Jersey office has experienced this first hand, "Many of our clients are increasingly demanding that their suppliers have an ESG policy in place when they are looking to partner with or outsource functions. It is something that we take very seriously.”
ESG considerations no longer a ‘nice to have’ but a must
As identified by the World Economic Forum in 2018, eight of the top ten global risks are ESG related². Therefore, as agents of long-term enterprise value and risk oversight and with a legal duty to act in good faith and in the best interests of the company, boards must understand how their risk oversight role specifically applies to ESG related risks.
By working with management to identify ESG risks such as ecosystem degradation and opportunities such as clean tech, boards can then integrate values, goals and metrics into their business strategy to mitigate ESG risks and inform decisions that are aligned with their fiduciary duties. At Ocorian, Brendan continues, "our Board agreed a set of initiatives and KPIs so that we can track our own ESG progress in key areas such as energy, waste, diversity and inclusion, business policies and employee well-being. In order to keep our policy relevant and to provide oversight we created an ESG Global Committee, which has responsibility for setting the ESG agenda, reporting, managing budgets and tracking associated cost savings. We have also appointed local ESG Champions to drive the ESG agenda forwards in all of our jurisdictions."
Holistic risk-management approaches not only makes the company stand out to investors as a forward-thinking, cohesive organisation focussed on long-term performance and value creation, but also to clients, employees and a society that values sustainable, ethical practices.In a global survey on valuing ESG programs, McKinsey identified that C-suite leaders and investment professionals would be willing to pay about a 10% median premium to acquire a company with a positive record for ESG issues over one with a negative record.
Notably, asset managers are also developing sophisticated methodologies that evaluate a company's ESG criteria. State Street Global Advisors' R-Factor™ product measures the performance of a listed company's business operations and governance, generating a unique ESG score. Developments such as the R-Factor™ stress the importance of ESG to a company's strategic direction and overall value. However, if boards are complacent in implementing ESG into their strategies, they put both themselves and the company at risk. When an unethical issue such as child labour or cruelty to animals surfaces in the media, often the first question asked is "Where was the board?". In these instances, both the company and personal reputations of the board can be destroyed by association or ensuing lawsuits; ESG is no longer a 'nice to have', but a must.
For boards seeking to build company resilience to ESG related risks, guiding principles include:
- Assess which ESG risks the company is most exposed to and seek advice from specialists on how to mitigate these risks.
- Evaluate whether monitoring of ESG risks is adequately delegated to management and is properly resourced.
- Within the evaluation board process, conduct yearly ESG skills audits on directors and impart required ESG training to the directors.
- Initiate an annual affirmation process on ESG compliance and by the directors as well as an ESG risk assessment matrix.
- Encourage high-quality ESG reporting and proactive disclosures.
- Promote engagement with all stakeholders on ESG related issues.
The Sustainability Accounting Standards Board's financial materiality map identifies industry-specific sustainability issues that are likely to affect the financial condition or operating performance of companies.
Boards that adapt will prosper
As social and environmental issues continue to affect consumer and investor behavior and capital is re-allocated towards those enterprises with clear ESG strategies, boards must adapt to a more 'conscious capitalism' where ESG - when adopted effectively - can limit risk and contribute to improved returns.
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 KPMG - ESG, Strategy and the Long View - A framework for board oversight
 Financial Times, 28 January 2020 - State Street vows to turn up the heat on ESG standards