In our next instalment of the Golden Rules series we hear from Anthesis’ Advisory and Communications practice leader Jennifer Clipsham on the increasing importance and value of ESG topics to Executive Leadership Teams and Boards.
Rule 5 – Without a seat, three legs of a stool are useless
We’ve seen a number of high profile organisational incidents related to corporate responsibility (CR) or Environmental, Social and Governance (ESG) topics in the last few years, with far reaching impacts. Failure to operate ethically, transparently, or to manage stakeholder expectations effectively, can be connected with the poor financial performance of a business. Investors are keenly aware of this and are increasingly valuing the importance of the role of good governance in “triple bottom line” performance, recognising that ESG metrics are among the best indicators for the long term financial performance of a business.
In 2017, there were a number of high profile incidents where poor CR performance led to a significant loss in valuation and reputation.
- Uber faced a number of management harassment allegations that resulted in a valuation loss of $10 billion. Uber has since hired its first Chief Diversity Officer to launch a diversity and inclusion initiative and help address and mitigate the culture issues they face.
- Google also faced some serious allegations based on an employee memo that highlighted potential lack of diversity and perceived gender bias in the organisation that was followed up a series of additional lawsuits. They suffered a significant reputational hit that may pose attraction and retention challenges.
- Equifax suffered a major data breach that eroded public trust and resulted in a market cap loss of $6 billion in 8 days.
- Shares in Tahoe Resources, a Canadian mining company, fell significantly after the company was forced to halt production at a mine in Guatemala after the Supreme Court suspended its license due to human rights abuses of local Indigenous Peoples.
These companies, and many more, have faced significant financial and reputational hits because of these scandals. As a result, companies across the globe – and their investors — are realising that their Leadership Teams and Boards need to be more aware of the ESG risks their companies could face and should be better equipped to manage those risks.
Other Drivers for ESG’s Increasing Relevance
Many other stakeholder bodies are also advocating for stronger governance of CR or sustainability topics deemed material to companies.
The growth in stock exchanges building in mandatory ESG disclosures is significant. 12 global stock exchanges have already incorporated ESG requirements into annual corporate financial reporting rules, another 15 provide formal guidance to issuers, and an additional 23 stock exchanges have committed to incorporating ESG requirements.
The Task Force for Climate Related Disclosures (TCFD) recommends that both investors and companies assess, and publish, forward looking information on the financial implications of climate change for their business including impacts on carbon, water scarcity and water quality. And in November 2017, the PRI launched its guide to address ESG risk in supply chain for private market investors, signalling significant changes in the marketplace prioritising sustainability and long-term thinking on climate change for ensuring optimal financial business performance.
The Sustainability Accounting Standards Board (SASB) has developed sustainability accounting standards for 79 industries in 11 sectors. These standards were designed to help public corporations disclose financially material information to investors in their proxy statements in a cost-effective and decision-useful format. Many of the world’s leading asset owners and asset managers participated in industry working groups to develop the standards, and are now becoming increasingly vocal about the need for their implementation by companies.
The World Business Council for Sustainable Development (WBCSD) and COSO have partnered in coming out with new draft guidance for companies on how to better identify, assess and mitigate ESG risks using the COSO Framework, which is the most common framework in use by corporate Enterprise Risk Managers. Risks that make it to the top of corporate risk registers get the attention of the Board.
Governance as the Seat of the Stool
Corporate governance has always been an important factor in terms of how well companies are or aren’t managed, but there is increasing pressure on companies to elevate ESG risks to the board level in a comprehensive and robust manner and to ensure that their Board is well versed on potential risks and what the company is doing to mitigate those risks. This illustrates why we refer to governance as the seat of the sustainability stool, functioning to recognise and incentivise the environmental, social, and economic performance of the business.
Groups like ISS Corporate Solutions who benchmark the quality of corporate board performance are now assessing factors like social and environmental disclosure in addition to factors such as board and committee composition. The ISS has projected that the following will be key governance themes that investors are looking to corporations to improve performance in for 2018:
- Increased scrutiny on board composition, refreshment, succession planning, and performance evaluations (including gender diversity, and diversity in skills and capabilities;
- Heightened focus on environmental and social disclosures with particular emphasis on gender pay gap and climate change due to the Task Force on Climate Related Financial Disclosures (TCFD);
- SEC Rule-making slowing, giving rise to greater private ordering – many trends and political realities continue to propel—or oppose—corporate governance change; and
- Amplified public scrutiny around corporate reputations and cybersecurity preparedness, recognising that there are significant and potentially long-term costs associated with cybersecurity breaches and that directors have a fiduciary duty to understand and oversee cybersecurity.
We will likely see the number of shareholder resolutions on these topics increase in 2018-2019. Increasingly external investors are recognising the value of their investments in companies who have sustainability strategies that are well integrated into the business, and that have a governance system which incentivises for sustainability performance.
Building a Stronger Stool: How We’re Helping Clients Respond
At Anthesis we’re providing guidance for companies to recognise and understand the importance of governance in their sustainability strategy. In one example, we are working with a client to develop a Corporate Responsibility (CR) Dashboard of their key ESG performance metrics that will be used to communicate on the company’s quarterly performance to the Board. This dashboard will not only appear in the CR Report but also in their annual report to show the continued integration of ESG factors in traditional enterprise risk management processes and reporting. This company is also actively evolving their Board skills matrix to ensure gender and ethnic diversity, but also to ensure they have Board members who are proficient in their key ESG risk areas.
We are supporting a number of other clients to ‘up level’ the outcomes of their materiality assessment processes in their organizations. We are aligning the terminology and criteria used in the sustainability materiality exercises with the language and thresholds applied in their ERM processes. We are also working to more actively engage corporate risk management functions, strategic planning functions and Executive Leadership teams on the outcomes of the materiality assessments. Getting their attention requires us to speak their language, apply their tools and make it business relevant from an Investor Relations point of view.
To build shareholder confidence we are also supporting a number of clients in the socialisation of the requirements of TCFD, including reviewing the requirements with stakeholders from Investor Relations, Risk, and Legal & Operations.
All of these examples point to the fact that companies are taking note – and are taking action – to increase their own understanding of the implications of ESG risks. As BlackRock’s recent paper points out, ESG factors are becoming integrated into traditional financial analysis as a means for evaluating risks and opportunities. And significant risks or opportunities deserve the attention of the Board.
Is Your Board Engaged with Potential ESG Risks Your Company May Face?
- Do you know how your investor expectations have changed of you from a transparency point of view? From an ESG risk assessment and quantification point of view?
- Are you already tracking risks that could be categorised as ESG risks but aren’t captured in that frame?
- Do you have a solid understanding of the ESG risks your company should be managing and mitigating?
- Do you know how you compare to your competitors and peers?
If you have trouble answering any of these questions, please reach out to Jenn Clipsham to discuss how we can support you in developing this critical awareness.