For some, the term ESG (environmental, social, and governance) still conjures notions of issues not linked to the financial performance of the company. But given the heightened focus from a variety of stakeholders (including regulators) and the growing understanding of its impact on performance, ESG is a critical topic in the boardroom.
ESG presents real risk—and potentially even bigger opportunities.
Since we first published our director’s guide to ESG in November 2020, much has changed, but the fundamental principle underpinning our guide remains the same—ESG issues are inextricably linked to a company’s strategy and need to be part of the board agenda.
Understanding the board’s role in ESG oversight
Management teams need a strategic plan that takes advantage of market opportunities and addresses material risks. In its oversight role, the board is responsible for ensuring that the company’s strategy is appropriate, takes account of material risks, and is likely to deliver results. Because ESG is grounded in risks and opportunities, the ESG lens is often a more comprehensive way of packaging existing work and analysis.
Here are some considerations for the board on how to address ESG oversight:
SEC’s disclosures
In March 2022, the SEC proposed new rules for cyber and climate-related disclosures. While they are not yet final and are open for public comments, the SEC is likely to advance rules that obligate companies to describe in detail the processes through which the board of directors provides oversight of cybersecurity and climate-related risk and expertise.
The board may want to consider the following questions:
- Does management have a robust documented process for identifying and managing both cybersecurity and climate-related risks that is discussed with the board?
- What is the board’s process for ensuring directors’ skills and expertise align with the risks and opportunities inherent to the company’s strategy?
- Do existing ESG disclosures contain high-quality, consistent, and decision-useful information that investors and other stakeholders can use to make decisions?
The board´s role in materiality
The board should understand management’s process for identifying the ESG issues relevant to the company, assessing those issues for materiality and deciding what to disclose and where. The board should understand and challenge management’s materiality assessment process.
The board may want to consider the following questions:
- How has management determined those ESG risks and opportunities that could have a material impact on strategy, operations, or financial performance?
- Beyond investors, which groups of stakeholders is the company accountable to?
- Is the company considering the interests of employees, customers, suppliers, and communities?
- Has there been an assessment of how the broader group of stakeholders could impact long-term value?
- Is the materiality analysis used as a strategic business tool—to identify both risks and opportunities arising from ESG issues—as well as to guide disclosure decisions, taking into account regulatory and reporting requirements?
ESG maturity
Many companies try to assess where they fall from an ESG maturity level. We provide some considerations to help with that assessment. This includes considering the company’s policies and procedures in place over collected data, internal controls, and much more.
Governance of EGS
Because ESG strategy should align with business strategy and focus on material risks and business drivers, the full board will want to understand how those risks and opportunities are being addressed. The board will also be interested in how management is using ESG to differentiate the company in the market. If this is a new area of focus for the board and the company, directors may need to assign detailed oversight to specific committees to help the ESG strategy launch smoothly. Ultimately, though, ESG issues will be relevant to all committees.
Conclusion
Companies have made rapid strides in unlocking the business value of ESG in recent years. The ESG issues a company faces vary widely by industry and company maturity, and there’s no one-size-fits-all solution. The rapidly evolving regulatory environment, including the proposed SEC rules for cyber and climate-related disclosures, means that companies should take action now to reduce the burden of future disclosure requirements. Directors have a big role to play in guiding management to allocate the appropriate resources and attention. Forward-looking companies value being a frontrunner on ESG issues because they see the connection to the company’s long-term success.
(Courtesy: PwC)
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