While we can all agree that the word “unprecedented” is overused today, this year has seen several distressing events take place on a global scale—bushfires destroying homes and wildlife in Australia, a series of wildfires in the US, a global pandemic affecting all of us, and civil unrest on racial inequality ignited by the unjust killing of George Floyd.
Despite the fact that world economies ground to a halt as a result of Covid-19, investors have not slowed down their efforts to engage and improve the environmental, social, and governance (ESG) practices and disclosures of their portfolio companies. In fact, 2020 has been a pivotal year in which even some of the ESG sceptics in leadership roles, including board members, have been forced to reckon with the ESG issues at hand, whether it be health and safety of workers or extreme weather events disrupting business operations.
Investors are rightly putting pressure on board members, serving as their representatives, to be independent, diverse, qualified, committed, and experienced. ESG-conscious investors, such as Legal & General Investment Management and BlackRock, are progressively voting against board members due to poor reporting practices on environmental risks.
BlackRock has taken its position a step further and publicly reports the rationale for their opposition to board members for inadequate reporting, including failure to follow the recommendations from the Task Force on Climate-Related Financial Disclosures (TCFD).
The first pillar of the TCFD framework correctly focuses on governance, which recommends a company disclose the existence and mechanism of the board’s oversight on climate-related issues. But the important question is, do these board directors have the knowledge and expertise on the subject to sufficiently assess the risks and opportunities posed by climate change (or any environmental and social topic) in the context of the business they oversee?
ESG skills and competencies
As the materiality of ESG issues vary across sectors, the types of skills and competencies on sustainability issues required on the board also differ. Given the increased focus on a variety of ESG factors by investors, it is likely that many boards do not hold relevant experience or expertise to understand the material sustainability issues and incorporate them into the corporate strategy or financial decision-making processes.
While ESG topics reach the top of the board agenda, adding one board member with extensive knowledge on ESG may not be sufficient, especially if the boardroom culture is not accommodating to new ideas. This suggests that not only one, but a majority or all of board members should be ESG-competent to have a meaningful conversation and make decisions that benefit all stakeholders. As a litmus test, board members should ask themselves if they feel confident they could address shareholder questions on the company’s climate risk strategy.
As such, boards need to take a step back and evaluate:
- if all board members understand and have assessed the material ESG issues impacting the company they oversee, from a multi-stakeholder and financial perspective;
- which ESG issue is most material to the company’s operation and therefore should be prioritised;
- whether the current board makeup in terms of skills and knowledge makes sense in terms of sufficiently addressing pressing ESG issues; and
- whether there is a need for training to ensure all board members are ESG-competent and potentially nominate candidates who may bring in different perspectives and skill sets.
In 2021, it is crucial for the boards to reiterate that their strategy is aligned with their corporate purpose and find ways to evidence this to their stakeholders. With ever-increasing scrutiny from customers, employees, shareholders and regulators on a myriad of sustainability issues, the pressure on boards to “do the right thing” is at an all-time high. Shareholders will not shrink from calling out a lack of leadership on sustainability issues and demanding boards that are comprised of the right skills and experience.
ESG is here to stay and will shape future conversations. We’ve provided our view of the key themes of focus for investors in 2021 here. So, the question is: how ESG-ready is your board?
Anna Hirai is vice president, ESG advisory at shareholder advisory firm SquareWell Partners.