The European Commission’s recent motion for a European Parliament resolution to set out concrete obligations on sustainable governance for companies, and a new framework for defining company directors’ role in the area, extends the focus on sustainability beyond just reporting. The motion, supported by a majority of MEPs, brings sustainability into the heart of the boardroom and will require directors to actively address sustainability concerns.
This development reflects the main conclusions of a recent report Time for Sustainability to be at the Heart of Business, published jointly by Mazars and ecoDa, calling for a step change without delay by boards, investors and others in their moves towards creating a sustainable future.
Our call followed roundtables with directors and investors highlighting that while progress is being made on this defining topic for business and wider society, the primary measure of performance for most boards and investors largely remains short-term financial earnings.
‘Never let a crisis go to waste’
As boards around the world strive to respond effectively to the first global pandemic since 1918 they would do well to remember the words attributed to Winston Churchill in Britain’s dark days around 1940 to “never let a crisis go to waste”. The necessary actions taken to strengthen resilience and viability in the immediate future should form part of a journey to create a business that is also sustainable over the longer term.
This will require boards to address the existential threat posed by climate change together with social changes arising not least from globalisation, challenges that will remain undiminished after the tremendous loss of life and economic damage brought on by the pandemic hopefully subsides as successful vaccines and treatments emerge.
The nature and degree of change needed to embrace sustainability in environmental, social and financial terms will naturally vary between industries. It will be greater in environmental terms in, for example, oil and gas, mining, the car industry, aerospace and airlines. Social issues will be to the fore in luxury goods and retail with regard to their supply chains and in tobacco in respect of harm to health. The social and environmental risks are, however, inextricably linked as the Rio Tinto case recently highlighted when the chief executive had to step down due to investor pressure following the destruction of 46,000-year-old rock shelters at Juukan Gorge in Australia.
A commitment to sustainability in the boardroom
The motivation for change will directly impact the resulting benefits for the business and society. If arising from a wholehearted commitment to sustainability, both the change needed to fully embed the new approach in the business, but crucially also the positive impact of doing so, are likely to be much greater than if the board is just trying to give the impression of taking a leadership role or if it feels forced into responding to external calls for change. That said, recognising a crisis as a wake-up call for deep change may well lead a board onto a successful new path.
The commitment to sustainability must be shared by the whole board, executive and independent directors alike, with the chair and CEO each having a key role to play, otherwise it will be a source of continual boardroom tension. It similarly needs to feature prominently in the choice of all new board members and in the executive reward structure. Above all, board members need to lead by example which will include backing difficult decisions where trade-offs are needed between short-term profits and bearing the costs of making the transition to a more sustainable future.
Different board structures are possible. There may or may not be a board-level chief sustainability officer and/or a specialist board committee with different models having alternative benefits and drawbacks. What really matters is that sustainability is central to the board’s decision-making, including on investments, and that enough time is devoted at board level to reviewing performance and plans using a broader ESG (environmental, social and governance) measure of success.
Cultural change for business model transformation
Some boards will have to implement major cultural change across their businesses if their business model faces substantial amendment such as oil or gas companies moving towards clean energy. As Bernard Looney, BP’s new CEO, said in introducing its vision “Reimagining energy, reinventing BP”: “We have got to change—and change profoundly”.
And he will know legacy companies have not always found it easy to lead in new markets. Facebook and Twitter did not emerge from newspaper or broadcasting companies; nor Amazon from existing bookshops or retailers; nor Microsoft from typewriter manufacturers. Some leading national landline phone companies have built a successful mobile and internet presence, but often after a difficult transition.
Conversely, the new technology communication giants have learnt by bitter experience that it is not enough to provide an innovative platform—you cannot avoid some responsibility for the content put on it by hundreds of millions or more users. As banks found after the financial crisis, changing culture—in that case from being transaction-led to more relationship orientated—can take years to achieve.
Even in situations where the business model does not require wholesale change, all boards committed to sustainability will have to ensure ESG is properly reflected in their strategy, KPIs and human resource and management control systems, making sure environmental and social information is subject to the same rigour in its preparation as is financial information. Particular attention should be paid to risk management with an assessment of the salient, or key, risks judged from their stakeholders’ perspective rather than their own and which should include the impact on the environment, people and communities. This avoids negative externalities created by the business impacting their reputation.
Authentic stakeholder dialogue
Authentic dialogue with stakeholders will be vital for boards committed to an integrated ESG approach: the board, primarily through its CEO, will need to be advocate, fair and balanced reporter and listener at the same time. Employees and potential recruits will need to feel enthused by working for a strongly ethical business committed to enabling them to realise their full potential. At the same time, there should be a strong “speak-up” culture where practice falls short of that expected.
Meanwhile, though investors may need some persuasion to support a possible reduction in near term earnings to cover ESG transition costs, increasingly their leaders are indicating their support for such an approach and fund managers should be held to it. That said, challenge should rightly still be expected, if investors consider management could be performing better within the adopted strategy.
Moreover, all stakeholders have a right to high-quality social and environmental as well as financial information in the annual report and any dedicated reports published separately. This will be supported by the adoption of a leading international framework adopted with disclosures covering the challenges, and not just the successes, and with information provided on future plans. Increasingly, such information will be expected to be subject to thorough assurance similar to that for the financial statements to enhance its credibility.
Covid-19 has shown many boards that they can extend the boundaries of their capabilities. All stakeholders now need to work together to enable sustainability to be at the heart of business but it is the responsibility of boards to lead on its implementation in their companies and they should make this the big issue on their agenda now.
Anthony Carey is a partner with Mazars in the UK and leads its board practice. Alexia Perversi is a director in Mazars’ Global Sustainability Service Team.