New Year is a time for resolutions to make positive changes requiring resilience, and as we start 2022 boards should ask how they can strengthen the ESG performance of their businesses. A good reputation to date does not make this any less important, as the risk of unintended complacency is present at a time of a substantial raising of stakeholder expectations.
Investors, bankers and insurers have all sharply increased their ESG focus and in a tight labour market being seen to be a responsible employer is vital to being able to attract and retain the most talented employees. NGOs are also more willing to take legal action to pursue their goals, as was witnessed recently with regards to the proposals for Heathrow Airport’s third runway.
In addition, governments are keener to hold business to account for their performance on climate change and human rights issues, and not to let negative externalities continue to go unchecked. This has increased following new commitments agreed at COP26 in Glasgow last year. Strengthened regulations have recently been introduced, or are on the way in many jurisdictions, often affecting smaller as well as larger companies given their emphasis on supply chains. There are also important reporting developments with the formation of the International Sustainability Standards Board (ISSB) and significant work being undertaken at a European Union level.
Covid-19 has also added to support for holding corporations to account on ESG issues with recognition that business has to be responsive to society’s needs given its dependence on state support to survive the pandemic. Recent extreme weather events across many continents—wildfires, severe floods and vicious hurricanes and tornadoes—have also highlighted the significant and imminent threat posed by climate change.
Why boards must focus on ESG performance
Greater unity of view amongst investors and governments respectively are among the principal drivers of the new pressure on business to up its ESG performance.
Until fairly recently sustainability sometimes appeared to be primarily of major interest to some specialist funds. Some institutional investors sent out mixed messages with their governance teams often actively advocating sustainability but a number of fund managers remaining focused on short-term financial performance.
There is now full recognition by leading investors of the threat to the future sustainability of leading listed companies if climate change issues are not seriously addressed—for example in the oil and gas, mining and coal industries—while the investor reaction to the destruction of sacred caves by Rio Tinto demonstrated that human rights issues are moving up the agenda too.
While COP26 showed some differences among governments, most notably on phasing down or phasing out the use of coal, elements of climate change scepticism strong in some places just a little while ago have largely disappeared. This has helpfully reduced the challenge of differential pressures on key players in some global industries, such as oil and gas, which risked those responding to ESG issues suffering short-term earnings disadvantages relative to their competitors.
Governments have also in the past been keener to make long-term commitments rather than to supplement them with road maps of how they are going to achieve them and how performance will be monitored but this is starting to be addressed following COP26 increasing the pressure on companies to help make change happen.
So just as success in our personal New Year challenges requires a recognition that significant change is needed and a determination to make it happen so too with boards if they are to lead a step change on sustainability and ESG performance. A Practical Guide for Boards and Leadership Teams on Sustainability, recently published jointly by Mazars and ecoDa, the European directors’ organisation, highlights seven principles of sustainability boards should follow to achieve this goal.
The sustainability principles are:
- being purpose-led
- providing leadership and setting the right tone from the top
- being stakeholder orientated
- having a strong organisational culture of sustainability
- embedding sustainability deeply throughout the organisation
- developing a learning approach and openness in reporting.
Key pitfalls to avoid include sustainability being seen as a primarily a “greenwashing” exercise. This may be manifested by a focus on currently trendy issues regardless of whether they represent the key impacts of the business on the environment and wider society or a lack of linkage between performance on sustainability and recruitment, retention, progression and reward.
Another key challenge arises where there are poor controls over the gathering of reliable sustainability information, which results from treating it as far less important than its financial counterpart. Similarly, a failure to look at climate change and other sustainability risks from a stakeholder perspective, or if it is low on internal audit’s radar, again points to it being treated as an add-on rather than an integral part of the business.
Goals and reporting
For an outsider looking in, the quality of external reporting provides strong clues to how seriously the board is treating sustainability, often by reference to what is not said as much as to what is on the page: are the sustainability goals clearly set out with progress towards them discussed, including challenges faced? Is measurement and reporting focused on the key impacts of the business on society or does disclosure centre around selective good news stories? Where external assurance has been applied does it cover the important issues?
Last but far from least, do the members of the board “walk the talk”? Do they lead by personal example, with their sustainability performance significantly influencing their remuneration? Does the board spend sufficient time on sustainability issues, having ensured it has the optimum board structure for its circumstances and the necessary expertise at executive and non-executive levels?
Authentically adopting the seven sustainability principles will enable the board to put sustainability at the heart of its business for the benefit of all its stakeholders including their investors who will benefit from a more motivated workforce, better access to finance at more competitive rates and a strong licence to operate with lower reputation risk and less likelihood of regulatory penalties.
As with our New Year’s resolutions, while we know the journey will not be all plain sailing, the opportunity of securing long-lasting gains provides the impetus to get on our way without delay.
Anthony Carey is senior adviser, board practice and public policy and Alexia Perversi is director, sustainability services at Mazars.