You can’t improve all the ESG compliance all the time. So how should boards triage and decide which issues deserve their attention? Helle Bank Jorgensen outlines four approaches — via compliance, strategy, ethics and data collection — that can help leadership decide what lies within their scope.
As Oliver Hardy often quipped onstage or onscreen to his partner Stan Laurel: “Well, here’s another nice mess you’ve gotten me into.”
Nearly 70 years after their last performance, that phrase is resounding in boardrooms the world over. Every which way they turn, board directors are confronted with huge challenges. Some of these are self-inflicted (such as corruption, lack of diversity and child labor), but others (such as COVID-19 and cyber attacks) arrive on the doorstep without an invitation.
Board directors must keep a laser-like focus on the most pressing issues at hand. They, and their organizations, cannot afford to get distracted by other shiny objects on the agenda. However, that is easier said than done!
Environmental, social and governance (ESG) issues are now on many of those agendas, even though many boardrooms have a worrying lack of understanding as to what steps to take. A recent Deloitte Global report highlights many of these gaps.
The Audit Committee Frontier: Addressing climate change surveyed more than 350 audit committees from 40 different countries and found:
- 42 percent of respondents were “disappointed in the strength and speed of their organization’s climate response”;
- 65 percent indicated that their companies lacked any clear strategy on climate; and
- Only 47 percent of audit committees considered themselves climate literate.
Let’s examine how to determine which ESG issues deserve the board’s attention through four different lenses:
- Trustworthy data
Compliance: determine the ESG laws and regulations you must comply with.
Board directors must understand the fluid ESG regulatory map in which they and their companies operate. They need to be prepared for more and more stringent regulations and reporting requirements from all sides.
Boards will have to be regularly updated on new laws and regulations that will impact business and strategy. The speed at which regulations around environmental and social issues are being adopted — and in some instances enforced — is remarkable. We are seeing a tsunami of regulations. Indeed, many companies are actively encouraging more regulations on climate and other issues to ensure a level playing field.
This map is a mixture of hard and “soft laws” – and it keeps changing. For example, two key ESG emerging regulatory issues that should be on all boards’ agendas are climate and human rights.
Some notable soft to hard-law developments on climate and human-rights disclosure in the past few years include:
- The New Zealand government was the first to pass legislation making climate-related disclosures mandatory in line with the Task Force on Climate-related Financial Disclosures (TCFD) in 2021. Then the U.K. announced that they will become the first G20 country to make it mandatory for Britain’s largest businesses to disclose their climate-related risks and opportunities in line with TCFD recommendations and more countries followed.
- In terms of human rights, the California Transparency in Supply Chains Act in 2012 was the first that required companies to disclose actions relating to product supply chains.
- Many followed their lead. The Modern Slavery Act (UK, 2015), Corporate Duty of Vigilance Law (France, 2017), Modern Slavery Act (Australia, 2018), Child Labour Due Diligence Act (Netherlands, 2019) and the Supply Chain Due Diligence Act (Germany, 2021) have all imposed legal rigor on business transparency and fundamental human rights and decent work.
Climate and human-rights disclosure is not going to go away, so companies should start or improve the reporting process before they are forced to do so. In 2022, more countries will legislate and I believe we will see more enforcement of the laws as we witness how the US and other countries now more frequently stop goods at the border due to human-rights allegations.
Climate and human-rights legislation are not the only ESG areas to watch. Boards will need to discuss how to take a proactive stand on determining how voluntary reporting will enhance the company’s reputation and build trust with stakeholders.
Strategy: determine the ESG issues that can make or break your strategy and its execution.
It is not only ESG-related legislation that can impact a business and its strategy. As a board member, you must know what potential ESG risk issues the company must mitigate, adapt to or be successful in to execute the strategy.
For example, a growing number of employees (current or potential) do not want to work for a company that pollutes the atmosphere. Many don’t want to make their living from a business that is unethical in how it treats employees, customers, suppliers or local communities.
ESG issues can also affect your supply chain; just look at the problems electric and hybrid vehicle manufacturers are having getting the necessary elements for new cars. It is not enough to have a booming market demand if you can’t supply what consumers want due to not having the parts or metal needed in your production.
Climate change comes into this picture, too. Your strategy may be to go into a new country or region, but board directors should look at temperature and weather pattern predictions to ensure your strategy is fit for a warmer and much more unpredictable future.
Ethics: determine the ESG issues that will be deemed unethical business practices.
Back in 1997, when I took my state authorized public accountant (CPA) exam, one of the questions was “How much can you deduct if you pay a bribe?” The answer was that you could deduct 10%. Today, you can go straight to jail for paying a bribe.
In terms of values, much has changed in a few decades. Remember when you could smoke in airplanes?
Board directors should look not only at what are acceptable ethical business practices today, but also what it will look like in five, 10 or 15 years’ time. More board directors and more companies need to follow the example of the late, great Ray Anderson. The former chair of carpet tile at Interface had an epiphany in the 1990s: “My company’s technologies and those of every other company I know of anywhere, in their present forms, are plundering the earth. This cannot go on and on and on.”
Anderson revolutionized the business practices of Interface, taking the pollution, waste and fossil fuels out of its supply chain, because it was the right ethical business decision. “In the future,” he said, “People like me will go to jail.” That future is nearly on the doorstep.
Companies need to uphold acceptable social and economic standards. In order to do so, they must instill rigorous monitoring mechanisms. Your stakeholders and asset managers want to see your company’s true ESG performance, and they want them now. However, even the best rating or ranking can be swept away by any action or inaction deemed as unethical business practice by your stakeholders today — and tomorrow.
Trustworthy data collection: determine the key ESG issues to measure and ensure you trust the data.
Having identified the ESG issues that deserve the board’s attention, the board of directors must ensure that they, and their key stakeholders, can trust the data in front of them. Therefore, the board needs to understand the ABCs of ESG and climate so they become as comfortable signing-off on ESG data as they are on the financial data.
That data must be trustworthy. It needs to show that the company complies with regulation, is on track with its strategy and is ethically transparent.
The best way to establish trust and sign-off on the data is through audits. If possible, start with having the internal auditors ask broader questions, and check how well the company has established a rigorous system with data points between departments and built-in controls, the same checks and balances as financial audits. Then invite the external auditor.
The company and its board directors must take the time and make the necessary investment to do these ESG audits at the same level and with the same rigor as the financial ones. Too many organizations baulk at the cost and time, but that hesitation is costing us all in the long run. These audits are your company’s (and increasingly, the directors’) ESG insurance policy.
There’s a lot of work to be done, but boards must know how to address these ESG issues and fast, or they have a problem.