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ESG: Environmental, Social & Governance

Shareholders continue to prioritize ESG (i.e., environmental, social and governance issues). But why? On one hand, the term seems hyper-focused; it shines a spotlight on environmental impact and corporate social responsibility—topics that were rarely considered significant board matters in years past. On the other hand, the focus on governance seems helplessly all-encompassing—and often leaves boards wondering what to prioritize.

For today’s institutional investors, an “ESG” focus looks beyond the balance sheet to consider the unique risks and opportunities facing today’s companies, both now and in the future; it also considers the impact a company has on its employees, customers and the communities within which it operates.

What actions do today’s institutional investors expect companies to take? How do environmental, social and governance issues translate to board oversight? How are industry leaders reporting around these topics–and where are the gaps in communication?

Board members are aware of some of these issues, but they’re not always fluent. And that lack of fluency gives it away that they’re not really discussing ESG at the level they should be.

— Rakhi Kumar, Senior Managing Director, Head of Investments & Asset Stewardship, State Street Global Advisors

Understanding ESG

The Broader ESG Message

The meaning of the acronym often gets clouded by semantics. Instead, boards should focus on the message that today’s investors are trying to communicate. In his annual letter, BlackRock CEO Larry Fink urges today’s companies to adopt a “sense of purpose”. Purpose, he says, is not at odds with profits, but rather the animating force for achieving them:

…when a company truly understands and expresses its purpose, it functions with the focus and strategic discipline that drive long-term profitability. Purpose unifies management, employees, and communities. It drives ethical behavior and creates an essential check on actions that go against the best interests of stakeholders. Purpose guides culture, provides a framework for consistent decision-making, and, ultimately, helps sustain long-term financial returns for the shareholders of your company.

— Larry Fink, CEO of BlackRock

Investors are focusing heavily on board composition and diversity as indicators of board quality and effectiveness: Does the company have the right people sitting around the board table in order to achieve its three-, five- and ten-year strategy?

Board Oversight of ESG

Structuring Oversight

So far, board oversight around ESG varies widely. Discussions around the “G” (i.e., governance) are often spearheaded by the nominating & governance committee with involvement from the full board–particularly when assessing how environmental, social and governance risks integrate with the ERM program or impact long-term strategy. In addition, more boards are incorporating the “S” (social considerations or corporate impact) into the strategy development process, according to PwC’s Annual Corporate Directors Survey:

Q: Which Social Issues Should Play a Major Role in Strategy Formation?
PwC Annual Corporate Directors Survey on ESG

When it comes to structuring oversight around the “E” (i.e., environmental issues), a recent global study by the Diligent Institute found that best practices are still largely undetermined. Fifty percent of the 447 survey respondents indicated some form of board-level oversight, either by the full board or a board committee, while 19% indicated oversight within the organization. Another 35% percent indicated that environmental issues are “not overseen” by the company or that they “don’t know.”

Q: Where Does Formal Environmental Sustainability Oversight Live?
Diligent Institute Report on Environmental Sustainability

The best approach to oversight will vary by board and will be influenced by industry, company type, global footprint, existing committee structure, and so on. However the board decides to structure oversight, every board member should have a thorough understanding of (a) how environmental, social and governance risks impact the organization and (b) what kind of disclosure is important to their investors. Don’t miss our recent webinar, where investors like BlackRock and the AFL-CIO share their expectations for today’s boards.

ESG Reporting & Disclosure

Telling Your ESG Story

With the rapid rise of ESG, investors and boards are now navigating a communication gap. Investors are looking for more standardized reporting in order to compare one company to the next: “Companies are starting to provide [disclosure],” said Brandon Rees, Deputy Director of Corporations and Capital Markets for the AFL-CIO, “but because we don’t have uniform presentation of the information, it’s very difficult for investors to digest it when you’re relying on a CSR report as opposed to a uniform SEC disclosure.

On the other hand, corporate issuers are finding that the types of metrics that matter to one company may not matter to the next. Both boards and investors are increasingly turning to organizations like the Sustainability Accounting Standards Board (SASB), Sustainalytics or MSCI for reporting frameworks that offer some level of consistency and financial materiality among companies within a given industry.

Key Challenges

ESGEffective oversight of environmental, social and governance issues will depend on whether today’s boards have the right information at their fingertips. In a research report by Forrester and Diligent, governance professionals indicated that their greatest dissatisfier was “visibility into sustainability and ESG issues.” Not only are boards facing a lack of visibility internally (across the organization), but externally, as well…

Do You Have the Data Your Investors Have?

How does your board composition compare to your peers? What skill sets is the board lacking? What conflicts of interest might your investors have uncovered? Quick access to information helps board members identify governance red flags raised by shareholders and activists. Click here to learn how Diligent’s Nomination & Governance module is driving these types of insights.