In a rapidly changing regulatory landscape, how can directors be best prepared for new developments in the realm of ESG?

Listen to Episode 69 on Apple Podcasts  

Guest: Andrew Droste, Head of Stewardship for the Americas for the Carbon Tracker Initiative

Hosts: Dottie Schindlinger, Executive Director of the Diligent Institute, and Meghan Day, Senior Director of Board Member Experience for Diligent Corporation

In this episode:

  1. Current ESG Regulation: Droste gives an in-depth overview of the current state of ESG regulation and the developments we’ve seen in the last few years.
  2. Lessons for Boards: Given the rapidly developing regulatory landscape, Droste gives directors some tips to stay ahead.
  3. Looking to the Future: We asked Droste to give his predictions for what the future of ESG will look like in the corporate space.

Summary:

In this episode of The Corporate Director Podcast, hear from Andrew Droste, Head of Stewardship for the Americas for the Carbon Tracker Initiative, an independent financial think tank. Droste discusses the current ESG regulatory and investor landscape, future evolutions in the space, and what corporate leaders should be doing as a result.

Current ESG Regulation

Recently, we’ve seen ESG regulation move from soft law into hard law. Droste gives a quick rundown of this shift over the last year, beginning with the SEC: “In February 2021, the SEC appointed a senior policy advisor for ESG, something we had never seen. Then, in March, the acting SEC chair requested input on questions related to climate change disclosures, specifically about whether enough information was being provided. Human capital, ESG funds, board diversity, and more are all being added to the SEC rulemaking agenda.”

Then, he turns to regulation coming down from governments, both in the US and Europe: “In the US, we had the May 2021 Executive Order mandating greater disclosure on financial climate-related risks for companies engaging in federal government contracts.” He goes on to compare these ESG-developments to Europe: “The EU has been well ahead of the curve for ten years with SFDR. The Green Taxonomy has come out in recent years and will be codified soon. Expect some major changes.”

Nongovernmental organizations have also led the charge on ESG, particularly the UN: “The Sustainable Development Goals (SGDs) have been around for a while, and while those are related to global issues more broad than ESG disclosure, there’s been lots of alignment there.”

And of course, there was the UN IPCC Sixth Assessment report: “This summer, the UN used their strongest language yet: They moved from saying there was ‘strong evidence’ that human activity influences the climate to ‘very likely’ to ‘extremely likely,’ and now finally to ‘unequivocally.’ Because of that, country over country decided this is the language they should use. It signals that we have to act swiftly and effectively.”

“We’ve seen nothing short of a sea change around ESG in the last year.”

Andrew Droste, Head of Stewardship, Americas, the Carbon Tracker Initiative

Lessons for Boards

Droste stresses the importance of stakeholder engagement: “Directors and board leadership must engage early and often with key stakeholders. This is not a novel concept. It’s been the key to good governance for decades, and it’s a sentiment that’s worth repeating.”

He goes on, “BlackRock has witnessed poor communication from the companies who saw losses, lower levels of director support, and so on. Treat investor involvement like free consulting. The investors poking you are doing you a favor. Look at them as leading indicators, as early detection systems for risk and opportunities. Novel shareholder proposals are garnering more support year-over-year. One big example is political expenditures, which now have 50% average support! In the beginning, it was in the single digits.”

“The investors are doing you a favor when it comes to ESG. Look at them as leading indicators or early detection systems for risk and opportunity.”

Andrew Droste, Head of Stewardship, Americas, the Carbon Tracker Initiative

Information flows are essential to, says Droste: “Boards need to take away from this proxy season that they need more and more information from management. It’s not only about what you’re hearing. It’s about the industry too, reviewing and comparing ESG targets, strategy, and disclosure. These things could be an indication of whether you’re next on that target list for activism.”

Looking to the Future

Droste then addressed those directors who believe that ESG is just a fad: “To be blunt, as an investor, those are the companies that I would target. I would want to know who those board members are and where they sit. ESG data is going to become more material very quickly.”

He also emphasizes the importance of upskilling current board members instead of only focusing on bringing in an ESG expert: “The entire board doesn’t need a one-trick pony who can speak the ESG language, we need all of them to be ESG-conversant. If they cannot understand the information that’s becoming more quantitative in CSR reports, they’re going to be in trouble with institutional investor community who are engaging with ESG and talking about it. If you can’t speak the language, that will be picked up as a gap. If you don’t understand ESG strategy in these engagements, that’s a red flag.”

“If you are one of the boards who think ESG is just a flash in the pan, you may be in for a rude awakening.”

Andrew Droste, Head of Stewardship, Americas, the Carbon Tracker Initiative

Droste then discusses the future of ESG: “Ideally, investors want ESG to be fully integrated into ERM and also on the strategic level. It should be part of everything the company is doing from risk and opportunities standpoint.”

He breaks the future down into two broad phases: “Placing ESG under the purview of GC or CHRO, or hiring a CSO using a search firm, that’s ESG 1.0. Identifying material ESG issues, measuring them, and disclosing them according to whichever framework you’re dealing with falls under that phase too.

If that’s ESG 1.0, ESG 2.0 is true integration, says Droste: “The CEO should own ESG too at this point. It needs to come from the top of the house. There are ways to do this throughout the enterprise from a management and board standpoint to effectively manage, oversee, disclose and communicate to your community and other stakeholders.”

Also in this episode…

Droste also gives some background on the Carbon Tracker Initiative: “We’re a mission-driven organization; an early thought-leader in the space, that directly links to the massive energy transition that the world must go through. We focus on carbon-major industries that make up the majority of global carbon emissions. We engage with companies, educate, and work with financial regulators under the umbrella of helping market participants stay aligned to the 2015 Paris Agreement. We believe that investors need to act intentionally, for society and their portfolio value.”

Resources from this episode: