With the world of ESG expanding on a daily basis, I frequently receive questions on how companies should structure their board’s governance over the environmental and social matters included in their company’s definition of ESG. The short answer here is that, as is the case with traditional areas of corporate governance, there is no one-size-fits-all approach. For some companies the right answer will exist in better defining the scope of the responsibilities of their existing board bodies, for others, the right answer will exist in creating a new board body. Which approach is the right approach will depend on the board, its current composition, and the ESG strategy that the company is pursuing. Either way, there are a number of steps that every company should take before creating an ESG board committee (or assigning ESG duties to existing board bodies). Here I outline what those five steps are.
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1. Identify ESG Team Players
First, companies need to identify the key ESG team players in their operations, risk management and legal and compliance functions, as well as their external ESG support. The role of the board is one of oversight, not management, and before a company sets up an oversight structure, it makes sense to identify who is actually going to be charged with the day-to-day, management-level responsibilities for actually “doing” ESG. With the mounting pressure companies are facing to report on ESG, it can be tempting to create ESG disclosure, any ESG disclosure, before a company actually takes the steps to identify their ESG goals and strategy. This is definitely putting the cart before the horse and is always a mistake. Companies that report before they plan are far more likely to find discrepancies between their reporting and their actual practices down the road.
2. Understand ESG Data
Second, before companies think about how the board will oversee ESG matters, they need to understand their data, and how their data is created and communicated through the organization. Before a company can report to its board on ESG, the members of management need to know what they know and how they know it. What risks are already being tracked by the enterprise risk management function, and are there non-financial risks that are already being reported to the board? What information does the company already have about environmental and/or social matters in its supply chain? What reasonable goals does the company have to become more sustainable or more diverse, and how does the company define “sustainable” and “diverse?” Doing an ESG data audit is not something investors are likely to ask about, but it is a critical step in creating the types of information that investors are likely to ask for without creating unnecessary risks for the corporation.
3. Identify ESG Materiality
Third, the internal ESG team needs to identify what is material for the company from an ESG perspective. One of the most frequent complaints I hear from directors is that they are inundated with too much immaterial information; board books have become too cumbersome, and dumping information on directors creates its own set of potential risks. Instead, I recommend using the five lenses of materiality to identify the company’s unique recipe for ESG success. As I have discussed in my other articles, the five lenses of materiality are: (1) what is “material” to the company’s specific stakeholders (i.e., investors, employees, customers, communities and business partners), (2) what is “material” to the company, including with respect to how it wants to be viewed in the marketplace and compared to its peers and competitors, (3) what external standards of materiality should apply to the specific area of disclosure (i.e., EU Sustainable Finance Disclosure Regulation, SASB, GRI, Joint Statement), (4) how does the U.S. federal securities law definition of “Materiality” apply to the company’s business, operations and financial statements, and what does that definition require in terms of disclosure, and (5) with respect to each of the foregoing, how does Point A compare to Point B, in other words, how is materiality moving and what will it mean tomorrow?
4. Consider Litigation and Political Strategies
Fourth, companies need to consider their litigation and political strategies. If a company’s litigation and political strategies say one thing, and its sustainability report says something else entirely, the company is not creating a consistent message, and a lack of consistency can, at a minimum, put the company’s social license to operate at risk, and, at worst, create litigation risks.
5. Understand the ESG Communities’ Expectations
Finally, each company needs to understand its ESG communities’ expectations. This obviously includes investors, but it also includes employees and the communities in which the company does business. In this regard, the perspective and buy-in of employees is particularly important. Do you know what your employees think about your ESG strategies? Are they onboard with supporting your ESG efforts? Ultimately, just like with ethical and compliance-related matters, the ability of a company to turn its ESG goals into reality comes down to whether or not it has a culture that supports those efforts.