Dentons

"What oversight should our board exercise over the environmental and social performance of our business?", is the question of the moment from clients who sense the increased momentum and enterprise risk associated with ESG. In recent weeks, we have witnessed tangible impacts of scrutiny from investors, consumers and local communities. Share prices have collapsed in the wake of supply chain labour issues. Court actions alleging breaches of human rights have multiplied. Senior executives have resigned over "breaches" of the "social licence" to operate. As the impact of civil society intensifies, this is an important moment for boards to pause and reflect on:

  • their accountability for the enterprise risk associated with environmental and social performance; and
  • the effectiveness of the business' environmental and social management systems.

Lessons are being learnt in real time on the journey to responsible capitalism. To protect your enterprise value in the current climate of activism, here are five governance tips for your board

1. Decouple ESG from pursuit of shareholder value at your peril

As recent examples show, outperforming your sector and returning value to shareholders might not be enough to save executives as activist shareholders and civil society demand accountability for environmental or cultural damage in pursuit of short-term profit. The economic debate surrounding stakeholder capitalism continues to evolve, but the reality for corporate leaders in 2020 is that sustainable shareholder value is linked, unequivocally, to environmental and social performance.

2. Governance of environmental and social performance must start at the board

Given the enterprise risk of failing to meet society's expectation of environmental and social performance standards, governance must start at the board. The board must question the management structure for ESG performance and be assured that the executive has visibility of, and is actively managing, the risk. As custodian of investors' money, anything less would be a dereliction of duty.

3. Do not use the law as your only reference point for "compliance"

The point about civil society's expectation is that the bar for environmental and social performance has risen above existing legal requirements. I have written before that the law of negligence has not changed, but the views of the people on the Clapham Omnibus have sensitised to environmental and societal damage. What was once collateral damage in pursuit of shareholder value may now be unacceptable to civil society. This means your approach to "compliance" has to pivot. Your company must have a clear vision of its commitments and a methodology for performance management. Some sign up to the UN Global Compact, others follow the IFC Performance Standards, but in all cases, establishing your environmental and social performance reference point and operationalising these commitments is key because local law is no longer the yardstick for "compliance".

4. Empower the environmental and societal functions within your business

In many of the recent examples where businesses have been responsible for environmental or cultural damage, it would appear that the risks and consequences of the company's actions did not reach the executive or operational decision-makers. This provides little comfort to stakeholders after the event and underlines the importance of empowering the environmental and societal functions within your business. To be effective, these functions must report directly into executive leadership as well as key operational decision-makers. Tragic accidents such as the Piper Alpha disaster led ultimately (via the Cullen Report) to highly regulated health and safety management. This is a "burning platform" moment for ESG, and the need for clear authority for both your environmental and social management functions is now crucial.

5. Review your internal management systems

Given the rapidity with which ESG is evolving as an enterprise risk management issue, many (maybe most) companies would do well to reinforce their internal systems. Modern slavery and human trafficking laws in California and the UK have prompted some review of systemic resilience against human rights exposures in the supply chain, but this is only a small segment of the risk that sits across the environmental and social performance spectrum. As your board moves further from the high water mark of Friedman's view of capitalism, investing in internal management systems to ensure effective environmental and social performance is perhaps the most important improvement a business can make to protect shareholder value.

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