Why board members are holding back ESG and sustainability
Environmental, social and governance (ESG) factors are increasingly important to investors, customers and other stakeholders. As a result, board members have a responsibility to understand ESG and how it can impact their company’s long-term success.
Since around 2020, ESG and sustainability have moved beyond the concept of ESG investing. Yet many board members have a view of ESG, corporate social responsibility (CSR) and sustainability from five or ten years ago – when ESG was very much an investment-led strategy – and these outdated views are holding companies back from developing clear ESG strategies.
What is the ‘old ESG’ that existed before 2020?
The old ESG that most directors are aware of relates to ESG investing, and came about after investors started asking questions about climate change and ‘green’ initiatives as part of their investment decisions. Up until about 2020, the investment community mostly considered climate change factors and whether the company was in a ‘dirty’ or ‘clean’ industry, and these two considerations were branded as ‘ESG’. So it is no surprise that most directors developed a view that ESG only covered this narrow investor-led lens.
For the purpose of comparison, we have coined this investor-led view of ESG as ‘old ESG’: an ESG that was focused on investment decisions based on climate and greenhouse gas usage, and, on rare occasions, a few other areas of the United Nations Sustainable Development Goals (e.g. anti-corruption).
Governance has taken on a different meaning since 2020
Boards also considered ‘corporate governance’ or ‘governance’ through their own (relatively narrow) lens. Most boards equated these terms with board diversity, board structure, board committees and board attendance. The view of corporate governance and governance was very much about the board and not looked at from other perspectives.
This area has also developed in more recent times, with governance and corporate governance becoming much broader concepts that go well beyond the boardroom and directors. Governance now includes the entire company and covers elements like the company’s overall purpose, value and integrity; the roles of board, management and employees; and the way that the company is managed from a risk perspective.
Investor relations pages on websites have equally portrayed ESG as old ESG and confused ESG with CSR
Other evidence of this old ESG thinking is seen on company websites, where board members and structure are identified (often as part of the ‘investor relations’ pages). While the role of the board is primarily to engage with investors, substantive dialogue on ESG is probably not best categorised as investor relations. There should be separate ESG and sustainability sections of websites, with the board featuring prominently.
The lack of understanding of ESG and a following of old ESG also leads to confusion between ESG and CSR. While ESG and CSR are often used interchangeably, ESG is a broader term that encompasses a company’s performance on a range of sustainability-related issues, while CSR is more focused on a company’s charitable giving and community involvement.
Company websites often overemphasise corporate philanthropy as being a large part of ESG, so they may label their pages as ‘governance’ and ‘ESG’ yet talk mostly about CSR. There is no doubt that CSR is a part of the ‘S’ in ESG, but it is certainly not totally representative of ESG.
Unfortunately, many boards also consider political views of ESG. Many (mostly United States) congress members view ESG in the light of old ESG, focusing on how financial companies might restrict capital to their constituents that operate in industries that may be carbon challenged. These congress members focus their attention on doing everything they can to continue capital flowing to their constituent companies and limiting the impact it might have to industries in terms of job losses if that capital is reduced. Whether because of their association in the same economic/social circles or simply because it is what they are hearing, there is likely some influence on board members to conform to this thinking.
What is the ‘new ESG’ and how is it different to old ESG?
Since at least 2020, ESG has described the environmental, social and governance initiatives that form part of a company’s performance on a range of sustainability-related issues. Environmental factors include a company’s impact on climate change, water resources and biodiversity. Social factors include a company’s labour practices, human rights record and commitment to diversity and inclusion. Governance factors include a company’s board composition, anti-corruption efforts, transparency, integrity and compliance, whistleblowing, executive compensation and risk management practices.
New ESG looks at ESG across several sub-areas. In Speeki's ESG model, there are 19 major areas falling within the ESG spectrum. If these 19 areas are broken down further (as some reporting standards like the Global Reporting Initiative do), there could be over 50 different areas.
The new ESG is far different from the old ESG. Old ESG was:
- investor led and focused on very narrow mandates from investors
- focused on climate matters and greenhouse gas usage
- focused on boards and directors (as these are the groups that would typically engage with investors).
But new ESG is more about how the company:
- handles ESG matters across a broad spectrum of topics
- integrates sustainability into its business
- reacts to a broad group of stakeholders or interested persons (including the potential investors that are the subject of old ESG)
- considers the impact to its product lines and its customers
- responds to its own impact on the environment, the economy and people
- considers the changes to the company and its business by virtue of the changes in the environment, the economy and its people.
Why is handling new ESG so different to handling old ESG?
New ESG sits squarely within the scope of ‘management’ and is very much part of the day-to-day matters that management needs to deal with. These issues rarely get to the board or governing body, except in management updates, because they are truly management issues.
The problem is that there may now be two different definitions of ESG and two different approaches to manage it happening within the same company: the approach of the board, which is focused on old ESG, and the approach of management, which is more on the day-to-day arising from new laws, reporting requirements, customer expectations and changes in the marketplace. It is the classic old thinking versus new thinking.
Both old ESG and new ESG have a role in companies. However, due to the definitions, new ESG can easily encapsulate old ESG and will be the survivor. We only need to look at the new laws on ESG reporting to see that this is the case and that the direction to embed ESG into the fabric of a business is key.
The challenge now is combining that thinking into the business and reassigning the board to continue its role within new ESG (engaging with investors) while understanding that it is part of a much broader concept that it needs to align, engage, fund, support and play an active role in.
Why is it important for boards to be upskilled to appreciate and understand the new ESG and bridge the divide?
It is becoming increasingly clear that sustainability is not just a nice to have, but a business imperative. Companies that are not taking ESG seriously are at risk of losing customers, community support and talent. ESG can help companies identify and manage risks more effectively, recognising that some of these risks are due to the changes in the planet and the communities that live within it. For example, companies that are not taking steps to reduce their carbon emissions are exposed to the risk of regulatory changes or changes in consumer preferences.
ESG can also lead to new opportunities. For example, companies that are developing sustainable products or services can capture a growing market. There is a significant opportunity for companies to get ahead of new ESG and think through how they can leverage it and maximise its value.
So it is clear that new ESG, which is principally being handled by management and supported by the board in certain areas, has now outgrown the original old ESG and needs to be repositioned within companies. Directors and governing bodies need to be urgently briefed on new ESG to realign the board and management to have one understanding and approach to ESG.
What is the risk if companies don’t make this realignment?
Our work at Speeki has shown that boards that are not thinking about new ESG typically:
- don’t assign clear responsibility to management to manage ESG because they think they have it under control
- think too narrowly about ESG and consider only the input from banks, investors and ratings agencies
- miss opportunities to leverage ESG for the benefit of the customers, partners, suppliers and employees
- miss the ability to effect change in their industry and drive solutions that can help the planet
- miss the fact that there are other stakeholders to consider beyond investors when it comes to ESG and that those other stakeholders (like customers, employees, and the community) must be on board with the ESG strategy
- don’t appreciate that new reporting standards will significantly change the focus of both ESG reporting and assurance of those reports, and that boards are most likely going to be held responsible for the accuracy, completeness and effectiveness of those reports
- confuse ESG with CSR
- do not understand the risks and opportunities of ESG (for example, companies that are not taking steps to reduce their carbon emissions are exposed to the risk of regulatory changes or changes in consumer preferences, while companies that are seen as leaders in ESG can attract customers, investors and talent)
- are not involved in setting clear ESG goals and targets to help the company measure its progress and ensure that it is on track to achieve its objectives
- neither participate in ESG nor encourage management to integrate ESG as an integral part of the company’s strategy by factoring ESG into all aspects of the business, from product development to marketing to risk management
- do not clearly communicate ESG to stakeholders such as investors, customers, employees and regulators.
What are the top eight things that companies should do to bridge their knowledge gap and adopt an aligned new ESG?
1. Define ESG
Clearly defining ESG and sustainability will help avoid confusion in the future and allow the company to adopt a clear shared view on ESG.
2. Educate themselves about new ESG
Board members (and management teams where necessary) should read about ESG, attend conferences and talk to experts. They should immediately start to get a more diverse understanding of ESG matters and the stakeholders (interested persons) that are impacted by the programme.
3. Understand importance and materiality areas beyond climate change
Board members should get involved in the (importance and) materiality assessments and exercise direct oversight over management’s development of this process. The board must be a strong player in these assessments, not just an approval mechanism.
4. Define roles and responsibilities of ESG
There are clear roles of both management and directors in managing aspects of ESG. Documenting these roles is a good approach.
5. Ensure that management actively incorporates new ESG into the company’s strategy
The board should ensure that ESG is a key consideration in the company’s strategic planning process, making ESG a part of the bonus plans and incentives for the board and senior management.
6. Actively oversee the company’s ESG performance across all important and material areas
The board should regularly review the company’s ESG performance and ensure that it is meeting its goals and objectives. ESG should be embedded into the company reporting systems.
7. Adopt clear reporting
The board needs to oversee and have a detailed understanding of ESG reporting now and in the future to ensure it is valid, accurate, complete, verifiable and transparent.
8. Engage with stakeholders on ESG issues
The board should engage with investors, customers, employees and other stakeholders on ESG issues. They should not limit themselves to just dealing with investors.
ESG is an important issue that board members need to understand. By taking steps to educate themselves about new ESG and incorporating it into company strategy, board members can help their companies achieve long-term success. The days of ESG being about investing, capital and mandates of investors are gone. Board members need to get up to speed on new ESG before they are held personally liable for its failure.
Additional resources for board members who want to learn more about ESG:
- The Corporate Governance Institute’s A board member’s guide to ESG
- INSEAD’s Designing Sustainability Governance report
- The Harvard Business Review’s article, ‘The Board's Role in Sustainability’
