by Helena K. Grannis and Jeff J. Shim
Robust interest in ESG-related matters and growing demands from shareholders, regulators and various other stakeholders during 2021 have put management and boards of public companies firmly on notice that strong ESG policies, practices and commitments are key components to long-term organizational success, business resiliency and value creation.
As the relevance of ESG continues to accelerate, boards need to examine whether they are keeping pace. A PwC survey from 2021 found that 47% of executives believed their boards lacked expertise in the ESG area.[1] A Willis Towers Watson survey of directors and executives from 2020 also found that while 78% of respondents believed that ESG is a key contributor to strong financial performance, only 48% believed they have incorporated these plans into all aspects of their company.[2] Moreover, stakes for failing to appropriately deal with ESG matters are getting higher. Investors are increasingly asking how boards are overseeing material risks, opportunities and reporting related to ESG and may bring litigation or engage in activism to hold companies accountable to public statements or if they think their boards are lagging behind.
Accordingly, as ESG matters continue to gain in importance in 2022, boards should be prepared to navigate the developing ESG landscape, regulatory requirements and shareholder engagement and demands by critically evaluating their companies’ organization and oversight around ESG and ensuring that they are well-positioned to engage and communicate on ESG matters. Below are key reminders for boards reflecting on ESG matters.
Assess ESG Drivers of Long-Term Strategy and Adoption of Meaningful and Realistic ESG Goals
Investors are increasingly looking for companies to be able to articulate and consider key material ESG risks and opportunities. In response, boards and management should take into account ESG factors when making decisions, especially those that could have a material reputational or financial impact on the company.[3] To do so boards should assess their ESG strategies, receive regular updates from management and other experts with respect to relevant ESG risks and opportunities and build ESG consideration and updates into the regular cadence of board meetings in order to drive an ESG-informed long-term strategy.
In addition, boards should understand management’s decision making around performance indicators, targets and goals – why specific ESG metrics were chosen for tracking reporting and performance measures. Boards should review ESG metrics to ensure they are tailored and meaningful to the company and relevant to the board-developed strategy.
Implement a Tailored Oversight Organization
Boards should assess and consider revising their governance documents, including their corporate governance principles and board committee charters, in order to memorialize their commitments and responsibilities in relation to ESG and clarify which bodies have oversight over ESG matters. Taking such steps to clearly delineate each body’s role with respect to ESG prevents responsibilities from getting lost in the absence of clear delegation and ensures regular inclusion of ESG matters on board and committee agendas. Boards should give consideration to their directors’ strengths and experiences and their existing board/committee organization when considering the “right” framework for ESG oversight.
While there is no one-size-fits-all approach, thoughtful consideration of organization can help ensure that consistent and effective coordination exists among management and the board. In some cases, no committee is tasked with responsibility for certain areas; for example, cybersecurity and climate change risk sometimes fall to the whole board for consideration. In such situations, it is important to ensure those matters are regularly on meeting agendas, potentially through inclusion in corporate governance guidelines or specific board oversight guidelines.
We also note that some boards delegate full ESG oversight to the nominating and governance committee, often out of evolution from historical practice. While this can be a good fit for some companies, we recommend that boards reevaluate whether it remains the best solution given the pervasiveness and diversity of ESG considerations and the heightened focus of investors and other stakeholders.
Similarly, some companies may choose to form a standalone ESG or sustainability committee to supervise all matters relating to ESG. While support for a standalone ESG committee appears low among directors[4] and only 11% of Fortune 100 companies currently have a dedicated sustainability committee to oversee corporate responsibility matters,[5] at least one study suggests that companies with a standalone ESG committee demonstrate better ESG performance than those where oversight is carried out by the full board or split among existing committees.[6] However, whether having a standalone ESG committee is beneficial would depend on the company’s particular circumstances, including whether the company operates in a sector with heightened ESG risk and scrutiny.
Finally, as in other areas, boards should ensure that their ESG oversight includes a robust recordkeeping practice that will anticipate stockholder demands for books and records, potentially as a precursor to derivative complaints relating to ESG performance.
Establish a Strong Disclosure and Reporting Framework
Given the increased emphasis on disclosure and reporting, building an effective ESG reporting infrastructure is critical to effect accurate and relevant disclosure. In preparing relevant disclosure and assessing the impact of ESG factors on financial and other ESG reporting, whether it is within the periodic reports filed with the SEC or in a standalone report, boards should pay particular attention to the disclosure controls and procedures.
Companies should implement or maintain systems to ensure that ESG disclosures, whether available on company websites or contained in company filings with regulatory authorities, are assessed for accuracy, are not misleading and meet any regulatory requirements. The development of strong controls with established systems of assessment allows for rigorous review and vetting of material disclosures. According to a 2019 McKinsey study, 97% of investors want sustainability disclosures to be audited in some way and 67% believes that sustainability audits should be as rigorous as financial audits.[7] A 2021 survey also found that investors had significant reservations about the quality of ESG-related information contained in company disclosures.[8] While audit firms are beginning to prepare ESG review procedures, there has not been large-scale adoption of audit-type procedures for ESG disclosures. Notwithstanding the lack of formal audit, it is important that a company’s internal procedures include robust review by various stakeholders, including controllers or internal audit, legal and sustainability departments and outside advisors, in similar fashion to periodic reports.
Conclusion
Investors are actively engaging with boards on their oversight of ESG and seeking transparency on the organization of a company’s ESG review processes. Boards should spend time in 2022 assessing how ESG matters drive long-term strategy and planning, how management is using ESG performance indicators, metrics and goals to assess and move the business forward and how effectively the board’s organization and oversight covers ESG risk, opportunity and disclosure. A focus on oversight and controls can help companies develop ESG metrics that effectively connect operations with the board’s strategy and produce disclosure that is meaningful to investors and supported by reasonable grounds.
Footnotes
[1] PwC, “Board effectiveness: A survey of the C-suite” (November 2021), available here.
[2] Willis Towers Watson, “2020 ESG survey of board members and senior executives” (December 16, 2020), available here.
[3] Materiality assessment may be based on financial analysis and investor interest for specific ESG matters. Reporting frameworks like SASB and TCFD are useful for consideration; for example, SASB has a Materiality Map (available here) that identifies, by industry, ESG issues that are most likely to affect the financial performance of a company.
[4] According to PwC’s 2021 Corporate Directors Survey (available here), only 11% of directors believe that their board should have a standing committee dedicated to ESG issues.
[5] EY, “What boards should know about ESG developments in the 2021 proxy season” (August 3, 2021), available here.
[6] Morrow Sodali, “The Relationship Between ESG Oversight and Performance” (October 29, 2021), available here.
[7] McKinsey Sustainability, “More than values: The value-based sustainability reporting that investors want” (August 7, 2019), available here.
[8] PwC, “The economic realities of ESG” (October 28, 2021), available here.
Helena K. Grannis is counsel and Jeff J. Shim is an associate at Cleary Gottlieb Steen & Hamilton LLP.
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