How should Boards approach ESG? We get perspective from Ceres.

August 21, 2020

Ceres, a sustainability non-profit, issued a White Paper on how boards should be thinking about ESG risks and opportunities. We asked their Governance Managers Hannah Saltman and Melissa Paschall to walk us through the approach.

This is an interview with Ceres. NYSE presents the information for informational purposes, but does not endorse, represent nor warrant the accuracy of the narrative, which relies solely on material provided by Ceres.

Your white paper focuses on how boards should be thinking about ESG. Can you talk a little about 1) your recommendations for directors and 2) how that shapes the way management teams should be approaching these issues as well?

The global COVID-19 pandemic has demonstrated the importance of company preparedness for systemic risks that have the potential to cause major disruptions to enterprises and the economy writ large. Environmental, social and governance (ESG) issues have long posed significant risks to business performance and need to be evaluated as such within a company’s risk management process. Companies that have robust systems in place to surface the impacts of such risks on the company are those that will be best positioned for resilient growth.

The Ceres report Running the Risk: How Corporate Boards Oversee Environmental and Social (ESG) Risks provides guidance to corporate directors on how to proactively oversee ESG issues that could pose risks to business strategy and performance. The report explains how a number of ESG issues such as climate change, water scarcity, and human rights abuses can result in major financial impacts to the company across all areas of traditional business risks. Boards have a critical role to play in ensuring that companies are aware of and able to navigate an ever-evolving risk landscape. The report offers a framework to corporate directors on how to integrate ESG risk into their risk oversight process - which in turn can be used by management to support and prepare their boards to effectively oversee ESG risk:

  • Identify ESG risks. Directors need to ensure that corporate risk management systems both identify and evaluate salient risks within the context of the company’s business strategy. As a part of this oversight role, directors should work closely with management to ensure that all ESG factors that have the potential to affect corporate strategy and value are considered. This includes considering the variety of ways in which ESG factors could affect corporate strategy, evaluating the adequacy of existing processes, drawing on a range of information sources, testing assumptions, and integrating these within the enterprise risk management process.
  • Assess the impact of ESG risks. Once risks are identified, management should assess and prioritize them to direct the board’s focus on those topics most relevant to the achievement of key strategic objectives. This includes using a materiality lens to assess ESG risks and considering the fluency of the board to consider ESG factors.
  • Act to mitigate or adapt to ESG risks. Ultimately, board deliberations on ESG risks should be integrated within deliberations on company strategy and performance. Once the board and management are satisfied that the right ESG risks have been identified and prioritized, the next steps are to evaluate how the company can navigate the top ESG risks affecting the business, including through strategic planning, corporate finance, and capital allocation. This includes considering how prioritized ESG risks affect organizational strategy, understanding the business strategies available to mitigate or adapt to the risks and holding executives accountable for ESG performance.

Your report focuses on ESG risks. How do you view the other end of that spectrum, the opportunities an increased focus on ESG creates for some companies?

Risks and opportunities are two sides of the same coin. Running the Risk points to a number of ways in which companies could address ESG factors by integrating them within their organizational efforts towards competitive differentiation or new market capture. Opportunities include:

  • Capitalizing on emerging markets: Electric vehicles are on track to account for over half of new car sales by 2040
  • Brand enhancement: Nearly 9 out of 10 U.S. consumers say their purchasing decisions will be impacted by a company’s stance on an issue they care about
  • Employee retention and satisfaction: Companies that have more diverse management teams have 19% higher innovation revenue and report better overall financial performance
  • Cost-savings: In 2016, 190 Fortune 500 companies collectively reported $3.7 billion in annual savings as a result of energy efficiency programs
  • Early compliance with emerging regulations: The number of climate change regulations has grown to 1,500 globally, up from 72 in 1997
  • Improving access to capital: There is an increasing focus on ESG performance as a factor in mergers and acquisitions-related company valuations

How important is the process for investors - i.e. the infrastructure a company and board have in place to assess these issues

Investors are very focused on the systems that companies have in place to oversee ESG factors, including at the board level. The existence of these systems signal how seriously companies are taking ESG risks as business risks. Additionally, companies that have these systems in place for ESG factors are considered well-managed companies overall.

Specifically, investors are interested in the following systems:

  • Does the company have at least one board committee that is explicitly focused on ESG issues, demonstrated by charter incorporation? This indicates that ESG factors are considered regularly and systematically at the board level.
  • Does the board of directors have demonstrable fluency in ESG factors? This indicates that the board considers ESG issues in order to make informed decisions.
  • Does the board link ESG factors to executive compensation? This indicates that the board is willing to hold leadership accountable for ESG performance.

What trends are you seeing around which board committees are overseeing ESG risk?

In a 2018 analysis of the world’s largest global companies, Ceres found that board oversight of ESG typically resides within board committees with a specific ESG or sustainability focus (38%) or nominating and governance committees (18%) with environmental, health and safety (14%) and public policy (13%) committees next in line. While less common, some audit (2%), risk (6%) and compensation (1%) committees oversee ESG risks as part of the overall organizational risk management process. Running the Risk provides examples for how each of these committees oversees various ESG issues, including specific company examples.

While specific committees have an important role to play in overseeing ESG, related risks and opportunities should be surfaced at every relevant committee of the board - and many need to be discussed at the full board level.

What advice would you give a company that is new to ESG disclosure and looking for a place to start?

As a first step, a company should determine which ESG issues are most relevant to its strategy both from a risk and an opportunity perspective. Examining what peer companies disclose on ESG issues as well as engaging stakeholders and shareholders can illuminate expectations from a company’s key constituents. Running the Risk includes recommendations for companies on how to disclose material ESG risks within financial filings and how to effectively disclose the board’s role in overseeing these risks.

Next, a company should identify its primary audience for its disclosures. This will help the enterprise both understand how to hone and focus its disclosures, as well as pinpoint the most relevant disclosure framework to use. While there are a number of ESG disclosure frameworks in the marketplace, many of them are honed to the needs of various stakeholder groups. You can find more information on a few of these in the NYSE Disclosure Guidance Library.