Getting to grips with ESG

Environmental, social & governance (ESG) issues have become a front-line board agenda item — and boards need a framework to help them avoid false starts. 

Once a quintessential “soft” issue, ESG is important not least because an organisation’s credentials in that regard affect investor confidence and, increasingly, its social licence to operate.

Leading investment manager BlackRock has led the way, making sustainability a criterion for its investment advice. The link between ESG and financial performance is becoming a mainstream position; directors need to understand how this affects their fiduciary duties.

While there haven’t been any specific moves to introduce regulations in this regard and no real jurisprudence relating to the duties of directors specifically, it is only a matter of time before both occur.  

While the importance of ESG is easy to conceptualise, nailing down the details of concrete actions that boards must take and disclose is more difficult. What ESG issues are material to an organisation, and how can they be integrated into its strategy and operations?

What are the specific risks relating to ESG, and how are they to be mitigated? What is the actual ESG governance/oversight structure required? What new skills does a board require to provide oversight of ESG issues?  

Taking the longer-term view

Overall, ESG’s increasing prominence should be seen as a move from short-term to long-term value creation. In that context, one should also think of moving from a compliance-based, typically a tick-box mindset — as evidenced by governance issues more broadly. Research conducted by PwC in 2019 appeared to indicate that boards were slow to appreciate the shift and were still tending to focus on “an outdated emphasis on short-term value maximisation”.

What’s really useful is a framework developed at Oxford’s Saïd Business School (see “The board’s role in sustainability”, Harvard Business Review, September-October 2020). This framework, dubbed Score, was developed as the Enacting Purpose Initiative that brings together academics and businesspeople to provide research and guidance on linking corporate purpose to strategy and performance.

“Corporate purpose” provides the rationale for boards to increase their focus on ESG and position their firms for long-term success. Score proposes five actions that can help boards articulate and foster a firm’s value proposition:

• Simplify. To be effective, purpose needs to be straightforward enough to be understood by the whole workforce, the supply chain and all stakeholders. This message should be issued by the board and should be distinctive, not something generic to which any company could put its name.
• Connect. Once the corporate’s purpose has been successfully articulated, it should be connected to the strategy and decisions about resource allocation. An important element here should be a focus on metrics so that executives can make the business case for ESG initiatives. By connecting the dots between strategy, resource allocation and value creation on the one hand and ESG in this case, moving to a longer-term focus will be easier.
• Ownership. At the board level that means putting structures, controls and processes in place to ensure the firm’s purpose is embodied in every aspect of the company. At a practical level, this will mean ensuring the audit and risk committees are equipped to look beyond financial reporting and risk. There is some debate about whether ESG should, in fact, have its own board committee.
• Reward. Remuneration traditionally drives short-term profits, but as purpose becomes more important it should also be repurposed to evaluate longer-term performance using a mix of financial and non-financial metrics. The Global Reporting Initiative, the Impact Management Project, and the Sustainability Accounting Standards Board have laid the foundations for a set of global standards to evaluate ESG impact, similar to those used in financial performance.
• Exemplify. This talks to the disclosure in both qualitative and quantitative terms of how purpose is being achieved. Companies need to link financial and sustainability performance, along with a consistent narrative.

The Score approach is broad, but has the virtue of encouraging the integration of purpose and strategy — from an ESG perspective, this will help to avoid wasting time in mindless compliance.

• Natesan is CEO, and Dr Du Plessis facilitator, at the Institute of Directors SA.