Helping boards come to grips with ESG

By Parmi Natesan and Prof Prieur du Plessis

Environmental, social and governance (ESG) issues have become a frontline board agenda item – boards need a framework to help them avoid false starts.

Once a quintessential soft issue, ESG is now an important board agenda item, not least because an organisation’s ESG credentials affect investor confidence and, increasingly, its social licence to operate.

BlackRock, a leading investment manager, has led the way, making sustainability a key 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 have not been any specific moves to introduce regulations in this regard and no real jurisprudence relating to the duties of directors specifically, there is no doubt that it is only a matter of time before both occur.

While the importance of ESG is easy to conceptualise, nailing down the details of what concrete actions the board must take and then disclose is harder to do. What are the ESG issues that are material to the organisation, and how can they be meaningfully 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 that needs to be put in place? What new skills are needed on the board to ensure it can provide oversight of ESG issues and put the right structures in place?

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 tick-box mindset – something that we are seeing with governance more broadly. Research conducted by PwC in 2019 seemed to indicate that boards were slow to appreciate the shift and were still tending to focus on “an outdated emphasis on short-term value maximization”.

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, 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 and what will make it real:

Simplify. To be effective, it’s important that purpose is 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, and 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, in this case, ESG, it will be easier to move to a longer-term focus.

Own. Ownership at the board level 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 is traditionally to drive 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 foundation for a set of global standards for evaluating ESG impact, similar to those used to evaluate 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.

Parmi Natesan and Dr Prieur du Plessis are respectively CEO and facilitator of the Institute of Directors (IoDSA); email: info@boardgovernance.co.za

Parmi Natesan		Dr Prieur du Plessis