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  • Justine Sacarello, Senior Manager |
5 min read

ESG’s ‘Governance’ is generally regarded as referring to the approach corporates take in addressing their environmental and societal risks. Governance also plays a pivotal role in how corporates integrate those risks into their strategy.

Boards that exercise good governance principles, including those set out below, will be better informed and prepared to overcome ESG’s challenges and pursue ESG opportunities for their competitive advantage. 

Principle 1: Strategy

To develop a credible strategy for meeting ESG targets, boards need to be aware of, and comply with, their existing ESG commitments (not least to avoid accusations of greenwashing). Integrating ESG at the core of corporate strategy is a pre-requisite for investors and other stakeholders who regard effective ESG management as improving performance by facilitating the identification of reputational, operational, and financial risks which, in turn, creates commercial opportunities.

Good governance tends to translate into high performing corporates, for example, improving equality, diversity and inclusion through a transparent talent strategy fully integrates D&I into a corporate’s infrastructure, leading to reduced risk and delivery of long-term value.   

Principle 2: Data and Disclosure

Good governance requires stakeholder engagement (especially shareholders) in a corporate’s strategy.  Progressive corporates actively manage their climate and transition risks by tabling realisable ESG strategies for investor scrutiny.

A critical element of engagement is the availability of systems that generate reliable data to assess physical and transition risks and publication of those climate disclosures in accordance with TCFD recommendations.

Boards, investors and legislators recognise the need to address climate risk and strategise their transition to a net zero economy. Corporates must step-up ESG data disclosure on issues like their environmental performance. The Task Force on Climate-related Financial Disclosures sets the global standard for climate disclosures, against which premium listed companies in the UK are required to report, this is likely to be mandatory for  large corporates, banks, asset managers and pension schemes by 2025. The Sustainable Finance Disclosure Regulation will require other financial market participants including EU asset managers to disclose an array of sustainability data.  

Principle 3: Annual General Meetings (AGMs)

As AGMs migrate online this year, boards must use technology to guard against potential ESG activism. Stakeholder activists have recently challenged corporates on working practices, key worker remuneration, and climate change.

Shareholder resolutions asking banks to cease financing carbon-intensive businesses have become a feature of recent AGMs. Increasingly, there is an expectation for an annual vote on climate disclosures, a ‘Say on Climate’ resolution, and publication of transition plans to net zero.

The UK Investor Forum has gone as far as asking that the Government make ‘Say on Climate’ votes mandatory for listed companies. Boards may be well advised to avoid conflicts before they arise, by proactively offering advisory votes which would encourage the corporate and its investors to collaborate in the formulation of transition plans and strategy.

Principle 4: Merger & Acquisition (M&A) Transactions

When exercising governance of transactions, boards must be aware of ESG factors, including  possible government intervention in M&A transactions where government feel they need to protect national interests. For example, the Competition and Markets Authority is likely to follow Germany’s approach to countering the power of strategically important digital businesses. Good governance should insulate against risks of foreign investment or merger controls, and heightened regulatory scrutiny especially in relation to cross-border investments in the fourth industrial revolution’s tech sector. 

Principle 5: Litigation Risk

Heightened threats of litigation and broader regulation are emanating from ESG and also from public demand for corporates to take greater responsibility. Boards must scrutinise their supply chains, by conducting human rights due diligence etc, to protect their businesses from litigation including class actions.

In English law, separate corporate personality protects parent companies from automatic liability for harm caused by their subsidiaries . Nevertheless, parents of multinational groups should limit their involvement in their subsidiaries’ business. For example, an action for environmental and economic damage allegedly caused by a subsidiary’s oil pollution in the Niger Delta was successfully brought in the UK courts against an overly-involved London parent (Okpabi v Royal Dutch Shell).

Good governance must manage this litigation risk, by achieving an appropriate balance between implementing group-wide risk management policies / procedures, and the parent’s degree of control  over subsidiary operations.

Principle 6: Diversity and Inclusion (D&I)

Climate change (Environmental) is no-longer the only priority for corporate boards and senior management. Corporate stakeholders are requiring boards act on a myriad of governance and social issues  relating to D&I, human rights and corporate responsibility, especially their impacts through supply chains etc..

The  human rights impact on businesses and their supply chains present significant risk for corporates especially if they have global operations. Civil claims against corporates have escalated exponentially recently, giving rise to legal risk as well as reputational risk. Boards must be aware of, and engage in, their management’s actions to address human rights and diversity and inclusion.

Principle 7: Executive Pay

Recent attention on executive pay has required boards to justify their decisions on pay (pension contributions and other benefits) to shareholders, investors, regulators, employees as well as the general public. Pay is increasingly measured against a corporate’s ESG and sustainability performance, for example, the FCA’s requirement for premium-listed companies to disclose their business’ impact on the climate in reports as from 2022, is likely to lead to a further alignment between pay and sustainability metrics.

Data can help boards here too. Boards who utilise clear reporting to inform them of the impacts of events like the COVID-19 Pandemic, are better placed to explain how decisions relating to executive pay were made. The Financial Reporting Council has demanded better reporting and detailed disclosures on remuneration. Corporates also need to be mindful of the requirements of the Corporate Governance Code, simply relying on doing what they’ve done previously will not be enough.  

Good governance drives value creation by ensuring business resilience and continuity. 2050 won’t wait, now is the time to apply an ESG-lens when setting board management and corporate governance objectives.

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