C-suites face strict requirements under ESG rules that place new demands on execs in the governance of their organisation. Standard corporate governance disclosures that were traditionally covered by voluntary reporting will now be mandatory under new ESG regulations such as the EU’s CSRD, due to come into force in 2024.
The ‘G’ in ESG is a key pillar of environmental regulation that requires organisations to manage and account for non-financial reporting, corporate accountability, bribery, corruption and executive pay. Corporate governance is the process of managing non-financial risks that may have a material impact on a company’s stakeholders and, like many areas of ESG, is a new compliance issue that must be addressed.
The EU corporate sustainability reporting directive (CSRD) will be adopted into national EU member state laws in 2024 and place a lot more requirements and expand the number of companies subject to the sustainability reporting framework.
The implications for business
The changes in governance regulations will have important implications for business and industry, explains Kirsty Green-Man, head of corporate responsibility at Burges Salmon. “Disclosure requirements will go beyond what we’ve traditionally been used to with new environment and climate reporting to include social and governance matters. Governance in the CSRD covers things like respect for the employee and human rights, anti corruption and bribery, corporate governance, and diversity and inclusion. The ‘G’ will also require disclosure that due diligence processes have been implemented in relation to sustainability and the actual potential adverse sustainability impacts of a company’s operations and value chain.”
The new rules are likely to present a challenge to many companies that have to date mainly focussed on the environmental elements contained in recent regulation because, when it comes to ESG, governance is often overlooked Green-Mann believes. “When people talk about ESG they tend to focus on climate and net zero and few really understand the breadth of ESG. I think it’s to do with the fact the G has a real compliance element and that historically CSR was mainly focused on community engagement. There is more of a realisation now that the G is fundamental to enabling both the social and the environmental elements. It’s the bedrock of responsible business.”
Creating an effective governance strategy
For proactive C-suites the creation of a robust ESG strategy and framework is a core requirement of forward-thinking business. “The first step is to understand the requirements and identify your objectives,” Green-Mann urges. “It’s helpful to look at and benchmark other organisations that excel in governance and ESG. You don’t need to reinvent the wheel.
“Then it’s the nuts and bolts of setting up the right structures for committees, putting the right policies, code of conduct and auditing tools in place, addressing remuneration to support the right behaviour and having reporting measures in place to monitor progress. It’s really important to define accountabilities that are going to enable all these elements.”
Engagement with shareholders and wider stakeholders is vital in order to manage expectations, Green-Mann continues. “It is important that all involved understand how the strategy is going to be shaped, spaced and delivered. And finally, it’s making sure that the committees and the reporting structures are in place to monitor effectiveness and make ongoing improvements.”
David Duffy, founder of the Corporate Governance Institute, believes the key to good governance is boardroom ability – and robust data. “You begin with an evaluation of the skills and experience on the boardroom table,” Duffy says. “Is the board able to integrate all the elements of ESG into its existing corporate strategy? It can’t be a standalone element.
“But the big challenge in creating an ESG strategy is gathering robust facts and figures. You will need data to support your strategy but how solid is that data? Auditors understand how to audit financial systems but few understand how to audit the data that supports environmental or social and governance reporting. It is a new skill area for many.”
The journey to a universal governance framework will be long, due to the many complexities involved, Duffy suggests. “I really don’t think the statutory authorities have got to grips yet with the many differences in industries and business operations because they will need an overwhelming amount of data to understand whether companies are meeting their obligations or not.”
New liabilities demand new skills and approach
New liabilities around ESG are set to demand new skills and a new governance approach, with the complexity involved highlighted by plans for new regulation in the USA that will impact c-suites worldwide.
“Last year Lisa Monaco, Deputy Assistant General of the Department of Justice, announced that the DOJ was focusing on compensation systems for C-suites, top executives and boards of directors and intends make them responsible for the decisions they make – or actions they don’t take,” explains Vera Chereponova, ethics and compliance specialist at StudioEtica.
“The DOJ wants to shift the burden from any mishaps or misconduct cases, penalties and fines from shareholders to those individuals who took the decisions that led to the investigation. The DOJ wants to see in the compensation packages so-called ‘clawback’ provisions which mean that execs must return any bonuses, etc they may have been paid while overseeing an organisation that has been found guilty of breaching ESG regulations.”
“It would be a big headache for HR and legal departments due to the many technicalities involved. How do you put such a mechanisms in place, what kind of accusations would be involved and what would be the trigger for the clawback? And what happens following a ‘guilty’ verdict from the DOJ? Docking someone’s pay would open the door for potential lawsuits alleging that compensation was improperly withheld or clawed back. There are many issues to consider and new governance skills will definitely be required.”
Executive pay, corporate responsibility and environmental concerns have seen the many issues around corporate governance propelled into global headlines and big-money court cases. The DOJ’s ‘clawback’ plans merely reflect the growing calls to hold business and industry to account for their impact on the environment and society.
Now is the time to consider and act upon the implications of ‘G’ in ESG as without good governance there can be no effective – and accountable – transition to net zero.