Shareholders are swiftly moving companies from an era of disclosures to one of strategy and business integration when it comes to environmental, social, and governance (ESG) issues.
Across the globe, the 2021 proxy season has already produced many unprecedented developments on ESG-related topics, culminating with an activist winning three board seats at Exxon Mobil. Investors are watching ESG at publicly traded companies, and they're taking action if they don't see measures from disclosure reports playing out to their satisfaction in business operations.
These events, though dramatic, represent the next phase in a natural progression. As sustainability reports move from marketing materials to investor communications, shareholders have become fluent on ESG topics. As they increasingly recognize ESG's impact across the enterprise and value to the bottom line, their questions have shifted from 'what are you doing about ESG?' to 'how does ESG fit into the overall business?'
For example, how is a company integrating ESG metrics into executive compensation? How is the company managing long-term risk and situating itself to be sustainable?
Such an expanded, elevated, and integrated focus intensifies the pressure on boards and management. Companies must now demonstrate how ESG activities play out in business operations, not just report these activities in 10Ks, proxy statements, and sustainability materials.
As proxy season continues, boards across industries will be watching the news and asking themselves: How do we respond to shareholder concerns? How can we avoid being the next company making headlines when shareholders launch their proposals and voice their concerns at the ballot box?
An important step is moving ESG beyond reporting into overall strategy, and one place to begin, ironically, is with a reporting framework: the Task Force for Climate-Related Financial Disclosures (TCFD).
Provocative Questions Across Four Pillars
Chances are that your company is already familiar with TCFD. A recent study reports that two thirds of companies in the FTSE 100 referenced TCFD in their 2019 annual report, up from 39 percent in the previous year.
When a company conducts TCFD reporting, it collects and compiles valuable information stakeholders and investors want to see related to environmental, social, and governance issues. This information plays out across four key pillars: governance, strategy, risk management, and metrics and targets, with 13 recommendations in all. Many TCFD recommendations focus on reporting; the 'D' in 'TCFD' does stand for disclosures, after all. But supporting guidance often plays out more broadly.
- Does the board have ongoing ESG oversight, with committee chairs assigned specific responsibilities?
- Are ESG targets, risks and opportunities integrated into board decision-making?
- Is ESG integrated into the company's broader governance, risk and compliance (GRC) platform?
- Are ESG metrics and targets monitored year-round, not just during proxy season?
GovernanceUnder the Governance pillar, the TCFD framework poses thoughtful questions on things boards should be asking themselves and management. For example:
- Does the board consider climate-related issues when reviewing and guiding strategy, major plans of action, risk management policies, annual budgets and business plans?
- Does the board consider climate-related issues when setting the organization's performance objectives, monitoring implementation and performance and overseeing major capital expenditures, acquisitions, and divestitures?
- How does management monitor climate-related issues?
True to its name, the Strategy pillar gives boards a framework for examining how climate-related issues have affected areas such as business operations, strategies, and financial planning.
One area of TCFD guidance under this pillar prompts boards to consider the impact of climate-related issues on:
- Products and services
- The supply chain and/or value chain
- Adaptation and mitigation activities
- Research and development investments
- Operations across facilities and locations
Reporting guidelines also support strategic integration. Companies are asked to describe how climate-related issues impact financial planning and the prioritization of risks and opportunities. Many of the suggested areas of reporting fall into areas related to strategy and growth, such as acquisitions, divestments and the access to the capital to make such activities happen.
'Organizations' disclosures should reflect a holistic picture of the interdependencies among the factors that affect their ability to create value over time,' the Task Force notes.
Governance professionals have been discovering how governance, risk, and compliance (GRC) and ESG work together.
Megan Belcher, Senior Vice President, General Counsel, and Corporate Secretary for Scoular, called ESG and a strong governance, risk, compliance and audit program 'very symbiotic.'
She spoke in a recent Diligent webinar about how many of the metrics and governance mechanisms that make for a strong ESG program also live in a modern GRC program. This includes the technology and tools that she called the 'backbone' for effectively tracking activities and driving progress. Companies can 'easily tap into strong GRC muscles that can then launch you much more quickly on the ESG side,' she said.
TCFD similarly recognizes the power of an integrated approach. Take for example, this guidance under the Risk Management pillar.
'In describing their processes for managing climate-related risks, organizations should address the risks included in Tables 1 and 2 (pp. 10-11), as appropriate,' the Task Force's report advises. The scope of what these tables cover is extensive, encompassing:
- Research and development
- New products and services
- Customer preferences
- Market expansion
- Business diversification
TCFD guidance also encourages companies to describe how their processes for identifying, assessing, and managing climate-related risks integrate into their overall risk.
These insights require an integrated view across the business, where areas like GRC and ESG work together rather than in a siloed fashion. Companies can achieve such visibility through a common solution that connects the entire organization, from the board to day-to-day operations, for a comprehensive, reliable picture of organizational performance, possible gaps and risks.
Metrics and Targets
This pillar includes the expected metrics and targets for a climate-related framework: greenhouse gas (GHG) emissions, internal carbon prices, and more.
But TCFD offers broader suggestions as well: 'Other goals may include efficiency or financial goals, financial loss tolerances, avoided GHG emissions through the entire product life cycle, or net revenue goals for products and services designed for a lower-carbon economy.'
In addition: 'Organizations should consider including metrics on climate-related risks associated with water, energy, land use, and waste management where relevant and applicable.'
And one recommendation under this pillar explicitly states: 'Disclose the metrics used by the organization to assess climate-related risks and opportunities in line with its strategy and risk management process.'
The TCFD's recommendation for Scope 1, Scope 2 and Scope 3 emissions also has been a catalyst for business action. Chevron, for example, has long demonstrated and disclosed its commitment to Scope 1 and Scope 2 ESG goals. In May 2021, however, shareholders voted 61% in favor of a proposal to cut 'Scope 3' emissions, upping the ante significantly for Chevron's ESG initiatives.
In such a complex, evolving, and expanding ESG environment, the ongoing monitoring and analysis mentioned at the beginning of this piece is essential. In today's ESG environment, tracking metrics only during proxy and reporting season is no longer sufficient. Not only do companies need to keep compliant with evolving regulations, business strategy demands that they also know how they're doing against their competition and shareholder expectations.
Companies can use governance analytics and curated intelligence to benchmark against competitors on critical governance factors such as board composition, effectiveness and compensation and gain timely insight into rising trends, reputational issues and market movements.
Boards today must recognise and understand how the complex and interconnected web of climate-related and ESG risk affects their business's ability to function successfully. Frameworks that acknowledge the intersection of ESG and strategy, supported by modern governance solutions, can help.
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