DealMakers - Q2 2022 (released August 2022)
ESG matters need a co-ordinated and practical approach
by Nomsa Mbere and Safiyya Patel
The growing importance of Environmental, Social and Governance (ESG) matters to stakeholders necessitates a co-ordinated approach to managing and reporting these issues to the board, which could justify appointing a dedicated ESG Manager.
Companies’ boards of directors should be fully aware by now that (i) investors are increasingly looking to invest in companies that are better positioned on ESG issues, (ii) lenders are becoming increasingly aware of the potential impact of significant ESG risks on the creditworthiness of businesses, and
(iii) shareholders, customers and civil society are increasingly pushing the ESG agenda. Therefore, it follows that a negative response to the effect that a company's operations have on ESG will impact the relationship which that company will have with its stakeholders.
Stakeholders now expect company boards to be more conscious of, and report in increasing detail on, how they are fulfilling their ESG responsibilities. This has also become a regulatory issue. In February 2022, the EU published a proposed Directive on Corporate Sustainability Due Diligence (EU Directive), which will apply not only to companies operating in the EU, but also to non-EU companies active in the EU that meet certain criteria, including South African subsidiaries.
The EU Directive requires companies to integrate the implementation of the due diligence policy into the corporate strategy, the compliance of which must be overseen and monitored by the board.
Furthermore, the EU Directive provides that, when fulfilling their duty to act in the best interests of the company, directors must consider the consequences of their decisions on sustainability matters. To ensure that executives deliver on strategic ESG objectives, some companies are now looking at introducing ESG KPIs aligned to executive compensation.
However, the practicalities of data collection, data analysis and reporting, including what needs to be reported on, how much detail is required, and who is responsible for co-ordinating ESG compliance in an organisation, still contains many grey areas.
Recommendations such as the recently launched JSE Sustainability Disclosure Guidance, GRI Sustainability Reporting Standards, and the Taskforce on Climate-related Financial Disclosures’ recommendations provide general guidelines on disclosure and reporting (much of it on climate change commitments). But to ensure that they are meeting their responsibilities, boards need a practical checklist to track ESG performance and evaluate the ESG impacts of their company’s operation against the set strategic goals.
Who is responsible for reporting to the board on ESG?
This is a critical question. Some companies have an ESG manager who reports to the Social and Ethics Committee and/or an ESG and Sustainability Committee on various ESG aspects. In other companies, different areas of responsibility are reported separately; for example, issues to do with gender and race are reported to the Social and Ethics Committee by the Human Resources Manager; ethics/ procurement by the Procurement Manager; and diversity/inclusion by the Transformation Executive. Alternatively, responsibilities such as the monitoring and reporting of specific ESG-related risks, such as the supply chain risks and ESG and sustainability reporting, is delegated to a different board committee, such as the Audit and Risk Committee.
The lack of integration and a siloed approach to these issues is not ideal. In some international companies, a Chief Sustainability Officer (CSO) with executive seniority has been appointed, and South African companies may follow this trend. In a recent report, the Institute of International Finance and Deloitte surveyed over 70 financial services companies to determine the role of the CSO as a co-ordinator of ESG within the company. In the report, it was found that companies who have given the CSO strong executive support and a broad strategic mandate derive more benefits because of the greater integration of ESG matters and the ability to deliver ESG commitments in a coherent manner for commercial gain.
Covering all three – E, S and G
Initially, much of the focus has been on how companies measure and report on their goals to reduce emissions of greenhouse gases. This has broadened, with companies now reporting on other environmental issues, such as water consumption, and effluent and air emissions.
Equally detailed measurement and reporting is increasingly required for social aspects, which should include not only interaction with employees and surrounding communities about health and safety, but also transformation and training goals. This extends to ethics, including how the company procures goods and puts measures in place to prevent or address corruption. Similarly, governance reporting is expected to move beyond listing who attended board meetings and how much they earn, to demonstrating what difference the leadership of the company has made, how independent it is, and how
it has demonstrated its ethical stance. In so doing, it demonstrates its commit-ment to ensure that the negative impact of the company’s operations in respect of ESG factors is reduced.
How do directors know that they have fully discharged their ESG responsibilities?
The starting point is to set specific strategic goals, either as a percentage (e.g. 30% of top management to be female by 2025) or measured from a base year (e.g. to reduce 2019’s levels of water usage by 30% by 2025), and to introduce short-term and long-term goals in order to monitor the progress and stress test the achievement of the set strategic goals.
To provide effective oversight, the directors need to understand the consequences of their decisions on sustainability. They must fully under-stand what the risks are, and the challenges in meeting these set targets, and closely monitor the progress, including identifying specific issues that are blocking progress. In this regard, companies will have to upskill their directors by employing a variety of methods, such as providing specialised board training for the directors on ESG matters and/or appointing directors with ESG expertise. In addition, the directors must understand their various stakeholders' interests on specific ESG issues, as stakeholders are increasingly demanding answers from directors on these issues. Even if company policy is that directors should not respond to any questions on matters related to the company, in certain circumstances, directors may be at risk if they do not speak out. Directors must be made aware that they may be required to speak on certain topical ESG issues in relation to the company's operations or, at the very least, explain the company's ESG strategic goals, and should be provided with relevant holding statements on these goals.
The ESG Manager or the CSO may be tasked with ensuring that the relevant and useful ESG information is provided to the directors and included in the company's integrated report, to give it prominence alongside financial reporting. Such a functionary would be instrumental in ensuring that relevant and useful ESG information collected across the various departments is provided to the directors or the relevant board committees in a co-ordinated fashion. This person will be able to assist the board in interpreting the issues raised, pressure test the goals, and monitor the progress in achieving them.
Mbere and Patel are Partners | Webber Wentzel.