Submitted by Nasdaq
As companies face even greater scrutiny for their environmental, social, and governance (ESG) policies, board oversight of ESG issues becomes increasingly important. Not only do a growing number of investors demand a well-defined ESG role responsibility for board members, but legal and regulatory trends are beginning to specify ESG oversight as part of a board’s fiduciary duty. However, the rapid evolution of ESG compliance means that best practices for governance are still developing, leaving companies with important questions to answer. What does effective board oversight of ESG entail? How should ESG governance be structured? And what does good board oversight of ESG look like in actual practice?
What Is Board Oversight of ESG and Why Is It Important?
In the past, traditional regulatory and legal frameworks gave boards generous discretion to exercise business judgment and determine which issues were material enough to require active monitoring and engagement by the board. Few, if any, boards considered ESG issues relevant to business strategy and operations. But things have changed. “Those days are over,” declared SEC Commissioner Allison Herren Lee in a 2021 speech. “Boards increasingly have oversight obligations related to climate and ESG risks—identification, assessment, decision-making, and disclosure of such risks. These obligations flow from both the federal securities laws and fiduciary duties rooted in state law.”
As investors became more interested in ESG factors over the past decade, more companies began to include ESG metrics in official filings, but increasing disclosures did not always align with formal board oversight. But investors’ ESG expectations are ratcheting up, a trend that could have a direct impact on the materiality of ESG issues. With influential institutional investors making ESG issues a priority, companies may have to account for ESG not only as a matter of investor relations but also in terms of potential impact on access to capital. As Commissioner Allison Herren Lee pointed out, markets and government policies are combining to make ESG matters material to long-term business strategy and risk management. As a consequence, boards will increasingly have the same fiduciary duty to monitor relevant ESG factors as they do for conventional aspects of business.
ESG and Board Member Obligations
The first step is to define the board’s responsibilities and structure. Companies need to determine which committees will have oversight for specific ESG issues or whether a dedicated ESG committee may be needed. What are the objectives, risks, and opportunities? Does the board need to perform a materiality assessment?
After the structural risks and opportunities have been addressed, the board will need to determine how to monitor and measure ESG performance. There is no one-size-fits-all solution, and practices vary widely. But some industries have adopted common practices based on leading companies that can be used as benchmarks. In addition, certain reporting frameworks, such as the Sustainability Accounting Standards Board and Global Reporting Initiative, provide industry-specific standards and guidelines.
But companies do not need to start from scratch to define standards, build their own solutions, and gather meaningful data. Boards and their companies now have access to an array of services to help improve their ESG practices. Nasdaq OneReport and Metrio, a Nasdaq company, for example, simplify the process of ESG data capture, engagement, oversight, and disclosure. But regardless of what kind of model or framework is chosen, companies ultimately will need to get specific about how board oversight will be implemented. So, what does good ESG board governance look like in actual practice?
Examples of Good ESG Board Governance
Across industries, companies have adopted a variety of approaches and frameworks for board oversight of ESG. A report published in 2021 by the Harvard Law School Forum on Corporate Governance divides companies into three maturity levels according to their practices for ESG disclosures—laggards, middle of the pack, and frontrunners—and the role of the board plays a significant part in determining each maturity level. Laggards have no defined role for their boards, while board oversight for middle-of-the-road companies is only “scant at best.” For frontrunners, however, “ESG strategy is regularly reviewed by board/committees and embedded in core operations.”
But even for companies that have fully engaged boards, a standard governance model has yet to be established, and approaches vary. Apple divides oversight among multiple board committees, assigning specific responsibilities to each one. Amazon gives primary ESG responsibility to the board’s Nominating and Corporate Governance Committee, but Microsoft assigns the lead role to its Regulatory and Public Policy Committee.
Some companies are going farther and forming entirely new committees for ESG oversight. In 2018, Gilead Sciences created its Corporate Responsibility Committee to be responsible for managing ESG issues. The CEO message in that year’s annual report explained that establishing the CSR “reaffirms our commitment to drive short-, medium- and long-term action in the areas of human rights, labor, environment and anti-corruption.”
Tenet Healthcare formed its dedicated ESG Committee in 2021. The company’s annual report stated that the committee would consist entirely of independent board members and would provide oversight for ESG strategy as well as guidance on ESG matters that are relevant to Tenet’s business. The reason behind the move was pragmatic. As the company’s 2022 ESG progress report explained, “We view ESG as part of our culture and ingrained in our business. We continue to align our approach to the areas that we believe are in the best interests of our stakeholders and our business, while seeking ongoing improvement.”
How Can ESG Board Members Get Up to Speed
Most boards will not start the ESG journey with directors who have specialized knowledge or skills, but an expanded ESG oversight role ultimately will require directors to become more knowledgeable. In fact, a recent S&P Global report predicts that corporate boards “will face rising pressure to demonstrate that they are adequately equipped to understand and oversee ESG issues.” Moreover, because practices, metrics, and issues will continue to evolve, boards will need to have a strategy for ongoing education to remain current.
Even though the focus may be on ESG, a comprehensive assessment of the board’s capabilities might be a more effective way to start. This approach could result in better overall alignment, including such benefits as matching skillsets to responsibilities. For example, Nasdaq’s Board Advisory Team works with boards to customize and execute board evaluations and provide an analysis of strengths and gaps in performance with the goal of generating actionable insights.
The potential benefits of third-party expertise also should be considered, and a variety of services and solutions are available to provide support. The Nasdaq ESG Advisory Program, for example, offers comprehensive in-house resources to help companies identify the material business drivers that should guide their ESG strategy.
Upskilling and education are also key. With so many companies needing to get up to speed on ESG and not enough qualified ESG professionals to go around, a number of standard setters and organizations now provide online courses and other services to help business leaders acquire the information they need. For example, the Task Force on Climate-Related Disclosures offers workshops on governance, risk management, metrics, and more. The Sustainability Accounting Standards Board has developed a Fundamentals of Sustainability Accounting program to help business professionals understand how financially material aspects of sustainability can affect enterprise value.
Although expertise can enhance governance, it is not a substitute for the core qualities of character and judgment that board members need in order to be effective. Consider the example of American Airlines. The company assigns primary ESG oversight to its board’s Corporate Governance, Public Responsibility and Safety (CGPRS) Committee, but that arrangement is unremarkable in itself. However, the way the members of the committee go about their duties is instructive. In an interview for the company’s 2021 ESG report, Sue Kronick, who serves on the CGPRS Committee, explained, “Importantly, the committee is trying to provide oversight in a way that is not boilerplate. We are looking for management to talk to us about challenges and how they’re working to find solutions. Even if we miss our goals, we can dig into why and what it’s going to take to correct course.”
Regardless of structure and other factors, directors need to be actively engaged and curious in order to provide effective oversight of ESG policies. This is one fundamental principle of good governance that will never change.
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