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Does your Board pass the ESG acid test?

Is your Board up to speed with its sustainability responsibilities?, asks TPB’s Business Development Lead, Fiona Donnelly.

Boards of listed companies seem to have an ever-growing list of responsibilities as new compliance requirements and regulations add to the already broad range of asks of them. All directors have the same legal duty  and must act in the interests of the issuer as a whole, so it should be simple enough to allocate all the various responsibilities and roles.

However, boards are entrusted by shareholders with a lot of responsibilities: complying with hard requirements that are stipulated today while tracking new issues that are emerging as well as drivers from softer yet impactful sources like shareholder-activists, among other stakeholders. They must also factor in different requirements in different parts of the world and the variations across lines of business.

One relatively new topic – environment, social and governance (ESG) – can cause confusion. ESG is one of the all-inclusive labels given to the holistic sustainability issues that affect all businesses in varying ways.

Companies typically will already be addressing some issues that fall under the ESG umbrella, such as employment policies, and tracking other aspects through existing procedures, such as enterprise risk management logic, so while the ESG framework and systematic thinking of these issues in this way may be new, some of the actual topics will not be. On one hand, boards of issuers should take comfort that this is not an entirely new additional requirement; but on the other hand, ESG requires a broader, more strategic consideration than “changing to low energy light bulbs and trying not to print” as is an oft-quoted tactic for the many service-dominated companies in the Hong Kong economy.

ESG doesn’t have an obvious home in the corporate world and will by nature of the topics involved, necessarily have to operate across traditional corporate functions, much like related topics such as innovation. In an organisational structure, ESG can justifiably be located in a number of places: if considered a compliance issue, the company secretary or In-house Counsel may lead. If it’s seen as key to business strategy, it could reside with the corporate planning team. Looking at board level, ESG doesn’t tidily slot into one of the committees mandated by the Corporate Governance Code either. However, it should be within the scope of a board’s responsibility to risk.

“ESG is the ultimate business-critical issue.”

ESG is the ultimate business-critical issue. If a business today is based on fossil fuels or manufacturing of disposable plastics, what business will that company focus on in the future? Change will also arise from developments outside the company’s control. If a significant percentage of property assets are in locations at risk due to rising sea levels, boards will want to factor that into strategic planning. On more social issues, ask any of the Hong Kong issuers that have suffered data security incidents about the hit to reputation and share price through not managing that risk. ESG thinking can flag issues of economic sustainability and commercial viability, topics that are firmly a concern of the board.
 

Responsibility

A board’s responsibility for ESG is stipulated clearly in Appendix 27 of the Listing Rules:

The board has overall responsibility for an issuer’s ESG strategy and reporting.

In line with the Corporate Governance Code, the board is responsible for evaluating and determining the issuer’s ESG related risks, and ensuring that appropriate and effective ESG risk management and internal control systems are in place. Management should provide a confirmation to the board on the effectiveness of these systems.

The need to disclose details about ESG policies, compliance and achievements is underscored in other sources from HKEX including Analysis of ESG Practice Disclosure, as well as the Business Review of the Directors Report per Companies Ordinance (Cap.622), among others. Such compliance needs set out the minimum ESG activity and disclosures required. Those who recognise the most value from strategically embedding sustainability are going much further. For example some align to international concepts as the UN’s Sustainable Development Goals  and supporting global governments commitments under the Paris Agreement.

So what does this mean in practice? How do boards best take on this responsibility? Materiality is one of the Reporting Principles that underpins the preparation of an ESG report and should be a guiding approach for determining what ESG issues a board addresses. Boards should not consider all ESG matters, instead they should look to those that are sufficiently important to investors and other stakeholders, and where the company makes the biggest impact.

Make time to engage with significant shareholders to closely understand their areas of concern and focus. Many asset owners are realising the better long-term returns that can be made through aligning portfolios more strongly to more exacting ESG factors. Board members of an investee company want to be close to investors’ current and emerging needs, so that the risk of divestment is mitigated.

 

Roles

Board roles in relation to ESG will not be dissimilar to other areas, but may require more deliberate consideration given the newness and level of maturity of understanding of the topics involved. ESG is a dynamic area and is often a new way of looking at a mix of familiar and new topics. Directors may need to invest time and effort to upskill so that they can meet their responsibilities. For example, would board members be able to tell a good emissions policy from a bad one? If not, then they need to put themselves in a position to be able to do so.

Delegation of ESG matters is vital but that delegation does not absolve ultimate responsibility from the board. The delegatee must have the experience, skills, motivation and capacity to get the job done, as well as the appropriate resources, especially an adequate budget and the right people. Appropriate processes and internal controls need to be developed to manage the flow of relevant information to the board from operations, in order for the board to keep abreast of progress, compliance and other issues. A lot of this information will be non-financial and require new reporting and management to be developed.
 

Acid test

Here’s a simple questionnaire to help board members determine if they are on top of and implementing ESG matters as much as they should be:

  • I know the ESG matters that are material to the business, and can talk about the ESG strategy to a certain level of detail
  • The board is involved in evaluating and determining the ESG risks
  • We are looking to the future and evaluating how different ESG scenarios will impact the financials
  • We have a diverse board so that we have good perspectives and understanding on ESG and other areas
  • We know what ESG matters our key investors are wanting to know about

If ‘No’ is the answer to any of the questions, there is a good chance the board is not as close to ESG as it should be and the company is being run with unnecessary exposure to ESG risks and or unexploited ESG opportunities. Putting ESG on the agenda of your next board meeting, could be the most important step that your company makes.

 

This article was first published in Momentum, the official magazine of the Hong Kong Chamber of Listed Companies (www.chklc.org), Summer 2019.

 

TPB can help your Board and senior executives keep up-to-date with ESG responsibilities and help develop strategies that help your company thrive.  Contact us  to find out how.

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