Circling to land

Companies and boards must be prepared to face the messy reality of ESG

Environment, social and governance (ESG) is all the rage these days. Companies are rushing to embrace it, investors are showcasing their green credentials and what’s more, governments are committing to meeting ever stringent targets, with a bit more seriousness, I hope, than their promise to be more fiscally prudent in future. But the ducks don’t seem to line up. Companies expect regulators to tell them what to do. Investors hope that they will be given digestible data to integrate with their stock selection. And regulators hope that if they mandate targets in line with global commitments, companies will find the secret sauce.

There are, of course, those who think they will know what to do if only they looked west, but fail to acknowledge that while the West may have focussed on ESG before India did (though many will debate this), most entities, like their counterparts here, continue to approach ESG tentatively. Surprisingly, even after this head start they offer no clear road map. In fact, there is a lack of agreement even on what constitutes ESG.

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Last summer, the US Chamber of Commerce’s Centre for Capital Markets Competitiveness (CCMC), together with NASDAQ and a few others, published the findings of their survey regarding the outlook for climate change and ESG reporting from the public company perspective.  Most companies appear cautious about the term ESG. Only 8 per cent say ESG encompasses a generally understood set of issues and can be easily defined by regulators. Sixty one per cent say it is a subjective term that means different things to different companies and is difficult to define. And this is when the survey finds that most companies over the last decade have increased the amount of climate change disclosures that they provide.

Compounding this blurriness is that the conventional cost-benefit analysis will not point the way forward. In the context of climate, it extends well “beyond the traditional horizons of most actors in imposing a cost on future generations that the current generation has no direct incentive to fix.” Mark Carney, former governor of the Bank of England, fittingly called this the tragedy of the horizons. The social aspect has its own set of challenges, and companies need to move away from matrices that the West wants them to report on, and target what matters to us as a nation — so expect social to have the steepest climb. For most, governance comes first. A company that has strong governance will be managed well in every way. Thankfully, it has bright lines drawn out.

This lack of clarity does not mean that boards and companies do nothing till they see the runway. To talk of just two aspects: (a) What is to be done and who decides and ( b) reporting and communication. Both point to the need for boards to chart their own paths. Boards need to ensure that the company has rightly identified the ESG risks and the opportunities. This implies a comprehensive review of the financial performance, risk management, supply chains, increased revenue potential and competitive differentiation.

How does the board work on this? Again, there is no one right way. A recent BCG study regarding board practices finds that the most common approach (31 per cent) for anchoring ESG into board governance is assigning oversight of these issues to the full board. This is followed by having the issues governed by a dedicated ESG committee of the board (20 per cent) or by having just one member of the board—with no separate committee—lead on ESG issues (15 per cent).  The right structure, says the report “will depend on factors such as the composition and ESG knowledge base of the board, its existing governance practices, and the maturity of the company and the board when it comes to addressing ESG topics.”

An important part of this exercise is setting both the intermediate goals and final goals; this includes drawing up the transition plans — because having the eventual target stretching out a couple of decades into the future will mean that these are side-stepped. Further, there is the need to tie these to targets for the senior management’s compensation.

Having identified the goals, companies need to report their numbers. The CCMC survey cited finds that the basic disclosures are driven by one or more of the standard setting bodies like Sustainability Accounting Standards Board (44 per cent), Global Reporting Initiative (31 per cent), Task Force on Climate-Related Financial Disclosure (29 per cent), CDP (21 per cent). But “46 per cent of the firms surveyed said that almost as much of the additional disclosures are driven by shareholders asking for more information.”

So, while I expect the business responsibility and sustainability reporting will provide our boards greater clarity, these will need to be bolstered by additional disclosures to conform to global expectations. And there will be the additional need to communicate on ESG matters with stakeholders, other than investors, and specially employees who will be driving progress towards these goals.

Companies and boards must prepare to face the messy reality of ESG. Regulations, no doubt, will standardise ESG disclosures and provide investors with comparable information. But this will not be the end, as multiple requirements and guidance will continue to flow and expectations build up to step beyond the regulatory ambit. Boards, it appears, must prepare to circle, not land. 

The writer is with Institutional Investor Advisory Services India Limited, a proxy advisory firm. The views are personal. @AmitTandon_in