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May 07, 2024
ESG focus continues to drive the agenda of investors, lenders, regulators, consumers, and society at large. The focus on companies' exposure to ESG-related risks and opportunities and the company's performance on its ESG agenda is increasingly getting scrutinized. There is heightened pressure and focus by investors and other stakeholders to understand how companies create long term value by incorporating ESG objectives into strategy and key decisions. Investors want to know how companies are addressing ESG risks and opportunities because of their potential impact on shareholder value. Environmental issues such as climate change and social issues such as racial injustice and inequality can affect a company's cost of capital, long-term growth prospects, and ultimately, its viability.
Lackadaisical approach to ESG governance risks negative impact on the bottom line and reputation, besides losing out on opportunities that ESG provides that could boost the topline, build a strong investor base, lower the cost of capital, and provide better overall access to financing.
For most companies, ESG reporting falls under the responsibility of the Audit Committee, the 'go-to' committee of the Board. This is more a matter of convenience and, generally, an attempt to keep the number of board committees under check. So, in most companies the Audit Committee continues to be the workhorse, the first line of defense, for risk oversight and governance. It continues to oversee financial risk, non financial risk, and other significant risks that are currently impacting or can potentially impact the future. Audit Committees must ensure that there is a clear 'ESG Agenda' and that the management is delivering. Furthermore, given the high rate of new developments, ensure that they are regularly monitored and reported.
With a growing shift from voluntary to mandatory ESG disclosures already underway, the role of the audit committee in overseeing ESG reporting will become more critical.
The Audit Committee must educate and train itself on ESG because it is a specialized field that requires a significant level of domain knowledge. The Audit Committee should focus on the following:
1. Understanding ESG disclosures: The audit committee should comprehend how ESG risks are identified, prioritized, and inform disclosure objectives and practices. ESG encompasses strategy, risk, and opportunity, making it essential for the board to assign specific aspects of oversight to relevant committees. Sustainability reporting is no longer confined to silos; it is now integrated into the core business model and disclosed transparently.
2. Framework for effective ESG oversight:
(a) The audit committee's role should include:
- Disclosures: Ensuring that ESG metrics are material value drivers for the business.
- Processes and controls: Overseeing the accuracy and reliability of ESG data are disclosed.
- Assurance: Verifying the completeness and accuracy of ESG reporting.
(b) Building strong ESG governance
Governance for ESG
Governance for ESG is a system of check and balance to ensure that the company's ESG agenda is delivering on its purpose. It is this system that provides framework for managing the organisation's ESG agenda. It identifies decision makers, provides authority to act, sets accountabilities, defines boundaries of behavior and enables performance.
The ESG agenda of the company must deliver on 3 vitals:
(1.) Business profitability
(2.) Business continuity &
(3.) Positively impacting the environment
Compliance
Check for the regulatory requirements applicable to your company. This is not an infinite list, cumbersome, may be, but 'doable'. Generally, lower in the priority list of the management. Create a checklist and ensure that it is getting done and that no surprises spring up.
Strategy
The business strategy provides the overall direction for the company. The ESG strategy should be an integral part of the business strategy. From an organisation's standpoint, every function and role within the company impacts the top line or the bottom line or both. Sustainability too must follow suit. So, the business objectives drive the ESG strategy. The scope of an ESG strategy varies for different companies and depends on the extent to which ESG factors are considered. In general, a company's strategy could be:
(1.) CSR-focused, which focuses on building goodwill and strong good stakeholder relations, including community relations. However, this is a restricted approach to sustainability and is usually only a small part of the business strategy.
(2.) Risk-based, where the focus is on managing risk exposures in sustainability matters to minimize adverse impact on the business. This is more reactive than proactive and is usually limited to peripheries of sustainability.
(3.) Integrated, where both the risks and opportunities resulting from ESG matters are integrated with the business strategy. This is more integrated, inclusive and strategies and if done well, is likely to give longer benefits to the organisation.
Performance
Performance of the ESG strategy is critical to the purpose of the ESG agenda. The board has oversight of management and implementation of the strategy. Consider looking for the following 5 key components:
(1.) Defined policies, practices, responsibilities, and accountabilities
(2.) Identified materiality risks and opportunities
(3.) Level of stakeholder engagement
(4.) System of measurement and review of ESG performance
(5.) Approach to and progress on capacity building
Compliance + Integrated Strategy + Performance are the key pillars of your sustainability agenda and form the basis of your company's sustainability governance. The outcome of your sustainability agenda must have an intended impact on the profitability of the business, on business continuity and must impact the environment positively. With this as your blueprint, you will continue to build a resilient sustainability practice that will continue to meet your investors and other stakeholder's requirements.
Conclusion
With a growing shift from voluntary to mandatory ESG disclosures already underway, the role of the audit committee in overseeing ESG reporting will become more critical. The audit committee may have a fiduciary duty to ensure that ESG reporting is complete and accurate. A well-informed, knowledgeable audit committee is an empowered committee that can deliver.
He is the Founder Director of 'The Sustainability Practitioners'. He is an Independent Director with Mcon Rasayan India Limited (listed entity). His expertise is in building and connecting strong sustainability practices to strong financial and environmental outcomes for clients. He is member of Board of Studies at NMIMS, 6 Sigma qualified, a published author and life member at Institute of Directors, Indian Institute of Corporate Affairs and Mentor My Board.
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