IOD SPECIAL TALKS - How ESG Impacts Modern Corporate Governance

Distinguished Guests, Ladies and Gentlemen

The rise of ESG

Twenty years ago, the life of a CEO was simpler. The CEO’s goal was simply to maximise financial return. Occasionally, politics or philanthropic virtue would guide a company’s actions. But financial return was usually the king and queen.

Then, soon after the start of the new millennium, the environmental, and social and governance movement was born. And in the last twenty years, the ESG movement has moved from the corporate social responsibility margins to the centre stage of the business world. Companies announce their adherence to ESG principles and significant capital flows are invested in ESG-linked products. Firms have recognised that their reputation depends not just on their financial returns but also the adoption of ESG practices.

What explains this shift in the business world?

What explains this embrace of ESG, its move from the margins to the mainstream?

First, the long-accepted idea that financial performance would be impaired by companies caring about their ESG impact began to be challenged. Studies emerged to show financial return was not a casualty of increasing attention to ESG in companies. Indeed, they showed rather the opposite. A seminal study in 2011 concluded that the “100 Best Companies to Work For”, where taking ESG seriously was part of the equation, outperformed their peers when it came to stock returns.

Second, and linked to this issue of companies’ performance, many studies over the last two decades showed that embedding ESG principles and actions improved the chances of recruiting superior talent and increased firm productivity with more engaged staff.

And third, societal change made ESG an imperative. In recent years, growing concerns about climate change, about inequality and exclusion, and about the character and behaviours of certain political regimes have brought an increasingly ethical dimension to the decisions of companies, and their shareholders and investors.

We have increasing examples of coalitions of pressure groups leveraging the power of collective investors to encourage firms and capital markets to incorporate environmental and social factors in to their day-to-day decision- making.

We see interpretation of fiduciary duties and the law change to keep up with the times. In 2014, the England and Wales Law Commission confirmed there was no bar on pension fund trustees taking account of ESG factors when making investment decisions. Pension funds, holders of insurance reserves, sovereign wealth funds – all now screen their investments with both eyes firmly on ESG factors. And in the world of multilateral development banks, such as the EBRD, where I was President from 2012 to 2020, debt and equity finance was increasingly focused on firms that took ESG seriously. Indeed, the Equator Principles, whereby loans are only provided where the borrower is able to comply with good social and environmental principles, were developed at the International Finance Corporation, part of the World Bank Group, some twenty years ago.

Even the conservative world of central banks has changed. ODI, the global affairs think tank where I chair the Board, conducted research which found central banks in a number of G20 countries are implementing the guidance of the Task Force on Climate Related Disclosures. TCFD, as it is known, provides a framework for an organisation’s governance, strategy, risk management metrics and targets. All of this is pushing companies to describe both board oversight of and management’s role in assessment and handling of climate- related risks and opportunities.

Indeed, the very best companies have board committees dedicated to ESG issues

The impact of ESG considerations on company governance

The acceleration in the ESG movement over the last two decades has led to a sea change in companies’ corporate governance.

Board agendas have changed. Twenty years ago, it would have been a rarity for a board to be discussing the firm’s environmental impact, example, its emissions, its waste and water management, its biodiversity imprint. Very few company boards twenty years ago would have been discussing workforce diversity or human rights. And almost none would have been looking at local community impacts or examining their supply chain through the ESG lens.

These are all now standard fare in corporate governance of the best companies. Indeed, the very best companies have board committees dedicated to ESG issues. The impact of ESG goes beyond company boards and committees. It is reflected in the management structures, with at least one if not more top-level executive tasked with the cross-cutting responsibility of ensuring ESG is taken seriously across the company.

For many in such ESG-focused management roles the going was initially heavy as their colleagues regarded ESG as a sideshow and likely to harm financial return if pursued too seriously. The going got easier as today’s new employees see ESG as part of their personal and professional missions.

And beyond structures, ESG has made it into management incentives. It is now commonplace to see executive performance scorecards and compensations based in part on performance against ESG indicators.

The case of ReNew energy global PLC

And the ESG march is not confined to companies operating in advanced economies. It is increasingly on the march in emerging markets too. I know this from personal experience as a member of the Board of ReNew, one of India’s leading renewable energy companies, listed on NASDAQ and incorporated in the UK. As Chair of ReNew’s ESG Committee, I can see how the whole ESG agenda has been embedded in the company.

ReNew, today, generates 1.9% of India’s total electricity while mitigating 0.5% of the country’s carbon emissions. While climate action has always been a centerpiece of the company’s business priorities, particularly striking is the progress ReNew has made on ESG.

In 2018, the company recognised global ESG trends and made a timely shift from the margins of corporate social responsibility to corporate sustainability, embarking on a transformative journey.

In the last 5 years, ReNew has moved from building a solid governance structure to embedding ESG in key decision-making processes.

For me, the company’s robust governance mechanisms have been the accelerator in ReNew turning its ESG commitment into action. The company has a three-tiered governance structure: a board-level ESG committee, a Management-level steering committee, and a working group. Each of these has well-defined responsibilities. The Board ESG committee is constituted of independent directors and shareholders. It is responsible for overseeing ESG objectives and targets, evaluating associated risks and mitigation strategies, and reviewing progress.

The committee plays an important role in shaping the company’s ESG ethos and culture, strengthening internal systems, and ensuring reporting and compliance as per frameworks.

The management steering committee, comprising business heads, ensures that ESG objectives are factored into business decisions of each function, laying out a strategic path to identify, measure, and mitigate ESG-related risks, and improve the overall performance of the organisation.

And the working group is responsible for planning and executing ESG-driven initiatives and managing data related to ESG performance, helping ESG and Steering Committees identify areas of further improvement.

Together, these three governance tiers ensure a strong alignment of ESG objectives in the company’s day-to-day operations and help prioritise sustainable business practices across the organisation.

ReNew now has a list of striking ESG achievements in the last 5 years. ReNew is the only pure play energy company in India to have its commitment to Net Zero validated by the Science-Based Target Initiative. ReNew has also performed exceeding well in various global ratings. Morningstar Sustainalytics ranked the company 10th globally among 698 utility companies, with an ESG risk rating of 11.6, a ‘low risk’, a significant improvement from 14.1 in FY21. Additionally, ReNew entered the ‘leadership band’ in Carbon Disclosure Project ratings with a rating of A- for its Supplier Engagement Rating in FY22. This rating is higher than both the Asia regional average of C and the renewable power generation sector average of B-.ReNew also scored an impressive 81.2/100 in Refinitv ratings in FY22, making it the top-performing company among all utilities and independent power producers in India and second among electrical utilities. And MSCI, recognising the company’s effective management of financial risks and opportunities, upgraded ReNew’s ESG rating to ‘AA’ from ‘A,’ placing the Company in the industry’s ‘Leader’ band.

These achievements are an outcome of ReNew’s relentless pursuit of driving excellence across its business by setting ambitious yet realistic targets, identifying risks promptly, developing a robust ESG culture, engaging employees and communities, and investing in innovative technologies for climate adaptation solutions. Very recently, the company was recognized by MIT Technology Review in its inaugural list of ‘15 Climate Tech Companies to Watch’.

The governance mechanisms, of course, have played a pivotal role in this pursuit of excellence.

There is also ReNew’s impact beyond just business. The company in 2021 was recognised by Fortune magazine among the top 10 companies changing the world. Sumant Sinha, the Founder, Chairman, and CEO, has been recognised by the United Nations as a Global SDG pioneer for ReNew’s commitment to advancing the SDG agenda through business and beyond.

Engaging communities has always been a priority for ReNew. The company has impacted over 1 million lives through unique social initiatives. One such initiative is Project Surya, where women salt farmers in Gujarat are being skilled as solar technicians, helping them access better livelihood opportunities.

I had the opportunity to learn about Kami, who worked as a salt farmer in very harsh conditions in the Rann of Kutch in Gujarat, India, who was trained by ReNew as a solar technician. She has now become a master trainer and is helping other women farmers in her village learn the same skill.

Together, these three governance tiers – Committee, Management and working group, ensure a strong alignment of ESG objectives in the company’s day-to-day operations

Conclusion: Challenges Ahead

So, ladies and gentleman, I truly believe the ESG movement is here to stay. It should no longer be seen as the enemy of financial return, but rather as its friend and enabler. As the Harvard Business School case study shows, ReNew, a fairly young company from an emerging market, has proven that creating value and building valuations can go hand in hand. And the company’s continuing attention to governance has been part of that successful ESG story. But that is not the end of the story. There is still work to do.

At the global level, we need to make ESG compliance a better understood process, where standards – among rating agencies, across industries and jurisdictions – become more consistent. This is vitally important, not least to answer the loud voices who accuse companies of “greenwashing” in response to the marketplace pressures.

And there is a particular challenge for emerging and developing economies, which are today under-represented in ESG investment flows. Analysis by Fitch and MSCI shows that the challenges surrounding ESG data and market regulations can and has exacerbated capital diversion away from emerging and developing economies, especially from lower middle-income countries.

Every effort should be made to support these poorer countries improve their ESG data quality, reporting and transparency and to help them develop ESG- investible products.

ReNew, a company that has made its name in little over a decade with all its operations in India, has shown how this can be done. We need to help others to follow.

Thank you very much.

*Excerpts from the ‘Keynote Address' delivered by Sir Suma Chakrabarti, Chair of ODI and Member of the Board of ReNew Energy Global PLC at the ‘Plenary Session II’ of IOD's London Global Convention held on October 17, 2023 in London.