The board of directors generally has two functions: strategy and oversight. It should be no different for ESG (environmental, social, and governance).
In terms of strategy, it’s less a question of whether a company should report on climate-related financial information but how it will do so. Boards and management should work together to define their climate agenda by asking questions like “What areas are important to our business, our industry, and our investors/employees/consumers?”
The reporting frameworks discussed in this Amplify article will dictate some of this, but there is room for firms to put their own stamp on it. My conversations with directors reveal that most boards struggle to develop the type of long-term strategy necessary for environmental change. Here’s how one director put it: “We strive for a good give-and-take with management once we see their plan, but with climate disclosures looming, we need more expertise. When we revisited our board matrix, it was eye-opening.” To be sure, a board needs either the expertise or the necessary education.
It’s also important to consider the area(s) in which a company can realistically make a difference and demonstrate real progress. Given that greenwashing is a frequent concern with ESG, the last thing companies want is to be overly aspirational. Indeed, 48% of global executives recently told Capital Group they believe greenwashing is still prevalent in the asset management industry.
Boards also need to stay up to speed on potential regulatory changes and their strategic implications. For example, the Heartland Institute, which advocates for anti-ESG bills, has identified, proposed, or passed bills in 24 US states, with Florida and Indiana the latest to pass such laws. Similarly, the US Supreme Court’s 6-3 decision in West Virginia v. EPA in June 2022 called into question whether or not SEC has the legal authority to adopt and enforce its climate-related disclosure rule.
Since the big three institutional investors (BlackRock, Vanguard, and State Street) are looking specifically for a company’s ability to transition to a net-zero economy and what business risks that may cause, the specifics of this transition must also be part of the strategy. Here, reporting on Scope 1 and Scope 2 emissions (those relating to systems that are within reasonable control of the firm) serves as the minimum.
Oversight flows from strategy. Not only do boards need to know what management is doing in terms of collecting, analyzing, and verifying the company’s climate data, but these efforts must be a central part of ESG oversight. According to board members I interviewed, this data should be in hand before disclosure and reporting decisions are made. “At the very least, we need it alongside reporting,” said a board director at a midsized bank-holding company. The board needs that information to perform its oversight and assess whether the time and money going toward sustainability are focused on long-term value.
Thus, it’s important to have a dedicated management team accountable for the reporting to ensure information accuracy. Since 88% of institutional investors subject ESG to the same scrutiny as operational and financial considerations, this is a C-suite and board-level responsibility. After Sarbanes-Oxley passed in the US in 2002, boards began establishing disclosure committees. These still matter and can be made up of insiders and board members to enhance coordination and information flow. This contrasts with the nominating and governance committee, which must be composed of independent directors, and now accounts for most of the board oversight of ESG issues. According to Spencer Stuart’s 2022 Board Index report, however, just 12% of S&P 500 companies have a standing committee dedicated to the environment.
To gain oversight of climate-related disclosures, one must understand disciplines from electricity to emissions to ecology before tackling the myriad frameworks for disclosing information. This idea resonated with directors I spoke with: “We’ve needed to ramp up very quickly over the past three years, and I still don’t feel like I know what I’m talking about,” said a consumer products company board member.
[For more from the author on this topic, see: “What Climate-Related Information to Disclose? Big Decision, Moving Target.”]
