Learning how to implement sustainable business practices can be challenging for companies in any industry, and boards may wonder how to integrate sustainability issues into discussions with management. NACD has compiled a set of resources offering practical information to help boards discuss climate-related risks, as well as opportunities associated with environmentally- and socially-sustainable business practices.
The first step is to assess why sustainability and social responsibility are such hot topics for the boardroom. Two important factors to consider are the political environment and shareholder expectations.
Signals From the Current Administration
President Donald J. Trump in June announced that the United States would be withdrawing from the Paris climate agreement, an international deal in which 191 countries have pledged to work toward goals to restrict the increase in temperatures globally to less than 2.0°C and reduce the amount of greenhouse gases being created.
The president in April also signed an executive order aimed at “promoting energy independence and economic growth,” curtailing federal environmental regulations. The order instructs the Department of the Interior to lift former President Obama’s ban on coal leasing activities on federal land.
Watchdog group Environmental Integrity Project recently reported that this year, the Trump administration, when compared to the prior three presidential administrations in the same period, has collected approximately 60 percent less in fines from companies’ violations of pollution-control regulations.
Opposing Pressure From Shareholders
Despite strong signals from the current administration that enforcement of environmental-related regulations will decrease over time, shareholders are applying an opposing pressure on corporations.
More than half (56%) of shareholder proposals introduced this year on proxy ballots related to social, environmental, or policy issues, and Proxy Monitor reports that this proportion is the highest it has seen since it began tracking such data in 2006.
Shareholder proposals relating to environmental and social issues 10 years ago sought fairly basic changes such as increased clarity into companies’ environmental policies. The proposals now seek, for example, enhanced disclosures around what the company is doing to manage climate risks and how executive pay links to sustainability initiatives, the Wall Street Journal reports.
Proposals about environmental issues received a record breaking average of 27 percent support this year, according to Proxy Monitor. That percentage was 21 percent last year and fell in the teens before that.
Meanwhile, State Street Corp., a global financial services and investment management firm with $2.47 trillion in assets under management, published a report earlier this year in which they found that traditional obstacles (like the lack of quality data about ESG) to investing more heavily in companies that prioritize ESG initiative are diminishing.
“Over the long-term, environmental, social and corporate governance issues can have a material impact on a company’s ability to generate returns,” Ron O’Hanley, president and CEO of State Street Global Advisors, said in a press release.
Resource centers are repositories for NACD content, services, and events related to top-of-mind issues for directors. In these resource centers, individuals can find practical guidance, tools, and analyses on subjects varying from board diversity to cyber-risk oversight. Below we have highlighted a sample of helpful materials from our new resource center on sustainability and social responsibility.
The handbook, produced in conjunction with EY, centers around four key recommendations:
Directors should understand the company’s definition of sustainability in the context of the company’s strategy and specific circumstances.
The board and management should align on the sustainability message and information the company chooses to report publicly.
Boards should clarify roles for oversight responsibility for sustainability activities, including external reporting.
Directors need to establish parameters for sustainability reporting to the board regarding the information required to support robust discussions with management.
A number of items included in the resource center provide expert commentary on myriad issues related to sustainability and social responsibility. A favorite of mine is “Living in a Material World,” an article written by Veena Ramani, program director of the Capital Markets Systems, at sustainability-focused nonprofit Ceres.
Ramani discusses the corporate director’s critical role in engaging with management over which sustainability issues are material for the enterprise. She offers four suggestions for board members who want to address the materiality of certain sustainability risks.
Boardroom Tools & Templates
The resource center houses several tools and templates to assist directors as they oversee sustainability-related risks and opportunities. One such tool is the “Self-Assessment: Is Your Board Sustainability-Ready?” evaluation. Directors can answer a set of questions to gauge their board’s level of engagement—or lack thereof—in sustainability oversight.
Videos and Webinars
The NACD BoardVision—Sustainability Oversight video in the resource center features a candid discussion by EY subject matter experts Brendan LeBlanc and Kellie Huennekens on how investors are engaging with boards around sustainability and social responsibility issues. (A transcript of the video is also available here.)
Our hope is that you find this resource center useful and visit it often. We will continue to update it regularly with new and interesting content. If you would like help finding resources on a specific subject matter, please let us know. We welcome the opportunity to engage with directors on pressing needs and concerns.
As Hurricane Irma made landfall Sunday morning, I watched the devastation unfold in fear. As the destructive path moves north, I can only hope that all of our families, friends, and loved ones have heeded the warnings of officials and moved to safer areas, or that they have found safe shelter if evacuation wasn’t possible. Unfortunately, this storm is predicted to keep moving and it will likely bring heavy damage to more areas in the southeastern region of our country. Our thoughts and prayers are with everyone in the state of Florida and in the southeastern United States, including the many members of the NACD Family who reside there.
In recent years, ERM implementations have generally focused on three questions:
Do we know what our key risks are?
Do we know how they’re being managed?
How do we know?
In responding to these three questions, executive management and boards in some companies have made progress in differentiating the truly critical enterprise risks from the risks associated with day-to-day business operations.
While seeking these answers is a useful exercise, is it enough? Directors should also ask:
Is our ERM approach helping us identify flaws and weaknesses in our strategy on a timely basis?
Is our organization able to recognize the signs of disruptive change, and is it agile and resilient enough to adapt?
Do we truly consider risk and return in our decision-making processes or do we blindly follow the herd and remain emotionally invested in the comforts of our business model?
Do we seek out what we don’t know? Are we prepared for the unexpected?
Is everyone competing for capital and funding with rose-colored glasses, making the resource and budget allocation process a grabfest?
Yes, companies have made progress in various ways with enterprise risk management, but depending on the answers to the above questions, more needs to be done.
Adoption and application of COSO’s Framework could alter the conversation by clarifying the importance of integrating risk, strategy, and enterprise performance. While a stand-alone process may be worthwhile and useful, it is not ERM as defined by COSO. The framework introduces five interrelated components and outlines 20 relevant principles arrayed among those components, offering a benchmarking option for companies seeking to enhance their ERM approach.
Four observations frame what COSO is looking for:
Integrate ERM with strategy. There are three dimensions to integrating ERM with strategy-setting and execution:
risks to the execution of the strategy;
implications from the strategy (meaning each strategic option has its unique risk-reward trade-off and resulting risk profile); and
the possibility of the strategy not aligning with the enterprise’s mission, vision and core values.
All three dimensions need to be considered as part of the strategic management process.
Integrate risk with performance. Risk reporting is not an isolated exercise. Operating within the bounds of an acceptable variation in performance provides management with greater confidence that the entity will achieve its business objectives and remain within its risk appetite.
Lay the foundation for ERM with strong risk governance and culture. The board and CEO must be vigilant in ensuring that pressures within the organization are neither excessive nor incentivizing unintended consequences. Such pressures may be spawned by unrealistic performance targets, conflicting business objectives of different stakeholders, disruptive change altering the fundamentals underlying the business model, and imbalances between rewards for short-term financial performance and stakeholders focused on the long term.
Tie risk considerations into decision-making processes. COSO defines “relevant information” as information that facilitates informed decision-making. The more information contributes to increased agility, greater proactivity, and better anticipation of changes to the enterprise, the more relevant it is and the more likely the organization will execute its strategy successfully and achieve its business objectives.
Boards should urge the executives within their companies to consider the principles embodied by the COSO framework to advance their current ERM approach. In this regard, we suggest organizations focus on three keys:
Position the organization as an early mover. When a market shift creates an opportunity to create enterprise value or invalidates critical assumptions underlying the strategy, it may be in an organization’s best interests to recognize that insight and act on it as quickly as possible. The question is: When the entity’s fundamentals change, which side of the change curve will it be on? Will it be facing a market exploitation opportunity, or will it be looking at the emerging risk of an outdated strategy? The organization attains time advantage when it obtains knowledge of a unique market opportunity or an emerging risk and creates decision-making options for its leaders before that knowledge becomes widely known.
Address the challenges of risk reporting. Consistent with the objective of being an early mover, risk reporting should help organizations become more agile and nimble in responding to a changing business environment. To truly impact decision-making, risk reporting must address three questions:
Are we riskier today than yesterday?
Are we entering a riskier time?
What are the underlying causes?
Risk reporting is often not actionable enough to support decision-making processes. Once risk reporting is designed to answer these three questions, it becomes the key to evolving ERM to a “risk-informed” decision-making discipline.
Preserve reputation by maximizing the lines of defense. How do organizations safeguard themselves against reputation-damaging breakdowns in risk and compliance management? The widely accepted lines-of-defense model consists of three lines of defense. The first line consists of the business unit management and process owners whose activities give rise to risk. The second line consists of the independent risk and compliance functions, and internal audit is the third line. Also important is the tone of the organization—the collective impact of the tone from the top, the tone from the middle, and the tone at the bottom on risk management, compliance, and responsible business behavior. The proper tone lays the cultural foundation for the effective functioning of each of the three lines of defense. Arguably, the final line of defense is senior management and the board. For example, top management acts on risk information on a timely basis when significant issues are escalated and involves the board when necessary.
These three keys offer a focused line of sight for companies and their boards seeking to advance their ERM approach consistent with the principles and guidance in the updated COSO framework. The relationship of ERM to the processes the CEO values most can be compared to the contribution of salt, pepper, and other seasonings to a sumptuous meal. The objective is to enhance the outcomes that the organization is attempting to achieve by enabling it to be more adaptive in a volatile, complex, and uncertain world.