Topics:   ESG,Featured

Topics:   ESG,Featured

November 18, 2021

COP26 Intensifies Boards’ Role in ESG Oversight (The Fundamental Shift in Finance Is Here.)

November 18, 2021

The United Nations’ annual conference on climate change, which took place in Glasgow and is commonly referred to as COP26, concluded Saturday. The two-week conference produced many historic moments, such as the United States committing to a net-zero economy by 2050 and phasing out federal financing of fossil fuel projects abroad by the end of 2023.

In addition, the Glasgow Financial Alliance for Net Zero was created, comprising 450 financial institutions representing more than $130 trillion in assets. A new global environmental, social, and governance (ESG) framework was also announced—the International Sustainability Standards Board—that aims to provide investors with consistent, comparable reporting of ESG data across countries.

Notably, the event culminated in 200 countries signing the Glasgow Climate Pact. This new agreement includes key elements around phasing down the use of fossil fuels, phasing out some fossil fuel subsidies, increasing climate financing for developing nations, establishing a carbon offset market framework, and requesting all parties come to COP27 next year with updated plans on how they will reduce greenhouse gas emissions by 2030.

Many expect the trend of private ordering that we’ve seen across 2021, with multiple stakeholders pushing for verification that companies are considering climate risks, to continue—increasing the expectations on and of directors. Below are key takeaways and considerations for boards:

1. Understand the energy transition’s financial impact on the business. A key focus of COP26 was the transition away from fossil fuels and toward a net-zero economy, one in which the emissions created are equal to those removed. It is imperative that directors understand how this transition, however fast or slow, will impact business operations and that they ensure this new expectation is reflected in corporate strategy.

Key questions for directors to consider:

  • How will the transition away from fossil fuels impact our business operations? Do we need to accelerate the retirement of high-carbon assets? How will that affect our balance sheet over time?
  • What is the company’s decarbonization strategy? Are we ready to set our own (realistic) net-zero target?
  • How will the energy transition impact our cost of capital?

2. Know that oversight of climate-related risks is becoming mandatory. While investors have focused on the board’s understanding and oversight of climate-related risks in certain industries, all directors should be prepared for an increased focus on climate competency. Investors are specifically looking for disclosure aligned with the Task Force on Climate-related Financial Disclosures recommendations. Insight into how directors are considering the energy transition’s impact on the business is critical—a lack of disclosure may have implications for director elections, as seen during the 2021 proxy season.

Key questions for directors to consider:

  • How is the board overseeing climate-related risks? Are climate risks actively integrated into the company’s enterprise risk management process, or are they presented in a silo?
  • How often is management reporting on climate-related risks to the overall business? How are they determining which of those risks are material?
  • What are the company’s top climate risks, and how are we prepared to mitigate those risks?

3. Prepare for increased regulation to meet the US reduction goals. The United States set a target of reducing its net greenhouse gas emissions by at least 50 percent below 2005 levels by 2030. To meet this target, the largest emitters in the United States—corporations—will need to reduce their emissions. Directors need to ensure their management teams have a realistic and achievable decarbonization plan that can be discussed with both shareholders and regulators, such as the US Securities and Exchange Commission (SEC). 

Key questions for directors to consider:

  • What is the implication of a carbon tax for the company’s operations?
  • How exposed is the company to a more activist regulatory and legal environment?
  • Has the company scrutinized whether management’s decarbonization pledges and targets are feasible?
  • Does the company have an effective internal process to comply with mandatory climate risk disclosures, which the SEC is likely to require over the next 12 to 18 months?

4. Ensure audit committees play a more active role in ESG reporting. The rising likelihood of SEC regulation around climate-risk disclosure, combined with investors’ expectations around disclosing information on climate-related risks, requires companies to ensure the data integrity of their ESG disclosures. As companies ramp up their reporting and reduction commitments, the board—and in particular, the audit committee—has a critical role in ensuring data integrity and rigorous internal controls around ESG data.

Key questions for directors to consider:

  • How was the data in our ESG report audited and verified?
  • Does the company have the same internal control procedures for ESG metrics and reporting as it does for financial data?

5. Don’t forget the opportunities. While risks abound from the transition to a net-zero economy, directors can encourage management to see the forest for the trees—the energy transition offers ample business opportunities and new revenue streams. Directors should encourage their management teams to explore new revenue-generating opportunities in addition to identifying relevant risks. Companies can differentiate themselves by driving positive socioeconomic outcomes for the business that benefit all stakeholders.

Key questions for directors to consider:

  • Where can the business reduce costs or create new cost-saving initiatives because of the climate transition?
  • How will this impact our customers and their expectations? Are there opportunities to create new products or services to help clients meet their own commitments? 
  • How is management considering ESG opportunities when performing due diligence for mergers and acquisitions?

The outcomes of COP26 will accelerate action by both governments and private markets. There is an increased priority placed on mitigating climate-related risks and integrating climate-related concerns into core board oversight and company strategy. While many of the considerations discussed above are longer term, in the short term, directors should expect a more intense 2022 proxy season, with a heavy emphasis on climate risks and how the company will help achieve the lofty goals set at COP26.

While acting Comptroller of the Currency Michael J. Hsu’s recent comments on climate centered around bank boards, his words ring true for all directors: “Questions that directors ask senior managers can shift [bank] priorities, reveal hidden strengths, expose fatal weaknesses, and spur needed changes.”

Limor Bernstock is senior director of governance and sustainability and Leah Rozin is director, head of governance and sustainability research at Rivel.


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