June 9, 2021
June 9, 2021
In the spring of 2021, NACD, with KPMG and Sidley Austin, convened more than 45 Fortune 500 audit committee chairs to discuss the emerging challenges and opportunities of environmental, social, and governance (ESG) matters. The discussion covered data assurance, the most relevant ESG metrics for the audit committee, and the new priorities of the federal government around confronting climate change. Participants repeatedly emphasized that this is not only an important issue that boards must tackle for long-term value creation, but also an issue on which action will increasingly be expected of them, if not regulated, by external and internal stakeholders.
The posture of the federal government toward ESG and nonfinancial disclosure has changed with the new administration. Following the pandemic and the social unrest of 2020, and in light of the ongoing challenge of mitigating climate change, the Biden administration directed agencies from the US Securities and Exchange Commission (SEC) to the Federal Trade Commission to examine issues related to ESG.
“With the SEC in the past few years ESG disclosure really hasn’t been on the agenda. The SEC had started discussions around climate disclosures and SEC advisory councils were making certain recommendations, but the SEC decided not to take action except with respect to human capital management under amendments to Regulation S-K last fall,” explained Heather Palmer of Sidley Austin. “What we are seeing now is a number of recent developments at the SEC focusing on climate and broader ESG disclosures.” Important to remember in all of this, as one delegate noted, is that “even if the SEC is slow in adapting to these changes, investors are continuing to insist—increasingly so—on companies disclosing ESG information. Boards need to be planning, and acting, for this.”
Beyond climate change, human capital disclosures broadly, and diversity, equity, and inclusion disclosures in particular, were top of mind for the delegates, who anticipate active engagement by regulatory bodies with increased disclosures forthcoming.
Of the 90 percent of companies in the S&P 500 that publish sustainability data, only 29 percent had any third-party assurance. The number of companies using third-party assurances is growing, as investors and regulators increase their demands for nonfinancial reporting. Claudia Allen of KPMG emphasized the importance of board oversight and the need for robust internal processes around ESG disclosures: “The board should understand who in management is overseeing ESG and ESG reporting. Having internal controls around nonfinancial disclosures, including controls relating to data quality, is necessary to ensure high-quality disclosure. And the board should agree with management on the data management will provide to the board, including metrics and key performance indicators.” When it comes to data and third-party assurance, it is best to start small, explained one delegate: “Focus on the metrics that matter for your organization’s strategy, business, and stakeholders. As time passes, expand the metrics to accommodate the changing demands of stakeholders.”
Another point was made clear by the delegates. When dealing with metrics, particularly new ones that have not been reported before, the context matters. So, while boards are focused on these new disclosures and assurance, close attention has to be paid to the narratives that support those disclosures. This requires a deeper level of coordination between the board and management. At times, it may even require the board to encourage new approaches to disclosure documents that enable this enhanced reporting.
Like all business processes, ESG is evolving in sophistication. Some delegates observed that ESG today is where cybersecurity and enterprise risk management were a decade ago. One delegate spoke about the growth and evolution that their organization went through as they began addressing the topic several years ago. In the early phases of the company’s work, ESG fell outside the responsibility of senior management; it was not integrated into the business, and it was driven by compliance and regulatory considerations.
More recently, the company shifted to viewing ESG through both the strategic lens as well as the risk lens. Responsibility for ESG has evolved; the CEO is now actively engaged, and the work is fully integrated throughout the business.
At the moment, organizations are at different places in their ESG evolutions. The focus and pressure from investors, employees, governments, and others will only continue to increase. Boards are responding to the coalescence around reporting standards like TCFD and SASB, to name a couple that came up in the session. With the identification of a few primary standard setters, boards increasingly have the focus and confidence to move forward as they work to keep pace in this rapidly evolving area.
Unspoken, but implicit throughout the conversation, was an acknowledgement that the COVID-19 pandemic and the social justice movement of 2020 have accelerated the interest in and changes to ESG that have been building for the last decade. Delegates expect 2021 to continue at a rapid pace and anticipate significant changes to the reporting frameworks for ESG and to the expectations of regulators and investors. Successfully meeting and managing through these new developments over the course of the next few years will depend on whether or not companies take the right early first steps now and lay the groundwork for effective disclosure and engagement in the future.
Note: The meeting was held using a modified version of the Chatham House Rule, under which participants’ quotes are not attributed to those individuals or their organizations, with the exception of cohosts.
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