Topics:   ESG

Topics:   ESG

February 1, 2022

Restoring Trust Around ESG Initiatives Through Process

February 1, 2022

The reputation risk du jour is the trifecta of environmental stewardship, social justice, and dutiful governance (ESG). To the board members of companies touting their ESG initiatives as a way of building their brands and attracting investors to preempt this risk, we want to stress: A lot of people simply don’t believe you. The lack of trust is eroding your brand and your reputation is at risk.

The solution? One word: process.

A process to oversee mission-critical operations. A process to ensure the resilience of a firm’s reputation. A process to create a coherent, enterprise-wide reputation risk management strategy. A process to communicate the risk governance and risk management process upgrades so that stakeholders can recognize, appreciate and value them above the noise of pablum and placebos. In short, an authenticated integrated ESG and reputation risk governance and management process.

Why is there widespread cynicism? In just the past few months, we’ve seen the US Securities and Exchange Commission (SEC) report that some investment firms were providing potentially misleading descriptions of their ESG investment strategies, often lacking adequate controls and compliance programs. A governor of Banca d’Italia estimated that 55 percent of ESG funds have exaggerated their claims, and a former BlackRock executive called sustainable investing a “dangerous placebo that harms the public interest.”

There was no shortage of anti-corporate sentiment at the recent United Nations Climate Change Conference (COP26), with even those banks seemingly most committed to ESG facing sharp criticism for their financing of fossil fuel companies. Ahead of the summit, for example, activist Greta Thunberg lamented, “Our hopes and ambitions drown in their empty promises.”

The ESG movement has drawn the corporate world into uncharted reputational territory at the same time that the potentially material impacts of reputational risk are increasing. So, how do companies avoid a possibly disastrous fallout from alleged greenwashing?

Processes for ESG Aspirations

Companies already have strong board processes in place for overseeing the accounting and reporting of financial results and for ensuring compliance. Stakeholders know what those processes look like, and they are validated publicly by outside auditors. While financial results may sometimes be disappointing, everyone understands the process; it’s transparent and can be tracked. Investors, regulators, and other stakeholders can make informed decisions about whether management and directors can be trusted.

However, there are no such standards for ESG activities. Companies may or may not have processes in place for aligning operations and governance practices with ESG aspirations. Even among those that do, those processes are rarely transparent. And all too often, corporate leadership fails to build a sense of accountability for achieving those goals into the organization’s culture or into the board’s governance duties.

This is despite the trend in the courts to consider corporate reputation a mission-critical function and to allow plaintiffs to press claims against boards of directors. In the past two years, six of 18 Caremark claims raised in the Court of Chancery have survived a motion to dismiss—an approximately 33 percent success rate.

In re Clovis Oncology Inc. addressed a board’s failure to protect the firm’s reputation for (pharmacologic) innovation; Marchand v. Blue Bell Creameries was decided on the board’s failure to protect the company’s reputation for (food) safety; and Inter-Marketing Group USA Inc. v. Armstrong was decided on the board’s failure to protect the firm’s reputation for (oil pipeline-related) environmental protection.

The three most recent cases, including In re Boeing Company Derivative Litigation, alleged failures in the oversight of (airframe) safety, financial controls, and “mission critical regulatory issues.”

The bottom line is that boards are now subject to much greater legal scrutiny of their oversight of mission-critical processes—the very processes that, when effective, mitigate risk, bolster reputation, and allow companies to reach their ESG goals. Courts have recently ruled that, in some cases, ESG claims—and a company’s failure to meet them—may be viewed as material by shareholders.

Statements of ESG goals promoted by marketing teams are no longer sufficient. Even the most serious, diligent companies are going to be questioned by skeptical regulators, investors, employees, politicians, and other public stakeholders.

What the CEO Must Have

At a minimum, dutiful oversight of a firm’s ESG and reputation risk management process should ensure that the CEO, as the accountable executive, has:

  1. Created a process under which the chief legal officer—our recommended responsible executive—oversees a reputation leadership team, a committee that includes executives aware of a company’s many stakeholders
  2. Authorized this reputation leadership team to develop tools or identify consultants for gathering reliable intelligence about the ESG expectations of their respective stakeholder groups
  3. Developed a triage process under which the team’s executives have a reliable, repeatable process for identifying ESG or other reputational risks among each stakeholder group and filtering that intelligence so the board becomes aware of threats to mission-critical assets
  4. Communicated the board’s strategy and established controls to ensure that the enterprise’s reputation risk management priorities are aligned with that strategy and that internal audit can validate those controls
  5. Reviewed metrics that are updated regularly to include the expected costs of meeting stakeholder expectations, resetting expectations, or bearing the costs of stakeholder disappointment regarding that which is mission-critical
  6. Considered the tactical use of captive parametric reputation insurance to absorb those potential costs and to augment customary liability insurance, as well as qualified for strategic parametric ESG reinsurance to disclose the authenticity and sophistication of the board’s oversight process to public stakeholders

Reputation risk is a new challenge as most boards now understand it. Few boards today have individuals with significant experience in strategic enterprise reputation risk governance and management. This means engaging an independent third party for support, validation, and risk management authentication can further authenticate a board’s commitment to the task at hand.

Just as a company’s financials require review by outside auditors, ESG and reputational risk management processes need to be measured against objective metrics using reliable data and historical reference points. That third-party validation, when communicated publicly, tells the company’s story in simple, convincing terms that ESG raters, institutional investors, and regulators can readily understand.

Insurance can be a strategic marketing instrument for many different stakeholder groups, showing that an outside party is willing to underwrite the risk and put its money where its mouth is. ESG insurance products, which are now available to qualified companies, help company leadership (including directors) address the legal and reputational risk of failing to meet ESG expectations.

A rigorous and transparent process, validated by objective third parties, will not eliminate all risk for all companies. Companies often must choose between competing interests that can’t easily be reconciled. But companies that are well equipped to understand and quantify risks will make better decisions and be in a stronger position to weather any storm.

Nir Kossovsky is CEO of Steel City Re, the exclusive provider of parametric reputation risk insurance and advisory services using a risk management framework informed by behavioral economics. Denise Williamee is Steel City Re’s vice president of corporate services, where she heads client relations and education for reputation leadership teams.

Restoring Trust Around ESG Initiatives Through Process

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