Few organizations or boards are capable of answering this question with any degree of certainty. Yet, the question is being raised with greater frequency and urgency due to actions by investors, regulators, customers, supply-chain partners, and competitors.
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Across every industry the increased focus on climate change is accelerating other megatrends such as disruptive technologies, digitization, urbanization, and evolving demographics. Underpinning these megatrends are a combination of technological leaps and upheavals in global society and the environment that will reshape economies, businesses, and lifestyles. For example, over $1 trillion worth of new markets for manufacturers are expected to develop over the next decade as industries transform. This shifting landscape creates many uncertainties, risks, and opportunities for new products, services, supply-chain structures, and improvements in resource management, among many others.
Taken as a whole, these pressures are driving companies to better assess, define, and enact strategies to increase their climate resilience. In their strategic oversight role, boards need better insights on the direct impacts of climate change on the organization as well as the indirect risks and opportunities associated with transitioning to a lower-carbon economy.
Yet, recent NACD corporate governance survey data suggests that many boards need a rethink on this issue. Six percent of respondents indicated that climate change would have the greatest impact on their businesses over the next year. The previous year’s report found that over 90 percent of public company directors believe that climate change would have negligible impact over the next five years.
Companies that focus primarily on climate change’s projected physical impacts expected to play out over the coming decades will have “blind spots” to the indirect risks associated with the transition to a lower-carbon economy. Companies must to go on the offensive to build climate resilience in order to gain competitive advantage.
Climate resilience has the capacity to adapt and succeed in the face of direct and indirect impacts of climate change. In addition to addressing and managing risks, it encompasses the ability to capitalize on the strategic opportunities presented by the shift to a lower-carbon and resource-constrained economy.
To provide boards with a line of sight into its organization’s climate resiliency, management teams can undertake one or more of the following actions:
assess climate vulnerability of operations and facilities;
embed climate impacts into enterprise risk management programs; or
undertake scenario analysis to enhance decision making around risks and opportunities.
As a start, companies can model the risk of physical assets to identify location-level risk exposure and the vulnerability of properties and assets to evolving weather events and climate change. A geographic portfolio review can also help map demographic and infrastructure vulnerabilities to natural hazards to better understand how supply chains may be impacted by weather events.
Existing enterprise risk management (ERM) and risk assessment processes can be used to increase awareness of climate risks and better assess resilience across the organization. Leading organizations are using their ERM processes to identify how direct and indirect climate impacts—including regulatory and technology developments—serve to accelerate or otherwise change the velocity of other trends and risk events. Framing climate as a risk driver helps to align the timeframe of the risk and opportunity assessment to that of most corporate planning cycles.
Scenario analysis is recommended by the Financial Stability Board’s Task Force on Climate-related Financial Disclosures as a technique to assess climate impacts. Modeling different environmental scenarios (such as warming by a margin of 2 degrees Celsius and associated changes) gives form to the amorphous problem of climate change and provides mechanisms to discuss potential future states of operation. In selecting and devising scenarios, companies should consider the appropriate trade-offs in quantification, but also avoid excess complexity and optionality. When assessing for operational climate-risk resilience, it is critical to include a minimum of one favorable and unfavorable scenario respectively. This empowers organizations to make informed decisions regarding their longer-term strategies.
Overall, it is clear that the dialogue on climate change within boardrooms and among C-suites of companies across all sectors must evolve to a focus on how climate change will impact their businesses. The real measure of a climate-competent board is one that can address this critical question: how climate-resilient is the organization?
Lucy Nottingham is a director in Marsh & McLennan Companies’ Global Risk Center and leads research programs on governance and climate resilience. All thoughts expressed here are her own.
Vanguard Group CEO William F. McNabb III just tipped the list. The world’s top three asset managers—Blackrock, Vanguard, and State Street Corp.—are now calling the companies that they invest in to adopt climate risk disclosure.
In a recent open letter to corporate directors across the globe, McNabb explained that Vanguard, the $4.5 trillion mutual-fund management firm, expects businesses to embrace materiality-driven disclosures to shine more light on sustainability risks.
Summing up the challenge of climate risk, McNabb wrote that it’s the kind of risk that tests the strength of a board’s oversight and risk governance. That’s the crux of the challenge for directors. As investors ratchet up the pressure on companies to analyze their exposure to the impacts of a warming planet, they’re calling on boards to be knowledgeable about material climate risk and capable of preparing for its impacts and capitalizing on its opportunities.
As we heard in Karen Horn’s opening keynote of NACD’s 2017 Global Board Leaders’ Summit, directors can no longer ignore the inherent impact of these issues on the long-term value creation of the corporate world —ranging from climate risk, natural resource capital, and implications of the Paris Climate Agreement.
Board-level competence around climate change and other sustainability risks is the way forward. Through an understanding of what climate change means, why it matters to their business, and what their organizations are capable of changing, directors can successfully make climate risk part of their governance systems.
In a new report by Ceres called Lead from the Top, we outline ways that companies and boards can build up that competence.
But rather than settling with bringing on a director who is competent in sustainability, our report explains why companies must work to build an entire board that is competent to oversee these risks. By engaging thoughtfully on material sustainability risks as one cohesive body, this kind of board is able to ask the right questions of its management, support or challenge senior management as needed, and ultimately make informed and thoughtful decisions affecting corporate strategy and risk.
We identified three key principles that companies and boards can use as they work to build a sustainability-competent board:
1. Sustainability needs to be integrated into the director nomination process. Finding directors who can apply their knowledge about climate and other sustainability risk to relevant board deliberations is a good first step. Companies can get the right people on board by approaching this systematically as a part of the board nominations process, specifically identifying experience in material environmental, social, and governance (ESG) risks in the board skills matrix and by casting a wide net to consider candidates with diverse backgrounds and skills.
2. The whole board needs to be educated on sustainability issues that impact their company. For sustainability to become part of the fabric of board oversight and integrated into decision-making on strategy, risk, and compensation, all directors on the corporate board need to be well informed on material sustainability issues so they can lead thoughtful deliberations and make strategic decisions. Companies can do this through focused, ongoing training programs that bring in experts from outside the company and by educating the board on the connections between climate change and material impacts and the connections to risk and strategy. Embedding ESG into the existing board materials so it does not become one additional issue topic to vie for directors’ attention is essential. Sustainability managers embedded within companies can play a key role in driving this integration.
3. Boards should directly engage a diverse array of stakeholders, including investors, on sustainability issues impacting their company. With more investors paying attention to climate change and other sustainability issues, shareholders increasingly expect boards to engage directly with them on critical issues. One of the goals of McNabb’s letter was to nudge directors to engage directly with shareholders. Given this growing focus, material environmental and social factors should be made a part of any dialogue between directors and investors.
It all comes down to the bottom line. Risk and opportunity define business. Corporate boards will have a difficult time performing their fiduciary duty to the companies they lead and the shareholders that they represent without understanding the risks and opportunities created by climate change. Our report lays out practical steps directors can take as they consider how to make their board competent in addressing climate change and other environmental, social, and governance issues.
Veena Ramani is the program director of Capital Market Systems at Ceres. Ceres is a sustainability nonprofit organization working with the most influential investors and companies to build leadership and drive solutions throughout the economy.
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.