Investors are on to a definite theme these days—and Kinder Morgan and Anadarko Petroleum Corp. are the latest companies to experience it.
Earlier this month, investors in the energy infrastructure giant backed shareholder resolutions calling for more transparency and reporting on how Kinder Morgan is addressing the impacts of climate change and mitigating the risks. A similar resolution at Anadarko also received a majority vote this month.
As I wrote in a recent NACD blog, one consequence of this growing focus on climate risks is that investors, led by major money managers such as BlackRock and State Street, are increasingly emphasizing the role of corporate boards in driving company responses.
And now Systems Rule, a new report from Ceres, shows that investors are right to push for strong governance systems for sustainability.
Our analysis of board governance practices and performance data of large global companies found that businesses that integrate sustainability priorities such as climate change into board mandates, director expertise, and executive compensation also demonstrate strong performance on sustainability issues.
The report provides important insights for boards to pay attention to as they consider how to oversee climate-change-related risks and strategy.
But here’s the issue: Most large companies aren’t among these performers because they still have fragmented systems of board governance, especially when it comes to sustainability oversight.
This is partially true because many directors and company leaders still do not understand the material impacts associated with environmental and social issues, like climate change. In fact, Systems Rule noted that only 17 percent of corporate directors have demonstrated expertise in sustainability issues.
For companies to get moving and establish governance systems that can deliver commitments and performance on climate change, the whole board needs to start by establishing some baseline fluency that will help them understand when these issues could in fact be material.
Developed specifically to increase board fluency in climate change, the report provides an overview of the different ways that climate change can impact an enterprise and how boards can integrate climate change oversight into their responsibilities in the boardroom.
It’s designed to be a valuable tool for corporate directors who want to educate themselves on what this issue means to their business and what they can do about it.
So how practically can directors build climate competency into their board?
Formally include oversight of climate-change-related issues in the board structure. Formalizing climate change’s importance to business by including it in board committees’ mandates ensures the topic is regularly discussed. Citigroup, Ford Motor Co., and Nike are just a few of the companies that do this.
Recruit climate-competent directors. Committees should cast a wide net through the nominating process so they can consider candidates with diverse backgrounds and expertise in addressing climate change.
Integrate climate change into strategic planning and risk oversight. Directors should ensure that management takes the business impacts of climate change into account at every level of the company. Businesses including BHP Billiton and Shell conduct scenario analyses to assess the impacts of climate change on their portfolio of assets and business policies.
Tie executive compensation to actions that mitigate climate change. To encourage action, executive compensation can be tied to a company’s progress on addressing and opportunities, such as cutting greenhouse gas emissions. Xcel Energy links 30 percent of its executive compensation to carbon emission reduction goals.
Promote climate change disclosure. Without robust disclosure, investors cannot accurately analyze how a company is responding to climate change. Companies including Aviva, Unilever, and Zurich Insurance committed to updating their disclosures based on new Task Force on Climate-related Financial Disclosure (TCFD) guidelines.
The takeaway from our research is clear. It pays for companies and boards to adopt strong board oversight systems for climate change. But as a first step, boards should first develop climate fluency to understand the material risks their company may face. Fluency with the issues and strong, holistic governance systems will lead to the performance impacts that investors and other stakeholders want to see.
Veena Ramani is program director of capital market systems programs at Ceres.
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.