How can boards demonstrate that they have oversight of environmental, social and governance risks?
The fourth edition of the Corporate Governance Council’s Corporate Governance Principles and Recommendations was released at the start of March 2019. While the final version did not contain the “social licence to operate” disclosure requirement previewed in the draft release, ASX-listed company boards will still have to articulate how they will exercise oversight of key non-financial risks that have a social impact. In this week’s article David Mahon, Principal Consultant for Carmichael Corporate Services, considers how an international standard on managing Environmental, Social and Governance (ESG) risks can assist Australian companies to meet these new requirements.
So, the ASX backed away from including the phrase “social licence to operate” in its final version of the fourth edition Corporate Governance Council’s Corporate Governance Principles and Recommendations (CGPR). The Council appears to have concluded that the phrase was too opaque, too contentious and just too much like political correctness gone mad. The Council appears to have accepted that having to voluntarily articulate the social benefit of a listed company on an annual basis under the non-binding terms of the CGPR was a stretch too far for companies in the gaming, alcohol, tobacco, fast food and mining sectors.
What has replaced the phrase, however, is more targeted language around the board’s requirement to define purpose and values, align remuneration with values, ensure accountability for accuracy of non-audited public information, protect whistle-blowers and actively oversee anti-bribery and corruption compliance. Directors will need to consider how their boards can formulate an effective oversight framework to address these new requirements.
Managing ESG Risks
One such framework that directors should consider was released in October 2018 by the Sponsoring Organizations of the Treadway Commission (COSO) in partnership with the World Business Council for Sustainable Development (WBCSD). The document, titled Enterprise Risk Management: Applying enterprise risk management to environmental, social and governance-related risks (ESGERM Guide), provides guidance to global businesses, government and not-for-profits that are operating in an evolving landscape of environmental, social and governance (ESG) related risks that can impact on their profitability, success and even survival.
The need to address these types of risks is not new to organisations. However, what the ESGERM Guide recognises is that the focus on ESG-related risks has accelerated rapidly over the last 10 years. The ESGERM Guide echoes the CGPR very closely in listing financial accounting and reporting practices, the role of board leadership and composition, anti-bribery and corruption, business ethics, and executive compensation as the topics of increasing concern. What is also driving the need to tackle these issues is the recognition of the inter-connectivity of ESG risks.
In 2018, the World Economic Forum’s annual Global Risk Report, which surveys business, government and thought leaders to understand the highest rated risks in terms of likelihood and impact, highlighted the complex relationship between environmental risks such as water crises, and social issues such as involuntary migration.
ESG-related risk events, once considered outliers, are now being reported as far more common and often manifest more quickly and significantly than previously considered likely. These risk events often impact on an organisation’s core operations or product, have the potential to damage an organisation’s intangible value, reputation or ability to operate, and are often accompanied by persistent media attention and even public policy debates that can impact on an organisation’s existing position or practice. The ESGERM Guide provides a timeline of global examples; Australians can reference an equal number of national events that illustrate this point.
ESGERM Guide’s examples of organisations that have experienced ESG-related impacts
Defining ESG Risks
The ESGERM Guide provides guidance on how boards can define their organisation’s environmental, social and governance risks, which are unique to each business model, by directing them to consider the definitions provided by MSCI and Robeco, as these are representative of current stakeholder concerns and focus.
Robeco describes Environmental Risks as:
“The contribution an entity makes to climate change through greenhouse gas emissions, along with waste management and energy efficiency. Given renewed efforts to combat global warming, cutting emissions and decarbonizing have become more important.”
Social Risks as:
“Human rights, labor standards in the supply chain, any exposure to illegal child labor and more routine issues such as adherence to workplace health and safety. A social score also rises if a company is well integrated with its local community and therefore has a “social license” to operate with consent.”
and Governance Risks as:
“A set of rules or principles defining rights, responsibilities and expectations between different stakeholders in the governance of corporations. A well-defined corporate governance system can be used to balance or align interests between stakeholders and can work as a tool to support a company’s long-term strategy.”
Linking ESG risks to an organisation’s purpose statement
The ESGERM Guide also provides a working example (Unilever) of how an organisation has linked its purpose and vision to ESG risks. It references Unilever’s purpose “to make sustainable living commonplace” and vision “to grow [its] business while decoupling [its] environmental footprint from [its] growth and increasing [its] positive social impact”.
Unilever has categorised the ESG issues that may affect achievement of this purpose and vision into five areas:
Reducing environmental impact
Packaging and waste
Responsible business practices
Ethics, values and culture
Data security and privacy
Governance and accountability
Responsible marketing and advertising
Tax and economic contribution
Responsible use of innovation and technology
Women’s rights and opportunities
Wider sustainability topics
Trusted products and ingredients
Animal testing and welfare
Consumers and sustainability
Improving health and wellbeing
Nutrition and diet
Sanitation and hygiene
These issues are integrated into Unilever’s overall enterprise risk management framework to identify, classify and manage the organisation’s strategic and macro operational risks.
Unilever’s approach provides a relatable starting point for boards of ASX-listed companies to consider how they could articulate their company’s purpose and values, and how they can define their ESG risks in terms of the challenges and opportunities of aligning their operations and strategies to their purpose and values.
ESG risk management for SMEs
The ESGERM Guide highlights the fact that the impact of ESG-related risks applies to SMEs as much as it does to multinationals like Unilever. SMEs need to utilise their available resources effectively by focusing on achieving key outcomes that will have the largest impact on identifying and managing their ESG risks, while still maintaining an awareness of other measures that they can plan to implement as resources become available.
For ASX-listed boards that have been left scratching their heads at the implications of the revisions to the CGPR, the ESGERM Guide provides tools and strategies that can help them navigate this new paradigm.
Carmichael Corporate Services Pty Limited (CCS), a division of DJ Carmichael Pty Limited, focuses on delivering expertise in corporate compliance, enterprise risk and effective governance to SMEs. CCS provides clients with these essential corporate skills in a bespoke fixed-price service package, “Board Room Solutions”, that can provide assurance and support for growing companies without the overheads of permanent staff.
Principal Consultant – Governance and Company Secretarial
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