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October 31, 2022

Boards under pressure because of mounting ESG requirements

The development of sustainable finance regulation alongside expectations on how companies deal with environmental and social factors are reshaping corporate governance.

Upcoming regulation and an increased attention to stakeholders concerns are driving sustainability stewardship on corporate boards, according to separate research reports from proxy adviser Institutional Shareholder Services and headhunters Egon Zehnder and Spencer Stuart.

Although regulatory initiatives on companies’ sustainability requirements are yet to be fully defined, their evolution will warrant attention as these policies could impact the decision making of board directors, argue the authors of the ISS report ‘Corporate Governance Evolves Amid Increasing Sustainability Awareness’.

The report, which focusses on the Stoxx Europe 600 and the S&P 500 indices, references the EU Directive on Corporate Sustainability Due Diligence and the Securities and Exchange Commission’s proposed rules on climate-related disclosures.

Under the EU proposal, directors’ duty of care would be expanded by requiring board directors to consider sustainability issues in their short-, medium- and long-term decisions. The directive has an overall goal to legislate for human rights and environmental due diligence in companies’ own operations and supply chains.

In the US, the SEC’s actions are centred on disclosure by demanding details on board directors’ expertise, oversight, consideration and goal setting for climate risks.

Stewardship and voting

How companies are dealing with the climate crisis has been a focus for investors for some time, especially during annual general meetings. Climate-related shareholder proposals have often reached the voting threshold to be added to AGM agendas, both in Europe and the US. 

ISS data show that median-level support for climate-related shareholder proposals submitted at S&P 500 companies reached a five-year high of 36 per cent in 2021, before lowering to 26 per cent in 2022. The decrease in support could be partly explained by the prescriptive or constraining nature of some of the shareholder proposals submitted in 2022, according to the report. Earlier this AGM season, BlackRock made headlines by stating it would likely support fewer climate proposals to avoid “micromanaging” companies. This standpoint, taken by the largest asset manager in the world, received criticism from environmentally conscious investors who had seen an increase in support of ESG proposals over the course of the pandemic.

Still, the ISS report also notes that lower support for these 2022 proposals could also be a sign of growing engagement between companies and investors on the topic. In Europe on the other hand, climate-related board proposals have emerged in recent years, which have to some extent replaced shareholder proposals. For instance, in the first half of this year, 27 management proposals (so-called ‘say-on-climate’ votes) were voted on across the Stoxx Europe 600, as opposed to just 10 shareholder proposals.

Despite sustainability issues becoming more prominent through regulation, investors’ engagement and society at large, board directors are still ill-equipped to face the magnitude of the challenge. 

“Many boards have not yet embedded the skills, mindset, and courage to pioneer a new way of doing business and change the ways in which long-term risks and opportunities are identified and assessed,” argue Rachael De Renzy Channer and Ashley Summerfield in EgonZehnder’s report ‘Boards: Stepping Up as Stewards of Sustainability’.

The report, which features data from this year’s Sustainability Board Report, looks at the 100 largest publicly listed companies globally and assesses their board preparedness and director engagement over ESG topics. 40 of these companies were based in the US, 23 in the EU and four in the UK.

A striking finding is that financial performance and shareholder value remain the predominant decision drivers for CEOs, while ESG issues only rank sixth — behind growth, talent management, innovation and health & safety.

ESG skills

The report warns there needs to be more focus on all the moving parts of sustainability, such as training on relevant issues and more diverse board candidates who together are able to challenge the status quo. This, however, does not mean all board members need to become experts in sustainability. Instead, Egon Zehnder argues it is “important that generalists are willing and able to improve their literacy on the various dimensions of sustainability – and develop a keen appreciation of the sustainability-related challenges and opportunities specific to their companies”.

In its 2022 UK Board Index report, Spencer Stuart notes an increase in the presence of board committees created to oversee environmental and social factors. Based on data available at the end of April, 46 boards of the largest 150 FTSE companies have such a committee, 15 more than a year earlier. In a separate recent survey of FTSE 350 chairs, the executive search firm has also found that three quarters of the 95 respondents said they preferred to have full board oversight of ESG topics.

While the role of ESG committees and chief sustainability officers has become a more prominent aspect of corporate governance in recent years, what the reports highlight is that directors’ ESG skills still need to improve before companies are able to embrace the opportunities and challenges ahead.

A service from the Financial Times