The responsibility for the oversight of an organization’s sustainability and environmental, social, and governance (ESG) matters lies firmly with the board of directors. They are ultimately accountable for the long-term success of an organization, and it is important as part of modern corporate governance to embed sustainability and ESG into decision-making and long-term growth strategies. Therefore, companies on a sustainability transformation journey need strong board leadership and members with adequate sustainability literacy.
The Board is responsible for ensuring:
- Relevant sustainability and ESG matters are incorporated into purpose, governance, strategy, decision-making, risk management, and accountability reporting.
- Understanding and alignment of sustainability and ESG priorities throughout the organization.
- Defined targets and metrics are identified and monitored.
- High quality reporting, with the aim that material sustainability and ESG-related information is connected to, and at the same level of quality, as financial information.
While it is clear that boards are responsible for sustainability and ESG oversight, how they discharge those responsibilities varies widely depending on the company, the industry, and the jurisdiction. With most boards around the world having at least one professional accountant board member, there is an enormous opportunity for the accountancy profession to influence sustainable governance practices in boardrooms. An important responsibility for PAOs is supporting their members serving on boards to stay up to date with relevant developments in sustainability and ESG.
To explore current practices for overseeing ESG, IFAC’s Professional Accountants in Business (PAIB) Advisory Group was recently joined by a panel of experienced board directors, who between them have a wealth of non-executive experience across a range of companies and jurisdictions. Nancy Tse, the Deputy Chair of the PAIB Advisory Group and an experienced board director herself, moderated the discussion between panelists, who included:
- Nicholas Allen, Audit & Risk Committee Chair, CLP Holdings Limited, & Chairman of Link REIT
- Susan Angele, Senior Advisor, KPMG Board Leadership Center
- Alan Johnson, Outgoing IFAC President, and non-executive director at Imperial Brands plc, William Grant & Sons Ltd, and DS Smith plc.
Some key learnings from the discussion were:
- Incorporating sustainability and ESG into purpose and strategy is not a separate exercise
For a purpose-driven organization, its purpose and strategy are fundamentally based on doing the right thing for society and various stakeholders. With this premise, embedding sustainability and ESG is not done in isolation; it is a core part of how an organization responds to challenges, risks, and opportunities affecting value creation in the context of the needs and expectations of stakeholders, and in line with planetary boundaries. Sustainability and ESG affect all organizations of all sizes and across all industries and sectors, including the public sector, and accountants serving as board directors are at the center of sustainability discussions.
- Aligning sustainability and ESG priorities throughout the organization can be a challenge
Boards are the stewards of long-term value and have an obligation to be bold in setting the strategy and embedding a culture that embraces sustainability and ESG and encourages innovation. But a key challenge for boards is ensuring a common understanding of, and alignment on, sustainability and ESG priorities throughout the organization. CFOs and finance functions have an important role to play in supporting the board by helping to break down organizational siloes and foster an integrated mindset to think, measure, manage and report in a more integrated manner.
Incentives and remuneration
Incorporating ESG into executive performance-related remuneration can be an effective way of incentivizing the right behaviors and holding those in leadership positions accountable for the delivery of the organization’s ESG goals. It can also help foster alignment of actions on key targets. ESG-linked remuneration is an increasing trend. For example, an EY European study on how boards can strengthen governance to accelerate ESG found that remuneration will be a main focus for many boards over the next two years.
Remuneration considerations for the board include:
- When to include such targets. It is important to first ensure alignment throughout the organization, and to identify the right metrics and KPIs - including consideration of time horizons and the need for interim targets.
- How much executive compensation should be linked to ESG targets.
- Which targets to include – it may not be appropriate for some ESG targets.
- Where to pitch the targets. Setting targets that are too ambitious may be demotivational, but equally, targets that are too easy should not be rewarded and may create unintended incentives. Balance is important with a focus on clear, measurable performance targets that will make an impact.
- Boards are focusing on the key metrics and KPIs
Companies are using various standards, reporting frameworks and metrics to measure and report on sustainability, but this can often result in much complexity.
In the board’s strategic capacity, using sustainability/ESG as a lens to think about strategy, risk and opportunity can help them to identify the 5 or 6 metrics that will focus their attention on key strategic issues making a real impact and that will align performance to sustainability targets and goals.
Many targets are longer-term. Therefore, it is important when setting targets to work backwards in shorter periods to effectively monitor goals over time against set milestones.
- Ensuring an appropriate oversight structure
Individual companies decide (within any legal mandated requirements) the most appropriate board structure, the committees needed, and if and when the board delegates responsibilities to its sub-committees. Companies are increasingly evolving their committee structures and mandates to ensure effective oversight of ESG and sustainability.
Oversight by the full board
- Involves deep dives on sustainability/ESG topics during full board meetings.
- Boards may also seek advice from an expert advisory panel where needed.
Establishment of a dedicated sustainability committee
- Typically supports the board establishing sustainability goals and strategies.
Incorporating sustainability into the mandates of existing committees
- As ESG is so broad, oversight responsibilities may be split across committees, for example:
- The audit and/or risk committee overseeing risk management.
- The audit committee overseeing disclosure against standards and regulations and related assurance.
- The remuneration committee incorporating ESG priorities into compensation and incentives.
- The investment committee considering ESG-related financing and investment decisions.
- 67% of S&P 100 companies spread ESG oversight over two or more committees.
The most appropriate committee structure will depend on factors, such as the:
- Jurisdictional legal requirements and corporate governance codes
- Size and structure of the company
- Complexity of sustainability and ESG risks in a particular industry. For example, companies in the oil and gas industry may need deeper expertise in a dedicated committee.
- 54% of FTSE 100 companies now have an ESG committee at board level (including 100% of mining and oil & gas companies)
Regardless of structure, boards must ensure minimal overlap or fragmentation of duties, while at the same time maintaining connectivity between committee agendas where relevant. They must ensure that the board is fully engaged in topics of importance. Having board members serve across more than one committee can be an effective way of achieving this. At the PAIB Advisory Group meeting, an example was shared of a company where board members serve on all committees to be able to see a complete picture and effectively link operational performance to strategic delivery.
- Audit committees have an expanding role
Audit committees have an existing mandate to oversee high quality financial reporting and internal and external audit, and as such are well placed to expand on this by:
- Providing oversight of mandatory sustainability/ESG disclosures and related systems and internal controls.
- Ensuring the financial impacts of material climate-related risks have been considered and, where appropriate, are reflected in the audited financial statements, including through:
- Oversight of management processes to ensure adequate consideration of ESG issues and monitoring of ESG compliance risks.
- Scrutiny of the work of the external auditors, especially their consideration of the impact of material climate risks in their audit of the financial statements.
- Ensuring the consistency of sustainability/ESG related disclosures across general purpose financial reporting and other public disclosures.
- Overseeing sustainability/ESG assurance, including internal audit activities, as well as the appointment of external auditors and ESG assurance providers.
With expanding roles, audit committee transparency is increasingly important for the board, investors and other stakeholders to understand the audit committee’s responsibilities and focus areas, including as they relate to ESG information and disclosure.
- All board members must be well-versed and competent in ESG matters
Many professional accountants serve on boards and must have adequate knowledge, awareness and literacy in the ESG issues relevant to the company and its industry. Although subject matter experts and advisors can be brought in where necessary, board members cannot be entirely reliant on outside expertise. Board members are responsible for ensuring they keep up to date with emerging issues and continually learn new areas relevant to their organization and industry. PAOs can support those who are professional accountants and subject to continuing professional development (CPD) requirements.
The Role of Professional Accountancy Organizations
PAOs play a key role in:
- Supporting and meeting the training needs of accountants serving on boards and audit committees. Training programs, guidance and other support tools are essential to ensure the members keep up to date with relevant developments in ESG. Example approaches include:
- Providing mandatory ESG training programs for non-executive directors
- Developing ESG resources specifically aimed at executive and non-executive directors
- Advocating for corporate governance best practices, such as:
- Board governance – including board structure, and roles and responsibilities of board members and executives
- Championing an integrated mindset to embed sustainability
The Organisation for Economic Co-operation and Development (OECD) is undertaking a review of the G20/OECD Principles of Corporate Governance, to consider a range of priority areas, including the management of environmental, social and governance risks; digitalization; and the role of institutional investors and stewardship.
Part of the proposed changes include the elevation of sustainability to its own section within the Principles of Corporate Governance, which IFAC supports. This reflects the current reality of the importance of oversight and integration of sustainability into high-quality corporate governance.
Appendix: Further reading
- Boardroom climate competence: Organizing for oversight (kpmg.us)
- ESG, strategy, and the long view (kpmg.us)
- An audit committee lens on ESG reporting (kpmg.us)
- Sustainability in the Spotlight: Board ESG Oversight and Strategy (spencerstuart.com)
- ESG: Advice for Boards (spencerstuart.com)
- Navigating The ESG Journey In 2022 And Beyond | Deloitte US
- ESG and the role of the board (pwc.com)