Prioritizing environmental, social and governance matters requires sustained effort.
Environmental, social, and governance (ESG) issues are increasingly factored into corporate performance.
Many investors recognize that poor ESG practices pose environmental, legal and reputation risks that can damage the company and the bottom line. And they are increasingly aware that companies with strong ESG performance have a better brand image, a more loyal and stable customer and employee base, lower cost of capital, better access to financing and, ultimately, a greater focus on long-term value creation.
In fact, the US SIF Foundation estimates that $12 trillion, or one-fourth, of all professionally managed assets in the United States incorporated ESG factors at the beginning of 2018, up 38% in two years.
For companies and boards, however, transforming ESG from a siloed, ancillary issue to a core competency requires significant and sustained effort. ESG often means different things to different people. And there’s no single model for organizations to follow.
Even for conscientious CEOs and boards, integrating ESG into corporate strategy isn’t easy. Among nearly 150 directors we surveyed in October 2018, just 22% said ESG is directly linked to the company’s strategy.
Still, the issue is on the radar for many boards; half of the directors responding to the National Association of Corporate Directors’ 2018-2019 Public Company Governance Survey said they would like their boards to link ESG to corporate strategy.
To explore how boards are addressing these issues, the KPMG Board Leadership Center interviewed directors and officers of major corporations that are recognized leaders in addressing ESG and sustainability issues. Based on those conversations, we offer the following observations.
The catalyst behind a company’s decision to focus on ESG issues is generally some combination of:
1) people understanding the importance of ESG and driving the company’s focus;
2) an increasingly intense focus by the board and management on enterprise risk management and strategy, which elevates the strategic importance of ESG issues as a risk and opportunity;
3) expectations of investors, customers, and employees.
“ESG issues are not static, they evolve,” as one director told us. “And if you look at our sustainability committee agendas, you will find that it’s been a totally evolutionary process. The implications of climate change for our strategy, including fuel efficiency and our carbon footprint, have been on the board and committee agendas for some time. But with industry disruption, the agendas have evolved to include the impact of new technologies on human capital and skill set needs and the need for innovation.”
Another director pointed out that the company’s significant ESG risks and opportunities are not always clear. “When we started on the ESG journey we wanted to better understand our carbon footprint, which we thought was our truck fleet. But when we mapped it out, it wasn’t the truck fleet but was power consumption in electronic devices we deployed in homes. That changed the whole discussion.”
Recognizing that the strategically significant ESG risks and opportunities will vary by industry and sector, most companies undertake an inventory to identify and assess all ESG issues material to the business, such as environmental degradation, product and worker safety, waste generation, etc., that could affect the business or its stakeholders. From this list, they then identify the two or three ESG issues that are core to the business strategy and key to the long-term health and viability of the business.
It’s also critical to make sure there’s a “home” for board oversight of ESG, whether it’s the governance committee, an ESG committee, or somewhere else in the board structure. Effective oversight hinges on having the right people in the boardroom, supported with quality information to enable appropriate oversight.
Of course, the structure and processes a board creates to oversee management of ESG issues will vary based on a number of factors, such as the size and complexity of the company’s operations (including its supply chain and whether operations are international), its industry, the magnitude of the company’s ESG risks and opportunities, the degree to which these issues are central to the company’s strategy, and the level of director expertise regarding the issues.
Addressing ESG as a long-term strategic issue and embedding it into the company’s core business activities requires understanding why ESG matters to the company’s long-term performance, a clear commitment and strong leadership from the top, and enterprise-wide buy-in.
For more, read “The ESG journey: Lessons learned from the boardroom and C-suite” at kpmg.com/us/blc.
Dennis T. Whalen is Leader of the KPMG Board Leadership Center.