The ‘G’ In ESG: Exploring the impact of corporate governance

The ‘E’ and ‘S’ in ESG (environment, social, governance) have had no shortage of attention following the Covid-19 pandemic and the rate at which the global climate crisis continues to heat up.

Despite this, ESG goes beyond an isolated consideration of ‘E’ and ‘S’. In fact, by leaving governance factors out of the decision-making process altogether, organisations risk missing a crucial opportunity to fully leverage the power that comes with embedding sound corporate governance and risk management systems into their corporate pillars.

This can spell disaster in a world where failing to act on governance matters – and omitting a holistic ESG consciousness – could induce implications for the financial performance of an organisation, as well as those investing in its future.

On the flipside, getting the governance proposition right can present an opportunity for companies to drive sustainable, long-term value creation. As boards enter the financial disclosure period for 2022, three certainties are apparent. The world continues to evolve rapidly, new generations of investors are influencing the investment sector like never
before, and technology has an immense role to play.

Here are five key governance considerations that all organisations need to be cognisant of when striving to embed the full breadth of ESG values and address systemic risks.

1. Defining and driving governance 
So, you’ve arrived at a critical juncture where your organisation wants to level-up its ESG approach. However, knowledge gaps exist with regards to which governance interests should be prioritised within the corporate decision-making process.

At this stage, being aware of governance risks and opportunities in the decision-making process is essential. The two most important steps here are:

• Evaluating the corporate governance performance of an organisation involves laying out additional key metrics that evaluate the or management systems, as well as its ability to manage long-term environmental and social risks and opportunities.
• Systems and structures in place to transform the organisation towards a model that will deliver sustainable business advantages and measurable value.

2. The core pillars of governance 
With ESG strategies maturing faster than initially predicted within many industry forecasts, it’s easy to become caught up in the hype and need to accelerate ESG adoption.

However, it’s essential to understand the key governance pillars involved and which of these apply to an organisation’s context before jumping straight in or spending time addressing the wrong areas.

These pillars are:

• Board structure and diversity – Assessing the composition of the board.
• Code of conduct and reporting on breaches – Assessing the mission, core principles, values, and rights of the organisation; in addition to any emerging allegations faced within the public realm.
• Transparency – Disclosure of publicly available information and reporting.
• Executive remuneration and link to ESG performance – Tying ESG performance back to executive remuneration.
• Risk and crisis management –Measures to assess emerging risks associated with ESG.
• ESG integration in supply chain – Ensuring incorporation of ESG aspects within supply chain screening of potential or existing vendors.
• Materiality assessment and impact disclosures – The processes of identifying, assessing and incorporating ESG material.

3. Understanding governance risks 
Insufficient governance practices can have a significantly negative impact on business reputation and investor confidence. According to a 2019 Diligent Institute report, ‘governance shortfalls’ at 14 companies recently cost shareholders a combined total of $490bn in value one year later.

The main risks that can lead to similar issues in the modern governance setting are related to compliance, resilience, transparency and disclosure.

• Compliance: Risk of reputational damage associated with failure to fulfil the reporting, accounting, auditing and complying with regulations risks.
• Resilient ‘E’ and ‘S’ systems: Incorporating environmental, social and economic systems into the investor’s decision-making process.
• Transparency and disclosure: Public disclosure of the key material topics association with the business exposure of the organisation to ensure maintenance of the environmental and social licenses to operate.

The cost of poor governance is high, hence it’s essential to address potential crises before they happen by embedding structural safeguards within ESG frameworks.

4. Benefits of strategic governance criteria 
Having strong governance criteria cements the foundations for successful ESG management. When initiated effectively, the value derived can deliver multiple advantages, especially promoting investor confidence, enhancing financial performance, instilling risk management, and laying a platform  for broader consideration ‘E’ and ‘S’ issues.

• Promoting investor confidence – Disclosing the organisation’s policies, standards, information disclosure, auditing and compliance to investors. For example, investors want to know that a company’s accounting is both accurate and transparent and that its business practices are ethical.
• Financial performance – Direct correlation between good corporate governance and higher financial returns
• Risk management – Fast-track the identification of risks for investors and shed greater light on the company’s prospects
• Consideration of ‘E’ and ‘S’ issues – Organisations with strong corporate governance structures and performance are better placed to understand, monitor and manage the environmental and societal issues that could impact the company value.

5. The role of technology 
Within any transformation that takes place in the contemporary business context, technology and digital touchpoints can’t be overlooked. When paired within the deployment process of essential ESG strategies, technology can play a role in bridging analysis gaps and strengthening the quality of ESG data.

Several governance solutions have emerged to help boards analyse their composition, benchmark against peers, identify inefficiencies, and stay up to date with industry trends and stakeholder expectations.

These include:

• Analytics programmes for benchmarking activities and flagging discrepancies.
• Systems that monitor governance ‘health’.
• Intelligence on standards, trends, news and stakeholder sentiment.
• Reporting solutions that consolidate frameworks and streamline stakeholder communications.

CREATING AND PROTECTING SUSTAINABLE LONG-TERM VALUE
Although the realm of governance is evolving, it’s clear that the ‘G’ in ESG is a vital cog that must be considered when instilling balance – not just in terms of financial management, but also social and environmental issues in the creation of a sustainable investment proposition.

Hamza Al-Haboubi, senior consultant – ESG advisory at WSP Middle East