In just a few years, ESG (Environmental, Social and Governance) has gone from “What’s that? Oh, you mean CSR” (Corporate Social Responsibility) to becoming integral to the way companies and investors operate, and society frames major decisions.
Actually, integral is an exaggeration, but “important” or “key consideration” is certainly true. In 2018, for example, the Global Sustainable Investment Alliance reported that global sustainable investment exceeded $30 trillion, up 68 percent since 2014 and tenfold since 2004. And the volume of talk about ESG continues to increase.
Now, thanks to a new push from the EU, the goal of integrating ESG into business and society is coming closer to reality. With the introduction of the Corporate Sustainability Reporting Directive (CSRD), and the coming-our-way-fast Corporate Sustainability Due Diligence Directive (CSDD), there is real momentum behind making ESG central to the way we operate as business and society.
What is the concept behind ESG?
At bottom, ESG is a framework that enables stakeholders and other interested parties to score how a company manages risk and opportunities around sustainability-related issues, from pollution to gender diversity. And as we all know, what gets measured gets done.
Obtaining a meaningful score requires the use of a common comparison framework, which is where voluntary standards like the Global Reporting Initiative (GRI) and the Principles for Responsible Investment (PRI) come in. The higher a company’s commitment to ESG, the higher their ESG rating will be – assuming they do what they commit to and do it properly.
Given both the growing financial and reputational imperative around ESG, it is clear that there is a growing need for professionals to understand ESG principles and how they operate in practice. And that message is spreading. Around 57% of legal officers list ESG among their top five risk areas for 2023 according to a recent survey.
What is corporate governance?
Corporate governance is a common term and concept among large organisations. But for medium and small organisations, not so much. Because of this, these are the organisations for whom the new ESG-related criteria and CSRD and CSDD directives will likely have the biggest impact, so it’s worth spending a moment to explain what corporate governance covers.
Corporate governance covers the rules, practices and processes that direct and control a company or organisation. It involves balancing the complex and sometimes contradictory interests of the organisation’s many stakeholders, such as shareholders, management, customers, suppliers, financiers, government and the community. And since corporate governance also deals with accountability and transparency in business operations, it is an important aspect of ESG. However, governance often gets overlooked in favour of the sexier environmental and sustainability aspects of ESG.
What is good corporate governance?
Good corporate governance aims to ensure the long-term success of the company, enhancing its sustainability, and also protecting the interests of its stakeholders. This requires the use of clear and transparent processes, promoting individual and collective accountability, fairness, and responsibility, and operating strong compliance processes and procedures within the company. When you don’t have those, you get “Dieselgate” or the fines for non-compliance imposed on a number of Dutch banks in recent years. You probably don’t even need to be reminded of what Dieselgate refers to, which gives an idea of the huge reputational damage Volkswagen experienced as a result of its poor corporate governance.
If there is such a thing as good corporate governance, then there must be bad corporate governance too. Examples include ill-defined processes, poor corporate housekeeping and outdated recruiting and promotion practices.
Current hot topics in corporate governance
The label “corporate governance” may fly under the radar in terms of what grabs headlines in the business world, but a lot of what business people are talking about is in fact corporate governance or corporate governance-related. Look at the average board agenda, and it is full of corporate governance items. Here are some typical examples:
- Board and company-wide diversity and the related areas of work culture and creating a more diverse work environment.
- The financial, moral, reputational and social benefits of being diverse and being seen to be diverse. Research by S&P Global Market Intelligence Research, for example, concluded that firms with more women on their boards of directors performed better financially than less diverse companies.
- Businesses are under increasing moral and legal obligations to ensure and demonstrate that supply chains are free from forced labour and other forms of modern slavery.
- Compliance with Anti-money Laundering (AML) and Counter-Terrorist Financing (CTF) regulations. Recently, we have seen businesses being fined huge amounts for non-compliance with these.
Because of the wide array of issues that fall under the G of ESG, it is extremely easy to overlook or be unaware of potentially critical topics. This can result in reputational damage for non-compliance and a fall in your ESG score. These in turn can make it harder to attract increasingly ESG-aware investors.
How do the CSRD and the CSDD fit into the picture?
As discussed in other posts, the introduction of the Corporate Sustainability Reporting Directive (CSRD), and soon the Corporate Sustainability Due Diligence Directive (CSDD), make it even more important for companies and organisations to have their corporate governance ducks lined up in a row. The administrative requirements that come with these directives are tough and burdensome, and non-compliance carries financial and reputational risks.
But there is good news: being compliant with the directives presents an opportunity to create value as getting your corporate governance house in order regarding the directives will increase your ESG score and make your business or organisation more attractive to investors, shareholders, employees, customers, the community and government.
We explore more about the value-creating opportunities of ESG, CSRD, CSDD and good corporate governance in another post.