To properly manage ESG risk, the risk must first be identified; to identify risks, companies must develop reporting procedures to gather high-quality ESG data. To maintain consistency among different data sets, companies should aim to have a standard process and create central repositories or reference sets for recording ESG data. Ideally, having automatic processes to record data as opposed to manually adding data would minimize errors in data sets.
Given the wide-ranging nature of ESG, a Board should focus on risks and opportunities that are material to its business. Companies may consult an established ESG framework to ensure that all ESG risks are identified or consider whether their stakeholders have a preference for a specific disclosure regime. A Board should also know what is expected of the company in terms of ESG disclosure based on the standards specific to its industry.
Once ESG risks are identified and risk management strategies are implemented, these should be integrated into the company’s corporate strategy and business decision-making. The ESG risks should be assessed and evaluated by the proper parties to determine which actions would best address or mitigate potential issues. Boards should look to establish ESG metrics and targets to track progress and measure and improve their companies’ ESG performance. When establishing ESG metrics, Boards should not only leverage metrics established by various governmental bodies and industry associations but also establish ESG metrics that are specific to the operations of the business and the industry in which it operates.
Once the ESG policies and procedures, including setting ESG metrics and targets, are established and implemented, directors should then ensure that they are functioning in the way the Board and executives intended. To be effective, employees of the company must not only be aware of the ESG policies and procedures, but they must also follow the framework to properly recognize and appropriately escalate ESG risks. The Board must be aware of and align the company’s ESG risk profile and the principal ESG risks on an ongoing basis. To achieve this, the Board should continuously engage in discussions with management regarding potential ESG risks. The Board should also consider incentivizing senior management to meet the company’s ESG targets through ESG metrics in their executive compensation plans. ESG policies should also include procedures designed to ensure that any information required to be disclosed by the company, whether in its annual filings or other reports, is communicated to senior management as appropriate to allow timely decisions regarding disclosure. For public companies, certain ESG disclosure obligations may be dictated by regulatory authorities that have established mandatory ESG reporting requirements. In addition, stakeholders of the company, such as shareholders or lenders, may require the company to provide non-regulatory reports on ESG matters. The Board must be aware of what is required to be disclosed in each instance and whether an ESG concern meets the materiality threshold that means it must be disclosed. Determining materiality in ESG can be complex; public companies can engage third parties to assist with materiality assessments to assist in determining whether a matter should be included in an ESG disclosure the company may make.
ESG Expertise of Board Members
According to PwC’s 2021 Annual Corporate Director Survey, when directors and executives were both asked how well their Board understood ESG matters, 80% of directors felt that their Board understood ESG matters very or somewhat well. In contrast, when executives were asked the same question, only 47% of executives felt that their Board had a good handle on ESG matters. A Board and the company’s directors should perform ongoing evaluations of whether its members possess the requisite expertise to understand and advise the company on ESG issues. This includes understanding best practices and nuances specific to their market and assessing performance standards when comparing their company to similar companies in the same industry. Therefore, determining the expertise of each board member with respect to ESG matters is essential when assigning roles and assessing ESG risk. As ESG is continuously evolving, directors should consider ongoing training to ensure they have the knowledge to address complex issues relating to ESG.
As a best practice, directors should ensure that the company has an ESG risk management policy that is aligned with the company’s values and is observed by all of its employees and suppliers. Once ESG risks are identified and communicated, directors must then evaluate the ESG risk and implement an appropriate strategy to address the risk. The chosen strategy should then be monitored, reviewed, and appropriately then documented and communicated.