In the stormy seas of modern markets, effective corporate governance can seem like Ithaca to Odysseus: a noble goal impeded by a litany of extraordinary obstacles. From technological innovation and population growth to resource constraints and climate change, a host of modern challenges are reshaping the competitive landscape of every industry, and the risk oversight responsibilities of corporate directors are evolving accordingly.
Mismanagement of these issues can have significant impacts on a firm’s financial outcomes and those of its peers. They can disrupt business models or even entire industries, they can create public relations crises, they can result in regulatory action—or they can do all three at once. Increasingly, a broad swath of stakeholders—from employees and key suppliers to customers and local communities—want to know how companies are managing environmental, social, and governance (ESG) issues.
Shareholders, too, have joined these ranks—although they may take a narrower view as they increasingly monitor corporate sustainability risks and opportunities. As the chairman of Vanguard, one of the world’s largest asset managers, noted in a 2017 letter to the boards of public companies, “directors are shareholders’ eyes and ears on risk.” Therefore, in this evolving competitive environment, ESG-related risk management is not just an operational responsibility for executives and their teams but also a governance issue that falls under the purview of the board’s oversight. Indeed, a board’s “sustainability literacy” is of growing concern to investors.
In their oversight role, boards—or, often, their audit or risk committees—must satisfy themselves that a company’s risk management approach is:
- Strategically aligned: this involves knowing which ESG factors are most relevant to the company’s business model;
- Appropriate to the organization’s risk appetite: this involves having comfort that the probability, magnitude, and timing of each issue’s impacts have been rigorously interrogated; and
- Present and functioning: this involves performance data through which the effectiveness of risk responses may be monitored.
The industry-specific standards recently issued by the Sustainability Accounting Standards Board (SASB) can help directors more effectively assess each of these key considerations. By viewing sustainability through the lens of financial materiality, the SASB standards identify the subset of ESG factors—six per industry, on average—that are reasonably likely to impact a company’s financial condition or operating performance. They are, therefore, fit to be incorporated into an organization’s enterprise-level risk assessments and discussions of strategy. And because they establish best-practice performance metrics, they can also be used for monitoring risk responses to inform an evaluation of residual risk. SASB’s Materiality Map, which can be seen here, illustrates the dimensions and key ESG factors to improve risk oversight.
As investors and their governance teams increasingly engage with directors and management around ESG-related issues, the SASB standards can help boards become more conversant on key, industry-specific sustainability factors. They can also help keep the lines of communication open beyond direct engagement through conventional channels, such as financial filings, sustainability reports, websites, and others. For instance, Nike provides an index of ESG-related performance indicators based on SASB standards on the investor relations page of its website, as well as in its sustainability report.
Such sustained and consistent communication about these issues is growing in importance—for example, of the 79 percent of investors who believe climate change is a significant risk factor, 61 percent believe enhanced reporting is the top priority for companies. For this reason and others, investors and companies alike have begun to embrace the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD), which have received public expressions of support from more than 450 companies with a combined market capitalization of over $7.9 trillion. Meanwhile, nearly 400 investors managing more than $22 trillion in assets have also done so. Notably, the TCFD specifically and repeatedly cited SASB standards as a practical tool for implementing its recommendations. This is because the standards, by design, help companies move their sustainability efforts “from principles to practice.”
As a result, although the SASB standards were designed primarily to fulfill investor expectations for consistent, comparable, and reliable data on ESG performance, they can also help directors respond to an evolving set of risk oversight responsibilities. Indeed, recent regulatory activity has indicated that boards may need to sharpen their ESG-related risk oversight. After the Securities and Exchange Commission issued cybersecurity guidance suggesting that boards play a strong role in overseeing cyber risk, a recent “red flag” enforcement order called out a financial services company’s board for failing to “administer and oversee” cyber risk. Meanwhile, the Federal Reserve reprimanded a commercial bank’s board for its “lack of inquiry and lack of demand for additional information,” which the Fed said led to “pervasive and serious compliance and conduct failures” related to customer welfare.
As corporate management and boards wrestle with a growing array of ESG frameworks and demands from ever-widening groups of stakeholders, the SASB standards can serve as a vital tool for achieving focus—in their reporting, their performance management, and their risk oversight. After all, effective decision making requires useful information—regardless of whether you’re an investor making a buy, sell, or hold decision or a director looking to identify, assess, and monitor the ESG-related issues most likely to affect your core business strategy and ability to manage risks and opportunities.
As directors attempt to navigate the shifting sands of competitive, regulatory, and capital market landscapes, new challenges are likely to call for new—or renewed—priorities. For example, in a recent NACD survey, most public company directors indicated they would like their boards to take more action to enhance ESG oversight and also identified strengthening oversight of risk management as a top improvement priority in 2019. With investors’ “eyes and ears” increasingly attuned to ESG issues, practical application of the SASB standards can be indispensable as boards modernize their risk oversight toolkits and help their companies proactively tackle tomorrow’s challenges today.
Matthew Welch is president of the Sustainability Accounting Standards Board (SASB) Foundation.