One of the key questions for companies that are just getting started with Environmental, Social and Governance (ESG) is which topics they should focus on.
Depending on which ESG framework you use, there could be more than 30 topics that fall under the umbrella of ‘ESG’. Companies are not expected to manage and report on all topics, but just those topics the company has determined to be ‘material’.
There are best practice methodologies for determining materiality that depend on your business objectives and audience. We talk more about materiality in this blog link, which references how we produced our foundational ESG report.
While it is ultimately up to each company to provide the rationale for how it has determined some topics as material and not others, there are some topics all companies should consider material right now, regardless of their industry, size or context, because of the global ESG landscape.
Here are three of those topics:
1. Gender diversity among senior leadership
The air time that board gender diversity received in 2023 is only going to ramp up over the next 12 months as global and local initiatives gain momentum.
The Sustainability Accounting Standards Board (SASB), which governs the ESG reporting methodology preferred by investors, links diversity at management level with an entity’s ability to attract and develop top talent.
2021 research conducted on FTSE350 boards found a positive correlation between gender diverse boards and better future financial performance, higher stock returns and less shareholder dissent.
What companies can do about it: According to Recommendation 1.5 of its Corporate Governance Principles and Recommendations, the ASX expects companies to set measurable targets for achieving more balanced representation and develop a recruitment strategy to support their goal. Companies with gender-balanced boards are expected to be able to evidence their strategy for maintaining that balance.
2. Climate change
A common misunderstanding about climate change is that any associated risks will be largely felt by companies in mining and / or fossil fuel industries, or those with a bricks and mortar business.
Climate change poses risks right along a company’s supply chain. These risks include increased operating costs thanks to higher insurance premiums and compliance, technology disruptions due to lagging decarbonisation efforts, supply chain interruptions, and decreased worker productivity due to health and climate-related illness.
In a revised edition of its corporate governance guidelines published in 2019, the ASX highlighted the relevance of climate change as an “environmental or social risk” which should be disclosed pursuant to recommendation 7.4 of its Principles and Recommendations. The ASX provides further guidance that “many listed entities will be exposed” to transitional and physical risks associated with climate change, and it encourages entities to review and disclose exposures, where relevant.
Legal opinion initially commissioned by the Centre for Policy Development in 2016, and updated in 2019 after the ASX published its revised guidelines, concluded that “profound and accelerating” shifts in the way Australian regulators, firms and the public perceive climate risk had elevated “the standard of care that will be expected of a reasonable director”, with benchmarks for that care rising.
Both the Australian Securities and Investments Commission (ASIC) and the Australian Institute of Company Directors have endorsed the legal opinion.
What companies can do about it: Climate risk analysis is a complex task best approached in small bites. Start by mapping your value chain and then considering at a high level where key physical and transition risks might exist. Descriptions for different types of climate risk are set out by the new globally leading standard for investor-focused climate risk disclosure, IFRS S2, issued by the International Sustainability Standards Board. Once the company has a high level understanding of its physical and transition risks, the company can use scenario analysis to test their resilience and develop strategies for managing those risks.
3. Supply chain management
There are very few (if any!) companies that operate in isolation. Most companies, including smaller companies, have some reliance on suppliers, which could include distributors, manufacturers and consultants. Smaller companies might even expose themselves to a different set of supply chain risks than their larger counterparts because they tend to outsource some management and governance functions that larger companies handle in-house.
Supply chain management is a crucial ESG topic for all businesses. Without proper supply chain risk analysis and management, companies could find themselves dealing with negative outcomes associated with ESG topics not obviously material to them, but material to their suppliers, such as data and privacy breaches or cyberattacks, modern slavery, climate change, water, biodiversity, and more. These outcomes are likely to have reputational, litigious and other financial implications for the company.
What companies can do about it: One of the simplest ways companies can begin to manage their supply chain is to screen their suppliers for environmental and social risks as part of their onboarding processes, and regularly survey their suppliers for any changes to their operations. Screening should be more than a tick-the-box exercise; companies should have a clear policy and management plan for handling suppliers that pose a high level of risk for any ESG indicators. The board should be informed of the policy-setting and risk management process.
