Confident in your board’s ESG competency? If not, now is the time to act

As ESG takes hold of minds and markets, boards of directors are expected to provide ESG oversight even though few have deep knowledge, formal reporting processes or clear accountabilities for climate resilience and ESG performance.

The ESG competency gap was an acceptable risk, until recently

Factors such as diversity, climate resilience and Indigenous reconciliation are now being scrutinized by shareholders, consumers, creditors, regulators and other stakeholders. Over the next five years, “social responsibility” is expected to be a company’s chief reputational concern, ahead of quality of service, vision and leadership, and even financial performance. Acting in the best interests of the company, many boards know they should interpret shareholder value to include addressing societal challenges, just as the public expects them to.

Yet, there’s a significant gap in terms of directors’ competency in ESG. The typical skills matrix for boards does not include ESG or climate risk. In a 2022 survey, only 47% of respondents said they believed their board had sufficient ESG competence and experience to challenge management on ESG plans and exercise board oversight on ESG execution. What’s more, few directors have formal training, experience or expertise in ESG and sustainability, or the material topics in their sector or operating jurisdictions. In particular, climate risk, low carbon strategy and emissions are the areas in which board members have the least understanding.

Still, boards are responsible for overseeing ESG risks related to corporate strategy and many boards certify corporate filings and reports that touch on a wide range of ESG issues and data. Until recently, this practice was an acceptable risk for most companies. The legal risks related to ESG remained a hypothetical until news that 11 of Shell’s directors are being sued for allegedly mismanaging climate resilience. Boards of directors and executive officers can now be held personally liable for their organizations’ ESG shortcomings.  Significant and record-setting penalties have been levied against organizations for making allegedly false and misleading ESG disclosure.

Addressing the ESG skills gap at the board level is not an easy task. Oversight comprises various interrelated parts: knowledge, accountability and process. Below are six actions for companies and boards to consider in preparing for increased scrutiny:

Can you “get real” about the risk?

To build knowledge, some companies are recruiting, upskilling through micro-certifications or engaging consultants for one-off training. But before ESG knowledge can be increased, the gap in ESG competency must be understood. Boards should evaluate the current skills and experience of their directors against the company’s ESG profile and update their skills matrix.

This includes material factors and ESG disclosure requirements. Another key part of the ESG profile is legal risk exposure, which can come from a wide range of internal sources such as data accuracy and performance, as well as external sources such as regulatory enforcement and shareholder activism. The assessment should depend on high-level self-awareness from the directors and a reliable  ESG profile. Otherwise, training can become a superficial and sometimes costly fix to address the knowledge gap. Once the specific knowledge requirements are determined, training sessions and resources should be customized for board committees and directors’ knowledge of material ESG factors and disclosure risks.

Where was the board?

A key component of effective oversight is the board’s accountability for management executing corporate strategy. The age-old question “Where was the board?” is as important as ever as directors are held to task over ESG commitments.

As a starting point, companies should understand investor and stakeholder expectations for their board’s oversight of ESG, as this may vary across sectors and jurisdictions. Soon, ESG standards and guidelines from the ISSB, SEC, OSFI and even the CSA will require companies to describe the board’s role and responsibilities when it comes to overseeing climate resilience. Any real or perceived gaps between a company’s commitment and performance can significantly impact directors.

In February 2023, the world’s biggest investment fund announced it would vote against re-electing the boards of approximately 80 companies including Apple, Nestlé, Microsoft and Samsung because they failed to set or meet ESG targets. While board committee mandates may contain the term “ESG,” companies should set clear responsibilities for the board and specific committee mandates in assessing progress against the transition plan as well as performance on other material ESG factors.

Can you trust the process?

While detailed processes exist for nearly every aspect of corporate governance, a wide range of practices apply when it comes to board oversight of ESG. Currently, no specific standards inform the frequency or structure for management reporting to the board on ESG risks or opportunities. As a result, directors’ ESG competency can determine the information required, level of discussion and ability to challenge management.

To combat this type of bias, review leading practices and emerging requirements in board duties and reporting to determine and document appropriate processes to enable ESG oversight. Moreover, as of 2024, most companies will need to disclose how climate-related risks and opportunities are identified, assessed and integrated into existing risk management processes at the enterprise level. Where ESG is not yet aligned or integrated with enterprise risk management (ERM), companies should review existing ERM policies and programs to refine risk identification, assessment and management in order to account for ESG risks and opportunities. 

As companies strategize and take action on ESG, leaders at every level should:

  • Stay on top of changes in stakeholder expectations: For example, an area of increased scrutiny is the use of carbon offsets, which until recently were considered a valid carbon-reduction tactic to meet corporate net-zero targets.
  • Monitor industry trends: By keeping an eye on the challenges and successes of peers and customers, companies can proactively identify risks of shareholder activism (e.g., Say on Climate resolutions) or alleged greenwashing.
  • Ensure consistency and balance in disclosures: Securities regulators and investors are now demanding refined diligence in ESG-related data and messaging across all corporate disclosures, marketing and communications, both new and old.

The MLT Aikins ESG practice group has wide-ranging and multi-disciplinary experience advising clients in all industries on their ESG strategies, governance and disclosure. Even if your company has substantial experience in publicly disclosing ESG and climate-related information, it is worth taking a fresh look at your board’s competency, reporting processes and accountability in light of upcoming mandatory reporting requirements and legal risks. Contact us to learn how we can help.

Note: This article is of a general nature only and is not exhaustive of all possible legal rights or remedies. In addition, laws may change over time and should be interpreted only in the context of particular circumstances such that these materials are not intended to be relied upon or taken as legal advice or opinion. Readers should consult a legal professional for specific advice in any particular situation.