Breaking down ESG – Governance strategy

Governance relates to the structures, policies, rules, and controls related to a company’s ownership, leadership, processes, and risk management. It ensures that a business operates fairly and has the right policies and processes in place.

Some of these will be set in law, like anti-corruption, anti-slavery and anti-bribery but others will be how businesses make their policies, declare finances, and distribute rights and responsibilities.

There are two models a business can implement when creating a Governance strategy; the shareholder model and the stakeholder model.

Shareholder model: The company is responsible only to its shareholders. Decisions will be based on the interests of shareholders, even if they go against what other stakeholders want. And as shareholders are more likely to be more self-serving and look at short-term gains. This means that the shareholder model is more for short-term decision-making and isn’t something that will work for companies that have more long-term plans that they want to put into place. 

Stakeholder model: The business has a responsibility to all of its stakeholders. This means they will look after the interests of everyone – including employees, customers, suppliers, and the wider community. This leads to better long-term decisions.

Pillars of governance 

Two pillars cover governance relating to an ESG policy. These are Corporate Governance and Corporate Behaviours. 

Corporate Governance  

Corporate Governance covers the range of rules and regulations that businesses need to adhere to. This includes areas such as the board structure, pay, ownership, accounting standards, shareholder rights, and cybersecurity. 

Board diversity and structure

In the last twenty years, diversity in the boardroom has gone through many changes. According to a survey by Deloitte, women sitting on boards globally is still low, at around 20%. However, women are now filling 40.5% of board roles in the FTSE 100, as per their report ‘FTSE Women Leaders’. People of colour and those in the LGBTQ+ community are also heading up more boardrooms. This increases engagement for the board and allows for more voices to be heard, ensuring important issues are discussed. Having a more diverse board structure also helps to create a more healthy culture in the organisation.

Employee and executive pay 

There is increasing pressure on companies to be more transparent with their pay structure and how executives are remunerated. There are no regulations or rules in the UK regarding how executive officers should be paid, but there have been headlines when failing or scandal-hit businesses still provide their C-suite employees with huge bonuses and redundancy packages. More businesses are now involving separate committees that help decide the remuneration packages based on a set of targets that the business has to reach. Some investors are beginning to use a variety of ESG performance targets in addition to the traditional metrics used when deciding executive pay, as they realise that managers focusing on more non-financial targets will help drive long-term value for shareholders. 

Accounting Standards & Reporting Obligations

Every business has to submit a set of financial accounts each year for tax purposes. These accounts have to follow a strict set of accounting standard, and are audited yearly for compliance. For financial services companies in the UK, there is an obligation to follow standards set by the Prudential Regulation Authority (PRA), the Financial Conduct Authority (FCA) and The Pensions Regulator (TPR). For listed companies and financial services sector organisations, there is also the Task Force on Climate-related Financial Disclosures (TCFD) set up in 2015 by the Financial Stability Board (FSB) to allow businesses to voluntarily disclose their climate-related finances. Organisations also have to follow certain regulations set out by the Companies Act 2006 which sets out the requirements for accounts reporting, and this now includes a variety of ESG-related details. 

Shareholder rights

Shareholders have certain rights concerning the shares they have, and equality between them is becoming more important for organisations to have in their ESG strategy. Companies are now held to account to make sure they don’t selectively disclose information to shareholders and leave others in the dark. All information must be made available to all shareholders at the same time. With sustainability becoming more important for businesses, there is a shift to getting shareholders more involved in those policies. Shareholders have a more invested interest in decision making processes and are an important part of a company. As such they are afforded rights that give them priority in discussions, decision-making, and how the business operates. 

Cybersecurity

There’s a growing need for cybersecurity to be an integral part of a business’s security strategy as well as part of its ESG strategy. According to the National Cyber Force, 49% of businesses have experienced a cyber breach or attack once a month. UK and EU businesses have to comply with GDPR and advise how they store sensitive data from customers, suppliers, and employees to ensure its safety. This means it is more important than ever for companies to protect their computer systems, networks, and data from cybersecurity threats. 

Organisations are starting to invest in training for employees regarding best practices and how to be aware of the potential risks to the business. In a report on statistics on UK Data Breaches in the UK from 2021, the National Cyber Force advises that only 11.3% of IT budgets in the UK are being used on investing in a secure cyber system. In this report, the UK is the fifth lowest country to spend on IT security. In the digital age, more businesses are reliant on technology and online systems, so having a robust cybersecurity policy is paramount. 

Corporate Behaviours 

Corporate behaviours will cover business ethics and values, tax transparency, and bribery and corruption.

Business ethics and values

The ethics and values you decide for your business will become the backbone of your decision-making. There are benefits of having an ethical corporate culture in a business, including employee retention and attracting new potential hires because their values align with the company. There’s also improved risk management as employees are better able to mitigate potential risks, as well as improved brand value.

A company that works with its employees to ensure that ethics and values are a part of daily life in the organisation will be more likely to have sustainable practices. Ethical decision-making, transparency and accountability, and stakeholder engagement are all important aspects that should be taken into account when looking at ethics in terms of an ESG policy.

Tax Transparency

Tax is fundamentally a social issue. It’s a financial measurement of a business’s contribution to society, and tax transparency is a business being open about that contribution. As the demand for transparency continues to grow among regulators, the public, and investors, it is an opportunity for businesses to show that they act ethically. By being transparent, a business can be realistic about its tax position, increase customer engagement, and strengthen its position with existing and potential employees who wish to work for a more ethical company. 

Bribery and Corruption

Businesses that have a strong ESG strategy will have policies surrounding anti-slavery, anti-bribery and anti-corruption. These policies will be readily accessible on their website, in employee handbooks, and in reports to shareholders and investors. And having these in place will reflect positively on a company’s risk management and compliance. 

Many organisations are working hard to ensure that their whole supply chain is free from slavery. It is a genuinely valuable part of an ESG policy and is front and centre for corporate compliance and risk managers. Having a robust anti-slavery policy will resonate with employees, investors, stakeholders, and customers alike.

Summary

As ESG continues to become a focus for many businesses, it’s critical for businesses to keep good governance practices as a focal point and a board priority. There are plenty of rules and regulations to follow, and these will change and adapt, but it is also about being ethical and having values that allow your business to align with customers, employees, and investors.