Sustainability governance structures

As environmental, social and governance (ESG) concerns take centre-stage in a post-pandemic world, corporate boards have to assess how they organise themselves and their executives to govern the identification, management and reporting of ESG issues to stakeholders.

The board can take a two-pronged strategy to increase the firm's effectiveness as an active participant of the ESG imperative.

Sustainability committee

The first is the formation of a board-level sustainability committee with accountability for the overall sustainability strategy and performance of the business. Boards may also consider delegating sustainability issues to other committees, such as audit and risk committees, or combining the functions, roles and responsibilities.

According to Handshakes, a data tech company, 18 companies listed on the Singapore Exchange (SGX) have established board-level sustainability committees as of 31 December 2021. And it is not just the large-cap firms that are getting on board. Mid-caps and small-caps like VICOM, SBS Transit, Delfi and BH Global are among the companies that have set up sustainability committees.

Board committees play a crucial role in the effective functioning of corporate boards, especially in the areas of audit, nomination and remuneration. When a board forms a committee that is not mandated by listing requirements, it signals that dedicated resources are being deployed to govern key issues that matter to the board.

Given the rising importance of ESG issues and the move by SGX to mandate climate-related disclosures from financial year 2022, there are increasing benefits of having a dedicated board-level sustainability committee. In the first phase, the reporting requirements will be rolled out on a calibrated basis, impacting the financial sector, agriculture, food and forest products, and energy industries.

Before establishing a sustainability committee, boards should identify ESG team players in the operations, risk and compliance functions - who can understand ESG data and identify materiality. There is also a need to understand the expectations of external stakeholders. The S&P Global Ratings ESG Risk Atlas, for instance, looks at environmental risk factors such as inherent exposure to land and water use, manufacturing footprint and packaging. Social risk, meanwhile, comprises factors such as human capital and safety management.

A dedicated sustainability committee, with members having knowledge and expertise in ESG issues, may be in a better position to frame sustainability from a value-creation perspective rather than a risk or compliance angle. Research has shown that a value-creation approach can strengthen the link between sustainability initiatives and firm financial performance; as addressing sustainability concerns can open new market opportunities.

A sustainability committee can also facilitate coordination across board committees. Dealing with sustainability issues requires an integrated approach that covers executive compensation, board renewal and reporting, among others. Board committees composition can include cross-memberships (directors in multiple committees), rotations and use of non-board members. External experts with specialist skills who are not directors may be invited to sit on board committees on an ad hoc basis, but with no voting rights.

Alignment with management

The second strategy is the appointment of a Chief Sustainability Officer (CSO), or equivalent, within the ranks of senior management. A 2021 global survey by Deloitte and the Institute of International Finance projected the emerging role of the CSO over the next 2 years. CSOs tend to be appointed when external stakeholder scrutiny over ESG risks intensify.

The CSO can play an important role in ESG governance. For instance, the CSO of City Developments Limited reports directly to the board sustainability committee, which includes the CEO and 3 independent directors. While reporting lines and sustainability management structures differ across firms, direct access to the board signals strong alignment between the CSO and directors on ESG matters.

A study by Ruchunyi Fu, Yi Tang and Chen Guoli of S&P 500 firms shows that having a CSO significantly improves the firms' engagement in socially responsible activities, based on the following corporate sustainability markers: community, diversity, employee relations, environment and product.

There is also evidence that a CSO reduces socially irresponsible activities (e.g. polluting the environment) and the reduction is more pronounced when a board has a sustainability committee.

Changing mindset

ESG has become a business imperative and will gain prominence as diverse stakeholder groups demand greater accountability from corporations. Boards and executives must work closely to identify, manage and report material ESG issues to stakeholders.

Having dedicated teams to drive ESG initiatives does not mean that other board members and executives can ignore sustainability-related issues. On the contrary, dedicated teams not only ensure focused deliberations on ESG issues but also facilitate coordination within the firm to effectively implement ESG initiatives.

Sustainability governance structures have become more clearly defined since SGX introduced sustainability reporting for listed firms, and this trend is set to grow. Stakeholders keen to assess a firm's commitment to ESG management are likely to scrutinise sustainability reports to determine whether ESG considerations are substantively infused in its governance structure and processes.

There is no one-size-fits-all approach. Boards must weigh the costs and benefits of having dedicated teams to decide what works best for their firms.

The writer is a member of the Environmental, Social and Governance Committee of the Singapore Institute of Directors.