Australian companies are embracing environmental, social and governance (ESG) issues despite facing a recession and the ongoing fallout from the coronavirus pandemic, according to a Governance Institute of Australia roundtable.
Economic crises traditionally prompt organisations to concentrate on their core operations to ensure they survive, but the unusual nature of the pandemic has brought traditional corporate purpose and ESG principles closer together.
That view was supported by recent Diligent Institute global research, which found that directors are spending more time considering ESG issues since the pandemic and expect to continue doing so.
“Going through the pandemic, it became pretty clear that board level decisions that impact stakeholders really took centre stage,” said Diligent Institute Executive Director, Dottie Schindlinger.
“There’s a lot of conversation happening, from the board level on down, about how the company can be responsive and do the right things around its employees, customers and stakeholder groups.”
Governance Institute of Australia recently brought together a diverse group of specialists to consider how the events that have made 2020 unlike any other year have shaped local perspectives on ESG.
ESG is aligned with shareholder value
Agreement isn’t universal
Just over 12 months ago, the influential US Business Roundtable redefined the purpose of a corporation from purely delivering profits to shareholders, to instead promoting an economy that serves the entire community.
This broadly split business and academia into opposing camps, with Harvard Professor Lucian Bebchuk and Oxford Professor Colin Mayer two prominent voices on opposite sides of the debate.
Consultation on including social licence to operate in the fourth edition of the ASX Corporate Governance Council’s Principles and Recommendations sparked similar discussion in the media. 2020 is the first year that listed companies must report against the updated recommendations.
Consensus around the table
Despite these dissenting views, the participants in Governance Institute’s roundtable largely agreed that corporate purpose and social purpose are not working in opposition, but are deeply intertwined.
Tim Nelson, Executive General Manager, Energy Markets at Infigen Energy and an Associate Professor of Economics at Griffith University, explained it from an investor’s perspective: “If I see a company that’s not practicing this stakeholder inclusion, then it’s just not going to generate long term returns.”
His view was shared by ASX Special Counsel, Regulatory Policy, Kevin Lewis. “I think the two things stand together,” he said. “You can’t achieve your outcomes for your shareholders if you don’t have employees or if you don’t have customers.”
It’s an interdependency that’s echoed at an economic level, according to Komal Jalan, Principal, Pacific Investment Management at Mercer Australia.
“Our investment activity has an impact on the environmental, social and governance construct of the economy, which in turn feeds back in our investment return,” she said at the roundtable.
Taking the pulse of ESG in a pandemic
Diligent Institute surveyed 406 directors and business leaders around the world on how boards are acting on the increased focus on stakeholder interests amid the challenges of 2020. The results were published in its report Stakeholder Capitalism: Translating Corporate Purpose into Board Practice.
An overwhelming majority (91%) of surveyed directors agreed with the updated Davos Manifesto on broader corporate purpose, according to the Diligent Institute report, with 70% strongly agreeing. The survey participants came from among attendees at a virtual panel discussion on stakeholder capitalism.
“A company is more than an economic unit generating wealth. Performance must be measured not only on the return to shareholders, but also on how it achieves
its environmental, social, and good governance objectives.” World Economic Forum’s Davos Manifesto 2020, article B
The survey of 406 directors and business leaders around the world found that 84% agreed that capitalism must focus on all stakeholders rather than just shareholders, and 50% strongly agreed (the result was even higher if US directors were excluded).
A snapshot of the survey’s key findings
COVID-19 has amplified the importance of ESG, while also giving it a local focus.
- ESG is being talked about more frequently at board level.
- Customers, employees and local communities are the most important stakeholder groups.
- Top issues for boards follow two themes: centred first around the pandemic and then on ESG.
ESG issues have become more significant
The Diligent Institute report explored the areas where boards have changed their guidance to management this year. It found that the top issues fell into two clear groups.
First were areas directly affected by the pandemic: 45% of directors surveyed nominated employee health, safety and welfare, followed by crisis management and preparedness (44%), and cyber risk (40%).
However, the next three issues were all traditional ESG factors: diversity and inclusion (31%), climate change and sustainability (30%), and succession planning and talent acquisition (also 30%).
Addressing climate change central to rebuilding Australia’s economy
Sustainability is seen as part of the solution to Australia’s current economic downturn, rather than a distraction from it.
In August, Global Compact Network Australia, a United Nations affiliate, wrote to Prime Minister Scott Morrison, urging the government to use the United Nations’ Sustainable Development Goals as a framework to help steer the economy through the coronavirus pandemic and create a more resilient future. The letter’s 52 signatories included organisations in the telecommunications, retail and consumer goods, financial services and legal industries, including Governance Institute.
Just days later, a group of Australia’s peak medical bodies also wrote to the Prime Minister stressing the importance of addressing climate change as part of economic recovery. The letter states that “the world is in the middle of two global health emergencies: the viral pandemic and climate change.”
It highlights the growing sentiment for meaningful action on sustainability amid the pandemic, and the shared responsibilities of government, business and individuals.
Reflecting diverse communities
Governance Institute’s roundtable reflected diversity in action. The 16 participants comprised equal numbers of women and men, and came from across sustainability, risk, finance, investment, regulation and governance (see breakout box for more details). Diversity was clearly an issue close to many of their hearts.
While diversity is slowly increasing across corporate Australia, the group called out the lack of diversity in senior executive ranks and the limited focus on other dimensions of diversity as areas where more progress is still needed.
For Andrew Buay, Vice President, Group Sustainability and Acting Vice President, Human Resources, at Optus and Singtel, diversity begins with considering the philosophy behind why it matters. That includes understanding diverse customer segments as well as supporting a strong culture of innovation.
“You’ve got to look at diversity from a more holistic perspective… The diversity of the organisation comes from the diversity of the community because that’s where we’re hiring from. So, having congruence between how the company operates, its values, and what it does to foster diversity in the community is actually quite important.”
Voices of experience
Moderator Catherine Maxwell, General Manager, Policy and Advocacy at Governance Institute of Australia was joined by a diverse group of specialists for the ESG roundtable:
- Dottie Schindlinger – Executive Director of the Diligent Institute
- James Hall – General Manager, Corporate Finance at AGL Energy and a former Chair of the Australasian Investor Relations Association
- Mans Carlsson – Head of ESG Research at Ausbil Investment Management
- Kylie Porter – Executive Director of Global Compact Network Australia
- Darian McBain – Executive Advisor, Corporate Affairs and Sustainability at Thai Union Group and a nonexecutive director of M.P. Evans and Be Slavery Free
- Peter Smiles – Deputy Company Secretary and Senior Manager, Group Legal at QBE Insurance Group
- Mathew Ronald – Director, People Advisory Services at EY
- Amanda Visser – Group Head of Sustainability at The Star Entertainment Group and Chair of Sustainable Development Partnership for the City of Sydney
- Kevin Lewis – Special Counsel, Regulatory Policy at ASX
- Tim Nelson – Executive General Manager, Energy Markets at Infigen Energy and an associate professor of economics at Griffith University
- Komal Jalan – Principal, Pacific Investment Management at Mercer Australia
- Kerry McGoldrick – Partner at ShineWing Australia and a member of Standards Australia’s Risk Management Committee
- Susan Campbell – Legal Counsel and Company Secretary at Queensland Sugar
- Julie McPherson – Former Group General Counsel and Company Secretary at Amcor
- Andrew Buay – Vice President, Group Sustainability and Acting Vice President, Human Resources at Optus and Singtel
ESG starts close to home
“There’s this overwhelming sense that this experience that we’ve all lived through of COVID-19 is going to forever change the way directors think about the impact of their decisions on more than just their shareholders,” said Diligent’s Dottie Schindlinger.
The groups which boards are most commonly considering in their current decision-making according to the Diligent Institute report are employees (79% of respondents), customers (70%), and local communities (47%).
They ranked well ahead of other stakeholders such as government (35%), the wider public (31%), and the media (18%).
Those results resonated with the roundtable, who said protecting staff health and wellbeing was a top priority for boards and executives. Whether people are working from home or, in essential industries such as energy and food production, adapting to changed conditions on site, safety comes first.
Darian McBain, Executive Advisor, Corporate Affairs and Sustainability at major seafood producer Thai Union Group, emphasised that if people were unable to work, organisations’ whole supply chains could collapse.
Looking after workers is paramount to be able to continue serving customers, whether those workers are employed directly or further along the supply chain.
Customers follow closely behind as the next most important group of stakeholders, with their safety vitally important. Supporting customers facing financial hardship and during lockdown were also focus areas.
Those themes were also highlighted by participants from investment markets as coming through strongly in the recent company reporting season.
The focus on local communities is a natural consequence of focusing on employees and customers. With our geographic footprint significantly limited amid the pandemic, the places where we live and work have become more important. Even global organisations are viewing stakeholders through the lens of a network of
communities, each with different needs, challenges and risks.
Actions speak louder than words
Reporting doesn’t always equal value
Accounting standards only have very limited ability to reflect the value of organisations’ human capital and environmental impact on the balance sheet but, while it’s an opportunity for change, the roundtable participants didn’t see it as a major limitation.
In a clear sign that disclosure does not always guarantee transparency, participants said that creating new reports wasn’t cost effective, efficient, or even particularly valuable.
On similar lines, there was scepticism for risk management processes that appeared to exist for their own sake rather than to inform decision-making. Kerry McGoldrick, a partner at ShineWing Australia and a member of Standards Australia’s Risk Management Committee, observed that risk management needed to be reflected in culture and action, rather than being an encumbrance.
The market already demonstrates that ESG factors are increasingly incorporated in how companies are valued. Those that fall short of expectations are swiftly called into question. Major investors have made it clear that environmental destruction and sexual harassment will not be tolerated regardless of strong financial performance.
Governance goes beyond the board
Boards often become more operationally focused during a crisis by necessity. In the current environment, that’s occurring in the context of greater public scrutiny of boards and their capability to adequately monitor risk management, particularly in relation to non-financial risks.
At the same time, management can find boards leaning too far into the detail can be both counter-productive and frustrating.
A perhaps surprising outcome of doing business in 2020 has been a trend in the opposite direction, with the focus on good governance extending beyond the board and into the management ranks.
“COVID-19 has brought out in a number of organisations how important governance is,” said Susan Campbell, Legal Counsel and Company Secretary at Queensland Sugar Limited. “Managers are having to embrace governance more and more in their day-to-day roles.”
How boards can do more
Roundtable participants had some suggestions on how boards could go further in addressing ESG issues, such as:
- Actively connecting profit with broader corporate purpose to create greater congruence, rather than seeing ESG as a separate area.
- Greater input into setting board meeting agendas, including bringing external perspectives to the table.
- Achieving greater diversity in executive teams, particularly in roles with P&L responsibility.
Measuring our progress
Metrics that matter
The difficulty of quantifying ESG factors from an accounting perspective underlines the importance of identifying appropriate metrics to monitor progress. It’s further complicated by the evolving range of hygiene factors that represent stakeholder expectations.
While comparing ESG performance between organisations benefits from using consistent metrics, metrics also need to enable them to focus on the issues that are most significant to them and their stakeholders.
Instead of assessing metrics individually, investors benefit from a more holistic perspective which incorporates a range of measures as well as relevant qualitative data. Boards need to take a similar approach when evaluating performance, ensuring that financial results are not achieved at the expense of ESG responsibilities.
There is a greater acknowledgment that ESG principles are deeply intertwined with financial outcomes, but the issue is when they crystallise.
Over the long term, positive ESG performance is aligned with investor value. However, there can be a tension in the short term if ESG metrics are achieved when financial targets aren’t hit.
Rewarding change for the better
Australian boards are increasingly tying executive remuneration to ESG factors, according to panellists. One participant said their organisation had recently included diversity measures among multiple ESG-related remuneration KPIs for top executives. APRA has pushed financial institutions to report on non-financial risks such as climate change.
Not all attempts to link ESG and remuneration have worked. One perverse outcome occurred when one transport company’s executives were rewarded because the lost time injury rate fell, even though the number of fatalities had risen.
Establishing a clear relationship between culture and remuneration is essential to make sure people are rewarded for what matters and avoid creating disincentives.
The unusual operating environment this year means boards need to be more actively involved in reviewing remuneration, particularly in relation to incentive pay.
EY partner, Mathew Ronald, highlighted the importance of boards carefully considering remuneration in a broader context and exercising discretion where necessary, whether that means withholding incentives despite hurdles being achieved or making limited payments. In a climate of rapidly escalating unemployment and widespread financial pressure, awarding significant payments to executives is likely to feel tone deaf to ordinary Australians.
This year has been a major test of organisations’ resilience and their ESG frameworks have a part to play in how they emerge from the economic and health crises. Those who actively consider and address how they can best contribute to positive outcomes across a range of stakeholders stand to generate long term value for investors and better outcomes for future generations.
Join Dottie Schindlinger, Executive Director, Diligent Institute, at the In-House Legal Virtual Conference, presenting on the topic 'What you (and your board) need to know about the future of ESG'.
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