Environmental, social and governance issues have become mainstream considerations for businesses . With much of the attention paid to the environmental aspects (such as climate change and pollution) and increasingly the social aspects (such as workplace health and safety), it may appear to the casual observer that the governance aspects (such as board structure and accountability) are neglected.
That would be a mistake.
It is said that the term “ESG” was first coined in a landmark study Who Cares Wins published in 2004, a project initiated by Kofi Annan and facilitated by the United Nations Global Compact. The initiative brought together global financial institutions to develop guidelines on ESG issues, connecting the financial markets to a changing world.
The report states that sound corporate governance and risk management systems are crucial pre-requisites to successfully implementing policies and measures to address environmental and social challenges. The term, “ESG”, highlights the fact that these areas are closely interlinked.
Environmental issues and social issues must be analysed alongside corporate governance issues. Governance is the golden thread running through sustainability.
Sustainability starts with governance
The preamble to the Code of Corporate Governance (Code) states that sustainability, accountability and transparency are tenets of good governance, and places the responsibility for good corporate governance on boards.
The central role of boards in the proper management of ESG issues is a key reason why Singapore Exchange Regulation (SGX RegCo) requires a board statement in sustainability reports. The sustainability report must contain a statement from the board on its role in determining material ESG factors and overseeing the management and monitoring of these factors.
When we surveyed financial institutions in early 2021, they confirmed our belief that without a strong governance structure, sustainability reporting becomes more of a recording exercise, instead of a cohesive framework that can be used to achieve desired business outcomes.
These findings led to the recent public consultation paper, “Climate and Diversity: The Way Forward” published by SGX RegCo in August 2021 (Consultation), where we proposed to strengthen the governance of sustainability issues. These proposals have now been implemented in the Listing Rules as well as the accompanying Sustainability Reporting Guide.
Among others, we proposed a refinement to ask boards to consider sustainability issues in the context of the company’s business and strategy. Sustainability issues are business issues. This enhancement sharpens the focus on ESG factors that arise from the issuer’s business and the board’s strategic response.
In addition, we proposed that the sustainability report should also describe the respective roles of the board and management in the governance of sustainability issues. Management has the responsibility to ensure that ESG factors are monitored on an ongoing basis and properly managed, while the board takes ultimate responsibility for the issuer’s sustainability reporting. The board’s close interaction with management will enable the board to satisfy itself on the effectiveness of sustainability governance within the company.
Leverage on existing risk and control structures
Today, boards must comment on the adequacy and effectiveness of the issuer’s internal controls (including financial, operational, compliance and information technology controls) and risk management systems. This requirement is an extension of the principle in the Code that the board is responsible for the governance of risks to safeguard the interests of the company and its shareholders.
It can no longer be denied that ESG risks have an impact on the company. The global momentum to combat climate change, for example, means that companies must take action to deal with climate risks and report on these activities to stakeholders. Boards would need to review whether the internal structures within the company are appropriately established to do so.
The internal control and risk management systems should therefore cover material ESG risks and opportunities and the sustainability reporting process. In order to fulfil these responsibilities, boards can leverage on existing governance frameworks.
For example, the enterprise risk management structures could be extended to look at ESG risks. The World Economic Forum’s Global Risks Report 2021 cites extreme weather, climate action failure and human environmental damage as the highest likelihood risks of the next 10 years. Knowing these trends, a responsible board would need to consider how to manage the associated risks. We ask that companies integrate ESG risks into enterprise risk reviews to enable boards to have a holistic view.
Another area would be internal audit. The Institute of Internal Auditors recognises a role for internal audit to play in sustainability reporting, such as conducting a review of the sustainability reporting process. Internal audit can thus provide reliable assurance to the board on the effectiveness of ESG risk management, including
ESG reporting. Internal auditors should cover key aspects of the sustainability reporting process in their internal audit plan.
Progressive regulation needs progressive boards
Companies differ in size, industry, operations and needs. Given the broad spectrum of companies, corporate governance rules are calibrated and designed to be applicable to different companies to varying degrees. A secondary benefit of such design is to allow consensus on best practices to develop. Over time, as practices mature, what was a best practice by early adopters could become a minimum requirement for all companies. From an ecosystem perspective, this differentiation mitigates the weight of compliance while still advocating market improvement over time.
The corpus of corporate governance rules comprises statutory law, subsidiary regulations, listing rules and codes of best practices.
The Code itself is also structured in a calibrated manner.
- The Principles of the Code set out basic tenets of corporate governance that all listed companies must comply with.
- The Provisions set out general practices that companies should adopt on a “comply or explain” basis. If they choose to adopt alternative practices, there is flexibility to do so, provided adequate explanation is made of how such substituted measures still meet the aim and philosophy of the requirement.
- A set of Practice Guidance gives more details on best practices that can be adopted on a voluntary basis.
Mandatory requirements apply to set baseline standards that all companies must comply with, such as the establishment of an audit committee by all listed companies in Singapore. The voluntary aspects, including recommendations on a “comply or explain” basis, depend on adoption by individual companies.
In relation to sustainability as well, a progressive approach is adopted. While the Listing Rules set certain basic requirements on the sustainability report (such as the inclusion of a board statement, or climate risks and opportunities consideration), companies are afforded flexibility in various areas. These include the determination of material ESG factors, and the adoption of a phased approach to gradually improve on their sustainability reporting. The quality of reporting is also an area for which the board is accountable – if any question is raised regarding the issuer’s sustainability reporting, the board and management should make sure it is addressed.
For a progressive approach to work, boards must give thought to what is best suited for the business and operations. The Code and the Sustainability Reporting Guide set out various recommendations that would benefit companies. In deciding which of these recommendations to implement, and when to do so, companies must not solely take the perspective of operational efficiency or practical convenience. Instead, they need to consider what would meet the spirit of the recommendations, while serving the needs of the company and its stakeholders.
The business environment is challenged by the pandemic, climate change, and new and disruptive technologies. The old adage, that change is the only constant, continues to ring true today. Boards are the master weavers of the corporate tapestry, and sustainability, its worthy loom.
By Michael Tang. Michael Tang is Head of Listing Policy and Product Admission at Singapore Exchange Regulation. This article first appeared in the Q1 2022 issue of the SID Directors Bulletin published by the Singapore Institute of Directors.