Wake-Up Call: Directors Must Focus on Sustainability Risks, BlackRock Letter Presses

For the past 30 years, I have had the fortune of advising some of the world’s leading companies on environmental, social, and governance (ESG) issues and sustainability. Those companies now see a high return on their investments: They save money; comply with regulations that other companies struggle with; attract talent, customers, and partners; have an easier time getting a license to operate and grow in new markets; and innovate solutions that reduce or help solve environmental and social problems.

These are the companies that have defined their purpose and have the resilience to not only survive but thrive in a world where compliance with “soft laws” and nonfinancial measures becomes the rulebook for success. They are the companies that develop sound decision-making based on long-term strategy versus quarterly goals. They are the companies with board members who focus on sustainability as a business driver.

Now, management’s and directors’ focus on sustainability can also—according to a recent letter from the CEO of the world’s largest asset manager, BlackRock—protect them.

As you may have noticed, Larry Fink’s letter includes this paragraph:

“Where we feel companies and boards are not producing effective sustainability disclosures or implementing frameworks for managing these issues, we will hold board members accountable. Given the groundwork we have already laid engaging on disclosure, and the growing investment risks surrounding sustainability, we will be increasingly disposed to vote against management and board directors when companies are not making sufficient progress on sustainability-related disclosures and the business practices and plans underlying them.”

A Wake-Up Call

Fink’s letter should be a wake-up call for all board members that it is time to ensure that their board has the insight and information needed to proactively oversee sustainability risks, opportunities, and disclosures.

NACD has been encouraging its members to answer this wake-up call, addressing sustainability (including climate themes) in the latest NACD Blue Ribbon Commission report, Fit for the Future: An Urgent Imperative for Board Leadership, for example, and in the blog post titled “ESG Risks Trickle Into Financial Filings.”

In that blog post, NACD senior research manager Leah Rozin states, “Companies struggle to identify the most relevant risks to disclose, and where in their reporting to disclose them. In 2019, 66 percent of companies in the Russell 3000 index discussed ESG risk but approaches varied widely.”

She also says that 30 percent of Russell 3000 companies “discussed climate change as a risk in their 10-K statement, with only 3 percent of companies discussing climate change risk in the [management discussion and analysis of financial condition and results of operations] section.”

That means that over 1,000 Russell 3,000 companies have not disclosed information about ESG risks—and over 2,000 have not discussed climate change as a risk in their 10-K statement. This lack of disclosure will no longer be accepted by asset managers like BlackRock or by the many shareholders and stakeholders whose expectations of businesses, and their actions and disclosures, are quickly changing.

I predict that these disclosure numbers will change dramatically in the coming years. However, the board must take the driver’s seat and ensure that disclosure drives real results. To quote Larry Fink, “The goal cannot be transparency for transparency’s sake. Disclosure should be a means to achieving a more sustainable and inclusive capitalism. Companies must be deliberate and committed to embracing purpose and serving all stakeholders—your shareholders, customers, employees, and the communities where you operate. In doing so, your company will enjoy greater long-term prosperity, as will investors, workers, and society as a whole.”

So, What Can and Should the Board Do?

First, I suggest that the board ask management to answer the following simple questions:

1. In the coming years, will the company’s customers and employees care more or less than they do today about the environmental and social impact of the company’s products and actions? (The board should expect that they will care more and question what management believes the key stakeholders will expect from the company’s future products and actions.)

2. Is the company currently making the most money on products that are solving environmental and social problems or products that are contributing to those problems? (The ratio will inform the board if or how fast a transition is needed.)

3. What are the risks and opportunities for attracting and retaining talent with the company’s current business strategy? (The answer will determine if the strategy needs to be revisited.)

4. What are the potential ESG and climate transition risks and opportunities for the company in the short-, medium-, and long-run? (The response to this question should form a good basis for a strategic discussion that also can involve a discussion of purpose.)

While management prepares the answers to those questions, the board should start on these “10 Steps Toward Good ESG Governance,” as developed by Competent Boards:

1. Determine if the board has the necessary insight on material sustainability, ESG, and climate matters or if more education is needed.

2. Determine the company’s most material stakeholders from the board’s perspective, and understand those stakeholders’ concerns.

3. Determine the company’s material ESG risks and opportunities and how they will impact the current business strategy and plans.

4. Ensure that ESG considerations are given sufficient attention across board committees.

5. Ensure that there are accountability measures in place.

6. Ensure ESG is integrated into strategic decision-making across the organization and its value chain.

7. Align ESG goals with incentives.

8. Ensure consistent and transparent reporting and disclosure.

9. Ensure that the company’s response to ESG demands is aligned with the materiality and proportionality of the issue to the business.

10. Maintain regular proactive dialogue with peers, policy-makers, investors, and other stakeholders.

With the above steps covered, management and the board should be able to sleep better at night and reap the benefits of being fit for the future.