ESG Matters transcript: How Boards should be thinking about Climate Change

Transcript

Anna-Marie Slot:
Hello, and welcome to ESG Matters at Ashurst. I'm Anna-Marie Slot, global sustainability partner at Ashurst and today we have a very interesting special episode, focused really on how boards should be thinking about climate change. I'm very happy to be joined today by two of my fellow partners who are experts in the field, Ellie Reeves, who heads up our London environmental and health and safety practice and Will Chalk, a corporate partner who focuses on governance and boards.

What we're looking at today is really the issue of climate risk and climate opportunity. It's fair to say that there are companies out there where the boards are at the very beginning of this process, and there are companies where the boards are across this issue in how they look at the business, now and in the future.

The point of our conversation today, for those of you who are on boards where you want to know where to start, and for those of you further along wanting to get a sense check of what you're doing and how that ranks against how others are looking at things, please continue to listen. We're going to focus in on the key issues, the plans of attack and provide some resources to help you in your journey. Will, maybe you can start us off. Where do you think board members should be focused here? What are the key issues? What should they really be doing?

Will Chalk:
Hi, Anna-Marie. I guess the way we'd start, it can't be wrong to start, by mapping out one's legal and regulatory obligations under the E part, of ESG. Both as regards, the positive duties of directors, the obligations of companies, and the requirements to report on what's been done. I guess, without getting bogged down in what is an increasingly long list, at a very high-level, the sorts of things that would include, are: SCCR, so streamlined carbon reporting for certain companies. Those on the main market, the relevant requirements with the normal financial information reporting regime and the policies and the due diligence that sit alongside that disclosure. Similarly, and for the time being, just for those on the main market at the moment, the TCFD recommendations. For FS firms, and certainly to your area of specialism Anna-Marie, a whole myriad of VU driven requirements, depending on where you do business. You'd have seen earlier on this week, a UK equivalent of the taxonomy regulation in the pipeline.

But, fundamentally as a director of a UK incorporated company, all of this being founded on what's in Section 172 of the Companies Act, so that duty to promote success of the company, whilst taking everything relevant into account. Then if you're a large company for accounting purposes, to report on that and in this context, what I'm particularly thinking about is taking into consideration the impact of a company's operations on the community and the environment. Let's be clear, that mapping of legal and regulatory obligations is really only the starting point.

Anna-Marie Slot:

So, you're advocating a map to start. What does that really mean in practice for boards? I mean, what should they really be doing?

Will Chalk:
Well, it might sound binary, but then as we've discussed in the past, good governance is all about doing simple things logically and well, minimizing risk, mitigating it where necessary, leveraging opportunities. For me, tackling climate risk and opportunity CRO starts with a basic understanding of the issues, that's stating the obvious to a degree. In fact, each and every director's duties are act with skill, care, and diligence, requires them to do so. Getting that base level of knowledge is just part of the job.

Building on that, ESG in its broadest sense has caused a lot of boards that we've come across to reassess their bench strength and their training, both individually and collectively. Now, that's not to say that this is just about one person. Every director needs that baseline level of knowledge. In the same way as they do, for example, in relation to understand the finances of the operation of which they're a director.

Will Chalk:
Nevertheless, boards, and in particular nomination committees, need to consider if they have the right mix of skills, qualifications, and expertise to make decisions when it comes to CRO issues. Do they need to recruit that subject matter expert, whether it's to the board or to the senior leadership team? Particularly boards in high-risk, high-emitting sectors will need to give this particular thought and it's perhaps no surprise that the title of chief financial and sustainability officer is starting to emerge.

Of course, as in all things, where a board ends up on this will be dictated by the extent of the risk that the company faces. If you're a director who's new to this, and many quite understandably are at the moment, where to start on the up-skilling front. Well, I'd highly recommend the excellent resources produced by Chapter Zero, and for those that don't know, that's an association of non-executives attempting to educate each other on the issue of climate change. In particular, they've produced a list of questions for NEDs to ask, as regards oversight of physical climate risk management, which is another really useful toolkit among others that they've published, so NEDs could deploy as part of any induction.

Anna-Marie Slot:
I think you raise really good points there. I mean, people have started focusing, especially on that resource, do you have the right people on the board? I know that question has come up now around governance issues in different ways in the past for HR issues, modern slavery issues, various other things, but expanding that out now into an environmental and climate risk, is a really interesting question and one that you see talked about in the news, certainly on whether there's enough people who know what to do. The reference to Chapter Zero is really interesting, and a great starting point for people. I think once you have that board at least put together, or people focused in the right area, what do you think is the next point in terms of strategy for the board?

Will Chalk:
Well, again, that's probably stating the obvious, but the next part for me is an evaluation of one's business model and strategy. Relative to the risks, both for the physical risks and transitional risks, and the opportunities presented by climate change, so the work here is the foundation stone of one's actual response. As part of that, peer analysis would also be really useful.

The four pillars of the TCFD recommendations set out a really helpful methodology for attacking the issue in many ways. But of course, remembering that the goal of the TCFD recommendations, the purpose of the exercise is not disclosure to my mind. That's the wrong end of the telescope. The goal is the strategic planning, the risk management, the risk mitigation, and taking the opportunities presented by the challenge of climate change. With the work done subsequently being presented in what is hopefully a coherent report.

As part and parcel of that, of course tone from the top, to my mind, is absolutely vital, as it is with any issue of significance, whether it's corporate purpose strategy or culture more generally. If the board and senior management aren't invested in the issue, if the perception is that it's not seen as a matter of strategic importance to them, if it's not part of their daily discourse with stakeholders, both internal and external to the organization, stakeholders generally and particularly employees just won't ascribe any value to it either.

Anna-Marie Slot:
No. Exactly. That tone from the top you're seeing reflected in your comment about having the CRO also cover sustainability, it is that movement from something that someone in the organization handled to really pushing it up the food chain in terms of how it's looked at from a real commitment at the management and the board level. Ellie, what do you think, how should the board approach these questions?

Eleanor Reeves:
Thanks, Anna-Marie. Well, picking up on Will's points about tone, for some companies, climate related risks and opportunities, which we're referring to as CRO, play into every aspect of an organisation. But, taking a step back, it's important to understand that the nature and materiality of CRO will vary from company to company.

I think, five key points to consider should be: First, if a company's aims in relation to CRO should be informed by it stated purpose and indeed, it's purpose may need to evolve in light of CRO, as well as its values and culture. Second, the company's business model and strategy will need careful scrutiny in light of CRO. Third, CRO metrics and targets may alter KPIs or create new ones. Fourth, CRO may play into board and senior management recruitment and incentives. There's certainly an increasing focus on the latter from the investment community. Five, CRO will require significant commitment of time from those responsible for finance, legal and internal control and assurance.

Moving on to disclosure, an annual report provides a litmus test as to the extent of that integration. Some key questions for the board to consider include: Does CRA get mentioned other than in the risk and corporate responsibility sections at the annual report? Are the mandatory greenhouse gas emissions disclosures linked to, or even developed by, disclosures elsewhere? If the company has made voluntary disclosures in accordance with TCFD recommendations, has that work provided a foundation for further CRA disclosures, as far as the company's business model, its strategy, KPIs, risk, culture and stakeholder engagement are concerned?

It's worth noting that TCFD seeks to work within the existing business and governance structures and aims to integrate climate considerations into all business decisions. Finally, perhaps most importantly, is it clear from the financial statements, how CRA has impacted on them, including in relation to the future viability of the business?

Anna-Marie Slot:
A lot of things on that plate, there are a lot of different things to consider actually for the company. I think the TCFD lead is really interesting. I mean, being something that has evolved out of business leaders getting together and looking at what they would think good looks like. I guess, bringing that back down to an organizational level and a question for how the board can help themselves on this. You mentioned, and we've mentioned before in other conversations, engagement across organizations and what does that good look like? Will any thoughts on that?

Will Chalk:
Well, I think fundamentally Anna-Maria, engagement's got to be a two way street. It's got to be a dialogue and not a monologue within an organization. It shouldn't be a box-ticking exercise. I think it really presents the opportunity for a really interesting cultural opportunity to be leveraged. So, what are we seeing? Well, we've seen cross divisional working groups or climate forums, as some companies are calling them. They've been playing quite an important role in risk identification, risk mitigation, but their principal benefit appears to be in the discovery and the development of the opportunities a company might seek to exploit in relation to CRO.

In many ways, it takes us back to the first point that we just talked about, about bench strength, about diversity. In many ways, this is cognitive diversity at work. Getting the perspectives from different individuals in different areas of the business who have different skillsets, backgrounds, professional qualifications, outside interests, and also drawn from different age groups. This then chimes with the most recent McKinsey research, which concludes that there's a strong correlation, okay, correlation isn't causation, but a strong correlation between diversity and our performance. This approach, particularly the use of climate champions, brings the additional benefit of creating that secondary issue that I mentioned, creating that shared sense of ownership of the problem, the solutions, and indeed the opportunities. In helping to underscore the importance of the issue in the wider organization, it then creates that flow of decision useful information back to the board.

Anna-Marie Slot:
Where, hopefully, the board then has time to consider it. I think it's really fascinating to me, especially the impact of COVID, on how boards think about risk in particular. I think the climate is a similar type of risk to something like a COVID because, three years ago, I'm sure boards all had a five minute slot to discuss what happens if we have to put all of our people offsite overnight because of some global pandemic. Will, correct me if I'm wrong, they probably spent a couple of minutes doing that before they moved on to the more pressing, and more immediate for them, challenges about various other goal setting they were doing, or governance that they were looking into. I think climate in some ways, has a lot of similarity to that. COVID, if you're in a pre COVID world, it seems really far away. I mean, people are setting targets for 2050. 2050 is hopefully, for us at least, after our working careers are over and we're happily sitting in retirement somewhere, preferably by a beach in my case.

Will Chalk:
Well, let's hope so.

Anna-Marie Slot:
How do you bring that in? How do you make that real? How do you create those time horizons around that target setting?

Eleanor Reeves:
Absolutely, Anna-Marie, the setting of targets is intrinsic to the CRA challenge. To be meaningful, I think those targets need to measure up against the tried and tested SMART approach, so are they specific, measurable, attainable, relevant, and time bound? In fact, the financial reporting council's view is that disclosed corporate CRA targets also need to refer to overarching geopolitical commitments, such as The Paris agreement, and to NDCs, the nationally determined contributions, which are the efforts by each country to meet those commitments and the UK published its revised version in December.

Also, to enable benchmarking and direct comparison with the company's peers. I think stakeholders, and particularly investors, also want to understand the milestones a company is trying to hit along the way, i.e. the transition plan. That's because, as you know, that most climate related targets are based on time periods, which extend well beyond traditional business planning cycles and certainly beyond the 10 years of most board members. Without those interim goals, it's very difficult to assess progress meaningfully.

We're also seeing increasing demand from investors, for those targets to be science based, or at least backed by evidence. TCFD is also developing principles for defining metrics and there's a move towards transition planning, via TCFD, perhaps the new frontier. For setting and hitting interim milestones, this allows momentum to be maintained and even success to be celebrated. That may enhance organizational morale and that's a vitally important, if not intangible, aspect of corporate culture. There was a recent study published in The Lancet, that suggests that many younger people's mental health is being affected by climate anxiety and so, there's an opportunity for employers to seek to address that issue with affirmative action based on realistic, short, medium targets. Perhaps the road that's being traveled, is that always as important as the destination?

Anna-Marie Slot:
Ellie, a really interesting point to end on and I think a key takeaway for everyone listening today. So, boards, if you haven't started the journey, don't be afraid, open up the topic, look at the Chapter Zero work being done, where NEDs are getting together and talking about this at the NED level. For boards that are further along the way, really focus in on creating measurable tasks that are time delineated and that have impact outcomes and just general good governance across the board for all of these issues, I think, will help.

Anna-Marie Slot:
Thanks very much Will and Ellie for joining me today.

Will Chalk:
Pleasure.

Eleanor Reeves:
Pleasure.

Anna-Marie Slot:
Thanks for listening to this special edition podcast. We hope you found it worthwhile. To learn more about the issues we've just covered, please visit ashurst.com/podcasts. If you'd like to hear more on the compliance and governance side, please do look up our Ashurst governance and compliance update, which Will and our colleagues in the corporate department are putting out on a regular basis.

This special episode is just one part of our continuing podcast series, ESG Matters, at Ashurst. Make sure you don't miss any of our future episodes, including our 30 For Net Zero 30 series, where we talk with 30 climate change advocates around the world, on what they're doing now, to fulfill 2030 goals. Feel free to subscribe via Apple Podcasts, Spotify, or wherever you listen to your podcasts. While you're there, you can listen to our other episodes and leave a rating or review and please feel free to tell us if there's anything you'd like us to cover. In the meantime, thanks again for listening and goodbye for now.