Board ESG oversight: How to embed ESG in corporate strategy

Written by
Héloïse Courault

Corporate Governance and Stewardship Analyst, AXA IM

Integrating environmental, social and governance (ESG) issues into a company’s corporate strategy helps businesses identify growth opportunities, strengthens their risk management processes and, as a result, positively impacts their financial performance.

But to integrate ESG effectively, adequate corporate governance mechanisms need to be in place – and at the highest level of the company. Board directors must be capable of identifying ESG risks and opportunities and challenging management on sustainability issues.

The importance of getting the board on board

The key role of the board has been highlighted by recent regulatory developments. In the US and Europe new rules may or will require boards to show how they are tackling issues such as sustainability and climate change. Here at AXA IM, we use our voting policy at AGMs to ensure that the governance of companies we invest in enables an appropriate oversight of ESG issues.

We have identified the three main ways companies can oversee ESG:

  • Oversight by a broader committee

Some companies extend the remit of existing key board committees to include broader ESG-related responsibilities. Sometimes, for example, the Audit and Risks Committee is asked to oversee ESG reporting and the identification of ESG-related risks. The danger of this type of governance structure is that board supervision of ESG issues is limited to certain aspects of sustainability. One recent study found that ESG scores for companies with combined committees were lower than for companies with below-board committees or a standalone board committee.1

  • Standalone ESG committee

With this type of ESG-focused committee, shareholders can easily identify the directors responsible – and accountable – for the supervision of ESG issues. Some companies also appoint a Lead Director dedicated to climate or broader ESG issues. The risk with both these approaches is that they could isolate ESG-related issues from broader strategic discussions. Therefore, we consider it key for standalone committee to coordinate with other key committees on specific ESG-related issues, and to regularly report to the full board.

  • Full board oversight

The more holistic approach is to make the entire board responsible for ESG oversight. Unfortunately, boards are now busy places, and the risk is that ESG issues may be overlooked. If this approach is to work, the full board must have overall responsibility for ESG oversight, but key committees also need to be involved depending on their specific responsibilities. Committees should also report back to the full board, allowing for a more comprehensive oversight of ESG issues.

The need for ESG skills

To ensure effective oversight, Board-level ESG skills need to be up to scratch. A 2021 survey from PwC found that only 25% of directors say their boards have a strong grasp of ESG risks. 2 This is concerning to say the least and it’s why we push investee companies to include, disclose and properly assess relevant sustainability skills in their board skills matrix. Regular training on sustainability is also a must for board members.

The ingredients of a successful board

‘Traditional’ standards of corporate governance, such as diversity of profiles and expertise, play a key role in ensuring efficient board ESG oversight. Boards should also have a sufficient proportion of independent directors, to be able to challenge management on sustainability issues and ambitions.

There is no ‘one-size-fits-all’ approach to ESG oversight. Company boards are best placed to determine which type of governance is best suited to them, depending on the company’s industry and maturity of its sustainability strategy. Whichever governance model they choose, what matters is the credibility of the company’s commitment to its sustainability strategy.

We expect boards to clearly identify the responsibility for ESG oversight, and report on their ESG-related responsibilities and activities as seriously as they do on their other functions. We also expect board members to devote time to ESG oversight: it should be incorporated into all areas of the board and key committees’ work. Only by doing this, can companies fully embed sustainability in their corporate strategies.

  • Tk4gSW52ZXN0bWVudCBQYXJ0bmVycywgR2xhc3MgTGV3aXM6IOKAnEV4cGxvcmluZyB0aGUgbGlua3MgYmV0d2VlbiBFU0cgc3VwZXJ2aXNpb24gYW5kIHBlcmZvcm1hbmNl4oCdLCBBdWd1c3QgMjAyMQ==
  • UHdD4oCZcyAyMDIxIEFubnVhbCBDb3Jwb3JhdGUgRGlyZWN0b3JzIFN1cnZleSwgY29uZHVjdGVkIGFtb25nIDg1MSBVUyBib2FyZCBtZW1iZXJz

Our engagement approach to sustainability skills

We met with a European bank ahead of its 2022 AGM to discuss candidates for election to the board. We take seriously our voting responsibility and assess whether the board is appropriately skilled to address the strategic challenges facing the company.

This year, for the first time, the company started reporting on the level of its board’s expertise in sustainability. Considering the materiality of climate change for the financial sector, and with no further information available, we conveyed our expectation that climate-related issues be clearly identified in the Board Skills Matrix and the directors’ publicly available biographies, enabling us to ensure that the board is sufficiently equipped to set and monitor ambitious climate-related objectives.

Download the full document
Download (266.74 KB)