This article first appeared in the Q3 2024 issue of the SID Directors Bulletin published by the Singapore Institute of Directors.
Sustainability is growing in strategic importance for companies. The focus on environmental, social and governance (ESG) concerns is prompting organisations to rethink their corporate structures and decision-making processes around sustainability.
As global attention on ESG issues intensifies, corporate sustainability units are under increasing pressure.
The scope of ESG initiatives has extended beyond climate change and biodiversity to include crucial elements such as reporting, mandatory assurance and governance. This shift is driven by heightened stakeholder expectations, evolving regulatory requirements and the need for greater transparency and accountability.
A robust ESG framework can result in stronger ESG assurance for the company, as it signals that companies’ sustainability commitments can and will be delivered over the longer term. Having an actionable plan also allows companies to identify business opportunities linked to sustainability trends.
With growing scrutiny on ESG, corporate structures will need to evolve in tandem to ensure a strong governance structure. Failure to do so may expose the company to negative implications for businesses such as damage to reputation, higher operating costs, regulatory and legal risks.
Beyond just mitigating these risks, having dedicated sustainability teams can also accelerate the speed of adoption of ESG into business operations. In-house expertise enables companies to proactively source for emerging opportunities.
Some companies have set up centralised units dedicated to driving and embedding sustainability work firmwide. Centralised structures could work for companies that are just embarking on their ESG roadmaps, and need to have a coordinated firmwide direction to ensure consistency across the organisation.
In other instances, sustainability units can also take the form of smaller groups, where respective business units build their own knowledge and capabilities to implement sustainability changes within their scope.
Board oversight
Regardless of the structure, it is clear that there is more interest and demand from companies on having dedicated teams focused on sustainability work. Boards will play a critical role in the process. For example, they will need to be responsible for strategic oversight to ensure sustainability initiatives align with overall business strategy.
One growing area of concern is also ensuring compliance with emerging ESG regulations, which ties in closely with the company’s reputation and assurance. For example, listed companies are currently required to have an internal review of their sustainability reporting process, which should be conducted in accordance with the International Standards for the Professional Practice of Internal Auditing issued by The Institute of Internal Auditors. From FY2027 and FY2029, there will be requirements for external limited assurance on Scope 1 and 2 greenhouse gas emissions for listed issuers and large non-listed companies respectively.
While compliance to emerging regulations is important, producing a well-rounded and holistic strategy that clearly reflects the company’s commitment to sustainability and social responsibility can significantly enhance its reputation and build greater trust among stakeholders. Boards will need to ensure that sustainability units within the organisation are well-equipped to handle such pressures.
Shareholders are increasingly concerned about companies having strong ESG propositions which result in stronger business performance. With regards to top-line growth, shareholders may question whether the company can grow its customer base with more sustainable products, or achieve greater strategic freedom without running into regulatory obstacles. Companies that can enhance investment returns by better allocation capital for the longer term will be a focus point.
Boards should consider the following when when setting up sustainability functions:
1. Effective cross-functional collaboration between departments
Boards should ensure cross-functional collaboration (e.g., sustainability, finance, strategy, risk management, IT, investor relations, legal, internal audit, human resources, etc.) to strengthen the quality of reporting. This must be supported by clear roles and responsibilities in line with the company’s governance structure.
Leveraging company-wide skills and expertise greatly strengthen the quality of reporting. It also augments the quality of data by giving multidimensional perspectives on how ESG changes can affect the company. For example, finance teams can lend their expertise in modelling the future financial impacts that environmental changes can incur; while other support functions, such as human resources, would be most in tune with the social-related aspects of ESG data.
2. Data collection and reporting close process
Boards should consider equipping sustainability functions with tools to enhance the quality of sustainability reports or establish and implement a robust reporting framework. This should include appropriate mechanisms that ensure the precision and timeliness of data reported.
For example, the new sustainability reporting requirements can present challenges for companies as they are required to report sustainability-related financial disclosures along with financial statements. This means that there will be a need for investment grade data, high-quality and reliable information on ESG factors. This should meet the stringent regulatory standards required by investors to ensure that the report is accurate and robust.
3. Internal assurance framework
To ensure the integrity of sustainability-related financial disclosures, departments tasked with overseeing these disclosures also need to rely on robust internal assurance mechanisms. This includes involving risk management and compliance functions, alongside engaging internal audit efforts.
Here, collaboration can help in preserving the integrity of sustainability-related disclosures. Working with departments tasked with this, such as internal audit or legal functions, is important in ensuring thorough oversight and a more holistic internal assurance framework. In some cases, organisations can also consider seeking external auditors or consultants to provide an independent analysis on ESG data to enhance credibility and identify areas for improvement.
With the above considerations in mind, determining the right key decision-makers for ESG in the organisation is also important. Organisations may struggle with this due to the complexity of ESG issues that can often cut across many areas of the firm. The box, “How ESG is Evolving in Corporate Structures” gives some insights on how ESG is evolving within corporates.
Implications on performance and pay
ESG topics are increasingly part of core corporate key performance indicators, including in management-level performance reviews. They are used in calculating executive pay in both short-term and long-term incentives. Variable executive pay is also linked to ESG indicators.
However, on whether to include ESG variables in incentive plans, boards will need to draw a clear link to the other disclosures in the company’s ESG strategy. This will enable the company to put up a compelling case on how incorporating ESG into incentive plans can create long-term value for shareholders. This is also to combat the fear of greenwashing, where companies follow market trends of adopting ESG measures without considering whether it is part of the company’s strategy.
Building robust ESG governance
Ultimately, the first step in building a successful and robust ESG governance structure begins with examining how closely the business aligns with or diverges from sustainability strategies. Following this assessment, decisions can be made on how the identified strengths and weaknesses will shape the company’s ESG approach and overall strategic direction.
To do so, corporates can develop a RACI (Responsible, Accountable, Consulted and Informed) matrix. This involves revising the risk management framework and internal controls along the way to embed sustainability factors. Companies will also need to equip their boards with the necessary knowledge and expertise to engage meaningfully on ESG matters.
How ESG is evolving in corporate structures?
Who oversees ESG?
A dedicated board-level sustainability committee and, at times, the audit committee (due to sustainability primarily being a reporting requirement) can oversee ESG. Furthermore, ESG can involve other functions within the organisation such as remuneration, safety and culture. When determining governance structures, corporates should consider which functions would be most impacted by ESG implications – and the extent of the change required to achieve its sustainability goals.
Who runs ESG?
While the CEO is largely responsible for sustainability in most organisations, they can be supported by a dedicated chief sustainability officer. Depending on the extent of implication on other departments, sustainability work can also be led by people with a range of job titles: the Chief Financial Officer, Chief Human Resource Officer, Chief Corporate Affairs Officer, Chief Transformation Officer and Chief Operating Officer.
Corporates may also opt for a separate decisionmaking body for ESG, sometimes known as the sustainability committee or council. Where these exist, most include representation from finance, accounting and controlling as well as the group sustainability unit. The majority also include human resources, legal and top C-level executives. Occasionally, the committee and council could even include a representative of that corporate’s artificial intelligence ethics committee, communications, investor relations and sales.
Regardless of who drives ESG, the first step to having a clear governance framework starts with an introspective analysis of the company’s currently status. Transiting the company to a more sustainable future does not always entail overhauling business operations and structure.
Who leads ESG reporting?
In Singapore, listed corporates and corporates in the financial sector are subject to several ESG reporting requirements. Some of these include requisites by the Singapore Exchange, and the Monetary Authority of Singapore’s guidelines on Environmental Risk Management. Corporates based in Singapore and with multi-jurisdictional operations could be subject to the European Union’s Corporate Sustainability Reporting Directive.
Increasingly, ESG reporting involves a joint responsibility between various functions in the firm, such as sustainability, finance, and communications. For example, the group sustainability unit could be the one in charge of driving ESG.
The decision of who leads ESG reporting in the company depends on the company culture and the company’s level of maturity in terms of ESG reporting processes and controls to address risks related to ESG reporting.
Given the cross-cutting nature of ESG, corporates have the opportunity to embed robust ESG and suitable governance by ensuring effective connectivity between functions. Corporates are encouraged to look at how boards can lead the transformation journey and drive long-term commitment to sustainability goals.
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