Investors put boards on notice over stronger social governance

Recent cases such as Rio Tinto and AMP show that managing stakeholder interests has never been more challenging for boards, especially in terms of social governance and meeting the demands of investors, says Brunswick Group Partner Pru Bennett GAICD.

Bennett, who points to Brambles, AGL and Lendlease as companies benefitting from integrated reporting, says that all boards need to lift their game and secure more data and targets around ESG. Bennett will speak at the  Australian Governance Summit on the topic of  Nowhere to Hide: Shareholders, stakeholders and the role of the board.

In a year where staff wellbeing has taken centre stage and investor power has ramped up to put Environmental and Social Governance (ESG) issues in the spotlight for boards, Pru Bennett, former Managing Director at Blackrock Asia Pacific and Chair of the National Foundation for Australia-China relations, is hearing loud and clear from investors that ESG remains a key focus.

“I've been talking with investors over this period of time and it is clear that the S (Social) of ESG has really come to the forefront. The treatment of human capital as a risk management issue as well as an opportunity, and the way boards and senior leadership teams have approached this, has also become a critical area. My conversations with investors show that the way management and boards have managed these issues during COVID-19 has been a litmus test of board and management quality.”

As we transition to a low carbon economy, boards also need to identify the risks and opportunities that a transition may afford companies, she told AICD in an interview. “We need to see more data and targets around ESG, so investors have some idea of progress, and how that relates back to ESG strategy.”

Following is an edited transcript of the question-answer interview.

Are there any companies managing ESG particularly well, in your opinion?

Generally Australian companies do manage ESG well and the standard of reporting has continued to increase. The next step is to look at ways of integrating ESG into the business, and at integrated reporting. There are a number of companies that have adopted integrated reporting, Brambles and AGL being two. And it's not just the reporting that's important, it's the integrated thinking that integrated reporting generates. I have spoken to a director of Lendlease, which is another company that has adopted integrated reporting. That director talked about the change in the conversation around the board table as a result of integrated thinking. This type of thinking is better for investors and other stakeholders over the long term as boards are more focused on the six capitals, where the value of the company lies and on value creation.

How important is ESG this year for corporate reporting, given the year that we've had?

In Australia, I believe reporting has generally been quite good. I work in the Asia Pacific region, so when I look at Asian companies, Australia is well ahead. However, our country is probably not as advanced as many European countries, even though Australia has had a big focus on occupational health and safety for a long time. So health and safety is managed and communicated well, but boards are going to have to lift their game in other areas, particularly when it comes to human capital and climate change.

When we look at the valuation of listed companies, and particularly service companies that are listed on the ASX, a big component of the market cap is human capital. Employees arrive or log in in the morning, then they log out or go home in the afternoon. If they're not logging in or coming into work the next day, that business doesn't exist. So how human capital is managed and reported, and disclosing the appropriate data to investors to demonstrate good practice, is vital information for investors. It’s not just about providing a description. Investors are trying to assess the quality of management.

You said recently there's never been a more challenging time to manage the interests of stakeholders. Why?

We have recently seen a couple of cases where there has been a very big focus on profit and returns that have been at the expense of stakeholders. In one instance, the board decided to impose a financial penalty on management, and that really didn't go down well with stakeholders. In another situation, we saw the loss of three senior leaders.

It is so important for boards to really understand who their stakeholders are, and how their strategy impacts society. There tends to be a focus on privatising profits and socialising costs. In some cases, operational costs are being socialised at the expense of society when they really should be internalized.

COVID-19 has been a real challenge for boards. While most boards would have had business continuity plans in place, I don't think any of those plans would have anticipated a significant portion of the workforce working from home for six months plus. That raised issues around employees, furloughed employees and how they are treated, and the mental health of employees.

Are you seeing any gap between the walk and the talk on the ESG issue?

There are gaps where the process is qualitative and there is a lack of data and targets. Once the data and targets come in, that demonstrates the walk, and without that, there is a gap between the walk and the talk.

So how can investors and boards put real muscle into the ESG approach?

Boards need to know what their investors are saying. It's not that the whole board should be meeting with investors, but it is important for the chairman, or for the lead independent director to engage with investors and take those views back to the board. The management team also has to understand what's top of mind for investors.

It is also important to understand the views of the different types of investors. In addition to index investors and active investors, asset owners are also a very important component of this equation. Asset owners’ funds are being managed by asset managers, yet asset owners are taking a much more active role in voting and they are much more focused on longer term issues such as ESG issues. It is important for boards to be aware of what those issues are. What's top of mind for asset owners at the moment? What's top of mind for active managers? How are their expectations changing?

So what do companies really need to consider when they're providing market guidance after the year that we have had?

I think, honesty, and that is quite difficult to communicate when you don't know what lies ahead. If you don't know something, you need to come out and be honest about that. I think investors will have more trust in a company that is honest in their reporting. And they will pick that up in the quality of reporting as well.

Is assurance an increasing concern? How can we have confidence that what's being claimed for ESG and reporting is actually being followed up and carried out?

Well when it comes to reporting, it's about materiality. If the risk is material, as a director, you would want to see assurance of the process and data. Such an approach will provide a level of comfort that ESG risk is being managed well. There are other issues with ESG disclosures that aren't material but may be important to stakeholders and therefore should be reported. Such information would require a lesser level of assurance.

You're the chair of the National Foundation for Australia-China Relations. So what is the board attempting to achieve?

The foundation is in a very unique position. First of all, it has a very diverse board, which I think is good. It's a board of 14 - so it is large. Members come from academia, the arts, local communities and business. My role as chair is to gather the experience and expertise of the people on the board, to ensure we are providing sound advice to the CEO of the Foundation and to the Foreign Minister. The foundation funds activities from a very broad range of activities, so we need to make sure we are funding the right projects that have good outcomes for both China and Australia. We are looking for projects that have mutually beneficial outcomes for both China and Australia, but also for our very large Australian Chinese diaspora.

Our focus is on driving positive outcomes, so this is a good time, when the foundation can actually make a difference and help business. We need to keep that relationship between Australia and China going, given the importance of China to the Australian economy and our local communities. I think it probably has a more important role now than it has had in the past. Because I have a governance background, my role is to bring in a whole new governance process around approvals. We are not there to replicate what other agencies are doing but to fill the gaps, provide initiatives and partner with appropriate agencies.