When we talk about ESG, we tend to focus on the ’E’ (environmental) and ‘S’ (social) aspects, while the ‘G’ (governance) often gets overlooked. But this is a mistake. Governance is a critical aspect of ESG, even if it’s not always discussed as much. Strong governance and controls can help organisations improve performance, mitigate risk, and meet critical reporting and regulatory requirements.
With emerging ESG reporting standards, government regulations and sustainability commitments, and shifting social attitudes towards corporate responsibility—organisations both big and small are recognising that they need to tell their story more effectively about how they balance economic performance with other metrics. Read more about why mid-market businesses should care about ESG.
Here we discuss the importance of governance and other ESG initiatives as well as accurately capturing and reporting that information to stakeholders.
What is governance?
Governance refers to how a company is run—its internal system of practices, controls, and procedures to govern itself and comply with laws and regulations. Good corporate governance will often include policies and procedures around:
- An independent board of directors
- Anti-corruption and bribery policies
- Lobbying rules
- A whistleblower policy and hotline
- Financial (and ESG) reporting
- Independent auditing and audit committees
- Risk management policies.
Aletta Boshoff, BDO in Australia’s National Leader for ESG & Sustainability, notes, “With the focus of sustainability often on climate-related matters, clients often start out thinking they have nothing in place. But in reality, most organisations have considered some social issues, and have usually implemented some level of governance policy, helping to begin the reporting process quickly.”
Why are governance policies important?
Failure of corporate governance can negatively affect an entity’s brand and impact everything from its bottom line to recruitment costs. Furthermore, when an entity’s suppliers face significant governance and ESG-related risks, the entity could be exposed to those consequences as well.
Unfortunately, there are many well-known examples of poor corporate governance. A car manufacturer cheating on emissions tests or bank employees opening fake bank accounts in an attempt to make sales goals are two examples. In such cases, there are often ineffective rules, practices, and processes in place—and a lack of qualifications or independence on the board. Poor corporate governance can lead to a variety of issues including financial penalties, employee layoffs, devaluation, and even bankruptcy.
ESG reporting standards are being developed
Measuring impact and progress is an important aspect of a company's ESG journey. Currently, there are several voluntary non-financial reporting frameworks that exist. Companies have adopted certain frameworks, but because there is no consistency in reporting it can be difficult to track impact and progress—some say this can lead companies to greenwashing. However, standards are being developed.
Given its experience creating accounting standards, the International Financial Reporting Standards (IFRS) Foundation is aiming to bring a much needed, globally comparable standard for reporting on ESG matters to the financial markets. Its International Sustainability Standards Board (ISSB) is developing the IFRS Sustainability Disclosure Standards. The board has issued two exposure drafts, one for climate-related disclosures and the other for non-climate-related disclosures, expected to be finalised and issued in June 2023. The finalisation of these standards will give regulators and capital providers a baseline to require companies to make these disclosures.
Why should small, mid-sized, and private entities report on ESG?
The ISSB standards will likely only apply to publicly traded companies at first. However, as part of Scope 3 disclosures, organisations will need to disclose the impact of their entire value chain. This means ESG reporting is going to affect small to medium-sized businesses and private entities as part of the broader supply chain of publicly traded companies. Not only will public companies require information on greenhouse gas emissions and climate impact, but information and data on governance and equity, inclusion, and diversity are likely to be part of their supplier-auditing processes.
Companies that fail to implement ESG reporting practices may be at a competitive disadvantage compared to companies that have strong ESG performance and reporting practices. This—along with expectations from other stakeholders like investors, employees, and customers—means small to medium-sized businesses need to proactively report on governance whether regulatory frameworks apply to them or not. It's not just a matter of compliance but also a strategic business decision that can affect a company's long-term success.
Additionally, the governance and ESG-related decisions a company makes have an impact on financial statements. Companies need to think about financial reporting and ESG reporting as a package. Read more about the connectivity between sustainability and financial reporting.
What steps can small, mid-sized, and private entities take to implement ESG reporting?
- Understand where the entity sits in the value chain of publicly traded companies
- Talk to their stakeholders and partners to understand what kind of information they want and when
- Evaluate what their key competitors are doing in the ESG space
- Conduct a proper risk assessment to better understand the impact of ESG reporting standards and build a plan to comply
- Put systems in place to track ESG data, report on the data, and implement proper processes and controls around those systems.
The key takeaway
The biggest takeaway from this should be the importance of governance in your ESG journey. Corporate governance is about ensuring that an organisation behaves responsibly towards all its stakeholders. And it's no longer just a concern for large, publicly held corporations. Governance and other ESG initiatives have become increasingly important to small and mid-sized companies as governments regulate more heavily and stakeholders demand greater transparency.
To learn more about how BDO can help you incorporate ESG into your financial and non-financial reporting, contact a member of our national sustainability team.
This article originally appeared at: https://www.bdo.ca/en-ca/insights/assurance-accounting/importance-of-governance-in-your-esg-journey/