Corporate boards are not adequately equipped to deal with a changing climate, according to recent studies.
There is growing interest in companies’ exposure to climate risks and how long-term shareholder value could be affected. As our understanding of climate impacts on business continues to grow, investors are pushing for climate-competent boards to better manage risk and lead companies into the low-carbon economy.
In 2016, CalPERS amended its corporate governance principles to require its portfolio companies to recruit board members with climate competence. That same year, Exxon shareholders passed a resolution seeking proxy access to nominate climate-competent board members. The recently released recommendations of Task Force on Climate-related Disclosures pulls out “governance and oversight” as one of the key categories of information on which companies need to disclose. Yet, recent reports have found that corporate boards are not equipped to address the risks and opportunities posed by climate change.
This blog explores why boards should be climate-competent, what climate competency looks like and whether corporate boards are where they need to be.
Why should boards be climate competent?
Climate competency at the board level is important for at least four main reasons:
- Companies with climate-competent boards can more effectively integrate climate change into risk management and strategic planning. Risk management is a fundamental responsibility of the board of directors. To manage risks effectively, boards of directors must have a full understanding of the risks to their business model, including those risks posed by climate change. Climate change considerations also provide important context and strategic implications for decision-making and longer term planning.
- Climate-competent boards can hold management accountable on climate integration. A climate-competent director must have the skills, knowledge, and independence to engage management in thoughtful discussions. Boards must have the information and agenda time to ask tough questions about issues such as carbon constraints, scenario planning and asset risk, as well as the impacts each of these might have on their business.
- Climate competent boards can better engage with shareholders and other stakeholders regarding their climate concerns. According to Kingsdale Shareholder Services, “[s]hareholders are looking to increase their confidence in the long-term strategic direction of the company, understand the board’s role in providing oversight and risk management, discuss governance issues like compensation or… raise concerns about management itself.”
- Boards and directors have the authority to consider climate change, and may also have a duty to do so. If directors, officers, and advisors neglect climate-change risks and opportunities and fail to manage the projected impacts on their businesses, this could constitute a failure of fiduciary duty, and these individuals could be exposed to potential liability. In fact, PRI, UNEP FI, and The Generation Foundation have launched the Canada Roadmap for Fiduciary Duty in the 21st Century which concludes that “failing to consider … ESG issues, in investment practice[s] is a failure of fiduciary duty.”
What does a climate-competent board look like?
Climate competency refers to a mix of individual board member competencies and the governance and oversight systems and processes the board has in place. For instance, a growing number of large institutional investors are putting forward shareholder resolutions calling for companies to appoint a board member with environmental or climate expertise. Such skills, experience and comprehensive understanding of the key issues would allow these board members to educate the others and ensure that boards are competent to discharge their duties and responsibilities.
Investor and other groups are also interested in whether board-level mandates or committees are in place to address climate-related issues. Many boards do address environmental issues in their committee and board mandates, for instance, environmental considerations traditionally relate to toxic spills, air pollution, environmental contamination, and species protection. However, these issues may be substantially different from the specific risks and opportunities emerging from climate change including issues such as carbon constraints, impacts of increased extreme weather, and resource availability.
Finally, a climate-competent board is one that has risk frameworks, oversight processes, and systems to tackle climate-related risks to business. The TCFD, for example, recommends that companies disclose:
- The processes and frequency by which the board and/or board committees (e.g., audit, risk, or other committees) are informed about climate-related issues;
- Whether the board and/or board committees consider climate-related issues when reviewing and guiding strategic decision-making and long-term planning; and
- How the board monitors and oversees progress against goals and targets for addressing climate-related issues.
Certain boards may even consider linking executive compensation with climate change goals, as Royal Dutch Shell opted to do in December 2016.
Are boards currently where they need to be?
Despite the strong case (and growing need) for climate-competent boards, recent studies suggest that corporate boards are not adequately equipped to deal with a changing climate. While companies are broadly acknowledging and disclosing climate-related risks, they are not reporting whether and how they are ensuring their boards are competent to understand and manage these risks.
A January 2017 report by SHARE looked at the public disclosures of over 50 Canadian energy and utility companies to determine how boards are disclosing risks related to climate change and the extent to which they are overseeing those risks. The study found that “public companies in some of Canada’s most carbon-intensive sectors [energy and utilities] are not currently disclosing to investors the extent to which their boards are adequately equipped with the right skills and experience, comprehensive understanding, and proper oversight processes and systems to tackle the risks climate change poses to their businesses”. In particular, the study found:
- While most (85%) energy and utility companies disclosed board skill/competency matrices to investors, not a single company in the study referred to ‘climate change’ in their list or matrix of board skills and experience.
- Very few companies (8%) reported any climate-related experience of board members.
- Board and committee mandates do not specifically mention climate change risk. While 35% of companies identified the board, an individual or subset of the board, or other committee appointed by the board as having direct responsibility for climate change, none of the companies surveyed explicitly reference climate change risk in board governance documents or committee mandates.
A forthcoming CPA Canada study reviewed the state of climate-related disclosures by Canadian public companies and found similar results. Specifically, the study found that less than one-third (29%) of the companies reviewed made specific disclosure of board or senior management oversight of climate-related issues. Furthermore, only 11% of companies disclosed compensation schemes linked to the management of climate-related issues. Zizzo Strategy was pleased to be engaged by CPA Canada to conduct the research leading to the report.
Long-term corporate strategy needs to account for the risks and opportunities associated with climate change. Boards that develop a comprehensive understanding of the issues and place it firmly on their agenda will be better positioned to meet this challenge. According to Richard Ferlauto, former deputy director of the SEC’s Office of Investor Education and Advocacy, “Director education programs on the latest climate science findings, technical innovations and risk-management metrics should be high on the to-do list of governance professionals.”
Zizzo Strategy offers tailored board training and education seminars for executives, boards, and other decision-makers on climate-related risks and opportunities. Please contact us to learn more.