Over the past decade, institutional investors, shareholder activists and the SEC have asked for increased transparency from companies about how they manage environmental, social and governance (ESG) risks. In the past 18 months, the far-reaching impacts of the pandemic and growing social demands have accelerated board oversight of ESG material risk factors, with a particular focus on diversity, equity and inclusion (DEI) and human capital management (HCM) risks.
Looking ahead to the 2022 proxy season, ISS, Glass Lewis and numerous institutional investors have announced an increased focus on ESG risk factors, including enhanced board diversity, disclosure of people-related risks and how companies are addressing diversity and inclusion in their workforce. Failure to respond to these types of demands can have a direct impact on companies’ bottom line and relationship with investors. Additionally, we expect the SEC to announce later this year new rules around more robust disclosures on board diversity, board oversight and climate-related risks.
So, how should companies and their boards systematically identify, prioritize, mitigate and oversee evolving material ESG issues? The first step is to ensure relevant parties are speaking the same language, which can be a challenge with multiple acronyms that have overlapping meaning.
If you picture ESG materiality risk factors as an umbrella term, HCM and DEI are initiatives that fall under it. While these terms overlap to some degree, stakeholders expect boards to be savvy about how they individually address each of these risk categories without lumping them into one general category.
Once a company has a good understanding of how these terms apply to their oversight activities, they must stay current on changes to stakeholder viewpoints, particularly changes to investor and proxy advisory policies.
How Stakeholder Expectations Are Changing
Evolving investor and proxy advisory firm voting guidelines will pressure boards to provide oversight of certain material ESG risk factors, including DEI and HCM. The list below highlights some key changes in sentiment by investors.
• ISS: Beginning in 2022, the firm will recommend votes against the chair of the nominating committee or other relevant directors at companies where no racially or ethnically diverse directors have been publicly identified (determined on a case-by-case basis).
• Glass Lewis: Beginning in 2022, the firm will generally recommend voting against the nominating committee chair of a board that has fewer than two female directors.
• BlackRock: The firm expects companies to identify and report on material ESG risks and opportunities and provide board oversight of HCM and DEI; it will consider voting against the reelection of directors where a board has not adequately demonstrated how material issues are identified, managed and overseen.
• Vanguard: While the firm has no minimum diversity requirements, a lack of diversity disclosures is the biggest risk for a vote against a board or support of a shareholder proposal for increased disclosures.
• Fidelity Investments: The firm will consider voting against boards that are not made up of at least 30 percent women in 2022.
With evolving viewpoints and regulation, companies must sort through all this information to properly prioritize actions and policies and provide sufficient information to the board for accountability purposes. To do so, consider benchmarking peer practices and disclosures, assessing regulatory requirements, and analyzing the policies and values of key stakeholders.
There are certain communication and organizational considerations that must also continually be evaluated by management and the board, including:
• Developing a compelling narrative that is consistent across internal and external communication channels
• Ensuring proper oversight and coordination between management and the board
• Reporting risks and opportunities that are material to the company and the broader industry in an effective manner
• Providing ongoing board education on material and evolving ESG topics
Every company is at a different phase in their ESG journey. Aon’s corporate governance and ESG advisors use data, analytics and experience working with all types of organizations to prioritize ESG actions and communications and drive functional accountability in navigating this process. Contact us to learn how we can help.