Environmental, social and governance (ESG) metrics can be hard to measure, but the risks surrounding them are increasing, as governments and citizens exert pressure on business to change their ways for the greater good. In this report, AGCS experts highlight some of the most pressing issues which should be on the boardroom agenda and outline how companies can mitigate risk and ‘do the right thing’.

Despite the shock it inflicted across the globe, the Covid crisis does not appear to have halted the march of ESG activists and agendas into the boardroom. If anything, it seems to have accelerated it, as a concern for the collective wellbeing has been thrown into sharper relief.

Social justice protests took place during the pandemic and environmental activists took to the streets, reflecting ongoing disquiet about ESG topics like climate change and diversity.

But it’s not just citizens who are putting the pressure on. Investor and shareholder action is increasingly focused on ESG, and a raft of regulation and guidance in many territories is leading to tougher disclosure and reporting rules for companies and their directors and officers (D&Os). Growing concerns about social inequalities are also leading to new requirements for businesses around diversity, pay and supply chains.

Europe is leading the way in this area. The EU Taxonomy Tool is a classification system that establishes a list of environmentally sustainable economic activities (outside of Europe a similar standard will be adopted by the Institutional Shareholder Services) and the EU Non‑Financial Reporting Directive obligates companies to report on a variety of ESG‑related metrics. In Germany, the Supply Chain Due Diligence Act will obligate larger German companies – and foreign companies with branches in the country – to ensure suppliers abroad comply with certain ESG requirements from January 2023.

- Shanil Williams, Global Head of Financial Lines at AGCS.

Between 2018 and the end of 2020, over 170 ESG regulatory measures at the national and EU level have been introduced – more than in the previous six years combined – with Europe accounting for around two thirds of these. Although no global benchmark exists for ESG reporting, the regulatory environment is becoming tougher. What was once a voluntary expectation of transparency is evolving into legally mandated disclosures. At the same time, litigation or investor, shareholder and activist actions increasingly focus on ESG topics such as climate change, pollution, diversity, cyber security and CEO pay.

The impact of this on the role of risk managers and directors means that elevating and identifying ESG concerns through a business’ risk registers and committees, and making sure it is understood how they will play out in and out of the boardroom, is crucial.

“Legislation is evolving,” says Shanil Williams, Global Head of Financial Lines at AGCS. “Regulators are becoming more active, as are many other stakeholders. Companies, their D&Os – and current and future D&O insurance underwriters – need to be aware of ongoing global ESG matters in order to adequately assess potential perils and how they can manifest in terms of potential liability. If an ESG issue is not handled or disclosed appropriately by the company or board, it can result in ‘bad news’ in their market, ‘bad news’ for the company share price and ‘bad news’ in the form of regulatory and legal action. ESG topics can pose a significant D&O risk for companies and their insurers.”

The coronavirus pandemic may have pushed climate change down the list of board concerns in 2020, but a series of extreme weather events has seen it rise back to prominence this year. Unprecedented wildfires, a winter storm in Texas, the ‘heat dome’ over parts of North America, and floods in Europe and China have changed the perception of climate change from an abstract peril to an everyday risk. There is rising activist and societal pressure on governments and businesses to address this.
Diversity issues are growing in prominence and businesses are coming under increasing scrutiny. This was seen in the wake of the Black Lives Matter protests of 2020, which were followed by an uptick in diversity‑related litigation, particularly in the US. Cases typically allege a failure in the fiduciary duties of directors given the inadequate level of diversity on the board or in management positions. With changes in regulation and legislation on diversity increasingly likely, D&O litigation risk will increase further still. As will the risk to a company’s reputation if it is deemed negligent in this area.
As the pressure on businesses to improve their carbon credentials mounts, concerns have been raised about ‘greenwashing’ – when businesses produce misleading information to exaggerate their ESG credentials and present a more responsible public image. With legal action by stakeholders and investors in this area on the rise, directors should be wary of setting unrealistic ESG targets they might fall short of or they could become the subject of litigation. For example, pressure groups often use institutions’ own ESG reports when it comes to assessing progress on carbon‑neutral targets.
Executive remuneration is another potential hot potato, particularly for investors. Norway’s $1trn sovereign fund – one of the largest in the world – is just one that has developed active stewardship of management compensation proposals in the companies it invests in, amid concerns about pay transparency. Several large global companies have announced they are linking executive pay to ESG and climate‑related targets and outcomes, such as greenhouse gas reductions.
Whether it’s the rise of home working, the acceleration of digitization, or the far‑reaching effects of the ransomware attack on the Colonial Pipeline in the US, the potential and actual vulnerabilities exposed by cyber‑crime and other cyber incidents have become shockingly apparent over the last year. The consequences of a data breach in terms of financial and reputational costs to a company can be grave – even if it is the result of an accident – and high‑profile cases have raised ESG concerns, particularly surrounding the sustainability of businesses.

Which areas of ESG are causing the most concern, and what is the role of the risk manager and board of directors in overseeing these? What are the consequences for companies that don’t meet ESG expectations or fail to live up to their own commitments?

Michael Bruch, Global Head of Liability Risk Consulting/ESG at AGCS, answers key questions.

Photos: Adobe Stock

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