Horizon scan: The UK Corporate Governance Code gets serious about ESG

“Who is responsible for ESG” is a question we are often asked.

The answer is “everyone” because identifying, managing and responding to environmental, social and governance risks and opportunities has to be embedded across both the strategic direction and operational implementation of a company in order to work.

The accountability buck ultimately ends with the company’s board and stakeholder expectations of Board Members with regard to ESG have significantly increased over the last few years. This has mostly come from the investor community, however the FRC’s (Financial Reporting Council) recently published a consultation paper on proposed changes to the UK Corporate Governance Code formalises this further. 

The proposed changes provide a very clear remit for board members to take responsibility for ensuring ESG factors are taken into account when considering a company’s strategy, when overseeing the implementation of the strategy and the reporting of progress. 

The comply or explain principle will apply to the reporting aspects i.e. where the Board reports on departures from the Code’s provisions, it should provide a clear and credible explanation.

The intention is for the revised Code to apply to accounting years commencing on or after 1 January 2025. This may seem some time away, but to comply with the Code, company boards will need to upskill their directors and embed ESG principles in their governance practices and this doesn’t happen overnight.

5 headline changes within the Code that directly relate to ESG matters

(note: copy in bold italics highlights proposed new text in the Corporate Governance Code.)

Headline change #1: Director and executive remuneration linked to ESG objectives 

Revised requirement:

“Remuneration (for executives, directors and senior management) outcomes should be clearly aligned to company performance, purpose and values and the successful delivery of the company’s long-term strategy including environmental, social and governance objectives”

One of the most striking additions to the updated Code is the introduction of a new principle under the Remuneration section to link executive, director and senior management remuneration to ESG objectives. 

Headline change #2: Increase in Board accountability for incorporating ESG into the business strategy

Revised requirement: 

“It (the Board) should describe in the annual report how opportunities and risks to the future success of the business have been considered and addressed, the sustainability of the company’s business model and how environmental and social matters are taken into account in the delivery of its strategy, including its climate ambitions and transition planning.”

For the first time, the revisions specifically call out the requirement for the Board to articulate in their annual report how environmental and social matters are incorporated into the delivery of corporate strategy. This therefore forces companies to embed environmental and social matters within their business strategy and annual reporting rather than seeing it as an adjacent and separate aspect of the business. The Code also requires companies to report on  their plans to transition to Net Zero which aligns with the requirements within TCFD (Taskforce for climate-related financial disclosures).

Headline change #3: Board accountability for the integrity of narrative reporting including ESG matters

Revised requirement:

“The main roles and responsibilities of the audit committee should include:.... monitoring the integrity of narrative reporting, including sustainability matters and reviewing any significant reporting judgements”

The proposed revision extends the audit committee’s role from monitoring the integrity of just the financial statements in the annual report to the integrity of the report narrative as well, including sustainability (i.e. ESG) matters. This revisions requires a review of the integrity of the whole report by independent non-executive directors and reflects the wider responsibilities of the board and audit committee for expanded sustainability and ESG reporting.

Headline change #4: An increased focus on organisational culture

Revised requirement:

“The Board should assess and monitor culture and report on how effectively the desired culture has been embedded”

The proposed revision extends the Board’s responsibility from ‘assessing and monitoring’ culture to actively reporting on the effectiveness of embedding the desired culture within the organisation. There are two important points here, firstly the fact that companies should be articulating the desired culture for their organisation and secondly, the extent to which this desired culture is embedded should now be reported publicly.

Headline change #5: An increased focus of the effectiveness of diversity and inclusion policies and actions

Revised requirements include:

“The annual report should describe the work of the nomination committee, including; an explanation of how the committee has overseen the development of a diverse pipeline for succession, the effectiveness of the diversity and inclusion policy, including progress towards company objectives and adherence to established initiatives”

“Both appointments and succession plans (for Boards) should be based on merit and objective criteria. They should promote equal opportunity, and diversity and inclusion of protected characteristics and non-protected characteristics including cognitive and personal strengths.”

There are several revisions concerning diversity of both the Board and the company as a whole. The revisions make it much clearer that Boards need to report on the actual effectiveness of their diversity policies and practices and and that diversity across the organisation is something that companies must be reporting against in a meaningful way. As the FRC says “We hope this will encourage companies to think about specific approaches that suit their individual circumstances, instead of using ‘boilerplate’ statements in their reporting.” There is also a new reference to protected and non-protected characteristics to encourage companies to consider diversity beyond gender and ethnicity. 

These changes along with the FCA’s targets on Board diversity all point to the importance key stakeholders are placing on increasing diversity at Board level and throughout the organisation as a whole. Board diversity is therefore something that all organisations should seek to achieve while being aware of the difference between diversity and tokenism. Boards should understand that the latter is unhelpful and can actually be damaging.

Summary

Some Boards will already be in a position to comply with the code revisions but many will need to increase their knowledge, expand their board capability and review their practices to ensure adequate time is given to discussing ESG matters. 

If this is true for your company, we would love to have a chat with you on how Thrive can support you to set your Board up for success in this area or carry out an audit of your company’s ESG activity.

Watch out for our next blog on what you can do to prepare for these upcoming changes. 

If you are interested in contacting us, please drop us an email or give us a call:

email: jane@thethrivebusiness.com

mobile: 07909 672 543