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Walking the talk on ESG has gone from a stroll around the block to a rigorous fitness regime.

Winning the ESG race

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Meaningful action on environmental, social and governance issues is now a baseline expectation for organisations in Australia and New Zealand. Disclosure alone is no longer enough – they need to demonstrate how they are contributing to a fairer, more sustainable future. Organisations at the back of the ESG pack can be daunted by the distance that lies ahead, but realising it’s a not a competition is the key to picking up pace.

Introduction

The cost of being last

Pressure to act is coming from the community, regulators, and customers. Meanwhile, organisations that fail to act will increasingly find their own sustainability is at risk. They are likely to face issues including:

⊲ Capital is harder and more expensive to access

⊲ High calibre staff are more difficult to recruit and retain

⊲ Customers turn to competitors who embrace ESG principles

⊲ Backlash from investors at general meetings

⊲ Unwanted attention from shareholder activists and media.

Yasmin Allen, a non-executive director of ASX, Cochlear and Santos, recently told the Governance Institute National Conference that ESG shouldn’t be viewed as a focus for large companies or even a cost to implement.

“I think it’s a business issue, and it’s a stay in business issue, and it’s also a future business opportunity,” she said. “So everybody from our small companies to our large companies really need to get this right, focus on it. If we don’t, it’ll be really hard for us to attract and retain future staff, and of course, future customers.”

Lifting your ESG gameThis report focuses on three areas which are a major focus for boards in Australia, New Zealand and further afield. It explores the latest thinking and global trends while offering some practical ways to implement best practice.

⊲ Environmental: A collective approach to climate change The recent report from the Intergovernmental Panel on Climate Change (IPCC) and the upcoming United Nations climate change conference (COP26) have put the urgency of action to address climate change in the spotlight.

⊲ Social: Creating workplaces that reflect our communities Increasing diversity helps organisations tackle operational challenges and improve decision-making, but COVID-19 has seen gender diversity progress stall.

⊲ Governance: Driving accountability and transparency Boards play a pivotal role in connecting ESG with strategy and culture to strengthen alignment and motivate better performance.

We hope this report helps boards, executives and governance professionals consider how their organisations can elevate their focus on ESG to build a more sustainable future.

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Environmental: a collective approach to climate change

The world is on the brink of being unable to contain global warming to within 1.5-2ºC, the Intergovernmental Panel on Climate Change (IPCC) has revealed.

Failing to achieve this key target of the Paris Agreement doesn’t only mean an increase in average temperatures around the world. There will be longer fire seasons, more extremes of cold as well as hot weather, more severe rainfall and flooding, and increased droughts.

In Australia, where extreme weather is part of the landscape and already visibly increasing, this is a sobering prospect. Post-industrial warming is 1.4ºC, higher than the global average of 1.1ºC. However, there is yet to be a unified commitment to reach net zero or the latest 2030 emissions reduction targets.

The November 2021 COP26 summit is expected to result in increased commitments by governments in a bid to meet the Paris Agreement.

“Because the global environment is a quintessential public good, the optimal response requires leadership by national governments and cooperation across governments around the world.”

– Carol Austin, non-executive director.

Make the commitment

Organisations don’t all have the same impact on the environment. In Australia, almost half of Scope 1 greenhouse gas emissions (47.6%) come from the 10 highest emitters.

It’s easy for others such as service-based businesses to say they’re powerless to make a difference. Every action, however small, creates a wider impact.

Beyond their direct impact, they send a signal that this is a collective effort and elevate the practices that are part of business as usual. This amplifies the pressure on other organisations that are slower to act, helping to motivate change.

How to do more

⊲ Commit to net zero

For organisations to play their part in tackling the climate change challenge involves making a commitment to reach net zero emissions. It needs to be accompanied by a timeframe, including initial targets along the way, and a practical plan to achieve them.

“Every company needs to have a pathway – a credible pathway – to net zero. And these plans will likely be accelerated, I believe, from 2050 to 2030, which is only nine years away.”

– Yasmin Allen, non-executive director

A quarter of ASX 200 companies have committed to net zero, according to an August 2021 report by ACSI. They go beyond the energy and resources sectors to include organisations such as Telstra, Woolworths and Suncorp.

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How small changes can add up

The Australian Legal Sector Alliance promotes sustainability practices including across more than 40 member firms. Members report annually on their initiatives across people, community, environment and governance in a succinct, consistent format.

Among the environmental metrics are the amount of paper used by the firm, and per employee. From 2016 to 2020, members have reduced their paper consumption by 43% per person.

With Australians the third-highest users of paper per person, it’s a comparatively small change which has already saved tens of thousands of trees, along with other reductions in resource use and pollution.

⊲ Check you can deliver

As the threat of irreversible global warming draws closer, organisations, institutions and governments are being galvanised into bolder action.

Making sure they have the capacity to deliver on their aspirations is an essential element of the plan. At a certain point, there will no longer be enough land to plant all the trees needed to meet collective offsets.

Environmental commitments need to be backed up with robust planning and analysis. Just as there are consequences for falling short of financial forecasts, companies that fail to deliver on ESG will be held accountable.

The threat of climate change litigation is real, and it’s growing. Australia is second only to the US in the number of climate change cases filed to date, according to a report from the London School of Economics and Political Science.

⊲ Use less and make it go further

One way for all organisations to tread more lightly on the earth is by using less. Reducing consumption, improving efficiency, increasing recycling and limiting waste have a cumulative effect. From moving to green power at offices to reducing food waste, small decisions add up when implemented on a wide scale.

Share the responsibility

Some organisations opt to reduce their environmental impact by divesting the operations or investments that are more emissions intensive. However, that shifts the burden elsewhere without addressing its root cause.

Working together is essential if we are to limit the effects of climate change before it’s too late. That means playing an active part assisting all industries to operate more sustainably.

Paying others to offset the effect of emissions is only a partial solution. It also involves investment in new technologies and sustained behavioural change.

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How to do more

⊲ Help others transition

Organisations reducing their own emissions is just the first step. The next step is for them to help their customers do the same. That involves looking beyond Scope 1 and 2 emissions to also consider Scope 3, and having an approach that encompasses the whole supply chain.

“The economic imperative will drive change and finding solutions for your customers is a really good place to start,”

– Yasmin Allen.

15 companies in the ASX 200 have set targets to reduce their Scope 3 emissions according to ACSI, including Origin Energy, Dexus Property and CBA.

⊲ Look for opportunities

The speed with which industries heavily affected by COVID-19 shifted to new business models demonstrates the extent of ingenuity and the pace that is possible when their survival is at risk.

As we move into the ‘new normal’, numerous organisations are choosing to incorporate changes to what they do and how they work as part of their ongoing operations.

The actions that organisations take to reduce climate change can create new products, markets, and revenue streams. Renewable energy and storage are a high-profile focus, but there are many other opportunities beyond the industrial arena.

Climate: the global perspective

The US is seeking to return to a leadership position on climate change after four years in the wilderness.

On his first day in office, President Biden issued an executive order to have the US re-join the Paris Agreement. He has pledged to cut US emissions in half by 2030 compared to 2005 levels – the most ambitious target set by any US administration to date.

Increased ESG disclosure is also on the cards. The US Securities and Exchange Commission (SEC) is making progress to introduce a mandatory reporting framework for public companies with the proposed rules set to be released before the end of 2021.

SEC Commissioner, Allison Herren Lee, highlighted the implications in her keynote address at the 2021 Society for Corporate Governance National Conference.

“These developments place ever greater responsibility on companies, and therefore boards, to integrate climate and ESG into their decision-making, risk management, compensation, and corporate transparency initiatives,”

she said.

Aotearoa New Zealand has taken a leading stance on climate change disclosure, moving to pass the world’s first legislation to mandate climate change reporting.

The bill currently before the Parliament would require around 200 of the country’s largest listed companies and financial institutions to report against new standards in line with the Task Force on Climate-related Disclosures (TFCD).

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How Australian institutional investors are incorporating ESG

Many Australian institutional investors such as superannuation funds have now closed their niche ESG investment options and embedded ESG principles deeply across their main funds. It means more than $300 trillion of Australian assets are increasingly incorporating an ESG lens as part of their standard investing process.

There is a growing body of evidence that ESG principles are correlated with business sustainability and even financial performance.

More than 40% of super funds surveyed by APRA in March 2019 said climate change was a material financial risk today and a similar same proportion said it may become so in the future.

Some ESG-inspired changes are generating immediate financial benefits. For example, some investors have installed energy monitoring systems in the buildings they own to slash energy use. However other changes are aimed at reducing risk, such as tackling climate change.

It remains a policy priority for APRA, which earlier this year released a consultation on its draft Prudential Practice Guide on Climate Change Financial Risks.

It will help organisations to develop frameworks to assess and monitor climate-related risks across governance, strategy, risk management, metrics and disclosure.

Governments and regulators in Europe have been even stronger. In March, a new European regime bolstered sustainability-related disclosures across the financial services sector.

Australian institutional investors are global investors and are increasingly playing by global rules. If local regulations don’t push companies to act on ESG, their shareholders will.

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Social: creating workplaces that reflect our communities

Without continuous action on ESG, we will gradually slip further behind. It’s part of a cycle where rising expectations drive increased performance, in turn further raising the bar.

The widening gender gap is a stark demonstration of this in action. Women make up just over half the Australian population but have disproportionately borne the economic and social impact of the COVID-19 pandemic.

Meanwhile, revelations of deep-seated mistreatment of women in the workplace have fuelled a wave of widespread outrage across the country.

Equal treatment

Community expectations of how businesses and institutions treat their people far exceed the minimum requirements.

Unfortunately, the changes set to be implemented by the Sex Discrimination and Fair Work (Respect at Work) Amendment Bill 2021 are a missed opportunity to redress the balance. Significantly, they fail to specifically impose a positive duty on employers to take reasonable action to eliminate sexual harassment, discrimination and victimisation.

However, there are welcome changes such as extending the Sex Discrimination Act to include contractors, self-employed workers, interns and volunteers.

How to do more

⊲ Speak out and help others do the same

Calling out everyday sexism is everybody’s responsibility. This shifts away from silence seemingly conveying tacit support for inappropriate behaviour to build a more positive culture.

Organisations need to ensure incidents aren’t swept under the rug and demonstrate there are serious consequences for unacceptable conduct. That includes limiting the use of non-disclosure agreements which stop victim survivors from telling their own stories.

⊲ Reframe risk management

Greater understanding of a risk leads to different approaches to how it’s managed. It may also reveal that the magnitude of the challenge means an effective response is as important as a sound preventive strategy.

Close to two in five women (39%) reported being sexually harassed at work in the past five years, according to the most recent Australian Human Rights Commission report.

How organisations respond is what shapes the resulting reputational impact far more than the occurrence itself. Swift, decisive action makes it clear that they are committed to improvement.

It’s especially important when the issue relates to a senior leader. The potential for an unfair dismissal claim must be weighed against the cost to organisational culture.

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Equal pay

Australia’s gender pay gap sits at 14.2%, based on average weekly full-time earnings in May 2021. This reflects a rise of 0.8 percentage points in the six months from November 2020, and effectively setting the country back three years in closing the gap.

The gap is even bigger at management level, where it is 23.2% and translates to an average annual difference of $46,578, according to the Workplace Gender Equality Agency.

How to do more

⊲ Employ ‘blind’ hiring policies

Removing gender when assessing resumes or conducting interviews (answers can be assessed by someone who was not part of the interview) can help tackle the unconscious bias that underpins much pay inequity.

⊲ Create tightly bound standardised pay ranges for each position

Men more often push for higher salaries than women, even if their qualifications don’t support it. A tightly bound pay range can help tackle this issue.

Increased transparency can also make a difference. In Australia, it is legal for employment contracts to prevent people from discussing their remuneration with other employees. This has been criticised as contributing to the gender pay gap, with the US and the UK partly loosening similar restrictions.

Equal representation

While Australia’s progress to improve gender diversity at board level has been strong, that drops off at CEO and senior executive levels.

Across the ASX 300, only 6% of companies have female CEOs, the 2021 Senior Executive Census by Chief Executive Women (CEW) revealed. Among executive leadership teams, female representation has remained static at around 25%.

However, the good news is that having more women on boards produces better gender diversity in the rest of the organisation, according to a recent study by the University of Otago (NZ) and Purdue University (US).

How to do more

⊲ Expand the pool of candidates

Recruiting for management roles can benefit from emulating the approach at board level and considering a wider scope.

Increasing numbers of non-executive director appointments are coming from non-traditional backgrounds, research from the Diligent Institute has found. This trend is strongest in Australia, where the proportion of new directors who haven’t previously been a CEO, CFO or COO is almost double the US (36.3% versus 18.8% in the first part of 2021).

It produces greater gender diversity as well as a wider skill set, with twice as many directors from traditional roles being men compared to their counterparts from other backgrounds.

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⊲ Set and elevate measurable diversity targets

While gender targets are an established practice among large public companies, they’re yet to gain the same traction at the bottom end of the index.

More than two in five ASX 300 companies (43%) lack meaningful gender targets, CEW reported, while more than one in seven (15%) have all-male executive leadership teams.

As progress towards gender diversity improves, initial 30% targets for female representation are being replaced with more ambitious goals which more closely reflect society, such as the 40:40:20 model. Half the companies in the ASX 100 have adopted gender diversity targets based on this approach.

Equal diversity

Cultural diversity is part of the fabric of Australian society, but it’s yet to be woven into board composition in a meaningful way.

Around three in 10 people in Australia belong to culturally and linguistically diverse (CALD) communities (28%). However, across ASX300 companies, only 7.5% of directors are from non-European origins, the 2021 Board Diversity Index has found. At the current rate of change, it will take around a generation before boards more closely reflect the multicultural community.

This puts boards out of touch with a major part of their customer base, as well as missing out on wider perspectives that support better decision-making.

How to do more

⊲ Expand diversity beyond gender

The rising number of women on boards highlights what can be achieved by focusing on a common goal. Expanding diversity efforts to include different ethnicities and abilities has the potential to deliver similar benefits.

⊲ Extend your networks

Director recruitment is evolving beyond the gold club, but personal connections remain important. But knowing someone is not always a guarantee they are the best person for the job. People from outside of personal networks can bring new experiences that benefit the organisation.

⊲ Set wider targets

It takes targets to change the status quo. For example, gold medallist Kurt Fearnley recently said too few boards represent the Australian community when one in five people have a disability and one in three households contains a person with disability.

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Diversity: the global perspective

Gender diversity

Australia was ranked 50th in the World Economic Forum’s 2021 Global Gender Gap Index, falling from 44th the year before. What changed? Nothing. Australia’s score in both the 2021 and 2020 indices was identical, at 0.731.

It’s all the more galling when looking at the longer-term trend. In the first index, conducted in 2006, Australia ranked 15th. Meanwhile, New Zealand has been ranked in the top 10 in all but one of the years. In 2021, it reached its highest ranking at 4th, and its highest score at 0.84.

As the graph above shows, Australia’s progress has flat lined, leaving us further behind New Zealand and the UK, while the US has also now moved ahead.

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2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2020 2021

WEF Global Gender Gap Index Scores

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Cultural diversity

Directors of US public companies put racial diversity as a top priority when considering new board appointments, according to research by the Diligent Institute. It comes second only to skillset/background, and outranks industry expertise, financial experience, and CEO experience.

In the UK, new requirements introduced by the Parker Review will see increased focus on cultural diversity at board level by large listed companies. This includes not only disclosure but also the requirement for boards to have at least one member from an ethnic minority.

Across the FTSE 100, 12% of board roles were held by people from ethnic minorities in November 2020, up from 8% in 2017 when the review was released. While this is slow progress, it is coming closer to reflecting the community, with people of colour around 14% of the UK’s population.

Meanwhile, the New Zealand government, having reached its target of 50% women on public sector boards, has increased its attention to cultural diversity. One-third (32.5%) of board members are from non-European backgrounds, including 22.3% who are Māori. This reflects an upward trend in all groups of diverse ethnicities compared to 2020.

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Governance: driving accountability and transparency

Measure progress

Focus on non-financial performance is at an all-time high. It’s part of the evaluation process for almost every institutional investor, with 98% considering non-financial disclosures, according to an EY survey.

Making sure the organisation is considering the metrics that matter most to investors is essential.

ESG metrics and reporting need to be relevant, appropriate, and able to be understood. That goes beyond technical specialists, requiring clear understanding at executive levels, by the board, and in external reporting, particularly to broad audiences.

“I'd be shocked if you haven't started talking about ESG-type measures in your board meetings. We see that more and more boards are talking about these issues at every meeting as averse to once a year or, in previous years, sometimes never.”

– Lisa Edwards, President and Chief Operating Officer, Diligent Corporation

At board level, regular dashboard-style reporting enables directors to monitor progress and offers a starting point for deeper discussions. It should incorporate the metrics that are most relevant for the individual organisation, with comparisons to industry trends and best practice.

Share progress

Plans are meaningless unless they’re backed up with ongoing action. But that action also needs to be clearly understood. ESG reporting must be accessible to the people who oversee the organisation and those who judge its performance.

Reporting frameworks provide a consistent basis to compare disclosure. However, sustainability reports frequently involve a combination of highly technical language paired with management jargon.

Murky communications make it hard to hold organisations accountable to their promises. At their worst, ‘greenwashing’ can conceal poor practices and even attempt to turn them into a marketing opportunity.

Reward progress

Executive pay often heavily rewards financial outcomes and appears to place relatively nominal importance on ESG. That can drive external perceptions that organisations aren’t serious about their broader responsibilities.

Over the long term, the interests of investors and other stakeholders converge. Eventually, what’s good for everyone typically also benefits the bottom line.

It’s imperative for boards to make sure there is alignment between what their organisations say and how they behave. Failing to walk the talk erodes trust internally, says non-executive director Carol Austin. That quickly extends to a wider audience.

“The most dangerous thing organisations can do is espouse a high-blown set of principles and then in the day-to-day operations, do the exact opposite. Staff hate to see hypocrisy by organisations.”

Good governance ensures an organisation has the framework to continually assess its obligations to all stakeholders and make changes as needed.

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More ASX-listed companies are addressing the issue and incorporating ESG measures as part of their executive remuneration frameworks.

That includes 57 of the ASX 100, reflecting a jump of 24% from 2019 to 2020, according to the Diligent Institute’s July 2021 report, More About Pay than About Performance. Across the ASX 300, the increase is only slightly smaller, at 21%, but coming from a lower base with just under 40% of this expanded index (38%) applying the practice.

US SEC Commissioner, Allison Herren Lee, has said linking executive pay to ESG performance sends a strong message to the organisation and the public.

“Boards that tie executive compensation to ESG metrics are using one of the most powerful tools they have to make real progress on ESG goals, and at the same time signaling the strength of their commitment to these issues.”

How to do more

⊲ Increase involvement

The significance of ESG calls for greater involvement by directors in relation to key disclosures.

At the Governance Institute of Australia’s National Conference, non-executive Kevin McCann AO highlighted the importance of this for organisations of all sizes, across all industries.

“In the annual report… directors must take a leading role in setting out the purpose of the company, setting out the activities in relation to diversity, in relation to climate change,” he said.

“It’s got to be owned by the chair, and the chairmen of committees, and the board more generally.”

⊲ Connect ESG and strategy

Ongoing increases in external expectations, accompanied by the expanding scope of ESG issues, are a major source of concern for executives.

It’s more acute for Australian CEOs than their international peers, with two-thirds (66%) fearing they will fall short compared to 56% globally, the KPMG 2021 CEO Outlook revealed. One of the drivers is increased demand for ESG reporting and transparency, particularly from regulators.

Boards can provide invaluable guidance to help CEOs tackle these challenges. Making sure ESG is embedded into the organisation’s strategy and business model, rather than viewed as a stand-alone issue or a regulatory burden, is crucial.

⊲ Reward what matters

While linking pay and ESG performance is on the rise, there isn’t equal emphasis on the metrics that are rewarded. Digging below the surface, social outcomes such as diversity, equity and inclusion are both more prevalent and more heavily rewarded than environmental performance.

While half the ASX 300 (49%) apply social metrics, that drops to one in five (19%) for environmental metrics, Diligent’s research reveals. Those environmental metrics have an average weighting of just 2.1% of total remuneration.

There’s no single approach to allocating executive pay across the range of key performance outcomes. However, with climate change becoming a dominant concern for directors, it’s worth reflecting on whether it needs to be given increased prominence.

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⊲ Anticipate setbacks

Regularly review ESG failures and consider what would happen if the organisation faced the same issues. How would you know? What would you say? What would you do?

“As a board, it's really important the way you deal with crises. That gives clear indications of your values and it can give an indication of shifts in corporate priorities,” said non-executive director, Carol Austin, at a recent Diligent webinar.

“You provide leadership by focusing on individual examples that people can take away and relate to and say, ‘If I apply those same principles in the crisis I'm dealing with, I will come up with an outcome that is consistent with the values that the corporation is seeking to espouse.’”

⊲ Engage with company secretaries

As ESG rises in importance and becomes more prominent on board agendas, it offers new opportunities to governance professionals.

Jane Kahler, General Manager of Risk & Governance and Group Company Secretary at Intrepid Group, sees company secretaries playing a broader role helping boards consider ESG issues.

“Company secretaries have traditionally been relied upon to provide governance knowledge to the board and the chair, but I see that spreading out now across ESG as well,” she said.

“We need to understand the ESG risks out there and what other companies are doing so that we can bring in best practice and support the board and senior management.”

Having the systems and relationships across the organisation to guide the ESG information the board receives enables company secretaries to maximise their impact.

Diligent

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