Good corporate governance practices are essential for businesses seeking to respond to the challenges posed by climate change and the transition to a net zero economy.
Climate change and corporate governance
Climate change and the transition to a net zero economy is seen by many as the defining shift of our time, something that will have consequences for, and impact on, every area of commercial activity. To remain competitive in terms of attracting finance, employees and partners, organizations of all types will need to keep up to date with changes in scientific thought, regulatory approach and public opinion. This is daunting, but with good corporate governance practices in place, it is a change that can be more easily managed.
Corporate governance refers to the legal, regulatory and voluntary frameworks which address how companies are effectively managed to, as the Institute of Chartered Accountants in England and Wales puts it, “facilitate effective, entrepreneurial and prudent management that can deliver the long-term success of a company”.
Boards of directors are responsible for the governance of their companies. The shareholders’ role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place. Good governance provides a framework for protecting the interests of shareholders, while ensuring the interests of employees, customers, suppliers and others with a direct interest in the performance of a company are considered.
Existing governance framework do not necessarily need to be redesigned for climate considerations, although ‘weak’ governance structures will rapidly be exposed. Rather, they must become part of that framework. How businesses build climate-related issues into corporate governance arrangements will depend on the circumstances of individual organizations – there is no single solution.
Investors, finance providers and other stakeholders are increasingly assessing the maturity of the organization’s preparedness for the impact of climate change and the transition to net zero. Within the TCFD’s reporting framework are ‘scenario planning’ requirements that can help infrastructure companies demonstrate their maturity.
The scenario planning requirements anticipate businesses will engage in “a structured exploration of different possible futures that allows a company to test its business model against the wide-ranging impacts of climate change”. This forward planning, facilitated by corporate governance, will inform today’s decisions with medium- and longer-term risks influencing strategy. It is corporate governance that underpins the ability of the organization and its directors to carry out these activities.
Climate and directors’ duty to promote the success of the company
Company directors in the UK have a statutory duty to act in the way they consider, in good faith, would be most likely to promote the success of the company for the benefit of its shareholders. In doing so, they are required to have regard to specified factors, including the likely long-term consequences of the decision in question, the interests of the company’s employees, the need to foster the company’s business relationships with suppliers and customers, the desirability of the company maintains a reputation for high standards of business conduct, and the impact of the company’s operations on the community and the environment.
Directors, then, have had to “have regard” to their company’s impact on the environment for many years. However, as no one factor takes precedence over another, the overriding duty to promote the success of the company for the benefit of its shareholder(s) may require one or more of these factors to be discounted, including environmental concerns.
This duty has received particular focus in recent years, following the introduction of a requirement that all large UK companies publish a statement on their website and in their annual report describing how directors have had regard to these factors when acting to promote the success of the company . Premium listed companies, obliged to apply and report against the UK Corporate Governance Code 2018 must similarly describe in the annual report how stakeholders have been considered in board discussions and decision-making. In addition, the Companies Act requires companies to report on principal risks and key non-financial performance indicators, including information relating to environmental matters.
Very large private companies are in a similar position, required to adopt and report against a corporate governance code. The Wates Corporate Governance Principles for Large Private Companies, drawn up by a working group chaired by Sir James Wates, is the government-endorsed code to be used for these purposes. The principles encourage companies to consider environmental matters in their risk management systems and in assessment and monitoring of how the company’s activities may impact both current and future stakeholders.
TCFD’s impact on governance
TCFD is about financial reporting. However, to meaningfully report, companies need to have in place a governance framework suitable both for performance of the actions that are to be reported, including policies and procedures, and for collecting and quality assuring the data and information required to analyze and present those actions and describe outcomes. Governance, then, is at the very heart of the recommendations.
When reporting on governance, organizations are invited to describe the board’s oversight of, and management’s role in, assessing and managing climate-related risks and opportunities. This is not intended to be a standalone obligation, separate from the board’s existing statutory obligations, but part of the organization’s current governance framework.
The board might choose to create a separate climate or sustainability committee or to task a director with lead responsibility for climate or sustainability matters. Alternatively, a risk or audit committee could be established to take responsibility. There is no “right” way, and much will depend on the risks identified. The question for the board will be how it exercises effective oversight of their activities. They will want to consider, for example, how frequently a committee reports back to it and whether climate-related issues are a standing agenda item or otherwise considered with some sort of regularity.
New internal operating and reporting procedures may be needed. However, this will not necessarily require changes to the way an organization’s governance operates. Rather, climate risk assessment should be integrated with established modes of delivery.
A series of TCFD recommendations feed into and rely on an organization’s corporate governance framework. For example, the recommendations: to identify and describe risks and their impact on businesses, strategy, and financial planning; to set and disclose metrics used to assess climate-related risks and opportunities and how they link to strategy; and to test and subsequently describe the resilience of the strategy.
Actions for infrastructure companies
Pinsent Masons, as part of the Net-Zero Infrastructure Industry Coalition, has highlighted the evolution of infrastructure climate-related financial disclosures in a new guide that is designed to help infrastructure companies implement the recommendations made by TCFD – and leverage opportunities from doing so. The guide aims to support asset owners, contractors, consultants, funders, investors and suppliers regardless of how mature their organization is in respect of TCFD compliance. Good governance is at the heart of the guidance.
Good governance relies more than ever on developing and maintaining mechanisms for effective information flow between the board and its committees and between senior management and non-executive directors. Embracing the TCFD framework provides an opportunity for infrastructure companies to revisit these mechanisms to ensure they are fit for purpose and allow for TCFD disclosures.
Written records of a board’s decision-making are crucial as the basis of future reporting. Corporate governance and culture are two sides of the same coin: corporate governance seeks to embed sensible business practice, while culture is the approach taken in and by a business to promote that agenda and the willingness to do so.
A culture that supports the mechanics of governance not only benefits the company itself, leading to better relationships with shareholders, but also wider stakeholders whose interests should be considered by the board. Combined with a culture of climate concern, TCFD-aligned reporting will be a natural outcome.