Directors of companies headquartered in the EU will likely soon face a pivotal shift in their duties regarding sustainability with the upcoming EU Corporate Sustainability Reporting Directive (CSRD) and Corporate Sustainability Due Diligence Directive (CSDDD). Under the CSRD, companies will have to disclose how sustainability matters are managed at the board level and how sustainability is integrated into directors’ incentive schemes, while the CSDDD sets out ambitious new guidance on the personal duties of directors specifically.
The first blog in the three-part series detailed key recommendations for companies to prepare for the Corporate Sustainability Due Diligence Directive. Here, we draw on our learnings from engaging with boards of BSR member companies and have identified six key questions for boards to determine their readiness to govern evolving expectations. We would also like to highlight the recent recommendations at the World Economic Forum related to human rights and the role of boards as an additional source.
A Holistic Approach across ESG
Governments, investors, and other stakeholders are increasing calls for boards to provide oversight on sustainability and environmental, social and governance (ESG) topics. Examples include the SEC’s draft rule on climate disclosure requirements, which would require board and management-related risk oversight and governance. The International Sustainability Standards Board (ISSB) has also released exposure drafts on sustainability and climate-related financial disclosures.
The EU Commission’s proposed CSDDD is far-reaching in terms of responsibilities, with a comprehensive approach beyond climate, spreading across a broad range of ESG subjects. The CSDDD sets out two provisions on directors’ duties for EU-based companies:
- Directors’ duty of care: When fulfilling their duty to act in the best interest of the company, directors should take into account the consequences of their decisions for sustainability matters, including human rights, climate change, and other environmental considerations, in the short, medium, and long term.
- Directors’ oversight responsibility: Directors are responsible for overseeing a due diligence policy and processes, with due input from relevant stakeholders, including rightsholders impacted by the company’s business activity.
One of the groundbreaking elements of the CSDDD is its potential link between the company’s sustainability strategy and the variable remuneration of directors. As stated by the European Commission,
Six Key Questions for Boards
Over the past 30 years, BSR has worked with companies and boards to integrate sustainability into business strategies and operations.
Based both on that experience and an understanding of the likely impact of these impending changes, it is essential that boards go beyond “check-the-box” compliance to provide effective oversight and governance.
1. Composition: Does the board have access to relevant knowledge and training on human rights and wider sustainability questions?
There is increasing awareness on the part of business of the need to fill the gap in sustainability expertise and skills at board and management levels, including human rights due diligence. Companies can address this gap through dedicated training for all directors to ensure that due diligence becomes integrated into the companies’ processes and by securing external expert guidance. Boards can also review their skillset when considering sustainability risks, including how ESG and human rights topics relate to other company material issues.
2. Oversight: How does the board examine and oversee ESG issues? Is there a dedicated committee or is sustainability integrated across all board committees?
The entire board must have the right level of understanding of human rights impacts and position these within the company’s wider ESG strategy. Relevant ESG topics can be integrated into respective committees (via nomination, audit, etc.) so they are addressed alongside other board considerations. This may also include a dedicated ESG committee.
3. Company impacts: Does the company have the appropriate approach in place to understand potential adverse human rights impacts on affected stakeholders?
Based on evolving norms in materiality and the CSDDD, companies should understand not just material issues to the business, but also salient human rights impacts. Potential adverse human rights impacts may vary widely, from supply chain labor to the use of algorithms in marketing campaigns to discriminatory effects of services. Such impacts may not be covered under narrower, “traditional” views of the financial materiality of ESG.
4. Stakeholder insight: Is the company conducting stakeholder engagement as a means of understanding relevant perspectives, risks and opportunities?
This could include two main components: Boards can first ensure company management has all necessary processes to create a meaningful and ongoing dialogue with affected stakeholders. In some cases, boards may themselves engage with and/or access regular insights from key stakeholders, including employees, trade unions, and affected community organizations, on salient issues covering sustainability strategy and ongoing relevant emerging issues. One mechanism through which this can be done is the establishment of a stakeholder advisory council, with which Board members may engage, along with management.
5. Emerging risks and strategic implications: Does the board have an approach—such as scenario planning—in place to identify emerging ESG and human rights risks and opportunities?
Boards look at strategic, capital, talent, and other commitments that will affect a company for years or even decades to come—yet few have a method for considering the profound impacts that social, environmental, and other sustainability-related trends may have on these plans.
Futures thinking employing scenario analysis enables companies to identify emerging risks, opportunities, and their potential implications for the company. While perhaps not standard practice for boards today, directors and leadership teams can use these tools to ensure that their business has allocated the right resources, against multiple “what if” scenarios to ensure they are truly resilient in the face of tomorrow’s disruptions. Whether that’s linked to geopolitical risks such as the invasion of Ukraine, acute physical climate risks, or policy and legal risks on human rights, boards have a duty to long-term governance, versus reactive shifts.
6. Accountability: Is executive remuneration aligned with the company’s sustainability objectives?
Any flexible components of Board and executive remuneration should be linked to the achievement of measurable sustainability targets (time-bound and science-based in the case of environmental targets) set in the company’s strategy and certainly to outcomes beyond share price.
The dynamic business and social context all companies face means that Directors will be most effective when they consider a diversifying set of perspectives and considerations. New EU regulations, whether the CSRD or in this case the CSDDD, mean that heightened and more sophisticated attention to ESG is not only smart practice, but required, to ensure that their Boards’ can be effective stewards of company strategy and performance to deliver long-term value. We invite companies to collaborate with BSR in enhancing board leadership on an evolving and expanding set of questions.