When I sat down to write this article about the main challenges and governance-related developments that boards will face in 2023, I was tempted just to type “see last year”. That isn’t a completely flippant response. While the details will differ, the big picture isn’t going to change in 2023. The conditions in which companies operate will continue to be tough and regulatory demands on boards – in particular in relation to ESG – will continue to increase.
The short-term priority for boards will remain steering their companies through the tricky waters of economic and geopolitical uncertainty – which has increased in the last 12 months with the war in Ukraine and the energy crisis – to ensure their survival.
At the same time, boards need to continue the process of integrating ESG into their strategic thinking and risk management to secure their company’s longer-term future and to meet the demands of regulators, investors and other stakeholders.
As in recent years, ESG is an area where regulators and standard-setters will be particularly busy in 2023, setting out what is expected in terms of boards’ responsibilities and duties and companies’ transparency about their activities and impacts.
For example, this year the OECD will be issuing an updated edition of its Principles of Corporate Governance – the global standard used as the benchmark when developing national policies and requirements – which will for the first time include a principle specifically addressing the board’s responsibilities for sustainability and resilience.
Similar references also seem likely to be added to the UK’s Corporate Governance Code, also due to be revised this year, while in the EU negotiations will continue on a proposed new Directive that will place a legal duty on boards to identify and address human rights abuses and adverse environmental impacts throughout the company’s value chain. Firms in the financial services sector can also expect more activity from their sectoral regulators.
The situation in relation to ESG reporting seems likely to be even busier. The International Sustainability Standards Board is expected to publish its first set of standards in the next few months, while new European Sustainability Reporting Standards are due to be adopted in June. National requirements on climate-related disclosures are also under development in both the US and Australia, while similar requirements in the UK come into effect in April.
As well as new regulations and standards, companies can also expect more demands for information from investors, not least because they are themselves increasingly required to make disclosures about the ESG impacts of their investment portfolios. Cumulatively there are potentially significant resource implications for companies.
It is not just in relation to reporting that investors’ expectations are increasing. One of the trends that we have heard about in recent discussions with companies and investors in the UK is investors’ growing concern about so-called ‘overboarding’ – the impact of holding multiple board positions on a director’s ability to do their job properly.
The rising profile of this issue is directly correlated to the increase in the responsibilities and duties that directors are expected to carry out, and companies in the UK and some other markets can expect greater scrutiny from shareholders of the directors being put forward for election in this year’s AGM season.
This issue and the increased demand for transparency both point to a broader question that boards need to consider: Do we have the capacity, at board level and in the governance functions throughout the company, to deal with the demands being placed on us and drive the company forward?
Capacity at board level is as much about quality as it is quantity and availability. In part it is a matter of ensuring the board has the necessary skills and capabilities, but the characteristics of how it works and thinks are also important.
Linking this back to the points I made at the beginning of this article, boards need to have the ability – and the agility – to address both the immediate pressures and the company’s longer-term sustainability. They also need to think of ESG as a strategic priority, not just a compliance issue (notwithstanding the ever-increasing compliance burden).
One way in which they can achieve this is by putting innovation right at the center of their strategy. Innovation has the potential to solve immediate problems and contribute to a more sustainable long-term business model.
Morrow Sodali has recently supported a review by the IoD Centre for Corporate Governance in the UK looking into the link between governance and innovation. The Centre’s report was published last November and concluded that the attitude of the board is perhaps the single most significant factor for successful innovation.
Unless innovation is prioritized and promoted by the board it is highly unlikely to flourish. Evidence suggests that this is more likely to happen if the board is diverse – in the broadest sense – and if there are board members with an entrepreneurial or creative background to counterbalance any tendency towards risk aversion.
While it is understandable in the current conditions that boards might be primarily focused on immediate priorities, I would encourage them to find time to consider whether they have an innovation-led long-term strategy and whether the company – and the board itself – has the capacity and capabilities to deliver it. If they do so, boards may find they are starting to solve some of the short-term problems at the same time.