The importance of G in ESG – a licence to trade

Sam Smith, CEO of finnCap Group shares with Business Leader, her thoughts on why ‘governance’ is vitally important for a sustainable future.

When it comes to ESG, all attention is on the ‘E’ with COP26 on the horizon and the recent publication of the grave IPCC Report into climate change. At the same time – and as we recently highlighted in Business Leader – the rise of ‘S’ has seen both companies and investors wake up to societal and cultural trends in terms of diversity & inclusion, equality, human rights supply chains and so on.

However, for business, what must not be omitted from general discourse is the ‘G’, governance.  If the other two areas are being tackled head-on, it feels as though governance is still in certain quarters treated as a tick-box exercise, to be disclosed in the Annual Report and the part of the website that nobody reads.  But governance is critical.  It is a licence to trade.  Without it, we will see more corporate collapses like Carillion.  That was just one of several high-profile corporate governance failures recently, which are putting board directors under increasing pressure to go beyond their statutory duties towards the companies they oversee.

So, what is governance? Corporate governance includes the structure and systems of rules, practices and processes by which a company is controlled and managed. It essentially involves balancing the interests of a company’s diverse group of stakeholders, such as investors, senior management executives, customers, suppliers, lenders, governments and the community.

The basic principles are accountability, transparency, fairness and responsibility.

Whilst governance encompasses almost every aspect of management from business plans and internal controls to performance management and corporate disclosure, the buck stops with the board of directors. The board is the primary force, and therefore held responsible, for overseeing and influencing corporate governance.

This brings the role of the Non-Executive Director (NED) into sharp focus.  A cohesive board will be pulling in the same direction. The executive team will look to the NEDs for support and backing but NEDs have a responsibility to the shareholders to hold the executives to account.  This means challenging, probing and, if necessary, voting against strategic proposals if they are not in the best interests of the wider stakeholder community.

And what does it mean for investors? When investors assess governance, they will want to be assured that a company’s business practices are ethical and that its reporting is transparent and accurate.  They will rule out investments where policies and practices are exposed to unacceptable levels of risk.

Measurement of governance is ostensibly more straightforward than the more nebulous areas of E and S; it essentially boils down to compliance. And in the UK at least there are clear guidelines. For companies with a Premium Listing on the LSE, they are required to disclose how they have applied the FCA’s UK Corporate Governance Code and for companies listed on AIM, the majority adopt the QCA’s Corporate Governance Code, which includes a list of 10 key principles.

As we move forward with ESG, governance will play a critical role in shaping the corporate landscape. Directors are more accountable, investors have greater expectations, and companies are being set higher bars to clear.  It is not just about rooting out the bad apples though. Investors will look to establish a connection between ESG performance with risk reduction and value creation.  Under the governance strand, companies with a positive screen will be able to enhance their overall reputation and brand equity whilst enjoying greater employee commitment and customer loyalty.