When we talk about ESG, we tend to focus on the "E" (environmental) and "S" (social) aspects, while the "G" (governance) often gets overlooked. But this is a mistake. Governance is a critical aspect of ESG, even if it’s not always discussed as much. Strong governance and controls can help organizations improve performance, mitigate risk, and meet critical reporting and regulatory requirements.
With emerging ESG reporting standards, government regulations and sustainability commitments, and shifting social attitude towards corporate responsibility—organizations both big and small are recognizing that they need to tell their story more effectively about how they balance their economic performance with other metrics. Read more about why mid-market businesses should care about ESG.
Pierre Taillefer, National Sustainability and ESG Leader at BDO Canada, was recently a guest on BDO’s Accounting for the Future podcast. On this episode, he discussed the importance of governance and other ESG initiatives as well as accurately capturing and reporting that information to stakeholders.
What is governance?
Governance refers to how a company is run—its internal system of practices, controls, and procedures to govern itself and comply with laws and regulations. Good corporate governance will often include policies and procedures around:
- An independent board of directors
- Anti-corruption and bribery policies
- Lobbying rules
- A whistleblower policy and hotline
- Financial (and ESG) reporting
- Independent auditing and audit committees
- Risk management policies
"When we talk to organizations about their ESG strategy the first thing we do is look into what they are already doing," Pierre shared. "The good news is that most, if not all, have already implemented some form of governance policy or program and can start reporting on these immediately," he added.
Why are governance policies important?
Failure of corporate governance can negatively affect an entity’s brand and impact everything from its bottom line to recruitment costs. Furthermore, when an entity’s suppliers face significant governance and ESG-related risks, the entity could be exposed to those consequences as well.
Unfortunately, there are many well-known examples of poor corporate governance. A car manufacturer cheating on emissions tests or bank employees opening fake bank accounts in an attempt to make sales goals are two examples. In such cases, there are often ineffective rules, practices, and processes in place—and a lack of qualifications or independence on the board. Poor corporate governance can lead to a variety of issues including financial penalties, employee layoffs, devaluation, and even bankruptcy.
"It just makes sense to integrate governance and ESG strategies into the management and operations of your business," said Pierre. "The people you want to attract and retain want to work for an ethical, socially responsible organization. And we've seen how proper governance can help a company become more profitable or increase its impact as a not-for-profit."
ESG reporting standards are being developed
Measuring impact and progress is an important aspect of a company's ESG journey. Currently, there are several voluntary non-financial reporting frameworks that exist. Companies have adopted certain frameworks, but because there is no consistency in reporting it can be difficult to track impact and progress—some say this can lead companies to greenwashing. However, standards are being developed.
Given its experience creating accounting standards, the International Financial Reporting Standards (IFRS) Foundation is aiming to bring a much needed, globally comparable standard for reporting on ESG matters to the financial markets. Its International Sustainability Standards Board (ISSB) is developing the IFRS Sustainability Disclosure Standards. The board has issued two exposure drafts, one for climate-related disclosures and the other for non-climate-related disclosures, expected to be finalized in 2023. The finalization of these standards will give regulators and capital providers a baseline to require companies to make these disclosures.
Why should small, mid-sized, and private entities report on ESG?
The ISSB standards will likely only apply to publicly traded companies at first. However, as part of Scope 3 disclosures, organizations will need to disclose the impact of their entire value chain. Which means ESG reporting is going to affect small to medium-sized businesses (SMBs) and private entities as part of the broader supply chain of publicly traded companies. Not only will public companies require information on greenhouse gas emissions and climate impact, but information and data on governance and equity, inclusion, and diversity are likely to be part of their supplier-auditing processes.
Companies that fail to implement ESG reporting practices may be at a competitive disadvantage compared to companies that have strong ESG performance and reporting practices. This—along with expectations from other stakeholders like investors, employees, and customers—means SMBs need to proactively report on governance whether regulatory frameworks apply to them or not. It's not just a matter of compliance but also a strategic business decision that can affect a company's long-term success.
Additionally, the governance and ESG-related decisions a company makes have an impact on financial statements. Companies need to think about financial reporting and ESG reporting as a package. Read more about why CFOs should make sustainability a part of their financial reporting.
What steps can SMBs and private entities take to implement ESG reporting?
- Understand where the entity sits in the value chain of publicly traded companies
- Talk to their stakeholders and partners to understand what kind of information they want and when
- Evaluate what their key competitors are doing in the ESG space
- Conduct a proper risk assessment to better understand the impact of ESG reporting standards and build a plan to comply
- Put systems in place to track ESG data, report on the data, and implement proper processes and controls around those systems
The key takeaway
The biggest takeaway from this should be the importance of governance in your ESG journey. Corporate governance is about ensuring that an organization behaves responsibly towards all its stakeholders. And it's no longer just a concern for large, publicly held corporations. Governance and other ESG initiatives have become increasingly important to small and mid-sized companies as governments regulate more heavily and stakeholders demand greater transparency. To learn more about how BDO can help you incorporate ESG into your financial and non-financial reporting processes contact: