Increased ESG focus creates new risk exposures for company directors and officers

Business culture is changing and considerations for boards and their risk management are altering too. Environmental, social and governance (ESG) factors are rapidly becoming an important focus for how organisational functions are carried out, encompassing a range of concerns from environmental sustainability to employment practices, ethics and compliance issues. ESG factors can be used to evaluate companies on how far advanced they are with sustainability.

The concept isn’t new. The CEO of global investment leader Blackrock, Larry Fink, called out ESG exposures in 2018, asking in his annual letter to businesses that they respond to broader societal challenges, not just to maximising shareholder returns.“Companies must benefit all of their stakeholders and the communities in which they operate,” he wrote. “Without a sense of purpose, no company, either public or private, can achieve its full potential.”

Business purpose that involves ESG concerns also links to value creation, according to a recent McKinsey & Company report, Five ways that ESG creates value, through:

• facilitating top-line growth
• reducing costs
• minimising regulatory and legal interventions
• increasing employee productivity
• optimising investment and capital expenditure. 

ESG implications for directors and officers 

To achieve these outcomes purposeful commitment to ESG at board level works to deliver socially responsible risk mitigation and sustainable long-term outcomes.

Organisations are facing increasing scrutiny about ESG initiatives. The drivers for this accountability are stakeholders such as shareholders, employees and customers, as well as increased scrutiny by regulators and activists wanting to see regard for ESG factors demonstrated through strategy and actions such as choice of investments, supply chains and business partners, and consideration when making executive appointments. With ESG this responsibility also extends to the communities in which the organisation operates. We have seen an increase in D&O “event-driven litigation” in recent years, with plaintiffs and law firms eager to bring class actions or force a settlement, and ESG concerns have been a focus of a number of actions.

Business culture is shifting in response to stakeholder expectations of company boards, with the result that the actions of organisations and their leaders are under greater scrutiny. Directors and officers could face litigation or prosecution as a result of ESG factors if they fail in their duty of care to staff, shareholders or other stakeholders, if they ignore or don’t actively guide the company to manage its ESG responsibilities, including: 

• the environmental sustainability of the organisation, and its effect on external parties, including climate change concerns 
• exploitation of labour in supply chains, including complying with modern slavery regulations
• avoiding greenwashing, where company disclosures about the extent of their environmental activities overstate the reality of the activities undertaken
• ensuring diversity in representation at executive and board level
• promoting inclusion and equality in the workforce
• defining and embedding the appropriate corporate culture into the company
• ensuring processes are in place to avoid unethical business relationships and money laundering 
• actively addressing ESG issues at board level.

The business risk exposures involved with ESG expectations

This ESG focus brings new risk exposures for organisations and their directors and officers to manage – this may not just result in a financial loss to the organisation, but the defence costs involved in managing an action can be significant. Directors and officers’ liability insurance underwriters want to see demonstrated ESG accountability and planning as part of the company’s ‘story’, or profile, through embedding ESG principles into their business purpose – underwriters want to see how ESG actions are being undertaken and measured in a practical way, rather than just organisational ESG policies being put in place. The KPMG Australia CEO outlook 2021 report, which canvassed 50 Australian business leaders among 1300 globally, found that:

• 94% of the CEOs canvassed intend to support ESG purpose through capital allocation 
• 87% said that ESG purpose is central to building their brand reputation
• 86% identified ESG purpose as part of their employee value proposition
• 60% saw embedding ESG purpose as increasing long-term value to shareholders.

The requirement for boards and senior management to actively manage internal risk management includes attention to employment conditions and the observation of diversity and inclusion principles, as well as truthful disclosures about governance, business relationships and the extent of their environmental activities. How a business observes ESG concerns is a significant factor in attracting and retaining employee talent, especially among millennials.

The growing focus on board accountability

Another compelling reason for actively pursuing an ESG agenda at board level is that company boards that neglect to address the need for ESG transparency and commitment, or by greenwashing the work undertaken, could risk litigation or prosecution if, under increased scrutiny from investors, regulators, activist groups and other interested parties, they are seen to have failed in their duty of care to staff, shareholders or other interested parties. This is especially relevant to disclosure obligations. 

The reputational fallout from liability claims based on ESG issues ranges from impact on profits, supply chain agreements, customer retention, potential litigation and regulatory investigations. The majority of CEOs surveyed also felt they would be held personally responsible for any failure to meet these rising expectations, and in the KPMG report Australian senior executives in particular – 46% compared with 30% globally – divulged that their remuneration was based ‘‘at least partly’’ on their company’s ESG performance. 

How Gallagher can support companies seeking specialist technical advice on ESG management liability issues

ESG has become a focus for insurers when underwriting risks and offering policy terms and conditions covering directors and officers’ liability. To help businesses obtain adequate insurance for ESG risks Gallagher can assist by 

• reviewing the current ESG activities of the organisation and board, and detailing how your current insurance policies might respond to a claim
• modifying existing coverage or procuring new coverage tailored to particular ESG exposures as required, for example, for regulatory investigations, misrepresentation or misstatements in disclosure documents, ESG-related securities class actions, employment practices liability issues
• preparing you for insurer presentations to ensure the key points insurers want to understand are addressed during these meetings.

Our financial lines and professional risks experts can guide our clients, including the organisation’s directors, officers and risk and insurance professionals, in how best to present their case to ensure they obtain the most appropriate and comprehensive directors and officers’ cover for the organisation.

Times change, ethics don't

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This commitment is central to our philosophy as a business – and always will be.

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