Companies must recognise that they are subject to increased expectations in terms of effective identification and management of social issues. A failure to do so – and the resulting inequality – is increasingly seen as representing a systemic risk to the resilience of business operations and value chains. Expectations are reinforced by the wave of new due diligence regulations and reporting standards focussed on addressing both the ‘E’ and ‘S’ in ESG (see, for example, our earlier blog posts on the EU’s Corporate Sustainability Reporting Directive here, as well as on the UK Financial Conduct Authority’s Greenwashing rules here).
CFOs have a critical role in communicating how companies are addressing wider social issues linked to their business operations and ensuring companies’ compliance with related regulations and reporting standards. To help CFOs execute this role effectively, the World Business Council for Sustainable Development (the “WBCSD“) and Shift have released a primer for CFOs for advancing the ‘S’ in ESG (the “Report“). The Report aims to provide a starting point for CFOs working to address the demands and challenges associated with the ‘S’ in ESG, covering both an overview of the what, the who and the how of corporate social performance and key recommendations for improving the measurement of that performance.
Defining the ‘S’ in ESG
The UN Guiding Principles on Business and Human Rights are the authoritative global framework for addressing the impacts that businesses have on society. These principles, which are also integrated into the OECD Guidelines for Multinational Enterprises, have become central to society-focused regulations and reporting frameworks across the globe (for further information on these principles and guidelines, read our earlier blog posts here and here).
The multitude of societal risks to be addressed by companies include (among other things):
- Customer satisfaction;
- Data protection and privacy;
- Gender and diversity;
- Workforce engagement;
- Community relations;
- Labour standards; and
- Human rights (which are impacted by all of the above and more).
By considering these factors through due diligence, companies can begin to build a picture of how they are impacting, and how their business activities are impacted by, social issues.
The importance of CFOs
The Report states that CFOs need to:
- understand the links between a company’s impacts on people throughout the company’s value chain and how this interrelates with financial performance; and
Understanding these links will enable CFOs to ensure that “ESG considerations are meaningfully integrated into enterprise risk management, statutory compliance, reporting requirements and the CFO’s own strategic guidance to the CEO and board” and “the integration of the company’s financial and non-financial data, analysis, decision-making and reporting…meet international and regional standards, including those related to social disclosures such as the European Sustainability Reporting Standards” (for further information on the European Sustainability Reporting Standards, read our earlier blog posts here and here).
- engage effectively with investors, regulators and standard-setters, whose interest in the ‘S’ in ESG is rising (for further information and investors’ and regulators’ activity in addressing human rights issues, read our earlier blog posts here and here).
The six focus areas identified below should serve as a useful starting point for CFOs in this regard.
Focus areas for evaluating social performance
The Report details six focus areas to help CFOs identify the types of indicators and metrics that can be tracked to evaluate and improve a company’s social performance:
- Focus on board and senior leaders’ actions to embed commitments into practice and corporate culture: the Report suggests that a challenge for companies is the overreliance on “indicators that offer little insight into how a company is actually performing“. To address this, CFOs should strive to demonstrate how social commitments are integrated in the company. This might involve, for example, an assessment of how employees are empowered to speak-up about potential social risks across operations and value chains;
- Consider the quality of risk identification and assessment: CFOs should ensure that the company is conducting robust human rights due diligence and is effectively engaging stakeholders (for further information on conducting human rights due diligence and engaging stakeholders, read our earlier blog post here);
- Assess whether actions are driving sustained behaviour change: CFOs should ensure that internal audit teams are equipped to understand and evaluate risks to people, by investing in collaborative, system-wide action with peers to address systemic human rights issues;
- Set targets and KPIs that meet robust and credible design criteria: CFOs should focus on KPIs that prioritise the most severe risks to people and identify sophisticated metrics that are “either a direct measure of outcomes for people or a measure of progress in addressing root causes of risk to people (e.g. targets that reflect the achievement of rights-respecting purchasing practices, the exclusion of exploitative labor recruitment agencies, or improved laws protecting indigenous peoples’ rights)“;
- Focus on inequality-related metrics when evaluating outcomes in the workplace: metrics might include gender balance, CEO-to-median-worker pay ratios, gender pay gaps, living wage levels and the amount of workers that are covered by a collective bargaining agreement; and
- Use sentiment or ‘voice’ data to gain insight into stakeholders’ experience: the Report suggests that since data about employee and consumer sentiment is already widely used as a source of business insight to inform strategy, there is an untapped opportunity to use similar methods to understand the experience of workers in the value chain, affected communities and at-risk consumers.
Initial questions for CFOs to ask themselves
The Report also provides some initial guiding questions that CFOs can ask themselves to better understand their company’s social performance:
- Does my company look across our operations and value chain to make sure we are aware of any impacts on people’s human rights, in particular those that significantly exacerbate inequalities? Do we understand how these issues may relate to business risks or opportunities?;
- Are we testing with others, in particular affected stakeholders or their legitimate representatives, whether we have any blind spots or false assumptions that would lead us to miss something?;
- Do we have the necessary controls, culture and relationships to manage risks to people such that we are contributing to better outcomes for affected stakeholders, tackling systems-level inequalities and driving positive results and resilience for the company?;
- Do our internal audit function and external assurance providers have the expertise they need to provide this evaluation?;
- Are we gathering the quantitative and qualitative information needed to evaluate the effectiveness of our actions? How are insights we gain factored into decision-making?; and
- How is our social performance impacting the implementation of our business strategy? How does our business strategy impact our ability to improve our social performance?
Mayer Brown lawyers are able to help companies comply with the increasing number of human rights-related obligations and offer advice on how best to deal with demands from investors for social issues to be at the heart of companies’ business operations.