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It’s not every day that a board director has to deal with a climate-change question. Most concerns are back of mind: Would a factory located near a coastline be knocked out by rising floods? Should a new headquarters avoid being near a forest that might be hit with global-warming fires? Could increasing numbers of Category 3 storms render a formerly reliable, well-planned supply chain worthless?
But under a proposed federal rule—buried beginning on page 98 of a 500-page document—such questions may be thrust to top of the boardroom agenda. And with it, the need for a level of expertise that only a fraction of directors have today.
All this come from a long-await proposal from the Securities and Exchange Commission (SEC), one that would require public companies to make extensive public disclosures of climate-related information. Companies would have to reveal their own greenhouse gas emissions, along with climate-related risks likely to have a “material impact” on the business. They will also need to disclose what expertise board directors have with climate-related risks.
To be sure, such proposals are a long way from being finalized, and the SEC itself is calling for many to be phased in. Still, experts say they could dramatically shift the makeup and responsibilities of boards. For starters, while the number has doubled, only six percent of current directors have any so-called ESG (Environmental, Social, and Governance) skills, according to the National Association of Corporate Directors. Experts say all this could lead to a talent sprint for a new breed of directors—assuming firms can determine how boards should handle this oversight, and whether they want directors with backgrounds just in the environmental or also social or governance issues. “You have companies that are up to date on climate-change risks, but many are years behind,” says Anthony Goodman, a Korn Ferry senior partner, ESG expert, and head of the firms’ Board Effectiveness practice. “This is certainly going to focus their attention on it.”
Although many firms have proposed reducing carbon emissions, few have focused on the financial risks global warming and other climate-related issues may have on their business. Nearly three in four Russell 1000 firms do publish sustainability reports, but experts point out that companies choose their own framework for such ESG disclosures, with no independent verification of the data. The SEC has not previously provided any guidance for benchmarking these practices for investors.
Under the new rules, all of that could change. To draw up its plan, the SEC says it relied heavily on a framework created by the Task Force on Climate-Related Financial Disclosures, or TCFD. The TCFD framework has been backed by the largest asset managers and comes with a seal of approval from the Financial Stability Board, which created the Task Force in 2015. The SEC notes in its proposal that “according to the TCFD, only a small percentage of issuers that voluntarily provided climate-related information presented governance disclosure aligned with the TCFD’s recommendations.”
Though the commission’s purview includes only public firms, experts say private companies would not be exempted, since public firms will put pressure on their supply-chain companies to provide data on, say, greenhouse gas emissions. The SEC is also looking to add these disclosure requirements not only to the IPO prospectus for private companies looking to list in the public markets, but also to shareholder materials related to acquisitions by public companies of private companies. Private-equity portfolio firms will also come under pressure, via the institutional investors who provide their capital. “This is going to leak into a lot of arenas,” says Goodman. “It’s going to require a lot of companies to do things differently.”
For directors, the SEC is proposing that companies disclose the extent of the board’s expertise on climate-related risks if any, how boards will provide oversight (such as via a committee), and how frequently management will report climate-related concerns to the board. Boards would also need to disclose how climate-related risks are integrated into corporate strategy and risk management, as well as the setting of targets and goals.
According to Goodman, the obvious step firms may take would be to add directors with climate-related expertise. “The idea would be suggest to stakeholders that the firm is taking action,” he says. But he points out that approach did not prevent ExxonMobil from losing a proxy contest to investment firm Engine No. 1 last year. In appointing a climate scientist to the board in 2017, Exxon was ahead of the game, but the directors Engine No. 1 added to the board in 2021 had broader industry expertise. “There is an inherent risk in adding board members with overly narrow expertise,” Goodman says, citing a well-noticed comment that a board full of one-trick ponies can just be circus.
Adding to the potential balkanization of the board, Goodman adds, is a different SEC proposal that would require boards to disclose if directors have any cybersecurity expertise. He says that firms that have merely added directors with that expertise discovered that those directors were unable to guide or challenge the main business of the board, including strategy and capital allocation, broader risk, and CEO succession planning. “Just having an expert in one area isn’t enough,” he says, “it's important for companies and boards to ensure that new directors have the broader experience and expertise the job requires.”
In Goodman’s view, smart firms and boards should first assess how much climate risk they have, and take steps accordingly. “You need to do your homework,” he says. “For many companies, maybe there isn’t any material risk. For others maybe there is a lot.” He also advocates that whether an expert is added or not, all directors need to become more much knowledgeable about the topic. “You don’t want to become too reliant on one climate scientist you might have on the board,” he says. “You want to be able to contribute fully to the firm’s overall risk oversight and strategy, including climate-change risk.”
In the end, he believes, many firms will want to add directors from an emerging pool of so-called ESG directors (see box), who are less specialized in any one field but knowledgeable on a range of ESG matters and grounded in business experience. “I think the baseline for every director is that boards need to get educated about climate and other ESG matters and not simply rely on experts,” he says.
For more information about ESG, reach out to us, or contact Anthony Goodman, senior client partner, ESG, and head of the firm’s Board Effectiveness practice. Also, see more information here.
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