The importance of governance within ESG

Addressing the ‘G’ in ESG

Governance is a crucial component of an Environmental, Social and Governance (ESG) strategy. It sets out how a company’s structure and practices are managed and those responsible are held accountable. Without the ‘G’, it would be difficult and time-consuming to implement effective ESG and sustainability strategies across an organisation.¹ Driving sustainable practices across a company is achieved by setting policies and procedures and assigning accountability to individuals to track and monitor progress. These are two aspects of governance that are important to consider. The first is the process and procedures required to embed sustainability into an organisation. The second is the disclosure of these governance structures to ensure alignment with reporting frameworks. Disclosures and frameworks have also placed great importance on companies disclosing their corporate governance practices when reporting how they manage their ESG and sustainability strategies. This is apparent in frameworks such as the Global Reporting Initiative (GRI), the Corporate Sustainability Reporting Directive (CSRD) and the Taskforce on Climate-related Financial Disclosures (TCFD).

What aspects of sustainability fall under the ‘G’?

The ‘G’ in ESG has evolved significantly in recent years, making it increasingly complex to define. The scope of governance has expanded as different sustainability frameworks emphasise various aspects of corporate governance, which often leads to inconsistencies in how companies communicate their governance strategies. For instance, the governance pillar of the TCFD framework focuses primarily on how a company’s board oversees climate-related risks and opportunities. It requires organisations to detail the processes they use to manage and assess these risks, making climate oversight a core governance responsibility. On the other hand, GRI places more emphasis on the broader governance structure, including the composition of the board, how members are nominated and how responsibilities for managing social and environmental impacts are delegated. Moreover, the European Sustainability Reporting Standards (ESRS), which aligns with CSRD, refers to governance as business conduct. Its sub-topics cover corporate culture, corruption and bribery and protection of whistle-blowers.

These differing focuses can lead to disparities in how companies frame their governance strategies, largely depending on which sustainability framework they choose to follow. This variation can create confusion for stakeholders trying to assess a company’s governance practices, as key elements of governance may vary based on the reporting framework a company aligns with. The expanding and flexible interpretation of governance in ESG reflects its evolving role in balancing transparency, accountability and corporate responsibility.

What is the UK’s take on corporate governance?

There is no right or wrong way for a company to manage, communicate and report on its corporate governance structure. However, in the UK, several pieces of legislation and guidelines are widely recognised as best practices in this area. One notable framework is the Wates Principles, introduced by the government in 2018. These principles provide large companies – those with over 2,000 employees – with a structured approach to developing robust corporate governance standards.² They help companies meet their legal reporting requirements while also demonstrating their commitment to best practices in governance. In addition to the Wates Principles, the UK Corporate Governance Code, originally issued in 2018, was updated at the start of this year and is now referred to as the 2024 Code. This revised version is organised into five key sections: Board Leadership and Company Purpose, Division of Responsibilities, Composition, Succession and Evaluation, Audit, Risk and Internal Control and Remuneration.³ While the 2024 Code is specifically aimed at companies listed in the commercial companies category or close-ended investment funds category, it is widely viewed as a model for best practice for businesses of all types to follow.

Key governance considerations

Two major governance considerations have increasingly drawn the attention of governments and stakeholders. These include mandatory sustainability governance frameworks and greater transparency around risk management.

1.Increasing focus on reporting governance practices

Governments worldwide are increasingly introducing mandatory ESG reporting and sustainability governance frameworks. One prominent example is the CSRD recently passed by the European Commission. The CSRD aims to enhance reporting requirements for companies operating within the EU and make sustainability reporting more consistent, comparable and transparent. In addition, it requires companies to report on their governance structures for managing their environmental and social challenges. By mandating comprehensive governance reporting, the CSRD aligns companies’ governance practices with long-term value creation.

2. Enhanced risk management

Stakeholders are also increasingly focused on how companies address and manage sustainability risks. As climate-related risks become more prominent, both investors and regulators are placing greater emphasis on how well companies integrate these risks into their overall governance frameworks. One key driver of this shift is the TCFD framework, which has become a leading standard for managing and disclosing climate risks. The TCFD framework encourages companies to improve their governance around climate risks and opportunities by ensuring that boards are actively overseeing climate-related strategies. This includes integrating climate risks into broader business planning, setting climate targets, and regularly reviewing the company’s exposure to climate-related threats, such as regulatory shifts, physical impacts, and market changes. Board-level involvement in these areas helps ensure that companies are not only mitigating risks but also identifying opportunities related to the transition to a low-carbon economy. CSRD also requires companies to disclose their risk management processes associated with impacts, risks and opportunities. Both of these sustainability frameworks help stakeholders to understand the company’s exposure to sustainability risk as well as the measures that are being taken by the company to address them.

Trending governance topics

Several key trends in certain aspects of corporate governance have also increased stakeholders’ attention in recent years.

1. Increased focus on board diversity

Companies now face greater scrutiny for promoting equity, diversity and inclusion at the board level. This scrutiny has particularly come from investors and shareholders pushing more for gender, ethnic and skill diversity in boardrooms.⁴ One of the reasons for this is that diverse boards can help improve decision-making and drive better financial performance.⁵ Europe is leading this push with the Women on Boards Directive, requiring listed companies to achieve 40% female representation on non-executive boards or 33% on all boards by June 2026.⁶ Many companies are already aligning with these targets, incorporating them into their ESG and sustainability reports, either voluntarily or due to legal obligations. This shift reflects a growing recognition of the business value for equity, diversity and inclusion at the board level.

2. The growing concern about cybersecurity and data privacy

In the digital age, cybersecurity and data privacy have also emerged as critical governance issues. AI especially poses a threat due to its data processing capabilities, potential misuse by cybercriminals, lack of transparency and the vulnerabilities it introduces to systems. It is of high importance to stakeholders that companies can demonstrate robust governance structures in these areas to reduce financial risks and protect shareholder value. As this concern continues to rise, companies will need to ensure to keep up-to-date with government regulations and carry out frequent cybersecurity and data privacy updates to avoid breaches, fines and cyber threats.

3. Linking executive pay to ESG metrics

Another key trend that has emerged has been companies linking executive compensation to ESG metrics to drive sustainability. Around 54% of S&P 500 companies now include at least one environmental performance target in their executive incentive plans.⁷ This growing trend reflects a broader shift toward holding top management accountable for sustainability outcomes, ensuring that the company’s leadership is fully invested in long-term environmental and social goals. This move is not only internally driven but also in response to increasing shareholder demands. Investors are calling for greater transparency regarding executive pay structures, wanting assurance that compensation aligns with sustainability business practices. By integrating ESG metrics into financial incentives, companies send a clear message to their employees and stakeholders that sustainability is a priority, fostering a culture of responsibility across the entire organisation.

Addressing the ‘G’ for future success and business resilience

Companies that establish effective corporate governance practices, policies and procedures tend to have sustainability well embedded in their culture and organisation. Moreover, businesses that prioritise corporate governance usually tend to perform better financially, which maintains and attracts investors. In the current landscape, there are increasing pressures from stakeholders for companies to report on their governance structures, procedures and processes as it becomes a larger risk for many businesses. By embedding sustainability into corporate governance, businesses ensure not only compliance but also foster innovation and long-term resilience in an increasingly complex global market.

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Author: Ella Narain, Consultant, Simply Sustainable

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