The ESG Risk Series: Why Governance Risks Should be High on the C-Suite’s Agenda

Regulators increasingly require corporates and financial services firms to incorporate Environmental, Social and Governance (ESG) risks into their due diligence and reputational risk management processes. ESG also brings opportunity: asset managers and investment banks have enjoyed significant returns by moving assets into sustainable funds, while companies who are transparent about their ESG commitments have been profitable. In the final blog in our ESG Risk series, we break down the “G” in “ESG” by identifying the main factors companies need to consider when assessing governance risks–and explain how Nexis® Solutions can cut through the noise to help surface and mitigate these risks.

Defining governance: what factors constitute good governance?

Governance is probably the least well understood pillar of ESG, but for the C-Suite it should be a standing item on their agenda. An assessment of a company’s governance record should consider the following:

• Values: Does the company have a clear vision and strategy which is underpinned by its values? Is its CEO prepared to make difficult decisions which support those values, and to take a public stand on issues which contravene them? Many CEOs with operations in Russia had to make such decisions after the invasion of Ukraine.
• Ethics: Does the company have policies in place to do business ethically, and does it set similar expectations for its third parties, suppliers and investment prospects as well as reviewing their governance processes?
• Compliance: Is the company’s anti-bribery and corruption regime thorough and compliant with national and supranational regulations, and do whistleblowers feel empowered to come forward?
• Risk management: Does the company have a good due diligence and reputational risk management process in place to certify that the governance structures of its third parties do not incur risks? Are asset managers and investment management professionals confident that they invest in companies which are run responsibly?
• Transparency: Does the company make regular and transparent reports on its activities to regulators, staff and investors? Are the policies governing its senior management and Board written in a way that promotes transparency and ethics? This can sometimes be revealed by incentive structures–for example, 27% of companies in the US Russell 1000 index link executive pay to ESG performance criteria.

Why governance failures are an existential risk for companies?

A lack of good governance spreads risks throughout the business, and undermines the confidence of consumers, investors and regulators in the leadership–which could be terminal for a company. A financial services company should therefore include governance in its due diligence checks on current and prospective clients and other third parties. There are several reasons for this:

1. Regulatory risk: Most countries have laws which mandate good governance to counter the risk of illegal activity in a company and its supply chain. The UK Corporate Governance Code 2020 codifies the principles of good governance that companies should follow. More recently, legislation has been introduced which requires companies to promote ESG through their governance approach. As part of its response to the Covid-19 crisis, the European Union stressed the “importance of embedding sustainability into corporate governance”, with specific rules on corporate governance for banks and investment firms.

2. Legal risk: Where firms suffer a failure of governance, or fail to spot one in a third party, enforcement actions and fines will follow. For example, a major global bank was recently fined £64 million by a UK regulator because of “serious weaknesses” in its Anti-Money Laundering controls for monitoring suspicious transactions.

3. Financial opportunity­: Where a company’s management has made good governance a priority and taken a value-based stand on societal issues, that company has often acquired new business and increased its profits and long-term sustainability. Our micro-documentary, Purpose & Profit, showed how a company in the Netherlands which only buys from sustainably sourced fashion brands has expanded internationally thanks to an explosion of interest from young consumers who want to pay more for ethical products. Related to this, there has been a move towards companies’ performance being measured against a ‘double bottom line’ of social impact, rather than purely profit.

Nexis Solutions: cutting through the noise to surface ESG risks and insights

Nexis Solutions helps firms to tackle the challenge of assessing governance risk, and other ESG risks, head on and surface insights related to ESG risks across our comprehensive data sources, from our news archive to company data to PEPs and sanctions lists. This supports companies’ reputational risk management, due diligence, and data-driven investment decisions.

In addition to our existing data, we have recently added ESG content to Nexis Diligence that enables users to confidently incorporate an ESG risk assessment into their due diligence research and reporting workflow, within a single interface of content chosen specifically for fast, cost-effective, and comprehensive due diligence:

• ESG Ratings is a new content type in Nexis Diligence, which displays an at-a-glance view of a company’s ESG profile. These ratings, provided by CSRHub, help customers understand a company’s reputational or ethical business risk. The ESG Ratings break down ratings for each ESG category into further sub-categories, as well as providing an overall rating for the company.
• ESG Custom News delivers users a set of predefined search terms, enabling them to carry out ESG research within our extensive set of news sources, customized to their preferences.
• ESG Factors Power topics allow users to post-filter all their news results using ESG specific topical indexing.

For more information about  Nexis Diligence, click here