How Boards can drive positive sustainable change: top five governance and culture challenges

At a glance:

• On 25 April, Deloitte hosted an event on Governance and culture: driving positive sustainable change, focusing on the themes raised in the Financial Conduct Authority’s (FCA) recent Discussion Paper.
• This blog sets out our reflections on the participants’ (board members, executives, and regulators) collective view of the top five governance and culture challenges that Boards of financial services firms will need to address to achieve their sustainability ambitions.
  1. Commerciality - Boards need to understand the material sustainability opportunities and risks to their business and use this information to drive their sustainability strategy, so that they are clear on how their strategy will affect financial returns.
  2. Outcomes - Boards need to focus on how their sustainability strategy is driving change in the business and the impact their activities are having on the environment, society, the market, and their customers.
  3. Consistency - To help embed the desired culture, Boards need to ensure that there is a common understanding of the sustainability strategy both vertically and horizontally across the firm.
  4. Engaging the business - Firms should focus on engaging the second tier of leadership in the business, as it is these individuals who need to execute the sustainability strategy. Scenario-based workshops and discussions are likely to be an effective approach.
  5. Joining the dots- Firms should ensure that they take a joined-up approach across their sustainability workstreams, and with other key initiatives, such as the Consumer Duty.
• Firms can use the FCA’s Discussion Paper as a prompt to ensure that they are placing sufficient focus on their governance and culture as they deliver on their sustainability agenda. This will be crucial if firms are to meet the significant and unique opportunities and challenges arising from the sustainable transition and drive real economy change.

Relevant to: Board Members, CEOs, Chief Sustainability Officers, CFOs, CROs and CCOs across banking, insurance, and investment management.

On 25 April, Deloitte hosted an event on Governance and culture: driving positive sustainable change. The event included panel sessions with a number of experts from industry, academia and the regulatory community. It discussed firms’ evolving practices and experience around applying governance and culture to drive positive sustainable change, focusing on the themes raised in the FCA’s recent Discussion Paper.

As firms look to meet their sustainability-related commitments, most notably on the transition to net zero, it is crucial that they have a robust governance and supportive culture. To do this, firms will need to make a sustained push across a number of themes that are highlighted in the Discussion Paper, such as purpose, governance, responsibility, accountability, remuneration and incentives, and training.

In some respects, these themes are familiar, and firms will have addressed them as part of previous transformation programmes. However, the sustainability transition introduces unique and significant opportunities and challenges that will affect nearly every aspect of a firm’s business. Therefore, we think that it is important that Boards prioritise how they can both leverage and improve upon their tried and tested methods on governance and culture. Only then can they realise the opportunities and address the risks from the transition and make a positive difference to the environment and society.

This blog draws on the themes discussed during the event to set out our reflections on the collective view of the board members, executives, and regulators who attended of the top five governance and culture challenges that Boards will need to address to achieve their sustainability ambitions.

Among other authors from industry and academia, Deloitte also contributed an article to the Discussion Paper on how to build an effective culture to support sustainability-related objectives. The article is summarised in this blog.

1. Commerciality

A key challenge raised during the event was the difficulty of reaching a clear view on how a firm’s sustainability strategy will affect financial returns. It is essential that Boards tackle this question head on. The sustainability strategy shouldn’t be something separate from business strategy and financial planning; the business strategy should drive the sustainability approach.

To do this, Boards need to understand the material sustainability opportunities and risks to their firm and the sustainability impact of their firm. Armed with this information, they will then be able to take a more informed approach to the tough decisions that need to be made, for example, on transition finance and when to divest.

As indicators of whether they are taking a commercial approach to sustainability, Boards can look at the proportion of time they spend on sustainability at key points, such as the Board planning cycle or Board strategy days.

In addition, there has been significant focus to date on climate change and the “E” in ESG. However, feedback during the event was that there is a real appetite among Boards to see a more holistic view on the implications of social opportunities and risks.

2. Outcomes

Across regulation, we are seeing increasing focus by the FCA and Prudential Regulation Authority (PRA) on outcomes. While Boards do need to understand the progress their firm is making on their sustainability transformation programmes, the more important questions they should ask are whether they are seeing tangible change in the business and the impact their activities are having on the environment, society, the market, and their customers.

Board Committees could request deep dive assessments that look at how the sustainability strategy is influencing capital and investment decisions, for example, (i) how many conflicts or dilemmas are escalated to Reputational Risk Committees, or otherwise flagged and discussed; (ii) the value and type of business that is rejected on sustainability grounds; and (iii) where risk appetite is biting. While data of this type may be difficult to expose, it is important that Boards seek to understand what is changing as a result of their strategy.

3. Consistency

Over the last few years, many Boards have dedicated significant resources to agreeing their sustainability strategy, upskilling, and ensuring that they are disclosing their approach to the market. But there is often a dissonance between the Board and the business, and across the business, with differing perspectives on sustainability and understanding of the firm’s strategy.

Boards should seek to ensure that there is a common understanding of the sustainability strategy both vertically and horizontally across the firm. There needs to be a clear thread running from the firm’s purpose, through to its strategy, objectives, targets, plans, governance, remuneration, and incentives. Sustainability shouldn’t be viewed as an “add on”, but as business as usual and integrated into decision-making and embedded into culture across the firm. Individuals will need to understand why the actions they are taking in relation to sustainability are integral to the firm’s purpose.

4. Engaging the business

Many Boards are demonstrating strong and consistent messaging or “tone from the top” on sustainability and may have a sponsor for their sustainability programme in place. In addition, due to the rapidly evolving regulatory landscape, sustainable finance considerations, such as climate risk and greenwashing, are now a key part of the second line of defence’s role, and increasingly part of the third line of defence’s role.

The next step is engaging the second tier of leadership in the business, as it is these individuals that need to execute the sustainability strategy. Scenario-based discussions are likely to be effective. When thinking about sustainability, the starting point should not be regulation or risk management. Instead, the focus should be on ensuring that the business understands the impact that their firm has on the environment and society and the commercial opportunities and risks. Firms could consider facilitating workshops where staff can raise and discuss specific opportunities or challenges or invite staff to respond to or engage in case studies that the business puts forward.

Firms will also need to ensure that their strategy is translated into credible actions and targets, with clear accountability. For example, firms can look at how responsibilities are included in the delegated authority framework.

Remuneration is also an important way to incentivise the behaviours that the Board would like to see. The FCA in its Discussion Paper said that soft targets or easy metrics could mean executives getting paid to do their day job, which would amount to “little more than greenwashing”. Therefore, the metrics and targets firms use as they include climate and sustainability considerations in executive scorecards and long-term incentive plans will need to link clearly to the strategy to provide the right incentives. Measures used will need to be meaningful, stretching, and transparent.

5. Joining the dots

Firms should ensure that they take a joined-up approach as they deliver on their sustainability agenda, and on broader initiatives, and only “dig up the road” once. For example, there is a significant governance element to both the sustainability agenda and the Consumer Duty, and greenwashing might lead to poor customer outcomes under the Consumer Duty. In addition, there will be Consumer Duty considerations for firms as they make changes to their products and services to deliver on their transition plans, as highlighted in a recent speech on green mortgages by David Geale, the FCA’s Director of Retail Banking.

There is likely to be an important role here for the Board Chair to ensure alignment between and across Sustainability Committees and the more traditional Committees, such as the Audit, Risk and Nominations Committees.

Conclusion

The FCA’s consultation on the Discussion Paper closed on 10 May. The FCA is now reflecting on whether to take further action, for example, by introducing new rules or guidance. However, regulation, standards, and guidance are already in train that cover many of the themes raised in the Discussion Paper, for example, from the Transition Plan Taskforce and International Sustainability Standards Board (ISSB).

Therefore, Boards’ work needs to start now. Firms can use the FCA’s Discussion Paper as a prompt to ensure that they are placing sufficient focus on their governance and culture as they seek to develop and achieve their transition plans, as well as deliver on their wider sustainability agenda. As they do so, they should ensure that they take a “joined up” approach with other initiatives, most notably the Consumer Duty.