ESG: Is Governance the "poor relation"?
Environmental, Social, and Governance (ESG) factors have emerged as critical considerations for investors, regulators, and society as a whole.
While the environmental and social dimensions of ESG often receive significant attention, the governance element is frequently overlooked.
In this latest Vaiie Views article we aim to shed light on the core components of ESG and explore why firms tend to prioritise environmental and social factors over governance. Furthermore, we will delve into how technology and RegTech can play a pivotal role in improving governance practices.
Understanding the core components of ESG
- Environmental Factors: The environmental element of ESG relates to a company's impact on the environment, such as its carbon emissions, waste management processes and resource consumption. It encompasses initiatives which reduce environmental harm, promote sustainability and foster responsible stewardship of natural resources.
- Social Factors: The social dimension of ESG focuses on a company's impact on society, including its treatment of employees, engagement with local communities, customer satisfaction, diversity and inclusion practices and respect for human rights. Social factors evaluate a company's efforts to contribute positively to society and enhance stakeholder welfare.
- Governance Factors: The governance component of ESG relates to how companies are managed, directed and controlled. It encompasses the systems and processes by which companies are operated, as well as the behaviour and accountability of boards, executives and shareholders. Governance factors include board diversity, executive compensation, shareholder rights, risk management, policies and procedures and ethical practices.
Governance: the Neglected Component
Despite the growing global recognition of ESG, governance beyond mandating specific tools, methodologies, or regulations often takes a backseat to environmental and social factors. Several factors contribute to this oversight:
- Tangibility and Visibility: Environmental and social issues are often more outward, tangible, and visible compared to the more inward facing area of governance. Carbon emissions, pollution and community engagement initiatives have a direct and measurable impact, making them easier to communicate and address. Governance practices, on the other hand, are typically internal and less transparent, leading to businesses placing less emphasis on this aspect of ESG.
- Media Attention and Public Pressure: Environmental and social issues frequently attract media attention and public scrutiny, forcing companies to respond to stakeholder demands. This external pressure creates a strong incentive for firms to focus on environmental and social initiatives to improve their public image and maintain customer loyalty. Governance issues, which may be less apparent to the public, often receive less attention unless a scandal or controversy arises.
- Regulatory Frameworks: ESG regulations and reporting requirements often place greater emphasis on environmental and social aspects, leaving governance as a secondary consideration. While separate regulations are of course in place to cover corporate governance they represent the bare minimum that a company must do and companies tend to prioritise areas with explicit regulatory obligations, directing their resources and efforts accordingly.
We are seeing a convergence between RegTech and ESG, the governance pillar is often overlooked as firms focus on the more externally visible pillars of E and S. Those understanding all three pillars are bringing new technologies to the market that help firms compute and report on all pillars of ESG.
Luke Hopton, Solutions Architect, Vaiie
Leveraging Technology to Improve Governance
To address the imbalance and to support businesses to implement comprehensive ESG practices, technology can play a transformative role in enhancing governance in the following ways:
- Risk Management and Compliance: Digital tools such as those from Vaiie can help companies implement or improve robust risk management frameworks and ensure compliance with regulatory requirements such as those mandated for Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT). Integrated RegTech management systems automate processes, track risks, and provide real-time monitoring and reporting capabilities. Compliance management software such as Vaiie Onboard can significantly improve the end-to-end customer onboarding process including the identity verification elements which are powered by Vaiie Identify and data collection phases. These solutions can help with the mitigation of potential compliance gaps that are often only identified too late or when the regulator finds them.
- Data Analytics and Reporting: Technology enables companies to collect and analyse vast quantities of data, providing insights into governance practices and identifying areas for improvement. Advanced analytics can identify patterns, risks, and opportunities, facilitating better decision-making and transparency. Real-time reporting platforms allow stakeholders to access relevant governance information promptly.
- Board Efficiency and Diversity: Technology can enhance board effectiveness by streamlining communication, facilitating collaboration and ensuring the availability of accurate and up-to-date information. Digital board portals and secure communication platforms enable board members to access crucial and confidential materials, communicate securely, and make informed decisions. Additionally, technology can aid businesses in promoting board diversity by expanding the pool of potential candidates using enhanced analytical tools and mitigating unconscious biases by automatically filtering or obfuscating data such as age, gender, or ethnicity.
- Stakeholder Engagement: Technology provides new opportunities to enable people to engage with their stakeholders and incorporate their perspectives into governance practices. Online forums, social media, and interactive platforms enable companies to receive feedback, address concerns, and foster dialogue with various stakeholders, including shareholders, employees and customers. This increased transparency and engagement can enhance trust and ensure the alignment of governance practices with stakeholder expectations.
Those developing or using RegTech and ESG solutions have the benefit of today’s significant computational power. Moore's Law is an observation made by Gordon Moore, the co-founder of Intel, in 1965. It states that the number of transistors on a microchip doubles approximately every two years, which has led to this increase in computing power and a decrease in the cost over time.
Whether on smartphones, desktop, or via the cloud thanks to the advances of technology, ever more complex ESG methodologies can be built and executed to show the sustainability of a business. Governance tools are now capable of taking and processing vast amounts of data and turning it into meaningful outputs using f today’s computing power.
It is crucial for companies to consider their environmental, social and governance strategies and plans as they develop their businesses and for investors to rigorously analyse the ESG criteria of those companies they are considering for investment. Businesses should be careful to pay equal importance to their governance criteria as well as the more visible environmental and social dimensions of ESG
Recognising the significance of governance and leveraging technology to improve governance practices are essential steps toward achieving holistic and sustainable ESG practices. By harnessing technological advancements, companies can enhance transparency, strengthen board effectiveness, improve risk management, and engage stakeholders effectively, thereby establishing robust governance frameworks and reaping the long-term benefits of comprehensive ESG integration.
To talk to us about Governance and the role RegTech plays or to find out more about Vaiie or any of our digital solutions, please contact firstname.lastname@example.org.