25/05/2023·5 mins to read
Embracing ESG in corporate decision-making
Three weeks on from the release of the Select Committee report, the conversation surrounding how directors should account for ESG (environmental, social, and governance) factors continues to simmer in boardrooms across New Zealand.
We have been reflecting on how the boardroom environment is adapting as ESG considerations become increasingly important in decision-making. New Zealand, among other countries, is grappling with the challenge of working out how to encourage company directors to account for ESG factors in their decision-making.
Under the current Companies Act 1993, directors are required to act in (what they believe to be) the best interests of their company, which has historically been interpreted as almost exclusively focussed on shareholders’ economic interests. However, a Private Member’s Bill, the Companies (Directors Duties) Amendment Bill, originally proposed explicitly allowing directors to take into account ESG factors in deciding the company’s best interests, such as:
- recognising the principles of the Treaty of Waitangi (Te Tiriti o Waitangi)
- reducing adverse environmental impacts
- upholding high standards of ethical behaviour
- following fair and equitable employment practices
- recognising the interests of the wider community.
The Economic Development, Science and Innovation Select Committee (which reported back on 8 May 2023) was unable to agree whether the Bill should pass, with the three Labour members voting in favour and the three National Party members voting against. The Government has not yet indicated whether it intends to pass the Bill this term, but the Select Committee agreed that if the Bill does pass, the amendment should simply state that “in considering the best interests of a company or holding company…a director may consider matters other than the maximisation of profit.”
In addition to potential issues raised by reference to the Treaty of Waitangi (discussed below), the Committee’s key reservations were that:
- listing specific ESG factors could give the impression that these factors should be given more weight than others;
- the Bill might be seen as creating inconsistencies within the Companies Act and with other legislation that uses similar wording; and
- guidance or training to educate directors could achieve the same outcome without changing the Companies Act.
Te Tiriti / Te Ao Māori
One aspect that set the originally proposed amendment apart from similar legislation in other countries was the explicit inclusion of the Treaty of Waitangi (Te Tiriti o Waitangi) as a factor for directors to consider in determining the best interests of a company. The Select Committee considered that the reference to the principles of the Treaty could be a source of confusion, as “the relationship between the Crown and Māori is governed by Te Tiriti, and this relationship does not typically include other individuals or private entities.”
The Select Committee did not address the wider question of whether it might have been appropriate to specifically allow company directors to take into account Te Ao Māori in deciding a company’s best interests. That would have been a significant step, encouraging a different lens to be applied to corporate decision-making and acknowledging New Zealand’s unique cultural context.
Many Māori businesses typically have multiple objectives or a holistic kaupapa approach, which aims to balance financial objectives with the social, cultural, and environmental aspirations of their stakeholders. While these organisations engage in commercial activities and measure their performance against economic indicators, wealth creation is not always viewed as an end in itself but rather a means to support and sustain their broader mission. The change proposed to the Bill, to recognise that maximisation of profit is not the sole reference point, is consistent with this.
Some may say that the failure to expressly include Te Ao Māori represents a missed opportunity to reflect the country's distinctive cultural context. Given, however, the non-exhaustive meaning of ESG, Te Ao Māori factors can be appropriate considerations in relevant contexts.
If Parliament elects not to pass the Bill, New Zealand will be following the example set by Australia, which in 2019 elected not to amend the “best interests” duty to expressly include the interests of wider stakeholders. However, Australian courts have stated that it is reasonable for directors to consider the interests of a range of stakeholders when acting in a company’s best interests.
Recognising ESG factors in company decision-making is a growing international trend. In the United Kingdom, directors are legally required, when considering what is “likely to promote the success of the company for the benefit of its members as a whole”, to consider the interests of wider stakeholders, including employees, suppliers and customers, the impact of the company’s operations on the community and the environment, and the company’s reputation. UK law allows a company to have a purpose that is not to further the interests of its shareholders. Where a company’s purpose includes purposes other than the benefit of its members, UK law recognises that the stakeholder interests listed above will be relevant to achieving those purposes. Larger companies (there is a defined materiality threshold) have to report on how directors have considered wider stakeholder interests.
Canada has taken the middle ground between the United Kingdom and Australia, with directors expressly allowed, but not required, to consider the interests of employees, retirees and pensioners, creditors, consumers, governments, the environment, and the long term interests of the company when considering what is in a company’s best interests.
Would this Bill make a difference?
The ESG factors listed in the original Bill (other than the Treaty) reflect the headline ESG factors currently considered relevant internationally to an assessment of a company’s best interests. Rather than blazing a trail, many will see this Bill as the law catching up with corporate practice. Many, if not most, directors are already considering ESG factors when making decisions about the company’s best interests: good ESG credentials influence customers, employees, investors and other stakeholders. Failing to consider ESG factors can pose risks to a company’s reputation. This fact, and the approach taken in Australia, seems to have underpinned the position of the National Party Committee members in deeming the Bill unnecessary.
We agree that listing specific ESG factors, even if defined as “non-exclusive”, risks creating an expectation that directors must consider those factors, leading to the potential claims being made against directors if they are not taken into account. Any change to the Companies Act must therefore be very carefully crafted. However, ESG factors are not a passing trend. They are here to stay and having good ESG credentials is essential for businesses to stay competitive.
Why are ESG credentials so important for businesses?
In Simpson Grierson’s 2022 Expanding Horizons report, we found that 75% of respondents said ESG factors are important to their organisation’s decision-making and 43% of them said that one of the key reasons that ESG factors were so important was their corporate reputation. Good ESG credentials improve access to both debt and equity capital and access to employees, and influence customer and supplier decision-making. Major credit rating agencies are incorporating ESG factors into their rating reports. These are all factors which directors should take into account.
On the debt side, banks are required to report on ESG risk factors relevant to their borrowers and offer sustainability-linked loans with preferential margins that require ESG performance metrics. Similarly, equity investors have a strong focus on investments with good ESG credentials as those investors promote the ESG credentials of their portfolios. In our Expanding Horizons report, we found that nearly 40% of investors have walked away from a deal due to ESG risks, and almost 80% plan to address ESG factors during due diligence investigations for proposed transactions.
Whether the Bill passes or not, the proposed Companies Act amendment signifies a broader global shift towards recognising the importance of ESG factors in corporate decision-making. Directors and business leaders need to be proactive about incorporating ESG factors into their decision-making if they want to stay competitive and attract investors. By considering ESG factors, directors’ decisions will support sustainable growth and long-term value creation for their shareholders and build stronger stakeholder relationships, contributing to the company's overall long-term success.