The US’s largest pension fund, the California Public Employees Retirement System, updated its Global Governance Principles, which drive its efforts on corporate engagements, proxy voting and investment decision making. The principles now state that board members of companies that CalPERS owns should have “expertise and experience in climate change risk management strategies.” They also call on companies to assign oversight responsibility on climate change to “a board member, board committee or full board.”
This move is hugely important, but it shouldn’t be seen as a surprise. For the past two years, CalPERS and other major U.S. pension funds have been targeting U.S. companies to adopt proxy access rules that will give large long-term investors the right to nominate directors onto corporate boards. A key reason why is investors want “climate competent” directors on the boards of carbon-intensive companies.
CalPERS’ action is especially noteworthy because it applies to all 10,000 companies in its $300 billion portfolio. By not linking its expectations on climate competent boards with any specific sector, CalPERS is effectively saying that climate change risks are pervasive and touch all parts of the economy. Ceres has long taken this position, but the investor community is just catching on. A Jan 2016 bulletin from the Sustainability Accounting Standards Board noted that 72 of 79 sectors they analyzed are materially affected by climate risks. In other words, it isn’t just carbon intensive sectors that are affected. The risks are ubiquitous and cannot be diversified away. Efforts to address climate change should therefore be universal and involve all sectors.
By focusing on how all company boards across the economy are managing climate risks, CalPERS has identified a way to jumpstart corporate climate action at the scale and urgency this colossal global threat warrants. As key influencers of company strategies, board directors are uniquely positioned to ensure meaningful consideration and action on climate risks and opportunities.
Investors have long recognized this and over the past five years have filed more than 250 shareholder resolutions calling on companies to establish explicit board oversight systems for climate change and other sustainability issues. But, given their objective to achieve substantive climate action from companies, CalPERS and other investors need to look harder at whether the oversight systems they’re asking for are achieving the desired performance improvements.
A recent Ceres report that I authored (View From the Top: How Corporate Boards Engage on Sustainability Performance) shows that board systems alone do not guarantee meaningful sustainability performance impacts.Based on interviews with three dozen corporate board members, company executives, investors and other experts, the report concludes that to be effective, board oversight systems need to be supplemented by other board actions, such as linking sustainability priorities to core business strategies and executive compensation.
CalPERS’ revised Governance Principles call on companies to make climate change the responsibility of a board committee or the whole board. Creating such explicit oversight will help ensure that climate change is considered more systematically by boards. However, as the Ceres report notes, effective board discussions and decisions on sustainability need to be linked with board deliberations on business strategies and, ultimately, bottom-line revenues. This will help ensure that climate discussions do not take place in a silo, but have broader business performance impacts.
One key way to drive sustainability through the business is to make the connection between sustainability and executive compensation, which the Ceres report underlines is a way to motivate management and reward the right behavior. This year saw investors filing a record number of resolutions asking oil and gas companies, including Chesapeake Energy and Devon Energy, to decouple replacement of fossil fuel reserves from executive compensation packages.
By calling on companies to recruit climate-competent board members, the principles identify another key gap. Our report found that even among companies with formal board systems for sustainability, only 19% of board members had any meaningful expertise in environmental and social issues. Onboarding an expert in climate change will go a long way in ensuring that key issues are raised and the right questions asked.
Our report also recommends that companies level up all board members on sustainability issues — through board training, involvement in stakeholder dialogues etc. – so that sustainability becomes a board-wide priority instead of falling all on one individual, thereby allowing for more meaningful impacts.
While there’s always more to be done, CalPERS’ new Global Governance Principles draw an important, advanced line in the sand on this profound global challenge that will require far stronger engagement and action from all economic actors. Corporate board members could play a critical role to lead and achieve the low-carbon global economy we desperately need.
Veena Ramani is a senior director at the nonprofit sustainability group Ceres.