Governance & ESG: What is ESG governance?

"G" for governance - what does it mean?

In this context, governance is the system that a company uses to manage its business and promote the interests of investors and other stakeholders. A governance system consists of, among other things:

• processes and controls to monitor and address impacts, risks and opportunities
• the relationship between the day-to-day management, the board of directors, and other stakeholders
• structures and processes for setting company objectives, following up on the progress made, and evaluating company performance.

In practice, companies are often run according to a more or less sophisticated governance system that may be explicitly adopted depending i.a. on the subject matter, legal requirements, and corporate culture and maturity.

Thus, organisations that are run according to an effective governance system have a framework that promotes efficiency, transparency and accountability in their decision-making.

Governance is one of the three pillars of ESG work

In companies' work with ESG, governance is one of the three pillars, with "G" standing for governance. The governance pillar often refers to a number of topics relating to the company's ethical values and conduct, including anti-bribery and anti-corruption, responsible tax practices, sustainability due diligence, good business conduct, and corporate governance (including the composition and remuneration of the management).

ESG governance is often implemented with the use of management systems

Governance is often implemented in the day-to-day work using one or more management systems within the framework set by the governance structure. Many companies design their management systems on the basis of recognised frameworks and models. 

Some of them can lead to certification (e.g. ISO certification), approval (e.g. Scienced Based Targets Initiative ("STBi")) or labelling (e.g. “Svanemærket”). However, there are also useful guidelines that are not certifiable but reflect best practice in responsible and ethical business conduct. These years, such guidelines are also being incorporated into ESG legislation at EU level and in the UN Guiding Principles on Business and Human Rights and the OECD Guidelines for Multinational Enterprises, which were updated earlier this year.

ESG and governance from a legal perspective

From a legal perspective, ESG refers to the regulation of environmental, social and governance issues. In Denmark, the governance of limited liability companies is mainly regulated by the Danish Companies Act, which sets out the overall requirements for the management's duties and responsibilities. One of the most important being the management's duty to ensure preparation of an annual report and compliance with the rules of the Danish Financial Statements Act.

For large listed companies, it means, among other things, that they must issue a corporate governance statement addressing a number of recommendations which also include sustainability.

Both large listed companies, State-owned companies and large unlisted companies above certain thresholds must report on their corporate social responsibility. This reporting obligation will be extended with the implementation of the Corporate Sustainability Reporting Directive (“CSRD”) on 1 January 2024, which will impose new reporting requirements and expand the scope to include other large companies as well as listed small and medium-sized undertakings.

Read more about the coming into force of the SCRD here.

The CSRD regulates a number of ESG issues

The CSRD regulates the obligation of companies to report on ESG issues in their annual report, but it does not specify how a company should organise its governance structures. However, the extensive requirements for analyses, assessments and results to be published by companies under the CSRD and for the collection and validation of data implicitly also affect governance issues.

New EU directive will include additional requirements

We expect EU’s upcoming Corporate Sustainability Due Diligence Directive (“CSDDD”) to also include a number of governance requirements. Thus, some of the key obligations in relation to the performance and follow-up on the company’s ongoing ESG due diligence are related to governance.

When the EU launched its first CSDDD draft in 2022, sustainable corporate governance was an important part of the scope, but some of the provisions have subsequently been abandoned following negotiations between the Member States. Based on the European Parliament’s draft resolution of 1 June 2023, we expect, however, a key provision on management’s responsibility in relation to sustainability to become a reality with the implementation of the Directive. In the present wording of the proposed directive, it is explicitly stated that companies can be held liable for failure to prevent potential adverse impacts and to terminate such impacts, where the failure has resulted in an adverse impact the extent of which should have been identified, prevented, mitigated, terminated or minimized using the relevant measures and which has caused harm.

Thus, the CSDDD will impose a number of ESG governance obligations on companies, including in relation to their due diligence procedures and the management’s duties and responsibilities.

How can your organisation implement ESG governance?

With the increased ESG awareness among policymakers, legislators and stakeholders, companies need to adopt a strategic approach when working with ESG. It is our experience that companies which have implemented a robust ESG governance structure have the greatest value adding potential. Typically, they have already established a link to other important business parameters.

To ensure a robust and value-adding implementation of ESG governance in your organisation, you may take the following steps:

How can managers promote ESG governance?

As discussed above, the management plays an important role in establishing and implementing ESG governance, both as a result of the legal requirements and as an integral part of the creation of value in the organisation.

In our experience, managers can promote effective and robust governance by establishing and maintaining a system based on the best practice already available.

If your company wants to prepare for the future, you can, among other things:

• integrate ESG objectives into your corporate strategy, action plans and incentive programmes for employees and management
• work to ensure transparency in management decision-making, which may enhance efficiency, consistency and trust
• take measures that make efforts to reduce negative impacts on ESG part of the company's DNA
• work with your customers, suppliers, other business partners and stakeholders to promote important ESG objectives that serve both your and your stakeholders’ interests (which is an important element in defining long-term, ambitious objectives in relation to climate neutrality, biodiversity protection, and human rights in each value chain).

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