In its latest annual report on the environmental performance of England’s water and sewerage companies, the Environment Agency (EA) has criticized the sector’s poor performance and indicated a need for tougher enforcement action. The report calls for courts to impose higher fines on companies committing serious and deliberate pollution incidents, along with an emphasis on taking action against directors, including the use of prison sentences for chief executives and board members whose companies are responsible for the most serious incidents.
The report raises complex issues surrounding potential tensions between various stakeholders, including shareholders, board members and the regulators, framed around a narrative pitching financial performance against environmental performance.
The EA has wide-ranging enforcement options in relation to most environmental offenses, with the choice to use either civil or criminal sanctions. Where a company is criminally liable, the EA may also take action against a director or other officer if the offense is a result of the individual’s consent, connivance or neglect. This has traditionally been seen as a high bar which is not reflected in EA’s statement.
Criminal prosecution has generally been viewed by the EA as a last resort, however, the report states that it will now take criminal action in relation to repeat offenders where it would have once used its civil powers.
The EA’s hard-hitting warnings for businesses and individual directors will naturally be a wake-up call for boards of water and sewerage companies to improve their environmental compliance. While the current focus is on the water and sewerage sector, the statements made, and potential approach to enforcement, could be applied to other environmentally sensitive sectors in the coming years. The water industry is perhaps scrutinized most heavily due to the visible nature of water pollution and the emotional connection that people feel to rivers and coastlines. As less visible impacts such as air pollution and habitat destruction are pushed further up the ESG agenda in other sectors, and therefore a wider population of companies and their directors, may come under additional scrutiny.
How should company boards respond?
- Boards should assess their governance structures and ensure that they have sufficient levels of technical and environmental expertise both at the board level and among those persons and committees reporting directly to the board. At present, the former is not driven by regulatory regimes such as the ‘senior managers and certification regime’ that applies to the financial sector, whereby chairmen, chief executive officers, executive directors and chairs of key board committees are required to meet, and evidence , certain standards of fitness and propriety. However, it is not inconceivable that such an approach will be considered in other sectors in the future.
- There will inevitably be unease among non-executive directors in particular, who will want to develop their knowledge of the company’s environmental obligations and performance.
- Boards will need to be acutely sensitive to the balance between (i) distributions to shareholders and executive pay and (ii) capital investment, to be responsive to the criticism that the environment is being damaged to fund excessive returns.
- Increased awareness and understanding of the operational and technical causes of non-compliance and pollution incidents will, in turn, facilitate more robust scrutiny of environmental compliance at board level, as well as informing decisions in relation to company strategy and investment. This requires a joined-up approach between financial, technical, regulatory and legal teams.
- Companies could link elements of variable executive pay to more specific environmental and compliance metrics, such as targeted pledges and/or the company’s EA Environmental Performance Assessment rating. This would both help to align performance with the company’s environmental strategic goals and foster executive focus on environmental protection.
- Robust procedures are needed to enable a rapid response to incidents that do occur to enable reporting and mitigation measures to be taken.
Opportunities for companies
For companies that have in place appropriate governance procedures, make suitable investment in infrastructure, and innovate to meet current and future challenges in respect of environmental protection, there are opportunities to operate in a way that best protects people and the environment. This is likely to attract positive engagement from investors and regulators alike.