Over the last few weeks, we have heard from both Valentina Lira, CEO of Viña Concha y Toro and, this week, Chris Coulter, CEO of GlobeScan. In both these episodes, these guests outlined how ESG considerations are increasing in importance for business, both well established, and growing. Whilst these guests have perfectly covered the ‘what’,today, we will cover the ‘why’. Why is ESG so important nowadays? And why is it so crucial for businesses to take the advice from Chris and Valentina seriously, and how taking this advice will ensure businesses can avoid some key risks by doing so.
What is ESG?
ESG stands for environmental, social and governance; these pillars represent the three key areas companies are expected to report in. The purpose of ESG is to capture all non-financial risks and opportunities associated with a company’s day-to-day operations.
According to Forbes, ESG issues were first referenced in the 2006 United Nations Principles for Responsible Investment (PRI) report, which included the Freshfield Report and “Who Cares Wins.” For the first time, organisations’ financial evaluations have to include ESG criteria. This endeavour was aimed at further creating sustainable investments. At the time, 63 investment businesses made up of asset owners, asset managers, and service providers signed an agreement to incorporate ESG issues into their $6.5 trillion in assets under management (AUM). As of June 2019, there were 2450 signatories, representing over $80 trillion in AUM.
Why is ESG important?
Climate change, the move from a linear to a circular economy, rising inequality, and balancing economic and societal requirements are just a few of the major challenges that our globe faces. Investors, regulators, consumers, and employees are increasingly demanding that businesses not only be good stewards of capital, but also of natural and social capital, and that they have the proper governance framework in place to support this. As more investors incorporate ESG factors into their investment decision-making process, ESG becomes more significant in terms of acquiring funds, both loan and equity. Failure to incorporate ESG practices leaves corporations at risk of losing investors, and further risks of diminishing capital in the future. The emphasis on ESG is increasing as significant institutional investors make it plain that they expect the companies they own to adhere strictly to ESG guidelines.
Crucially, ESG allows businesses to target specific areas of their organisations, in order to implement more ethical and sustainable practices – as an activity it remains crucial for companies looking to mitigate risk.
The Environmental Pillar
The ‘E’ of ESG is the most complex in terms of reporting, but, in simple terms, refers to a company’s impact on the planet. There is an expectation on companies to be good environmental stewards. This can include the use of recycled materials in production processes, and ensuring as many of the materials as possible are cycled back into the economy, rather than into landfill. Under this pillar, concerns surrounding land use, deforestation and threats to biodiversity are also expected to be reported under this pillar. For example, a corporation with bad environmental standards risks being faced with increased regulation, reducing earnings.
The Social Pillar
The second pillar of ESG concerns the impact an organisation has on people – staff, customers and the wider community. Companies are expected to report on how they handle staff development and labour policies. They also report on product liability related to the safety and quality of their products, as well as providing information about their supply chain labour, health and safety regulations, and contentious sourcing concerns. Where relevant, businesses are required to report on how they provide access to their products and services to impoverished social groups. A corporation with poor social practices puts itself at risk of suffering reputational damage, resulting in lost consumers and income.
The Governance Pillar
the final ESG pillar is about how a company is governed, and encapsulates everything to do with shareholder rights, board diversity, and how executives are compensated and how their pay is linked to the company’s sustainability success.It also addresses issues of business behaviour, such as anti-competitive tactics and corruption. A corporation with poor governance practices is more likely to face fraud or other financial issues. Given how damaging to corporate reputation such issues can be, it is important for companies to mitigate this risk in as many ways as possible, through the incorporation of ESG practices.
Designing an ESG Strategy
The Corporate Governance Institute provides some fantastic advice for companies about ESG strategies.In recent years, investors have placed a greater emphasis on environmental, social, and governance issues as they seek to invest in companies that are committed to positively benefiting society; as a result implementing an ESG strategy can help organisations demonstrate their commitment to these concerns and attract investors.
There are various approaches for a board of directors to implement an ESG strategy. They can, for example, set goals for lowering greenhouse gas emissions, implement programmes to promote employee inclusion and diversity, or improve supply chain transparency. Along with attracting investment, implementing an ESG approach can help with operational efficiency, risk management, and staff engagement. Implementing these strategies will become easier as more investors prioritise ESG issues.
Designing an ESG strategy does not come without its challenges, however. Companies often lack data and transparency about social and environmental issues, making it difficult to set clear goals. Additionally, developing these strategies can involve large investments to made at the initial stages, and can disrupt employees and consumers – both of which can create barriers for companies with limited resources. To overcome these challenges, companies can partner with NGOs with expertise in ESG strategies, and develop phased implementation policies to gradually implement new procedures, limiting disruption and the cost on company resources.
As we have learnt from our recent podcast discussions, ESG is not going away, and the risks of not implementing ESG strategies and procedures into a company can be devastating. It is therefore imperative that companies begin to implement policies aligning with ESG pillars.