Both the public and workforce have joined investors in ESG interest. A 2019 Fortune Magazine study found that 72% of adults believe social responsibility should drive business strategy.
The study also determined that 80% of 25 to 34-year-olds prefer to work for socially responsible companies. Only a few years later in 2022, we are beginning to see ESG as not only a ‘strategic differentiator’ but as license to operate in some industries and markets.
Understanding ESG risks
Businesses face new risks as investors, consumers, employees and partners demand greater corporate accountability, transparency and sustainability. Stakeholders want to know how organisations are affecting the environment, how they treat their employees, clients and communities, and if they conduct their business ethically.
These environmental, socioeconomic and governance variables, which are likely to affect the financial situation or operating performance of a company, are collectively referred to as ESG (Environmental, Social, Governance) risks.
While ESG variables are diverse, they all have one thing in common: they can have a significant impact on a company's long-term sustainability and profitability. A business that overlooks these risks could potentially incur large financial penalties and also lose investors, customers and stakeholder support.
However, not all ESG issues are created equal, and their relative relevance varies by company, industry and sector. This means each organization must identify, manage and reduce its unique material ESG risks.
As such tailored analysis and strategy is required to avoid falling into the common traps associated with poor ESG understanding and management. It is important to remember that your business needs to consider all of your stakeholders, the communities and industries that you operate in when formulating your environmental, social and governance goals.
Viewing ESG risks as opportunities
There remains significant opportunities for companies to leverage ESG risks to attract investors, reduce their cost of capital and grow their serviceable obtainable market.
The COVID-19 pandemic reinforced the importance of environmental, social and governance (ESG) issues. Delivering on the ESG commitment requires long-term, strategic thinking from executives on all facets of their business.
While companies recognize that an emphasis on ESG is critical to business resilience, many still struggle to put in place a framework for incorporating ESG factors into their operations. Failure to do so can be costly, as there is growing evidence to suggest that ESG performance is correlated to an enterprise’s valuation, revenue and cost of capital.
In recent years, there are increasing expectations by investors, regulators, customers and other stakeholders for enhanced disclosures on sustainability and climate change, delivered in the form of a sustainability report, also known as an integrated report or impact report. Leading exchanges and investors use these reports to assess how sustainable their portfolio companies are.
Authorities and regulators are taking more concrete action
Concurrently, authorities and regulators are taking more concrete action, including mandatory requirements or imposing taxes for ESG-related concerns.
Some of these ESG-related regulations may impact organizations not only in the country where they are incorporated but also in other markets where they have operations. This confluence of factors is compelling companies to embark on an ESG journey or step up the momentum in it.
In addition to investors, consumers are becoming increasingly ‘ESG aware’ and “Green Consuming” continues to gain market share. IBM Institute for Business Value (IBV) found that 93% of global respondents said the pandemic had influenced their views on sustainability and as we all know, environmental issues have only become more front of mind since with regular news headlines, climate disasters and concerning forecasts for years to come.
The same report from IBM surveyed 16,000 global consumers in February 2022 and found that more than half (51%) of respondents say environmental sustainability is more important to them today than it was 12 months ago. It also found that consumers’ actions are starting to match their intent.
These shifts are unlocking new opportunities and market share for businesses that are taking sustainability seriously as they build ESG processes into their decision-making, products and services.
Kick-starting the ESG journey
Companies seeking to drive sustainability can adopt a three-step approach: defining what sustainability means to their business, developing an ESG framework with the buy-in of the workforce, and communicating their ESG performance to external stakeholders.
How one defines sustainability goals will depend on the organisation. While there are many ESG issues, companies must decide which are the ones that have a material impact on their business and prioritize accordingly.
To be clear, sustainability is not necessarily just about the environment and climate change. It also encompasses any factor that can affect how sustainable the company will be in the long term. A financial institution, for instance, will likely consider responsible tax management, cybersecurity or data privacy as issues that are material to its sustainability agenda.
In trying to define sustainability, it is important to proactively engage with internal and external stakeholders to get a better understanding of their expectations. Examples of external stakeholders include investors, financial institutions, the supply chain, regulators and other key players in the value chain.
The next step is to develop a framework to determine the targets of the company’s ESG agenda, how the organization plans to drive that agenda as well as the type of data required to inform the strategy.
For instance, if climate change is a material risk for the company, it will need to set a deadline for achieving net-zero emissions, among other goals, and come up with a road map to achieve this objective.
The third and final step is for the enterprise to have the right level of ESG-related disclosures to fulfill regulatory requirements as well as regular communication with its stakeholders.
To drive sustainability, companies need to define what sustainability means to their business based on stakeholders’ expectations. They also need to develop an ESG framework and regularly communicate ESG performance to stakeholders.