Yet ESG is not always well understood and it is plagued by pervasive myths, such as the idea that it is only relevant for polluting industries, or the notion that it is just a flavor of Corporate Social Responsibility (CSR).
A stronger understanding of ESG (what ESG is, imperative for integrating ESG into business thinking and what it can do for your business) will go a long way in unlocking value for businesses, customers and communities.
ESG isn’t a feel-good initiative, and it isn’t synonymous with sustainable investing, CSR or socially responsible investing. ESG is part of the impact investing spectrum and also factors in ethical considerations to take environmental, social and governance factors into account alongside financial factors in the investment decision-making process.
Let’s look at each part of ESG.
Environment (E) focuses on the energy a business consumes and the waste it discharges. It also takes into account the resources that the business draws from the planet, and the consequences for living beings (not just humans) as a result of the draw on those resources. While carbon emissions, greenhouse gas and climate change are top of mind, it is important to understand that businesses use energy and natural resources and in doing so affect our environment.
Social (S) focuses on the quality of relationships businesses foster with employees, customers, vendors, partner institutions, and communities where they operate. S includes employee relations and diversity and inclusion. It underscores that every business operates within a broader, diverse society.
Governance (G) addresses the internal system of guiding principles, practices, controls, and procedures businesses adopt to self-govern, make effective decisions, comply with the law, and meet stakeholders needs.
ESG issues are increasingly having an impact on the corporate balance sheet. When done right the payoffs are high, but when mistakes are made the reputational risks and pitfalls can be debilitating.
Businesses that have an integrated ESG orientation can increase shareholder value by creating brand preference; proactively manage risks, including reputation; avoiding regulatory action; and gaining preferential access to new markets.
Businesses that improve employee conditions, including safety and well-being, enhance diversity, contribute to their communities, and stand for sustainable environmental practices that strengthen their brand favorability. Millennials in particular prefer to be associated as employees, consumers and investors with companies that are good corporate actors, and they reward those businesses with their loyalty.
Businesses and boards also have to be aware of the negative consequences of not addressing ESG risks, some of which can materialize quite suddenly.
Here are some examples:
3M has saved $2.2bn since introducing its “pollution prevention pays” (3Ps) program in 1975. The company prevents pollution upstream by reformulating products, improving manufacturing processes, redesigning equipment, and recycling and reusing production waste.
Starbucks, which had a challenging time gaining traction in China, leveraged the S in ESG effectively by offering healthcare to employee parents. Starbuck’s sales skyrocketed.
Unilever developed Sunlight, a brand of dishwashing liquid that uses much less water than other brands. Sales of Sunlight outpaced other products in that category by more than 20%.
Costco has introduced new environmental initiatives such as compostable coffee pods in its warehouses, a new policy regarding the use of chemicals, and a commitment to install solar panels at its stores. The company is also known for treating their employees well, offering a minimum wage of $15 an hour as well as awesome benefits. Having embraced and integrated ESG factors, Costco is better positioned for growth in the long run and less likely to be plagued by controversy or scandals.
The Wall Street Journal called PG&E “the first climate-change bankruptcy”. PG&E’s fall was fast and steep after it was engulfed by liabilities resulting from Californian wildfires potentially caused by its power lines. In October 2018, the company’s market capitalization was $25bn. In January 2019 it was removed from the S&P 500 when its value tumbled to below $4bn and its shares fell to their lowest level since 1972. PG&E’s case highlights the potential for climate change to damage company assets and cause a mushrooming of liabilities as an emerging enterprise risk, which needs to be proactively managed.
Wells Fargo continues to deal with the overhang of its 2016 customer-account scandal (in which it opened millions of fee-paying accounts without the consent of its customers). This highlighted weaknesses in governance and inadequate risk-management systems, and the company had its growth capped by regulators as a result. This came on top of the $100m in fines by the Consumer Financial Protection Bureau.
The Wells Fargo case and the recent Boeing 737 Max scandal are reminders that governance failures can quickly bring successful and storied brands to their knees.
For ESG to be sustainable and value creating in the long run, relevant ESG themes need to be integrated with business goals:
And specific ESG actions can be deployed to drive value in each of these areas:
Pick goals that meet the needs of the stakeholders and businesses, and proactively integrate the relevant ESG themes and key issues into your Enterprise Risk Management (ERM) process.
ESG factors are often deemed immaterial or expected to occur over the long term. Don’t bet on it. ESG risks should be assessed, including using a materiality lens to consider whether and when the issues surface and how that would impact (severity scale) business performance.
The Nestle stakeholder relevance and materiality matrix is a helpful way to organize thinking.
Is ESG integrated into our corporate strategy? Have we identified and set compelling sustainability targets and goals that resonate with our stakeholders’ interests? How do sustainability targets and goals compare to those of competitors?
How are our ESG story and sustainability targets and goals communicated internally and externally? What is the level of buy-in within the organization? Are adequate resources and skills in place to achieve those targets and goals?
How best to integrate ESG targets and goals with financial reporting? Are we providing meaningful updates to investors and stakeholders via financial reports, disclosures, quarterly earnings calls and investor roadshows?
What reporting framework (see Box) have we adopted, and why? What frameworks are our competitors using? What are the recommended industry frameworks? How do we avoid “greenwashing”?
What are the ESG risks facing the organization, and how well are they being tracked and managed as part of Enterprise Risk Management? How are these risks communicated in the public disclosures?
What accountabilities and incentives are in place to deliver on ESG goals and targets?
As a business leader you have an opportunity to shape your organization’s mindset to expand beyond shareholder orientation to stakeholder orientation. Identify relevant ESG themes. Communicate the why and how to internal and external stakeholders. Integrate ESG into business strategy, risk management and operational processes. Track and share progress. By doing so, foster a triple bottom line orientation (people, planet, profit) that creates a brighter and sustainable future for generations to come.
There is no common standard yet for ESG disclosures and reporting, so businesses have to be creative in blending multiple frameworks in order to better meet their needs. The various ESG frameworks follow different methodologies, resulting in many scoring systems and data interpretations.
Some of the popular frameworks are
GRI (Global Reporting Initiative)
GRI was launched in 1997 based on Ceres (formerly Coalition for Environmentally Responsible Economies) principles for responsible environmental conduct with endorsements from Tellus Institute, The United Nations Environment Program (UNEP), U.S. Environmental Protection Agency (EPA). The framework was then expanded to include social, economic and governance issues. Today, several stakeholders, including investors, businesses and governments, use the GRI Sustainability Reporting Standards to communicate on a range of impacts, including climate change, human rights, governance and social well-being.
SASB (Sustainability Accounting Standards Board)
SASB was launched in 2011 to develop standards to better align “sustainability fundamentals” with “financial fundamentals” with the goal of helping investors efficiently compare business performance on social and environmental issues in order to allocate capital to the most sustainable outcomes. The Harvard Initiative for Responsible Investments was also actively involved in shaping this initiative. SASB’s framework focuses on “financially material information” and complements other frameworks including GRI, the Carbon Disclosure Project, International Integrated Reporting Council and Taskforce for Climate-related Financial Disclosures.
TCFD (Taskforce for Climate-related Financial Disclosures)
The Financial Stability Board established the TCFD in 2015 at the request of the G20. TCFD’s disclosure framework enables businesses to report on their climate-related financial risks to investors, lenders, insurers and others. TCFD covers physical, liability and transition risks.
CDP (Carbon Disclosure Project)
Launched in 2000 to enable global economic system to operate within sustainable environmental boundaries and prevent dangerous climate change. CDP enables businesses to report on their climate, water and deforestation impacts.
WDI (Workforce Disclosure Initiative)
Launched in 2016, WDI collects data from companies on how they manage both employees and people working in their supply chain.
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