The answer has three letters, and it is ESG. Whether you are an investor or a company, big or small, Environmental, Social, and Governance (ESG) reporting and investing, is the framework to latch on to if you want to stay up to speed with the market.
The E in ESG, refers to environmental criteria. Every company has an impact on and is impacted by the environment, such as the amount of energy your company takes in and the waste it discharges, the resources it needs, and the consequences for living beings. It further encompasses carbon emissions and climate change. Social criteria (S), examines how a company manages its relationships with its employees, suppliers, customers, and the community. This includes labour relations, diversity, and inclusion. Governance (G) is the internal system dealing with how a company is governed. This includes the practices, controls, and procedures your company adopts. Governance is a useful tool that enables a company to govern itself, make effective decisions, comply with the law, and meet the needs of external stakeholders.
Thinking and acting on ESG in a proactive way has become a pressing matter for companies to investigate. ESG scoring and reporting has the potential to unlock information regarding management and the resilience of companies when they pursue long-term value creation. A well-established ESG reporting system has the potential to represent an important market-based mechanism that investors could implement to better align their portfolios with environmental and social criteria which consequently supports sustainable development.
There has been a spectacular rise in ESG-oriented investing. Global sustainable investment now tops $30 trillion (68% increase since 2014 and tenfold since 2004). ESG propositions can not only safeguard a company’s asset allocation, risk decisions, and generate sustainable, long-term financial returns, they can help customers, investors, and governmental regulators understand and manage the impacts which their operations have on the environment and on society.
ESG creates value in five different ways (Witold Henisz, 2019):
- Top-line growth
McKinsey research has shown that customers are willing to pay to “go green” since the payoffs are real. An example is when Unilever developed Sunlight liquid which made use of less water than its competitors. Sales of Sunlight and Unilever’s other water-saving products proceeded to outpace category growth by more than 20%. Another proof that ESG payoffs are real is that of Finland’s Neste Oyj company, (a traditional petroleum-refining company), now generates more than two-thirds of its profits from renewable fuels and sustainability-related products. Therefore, having a well-defined ESG proposition enables companies to tap new markets and expand into existing ones.
- Cost reductions and sustainability
Operating profits, by as much as 60%, can be saved, simply by fighting the rise in operating expenses such as raw-material costs and the true cost of water or carbon. An enterprise in “The Water Utility Industry” saved up to $180 million per year due to lean initiatives which were aimed at improving preventive maintenance, refining spare-part inventory management, and tackling energy consumption and recovery from sludge.
- Reduced regulatory and legal interventions
Regulatory pressure and administration are a headache for most companies. An ESG proposition can reduce a companies’ risk of adverse government action and provoke support from the government. More than one-third of corporate profits are at risk from state intervention. The impact of state regulations varies by industry. For pharmaceuticals and healthcare, the profits at stake are about 25 – 30%. For the banking industry, the value at stake is typically 50 - 60%. By simply having a stronger external-value proposition can enable companies to achieve greater strategic freedom, and accordingly ease up regulatory pressure and time.
- Employee productivity uplift
An ESG proposition gives employees a sense of higher purpose and inspires them to perform better. A weaker ESG proposition can drag productivity down, for example, strikes, worker slowdowns, and other labour actions. Therefore, employee satisfaction has a direct impact on shareholder returns.
- Investment and asset optimization
Stranded investments, impacted by longer-term environmental issues, can easily be identified through ESG. Not only can it identify stranded investments, but it could enhance investment returns by simply allocating capital to more promising and more sustainable opportunities such as renewables, waste reduction, and scrubbers.
In recent times humanity has become acutely aware of the impact that environmental, social and governance factors can have on business. This should force us to reassess our ESG reporting. Not only for the wellbeing of our business but also for the prosperity of the globe. The Covid-19 outbreak and climate change made us realise that we are not masters of our planet but rather stewards of nature.
Leonie de Lange
