ESG is integral to business strategy

Posted in Reporting and Sustainability on 9 December 2019 By Claire Fraser, Senior Reporting Consultant

As social and environmental issues continue to capture headlines, the days of ESG being treated as a separate, standalone concern by businesses are over.

2019 has seen environmental, social and governance (ESG) factors become a mainstream concern for businesses. 

ESG issues are dominating media headlines. Attention this year has been focused on climate change, and discussion around broader social issues such as inequality is fast becoming a key factor in December’s general election. But while these matters continue to gain traction in public consciousness, how ESG impacts companies and – more importantly – how they should be responding is trickier to identify and quantify, particularly with regards to strategy.

The challenges of integrating ESG into business strategy was the key area of discussion at an interesting session with the London Stock Exchange Group (LSEG), Datamaran and ERM: Environmental Resources Management. The session also busted some of the myths and misconceptions around what ESG is and what it's not. 

My three key takeaways from the discussion were: 

1.     Sustainability is now a must-have

Increasing regulation and non-financial disclosure requirements are driving sustainability into the mainstream of risk management, strategy and board oversight. It's no longer a nice-to-have, it's a must-have. 

ESG has moved up the corporate agenda and into boardrooms. There was a general consensus at the event that the line between financial and non-financial disclosure is blurring as the landscape has evolved from the softer days of CSR (corporate social responsibility), to the constantly evolving expectations and non-financial disclosure requirements of today. 

Our own research on the rise of ESG investing supports this, with James Armstrong at Bluefield Partners LLP commenting that ‘there has been a significant shift in the past 18/24 months, with investors demanding what funds are doing to address ESG considerations, whether it be issues surrounding climate change, transparency of reporting, through to increased diversity on boards. It is one of the most important themes for investment funds today and is almost certainly a long-term structural change.’

However, ESG is not simply about compliance, form-filling and box ticking. It’s all part of a drive for companies to consider their longer-term impact beyond short-term profits and shareholder returns. Companies cannot discuss ESG meaningfully unless it is truly embedded within business decision-making, strategy, risk management, board oversight and incentives. 

At the event, there was a lot of discussion around climate-risk and reporting. Specifically, what companies need to do and how should they adopt the TCFD framework. There was general agreement that the impact of climate risk is a difficult thing to quantify, however this needs to be on the agenda at the highest level in order for companies to consider and assess the impact on their business in terms of risk management, strategy and board oversight. 

2.     ESG is the link between risk and opportunity

ESG should relate to the language of the business. Essentially, it’s about business behaviour and conduct, corporate culture and stewardship, operational impact and reputation, risk and opportunity. Sustainability and enterprise risk management are intrinsic to one another; however, sustainability goes beyond risk to look at longer-term opportunities. 

These functions are often carried out by different individuals whose skillsets lie in different areas. This means there may be a need for upskilling and understanding of how financial and non-financial matters impact one another – and this also applies to senior leadership. Governance and board oversight of financial and non-financial matters should go hand in hand, which often requires changes to board committee terms of reference, and upskilling teams to bridge the knowledge gap.

3.     It’s all about value creation

Far from the philanthropic days of CSR and ‘giving back’, the concept of responsible business and sustainability is fundamentally how a business creates value and sustains itself, its reputation and licence to operate over the long term.

Sustainability is having a huge impact on every area of business and companies need to be responding in order to be able to safeguard their own long-term future. ‘The future is utterly about transition,' explained Mike Barry, sustainability expert and the originator of Marks and Spencer’s ‘Plan A’ strategy, in a recent Emperor interview. 'We are coming to the end of a 40-year cycle of stability. We are entering a decade of great disruption ... Every business needs to find a balance between shareholder returns, customer need and society and the environment as well.’

This is one of the driving forces behind the growing attention from investors on ESG – whether as part of their normal investment process, or for specific ESG or impact funds. Companies that have good practice when it comes to ESG are helping to safeguard their long-term value creation.

At the event, one of the participants from commercial banking commented that their focus is currently on negative screening, which excludes companies that do not comply with specific social and environmental criteria, to ensure there’s nothing harmful in their portfolio. You can find out more about how companies are selected for ESG funds in our research.

Engagement is key

In summary, ESG is not a standalone compliance exercise. It is intrinsically linked to every facet of your business, from your business model to your strategy, performance, risks, governance and directors’ incentives. Take a step back and consider how all these things influence and impact one another.

On the IR side, engage with your investors, fund managers and asset managers to understand what information they’re looking for and how you can best provide it. Engage with a wider range of stakeholders – including employees and customers – to give you real insight into what issues are most material to your business, your industry and your sector. Map these out so you can concentrate your efforts in these areas. Develop a clear strategy and set ambitious targets against which you can benchmark. Then you will be able to address it meaningfully. 

 

To find out more about integrating ESG within your communications and reporting, get in touch with me at [email protected].

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