Is ESG just a 2022 fad?
Leas Bachatene, CEO of ethiXbase discusses with Business Leader why ignoring ESG can be a costly mistake for your business.
From COP26’s spotlight on the environment and recent extreme weather events, to the devastating human rights violations and inequalities that continue to make the news, the 2020s have catalysed the momentum of Environment, Social and Governance (ESG) enforcement and it’s important on the people and businesses of our planet.
And this momentum is gaining fast. By 2025, Bloomberg calculates that global ESG assets will exceed $53 trillion USD, representing more than a third of the $140.5 trillion USD in projected total assets under management. Businesses used to reporting heavily on financial metrics need to be ready for sustainability accountability, as it fast becomes a focus of consumers, investors, regulators, employees and shareholders alike.
By incorporating broader environmental and sustainability metrics in their decision-making now, organisations can be on the front foot as demand and scrutiny increases. Failing to do so is quickly becoming a costly business. Here’s what you need to know to ensure you are ESG prepared.
What is ESG and why is it important?
In short, ESG stands for Environmental, Social and Governance and is a measurement of a company’s level of sustainability. It is a standardised set of criteria for a company’s operations that investors use to screen potential investments as well as monitor their performance over time.
ESG is scored on how companies perform in three key pillars:
- Environmental considers how companies use energy and manage their environmental impact, including factors such as energy efficiency, carbon emissions and waste management.
- Social considers how companies foster their people and culture and how that ripple effects on the broader community. Factors considered are diversity, inclusivity (D&I) and gender, employee engagement, customer satisfaction, data protection, privacy community relations, human rights and labour standards.
- Governance considers companies’ internal systems of controls, practices, and procedures and how an organisation stays ahead of violations.
The supply chain represents the largest potential risk for companies and is where ESG becomes vitally important. Today, it is estimated that 80% of global trade passes through supply chains. This exposes companies to significant reputational and operational risks which may harm their asset price or market value, financial performance and reputation. Supply chains fall outside of a company’s core operations and consequently lack common governance standards and are often opaque.
To manage these risks, companies must audit their third-party networks to reveal any red flags, missing information and outdated data on an ongoing basis. Understanding the ESG risks within their supply chains is vital to preventing reputational damage but given the sheer size of today’s disparate and multi-tiered networks of partners, suppliers and third parties, this is often easier said than done. Today’s ESG and sustainability risk management solutions can take much of this burden away and empower companies to maintain sustainable business practices quickly and cost effectively.
How can ESG ratings impact your company?
There are a magnitude of benefits of having robust ESG policies and credentials. A high ESG score correlates to increased profits, increased consumer demand and improved resistance and productivity during demanding times. According to the MSCI World Index, the average cost of capital of the highest ESG-scored quintile was 6.16%, compared to 6.55% for the lowest ESG-scored quintile.
Companies with high-achieving ESG scores are better positioned to attract better human capital and have more engaged and motivated employees. A report by Marsh & McLennan predicts that by 2029, the Millennial and Gen Z generations will make up 72% of the world’s workforce. These generations set a greater value on environmental and social concerns and will expect employers to share similar beliefs and values as them.
According to a report by the Environmental Defence Fund, 93% of consumers will endeavour to hold businesses accountable for environmental impact, and a report by PWC found that 48% of consumers want companies to show more progress on social issues and 54% on governance issues.
High ESG scores show that your company is doing its part to decrease environmental impact, taking stances on community issues and has a diverse and inclusive workforce. For investors, companies with good ESG scores are thought to be well prepared to deal with future tasks, foresee beneficial opportunities and make better long-term decisions.
Conversely, a company that has a poor ESG score or has not implemented an ESG policy can experience significant financial and reputational impacts. This will ultimately erode or even lose the trust of consumers and investors, which may then lead to reduced sales, funding and investment.
How is ESG measured and scored?
Though there remains some discretion as to exact scoring methodologies and frameworks governing ESG scoring and rating processes, some best practices across ESG scoring have emerged. In most cases, ESG rating agencies rate companies based on information gathered from multiple sources including a company’s own data, Government data banks, the media, and NGOs or other stakeholders. Questionnaires may also be used to gather further information from companies.
Verifiable ESG disclosures are expected to adhere to a specified set of mandatory and voluntary requirements. Until ESG scoring becomes mandatory, it has relied on transparency. This allows stakeholders to compare performance, gain a clear picture of a company’s direction and make long-term beneficial decisions.
However, as an increasing number of business-relevant legislative Acts are passed, such as the Modern Slavery Act in the UK and Australia or the more recent Lieferkettensorgfaltspflichtengesetz (LkSG) in Germany, it’s more important than ever for businesses to start viewing ESG scoring as a mandatory business process.
How to improve your ESG reporting?
The first step to achieving good ESG reporting is to have a reliable, sustainable business framework as well as choosing the right metrics. Taking steps that are recognised as being key to your company’s operation will shine through in ESG performance. This starts with integrating ESG data and an ‘ESG mindset’ into everyday business operations. This mindset will enable your organisation to create a platform for further internal activity and your supply chain.
Frequently reporting on processes used to meet ESG goals as well as any remediation action and methodologies that have been taken to improve your operations will help make accurate ESG judgments. By identifying exactly how your business is going to achieve your ESG goals is important to stay on top. Analytics and data visualisation plays a key role in this and can help your organisation identify which areas of your business need improvements on ESG areas.
Identifying the ESG gap in your supply chain is crucial and can be the difference between failure and long-term success. It’s fast becoming a fundamental business requirement to be able to prove that you are measuring authentic sustainability and social impact with genuine continuous improvement to gain trust and recognition in the market. Those that act now will reap the benefits, but those that delay will count the costs sooner than they think.