ESG as a competitive advantage
ESG as a competitive advantage
“ESG isn’t just for treehuggers”. Research for this article led us to these immortal words from a financial consulting firm in Madison, rural Wisconsin. Left of field though this may be, they are absolutely right. Whilst we at ESGmark® believe there is a moral imperative to conduct business in a responsible way, it is clear that environmental, social, governance (ESG) policies have become a critical competitive edge in the business world.
The pandemic has forced organisations around the world to focus on fire fighting and short-term solutions. However, as we start to emerge from our enforced lockdowns, ESG pressures are back at the forefront of our minds, meaning that the corporate world needs to respond with ESG policy. Well considered ESG policy incorporates elements across governance, ethics, fiscal responsibility and transparency of a company; management and boards must concentrate on decision-making in the medium and long term, creating value for all stakeholders and not only solve specific problems in the next quarter.
At its most basic, stripped of any moral obligation, ESG policy becomes risk mitigation and a series of risk analyses to ensure business resilience. ESG factors used to be on the backburner of risk assessments since they were seen as long term risks with little impact on the bottom line, but the rapid acceleration of climate, technological, political and cultural change has put ESG factors firmly on the agenda. Conducting an assessment of potential ESG factors helps companies anticipate and avoid hazards, strengthen their brand and deliver profitability.
As Larry Fink of Blackrock said in his famous annual letter to shareholders last year, “companies with a clear, well-articulated long-term strategy, and a clear plan to address the transition to net-zero, will distinguish themselves with their stakeholders – with customers, policy-makers, employees and shareholders – by inspiring confidence that they can navigate this global transformation”
The advantages of tackling ESG issues go well beyond creating good PR and placating uneasy compliance lawyers. A proactive approach to ESG demonstrates that a company’s management can look strategically at long term risks, opportunities and trends, and act accordingly. Again back to Fink - “there is no company whose business model won’t be profoundly affected by the transition to a net-zero economy”
Legal Requirements
The first and most pressing issue for companies not already engaged (or engaged enough) with the sustainability agenda is the fact that ESG-related disclosures will soon become legally mandated.
In March 2021, the EU introduced the Sustainable Finance Disclosure Regulation, making ESG reporting mandatory for asset managers and requiring disclosures to be available on businesses’ websites and in quarterly and annual reports. Germany announced in early May that ESG reporting will be mandatory for all sectors as part of its new Sustainable Finance Strategy. The UK is mandating compulsory disclosures in line with the Task Force on Climate-Related Financial Disclosures whilst the government’s Green Claims Code will render ‘greenwashed’ brands and products both a reputational and financial risk. Across the pond, the US Securities and Exchange Commission is considering rules requiring ESG disclosures for public companies and NASDAQ has proposed requiring its listed companies to disclose corporate board diversity statistics.
In short ESG-related disclosures are becoming government-mandated around the world and companies that can demonstrate a strong, pre-existing ESG position will be at a competitive advantage from the get go. They will avoid the fines and reputational risks associated with weak or unsubstantiated reporting, insulate themselves from bad publicity or interventions by activists and mitigate costs by avoiding litigation related to ESG court cases, (which may include data breaches, discrimination, harassment, pollution, modern slavery, and even local planning violations).
A strong ESG commitment now not only avoids any potential legal nasties but unlocks a host of short, mid and long term advantages. And just keep bearing in mind that if cost implications are uncomfortable, embracing ESG policy is actively good for business. Covid has turbo-charged the realignment of individuals looking to spend in accordance with their values, rather than simply their wallets.
Immediate profitability
Consumers increasingly want to make sustainable choices, and will purchase goods and services from companies they believe are environmentally and socially responsible. Contribution to the bottom line is immediate. According to the 2019 COOP/Ethical Consumer Magazine Twenty Years of Ethical Consumerism Report, conscious and value driven consumerism in the UK alone has grown from c. £11bn in 1999 to over £41bn in 2019. This trend will only accelerate as we move out of the pandemic and people look to spend their money in ways they deem to be responsible. Extreme weather such as floods, heatwaves and storms – the likes of which we have seen abundantly this summer – will also prompt ever more would-be buyers to put their money into goods they think make a positive difference to the climate crisis and socially focused initiatives.
Supply chain resiliency
As a competitive differentiator there are few changes you can make that are more impactful than increasing visibility in your supply chain. Transparency and traceability help you identify both risks and opportunities. A broad supply chain not only makes for more diverse suppliers - a big ESG tick - but spreads risk and minimises the threat of disruptions similar to those we have seen during COVID-19; sourcing options, production locations and a variety of distribution channels reduce the pressure on potential single suppliers. Good governance means stronger relationships with suppliers, more reliable service, increased efficiency and better credit terms. Responsible stewardship of raw materials not only protects natural resources but protects raw materials going into the supply chain. Due diligence on these issues can help reduce market volatility, reduce costs and strengthen relationships - all critical to the long- term viability and profitability of any business.
Access to talent
Deloitte’s annual survey of Millennials and Gen Z for 2021 found that fewer than half of respondents saw business as a “force for good” but that they expect the corporate world to step up. They are and will be the driving force within the corporate and financial worlds within the coming decade, so strategic forward-thinking executives will be taking steps now to improve labour conditions, enhance the diversity of their teams, give back to their communities and take a stand on environmental policies. Whilst the steps have tangible social and governance benefits, they keep both eyes firmly on the financials.
Talented, engaged Millennials/Gen Z’ers want to work for businesses who put purpose alongside profit and commit to organisations whose values are aligned to theirs. A 2016 study by Aon Hewitt found that a 5% increase in employees’ commitment to their employer led to a 3% increase in revenue the following year. The pandemic revealed for many companies the benefits of long term investment in their social and human capital, enabling them to mobilise talent and resources in innovative ways and continue to function through these uncertain times through a culture of trust, commitment and innovation. A loyal, motivated workforce creates long term value through increased productivity, lower voluntary turnover and improved labour costs.
Access to investment and capital
Company policy will also come to bear on investment opportunities as baby-boomer to millennial wealth transfer takes place in the coming couple of decades. Cash rich millennials will look to invest their wealth in organisations whose policies they agree with and value, becoming what is known as ‘sticky’ investors - values-based investors who are more interested in what happens in the coming years rather than the next quarter. They will behave more as activist investors who work to strengthen a company to build long term value rather than deliver short term returns.
A striking stat from the US based Forum for Sustainable and Responsible Investing shows totalled investment using sustainable, responsible and impact strategies reached $8.72 trillion in the US alone; an increase of 33% since 2014 and roughly one in every 6 dollars under management. Ever more investment firms are incorporating ESG evaluations into their portfolio risk assessment suggesting that increasing amounts of capital will flow into companies with strongly established ESG programs and practices. Remember that investors make evidence and fact based decisions - policy statements are not enough - the sooner you start working on an active ESG agenda, the sooner you will start accumulating the KPIs needed to make your ESG credentials provable.
Remember your market
Whilst millenials and Gen-Z will drive change towards a wholly ESG-focused agenda, we need to acknowledge that “ESG” is not a homogenous single-definition entity. Different elements under the ESG umbrella will have different impacts, risks and advantages dependent on the industry concerned. A hand made natural beauty products producer will have a very different ESG profile to a digital marketing start up, just as large scale electronics manufacturers in the American mid-west will differ from a financial services provider in Zurich.
The “environmental”, “social” and “governance” aspects will form differing portions and strategies for each, as will the impacts on the bottom line. A generic ESG policy might be an easy place to start, but over time it will need to be tailored to your company’s very specific profile, needs and desired outcomes.
Give your organization a competitive advantage
At the heart of ESG criteria is the simple idea that companies are more likely to be successful if they create value for all their stakeholders – employees, customers, suppliers and society in general, including the environment – and not just for the company.
Of course, all of the above makes no sense if the main objective of ESG risk analysis and management is not put into perspective and remembered: to improve the impact of the business on society. This may not be your top priority but failing to see the value in this idea risks that, your business proposition will be increasingly marginalised by companies that do.
The question you ultimately have to ask yourself is - what would be the cost if you choose to do nothing at all?