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From corporate boardrooms to social media, ESG is the matter of the moment. Those who have been around the corporate management block will remember how “sustainability” has shifted from the Triple Bottom Line to Corporate Social Responsibility (CSR), and now, in its latest iteration, as Environmental, Social and Governance (ESG). Companies across various industries are pursuing sustainability by developing and implementing ESG strategies.
But as the fervor of environmental, social and governance reporting builds, meaningful performance metrics lag.
Despite ESG’s rising prominence on corporate and investor agendas, a high level of confusion continues to surround standard requirements, climate risk and climate opportunity. Based on my experience working with companies large and small on a wide range of strategic issues, companies tend to make the following key mistakes when tacking ESG.
1. Avoiding the issue
It is a fallacy to think that ESG is a passing phenomenon. Rather than a disparate fad, ESG is the next iteration of a common thread — sustainability. Sustainability in the early ’90s and ’00s invited the corporate world to consider social and environmental factors in line with the traditional financial bottom line. In practice, the triple bottom line placed an outsized focus on environmental performance, risk management and efficiency orientation. Applied to company strategy, the triple bottom line was loosely defined and often lacked a systematic, actionable approach to KPIs.
The triple bottom line came to represent the principal theme of corporate social responsibility (CSR). Stakeholder capitalism taking ground, CSR mostly focused on discrete initiatives, such as corporate engagement with non-profits and stakeholder engagement, alongside other philanthropic efforts. Focused on a company’s accountability to stakeholders and the public, as well as its license to operate, CSR was an orientation in holistic reputation management. Tending to focus on program activities and their output, as with the triple bottom line, CSR too often lacks meaningful KPIs.
From this perspective, ESG is the next edition of this development. What’s changed? Instead of being internally led by corporations, investors have begun to drive the conversation by requiring ESG performance metrics as a precursor to investment. ESG concentrates on the entire range of non-financial issues that impact a company’s performance, its impact on society and the effect it has on the environment. Widening to include governance as a parameter, ESG places focus on the separation of power and duties, how decisions are made in organizations and other ethical considerations in doing business. Governance is sometimes used as a way to gauge leadership’s level of maturity, in terms of just good management. Now, there’s a real desire not just to measure but also manage all of these factors. And this is not going to let up.
This version of corporate sustainability introduced risk management and value creation. With a greater focus on KPIs, ESG gave fundamental importance to the measurement, monitoring and reporting of a company’s sustainability performance. Several voluntary reporting frameworks currently conceptualize ESG. A source of confusion and frustration, these are slowly moving towards harmonization. Investment professionals now are willing to pay a median premium of 10% for companies with a strong track record on ESG over those without it. Companies that voluntarily report their carbon emissions can save on average $1.5 million every year in interest repayments because of the lower cost of capital.
2. Overwhelm and grasp at the straws
In the wild west of ESG, this reaction is completely understandable. An alphabet soup of frameworks, standards and guidelines — UNPRI, SASB, PRI, SBTi, CDP, TCFD, SDGs, MSCI, GRI to name a few — can be overwhelming. The sense of urgency is heightened by the accepted belief that similar to financial reporting, one dominant standard must also emerge for ESG reporting. For companies, this can be very difficult to navigate.
As regulatory action on sustainability reporting seems imminent, pressure mounts on companies, standards and investors to subscribe to a consistent singular framework. This can be seen in the recent G7 meeting looking to require TCFD disclosures or the Securities and Exchange Commission (SEC) considering the implementation of ESG reporting regulations.
The lack of a common framework to compare the ESG reporting performance of different companies is a critical concern for transparency. Inconsistencies in the guidance and prescriptive actions given to companies mean “ESG” varies significantly on a practical level: the performance data that is being collected, presented and used to inform company strategy. It does not help that over half of the largest asset managers have been developing their own ESG frameworks. Nevertheless, the need for rigorous and quantitative company performance data continues to escalate in response to increasing pressure from investors, consumers and governments.
The knee-jerk response of companies is to frantically respond to every request from reporting entities or simply freeze and do nothing. As a result, time and effort are expended quelling near-constant fires, while the smoke obscures any connection to the overall company strategy and direction. In this setting, organizational silos proliferate.
This has a lasting impact on employee morale and consumer trust. By increasingly valuing company sustainability and ESG, these groups find themselves whiplashed by erratic corporate efforts of which they become increasingly mistrustful.
The reality on the ground is that a lot of ESG issues are hard to define and measure in a meaningful way, particularly the social elements. Different industries have different levels of risk and different expectations of them. The scope of issues is still being defined.
Therefore companies must own their ESG narrative, which begins with conducting a materiality assessment to develop a deep understanding of what issues are relevant to the company’s core mission and strategy, and what matters to its customers, employees, investors and other stakeholders. As with many things, constructing an understanding of these issues from the very beginning and then building internal programs and directing efforts on that basis will have huge savings on time, money and effort down the line.
3. A bolted-on approach
Companies that treat ESG as something extraneous to their organization face apathy, a perennial lack of resources and confusion in the face of ever-escalating stakeholder and regulator expectations. ESG is an operating philosophy and must be integrated with the overall company strategy.
There is an increasing expectation to manage and show progress on ESG issues. Accompanying these growing expectations is increasing concern about greenwashing. ESG is only as good as a company makes it. For those who are interested in taking ESG seriously, actions that “walk the walk” are likely to include expending time and energy collecting rigorous performance data based on the results of an internal materiality assessment. Or, it might include ensuring data integrity, setting ESG-related metrics and KPIs and tying executive compensation to the achievement of those results. Use the systems you have to further a well-thought-out, fully integrated ESG strategy by connecting them to company-wide goals, metrics and priorities. Integrate your existing risk management system, your supply chain management function and your vendor selection tools and procedures.
4. Thoughtless marketing
Over the last year, company interest in ESG credentialism has skyrocketed. Any self-respecting company is now expected to have a climate, sustainability as well as a diversity and inclusion statement, while many others have begun following suit. However, the lack of concrete action and the prevalence of chitter-chatter is seeing growing pushback.
Sustainability statements are rife, identical, and often unsubstantiated — unsupported by corporate strategy and action. The trend towards greenwashing is a wasted effort for companies facing growing skepticism from customers and governments who are starting to demand sincerity.
5. Taking it too far
Optimizing ESG is a balancing act and leaning too heavily on one parameter will compromise the outcome. Just as a world built on a single financial bottom-line has resulted in social and environmental neglect, economic prosperity cannot be forgotten in the gold rush on ESG.
The bottom line is that ESG performance is not just a measure of the company’s commitment and performance in their communities. It is increasingly seen as a proxy for not just for caring about others, but plain good management.