In Part One of this series, we looked at how a robust ESG strategy drives profitability for companies. In Part Two, we look at who is responsible for leading the shift within companies to a more sustainable future.
ESG is only one aspect of a broader sustainability transformation, but it has played an enormous role in how companies value sustainability. Primarily driven by the investor community, ESG looks at both risks and opportunities created by changing social and economic conditions.
ESG also highlights how unprepared many businesses are for major organizational change.
Investors and regulators have put tremendous pressure on companies for greater transparency into how they approach environmental and social sustainability. At the same time, companies are struggling with how to handle ESG disclosures (GRI, SASB, CDP, etc.) and the commitments they’re making to become more sustainable.
The responsibility of ESG reporting is often assigned to compliance or EHS teams. It’s a natural fit, considering many environmental and social processes are overseen by compliance teams. However, the expectations of a true ESG program differ drastically from the traditional performance objectives of compliance teams—as do the incentive structures that are driving this change.
Compliance Meets the Current Need, While ESG Is Future Focused
The primary role of a compliance department is to maintain legal compliance with the local laws and regulations that govern company operations. Making sure your organization is following best practices to prevent damages and minimize regulatory risk is a critical component of ESG. But the sustainability of your organization is more than simply complying with the law; it’s a holistic view of how your company is positioned to succeed in the future.
Consider the automotive industry. An automaker may be extremely profitable while only selling cars with internal combustion engines, which are currently legal across the world. But their share price today will reflect investors’ concerns about the sustainability of using gasoline-powered cars in the future. The risks associated with greenhouse gas emissions can increase a company’s cost of capital, meaning higher interest rates from banks and greater challenges raising capital through equity.
Taking this example further, two automakers with similar financial performance will be viewed much differently if one has made capital investments into electric motors and is considered a leader in the industry. Compliance certainly has a major role in the success of an automotive company and plays a critical role in ESG strategy, but ESG is about anticipating the risks and opportunities associated with social and environmental factors and transforming operations to meet the needs of an evolving market.
Each industry has its own set of challenges with environmental, social, and governance factors that pose great threats to long-term profitability—even if companies are fully compliant with the law. It’s up to every business to determine which ESG factors are most critical to their long-term economic performance and external perception by investors, rating agencies, and other stakeholders.
For ESG Success, You’ll Need to Address Risks That Regulations Don’t
Climate change is a glaring example of how businesses can follow all policies and regulations but still produce major negative externalities that create considerable risk. Companies that rely on energy from fossil fuels are subject to risk from energy price volatility and potential carbon taxes, public scrutiny around greenhouse gas emissions, and higher turnover rates from employees that prefer to work for a company with a better impact.
As ESG pressure increases and more disclosures and public commitments are expected, there will be growing demand for environmentally friendly options throughout the supply chain. Green concrete and green steel will play an increasing role in Scope 3 emissions, but McKinsey’s analysis projects that the demand for these products could be twice as great as the supply.
Deforestation and the use of Highly Hazardous Pesticides (HHPs) in agriculture, microplastics and water consumption in textile production, and the impacts of resource extraction on biodiversity are several other environmental impacts that are coming under intense scrutiny. Even if these practices are legal, investors and consumers are swiftly moving away from companies producing these harmful effects.
Environmental sustainability gets the lion’s share of the headlines, but social sustainability is often overlooked. In many industries, social risk is greater than environmental risk. For example, U.S. corporations that paid workers minimum wage may have been compliant with the law, but they faced difficulties with staffing in 2021.
Many investment firms have built out products that aim to identify strong workforce cultures, companies that avoid controversies and safety incidents, or those with diverse workforces, and many of those funds have outperformed the market. The social impact of ESG can be more difficult to quantify, but this also creates an opportunity for companies to distinguish themselves because companies that have a positive impact on their employees, their customers, and the world are less vulnerable to regulatory interference, labor shortages, and boycotts.
Many investors consider governance to be the most valuable ESG factor because when sustainability is taken seriously by the C-suite, they have the ability to integrate sustainability throughout the organization.
One of the main measures of sustainable governance is executive compensation. When compensation within the organization is tied to sustainable growth rather than quarterly earnings targets, the threat of disruption and short-term profit focus is greatly disincentivized. And there is strong evidence that performance-based pay, rather than process-based pay, is counterproductive.
Consider the 2008 financial crisis and its relation to corporate governance. Executive bonuses tied to short-term earnings, mismanaged risk analysis, and disregard of social impacts all contributed to financial disaster for many financial firms.
ESG is not a One-Person Job, but a Collective Vision and Effort
Risk and compliance are integral parts of ESG, but advancing ESG goals to build a sustainable future requires commitment from the C-suite, buy-in through operations, and an organizational mission focused on long-term profitability. This cultural shift is essential for achieving ESG success and building on that success over time.
You’ll also need the means to enable cross-functional collaboration and establish workflows for effective ESG data management—not only to ensure investment-grade data to satisfy investors and other stakeholders, but also to identify opportunities to improve ESG performance and make informed decisions. With a clear ESG vision and your enterprise data leading the way, you’ll be poised to compete and succeed amid growing demands for transparency and results.
The Benchmark ESG® cloud-based software platform helps 350+ subscribers and more than 2.9 million users worldwide manage risk, reduce costs, ensure regulatory compliance, streamline ESG reporting, and deliver on sustainability and ESG commitments.
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