Why ESG is at Center Stage and What it Means to You
Environmental, Social, and Corporate Governance (ESG) refers to the three central factors in measuring the sustainability and societal impact of a company or business. Founded with the concept of sustainable investing, the term ESG came into popularity in the early 2000s. Today, it’s clear it isn’t a passing fad, and companies are now seeing the risk of not tending to environmental, social, and governance issues.
While ESG is used as a framework to evaluate how an organization manages risk and opportunities that shifting market and non-market conditions create, ESG is also about creating and sustaining long-term value. Organizations can use this framework to manage organizations and adjust to a constantly changing world.
More recently, ESG is picking up steam as a corporate initiative. Corporations face unprecedented risk related to the climate crisis and its environmental impact, their use of water and other natural resources, how they treat workers throughout their supply chain, and the safety and usefulness of their products. Increasingly, many investors are eager to assess and measure companies’ progress in addressing those risks.
A corporation’s fit in society can be an abstract and polarizing question that is not high on the priority list of most boards. Yet, embedded in this question are strategic and operational issues critical to long-term value creation for the business. Today, ESG issues are becoming more important to the consumer, employee, and investor, and these stakeholders are expecting companies to have a way to address ESG.
What does ESG include?
The elements commonly cited in corporate responsibility and sustainability reporting are:
- Climate change impacts
- Water and waste management
- Natural resource scarcity
- Product and worker safety
- Supply chain management
- Workplace diversity and inclusion
- Talent management
- Employee relations
- Human rights
- Labor practices
- Executive compensation
- Political contributions
- Board independence, composition, and renewal
But ESG cannot be achieved by policy alone. It is important to note that some ESG issues may be defined differently depending on the industry, company characteristics, and the business model. For ESG to work, there needs to be a cultural movement within the workforce. Much like we covered in the Higher Calling of Harassment Training, good corporate citizenry relies on employee behaviors. Changing behavior requires a company to put in place the proper policies, communications, and education to set behavioral expectations accordingly.
For example, if a company decides to transition from fossil fuels to renewables to lessen its impact on the environment, there is an impact on its employee base. Companies need to consider how they will look at transitioning or training their employees to operate in this new work environment of renewable fuels. Renewable energy is just one example. The World Economic Forum reports that of the 3.3 billion people employed globally today, 1 billion will need to be upskilled by 2030. Many companies will feel the need to provide this upskilling to remain competitive. The worldwide labor skills shortage is predicted to reach 4.3 million workers and roughly $450 billion in unrealized output by 2030 – and that’s in the technology, media, and telecommunications sectors alone.
To be successful, socially conscious companies will make sure employees are not lost. Building the future with social consciousness means not leaving behind those employees that have supported the business. Companies need to equip current employees with the skills to help them succeed and not leave behind a generation of people in the process. Thus, good execution of ESG requires thoughtfulness about a robust learning environment for employees.
Why is ESG important?
For many, it’s been hard to think of companies as being about more than financial results. But the pandemic cast a spotlight on corporate resilience and purpose just as the climate crisis, changing demographics, social movements, emerging innovations in technology, and other forces began to re-shape expectations of business.
As a result, financial figures no longer tell a company’s whole story. ESG issues have risen in importance to the level of critical business issues. To sustain and thrive in this new era, companies should embrace ESG as a strategic business imperative in a changing world.
According to the 2017 KPMG Board Leadership Center survey, 35% of respondents viewed ESG as a brand issue. Nearly one-third reported their challenges in addressing ESG stemmed from pressure to deliver short-term results. This points to ESG being seen as a disconnected issue as one of the reasons companies are not addressing it more.
In 2020, ESG investment strategies surpassed $1 trillion for the first time on record after net inflows of $71.1 billion in the wake of the pandemic. Significant growth in ESG-branded funds and indexes points to continued momentum. ESG issues continue to rise on investor agendas for a good reason. Poor ESG practices pose environmental, legal, and reputational risks that can damage the company and have a lasting impact on the bottom line. On the flip side, firms with strong ESG performance may find it easier to build a stable and loyal investor base, lower cost of capital, and receive better access to financing, as numerous research papers have now documented.
And the stakes are high as it pertains to reputation. With the internet, everyone has a voice and a platform from which to be heard.
7 ESG trends to watch in 2021
According to an economic analytics firm, SPG Global, ESG is more important now than ever. Companies should note their predictions of 2021 trends in ESG that reinforce the growing strength of this movement.
- In response to demand and regulatory drivers, the quality and quantity of ESG data will continue to improve.
- The new Biden administration will reinvigorate ESG policies and climate urgency in the United States.
- Threats to nature and biodiversity will take center stage in environmental discussions.
- With this growing global urgency around climate, conversations about the energy transition will become increasingly nuanced.
- The nature of transition conversations will shift from climate mitigation to climate resilience.
- Investors will continue to press companies on social issues, particularly around COVID-19, worker safety, and diversity.
- Social issues will gain traction in global policy discussions.
While the Securities and Exchange Commission (SEC) does not currently mandate ESG disclosures, the reality is that societal forces are increasing pressure on companies to make this a priority and share what they are doing for ESG. As consumers, investors, and employees, Gen Z will likely bring different expectations related to sustainability, society, technology, ethics, and the role of private companies in providing public goods.
Creating long-term value requires companies to understand the impact of their strategies on key stakeholders—investors, employees, customers, communities—and the natural resources and supply chains on which the company relies. Considering a company’s total impact means that both companies and boards need to take a fuller view of ESG.
Even if the timing of an ESG mandate is unclear, companies should not ignore these critical issues. Keep in mind that ESG is a framework to develop your organization’s strategy. Identify the issues that matter most to your company and begin building your approach. Enlist vendors that specialize in the ESG components to fill gaps in your plan. The sooner you start building your ESG strategy, the better equipped your organization and your workforce will be to navigate our rapidly changing world.
John Arendes is the Customer Market Leader and GM - Global Compliance