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How ESG risks can affect your business

How ESG risks can affect your business

The post-pandemic world will see an ever-greater focus on environmental, social, and governance issues. Business leaders need to be aware of how ESG risks can affect their company, and register stakeholders’ priorities in this area

The rise of ESG

Up until a few years ago, environmental, social, and governance (ESG) criteria ranked well below financial performance in boardroom priorities. Keeping fund managers and shareholders on the side was key, and if that had to be done at the expense of sustainable business policies, a greener agenda, staff satisfaction, or consumer goodwill, so be it.

All of that has changed. Consumers are demanding social and environmental commitments from businesses as well as quality, value for money products, and services. They are wielding the power of a hyper-connected populace to push for vegan product lines, clear environmental credentials, the closure of gender pay gaps, and sustainable corporate practices. Companies are expected to publicly commit to the United Nations’ Sustainable Development Goals. Consumer trends in 2019 included demands for sustainability information on products, circular design and slow fashion, reduction in plastic packaging, and elimination of planned obsolescence.

Employees are another influential group in the expansion of ESG priorities. They want to work for companies with purpose, aligned to their own priorities. Firms with strong ESG credentials are increasingly able to attract and retain the best talent. In its 2019 report on ESG as a workforce strategy, Marsh & McLennan identified it as a significant competitive advantage. Top employers for employee satisfaction registered average ESG scores of 14% higher than the global average.

Investment practices are also increasingly influenced by ESG factors. Individual and institutional investors have begun focusing heavily on ESG assets. 2019 saw a record amount moved into ESG funds, with $20.6bn in new money transferred to funds following principles for responsible investment – four times the amount seen in 2018.

The impact of Covid-19 on ESG

The course of 2019 saw a rapid acceleration in the profile of ESG issues, capped in January 2020 with the commitment at Davos by many of the world’s largest companies to establish a set of universally recognised ESG disclosures. It was clear this was the direction that business would be moving in for the foreseeable future.

Then coronavirus surged across the world. But instead of halting the ESG momentum, the Covid-19 pandemic catalysed the importance of many issues, bringing to the fore the need for companies to have a wider consciousness and renewing the social contract between the business and the community. In the early days of the pandemic, acts of altruism and support of the most vulnerable positively enhanced the reputations of many businesses.

As the crisis has dragged on, popular movements have sprung up, demanding that companies state their policies then walk the talk on governance and sustainability issues. Black Lives Matter and Extinction Rebellion have arguably gained greater leverage over corporate behaviour as a result of increased scrutiny of companies’ social conscience. Boycotts and buycotts have also become a post-pandemic phenomenon, with consumers showing their approbation or criticism of corporate practices by through targeted buying habits.

Similarly, coronavirus seems to have increased the emphasis placed on ESG in investment decisions. By July 2020, the overall value of assets using ESG data stood at over $40trn, representing a year-on year growth of 15.3% since 2016. ESG indices consistently outperformed their parent indices in volatile mid-pandemic markets, making sustainability a savvy investment decision.

ESG risks and the risk of ignoring ESG

One of the main issues that companies can fall foul of when addressing ESG is the sheer breadth of the factors sheltered by this umbrella acronym. Encompassing elements as diverse as policy on palm oil to maternity leave allowance, diversity and inclusion policies, community outreach programmes, carbon footprint, and any number of sector-specific issues, the size of the field leaves companies open to backdoor risk. In concentrating attention on one element to the detriment of others, businesses may suffer reputation damage in the ESG arena.

The biggest pitfall in that arena is failure to be seen doing well on ESG factors. Companies that have already fallen foul of this risk include global investment bank Morgan Stanley. Despite being lauded as the first major US bank to publicly disclose how much its loans and investments contribute to climate change, the firm has seen its ESG credit sapped by a lawsuit alleging racial discrimination against its former head of diversity and other black, female employees.

On the flip side, we see major corporations trying to minimise ESG risk by publicly eschewing non-sustainable businesses and practices. Oil and gas giant BP’s decision to write down its assets by up to $17.5bn as part of the push to reduce carbon emissions is an indicator of this trend. Equally noteworthy in the realm of ESG investing is the exclusion of oil firms and other companies from the $1trn Norwegian sovereign wealth fund after it introduced a hard limit on coal-related emissions.

The future of ESG and reputation

With the ever-greater shift towards stakeholder-centricity, where the priorities of all stakeholder groups are accounted for when deciding upon business strategy, the power of ESG will only get stronger. In order to manage those risks posed by ignoring these issues, companies need to integrate ESG policies into their business practices and up their ESG ratings.

To preserve and enhance their reputations with multiple stakeholders across such a broad range of issues, businesses must be alert to the shifting emphasis on each and every ESG issue and identify which resonate most strongly with their primary stakeholders.

Business intelligence will increasingly help to do this. By weighting specific ESG factors in their data analysis to respond to social, geopolitical, and market movements, businesses will be able to be more agile. Business intelligence will allow them to adjust policy and practice to match the specific ESG demands of their most important shareholders.

It will also be vitally important to disclose and publicise ESG policies and practices, in order to reduce reputation risk and benefit from the positive associations of having strong ESG credentials. Businesses seen to be acting with strong social and corporate governance, and having environmental and sustainable corporate practices, will expand their reputational capital and be better able to ride out any potential crises.

A global pandemic couldn’t stop the rise of ESG, and in the long-term, it will be impossible to protect either corporate reputation or financial success without managing ESG risk factors.