In the post COVID-19 world, ESG shapes new disclosure norms and contributes to increased investor focus and revised policy frameworks across sectors and geographies.
In recent years, climate change has become a core concern for people across the globe. Investors are no longer only concerned with the financial performance of a company; they also actively research about the initiatives undertaken by these companies to benefit the larger community and planet. Environment, Social, and Governance (ESG) disclosures point to the company’s core values. Investors believe that companies with significant ESG contribution are less risky and more resilient to changes, a sentiment that has strengthened post pandemic. This shift from shareholder capitalism to stakeholder capitalism will have significant ramifications for companies that fail to develop a robust ESG portfolio.
According to the European Green Deal, all European Union (EU) members will transition to circular economies by 2050. It implies that they will have net zero emissions. Other research has shown that the companies with excellent ESG ratings have better returns on equity. Even in the FMCG sector, end consumers are paying attention to the ethicality of their products. They are buying more from "vegan" and "cruelty-free" brands. Customers and investors are not only rewarding the ESG-responsible companies but also punishing others by avoiding them and making them less profitable.
Challenges in becoming ESG compliant
While ESG offers many benefits in the long run, there are several challenges that companies have to face in order to become ESG compliant.
- Leadership: While the CFO is usually in charge of ESG (e.g., investments, cost of capital, and reporting), the CRO should take on certain responsibilities to allow for a more holistic approach. This could involve using an ESG lens to assess reputation risk, manage regulatory change, and oversee governance processes.
- Strategy and framework: Firms already have elements of ESG in their risk frameworks, but they also need to identify gaps and possibilities for better management. To compare ESG maturity to that of peers, a risk readiness assessment can be used.
- Data accessibility: ESG data is easily accessible or inexpensive to obtain. Because not all companies provide data and measuring procedures differ, comparing metrics among organizations, even for the same indicators, can be challenging.
- Information revelation: ESG disclosures are becoming mandatory for regulators, supervisors, and exchanges such as the TCFD, SASB, and World Economic Forum. Companies must determine what modifications to existing processes and capabilities are required for reporting and ESG disclosures.
Opportunities for companies to enhance ESG ratings
- Strategic opportunities: Establishing a clear goal based on feasible targets, setting short term targets and a clear roadmap towards becoming a net zero emissions stage should be implemented by the organizations.
- Investments: Future capital investments should be viewed via a sustainability lens. Carbon emissions should be provided a significant consideration. By explicitly accounting for their carbon footprint, companies should be able to adjust the goals for upcoming projects, lowering emissions, and supporting the company's sustainability initiatives.
- Technology: Digital transformation holds the biggest opportunities for the ESG journey of an organization. Organizations should implement sustainable digital technologies. For example shifting of a supply chain to a cloud-based ERP system is an important first step in assisting suppliers in tracking, reporting, and reducing their carbon footprint.
Key steps to take in the ESG compliance journey
1. Integrating ESG into the business strategy – It is very important for the company to disclose the way it is reacting to the macroeconomic trends and publish reports on how its business model impacts environment and society related to their domain. This can be done by the companies proactively by including the ESG factors affecting their business into their business strategy.
2. Identifying the core ESG topics related to the business – Companies must keep track of the emerging and existing ESG issues. The ESG factors should relate to the company’s sector and business, and investors and stakeholders should have relevance and value addition.
3. Striving to improve ESG ratings – Investors make their decisions by looking at the ESG rating of a firm. For better ESG ratings, a company should develop ESG ratings strategy, engagement with ESG rating agencies to understand the gaps and opportunities and work on them.
From ESG compliance to incorporating ESG in the core strategy
Step 1: Establishing a solid foundation
- Adjusting the volume - Creating a feeling of purpose within the organization to recognize the need of incorporating ESG into the business
- Materiality evaluation - Identify, prioritize, and validate the most important environmental, social, and governance (ESG) issues that the organization should address. Make the most efficient use of resources
Step 2: Core strengthening
- Governance - Increasing the board's and senior executives' oversight, proactive management, and continual ESG dialogue
- Risk assessment and management - Identify, analyze, and respond to ESG-related risks in company operations using a systematic method
- Strategy - Develop an ESG strategy based on the company's broader vision and goal and integrate ESG into strategic planning
Step 3: Disseminate the results of your work
- Assurance and reporting - Engage a third party to undertake independent assurance on ESG reports or ESG data, giving stakeholders trust in the authenticity of the report and data
1. Approach to identify the core ESG topics related to the business
Materiality is a notion for identifying the ESG issues that are most important to your company and its stakeholders. Companies should concentrate their limited resources and time on the most significant ESG issues that have the largest impact on their business and stakeholders.
2. Environmental data management
Global firms require a sound multifaceted and agile Environment Data Management (EDM) system to deal with the data that is being generated by the companies. Using the data to identify sources of risks that cause negative impacts on the ESG ratings of the firm is getting more and more crucial.
It is better for a company to outsource the existing ESG activities as the third-party provider would be containing industry standard and relevant solutions. Given the view of long-term growth and budget constraints, implementing best practices is better handled by outsourcing the activities to an expert.
ESG initiatives reporting has become one of the key factors that affects an investor’s decision to invest in a company and should complement the larger business goals of the company to communicate a unified message. ESG ratings improvement should be one of the top priorities in order to be an attractive investment opportunity. Compliance to the global regulatory frameworks is essential and tricky without proper expertise in the field.
Getting the ‘investment grade’ data for auditing and publishing requires the data collection process to be accurate, limited to boundaries, consistent, comparable, time-bound, assured, and balanced. Outsourcing these activities could help with not only cost reduction but also with ESG ratings improvement.
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