ESG issues moving to top of corporate agenda

Organizations that adapt to the new reality have a chance to redefine themselves in a way that creates new opportunities and can enhance competitive advantage. The alternative is to face headwinds across many critical business functions and drivers, ranging from difficulty in accessing capital and raising financing, emerging shareholder expectations around the green economy, evolving regulatory and compliance expectations, and challenges in attracting and retaining employees.
What’s pushing this new environment is the convergence of two powerful forces, which individually are quite powerful, but combined are poised to make an even bigger impact. Those macro-trends include changes to the legal and regulatory environment on one side, and the rapidly evolving expectations and pressures from financial markets on the other.

The legal and regulatory change is most clearly seen in the United States, where the new federal administration has quickly made its presence felt in new initiatives. Some of these changes tighten environmental regulations and their enforcement, through agencies such as the Environmental Protection Agency. There’s also re-engagement of the US with international initiatives such as the Paris Agreement, which seeks to limit global warming and is putting the environment back onto the agenda for both public and private industries. These forces represent a bigger regulatory “stick” under the Biden administration coupled with a bigger “carrot” in promoting the acceleration of a green economy, which is evident in the acceleration of the energy transition and industries such as renewable energy.

Many of these changes will take years to be fully felt. The push towards renewable energy, for example, may run into delays because of the time involved in permitting, and then building, power transmission corridors. The permitting process alone can take a decade, which may cause pressures to speed up the approvals process. Furthermore, the commitments of conventional energy to future energy will continue over time as the energy sector redefines itself over the coming years and decades.

The other powerful force pushing ESG considerations comes from the world of finance. Even a few months ago, it might have been unimaginable that the world’s largest financial institutions would be putting out such ambitious targets for greener portfolios. But recently, increasing numbers of large banks have announced targets of financing portfolios that produce net zero carbon emissions, to be reached between 2030 and 2050. The financial forces span bond markets, private equity, and large banking institutions, making the reach deep and wide.

Many of these trends have been in place well before the inauguration of the Biden administration, but may have been hard to see in the face of many headlines about the rollback and softening of environmental regulations.

But with the change of direction from the White House and from Congress, it’s perhaps easier to see what’s been in process all along. And, many of these trends have been noticeable in the European Union for some time.

For example, the world’s largest banks announced that fossil fuel financing in 2020 was down by nine percent from the previous year.

A UN body, Principles for Responsible Investment, wants ESG metrics be factored into corporate disclosures. This group says good institutional investors have a duty to act in the best long-term interests of their beneficiaries. This fiduciary role includes a belief that ESG issues can affect the performance of investment portfolios. As further evidence of the role ESG is playing in corporate reporting and investor disclosures, in May of 2020 the securities and exchange commission (SEC) Investor Advisory committee that could materially impact the reporting requirements of many publicly traded institutions to include “material, decision-useful … ESG requirements”. In effect, providing investors further visibility regarding known risks and uncertainties related to ESG factors.

One of the other factors pushing this renewed interest in ESG may well be COVID-related. The worldwide pandemic has forced many organizations to change how they work and how they engage with their supply chain. It’s also underlined the fact that it’s important to prepare for uncertainty – any other “black swan” unexpected event might come along to upend the usual way of working.

The pandemic has catalysed changes that will need to be harnessed if we are to reach the much-heralded mid-century net zero emissions target. We predict that sustainability will equal growth. During the market turmoil of 2020, returns on many funds committed to strong ESG outcomes performed better than those on comparable non-ESG funds. This trend is likely to continue.

ESG has quickly established itself as a mature discipline, showing up in risk calculations, finance and investor relations. This opens up new areas of competition, expressed in many ways -- including cost of capital, stock prices, insurance rates and even Glassdoor ratings showing attractiveness as a place to work.

To thrive in this new environment, companies need to understand the “big picture” – the ESG-related risks that they are facing, and the opportunities to do better. But they also need to be able to implement the required changes on a practical level. Then, quantifying the results becomes key. The final challenge is delivering on the promise of ESG strategy, ensuring projects and programs are designed to achieve the lofty goals being set by many industries and government agencies, while the balancing stakeholder demands.

What are the trends for the future? Remember that nothing lasts forever. The pendulum has swung towards ESG issues, and it’s likely to swing back again. But the new “middle” may well have shifted long-term towards greater value being placed on ESG considerations.