By Diana Fernandes
for the 2024 Risky Women Writing Competition, presented in partnership with Bovill Newgate
Explore the challenges of viewing ESG as a non-financial risk, the importance of long-term investment in sustainability, and the role of regulatory convergence in addressing climate risks. By shifting to a growth mindset, organizations can foster resilience and drive sustainable success.
Capitalist economy is often thought to optimise profit at the expense of communities. In this vicious cycle of profiteering, companies have ignored the well-being of customers, exhaustion of natural resources, supplier chain viability and economic hardship faced by the community. As a result, Environment, Social and Governance (ESG) is considered a barrier in business profitability. It is an expensive capital investment where returns are not immediate and may take a long time to materialize.
Businesses are not willing to make or defer ESG decisions despite the many benefits it brings in long term profitability and sustainability. However, one should note that the cost of deferral and transition goes significantly high if delayed and can cause irreparable damages to the future growth of business.
How do we create a mindset change to bring ESG into the main revenue stream of business?
As per the study done by Professor Porter of Harvard Business School and Kramer, the managing director of the social impact advisory firm FSG, companies could bring business and society back together if they redefined their purpose as creating “shared value”—generating economic value in a way that also produces value for society by addressing its challenges. A shared value approach reconnects company success with social progress.
Companies like Nestle, Unilever, Wal-Mart etc. have already embarked on the journey of shared value to reshape capitalism and have a positive impact on society. It opens new avenues to make bold strategic moves to align business portfolio, offerings and capabilities with the opportunities for ESG and sustainability.
E.g. Cricket for Climate Club is a nonprofit organisation in Australia creating a connected energy ecosystem to help cricket clubs and local municipal councils collaborate with providers of energy services and financing on demand-side action. This will generate cost savings and income streams for clubs and help take cricket to net zero emissions by 2035.
ESG is an intricate part of business, and its pillars are interconnected. E.g. social pillar overlaps with environment and governance. Governance looks at broader concerns of sustainability such as being clear, fair and not misleading in their conversations with customers, engaging regular dialogues and transparency with regulators and providing investors with valuable and accurate information.
It is well understood that a strong ESG proposition can foster a company’s long-term success. So, why create value with ESG? Research shows that building a strong connection with broad components of society will not only creates value but also builds resilience into the business model. Businesses need to play long game to satisfy the needs of customers, employees and communities. This helps to move out of the vicious circle to a virtuous circle of generating long-term sustainable wealth.
Businesses in different countries have different conclusions about the purpose of business. Some leaders may think of setting net-zero targets, decarbonisation pathways, mandatory climate disclosures or working through impacts of supply chain management, etc. Either way, there should be a trade-off for maximising wealth for the long-term demands.
There is no doubt, value creation is linking ESG to business. Will you consider ESG as a financial or a non-financial risk to better assess and manage it and bring value to business? Many may think ESG as non-financial risk, but the main distinguish between ‘financial factor’ from ‘non-financial factor’ is the motive underlying its consideration rather than the nature of the factor. In the words of European Insurance and Occupational Pensions Authority (EIOPA), “Climate change, environmental and social risks can have an important impact on human, social and economic life. If not managed properly, they can pose material risks to the assets and liabilities of insurers and pension providers”.
Additionally, management guru, Peter Drucker once said that ‘only what gets measured and monitored, gets done.’ It is important to have quantitative and qualitative data along with asset allocation in making investment strategy and financial decisions.
The firms to integrate ESG issues within its governance structures, supplemented by ESG specific governance and risk processes required. Some regulators require firms to assign a senior management function responsible for these issues (Bank of England).
ESG and climate risks are cross-cutting, transverse risk with material impacts across other risk types, similar to reputational risk. It is an emerging and evolving regulatory priority. Many institutions are seeking to integrate climate risks with overall risk management framework, but their approach is idiosyncratic or developed for its own specific purpose. There is a need to have regulatory convergence between global bodies on matters such as climate risk disclosures, scenario analysis and testing, identifying key data sources and metrics to ensure credibility, consistency and comparability, harmonizing carbon pricing and standards and enhancing risk, governance, strategy and management relating to climate risk.
Material divergence around disclosures of climate risks could leave misallocation of capital and regulatory arbitrage. Sharing knowledge, expertise and best practices can address with the speed necessary to successfully respond to climate changes in the timescales required.
While some countries and regions, notably EU, UK and countries in Asia Pacific region are leading the way, for others this is still very much an emerging regulatory theme.
The need to act on ESG and climate risk is urgent. Leaders and managers must shift from a tick box compliance mindset to focusing on growth mindset. The organisations’ culture should embed sustainability and tackle challenges centrally. This way, your organisation will set the pathway towards a sustainable future and create shared value.