There has been plenty of hype surrounding impact investing and ESG. Investors have lined up a slew of publications, reports, meet-ups, and funds across the globe. With the economic value of countries increasing steadily, the ESG trend is maintaining its momentum. However, the impressive growth of countries, stellar initial public offerings, and entrepreneurial achievements will not add to the sustainable value chain without a concrete foundation of ESG.
There are key trends that underpin ESG’s significance in today’s fast-paced world and are driving a line of thought that ‘business as usual’ is not the way for long-term returns. However, ESG is an ethical finance area replete with confusion. Investors have cited a specific reason for involving themselves in ESG. Our research classifies ESG investments across 4 key trends, which demand the attention of investors and the corporate world.
Changing face of corporate governance
Over the last decade, the corporate sector has been plagued by issues that have demonstrated that culture and conduct issues play a critical role in the business ecosystem. It is seldom that the corporate board has faced such public trust deficit. Such deficit includes weak oversight, complicity in promoting greed & fraudulent activities, and rewarding underperformance. For instance, HSBC – the world’s second largest bank – helped its clients conceal undeclared accounts and offered those accounts to corrupt businessmen. Within no time this issue was trending across the globe, leading to the bank’s falling public image.
Predictably, such trust-related issues are evoking strong responses such as robust regulatory actions and stakeholders striving to wield influence on governance. However, these well-intentioned responses are backfiring. This is surprisingly true, and the reason is attributed to pressure from investors, which simply engenders a box-checking mentality.
It is much more convenient to raise corporate governance standards. A right approach must involve a thorough diagnosis of the governance structure, led by an in-depth ESG research for identifying solutions and shortlisting priorities. Ironically, the corporate boards can easily evaluate these aspects by establishing a baseline. For instance, companies are engaging in a variety of good practices, including audit partnerships and compensation committees. Some companies are developing their corporate governance structure by appointing a maximum number of independent directors to bring objectivity to the oversight function and improve board effectiveness. For instance, Mahindra and Mahindra topped Asiamoney’s 2016 corporate governance poll in India with 6.26%, and 10.48% in CSR – followed by Bharti Airtel, Tata Motors, and Idea Cellular. These companies are among the best boards, and there is less ambiguity among decision-makers.
Climate change and shifting energy sources
Today, climate change issue is acknowledged universally. If climate change was meant to be a mere hoax, it would need a competent, scrupulous scientist. However, every piece of investigation has arrived at the same conclusion – climate change is real and the earth is warming. By refraining ourselves from acting now, we are allowing the climate change to aggravate. Eventually, it might lead to irreversible consequences. This thought process is gradually becoming a strong viewpoint of the business ecosystem.
Climate change is affecting the performance of companies. For instance, in 2012, Cargill, a leading food and agricultural company, published its worst quarterly earnings in two decades, largely because of the US drought. Such losses indicate slumping global supply coupled with severe ramifications for the agricultural sector. From a global perspective, droughts might lead to increasing water prices, thus scaling up the cost of energy with climate-related regulations. For example, the renewable-energy and high-tech sectors might face price hike stemming from increased competition for rare earths used in producing silicon chips, superconductors, wind turbines and electric vehicles. This is evident from the volatile prices of raw materials. Such adverse and unstable climate can further ratchet up the pressure, thus necessitating the need for companies to cope with uncertainties.
The Economist Intelligence Unit’s estimation suggests that investors are at risk of losing USD4.2 trillion due to climate change by 2100. These losses will accrue across diverse industries from real estate to manufacturing. Investors are now thinking of energy conservation, green energy, or water harvesting as primary investments for a robust climate change portfolio.
Short-termism thrives in business community
Given the C-suite pressures on creating short-term value, big-ticket companies are only adding to the climate change woes. Nevertheless, the real value can only be created and sustained over the long term. Short-termism thrives in the business community, especially the investor community. There is a need for companies to think beyond creating short-term value due to growing regulations, pressing environmental issues, and consumer pressure. Still, regulators need near-perfect solutions, and not necessarily the cheapest. Such regulatory reforms paradoxically pose challenges for businesses. Gone are the days when corporate enterprises used to ask the government for recommendations about what is environmentally acceptable – now businesses need to figure it out themselves. ESG research and deep insights about geographic environmental analysis are imperative for businesses.
In response to the regulations, some companies have rightly switched to efficient ESG investments. For instance, Unilever leads the FTSE CDP Carbon Strategy risk and performance index by dramatically improving its carbon efficiency since 1995. IBM has also attracted attention for its environmental protection initiatives by setting up rigorous greenhouse gas emission (a geographically precise need) standards. The company won a 2013 Climate Leadership Award from the US EPA for supply-chain leadership. So, a beginning has been made, and the ESG trend is poised to continue in future.
Partnerships for social development are flourishing
Touted as one of the most sought-after companies, Unilever is perceived to be a workplace of purpose. The company’s partnerships are aligned with social and sustainable development. Unilever steadily collaborates with external consortia across diverse areas of expertise including 2degrees, International Flavors & Fragrances Inc and the Hubbub Foundation to enhance the livelihood of the local population. Although it is tough for globally diverse organizations to partner with such a disparate public network for social development, Unilever has managed the extensive network exemplarily.
To establish trust and bridge natural organizational chasms, companies must strategically identify ESG needs and invest deeply. The ability to conduct thorough research and monitoring must be centered on a hyper-local level. Large companies lack natural advantages in customizing their on-the-ground presence for serving different communities. Some executives of large companies have perceived ESG needs as passing fads. However, companies can partner with local firms to develop an approach for delivering lofty ambitions of serving local needs. For instance, Barclays collaborates with local NGOs for a better understanding of local needs. The company partners with rural farmers strategically. Barclays is earmarking £100 million for UK farming loan to support growing agricultural demands in the UK. Such partnerships may be jeopardized as companies consolidate their global operations in key developing areas. However, today, ESG requires companies to refocus on more immediate imperatives.
Regulatory headwinds for sustainable investing
ESG regulations, once a topic for the public relations department, have now turned into mandatory regulations for institutional investors. The regulations surrounding the ESG landscape are eventually posing roadblocks for companies and investors. The pace and scope of regulatory reforms is rising exponentially:
- Investor disclosure (EU non-financial reporting directive)
- Stewardship laws and codes
- Shifting capital to sustainable assets
- Incorporation of sustainable objectives into investment decisions
These mandated regulatory reforms will soon turn into global ESG standards. For instance, California and France’s new energy transition law for the coal divestment bills are a mandatory regulatory action. By the same token, the Task Force on Climate-related Financial Disclosures (TCFD) is responsible for assessing climate risks and price risk, supporting informed capital-allocation decisions. The TCFD recommends a scenario analysis for considering resiliency of companies’ strategic plans. Moreover, the TCFD has also established a threshold for organizations keen to conduct scenario analysis. Such regulatory actions require deep research and expertise in the ESG segment.
The road ahead for ESG
The laws and regulations need urgent reinforcement for a sustainable tomorrow. The ultimate objective is to create a sustainable future for businesses from economic as well as environmental perspectives. Businesses cannot simply afford to continue investing in non-strategic areas if they want to thrive. It will require deep research, clear strategies, streamlined operations, and trust & accountability.
Regulatory entities will create competitive pressures for companies to develop a business case for developing sustainably. Eventually, businesses across the globe will realize the essence of creating a moral imperative for their stakeholders and the planet as a whole. Indeed, the time to take ESG seriously has truly arrived!
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