This is a guest post from ESG Partners Inc.
(Member since 2021)
Every business will have impact on environmental, social, and governance (ESG) factors, whether it is something they track or not. We have made progress because it wasn’t that long ago that most organizations didn’t even know how to spell ESG. Today, organizations that are paying some kind of attention to ESG are seeing how it can create value. These organizations also understand that ignoring ESG erodes value. Here are the ESG highlights:
Environmental includes energy use, waste management and climate change.
Social includes labour relations, human rights, diversity and inclusion, the rights of indigenous peoples and product liability.
Governance includes compliance, ethics, controls and procedures.
The individual aspects of ESG are intertwined, and one area can’t (or shouldn’t) be traded for another.
To highlight this point, let’s consider a well-known 2015 example. I expect we all know someone who owned a Volkswagen when the news broke that defective devices were installed on 11 million vehicles in order to pass (or cheat) emissions tests in an effort to deceive customers and regulators. Company costs were massive when this deception was revealed. Between dollars spent on recalls, loss of public trust, and declines in investor ratings, the economic impact to VW was tens of billions of dollars. Had a system been in place to assess the full range of ESG risks facing the company, VW’s corporate governance practices––coupled with their recent elevated warranty expenses––would have raised a red flag for investors.
While ESG is not new, it has undeniably grown in importance in recent years, and the COVID pandemic shone an even brighter light on the importance of ESG issues. The practice of ESG actually began in the 1960s as socially responsible investing. Then, the focus was more on the exclusion of certain stocks or industries from investment portfolios based on business activities deemed not to be socially responsible (think tobacco, child labour, etc.). Today, many of the same ethical concerns continue; however, the field of ESG has evolved and is not necessarily focused on negative screening practices but, rather, on the alignment of investment strategies with broader societal values and a more holistic assessment of risk.
Improving risk management is a key benefit of ESG integration, with institutional investors recognizing that risks related to ESG issues can have a measurable impact on a company’s market value and reputation. In addition to the example cited earlier, consider the impact on a company’s brand after a worker safety incident, waste or ecological impacts, and weather- (or pandemic) related supply chain disruptions. Attention has also been turned to companies’ resilience strategies in the face of climate change and the systemic risk it presents.
It’s not just institutional investors who are concerned about risk. We are increasingly seeing early-stage investors begin to integrate ESG into their investment analysis and decision-making process. These investors consider the full impact of companies that are more diverse and inclusive, conscious of their employees' health and safety, able to serve their communities, and understand their environmental impact.
As the investment community increasingly relies on ESG criteria to assess risk and make informed decisions, so too are a broad range of stakeholders––including consumers, employees, suppliers, and local groups who are expecting businesses to align their goals with those of society, who will appropriately hold them to account. It’s no longer about simply wanting to do the right thing; the public is now demanding transparency and sustainable action from the companies with which they engage.
Businesses that don’t embrace sustainability and ESG will most definitely be left behind. Those that do will become more competitive, resilient, attract talent and capital, and be able to add value back to the communities where they operate.
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