Is ESG the greatest opportunity or risk you haven’t seen?

Companies should view ESG risks as opportunities to attract investors and reduce their cost of capital.

In brief

• Companies are under pressure to drive sustainability as stakeholders increasingly expect them to address environmental, social and governance (ESG) issues.
• They can do so by adopting a three-step approach and need to keep up-to-date with sustainability incentives, regimes and taxes.
• Some potential benefits of better ESG risk management include lower tax costs and the ability to attract more investments.

The COVID-19 pandemic has reinforced the importance of environmental, social and governance (ESG) issues. Delivering on the ESG commitment requires long-term, strategic thinking from executives on all facets of their business. While companies recognize that an emphasis on ESG is critical to business resilience, many still struggle to put in place a framework for incorporating ESG factors into their operations. Failure to do so can be costly, as there is growing evidence to suggest that ESG performance is correlated to an enterprise’s valuation, revenue and cost of capital.

In recent years, there are increasing expectations by investors, regulators, customers and other stakeholders for enhanced disclosures on sustainability and climate change, delivered in the form of a sustainability report, also known as an integrated report or impact report. Leading exchanges and investors use these reports to assess how sustainable their portfolio companies are.

Concurrently, authorities and regulators are taking more concrete action, including mandatory requirements or imposing taxes for ESG-related concerns. Some of these ESG-related regulations may impact organizations not only in the country where they are incorporated, but also in other markets where they have operations. This confluence of factors is compelling companies to embark on an ESG journey or step up the momentum in it.

Kick-starting the ESG journey

Companies seeking to drive sustainability can adopt a three-step approach: defining what sustainability means to their business, developing an ESG framework with the buy-in of the workforce, and communicating their ESG performance to external stakeholders.

How one defines sustainability goals will depend on the organization. While there are many ESG issues, companies must decide which are the ones that have a material impact on their business and prioritize accordingly. To be clear, sustainability is not necessarily just about the environment and climate change. It also encompasses any factor that can affect how sustainable the company will be in the long term. A financial institution, for instance, will likely consider responsible tax management, cybersecurity or data privacy as issues that are material to its sustainability agenda.

In trying to define sustainability, it is important to proactively engage with internal and external stakeholders to get a better understanding of their expectations. Examples of external stakeholders include investors, financial institutions, the supply chain, regulators and other key players in the value chain. 

The next step is to develop a framework to determine the targets of the company’s ESG agenda, how the organization plans to drive that agenda as well as the type of data required to inform the strategy. For instance, if climate change is a material risk for the company, it will need to set a deadline for achieving net-zero emissions, among other goals, and come up with a road map to achieve this objective.

The third and final step is for the enterprise to have the right level of ESG-related disclosures to fulfill regulatory requirements as well as regular communication with its stakeholders.