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Organisations will need to identify new sources of capital to support the development of new and more sustainable products and services.
In brief
- Organisations across every sector and region are experiencing heightened stakeholder expectations to improve their sustainability performance.
- Investors are increasingly using ESG ratings for guidance on where to place their capital.
- Boards should enhance their capability in relation to ESG and sustainability generally by recruiting members with specialist expertise.
Organisations throughout the world are navigating a volatile and complex business landscape. Boards are contending with heightened geopolitical tensions and an uncertain economic outlook. In addition, sustainability is an ever more prominent issue.
Organisations’ stakeholders — including their customers, employees, investors, policymakers and regulators – expect them to play their part in tackling today’s major environmental and social challenges. As a result, boards may need to rethink how they allocate capital to both new and existing businesses, according to EMEIA board priorities 2023.
Over 11,000 businesses and other organisations have now committed to net zero targets, with the aim of achieving net zero carbon emissions by 2050 at the latest¹. However, many are struggling with the challenge of transforming their business models to be more sustainable while avoiding value destruction. This is leading to the adoption of value-led sustainability strategies where businesses create additional value through the launch of new and sustainable products and services, while conserving cash and resources. All capital projects are now expected to generate cash more quickly as they rush to preserve value amidst concerns around high interest rates.
Keeping funding channels open with the right ESG scores
Investors are alive to the opportunities presented by the net zero transition and are keen to play their part in funding it. Overall, the transition to a net zero economy is estimated to require US$125 trillion in investment globally by 2050². According to research by Bloomberg Intelligence, ESG assets already represent more than a third of the total assets under management (AUM) and may reach US$53 trillion by 2025³.
On the flip side, boards must be conscious that a poor ESG rating can act as a barrier to outside investment as the ESG reports from rating agencies are used by investors to inform their capital allocation decisions. Organisations without strong ESG scores are likely to be excluded from ESG funds and indices.
Organisations and investors need to work together to ensure that capital is channelled toward those investments that are likely to have the greatest impact on achieving net zero ambitions, thereby bolstering those critically important ESG ratings. Comparable, reliable and transparent sustainability reporting will help both boards and their investors get a more accurate picture of which investments are doing so. New regulations such as the EU Corporate Sustainability Reporting Directive (CSRD) will assist in this regard.
Boards also need to be aware of other sources of capital such as the EU Green Deal and the US Inflation Reduction Act which can provide funding for sustainability related initiatives and projects.
Understanding investor expectations and rethinking roles
In this new paradigm, boards need to work with the management to identify the major trends in ESG investment and understand how they are likely to impact the organisation's ability to secure funding. They must also take steps to ensure they are capable of influencing their organisations’ capital allocation decisions.
This will enable the board to ensure that capital allocation decisions are consistent with the organisation delivering on its net zero targets. It will enable them to challenge management on specific capital allocation decisions such as returning capital to shareholders when the organisation is behind on progress toward its net zero commitments.
It is, however, not always easy to find investment opportunities to achieve net zero even when boards are fully committed to the goals. If everyone is striving towards the same goals at the same time – say with regard to building electric car manufacturing facilities or offshore wind facilities - supply of opportunities can well take good few years until the market catches up. Therefore, achievement of goals and timelines also need to be realistic.
It may also be necessary to create a dedicated sustainability strategy committee to ensure that sufficient focus is given to sustainability and that it is not detached from strategy.
In addition, effective executive remuneration structures that influence behaviour and drive accountability for the achievement of sustainability objectives should be established. Metrics should be aligned with the organisation’s overall strategy and be relevant to both short and long-term objectives.
That reporting is critically important, and boards should engage with their auditors and other independent advisers to understand how they will approach the assurance of sustainability information and the likely form of the reports.
Summary
Poor ESG ratings can present a barrier to external investment for even the most successful organisations. The net zero transition will require investments of trillions of dollars in the coming years and investors are keen to support that, but only if organisations can provide clear evidence that they are making progress on sustainability targets. In this context, boards have a responsibility to ensure that capital is directed toward those initiatives and projects that are likely to have the greatest impact on achieving net zero objectives.
How EY can Help
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EY sustainability and ESG strategy consulting teams can help you with strategy, M&A, capital allocation, ESG due diligence and portfolio optimization.
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