Bruce Dahlgren
Browsing travel options on Google Flights, you may have noticed that airlines have begun to incorporate carbon emissions data into their offerings to consumers.
As a frequent flyer, all things — including price — being equal, I’ll always choose the more carbon-efficient flight. This is novel and striking to me. It’s exciting to have a new data point to understand my personal carbon footprint, but it also highlights a real inflection point for the investor community.
If environmental data is already available and marketable at the consumer level, this means the era of ESG – environmental, social and corporate governance – is essentially here at the enterprise level and it is the next big frontier in corporate governance, risk and compliance (GRC).
But right now, ESG is seen by some as all talk, little action – there may be hundreds of executives touting the importance of ESG, but we still lack a universal measuring stick for clearly understanding ESG performance. Without that, it’s difficult to determine what is right from what is wrong, or what is a strong investment from a shortsighted one.
The common denominator that investors must understand, without a doubt: The key to understanding ESG is all about collecting the data and having it in an actionable format for analysis. Once key metrics are measured, investors and executives alike can make smarter decisions. So how do we value ESG performance and make it more actionable?
A recent Morgan Stanley survey determined that 85% of all individual investors were interested in sustainable investing, up 10 percentage points from 2017, while a Bloomberg report indicated that ESG assets may hit $53 billion by 2025, which would be one-third of the world’s total assets under management.
Investors need to start thinking about ESG risk in the same way they consider investment risk, as a first step. Most stakeholders expect companies to play a role in decarbonizing the global economy and being responsible global citizens. Consider how strongly consumers react when corporate entities are caught being irresponsible: If companies are not holding themselves to a certain ESG standard, they have to answer to their customers, employees, investors and the larger global community.
Interestingly, we have seen this same paradigm play out in the broader risk management sector. Governments haven’t yet caught up to fast-evolving risk factors in a more digitized world – the metaverse and cryptocurrencies are great examples of new and risky territory with no set regulations.
As governing bodies catch up, companies must then set their own internal standard for how they manage and measure risks. This internal regulation is reinforced by the rest of the enterprise ecosystem – partners, suppliers, consumers and institutional investors all drive the need for GRC requirements as they size up their own risks and investments.
ESG investors can also take insight from the broader risk management space when considering how to value the role of ESG: For any risk, the best way to understand how to make informed risk decisions is to measure the risk as a monetary value. As a tail risk, ESG has long flown under the radar – the cost is so high, and the likelihood of a risk event is so low, corporate leaders tend to underestimate the likelihood and cost of an ESG risk event.
As investors, correctly quantifying ESG risk and understanding their plans to address risk events is essential to provide the proper discounts and premiums on an investment.
Look for the following signs when evaluating investments – these will point toward companies that are taking steps to self-regulate their ESG standards and are aware of the true size and scope of ESG risk threats.
ESG scoring is table stakes
Regulation in the ESG space will only increase as governing bodies continue to catch up to what is happening in real time within and between organizations. Congress recently passed the $1.2 trillion infrastructure bill, which included several ESG initiatives, and the Securities Exchange Commission announced its heightened focus on ESG disclosures.
As we see ESG become more closely tied to broader governance and compliance standards internally and externally, organizations that have a system of reporting and scoring ESG metrics will be better prepared for the future.
Until a singular framework is established as a global standard, companies that understand the importance of collecting their ESG data and making it readily available will have the advantage to attract investments, customers and employees.
ESG assessments are built-in to the business
Many leaders of major global businesses view their risk management team as a reactionary and diagnostic system, a need-to-have, “just-in-case” defense plan. But today, playing defense is falling behind. Any breach of risk, including ESG risk, happens so quickly that the business impact is immediate, and stakeholders expect a response just as fast.
However, it can take months to collect the data and manually build these ESG reports. I recall speaking with one senior leader whose team of over 30 people spent 11 months compiling the company’s ESG reporting. By the time the report was done, the insights were stale and it was difficult to infer actionable steps.
But technology can help change the game: Automation and AI within enterprise technology will spill over into how businesses measure ESG scores and help make these response systems faster.
Investors should look for how ESG and broader risk and governance data is collected in their portfolio companies. Ask your partners: Is data collection integrated and always-on, or are reports being generated manually? Are leaders leveraging automation and AI to stay focused on analysis and smart decision-making, rather than counting and reviewing disparate data?
Plans are set for short, medium and long terms
Stakeholder capitalism is all about delivering long-term, durable returns. Transparency around plans for a sustainable and compliant world is an important element of that promise.
For institutional investors and those conducting due diligence on future investments, the new normal is understanding how companies set their short-, medium- and long-term targets for ESG progress. Companies and leaders must be setting goals with achievable plans to meet them – this is critical to the long-term economic interest of shareholders.
Meanwhile, ESG standards continue to evolve and mature. It is now common for institutional investors to ask that companies issue regular, public-facing reports consistent with benchmarks that are developing globally, such as the Task Force on Climate-Related Financial Disclosures (TCFD).
The International Financial Reporting Standards Foundation (IFRS) announced the creation of the International Sustainability Standards Board (ISSB), which will develop global thematic and industry-based sustainability disclosure standards toward the end of 2022. The ISSB intends to build on the work of existing investor-focused reporting initiatives such as TCFD to become the global standard-setter for sustainability disclosures for the financial markets. Organizations can start preparing now for the medium-term expectations of ESG reporting by institutional investors.
The board is vocal and engaged in accountability measures
When companies participate in ESG scoring and can quantify the monetary value of specific ESG risks, corporate boards through their audit committees have more actionable information at hand to make better business decisions.
Thus, they have a much easier time understanding what’s happening in real time and signing on to accountability measures. Look to the involvement of the board as a factor in evaluating the long-term ESG value of an investment.
I see the current ESG landscape as a thematic echo of what we saw in the dot-com era. In the late 1990s, we saw the likes of Amazon, eBay and Google leading the way and betting big on a digital future. Many dismissed this technology and these companies’ investments as difficult to understand or just a minor, passing fad. While many failed miserably at the expense of their investors, those that balanced risk with a solid business strategy still dominate today.
ESG is not a trend or a buzzword – it is the next business imperative driving a more sustainable and responsible future. Stakeholders will continue to demand ESG reporting as a litmus test for investing, which makes it critically important that businesses move from “all-talk” about ESG to real action.
Companies that embrace these ESG insights today and take part in building a global ecosystem of responsible growth won’t just survive the ESG wave, they will thrive.
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