Research by: Ekjot Sodhi
ESG
ESG stands for - Environment, social and governance. These three broad factors cover issues from climate change to employee health and safety to corruption and tax avoidance. Historically, ESG goals have had conflicting definitions, perspectives, and misconceptions. In recent years, ESG has been making more of a buzz in the corporate world, but the Covid 19 pandemic has accelerated this significantly.
The benefits behind the integration of an ESG framework is to evaluate risks relating to these issues before making any decisions to ensure that they do not have a negative impact on factors promoting global environmental and social improvements. This means investing responsibly to make the world safer e.g., by looking after the environment, making communities sustainable and promoting workplace equality.
These broad issues range from climate change or boardroom diversity to having controls to withstand the impact of changing weather patterns. Financial markets believe that companies with robust ESG strategies will perform better in the long-term in terms of financial goals and performance. This means that integration of ESG factors in strategic decision making is critical . Let us examine the three factors in detail.
Environment
Environmental aspects of ESG account for issues relating to greenhouse gas emissions, reducing global carbon footprint, waste, pollution and the circular economy and it examines the strategies a business has in place, and has implemented internally and within their supply chain and ecosystems to tackle these. In essence, the activities undertaken by businesses should not damage natural resources or wildlife.
Figure 1
G7: Source www.ourworldindata.org/co2-emissions
Evidence
As the threat of climate change and depletion of resources intensifies, investors in businesses in these countries and globally will increasingly factor in sustainability investment decisions. Investment decisions regarding technology will need to consider how accurately it captures carbon emission data at source, measures impacts and drives the real-time analysis, reporting for the achievement of corporate ESG goals.
Tip No 1. Environmental Drivers - The breadth of factors that businesses and countries globally must consider is vast. In addition to proactive environmental risk management and horizon scanning being integrated into strategic investment decisions, the environmental protocols, and policies to be implemented and governed to positively impact environmental factors include but are not limited to the following:
Greenhouse gas emissions
Biodiversity
Waste production and management
Water usage and management
Energy consumption
Building, warehouse, and site efficiency
Business travel
Freight travel
Paper usage
Food and catering
Fuel consumption and readiness for the post-fossil fuel era.
Electricity consumption
Gas consumption
Plant and equipment efficiency
Recycling
Decarbonisation & carbon neutrality
Circularity strategy
Raw materials and goods
Air travel
Environmental risk management and horizon scanning
Social
Social elements include the human capital that a country, company, or business must consider. This includes having an inclusive employee culture, small businesses given fair and equal opportunities e.g., having a diverse workforce, promoting employee health, safety, and mental wellbeing, and providing adequate training and remuneration. Social sustainability is about managing the business impact on people.
The first of the six UN Global Compact principles focus on this social dimension of corporate sustainability, of which human rights is a key cornerstone. Businesses must undertake due diligence to safeguard human rights while undertaking their activities e.g., creating decent jobs, goods, and services to meet basic needs, have more inclusive value chains making decisions to promote social sustainability.
This encompasses the external workforce like supply chain and the ecosystem e.g., company relationships, reputation with suppliers, institutions, safeguarding communities where the company does business, corporate social responsibility, community impact, fair trade, and no child labor. These are vital to internal or external stakeholders e.g., today’s workforce millennials, generation Z and ethical investors.
Evidence
There is well-documented evidence that inclusive teams are more productive. Businesses must improve equity at all levels in workplace decisions. This starts from the top as leadership culture and top management in the workplace dictate this overall tone. One way for leaders to drive this forward is by including these people KPIs in contract awards, performance appraisals and performance-related bonuses.
Tip No 2. Social Drivers - The breadth of factors that businesses must consider is extensive. There is a need for proactive policies to govern decisions being made that could have a negative social impact on communities throughout a business supply chain and business ecosystem. The protocols and controls to be governed for social sustainability issues include but are not limited to those listed below:
Community impact
Human rights
Sustainable jobs
Employee demographic
Female board representation
Minority representation
BAME representation
SME representation
Supply chain relationships
Fairtrade
Child labour
Fair payment & minimum wage
Health safety and wellbeing
Corporate culture
Supply chain resilience
Continuous improvement
Equality and inclusion
Gender equality,
Anti-discrimination
Employee training and upskilling
Governance
Governance factors are the internal system, controls, and protocols a company adopts to govern itself, supply chain, make strategic decisions, comply with the law, and protect external stakeholders. It entails a company governing with integrity. There must be compulsory and proper sets of rules and regulations, that highlight the transparency of the company to safeguard the rights of shareholders for the long term.
Finance teams have a huge role to play in governance and reporting on this for example through balanced scorecard reporting. A strategic planning framework that businesses should use to report on ESG goals. The success of a business is no longer purely about profitability and financial earnings. The strategic business planning process is governed by finance and is one way that finance can have a huge impact.
Evidence
In January 2021 Reuters reported that demand for investments in ESG funds soared in 2020, driving assets under management up 29% in the fourth quarter to nearly $1.7 trillion in the US. According to Statista, there has been a dramatic increase in the ESG investment on a global scale in the past few years - from 11.35 trillion U.S. dollars in 2012 to approximately 30.7 trillion U.S. dollars in 2018.
Mckinsey states that from their experience and research - ESG is linked to positive cash flow in five important ways:
Facilitating growth
Reducing costs
Minimising legal interventions
Increased employee productivity
Optimised investment and capital expenditure.
They state that these five levers should form a checklist for ESG decision-making.
Tip No 3. Governance drivers - Policies, protocols and both qualitative and quantitative controls must be established and embedded within functions and operations. Controls at the conceptual, feasibility study and investment business case stages of decision-making should ensure alignment with ESG goals. The protocols and controls to be administered for governance include but are not limited to the following:
Organisation control / legal structure
Geographies - jurisdiction
Industry/sector risk
Information governance
Employee protection
Customer service
Shareholder protection
Ethical policies
Anti-tax avoidance policies
Anti-bribery & corruption
Anti-money laundering
Impact assessment and reporting
ESG risk reporting
Sustainable pension and investments
External & internal audits
Publicly reported emission data
Benchmarking competitor data and analysis
Freedom of information & whistle-blowing.
Equality diversity & inclusion policy
Corporate social responsibility
ESG integration
ESG integration entails integrating environmental, social and governance factors into business strategy. This is key to promoting sustainability in the investment decision-making process and vital for promoting ESG values and ethics to shareholders and stakeholders. ESG integration is the complete and systematic inclusion of ESG values in the investment analysis and decision process to promote ESG practices.
Finance can help by build trusted relationship, fostering transparency, collaboration, and equitable budgeting - by gender, race, disability etc. during decision making or by reporting on gender pay disparity, performance metrics, pension and investments, board level impact for buy-in competitor data and evidencing and driving the achievement of net zero carbon target by 2050.
Evidence
Finance teams can help by identifying targets and setting measurable KPIs that are actively reported and disclosing these as part of periodic regulatory reporting. This starts with integrating sustainable development goals - SDGs and ESG disclosure into corporate reporting. Key reporting principles are:
Relevance appropriately reflecting carbon emissions for decision-making.
Completeness - Accounting for and reporting GHG emission sources and disclosing any exclusions.
Consistency - Using consistent methodologies for the meaningful comparison of emissions data.
Transparency - Using factual, coherent audit trails, assumptions, references and calculations.
Accuracy - quantification is systematically over/under reasonable assurance, integrity.
Tip No 4. ESG Integration Drivers - Although there are limitations such as incomplete and inaccurate data, meaning that finance practitioners must be cautious with ESG integration. Commercial, finance, procurement and multidisciplinary teams can help in reporting, carbon footprint calculation, comparing ESG performance scores and using benchmarking data between companies, industry, and sectors by using these protocols.
Collecting cost data at source
Materiality thresholds
Data impact and relevance.
Time tracking to identify trends.
Assessing performance overtime
Consistent application of accounting principles
Identifying inventory boundaries
Setting calculation methodologies
Independent external verification
Accurate accounting of emissions
Direct consumption data monitoring.
Standardised rules for estimating emissions.
Asset age and usage
Managing carbon risks
Driving carbon reduction for net-zero carbon target by 2050.
Mandatory public reporting
Using and embedding ESG frameworks
Utilising R&D tax breaks
Utilising capital allowances
New green deal grants and opportunities
How CFBL can help you?
For real-life case-based training on how your commercial, finance, procurement teams and your supply chain can embed ESG factors in business strategy and implement protocols for emerging ESG costs contact cecelia.fadipe@cfbusinesslinks.com. Cecelia is a strategic partner of the Sustainability Institute.
Cecelia Fadipe, director CFBL Consulting, is an economist, chartered global management accountant fellow of CIMA and cost consultant. CIMA is a signatory to the UN Global Compact. Being a part of the Global Compact is a voluntary commitment to upholding the initiative's ten principles, in the areas of human rights, labour, the environment and anti-corruption.
References
UN Global Compact www.unglobalcompact.org/
Financial Reporting Council www.frc.org/
Task force for climate related disclosure www.fsb-tcfd.org/
Sustainability Accounting Standards Board https://www.sasb.org/
GHG Conversion factors Gov.uk
Greenhouse Gas (GHG) www.ghgprotocol.org
Reuters www.reuters.com
Statistica www.statistica.com
Mckinsey www.mckinsey.com
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