Bushfires; wage, banking and safety scandals; and the seemingly ubiquitous coronavirus.
This past few months has brought into sharp relief an area of business and investment that has been growing in importance for several years. Organisations of all sizes are experiencing increasing pressure from regulation and shifting societal expectations to measure and improve on environmental, social and governance (ESG) performance.
While billions of dollars globally are already being allocated to specialist ESG-aware investment mandates every year, considerations of ESG obligations are now extending far beyond investment markets.
Today, companies increasingly need a ‘social licence to operate’.
The influence of sustainability and social responsibility is having a very real impact on business – organic and MSC certifications and Fairtrade are just some examples. Organisations that can meet these consumer demands are well-placed to deliver investment returns over the long term.
These forces for change are expected to continue to challenge many facets of business now and into the future. For you, as a private business owner, this will bring opportunities and challenges.
ESG: Environmental, social and governance factors and characteristics
Ultimately, organisations that deliver on their environmental, social and governance obligations are likely to be operating sustainable businesses with a motivated workforce and supportive customers and investors. Below, we explore the facets of ESG in more detail:
Environmental: this area covers business activities that are likely to have a positive or negative impact on the environment. This could involve mining activities, land clearing for agriculture or poor waste management practices (e.g. allowing pollutants into waterways). It can also include things such as energy efficiency improvements and reducing greenhouse gas emissions.
Social: this covers topics ranging from workplace health and safety to links to gambling, tobacco, weapons or alcohol manufacturing and supply chains, and whether your organisation supports the local communities (both domestically and in developing countries in which operations take place). The ‘S’ segment is where ethical investors spend much of their focus.
Governance: this focuses on the controls and frameworks in place to provide structure and accountability. It governs:
- whether boards have a suitable representation of independent directors,
- if the organisation’s reporting meets accounting standards
- how well an organisation treats minority shareholders
- the organisation’s transparency in dealings with local authorities and shareholders, and much more.
And, increasingly, the ESG performance of the businesses that you engage with will have a bearing on stakeholders perceptions of your own organisation.
ESG in numbers: It’s worth the effort
Incorporating ESG is not about providing a material bump to next quarter’s performance, for either the organisation’s bottom line or owner’s capital value. However, over the medium-term studies show that organisations that rate well on an ESG basis provide far more predictable returns over time.
Bank of America Merrill Lynch (BoAML) research found that among companies it ranks on an ESG basis, 90% of bankruptcies could have been avoided by investing only in above average ESG score companies over the decade ending 2016.
In addition, BoAML’s study found that ESG scores have been strongly correlated with predicting future earnings volatility. Companies with high environmental and social scores are far more likely to have their S&P Common Stock Ranking improve (an earnings stability metric), with companies in higher ranks showing a 5% higher return on equity than others, on average.
Millennials will rule the world one day
Organisations are increasingly aware that they are selling more than a product for a margin. In what seems something of an irony lost on the Lamborghini PR team, they managed to at least note while launching an enormous SUV recently, that their factory was carbon neutral.
Whether you’re sipping craft beer with friends or enjoying smashed avo on toast while sitting on recycled milk crates, it’s important to remember that Gen X and Millennials are going to become an increasingly important part of the consumption portion of GDP over the next decade. And their preferences will dictate how capital is invested in terms of business environmental impact (E) and social responsibility (S). As an organisation delivering on ‘E’ and ‘S’ you should support this effort by ensuring that your organisation has well-established governance structures (G) that will protect capital.