The threat of climate change has been with us for decades, but like a spot on the horizon it remains out of reach. It's seen as an abstract, intangible, and future concern for many businesses. As such, Environmental, Social, and Corporate Governance (ESG) principles, which were established over 20 years ago, have primarily gained traction as a means to support selective investment and as criteria for reporting sustainability credentials, with little focus on its benefit to managing risk, creating value, and improving financial performance.
In addition to being a significant health crisis, the COVID-19 pandemic has brought with it a host of other problems, including broken supply chains and business models, contraction across key sectors, and increasing debt as governments and businesses invest to stay afloat. Nonetheless, it also offers a unique opportunity to peek into the future and understand the myriad of potential impacts that a climatic-based system shock could bring. Organizations have an opportunity to re-evaluate their business models, internal processes, and criteria for decisions, investments, and incentives to reset their course and better prepare for future eventualities.
Global ambition and heightening pressure
The landmark Paris Agreement in 2015 aims to strengthen the global response to climate change by keeping a global temperature rise below 2 degrees Celsius relative to pre-industrial levels, while pursuing efforts to limit the increase to 1.5 degrees Celsius. At a country level, governments have committed funds to drive investment in low carbon innovation and infrastructure and have developed strategies for a net zero carbon future.
Backed by increasing regulatory, consumer, and investor pressure, businesses are also being pressed for action to address near- and long-term threats. However, they have struggled to incorporate long-term climate targets into their business systems in a way that would enable climate-smart planning, financial management, marketing, strategy, and continuous improvement. To date, over 500 companies have committed to the Science Based Targets initiative, which promotes the embedding of targets aligned with the Paris Agreement into standard business practice. But more needs to be done.
The COVID-19 pandemic has also highlighted major economic and social concerns, such as business disruption, unemployment, and rising inequality. These concerns reinforce why viewing sustainability primarily through an environmental lens is insufficient. This point is recognized in the European Green Deal, of which a major pillar is the adoption of the Taxonomy Regulation by the end of 2020. This regulation, which is designed to establish a classification system for sustainable activities, and related delegated acts are part of the EU’s ESG regulatory framework. The framework aims to facilitate compliance with Paris Agreement climate targets.
Looking beyond the short term
Although sustainability is founded on the principles of ESG, it has commonly been focused on reporting as well as carbon emissions and mitigation activities that yield a positive return on investment. ESG, on the other hand, ensures a broader perspective of a company’s actions by assessing how it responds to climate change; treats its workers, consumers, and community; builds trust and fosters innovation; and manages supply chains. Rather than complicating decision-making, integrating ESG can create value.
Overall, the transition from a short-term lens to a broader, longer term perspective highlights a maturation of stakeholder needs brought on by increasing global ambition. There is also additional recognition of the importance of the social and governance pillars in ensuring positive business performance, growth, and risk management.
Reassessing business models
Business sectors have been impacted by COVID-19 to varying degrees. The retail, aviation, oil and gas, and hospitality sectors are among the hardest hit, with several well-known brands going bankrupt, such as Hertz, Chesapeake Energy, JCPenney, Virgin Atlantic, and J. Crew. Furthermore, sectors like automobile, entertainment, and in-person events have ground to a halt. However, other businesses are thriving. In addition to the health sector, those related to online entertainment, food delivery, online shopping, online education, and solutions for remote working are seeing big increases.
It is difficult to predict the future, but the current situation provides an opportune time to reassess business models to build resilience, ensure continuity, and develop dynamic capabilities to provide agility to adapt to the changing societal, customer, and employee needs and to deliver better outcomes.
The ESG framework provides a mechanism to ask key questions around environmental impact and risk, social practices, and governance in order to identify gaps, areas for improvement, and opportunities to raise ambition. A recent study by BlackRock reiterates this point by noting that companies with strong sustainability profiles performed better during the COVID-19 crisis than their peers and were better positioned to weather adverse conditions in the future.
Embedding ESG to build resilience and agility
Although inherently qualitative, integrating social issues into business systems should ensure that operational performance is not impacted by internal and external practices. Assessing labor practices—including benefits, health, safety and well-being, and education—to ensure they are aligned to the new paradigm will build confidence in worker motivation and productivity and reduce turnover. Furthermore, externally, the social factor addresses customer loyalty retention (both old and new) and maintaining relationships with business partners, suppliers, and communities affected by the company’s operations. For example, embedding ESG considerations into supply chain procurement practices—enabling local resourcing, consolidation, and alignment to lower natural resource and biodiversity impacts—could boost resilience.
Effective governance will ensure that sustainability does not remain a siloed aspect of corporate strategy. As such, it provides a key function to ensure that the strategic vison of the company is incorporated into its business systems and processes, such as customer relationships, enterprise risk, and treasury management systems. This means integrating sustainability criteria into enterprise applications, updating documentation, and communicating the changes to staff. For example, refining project investment criteria so they are assessed using a life-cycle cost analysis.
Overall, embedding ESG criteria into business systems will help institutionalize dynamic capability such as strategic decision making and process reviews to rethink product or service design and delivery channels.
The ESG is in the details
Given the complexity and variety of ESG criteria, data monitoring for measurement, analysis, interpretation, and reporting are important for companies to undertake. For many businesses, a lot of ESG data is already available and collected in existing data systems, such as SAP. To help unlock the power of this information, companies should conduct a rigorous review of their existing data collection systems and processes to ensure they reflect actual performance across all material topics and minimize estimations and inaccuracies. Where there are gaps, systems should be refined (or new modules developed in SAP) to collect relevant ESG metrics.
Beyond the norm, many ESG topics represent qualitative factors and intangibles. Big data analytics and machine learning can provide companies the ability to sift through both internal and external noise to improve predictive capability, and the quality of evidence to support decision making.
Stakeholder engagement to ecosystem management
Moving from inward requirements for embedding and monitoring ESG to the outward network, stakeholder engagement is a key governance feature of ESG. The COVID-19 pandemic has highlighted the importance of teaming with the right organizations and distilling a collaborative, inclusive culture. As such, businesses need to not just consider engagement, but also the ecosystems in which they operate. The benefits include new collaborative processes, such as pooling resources with other companies to reduce costs; looking beyond the norm to create more sophisticated, complete solutions with other organizations; and looking beyond obvious collaborators to new strategic positions and partners.
From the global challenges presented by COVID-19, it is clear that dealing with these issues requires effective collaboration within a company and across diverse organizations including suppliers, investors, and customers. Rethinking the ecosystem that a business operates—and making that part of the questions and decisions that need to be addressed—is key to reducing risk and building resilience against future shocks.
Planning for the future starts today
Establishing long-term ESG objectives is important to enable the transformation that businesses need in order to achieve a sustainable future for all. The correct long-term approach can drive growth, innovation, and transformational change. It will also ensure compliance with the new ESG regulatory regime evolving from the EU Green Deal.
The current pandemic offers an opportunity for companies to reassess themselves in how they manage risk, renew and enhance their brand image, improve profitability and performance, build resilience, and improve governance. It starts with a vision—and new policies and internal procedures to enable strategic action plans—and is built on a foundation of ESG measures that can be monitored to track performance and support strategic decisions.