As interest in environmental, social and governance issues grows, how can businesses, investors and philanthropists create long-term value?
- Stakeholders’ interest in environmental, social and governance (ESG) issues has grown.
- To create long-term value, business owners need to integrate ESG into their operations and strategy, while investors should embrace sustainable investing.
- Philanthropy makes a beneficial social or environmental impact if it is effective and the effectiveness is carefully measured and evaluated.
Climate change has led to realities that are hard to ignore. Extreme weather events and other natural disasters have caused mass destruction and further consequences that last for years and impact millions of people. With such events increasing societal interest in environmental, social and governance (ESG) issues, how can business owners, investors and philanthropists realize a sustainable future?
The world is already witnessing mass migrations due to flooding caused by a rise in sea levels, with the United Nation’s International Organization for Migration estimating that by 2050, there would be 25 million to 1 billion environmental migrants.
Besides causing risks to businesses and investments as coastal megacities are destroyed, such events also often affect the quality of life. A study by the Economist Intelligence Unit found that when these effects of heat, drought, flood, and freeze were scaled up, global gross domestic product could be US$7.9 trillion lower than what it would be without climate change.1
Consumers worldwide are starting to demand that companies implement programs to sustain the environment. These consumers are typically of the millennial generation (born between 1980 and 2000) whose global annual aggregate income is expected to exceed US$18 trillion by 2030 and continue surpassing the spending power of every other generation for at least the next five years thereafter.2 An increase in awareness also impacts the workplace. Six in 10 millennials were willing to take a pay cut to work for a socially responsible company.3 Unsurprisingly, research has also shown that a positive social impact correlates with higher job satisfaction, and employee satisfaction is strongly and positively correlated with shareholder returns.
Likewise, investor interest in responsible portfolios is rising. Sustainable investment is expected to be a new norm, especially with millennial investors. A 2019 survey revealed that 95% of millennials were interested in social impact investing, compared with 86% in 2017.4
Governments and various stakeholder groups are also banding together to agree on globally coordinated action. There are presently two main frameworks that guide ESG actions:
- The 17 UN Sustainable Development Goals adopted in September 2015 aim to end poverty, protect the planet, and ensure that all people enjoy peace and prosperity by 2030.
- The Paris Agreement that officially came into force in November 2016 aims to limit global warming to 1.5°C to 2°C above pre-industrial levels.
However, progress to date has been limited. The UN Environment Programme released a report warning that unless global emissions fall by 7.6% each year between 2020 and 2030, the world would not be able to meet the Paris Agreement target.5
In view of this, several global initiatives have sprung up to mobilize action toward the Paris Agreement’s climate goals. Alongside these global initiatives, the regulatory environment has also rapidly evolved to incentivize ESG actions and penalize non-compliance. These trends are likely to accelerate with increasing pressure for public policy announcements to tackle climate change. As stakeholders grow more aware of ESG issues and interested in taking action to create a more sustainable future, business owners, investors and philanthropists should consider several key areas.
Risks from ignoring ESG impact on other stakeholders
How can business owners create long-term value for all stakeholders to mitigate ESG risks?
Business owners should ask themselves how their organizations can create long-term value that lasts. Long-term value is created when companies align their goals with society’s goals. This means creating value not just for shareholders, but also for employees, communities, and the planet.
Often, ESG issues arise when companies neglect their impact on these other stakeholders. As people in society increasingly demand greater social responsibility from businesses they work for, buy from, and invest in, ignoring ESG issues would mean exposure to significant risks that ultimately affect the top and bottom lines.
To mitigate these risks, companies should integrate ESG into their operations and business strategy after identifying material ESG risks and opportunities:
- Identify what is material to the company
- Regularly engage internal and external stakeholders to identify key issues of concern
- Assess ESG risks along the value chain
- Map out a universe of issues that are most pertinent to the company, based on what was identified through stakeholder engagement, value chain assessment and industry and standards requirements
- Prioritize ESG risks and opportunities by considering the probability of occurrence over the short to long term and the magnitude of financial, operational and reputational impact
To further distinguish themselves, companies could benchmark their practices against industry ESG leaders, and explore sustainable financing options.
ESG issues often arise when companies neglect their impact on other stakeholders. As society increasingly demands greater social responsibility from businesses, ignoring such issues would mean exposure to significant risks that ultimately affect the top and bottom lines.
Investor demand for sustainable investments
Can investors do good and still do well?
Research from the 2020EY Climate Change and Sustainability Services (CCaSS) fifth global institutional investor survey (pdf) suggests that ESG information has never been more important, with the majority of investors surveyed (98%) signalling a move to a more disciplined and rigorous approach to evaluating companies’ nonfinancial performance.
The ESG due diligence process identifies material ESG-related risks and opportunities, and assesses the maturity of target investee companies in managing them. Value is added by providing insights into business-critical ESG risks and opportunities in the short- and long-term, which can be leveraged in deal evaluation, pricing and negotiation.
When incorporating ESG factors into the construction of their investment portfolio, investors have several strategies to choose from. These strategies are not mutually exclusive and are typically used in combination with one another. The choice of strategy is often dependent on the investor’s impact intentions as well as financial and non-financial objectives.
Sustainable investing typically takes a few forms — ESG incorporation, sustainability-themed investing, and active ownership. After an investment has been made, active monitoring — particularly on material ESG topics — will help companies to continue mitigating risks and identifying opportunities. Post-investment, investors should continue to monitor ESG performance of investees and the investees’ competitors to be able to constructively engage with them. Besides monitoring the ESG performance and practices of investees, monitoring the quantifiable risk impact on the investment portfolio is also helpful.
Family enterprises and philanthropy
How can family enterprises make a positive ESG impact through philanthropy?
There is a direct correlation between families’ personal involvement in evaluating philanthropic progress and their overall interest in effective giving, and owners of smaller and larger family enterprises generally believe that personal oversight contributes to effectiveness.
Where there is a desire to either institutionalize the family’s philanthropic efforts or reduce personal involvement for individual family members, professional mechanisms, such as family offices, may be a means of helping or providing support.
Philanthropy makes a beneficial social or environmental impact if it is effective and the effectiveness is carefully measured and evaluated.