For most companies, a commitment to upholding a high standard of environmental, social, and governance (ESG) disclosures has evolved from a “nice to have” to a “must have”: consumers are demanding transparency from companies, employees are showing greater interest in working for sustainable companies and regulators are enforcing policies that incentivizes ESG.
Beyond the altruistic incentive behind incorporating sustainability into business decisions, we are continuing to see strong financial justifications for incorporating ESG policies. Companies that demonstrate how they intend to protect their business against the world’s biggest sustainability issues not only show stakeholders that they are able to future proof their businesses, but also how they can maximize their returns.
Purpose-driven brands can better compete in the market by reaching an increasingly growing cohort of sustainability-minded customers. A 2020 study by Morgan Stanley found that over 50% of customers prefer to engage with purpose-driven companies. Organizations that have successfully implemented strong sustainability practices across all vertices of environmental, social, and governance are able to strengthen their brand equity, driving higher share prices over the long term.
Institutional investors have taken notice of this trend and are increasingly searching for sustainable investment opportunities by analyzing corporate ESG performance. According to Morgan Stanley, 33% of the $51.4 trillion in U.S. assets under management used a sustainable investing strategy in 2021. Over 80% of institutional asset owners and more than half of U.S. retail investors employed some type of sustainable finance strategy last year. In a survey conducted by PwC, over half of the 325 global investors surveyed said they are willing to divest from companies that are not taking sufficient action on ESG issues. Corporations that do not take a strategic approach to sustainability run the risk of isolating an increasingly growing pool of investors.
While it is important to acknowledge the growing importance of ESG in capital markets, the movement is still in its infancy. This makes things messy: reporting standards change, macroeconomic environments fluctuate, and ‘greenwashing’ is often easier than implementing real change. In the asset management space, institutional and retail investors are being held to higher disclosure standards when incorporating sustainability into their investment strategies, forcing investors to examine their portfolio companies’ reporting standards more closely.
So, where should companies start when trying to build an authentic ESG mandate when there is little consensus within the industry around reporting standards? And what steps should companies take to effectively tackle these issues?
Firstly, understand that authenticity matters
ESG represents a collective step in the right direction rather than a one-size-fits-all solution. Sustainability represents a complex ecosystem of factors that can be interpreted in different ways. When building an ESG strategy, companies should first look at incorporating sustainability into their company’s purpose—addressing the environmental and social impact of an organization, and demonstrate how this will differentiate them in the market.
Implement change from the top down
Change and a commitment to ESG must start at the top. The creation and implementation of a sustainability strategy may require an overhaul of business strategies forcing companies to innovate in order to capitalize on growth opportunities and value creation. It is necessary for an organization’s leadership to be actively engaged to create better alignment between purpose and profitability.
Communicate the strategy
Clear reporting—whether through quarterly reports or stand-alone sustainability reports—should help consumers, employees, and investors understand where a company stands in their ESG journey and provide valuable insight into an organization’s financial and operational controls. When communicating their sustainability strategy, organizations should emphasize how their business model translates into sustainable value creation for all stakeholders and outline the steps they are taking towards their goals.
Ensure transparency and consistency in reporting
There is no unified global standard for reporting ESG information. Companies need to employ industry-specific metrics, look at comparative data from peers, and disclose their methodologies in order to provide transparent and accurate information. Companies should treat sustainability reporting like they treat financial reporting—with factual data that stakeholders can use to track progress. A critical component here is consistency: once a company has begun reporting their ESG metrics, they must continue to disclose the same metrics and track their progress year over year to demonstrate their ongoing commitment to meeting their ESG goals.
While companies and investors are navigating a lack of consistent disclosure, ESG transparency continues to cement itself as a growing necessity. Companies must continue to incorporate sustainability factors into their business decisions and engage with stakeholders on the actionable steps they are taking towards ESG, or risk being left behind.
This piece is the first in a series outlining how sustainability is impacting capital markets and investment management. As always, our Capital Markets team is available to provide further insights on the items above as well as provide strategic counsel to organizations looking to deepen their knowledge on the topic.