December 19

How Companies are responding to ESG Pressures

Axel Kravatzky

ESG (Environmental, Social, and Governance) is the new watchword: what does it mean and how do its principles move companies to redefine their Purpose?  Here we discuss some ways in which companies are changing.

How could it be that in a world where most are still thinking that purpose of companies is to make profit, that the new buzzword in the business world, ESG, does not have another “E”, Economic, in it?

The term has come about in a world in which finance already dominates, and profits are in serious peril if companies are not taking care of their environmental, social, and governance risks. More recently, in the last three years, the world’s largest institutional investors have started to act on the insight that they cannot sustainably invest their clients’ money because there is no way to diversify away from ESG risks  – the whole world is in peril.

As a result, investors have demanded of their portfolio companies to create value beyond profit. So, the need for companies to remain profitable continues, but now profit must be created by generating wellbeing for people and regenerating the environment. In order to achieve profit without harming people and planet, Governance provides the framework.

Beyond finance - double materiality

Through governance, you determine what impacts on people and planet are acceptable. Through governance, you also determine the implication that changes in society and the environment have on the companies’ purpose, how it generates value, and through what strategies you achieve your goals. In this way, boards determine what’s material, or important, in both financial and non-financial terms (e.g. greenhouse gases, waste and pollution, resource depletion, working conditions, health and safety, employee relations, etc). In other words, boards determine what risks and opportunities, financial and non-financial, are important and should be acted on - and that is known as double materiality.

Relevant? Surely this is a fad

The relentless rise in ESG references, conditionalities for receiving investments, regulations, consumer demands, and high-risk liabilities for directors will only accelerate for the foreseeable future. Why? Companies’ philanthropic activities - ‘giving back’ to communities - were always welcome, but did they affect the fundamentally unsustainable nature of the core business?

We are experiencing the results of the unsustainable nature of our growth, consumption and incomplete accounting. The UN Secretary General, Antonio Guterres, called on all of us to ‘get serious’ because the recent Intergovernmental Panel on Climate Change report is a ‘code red for humanity’. An yet, Guterres said, a recent UN Report made it clear that if countries were to adhere to their present national climate commitments, emissions will go up by 16% by 2030 and that will condemn the world to a temperature rise of at least 2.7 degrees above pre-industrial levels – “a catastrophe”. To have a chance to limit temperature rise to 1.5 degrees, as agreed in Paris in 2015, we urgently need to start moving in other direction from the abyss – we need to achieve a decrease in emissions by 45% by 2030!

Gradually and then suddenly

Ernest Hemmingway, winner of the Nobel Prize in Literature, had one of his characters in his 1926 novel “The Sun Also Rises” give an apt response to the question “How did you go bankrupt?”: “Gradually and then suddenly.”

Even if the Caribbean contributes only miniscule amounts to total greenhouse gas emissions, our forests, oceans, coral reefs, cities, economies, and people are deeply embedded within the world that is heating up. Hurricane patterns are changing, sea levels are rising, coral reefs are bleaching, income inequalities are widening, poverty rates remain too large, consumer demands and expectations are changing, the financial system is transforming, energy sectors are on a roller-coaster – this pattern of increasing uncertainty and disruption will not slow down.  

Companies, like economies, have a choice – freeze, stare into the headlights, and hope the oncoming force will disappear, or change what and how we do things. How can we get there? If every organization, every leader, examines how consumer needs, nature and society are changing, perhaps we can uncover the risk and opportunities that change holds. Bill Gates reminds us that “we always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten.”

If you still have doubts

If you still have doubts, consider these facts: inflow to ‘sustainable funds’ increased by 18% year on year in the EU, and for the first time more than 50% of funds in the EU are earmarked for ‘sustainable’ investments. Financial market regulators are not only increasing ESG disclosure requirements but also issuing warnings to all ESG funds of the need to improve. The Edelman Trust Barometer of last year found that 87% say that customers, employees and communities are more important than shareholders to a company’s long terms success.

There are many companies that are making radical improvements – take for instance, Phillip Morris International, the company that not only aims to stop producing cigarettes but which has decided on a new and bold purpose: to solve societies’ problems from smoking combustible cigarettes. Their strategy is ‘to unsmoke the world’ – ‘to change society and deliver a better, smoke-free future with no combustible cigarettes’ (along with becoming carbon neutral in direct operations by 2030). The aim is not only for them to stop selling combustible cigarettes, but to work with governments, regulators, NGOs, and public at large to disrupt the entire industry over the next 10-15 years!

And in case you might think that any new target will do, recall the experience of Shell, the energy company, in May of this year: a Dutch court ruled in a landmark case in response to a lawsuit brought by climate change activists, that it was not enough that Shell committed to being net-zero by 2050 (in 29 years), but that they must reduce greenhouse gas emissions faster, 45% by 2030 (so in 9 years) based on 2019 levels.

This article is part of the "Purpose with Profit" Column and an earlier version was published in the business section of the Newsday (Trinidad & Tobago), Business Authority (Barbados). (Jamaica), and The Voice Newspaper (Saint Lucia) in September-October 2021.

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