ESG: From Business Necessity to a Business Barometer

04 March, 2019

In today’s world, the dynamics of everything around us, right from our ideologies and socio-political systems, to weather patterns, melting ice caps and rising sea level, rapid advancement in technology are evolving at a lightning speed. This has also translated into the rising global socio-political instability and the way businesses respond to the same. Considering how these transformations are forcing us to respond, ESG (Environmental Social and Governance) investment has become imperative. It is essential for businesses to focus on ESG for a sustainable future and long-term impact.

ESG has gained popularity in recent years, and this has enabled investors to assess the organisations they are investing in even further. These assessments are based on the present risks that these companies face and take future opportunities into consideration. Businesses simply cannot ignore ESG, and it blends perfectly with the increased environmental and social awareness, be it climate change, societal issues, or deforestation. In some case important stakeholders are also joining hands and responding, to ensure a better future for coming generations. A recent example is the European Union joining hands and working on a framework collectively that will coordinate efforts towards socially responsible investment.

The evolution of ESG has come about as corporates move to include sustainability in their attitude and thinking. Being sustainable on the environmental, social and governance front means that companies are securing the long term by addressing ESG Risks. By allocating funds to companies with impressive ESG scores, investors are motivating businesses not only have a positive impact on the society and environment but also perform well on the financial front. According to John Duncan, Head of Responsible Investment, Old Mutual, “Businesses that respond to the ESG challenge earlier than their peers show stronger resource efficiency, lower cost of capital, better staff retention, a more robust social license to operate, and better labour relations. These factors combine to produce a stronger competitive advantage, and consequently, higher valuations in the market.”

Increasingly Oil & Gas companies are repositioning themselves as ‘energy’ companies and touting their ‘renewable’ focus, they are still likely to get into trouble. Investors, thus, are either pressing for greater transparency while operating in this sector or moving away. Exxon Mobil and BP are the laggards who have witnessed plunging stock prices due to lack of focus and transparency around ESG. In the year 2017, the majority of Exxon Mobil shareholders consistently insisted on ESG disclosures which the company failed to comply, would Exxon Mobil shares have done better if they had acknowledged this broader shareholder shift. ESG Risks are not just relevant to fossil fuel-centric industries, the F&B industry is also being impacted. According to a news report in Morning Star UK in March 2018, Coca-cola has a low score on ESG due to its high spending on lobbying. A Sustainalytics report also suggests that excessive sugar intake is hazardous and corroborated by shifts in the consumer’s preference and consumption.

While many businesses are lagging, others have proactively embraced positive change and doing phenomenally well on ESG risk disclosures. A recent report by CDP said that 120 organisations including Danone, Infosys, Wipro, Klabin and Microsoft received an ‘A’ grade for their actions on climate change. Other global companies have also left a positive impact on all three categories of climate change, water security and deforestation. This can also act as an inspiration for other organisations to take care of the ecology that we are intimately entwined in. A recent report by IPCC suggests that the next decade is going to be crucial environmentally, and corporates can be the real change makers to bring about economic and ecological stability.

As urgency increases, and immediate action to implement ESGs is apparent. 2019 has already defining changing trends in ESG reporting. While a wide variety of issues have been covered, the end goal remains the same: Acting today can make a difference tomorrow. MSCI Research LLC reports that China has already begun a global war on banning 24 kinds of solid waste exporting countries. For decades, China was a major polluter due to improper handling and treatment of waste, and also the global leader in waste import. But looking at the current environmental conditions, it took the bull by its horns to clean up the mess. This has sent a shockwave throughout the world. Countries exporting solid waste are scrambling to devise innovative solutions and policies to reduce plastic and other non-degradable waste.

F&B organizations who rely on plastic as a primary component for packaging have also been affected by this. Sustainable packaging solutions in F&B are opening new doors to disruptive innovation, and winners are sure to emerge. Packaging through bio-degradable material is only one example. According to the MSCI ACWI index, companies with innovative paper-based packing have witnessed a steady growth in revenue as compared to companies in plastic packaging. Such solutions have also garnered the attention of investors all around the world. Another important trend of 2019 so far is that regulatory development around ESG investment will escalate as compared to ESG disclosures. The narrow and thematic point of view approach towards ESG investments or theme-style offerings won’t be available anymore. This year will focus on measuring the roles of investors as well as approach ESG holistically as an investment related risk.

The big data revolution has taken the world by storm, and the ESG investment domain has greatly benefited through this revolution. Investors are emphasizing on data patterns /data signals as compared to just data proliferation. New data sources have facilitated the understanding of investors portfolios and factors driving their performance. Big data has helped investors to understand the companies’ performances and their latent & future risks as compared to voluntary corporate disclosure. But data alone is not going to answer all these questions, to go deeper into this understanding, investors should be able to extract and understand relevant signals from the data.

Some investors focus on understanding and identifying ESG risks and opportunities, while others focus on the impact companies have on society and the environment. Tech solutions that deploy AI are also making it easier for investors to find complex patterns in ESG data and leading to a better understanding of organisational performance.

The discussion above is just the tip of an iceberg. The current social and environmental conditions we live under are not favourable for the long-term sustainability of humankind Strengthening ESG frameworks and integrating innovative investment metrics along with technology is going to be the key to a sustainable future. Corporates and investors have the power to turn the situation around and make ESG not just a business necessity but a business barometer.