Investigating how sustainability directly impacts financial performance
Most decisions in business are directly or indirectly linked to the finances of the company. While many lines of business and business practices can easily be linked to the revenues and the bottom line, sustainability is a function that has a powerful effect on the long-term success of the business, but the benefits are not apparent in the short term. A substantial body of research from academic institutions like the University of Oxford and financial institutions like Deutsche Bank confirms that ESG factors are correlated with superior risk-adjusted returns and better operational & stock performance.
ESG considerations in investment valuations and assessments can be linked to the building of sustainable competitive advantage and a positive societal impact. ESG risks are broad-based and cover major aspects of business operations. They include risks related to climate change, environmental management practices, work and safety conditions, human rights, anti-bribery and anti-corruption practices, and compliance to relevant laws and regulations.
Stakeholders led by institutional investors are demanding transparency in the disclosure of sustainability performance alongside financial performance. Investors have demonstrated their need to understand the sustainability practices of a company before deploying any capital investments; this is seen in the large community of investors, including the Rockefeller Foundation, exiting fossil fuel based business and other unethical businesses over the past decade. More than 80% of 320 institutional investors surveyed by Ernst & Young agreed that “Companies have failed to consider ESG risks and opportunities as core to their business”, and 71% would reconsider or rule out investing in companies where there is a “lack of direct link between ESG initiatives and Business Strategy”. Stakeholders are increasing their focus on the way companies are assessing ESG risks and the related opportunity analysis and the financial impact of these risks, before making decisions on buy-outs and acquisitions. This pressure from stakeholders is driving sustainability into board rooms. The need for businesses to focus on sustainability is clear. It is no longer just a way to be a responsible, mindful brand, but a reliable method to identify and manage risks to the long-term viability of the business.
This change has made it crucial for the real time capture, management and analysis of ESG data to identify short, mid and long-term business risks. Technology intervention in sustainability has made it easier for companies to track and monitor sustainability parameters on a real time basis giving the much-needed business clarity to C-level executives of a company. ESG supports creation of lasting value for an organization. Long-term value creation is not possible for companies entangled with ESG controversies. One of the most compelling examples of ESG risk is the Deepwater Horizon explosion and oil spill in the Gulf of Mexico in 2010, which led to decline of share prices of BP by 50%. The total cost to BP considering fines and cleanup costs exceeded more than $50 billion. ESG is an important factor from an investment point of view. If things go wrong, the economic consequences can be devastating and leave a lasting impact on the stakeholders connected to the business, including investors, employees, and communities. At the same time, those organizations that can identify ESG Risks and view them as opportunities for sustainable competitive advantage will thrive over the long term.
With stakeholders now focused on ESG performance of companies and specifically on ESG risks, CFOs and Chief Risk Officers have started engaging and collaborating at a deeper level with sustainability teams in their companies. The hesitation of investors to deploy capital without ESG data, the business impact of ESG issues, and the alignment of sustainability and business performance has made it evident that sustainability practices of a company affect the bottom line. Or should we say, the triple bottom line.