- Environmental, social and governance (ESG) strategies represent an opportunity for investors to make a difference, and a fundamental shift in how businesses must operate.
- To unlock its full potential, businesses must expand the concept of ESG to be more financially relevant and to cover a wider range of disclosures including biodiversity and wellbeing.
- Business leaders should take five key actions to do this, including boosting stakeholder engagement and embedding ESG more widely throughout their organizations.
The rapid ascent of sustainability on the global agenda is driving the world toward a new set of priorities. In the next five years, investments seeking to make an impact in environmental, social and governance (ESG) terms are estimated to double.
This is the ESG approach in action. It represents both an opportunity for investors who want to make a difference and a fundamental shift in the way businesses must operate going forward. It has the potential to enable businesses and their stakeholders to make more informed decisions based on an accurate understanding of an organization’s true impact and value. This means being much more than a disparate – and sometimes confusing – set of systems for reporting. It means being a catalyst for real change by providing trustworthy information and incorporating new and emerging types of disclosure.
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ESG is vital, but it must evolve
To realize its full potential, ESG must evolve; from an alphabet soup of competing standards to a standardized system of complementary ones; from a perceived compliance task to a strategic enabler; from what some see as a burden to a catalyst.
ESG needs to align more closely with financial reporting and innovate and adapt more quickly to new information demands. A report recently published by Ernst & Young Global Limited (EY) outlines how more financially relevant ESG (FESG) can help enable businesses to deliver meaningful change. In addition, it highlights how FESG should be adapted to include future disclosures on biodiversity, innovation, wellbeing and more (FESG+), to position businesses for whatever comes next.
The reality is that many of the changes we need to see aren’t happening fast enough. The new ESG approach must have a unified set of reporting standards because too many sets of standards are complex and exhausting to navigate. It must be adopted widely and applied consistently. It must integrate assurance because non-financial reporting, just like financial reporting, has to earn and inspire trust. And it must be responsive to innovation because new strategic thinking will be required to meet stakeholders’ information needs more quickly.
Business must lead from the front
How do we get there, and what does this mean for business? Action, based on better information, by consumers, investors and other stakeholders will of course be the key to making progress. ESG reporting can deliver this information, but rather than wait for others to act, business must lead from the front.
There are five actions business leaders can take now that will help ESG realize its true potential and become a catalyst for change.
1. Engage with stakeholder demands
Consumers and regulators are not just hungry for transparency – they want evidence of change. The latest EY Future Consumer Index shows 68% of consumers believe companies need to drive positive social and environmental outcomes. In Europe, the EU Commission recently adopted the proposed Corporate Sustainability Reporting Directive (CSRD). It is being shaped by a multi-stakeholder group led by the European Financial Reporting Advisory Group (EFRAG).
Non-governmental organizations are lobbying for changes too. The Green Technical Advisory Group (GTAG) will advise the UK government on the creation of a ‘green taxonomy’. The US Securities and Exchange Commission (SEC) is holding similar consultations with market participants. Business leaders should actively engage with their stakeholders to stay on top of the evolving perspectives that are shaping their future, embedding them across their businesses.
2. Respond to investor pressure
Organizations that want to remain attractive to investors must make FESG+ a priority. Companies with strong ESG performance deserve a premium valuation to their share price, according to 89% of institutional investors across major markets. And 90% agree that companies that prioritize ESG initiatives represent better opportunities for long-term returns. Meanwhile, EY research shows 91% of investors now view non-financial performance as “pivotal” in their investment decisions. The United Nations-backed Principles of Responsible Investment is also considering stronger measures, including third-party assurance, to build confidence in data and drive impactful investment.
3. Own the FESG+ narrative
Organizations must prepare for change as a range of new FESG+ factors start to emerge. They can measure and report their own metrics as part of their own unique narrative, but the disclosures supported by the World Economic Forum’s International Business Council are a good starting point. The current focus on employee mental health is just one example of the type of disclosure that companies could consider measuring and reporting. Business leaders should think about what opportunities there might be to differentiate their organizations by defining new factors and using them to inform the strategic choices they make.
4. Understand the data
The EY Global Climate Risk Disclosure Barometer confirms that data quality is a key challenge for many businesses. Organizations need the right data professionals. They must be equipped to handle both current and emerging reporting requirements, with a clear understanding of how data will be interpreted by third-party organizations. Finance professionals must also get closely involved in sustainability reporting, leveraging their skill sets in collecting, processing and reporting data.
What is the World Economic Forum doing to help companies reduce carbon emissions?
Corporate leaders from the mining, metals and manufacturing industries are changing their approach to integrating climate considerations into complex supply chains.
The Forum’s Mining and Metals Blockchain Initiative, created to accelerate an industry solution for supply chain visibility and environmental, social and corporate governance (ESG) requirements, has released a unique proof of concept to trace emissions across the value chain using distributed ledger technology.
Developed in collaboration with industry experts, it not only tests the technological feasibility of the solution, but also explores the complexities of the supply chain dynamics and sets requirements for future data utilization.
In doing so, the proof of concept responds to demands from stakeholders to create “mine-to-market” visibility and accountability.
5. Embed the approach widely
Many businesses still need to embed strategic thinking about FESG+ more widely than just their sustainability team. Boards and executives need to place sustainability at the core of strategic thinking and ensure a close connection between the finance function, the sustainability team and top-level leadership. Successfully embedding FESG+ factors into decisions across every part of the organization – from strategy development to execution, new product innovation, manufacturing and distribution – will require new leadership models that allow businesses to embrace the complexity of the challenge ahead and respond to it effectively.
Realizing the full potential of FESG+
Addressing these five areas will take time and the external landscape will continue to evolve. The overarching priority for business leaders should be to start building the necessary expertise across their organizations now. This challenge is significant but the opportunities for organizations that position themselves to think beyond ESG and realize the full potential of FESG+ are substantial – and so are the likely rewards.