6 minute read 14 Jan 2022
Sustainable IPO

Why ESG is gaining importance in pre-IPO process

By Shailesh Tyagi

EY India Climate Change and Sustainability Services Partner

Committed to ESG, decarbonization and safety performance transformation. Advocate for workplace diversity. Holds a blackbelt in Taekwondo and a fitness enthusiast.

6 minute read 14 Jan 2022

The role of ESG has become one of the critical factors for stakeholders at the IPO stage.

In brief

  • The need to incorporate ESG into business models is an urgent calling, which is set to gain traction in the coming times. This knowledge paper decodes the importance of ESG integration for emerging public organizations. Businesses need to venture early on the path of  sustainable reporting to enhance the credibility and visibility of their IPOs in a world that is increasingly becoming ESG-centric.

The outbreak of the COVID-19 pandemic has put a great emphasis on how integration of Environment, Social and Governance (ESG) in the overall strategy and business objectives can help companies become resilient to ensure sustenance during adverse times. While there is a growing inclination towards mainstreaming sustainability in publicly listed companies, the role of ESG has also become one of the critical factors for stakeholders at the Initial Public Offering (IPO) readiness stage too.

The need to be ESG driven is a business imperative. This is further supported by the fact that the world of investing has witnessed a paradigm shift in the values that drive investment. In 2020, the pandemic resulted in a historic market crash, being the most severe since the global financial crisis of 2008. Nonetheless, investors with a focus on integrating ESG into their investment decisions remained relatively safeguarded due to the resilience of high-rated ESG funds. The MSCI World index dropped 14.5% in March 2020. However, 62% of large-cap ESG funds outperformed the index. Also, 42% of open-ended funds and ETFs available in the US market were ranked in the first quartile of their category, according to Morningstar. While this outperformance is partly due to the exposure of these funds to sectors that are less impacted by containment and social distancing measures (such as tech or telecoms), investment flows into ESG funds were  much more resilient during the crisis.

How can being ESG compliant benefit IPO?

Companies that endeavour to go public maintain a resolute focus on demonstrating their resilience and building their investment thesis. The primary areas that these companies aim to strengthen the most includes profitability, promising revenues, strong growth outlook, and market share. However, the COVID-19 pandemic has highlighted the need to pay attention to not only generating value for shareholders, but also building resilience by integrating ESG into business operations and strategies to be able to weather uncertainties. Disclosures on ESG goals and performance can help emerging public companies to generate responsible value for all the stakeholders, not just shareholders.

Companies with strong ESG scores have a solid competitive edge against their peers, which facilitates them to generate returns that are beyond normal. 52 of Morningstar’s 69 ESG screened indexes (75%) outperformed their broad market equivalents in 2020. Furthermore, 57 of 65 ESG indexes (88%) outperformed for the five years through the end of 2020.


1.  The valuation upside of ESG integration

How a company responds to these ESG-focused issues could also be considered as the leading indicator of its financial performance and stability in the future. The International Valuation Standards Council (IVSC) recognizes ESG as a ‘pre-financial’ information rather than a ‘non-financial’ information.

ESG factors reflect on the long-term prospects of a company, which takes into consideration its financial performance, resilience, and the ability to sustain during adverse situations.

2.  Gaining investor interest

As ESG consciousness is increasing amongst the investor community where integrating ESG factors into investment decisions is  prevailing along with financial performance and market benchmarks. To this end, investment funds have upgraded their requirements to conduct due diligence and incorporate ESG aspects in line with the international ESG frameworks and standards such as Task Force on Climate-related Financial Disclosures (TCFD) and Sustainability Accounting Standards Board (SASB), amongst others when considering investments.

3.  Strengthening competitive edge

Not only investors, but consumers also  place great emphasis on company values. With the growing need for sustainable development, consumers expect companies to contribute towards the betterment of environment and society. They prefer brands that resonate with their belief of focusing  on short term solutions. The idea is to  invest in cost-effective and  sustainable innovations that are poised to generate consistent returns over the long-term.

4.  Improved Market Reputation

Periodic ESG reporting and communication that is accurate and transparent acts as an effective brand management tool for companies. Companies that are committed to generating holistic value for all stakeholders are not only reliable, but also nurtures positive market reputation of their approach towards sustainability. ESG integration can be instrumental for emerging public organizations in building long-term trust with its consumers while leading to a positive press image.

5.  Recruiting and retaining employees

Employees care about the organizations they work with. Today, millennials and Gen Z are amongst the largest generations in the workforce that seek purposeful employment opportunities. As a result, individuals are increasingly choosing job opportunities with companies that are committed towards bringing lasting change in the environment and society while building reliable corporate governance. As per a LinkedIn research, professionals  are proudest  working at companies that promote work-life balance and flexibility (51%), foster a culture where they can be themselves (47%) and have a positive impact on society (46%). 

How can companies start their ESG journey before IPO?

  • Aligning the company’s purpose with its sustainability objectives: It is crucial for companies to align its purpose with their sustainability goals. A company’s purpose should go beyond just meeting shareholder expectation and include all its stakeholders. This further enables the company to work towards delivering holistic value.
  • Identifying Risks and Opportunities: For companies moving towards adopting sustainability, identification of ESG-related risks and opportunities is an important aspect. It is generally difficult for companies to identify risks and opportunities due to the lack of relevant expertise and resources. However, such organizations may choose to hire employees with prior experience in the field of ESG or collaborate with consultants that can help them in developing a sustainable strategy relevant to their businesses and industries.
  • Adopting Standard Framework for measuring ESG Performance: Since impact investors pay attention towards the value generated by an organization for all its stakeholders, it is important for a company, aspiring to go public, to ensure accurate and quality ESG disclosures on its performance to report and communicate its efforts. While there is no standard approach to assess an organization’s ESG performance, certain globally recognized approaches can be adopted by companies to benchmark their disclosure to communicate the impact created by them.
  • Communicating the Company’s Sustainability Strategy: Organizations that are preparing to go public should adopt sustainability to attract socially focused investors. Nevertheless, more importantly, companies should also focus on communicating their ESG strategy in a clear and defined manner. While reporting, it is crucial for a company to have a sustainability strategy that explains its approach towards addressing the issues that are material to the business. 

Summary

While established companies are rapidly adopting ESG to deliver lasting value and build trust among stakeholders, it is equally important and beneficial for early stage and growing organizations to embark on their ESG journey soon to become truly resilient and responsible while strengthening themselves before going public.

Our paper underscores the importance of sustainable IPOs, benefits of ESG-driven business practices in the valuation process and the growing regulatory environment in this space.

About this article

By Shailesh Tyagi

EY India Climate Change and Sustainability Services Partner

Committed to ESG, decarbonization and safety performance transformation. Advocate for workplace diversity. Holds a blackbelt in Taekwondo and a fitness enthusiast.