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In this decade, economic recovery anchored on environmental, social and governance (ESG) management is critical to driving sustainable growth.
In brief
- Successful ESG management is reliant on better engagement and understanding of stakeholders’ interests.
- ESG-driven growth requires coordinated responses from all stakeholders in the ecosystem to define and enable fit-for-purpose businesses to thrive.
As we enter this decade, it is clear that the two most serious challenges to mankind and business revolve around the COVID-19 pandemic and climate change. This is affirmed in the World Economic Forum’s Global Risk Report 20211 where climate-related issues and infectious diseases dominate the top five long-term risks in terms of impact and likelihood.
While economic growth and recovery are anticipated in 2021 with the deployment of vaccines, implementation of stimulus measures and improving global gross domestic product (GDP), climate change continues to threaten economies. The impact of climate change could exacerbate the health crisis with sudden events such as extreme weather, or manifest in long-lasting disruptive consequences to our economy, food supply (or security) and quality of life.
In this regard, an economic recovery anchored on environmental, social and governance (ESG) management would be critical to drive sustainable growth.
Stakeholder capitalism and ESG disclosures take centre stage
With COVID-19 pandemic and climate change exacerbating social challenges such as rising inequality and collapsing social safety nets, companies are beginning to understand that considering ESG risks and opportunities is not just good business, but an imperative strategy to maintain the social license to operate, regardless of sector or industry. This ongoing shift from shareholder primacy to stakeholder capitalism is aligning businesses to focus on enhancing the ways they capture (and measure) risks and opportunities related to a larger group of stakeholders and create value for all in a longer timeframe. The key to sharpening ESG management is through better engagement and understanding of stakeholders’ interests:
1. Investors want more data on a company’s ESG performance
The global pandemic has highlighted the importance of ESG issues and is accelerating ESG integration by institutional investors. The fifth EY Investor Survey: How will ESG performance shape your future? revealed that 98% of investors evaluate nonfinancial performance based on corporate disclosures, with 91% saying that nonfinancial performance has played a pivotal role in their investment decision-making over the past 12 months. In fact, large investors like BlackRock and Norway’s Sovereign Wealth Fund have rapidly increased ESG performance analysis into their investment strategies.
In Malaysia, the demand for sustainable finance, focusing on ESG considerations, has been gaining momentum since the launch of the Sustainable and Responsible Investment Sukuk framework by the Securities Commission Malaysia (SC) in 2014. As of June 2020, a total of nine investment managers and asset owners in Malaysia – which include the Employees Provident Fund, Khazanah Nasional Berhad and Kumpulan Wang Persaraan, among others – have signed the United Nations-backed Principles for Responsible Investment, under which they have pledged their commitment towards ESG best practices and sustainable investing principles.
2. Customers are demanding more sustainable products and services
Consumers worldwide are redefining market demand through purpose-driven purchasing, raising brand image and reputational challenges for businesses that do not have effective ESG management in place. These consumers are typically of the millennial generation whose global annual aggregate income is expected to exceed USD 18 trillion and to continue surpassing the spending power of every other generation for at least the next five years thereafter.
3. Regulators are increasing regulation around ESG issues
Under the Paris Agreement, Malaysia has pledged to reduce her greenhouse gas emissions intensity of GDP by 45% by 2030. In line with achieving that goal, Malaysia has committed to increasing the renewable energy capacity mix to 20% by 2025. This has opened opportunities for companies to expand into renewable energy, with various incentives offered by the Government.
Meanwhile, regulations are rapidly evolving to consider sustainability elements:
- The Malaysian Code on Corporate Governance 2017 issued by the SC encourages large companies to adopt the Integrated Reporting framework.
- Bursa Malaysia has also encouraged listed companies to adopt sustainability frameworks, such as the Task Force on Climate-related Financial Disclosures, the Integrated Reporting framework and the United Nations’ Sustainable Development Goals.
- In July 2020, SC issued a guideline that outlines Directors’ responsibilities to oversee sustainability and non-financial performance.
4. Employees want to work for employers that incorporate ESG into their purpose
An increase in ESG awareness has also impacted the workplace. Six in 10 millennials are willing to take a pay cut to work for a socially responsible company2. Unsurprisingly, research has also shown that positive social impact correlates with higher job satisfaction and employee satisfaction strongly and positively correlates with shareholder returns.
5. NGOs and communities continue to pressure for transparency and effective ESG management practices
With increased accessibility to information and greater public scrutiny in an age of social media, NGOs and communities have been able to spread awareness at a faster rate, thus rallying swifter collective action on issues ranging from labour malpractices and women’s rights to pollution from illegal dumping, biodiversity loss, and land issues and rights of the Orang Asli. As more issues are being mainstreamed and openly discussed, this is catalyzing greater regulation and penalties on offending companies that have a responsibility over both their direct business activities, as well as their supply chains.
How can businesses effectively drive ESG management?
A top-down approach in an organization is key to driving long-term value creation. The Board and leadership can consider the following questions to start thinking about how to address ESG:
To ensure company purpose is clearly established and aligned with interests and concerns of stakeholders, it is critical to establish a performance review process which considers material ESG-related matters supported by clear key performance metrics and outcomes. Companies could take the following six-step approach to integrating ESG into their operations and business strategy:
- Identifying what ESG matters are material to the company, from internal and external considerations
- Regularly engaging internal and external stakeholders to identify key issues of concern
- Assessing ESG risks along the value chain
- Mapping out issues that are most pertinent to the company based on what was identified through stakeholder engagement, value chain assessments and industry and standards requirements
- Prioritizing ESG risks and opportunities by considering the probability of occurrence over the short to long term and the magnitude of financial, operational and reputational impacts
- Benchmarking the company’s practices against industry ESG leaders and exploring sustainable financing options to further distinguish itself
Challenges in mainstreaming ESG management
The key challenges in mainstreaming ESG management are typically due to limited knowledge of ESG risks and opportunities and difficulties faced in quantifying them given the current absence of a clear framework or a set of measurements that is globally aligned and accepted. Unlike financial performance, social and environmental outcomes cannot be readily monetized.
It is critical to note that the absence of standard metrics for reporting performance creates a possibility for organizations to cherry-pick what they report to greenwash their image. Hence, regulators emphasize the importance of organizations providing clear context, industry benchmarks and historical performance analysis as well as considering external assurance on material metrics as their ESG management process matures.
As society increasingly demands greater social responsibility from businesses, sustainable or ESG-driven growth would require coordinated responses at all folds of the ecosystem to define the market of the future that enables fit-for-purpose businesses to thrive
Summary
Along with the global COVID-19 pandemic, one of the defining issues facing mankind and business today revolves around climate change. To address this monumental challenge and place us on the path of sustainable growth in this decade and beyond, an economic recovery anchored on environmental, social and governance (ESG) management is key.
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