The importance of business ‘doing the right thing’ has been emphasised during the pandemic. Few would now question the need for companies to place greater priority on the needs of stakeholders, including employees, suppliers, customers and society at large. However, solving the problems of people and planet requires significant investment, so attracting and retaining the support of investors remains vital.
But the expectations of those investors are rising. Driven in part by regulation and in part by shifting market perceptions on what contributes to enterprise value, investors are increasingly focused on ESG factors, making these more and more important in attracting and retaining capital.
Perceptions of sustainability are changing – from seeing ESG as a form of risk management to understanding its role as a driver of value. The idea of a trade-off between doing good and delivering good business performance is being replaced by a growing realisation that other stakeholders’ and shareholder priorities are in fact closely aligned: meeting the needs of one drives a more sustainable form of value creation for the other.
So, how can organisations understand investors’ current and evolving ESG needs? And how can they garner investor support?
Through our many interactions with investors as part of both our Stewardship Reporting initiative, and our leading role in global sustainability programs – including the Embankment Project for Inclusive Capitalism (EPIC), the World Economic Forum’s Common Metrics for Sustainable Value Creation, (WEF) and Climate Action 100 – we have developed unique insights into investor priorities, and what they look for when assessing how sustainability issues impact enterprise value.
Stewardship – investors’ responsibilities broaden
The new 2020 UK Stewardship Code sets high expectations for institutional investors, and is undoubtedly contributing to their higher expectations of corporates.
We see that investors are increasingly looking for tangible proof that the companies they invest in are supporting their own stewardship requirements.
But currently, few investors receive all the information they need. This disconnect was evident in the 2020 EY Climate Change and Sustainability Services (CCaSS) Institutional Investor survey. While 98% of investors signalled a move to a more disciplined and rigorous approach to evaluating companies’ non-financial performance, an increasing proportion believe that companies do not adequately disclose ESG risks. They are frustrated by the disconnect between ESG and mainstream financial reporting. They want ESG disclosures which demonstrate the impact of sustainability issues on enterprise value, and which describe how material sustainability issues are managed through appropriate governance structures, reviews and controls.
So, to address this, organisations must take action across all three ESG pillars:
Environment – climate change is investors’ number one stewardship priority
Without reliable climate-related financial information, investors cannot price climate-related risks and opportunities correctly. This is creating the need for companies not only to improve disclosures in this area, but also to fully assess the impact of climate change on their business models.
In EY’s 2020 CCaSS Institutional Investor survey, when investors were asked about the most valuable ways companies can report ESG information, the Task Force on Climate-related Financial Disclosures (TCFD) framework came out on top, and adoption of the TCFD recommendations has now been made mandatory for UK premium listed companies for periods commencing after 1 January 2021. TCFD disclosure recommendations are structured around four thematic areas that represent core elements of how organisations operate: governance, strategy, risk management, and metrics and targets. These thematic areas interlink and inform each other, illustrating the breadth of the challenge and the need to embed climate risk throughout an organisation’s operations and strategy.
By doing so it is possible to demonstrate to investors and other stakeholders how an active approach to climate change can not only protect your organisation from associated physical and transition risks but also increase resilience and support long-term success.
Social – delivering for all stakeholders
COVID-19 brought business purpose into much sharper focus – during the pandemic we quickly saw what organisations ‘stood for’. It also highlighted the value that businesses create, not only for investors but also for employees, customers and communities.
This emphasised the need for businesses to clearly identify their purpose and deliver on it by demonstrating the value it creates for all of its stakeholders.
Corporates can find it difficult to demonstrate the value that is being delivered from their broader sustainability strategy, whilst investors are clear that they view societal issues as having a clear bearing on enterprise value.
The broad array of sustainability reporting standards, combined with increasing demands from investors, is placing huge pressure on reporting for corporates. Significant developments are being made towards convergence, but it is still likely to be years before non-financial metrics become standardised.
EY worked with the World Economic Forum’s International Business Council (WEF IBC), Deloitte, KPMG and PwC to develop a core set of metrics for sustainable value creation, endorsed by investors, that aligns existing metrics around four pillars — governance, planet, people and prosperity. These pillars apply across all industry sectors and relate directly to the principal categories in the UN’s Sustainable Development Goals.
These metrics can help corporates to identify a base level of reporting that is intended to be common to all organisations, regardless of sector. Investors will, no doubt, want more information however – both on how sustainability issues are impacting enterprise value and what impact an organisation is having on the issues of people, planet and prosperity.
Our work on EPIC, supported by asset owners, managers and creators representing $30 trillion of assets under management, has given EY unique insights into investor priorities. It enabled us to hone our long-term value methodology for identifying and measuring what drives enterprise value, based on the key outcomes intended for stakeholders.
Applying this approach is an excellent way of prioritising key sustainability issues for organisations, helping them to develop or refine their sustainability strategy to focus on those areas that will have the most significant impact on their long-term value.
Being able to articulate this clearly for investors is key to underpinning an equity narrative in which sustainability indicators are becoming increasingly prevalent.
Governance – the guiding force
Governance - the system by which all the activities of a company are directed, controlled and monitored - is critical to the creation and protection of value.
The overall governance framework within organisations, which supports how risks are identified and managed, is key to this, and is likely to need to be adapted to properly address sustainability-related risks. From an investor perspective, we know that they generally consider the identification and governance of climate change risks, in particular, to be sub-standard. As more focus is given to non-financial reporting measures, the data, processes and controls which underpin these will also need to be more robust, and additional assurance may be appropriate.
Beyond risk oversight, investors will also be concerned about succession planning and leadership composition – particularly from a gender and ethnicity, executive remuneration and independence perspective.
Overall business conduct and ethics are also seen to be an important indicator here, so mechanisms for identifying and reporting ethical and unlawful behaviour or concerns about organisational integrity will also need to be transparent.
How we can help – a multi-disciplinary approach
Our teams can work with you to identify the risks and opportunities arising from climate change and sustainability issues.
We can help you:
We can also work with you to understand and evaluate the broader value, impacts and outcomes related to ESG factors and support the reporting of non-financial performance risks to stakeholders.
Once your ESG priorities and metrics have been defined, we can help guide the design of an ESG strategy that aligns to your business objectives and delivers to all stakeholders.