As investors sharpen their ESG focus, Dr. Matthew Bell, EY UK&I Climate Change and Sustainability Services Leader looks at how organisations must respond.
When EY published its first institutional investor survey back in 2013, I think it’s fair to say that ESG factors were barely on the agenda of even those with the most long-term focus. Fast forward to 2021 and the contrast could hardly be sharper. Our recently published 2021 EY Global Institutional Investor Survey found that 86 percent of respondents believed that a corporate’s ESG programme and performance would have a significant impact on investment decisions, with.
While many thought that the pandemic might knock ESG approaches off course as companies and investors went ‘back to basics’, it seems that the opposite has happened. Three quarters of all investors surveyed said they’re now more likely to divest shares of companies with poor ESG performance post-pandemic.
Companies under pressure from all sides
Given that just about all companies need to keep their existing investors happy or attract new ones, those are persuasive findings. But in many ways, investors are only one source of the pressure that companies are now under to intensify their focus on ESG. Consumers have also upped their interest, with research from The Economist Intelligence Unit, commissioned by the World Wide Fund for Nature, finding that online searches for sustainable goods have risen by 71 percent globally over the past five years. Regulators are also piling on the pressure, with UK Chancellor Rishi Sunak using COP26 as the platform to announce new requirements for corporates to set out detailed public plans for how they will move to a net zero carbon future.
Satisfying these multiple demands is not going to be easy and many organisations are understandably ill-prepared. The initial premise, widely held when we started publishing our reports, that ESG could be dealt with by a small team operating apart from the main business, is clearly out of date but is sometimes evident. Similarly, the history of ESG being viewed as a marketing or product development problem is being replaced by the gradual realisation that it actually needs to be ‘wired in’ across the business.
Building an integrated approach
That lack of a joined-up approach can even be seen among investors. For example, despite the impact of COVID-19 described earlier, fewer than half (44 percent) said the events of the past 18 months had resulted in them updating their investment risk management strategies and processes.
Common standards, or a lack of them, are also a significant problem. What Gillian Tett of the Financial Times called ‘an alphabet soup of green standards’ risks getting even more complex, with some commentators now referring to it as more like the Wild West. The inherent danger here is that if companies are allowed to effectively ‘mark their own work’ by choosing their own green standards, then there will be no level playing field and, instead, it will foster an environment where the efforts of those companies doing things properly will go unrecognised and those who fail to do so will not be held to account.
This issue was reflected in our survey, with 89 percent of investor respondents saying that they would like to see globally consistent standards for reporting of ESG performance. At EY we have been working hard to respond to this urgent need through work such as that carried out with the World Economic Forum and our competitors in the Big Four, to create the International Business Council sustainability metrics. IFRS’s announcement of the formation of the International Sustainability Standards Board during COP26 in Glasgow in November was another significant move forward toward more common standards.
It’s clear that there is still further work to be done on these common standards, but businesses should not wait. Instead, find the current standards that are most appropriate for your organisation and start applying them, otherwise it may be too late to catch up.
New rules for capital allocation
With relatively few businesses currently ticking all the ESG boxes, there are capital allocation risks at both ends of the scale. More than three-quarters (76 percent) of investors surveyed agreed the “shortage of supply in suitable green investments will lead to some investors overpaying for green assets, creating the risk of a market bubble”. At the other end of the spectrum, emissions-intensive industries such as energy risk being starved of investment, just at the very time when it’s needed most. The International Energy Agency calculates that, to reach net zero emissions by 2050, annual clean energy investment worldwide will need to more than triple by 2030 to around $4 trillion. That sort of money will be hard to raise if investors’ ‘green lights’ aren’t flashing. The answer is for all businesses to have coherent and credible net zero plans in place to unlock the funding they need from ESG-conscious investors.
This illustrates the wider challenge that will impact all businesses – the green revolution is changing the basis on which capital is allocated and being caught the wrong side of these powerful currents will be dangerous.
The next frontier is almost certainly ‘greenwashing’, which not only exposes individual companies to risk if their green credentials are questioned, it also threatens to hinder society’s ability to address climate change. That’s because one of the keys to a sustainable future is encouraging consumers to buy green. But if they find that the information they’re getting about sustainable products, or the companies that they buy them from, is just greenwash, then that loss of trust may obstruct those vital changes.
This focus on trust is another reason why old approaches to ESG are doomed. Whereas in the past putting a certain amount of spin on green credentials was par for the course, we are now living in a world where transparency, accountability and proof will increasingly be required.
Running ERP systems on green data
Which brings us neatly on to the question that may be on readers’ minds: what does this have to do with ERP systems? The answer lies in how ESG factors are becoming crucial to the success of the enterprise: from attracting investors to satisfying customers and from driving short-term performance to creating long-term value.
Yet, although most organisations have built sophisticated and expensive systems for financial data management, they more often than not have relatively basic ways to collate and calculate the non-financials that dominate the sustainability agenda. That represents a huge risk on two separate accounts. Firstly, if you’re not measuring non-financial data properly, you can’t meet reporting needs. Secondly, and more importantly, if you’re not integrating financial and non-financial data within your management systems then you simply do not have the optimum basis for decision making.
If that gives you plenty of food for thought ahead of the festive break, here’s an appetiser that might lessen the chance of indigestion. Nobel Laureate Al Gore described the sustainability revolution as “the single biggest business opportunity in the history of the world – it has the scale of the industrial revolution coupled with the speed of the digital one”. Now there’s something that would be a shame to miss out on in 2022.