Developing an effective strategy for ESG: 7 key steps
Companies are under greater scrutiny than ever before. It is widely accepted they have an impact on the planet that needs to be managed and a duty to those they work with or who are impacted by their activities. Investors, and now regulators, are demanding to see how these material issues are being managed, so taking a passive approach to environmental, social and governance (ESG) issues is no longer an option. As such, developing an effective strategy for ESG has now become a fundamental requirement for most businesses.
Sustainable investing driving ESG
Investors were first to adopt the idea that the responsible management of environmental impacts, social concerns and corporate governance both improved long-term corporate sustainability and helped protect investments. Indeed, for many investors, a strong ESG rating is now regarded as a proxy for good corporate management which can also lead to preferential terms for corporate finance.
With global ESG assets expected to exceed US $53tn by 2025, (accounting for more than a third of all assets under management, according to Bloomberg Intelligence) it is clear that businesses will need to provide meaningful data on their ESG performance in order to attract this rapidly expanding supply of sustainable investment.
A changing regulatory landscape for ESG
What we are also seeing, is a significant shift in the legal landscape as regulators move to enshrine into law some of the corporate reporting expectations demanded by investors.
The need to disclose financially material information has been an established practice across most financial markets and a legal requirement in many jurisdictions for some time. This is now being supplemented with calls for the mandatory disclosure of related information on the material impact of a company’s ESG performance. Known as double materiality, it is this concept that is driving the regulatory changes to the reporting requirements currently emerging, most notably in the EU with its Non-Financial Reporting Directive (NFRD) and Sustainable Finance Disclosure Regulation (SFDR) the proposed Corporate Sustainability Reporting Directive (CSRD) and more recently, the proposed EU Sustainability Due Diligence Directive.
This combined pressure from investors, regulators and wider society for companies to identify and mitigate their material ESG impacts means that managing ESG concerns is becoming not just the norm, but a core pillar of business strategy and enterprise risk management.
This has been a rapid transition. As recently as 2019, businesses reported that while much was being written about ESG in the financial press, investors rarely asked about ESG matters in face-to-face meetings. This is no longer the case. Investors now routinely raise ESG matters, ask detailed questions and expect companies to demonstrate a clear understanding of their material ESG issues.
Many companies are absorbing this change, devising a clear ESG strategy and resourcing teams to prepare the necessary information. The following seven steps are essential to developing an effective strategy for ESG.
1. Identify all material ESG issues
Often referred to as a materiality assessment, the process of identifying key ESG issues that are likely to have an impact on both business performance, and the organisation’s various stakeholders is the critical first step in the development of a good ESG strategy.
Every company will have different ESG risk factors depending on the nature of the business, the location of its operations and the complexity of the supply chain. So, while all ESG considerations are important, these issues need to be prioritised according to the impact they are likely to have on the business. Companies will need to consider a range of topics including issues such as corruption, human rights, worker welfare, community engagement, diversity and inclusion, data protection and privacy as well as other environmental and governance issues.
GoodCorporation applies its extensive experience of implementing and assessing responsible business practice to help companies identify which of these ESG considerations needs to be prioritised- in terms of the potential risk and likely impact on business performance. This can be complex and companies need to consider how these issues may overlap. For example, when considering the impact of activities on the planet, companies need to understand not just any damage to the environment but also the social impact of any environmental harm caused. Getting this right will ensure that ESG risks are properly prioritised.
Guidance documents such as the United Nations Sustainable Development Goals, the United Nations Guiding Principles for human rights matters or for anti-corruption and the Ministry of Defence guidance on the Bribery Act can provide a useful guidance to help identify the areas that need to be considered.
2. Understand investor and legal requirements
To develop an effective ESG strategy, companies must have a clear understanding of any regulatory or reporting requirements they may be obliged to meet. This should include the expectations of lead investors and ratings agencies, to ensure that the ESG issues identified, and any data collected, will be sufficient to meet their needs. As this market matures, companies need an insight into how their competitors are providing this information, so a peer analysis of competitor ESG data is also recommended. To assist with this, GoodCorporation has an ESG benchmarking tool that can identify where a business sits in relation to their peers in terms of ESG data provision.
There is no doubt that Investors are looking for data that is equal to that provided as evidence of financial performance. Consequently, companies will need to identify appropriate ESG metrics and KPIs that will help track performance meaningfully and measure progress over time.
And it’s not just investors that are looking for meaningful ESG data. The legal landscape around reporting requirements is changing rapidly and companies need to ensure that the data being collected will also meet any new or emerging legislation. Companies should also consider obtaining independent verification of their ESG data, as this is likely to become the norm as the management of ESG matters matures.
3. Create an ESG baseline
Once the material risks have been prioritised and the investor and reporting requirements understood, companies should review what they already have in place. This will include an assessment of relevant governance polices, ESG metrics, procedures and engagement programmes. A gap analysis of this information will enable the business to identify what is already being managed and measured, and what is needed, either for regulatory compliance or to evidence substantive ESG performance to investors. It will also enable ‘quick wins’ to be identified that will help evidence annual progress efficiently.
It is important to consider all the different business functions when gathering this information to make sure that relevant data is not overlooked. Relevant reports from the different business functions need to be analysed and ESG issues recorded to show how they are being managed and where improvements can be made.
We also recommend benchmarking this information. This will provide insight into the adequacy and effectiveness of existing systems and offer an assessment of the level of ESG maturity within the organisation.
4. Setting ESG targets
A good ESG strategy should set clear objectives and goals. These should relate to the ESG priorities identified and to the nature and impact of business activities. GoodCorporation helps clients to set their ESG objectives, consulting stakeholders to create a sense of ownership and establish a commitment to ESG matters across the business. It is also important to ensure that the objective and goals align with the organisation’s overall purpose and strategy.
Companies need to consider these ESG goals and objectives carefully. While it can be important to set ambitious targets, they must also be achievable. It is therefore essential to set meaningful goals that can be embedded into business operations and where progress can be measured.
Not only does this make it clear what the company hopes to achieve, it provides the basis for a framework upon which future performance can be measured.
5. Building an effective framework for ESG
To ensure that the goals and objectives can be met, an ESG framework is needed that will specify the good practice being put in place and ensure that the ESG strategy can be implemented across the organisation.
The framework should cover all the material ESG issues identified, the risks and challenges associated with these factors, the management systems required to establish best practice, and the monitoring and measurement process being used to track performance and measure improvement.
6. Establishing a strategic roadmap for ESG
Embedding ESG meaningfully into business activities and decision-making requires a viable ESG implementation plan. GoodCorporation works closely with clients to develop a practical and strategic ESG roadmap that can be incorporated the business. Building an effective ESG programme to manage these material non-financial issues and associated risks can take time. No company can do this immediately. It is therefore vital to prioritise the risks, agree how these can be managed and build a robust measurement system that will allow the organisation to track progress over time.
This will require the input of senior management, committed to the implementation of a rigorous programme to address the issues identified and avoid the temptation for greenwashing. A strong governance structure is also needed, with clear reporting lines and designated responsibility. Senior management must also ensure that appropriate allocation of resources to help guarantee that the programme is delivered and to the agreed timeline.
7. Communicating ESG performance
Once the ESG framework has been agreed and a roadmap for improvement embedded into the organisation, companies need to develop a clear communications programme to convey the ESG strategy to key stakeholder groups, in particular investors, employees, customers and suppliers as well as regulators. A company that succeeds in developing and embedding an effective ESG strategy can more easily control the agenda, providing accurate, relevant and meaningful information to satisfy both investment and regulatory requirements whilst also meeting the expectations of other stakeholders.
Implementing an effective ESG strategy will become the norm
Investors, regulators, and increasingly businesses, recognise that the careful management of governance alongside an environmental and societal impacts delivers sustainable companies. This works on the macro level to help prevent the potential economic devastation of climate change and make progress in reaching the UN’s Sustainable Development Goals.
At a micro level, it seems clear that ESG assets will continue to grow, making it increasingly important for companies to provide the information required to support ESG capital allocation. Many companies are also starting to recognise that the effective management of material ESG matters reduces risk. It improves compliance in areas such as human rights and corruption, while building trust and strengthening relationships with core stakeholders such as employees and suppliers. Developing and implementing an effective ESG strategy, therefore, creates a virtuous circle and as such is fast becoming a core tenet of good business management.