Embedding ESG into business models

With environmental, social and governance (ESG) issues continuing to dominate the agenda, the 2022 Chatham House Responsible Business Conference explored how ESG matters will be adopted into meaningful and normalised decision making.

GoodCorporation director Gareth Thomas joined the panel that focussed on ESG and sustainable finance. This session examined the role of regulators, corporates and the finance sector in aligning the financial system with companies and projects that truly embed ESG commitments into their business models and activities.

Sustainable finance and the drive for ESG

First mooted by Kofi Annan in 2004, the idea that embedding environmental, social and governance factors into capital markets made good business sense took a while to catch on beyond the UN Global Compact. However, with $30tn now invested in ESG and impact assets, it is very much on the agenda. For most of the last decade, the momentum behind ESG has come from those investors increasingly looking for indicators of long-term sustainability to protect their capital investment from a growing range of risks.

This has led to the development of ESG teams within the finance sector that are focussed on analysing corporate ESG goals looking for substantive progress in areas of sustainability, responsible corporate management of non-financial risks, integrity and good governance.

Building a regulatory framework to support ESG

More recently, it has been the turn of regulators to underpin the lead taken by investors and enshrine into law some of the demands already being made by the investment community. First came the EU Non-financial reporting directive (NFRD) which requires companies of a certain size to disclose relevant information on policies, risks and outcomes as regards environmental, social and employee related matters.

Building on that is the EU Taxonomy which translates the EU’s environmental objectives into a clear framework for investment purposes. Across the G20, the Task Force on Climate Related Financial Disclosures aims to provide a framework for the type of information that companies should disclose to support investors, lenders and underwriters in their assessment of risks related to climate change.

As regulators and the finance sector become more closely aligned as to the governance, strategy, risk management and metrics required as viable indicators of long-term sustainability, it should become easier for companies to provide the information required to support ESG capital allocation, as doing so is fast becoming a legal requirement.

The investment community has long held the view that companies themselves are best placed to explain the sustainability issues that are important and material to their business. Indeed, well-managed businesses do understand these risks and challenges. Consequently, they are in a good position to measure and manage the material issues relating to their social and environmental impacts and show a clear pathway for improvement.

Businesses increasingly embedding ESG into business models

However, embedding ESG into business models and activities takes time, no company can do this immediately. Investors and regulators need to understand that this will be a journey, and companies need to recognise that this is about building trust. The temptation for greenwashing may be high, but transparency and openness are vital to maintain integrity. This will involve regular measurement, at least annually to evidence continuous improvement and ensure that the data doesn’t become meaningless.

For investors and companies alike, ESG is complex and nuanced, it is also far-reaching. The impact on wider society of the negative externalities that are already in train is huge. Consequently, we need to put boards in place that will look to the long-term and set ambitious goals to minimise risks around human rights, corruption and environmental degradation as well as climate change. Such sustainability issues align with the risk perspective of most shareholders and should therefore be considered as integral considerations that uphold their fiduciary duty.

We also need to place a net present value on these negative and material cost impacts and start to consider how such costs should be funded. This forms part of the ESG services provided by GoodCorporation to a wide range of companies across many sectors.