Environmental, social and governance concerns creep up corporate and government agendas
Long-term profitability can only be found where sound environmental and social approaches meet with good governance, say experts
US Steel’s decision to hire Price Waterhouse to verify its 1902 accounts produced what is regarded as the first annual report of the modern era, a 40-page document intended to dispel public suspicions over the way the group’s assets were valued.
Although it would take more than three decades – and the many scandals laid bare by the calamitous 1929 stock market collapse – before the practice became a legal requirement in the US, the global trend since then has been one of ever deeper and broader levels of disclosure.
The dominant philosophy guiding today’s corporate reporting is built around the understanding that sustainable, long-term profitability will be found where sound environmental and social approaches meet with good governance. Dodging taxes, enslaving workers or destroying the environment will prove just as fatal to companies as red ink on the bottom line.
“It is no longer feasible nor profitable in the long run to measure the success of a company based only on short-term growth and margins,” says Jean-Marc Champagne, climate finance adviser for the global environmental group WWF-Hong Kong. “Growth with sustainability and regard for the planet are the only way forward – this is not just a moral issue, it’s a financial one.”
Public policy and corporate interests have not always seen eye to eye on sustainability, says Usman W. Chohan, an expert in policy reform at the University of New South Wales in Australia.
“In some countries corporate interests took the initiative, while in others it was public policy,” he says. “However, there is a greater convergence in interests as both sectors lay greater emphasis on the need for a green approach and a sustainability strategy.”
Regardless of whether it is companies or governments that are driving the change, environmental, social and governance (ESG) concerns have been creeping up the agenda for leaders of both, according to the World Economic Forum’s 2017 Global Risks Report. As recently as 2010, economic and geopolitical issues dominated the top concerns of business and political leaders surveyed, in terms of those events judged most likely to occur and those that respondents felt would do the most damage.
This year, only terrorism and weapons of mass destruction made the cut – and while the latter tops the table for biggest potential impact, it’s seen as the least likely risk to materialise after the currently improbable danger of runaway inflation. Extreme weather, natural disasters, water crises, refugees and data security crowd out this year’s league table of C-suite fears, all areas where ESG has a central role to play.
“Our collective understanding of sustainability issues is not static,” says Tim Mohin, chief executive of the Global Reporting Initiative, a non-governmental organisation that sets the worldwide benchmark for sustainable disclosure standards. “It is a process driven by transparency.”
That process begins when advocacy and awareness campaigns shine a light on emerging issues that negatively impact the global economy and society, creating a moral imperative for organisational accountability, he says.
“Next, leading companies and other organisations begin voluntarily disclosing information about their impact on the problems and take action to find solutions. This builds a body of evidence that corporate action can help. Finally, legislatures and policy makers take note and bring the topic within regulatory frameworks.”
International efforts to combat aggressive tax avoidance, bribery and money laundering have raised the potential costs of weak governance. Campaigns targeting exploitation of workers and child labour do the same for the social aspect of the ESG spectrum. But it is the environment – and in particular the impact of the Paris climate agreement to hold the global average rise in temperatures to less than 2 degrees Celsius – that is now the leading risk for companies and investors.
“Climate change remains the number one concern for our signatories because of the material risk to portfolios around transitioning to a 2 degrees world,” says Fiona Reynolds, London-based managing director of Principles for Responsible Investment (PRI), whose 1,700 members own or manage over US$73 trillion of assets. “Harnessing private capital for green finance and clean energy projects is essential to ensuring the inevitable move away from fossil fuels.”
Organisations such as PRI and WWF seek to convince pensions, family offices, sovereign wealth funds, endowments, banks, and insurance companies that own huge pools of assets of the risks that climate change and other ESG issues pose to their investment. Bringing their internal governance into line with sustainability goals creates a cascade effect as firms seeking mandates to manage these assets must do so too, in turn raising pressure on the operators of the companies and other assets at the end of the chain.