Recently, while interviewing a young aspirant who was looking for an opportunity to switch to environmental, social and governance (ESG) consulting—he had spent some years in the manufacturing industry and been working closely with the strategy leader in the company— the conversation pivoted around the imperative of businesses towards an ESG framework. I was impressed to note that his company, despite being an unknown name in the business category, had substantially committed to ESG matters. At some point, when asked why his company considers the ESG framework important, unsurprisingly, he said that there was no choice: their investors insisted on it and customers demanded it.
“ESG is not a choice, but a necessity” is a sentiment that echoes across business corridors globally. In fact, the interest in the topic has been unprecedented in recent times.
Although industrialisation progressed at a rapid pace over the last couple of centuries, the outcomes in the past few decades have been incredibly different from the previous ones. While, on the one hand, we are awestruck with the advances and the resulting conveniences in our lives, on the flip side, human lives have been overwhelmingly affected by resource depletion and environmental degradation.
“The cost of inaction is high,” say several industry leaders while narrating their experiences. They cite a wide range of situations that result from inaction, like a community outcry that forces the closure of an industry, demonstrations by social organisations disrupting operations, customers moving away, the regulator’s notice regarding pollution issues, the investor’s threat of pulling out, insecurity about the availability of raw material and products or services being expensive or redundant due to sustainability-linked barriers, among others.
A majority of such instances are indeed avoidable. The monetary loss due to such occurrences are usually far greater than the cost that would have been incurred for the implementation of an ESG framework that would have identified risks in advance, enabling appropriate precautionary actions or mitigation plans. In a number of cases, a structured framework can allow for the identification of opportunities ahead of the competition.
While monetary profit is, and will remain, one of the primary objectives of any business, rethinking value creation as another major dimension is emerging rapidly. The purpose of business is, thus, being redefined from the perspective of not only a shareholder, but also the overall advantages it provides to the entire range of stakeholders, including community, society and humanity at large.
The Western world has benefited from industrialisation much ahead of India and also been able to accumulate enough wealth to enable it to afford mitigation solutions far more easily. India, on the other hand, does not have this luxury. For us, it is like walking on a tightrope in catching up with and surpassing the world in terms of economic development, along with doing it in a manner that makes the development sustainable in the long term. Considering this, the context of adopting ESG principles and framework is exorbitantly important.
In today’s world, financial parameters are not the only determinants of the overall worth of an organisation. Organisations gain value through conspicuous ESG performance and disclosure that help them in meeting prominent ESG indices—innovation, good governance, stakeholder-centricity, creation of social value, carbon-neutrality and resource conservation are among some of the significant performance indicators that matter.
When we speak about performance, it is not limited to the physical boundaries of a company. The imperative of an organisation is now believed to be intrinsically linked with its value chain, and it is essential that a company create a sustainable business case of existence along with its suppliers across tiers and its associates along the line of delivery of products or services. While adopting ESG measures within the fence is the first requirement, it is equally significant to motivate others in the chain. Importantly, when an organisation moves to a leadership position in sustainability, it starts influencing others within and outside in various sectors, thereby contributing to the creation of a sustainable ecosystem of a business network.
Climate concerns are perhaps one of the top challenges in the world today. In times to come, we can expect them to become more formidable. Therefore, predictably, climate action is receiving priority among businesses, especially the businesses that are related to energy, infrastructure, natural resource extraction, manufacturing, built environment, transportation, agriculture and animal farming. Radical changes in processes and technologies are expected to take over in the coming years. These will redefine the characteristics of these industries. ESG awareness has, so far, largely been higher among these sectors, and actions have followed suit. The pace of acceleration will determine how the world averts a climate crisis.
Regulatory frameworks around ESG performance disclosures are emerging the world over. The US and Europe are tightening their regulations and climate-related disclosures to feature prominently in the new scheme of things. These changes are trickling down across the globe. In India, until recently, sustainability disclosure was a matter of voluntary choice. The present regulatory requirement mandates the top 1,000 listed companies to disclose as per business responsibility and sustainability reporting requirements from FY23 onwards. Going forward, more companies are expected to be covered by the mandate.
The key player which can motivate the industry on an ESG framework is the financial services sector, since it holds the flow of funds to businesses. In the recent past, we have seen an encouraging trend of reliance on ESG matrices for investment decisions, although much more is, perhaps, needed. Concepts of sustainable finance or responsible investment are here to stay, and, increasingly, businesses need to demonstrate their ESG quotient to attract money. Capital markets, globally, are networked like never before, and alternatives will be difficult if red flags are raised about a business by any investor.
Various initiatives are being introduced to address the growing importance of ESG compliance in investments. For example, the Sustainable Finance Disclosure Regulation (SFDR) was introduced in the European Union in March 2021 to regulate the integration of an ESG regime into investment and financial advisory processes. It helps in ensuring rightful usage of sustainable funds. The SFDR works along with the European Union Taxonomy Regulations that has a classification system for environmentally sustainable economic activities. This goes a long way in preventing “greenwashing”, a situation in which financial products are marketed as being sustainable without meeting the sustainability criteria. Interesting terminologies are emerging, such as “Double Delta” focus that provides preference on high-growth potential impact companies that address climate, environmental or social issues directly and focus on sound corporate governance.
“No escape” is the oft-heard phrase in the ESG context of a business, unless the intent is really short-term. In today’s world of uncertainties and challenges, future-proofing of businesses invariably requires a profuse institutionalisation of the ESG framework that derives strength from the economic, social and environmental pillars, which are laid over a solid foundation of corporate governance.
Dipankar Ghosh, Partner and Leader, Sustainability and ESG, BDO India
