Climate change and energy transition, shifting from a linear to a circular economy, rising inequality, balancing economic needs with those of society – these are the unprecedented global challenges we all face. Investors, banks, regulators, as well as consumers and employees, are scrutinising businesses like never before and demanding that we address these challenges, explains Mark Stewart, Partner, Corporate Finance and Head of Energy, Infrastructure and Sustainability at business advisory firm, Johnston Carmichael.
And that’s where ESG comes in. Through clear environmental and social governance, which is reported on, businesses are able to demonstrate and deliver proper and measurable stewardship of people and the planet.
ESG will no longer be the domain of listed companies; it’s for every business that not only wants to do the right thing but knows that ESG is one of the smartest financial decisions it can make.
More and more investors are incorporating ESG elements into their investment decision making process, making it increasingly important from the perspective of securing capital, both debt and equity.
But before diving headlong into an ESG strategy, businesses need to take a step back and set some basic parameters and definitions.
Everyone’s talking about sustainability: net zero, equality, diversity and inclusion. But what do these mean within the context of your business? At Johnston Carmichael, we believe sustainability is the moral compass which sets out a broad set of principles to which an organisation should aspire and ESG is the reporting framework which brings that sustainable ambition to life.
But at the heart of it all lies data. If you don’t have a deep understanding of the data that underpins your approach, your ESG is vacuous and will simply smack of greenwashing!
AI for ESG reporting
One of the most crucial developments in ESG reporting will be the development of AI and data extraction algorithms. Without accurate, real-time data there can be no ESG. Surface-level isn’t good enough. We need to go deeper and make smarter connections.
ESG reporting must not be treated simply as a compliance exercise. By collecting the data, you are taking the first steps towards managing ESG issues meaningfully and in the same manner you would manage financial issues.
The various ESG reporting frameworks, whether TCFD (Task Force on Climate-related Financial Disclosures), GRI (Global Reporting Initiative) or SASB (Sustainability Accounting Standards Board), are all predicated on setting material risks for the business in relation to the sector in which it operates.
These reporting frameworks require a huge amount of data gathering before a business can accurately disclose against these key material factors.
It is only by collecting accurate and relevant data that any substantive change can be made. Data itself won’t change anything, it’s the insight and then the actions taken based on that data that result in transformational change.
Developing a basline
As part of a pioneering initiative within Moore Global, a worldwide accounting and advisory network with almost 550 offices across more than 100 countries, we are trialling an ESG platform which allows us to establish a baseline for our ESG so that we can understand what we’re doing right today, where there are gaps and how to fill them.
The main challenge for us, and our clients, is a lack of consistent ESG reporting and, until there is convergence into a single framework, it will be difficult for businesses to make informed judgments on a level playing field basis, especially when it comes to credit ratings agencies.
The correlation between the top five ESG data ratings agency is less than 1% which indicates a lack of consistency in rankings. This means that investors or lenders will require a lot of analysis to independently verify that firms are doing what they say they are in relation to ESG.
Glasgow Financial Alliance for Net Zero
COP26 established the GFANZ alliance which was resolute in its commitment to providing global finance to only those businesses who have a clearly articulated net-zero journey and a demonstrable ESG strategy. Financial institutions across the globe are now including climate related stress testing to understand their potential exposure. International sustainability standards will in time hold all businesses to account, and we are already seeing funders across the spectrum putting ESG at the forefront of their funding considerations at all levels.
As a result, we are seeing a sharp rise in the prominence of ESG in M&A due diligence. This includes a review of materiality – the effectiveness and financial significance of a specific measure as part of a company’s overall ESG analysis. Material factors are financial and non financial elements deemed fundamental to the long-term success of a company’s ESG strategy. Double materiality is becoming really important for investors to assess, not just profit but how that profit is made and the impact the business has on the wider world. Preferential funding terms are available for those who can commit to ESG key performance indicators, and green finance is becoming more mainstream every day.
It makes sense
The ESG goal must be to demonstrate that your company is a good steward of all forms of capital, not just financial, but human, environmental and social as well. ESG is not only a business imperative – it makes sense from a moral, ethical and climate change perspective. Doing the right thing has never made more business sense.