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ESG – from risk to opportunity

Companies attuned to the need to adapt to changing environmental and socio-economic conditions are more likely to spot new opportunities and pitfalls early.

The rapid increase in the importance key stakeholders assign to Environmental, Social and Governance (ESG) criteria is “fundamentally changing how businesses make decisions.” That’s the overwhelming view of the 70 participants at a recent gathering of leaders from business and the capital markets organised by specialist communications boutique Thoburns. Sustainability, and how to communicate it externally, now “sets corporate agendas internally”, “tops the agenda at Board level” and is “the most important issue facing us right now,” according to the attendees present.

Until recently though, the ESG discussion was framed largely in terms of risk: the financial impact of causing environmental damage, the reputational damage of adverse publicity around environmental, social or employment issues and the fundamental threats to business caused by climate change and regulation. Instead of those risks, today’s business leaders increasingly see opportunities.

The first and most obvious reward for companies with a proven commitment to ESG principles is financial. ESG criteria have moved from being the niche preserve of a handful of ethical investors to being a key driver of capital flows from mainstream institutional investors in both the fixed-income and equity markets. Credit ratings agencies are incorporating ESG into their rating processes. Insurance companies are pricing ESG risk into policies. All this increasingly means that a demonstrable commitment to ESG drives down companies’ cost of capital.

Longer term, participants agreed that where companies genuinely incorporate ESG considerations into real business decision-making, to the point at which it becomes a strategic business tool, the rewards are more profound. Companies that choose business opportunities that accord with sustainable ESG criteria are increasingly regarded as better managed and with better prospects for long-term valuation and performance. They are likely to have more motivated staff, more flexible suppliers and more loyal and engaged customers and communities. And companies attuned to the need to adapt to changing environmental and socio-economic conditions are more likely to spot new opportunities and pitfalls early.

Thinking about ESG encourages more innovative strategic thinking. And it’s an opportunity to differentiate from competitors.

However, as attendees at Thoburns’ breakfast pointed out, in practice these opportunities are in danger of being lost in the confusion around what is expected by the key stakeholders.

Internally, integrating ESG into business strategy requires buy-in at CEO and Board level. There is a growing realisation that the business gets little real value back from perfunctory tick box exercises and instead needs to have a proactive and comprehensive strategy.

Externally, it is critical that companies understand what significant stakeholders want and that those stakeholders in turn understand companies’ ESG stance, strategy and practices. Without clear and tailored communication of often complex stories, it is almost impossible to extract the financial and reputational benefits of investment in strategic ESG.

For many, moving to this integrated model in which ESG genuinely influences business strategy, drives real business decision-making and helps management run businesses better is still something that needs to be done.

That said, attendees at Thoburns’ session agreed that ESG concerns seem to have reached a tipping point: even in the last six months the emphasis on the subject in both financial markets and within the corporate community has increased dramatically and within their own organisations they detected new momentum.

As one said, “at UK PLC, we are just at the end of the beginning.”