The term ESG was first coined in 2005 in a landmark study, Who Cares Wins, initiated by the United Nations. Environmental, Social, and Governance (ESG) refers to the three core themes in measuring the sustainability and societal impact of an investment. These criteria also help in determining the future financial performance of companies. For those hearing the acronym ESG for the first time, does it sound like the latest 3-letter word or a fancy jargon? For those using the term ESG loosely as a way to sound nice, here are some points to ponder.
- How do you improvise the existing ESG standards?
- How do you improve on the existing processes that impact ESG performance of your firm?
- How do you compare with global benchmarks? How do you prove to be a pioneer in your industry and geography, as well as globally?
Environmental, social and governance (ESG) issues concern and impact every company, irrespective of where the company operates. Environmental issues range across climate change, carbon emission concerns, waste management and , pollution (air and water). Social issues range across labour issues, modern slavery, under-the-table sourcing practices, product liabilities, privacy concerns, and data security.
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Governance issues range across business ethics, corporate culture, organisational practices, board impact, enterprise risk framework, and granularity of disclosures. ESG will play a vital role in the very existence, growth and sustainability of companies.
In this 21st century global village, it is no longer just about maximising profits. It is also about using sustainable supply-chain practices to ensure long-term growth and longevity. The rise of ESGs adoption and influence point to a positive way of doing business. In recent years, investing in sustainable companies has been associated with ‘doing good’ investors.
ESG is no more about “investing plus sustainability”. It’s no longer a “nice to have” special project in a firm, but an important part of the organisational DNA, culture and board imperative. ESG-ness of a firm would neither happen overnight nor can be bought by simply copying SOPs from an advisor. ESG will be a continual process in any organisation and there is no better time to begin than today.
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Social licence and ESG
Sustainability is not a mainstream story yet, especially in most of Corporate India. It cannot be just a few pages tucked inside the annual report. Sustainability is specific to a company, an industry and a country. Companies need to measure their positive and negative impacts, identify the baselines, and disclose in a transparent and consumer-friendly manner. Regulatory requirements seem to have influenced disclosures, but not the spirit and details of such disclosures.
A social licence simply refers to the acceptance of an organisation by the community in which it operates. In other words, it is the ability of an organisation to carry out its business, simply because of the confidence the (local) society has that it will respect all rules and traditions with accountability and, in a socially and environmentally responsible way. The social license to operate is made of these three elements.
Legitimacy: The extent to which an organisation operates by the rules of the game (the norm of the community, even if they are not coded as law).
Credibility: The organisation’s ability to provide true and detailed information to the community and fulfil all its commitments on time, without reminders.
Trust: This aspect of highest quality of a relationship takes time and effort to nurture and sustain.
Organisations which think that social licence is something that they can pay for end up with issues of credibility. Companies with questionable processes try and buy such credibility by giving out community grants (in the form of social funds). This kind of transactional nature of the behaviour would break any trust that the community has with the organisation. Even a broken relationship can be mended or healed by carefully rebuilding that trust.
Trust assumes that all parties involved would nurture the relationships based on mutual respect and highest levels of probity. Social licence of profit-making entities has to be a full-time engagement. Organisations that champion community initiatives usually have their best and senior resources overseeing those efforts. Such organisations ensure that their Boards are appraised regularly of the initiatives, however, small the projects are in their balance sheet. It is the guiding principles of those initiatives that matter and not the project cost.
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Net-Zero by 2035
Net Zero Emissions is a term in usage since the Paris Agreement in 2015. Many governments agreed to achieve net zero emissions by 2050. Net zero means achieving balance between the greenhouse gases put into the atmosphere and taken out.
A country just cannot deliver its net-zero promise unless it transforms the way its industries operate. With regulations seeking those changes, businesses are increasingly coming forward with net-zero commitments. It is natural for many businesses globally to wait and watch in today’s global economic situation. Business leaders could simply procrastinate and postpone, taking large call for investments towards Net Zero challenge.
As the countdown to Net Zero begins, the polity and policy makers will start taking decisions on behalf of corporate leaders and force tougher regulations including huge monetary penalties.
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ESG magic in boardrooms
To achieve sustainability, it has to be a top-down, company-wide cultural effort. There are many firms that rate the ESG initiatives of entities. Most of them have opaque attributes whose count and quality differ. It is surprising that globally the rating agencies have not come together to have a global framework including attributes.
What you measure is what you get. If you measure the wrong attribute, you can make the data look nice in the final interpretation. Standardisation is key to creating a common language and benchmarks, and therefore a need for transparency. That’s where critical stakeholders have to showcase transparency.
And this is also where the naysayers go wrong. ESG measurement cannot be just a number, but has to be seen in context of qualitative parameters too. Addressing all ESG concerns at once is nearly impossible even for the most forward-looking and well-intentioned companies. The key to success is materiality. The understanding of which ESG risks are relevant to a company and the overall operating context is important.
While ESG seems to be a black box to some, it looks like the magic moment for many. It’s not as easy as getting the company rated and just spouting the ESG pride.
Boards usually have governance expertise on business matters. At the beginning of the millennium, climate change became a global debate. It took time for it to percolate to the corporate world as a serious topic that could impact their future business as well as future of business. With ESG standards gaining momentum across stakeholder groups, Boards are discussing:
- Societal changes and evolving expectations of the society
- Adapting the corporate brand promise in alignment with ESG objectives
- Various risks including Global risks, country risks and corporate risks.
- Reputational issues
- Disruptive elements in their industry / geography
- Global momentum on ESG and expectations.
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ESG: Bringing all voices together
The first observation on social licence debated the intersection of corporates and communities. The net zero observations discussed the intersection of governments and corporates. The ESG measurement is about the assessment of individual corporates. A successful ESG way-of-life would be possible only when we have the above three intersect and work in tandem.
Conversations around ESG needs to move out of specialist journals, multilateral institutions annual summits and corporate board rooms to classroom debates, panchayat discussions, and mass media across various languages.
Productive ESG thinking depends in building initiatives that are authentic, inclusive, actionable and focused on driving a real-world result, not just an ESG rating or award. ESG is not a revolution, but more a mindset-evolution. Just as ECG can detect heart condition and potentially save lives, ESG assessment can foretell organisational health. Capital, human capital and social capital have to come together for impactful ESG outcomes. In this transformational journey to make the world ‘good’, every voice counts and every positive act matters.
(Shailesh Haribhakti is a renowned chartered accountant and corporate leader. Srinath Sridharan is an independent markets commentator.)
Shailesh Haribhakti is a Chartered and Cost Accountant, an internal auditor and a certified financial planner. He is a board chairman, audit committee chair and independent director at some of the country's most preeminent organisations. He is a thought leader on the Indian economy and public policy.
Srinath Sridharan is a strategic counsel with 25 years experience with leading corporates across diverse sectors including automobiles, e-commerce, advertising and financial services. He understands and ideates on intersection of finance, digital, contextual-finance, consumer, mobility, Urban transformation, and ESG. Actively engaged across growth policy conversations and public policy issues.