Updated: Nov 1
To grow and thrive in the long-term, a business has to be alert and responsive to the needs of its ecosystem, with sustainability ingrained in its purpose and strategy. Environmental, Social and Governance (ESG) strategy is an indispensable framework for companies to integrate sustainability into their operations, and communicate their sustainability performance and targets effectively to various stakeholders. This article outlines our roadmap to ESG strategy and its building blocks – development, execution, reporting and communication.
The rising importance of ESG strategy
We live in an increasingly VUCA (volatile, uncertain, complex, and ambiguous) world, shaped by multiple mega-trends. These mega-trends range from climate change and degradation of natural capital to changing values and lifestyle choices of younger generations to major technological advances affecting many aspects of our lives. These developments fundamentally alter many stakeholders’ expectations from companies beyond economic and financial considerations. Non-financial elements covering environmental and social responsibility of the business, as well as the quality of its governance, are becoming more critical matters for both internal and external stakeholders of companies.
Corporate purpose and stakeholders’ interests
Source: KEN Associates
In the face of these mega-trends, a company needs a sustainability or ESG strategy that addresses existing and potential risks and opportunities of the changing world. The ESG strategy defines how the company will use its resources to achieve its sustainability objectives. The long-term ESG goals of the business are driven by its corporate purpose and should reflect the economic, environmental and social interests of its key stakeholders – investors, customers, employees, suppliers, local communities and government agencies.
The four pillars of ESG Strategy
Source: KEN Associates
Developing ESG strategy
When drafting a company’s long-term ESG objectives, its leadership should be flexible to balance the priorities of different stakeholder groups, and ensure that these priorities are aligned with the corporate purpose. That requires assessment of relative importance of various economic, environmental and social factors that are material to the company’s activities.
Materiality analysis is a fundamental element of ESG analysis. It aims to assess the effect of different ESG factors on the company’s performance, and also the impact of the company’s activities on the environment and society. For a comprehensive materiality analysis, the company and its consultants need to engage with all relevant stakeholders to learn their perspectives of the issues that are most material to them. Importantly, materiality analysis should be conducted periodically to reflect the evolving importance of various sustainability factors.
There are more than 100 ESG factors or themes that could be assessed as part of the ESG analysis, however the selection of concrete indicators depends on the importance of various topics for the company in question. For example, for a food retailer, the level of direct and indirect GHG emissions (Scopes 1, 2 and 3), water use and labour conditions across its value chain are likely to be among the most material ESG topics. Conversely, financial and conduct risks management, part of broader governance factors, is more relevant to banks and investment companies.
The results of materiality analysis should be communicated to the company’s leadership – board committees and executive management – and discussed with the relevant corporate functions– product development, procurements, manufacturing, sales, marketing, risk management, compliance, HR and finance. The purpose of these discussions is to review the existing products, policies and objectives and align them with the findings of materiality assessment. The tangible outcomes of this cross-functional collaboration will be updating of the firm’s corporate strategy, setting up or revising ESG metrics and targets with the aim of reducing ESG-related risks and capitalising on sustainability opportunities.
Engaged leadership is critical for a successful execution of the ESG strategy
While corporate governance structures vary across companies, mainly driven by local legislative requirements, company size and ownership structure (public or private), they all should be aligned with the firm’s sustainability priorities. To implement its ESG strategy successfully, a company’s board and senior management should be actively engaged in its sustainability agenda and provide ongoing support and oversight.
We identify the following major areas for the board’s engagement in the company’s sustainability agenda:
- Review and approval of ESG policies, metrics and targets, including for the senior management;
- Fostering sustainability integration into company’s culture by supporting salient ESG initiatives, including cross-functional collaboration and sustainability trainings for employees, and if feasible, subcontractors and suppliers; and
- Oversight of ESG strategy execution, reporting and important outreach programs
Senior management has a critical part to play in executing the company’s ESG strategy. In particular, they need to ensure that the ESG function is equipped with the necessary resources to drive the sustainability agenda, and that ESG plans are clearly communicated to and adequately implemented across various departments of the organisation.
The major benefits of integrating ESG into business strategy and risk management include:
- Enhancing the long-term sustainability of the company’s business model;
- Increasing profitability by expanding market shares through introducing innovative products and processes that meet customers’ growing sustainability needs
- Mitigating ESG risks stemming from climate change, new environmental and social regulations, as well as changing consumer preferences
- Augmenting brand value and improving reputation among sustainability-minded employees, investors, customers and local communities
Stakeholders require greater corporate sustainability disclosures while ESG reporting still lacks standardisation
Unlike financial reporting, which is largely conducted in accordance with the International Financial Reporting Standards (IFRS) and US Generally Accepted Accounting Principles (US GAAP, mainly used by US-registered and -listed companies), there is no single internationally adopted ESG reporting framework. Some countries have introduced local sustainability reporting requirements, while others are working towards developing their own standards. In addition, the International Financial Reporting Standards Foundation, or IFRS Foundation – the non-governmental body behind the IFRS standards - has joined the race to develop global sustainability reporting standards.
The sustainability reporting standards approved by the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB) currently are the most widely used ESG reporting systems. There are a number of other international frameworks that have more narrow focus on reporting sustainability-related issues, such the Task Force on Climate-Related Financial Disclosures (TCFD, for reporting on climate-related risks and opportunities) and the Equator Principles (for reporting environmental and social risks in project finance transactions).
Many large, global companies simultaneously report under several ESG frameworks. Smaller and privately held companies with more limited resources could choose between GRI and SASB. A company’s choice of its ESG reporting framework should take account of the information needs of its stakeholders. GRI standards follow the principle of double materiality, which requires disclosure of ESG matters important to the company and the impact of the company’s activities on the environment and society.
Disclosures under SASB are more tuned into the needs of investors as they aim to reveal ESG matters that could have financial impact on the reporting entity.
Regardless of the ESG reporting framework, we advise companies to obtain external verification of their sustainability reports, as well as their main long-term sustainability targets, such as GHG reduction. Engaging reputable external parties not only will add credibility to the company’s ESG reports but will also provide an independent perspective on the reporting entity’s sustainability agenda that might need adjustments.
Ongoing market outreach and thought leadership are critical for effective communication
Reaching sustainability milestones and disclosing them in ESG reports should be complemented by effective communications. Companies need to run frequent market outreach campaigns and demonstrate thought leadership in ESG matters to ensure that all key stakeholders are informed of the successes achieved and remaining challenges.
Authentic engagement with various external parties will give company leadership opportunity to receive valuable feedback on their ESG performance. Moreover, the ongoing dialogue with the market can help companies stay up to date on evolving sustainability trends and competitor activities, and as a result introduce necessary improvements to their ESG strategy.
About KEN Associates
KEN Associates ltd is a UK-based consulting firm. We help companies, investors, governments and development institutions across the world to meet their sustainability goals with cutting-edge consulting and research solutions.
To learn more about our work and get advice on your company's ESG strategy, please send an email to firstname.lastname@example.org or visit our website at www.kenassociates.co.uk