Why firms need ESG

In the 2021 Global Risks Report of the World Economic Forum, four of the five top risks pertain to ESG factors. The fact that companies are being challenged by activists, activist shareholders, proxy advisers, asset managers, large fund houses, pension funds, and employees, etc., makes the case for change even more compelling. Technology and access to information have catalysed the process and the question each company must answer is—how aligned is its business model with social and environmental priorities, not just regionally or nationally, but also globally?

For several years, gurus and practitioners of management talked about ‘triple bottom line, balanced score-card, conscious capitalism’, etc., but it is only after large fund houses and asset management companies overtly stated the rules for capital allocation that there has been a noticeable shift. Calpers was amongst the early adopters in 2016, of a five-year plan to include ESG principles into its investment process. Similarly, consistent with the 2018 letter from its chairman and CEO, Larry Fink, BlackRock plans to have $12 trillion in ESG assets within the next 10 years. There are currently 10 ESG funds in India with $1.4 billion in assets under management and approximately $37.8 trillion is invested in global ESG assets, as of March 2021. Lack of sustainability is a risk that most shareholders want to avoid.

Central to the idea of ESG is the cohesion between our planet, its people, and the principle of shared prosperity. It shifts the focus from just generating profitable returns for shareholders to the manner in which these profits are generated and equitably shared among all stakeholders. Increasingly, ESG discussions are gathering momentum in business and board agendas. At its core, ESG is about the responsibility of business—not just the right words, but clear and consistent actions. This requires a shift in mental models and different metrics of success. In some cases, these are driven by conscientious leaders; in most cases, by a regulatory and legal framework that establishes the boundary conditions within which to operate. ESG is also a recognition that business is an inherent part of an interconnected ecosystem and financial/competitive performance is not its only measure of success. It is a systemic concept which cannot be addressed through tokenism, but through thoughtful choices that recognise and respect the rights of all stakeholders—not just maximise returns for shareholders.

In many ways the Covid-19 pandemic has yet again reiterated the connectedness of our planet and exposed its multiple inequalities—from economic and social disparity, to uneven access to healthcare, and vulnerable supply chains. Companies, therefore, cannot be mute spectators in a world that has lost over 178 million hectares of forest since 1990, where melting glaciers, rising sea levels, worsening droughts, increasing tornados, hurricanes, and forest fires wreck havoc with people and livelihoods, and where nearly four billion people live on less than $5 a day.

A critical question, against this backdrop, is the significant role of the Board to help companies navigate this challenge, such that the highest ethical standards form the foundation of the governance cadence, where social indicators recognise inclusion, diversity, and equity, and where environmental concerns ensure that all actions to reduce greenhouse gases, increase water conservation, biodiversity, solid waste management, sustainable agricultural practices, etc., support commitments to the sustainable development goals and the Paris climate accord.

In the very likely scenario of escalating ESG-related shareholder activism, governance of environmental and social indicators will become more important than ever before, propelling greater demand for environmental expertise, as well as greater attention on inclusion and diversity—from the boardroom to executive teams. For companies, leadership in ESG is potentially a differentiating factor. Clarity, consistency, and comparability of ESG metrics are a challenge and require investment in good quality data to build a knowledge base. Ultimately, it is the responsibility of political and business leadership to take the right actions for a cohesive and sustainable planet.

Views are personal. The author is a strategy adviser and an independent director.