ESG integration is increasingly recognized as a crucial ingredient in a successful ESG strategy. As ESG (environmental, social and governance) considerations move center-stage, organizations must realize that to fully leverage the potential benefits of improved ESG performance, they need a robust and company-wide strategy.
Ad-hoc ESG initiatives, or programs that take a siloed approach to operationalizing ESG principles, won’t deliver. ESG integration is the order of the day, but what does this really mean? When we talk about ESG integration, what does it look like in practice? And how do you know if you’re succeeding in your ESG integration efforts?
What Is ESG Integration?
If you want your ESG program to deliver value (and what organization doesn’t?), it’s vital to ensure that you fully integrate ESG company-wide. Environmental, social and governance considerations need to be embedded in the DNA of your corporate strategy. What does this entail? It means:
- Identifying ESG risks throughout your supply chain
- Making purchasing decisions with an eye to suppliers’ ESG credentials
- Implementing policies to improve diversity and inclusion
- Embedding ESG into your corporate investing strategy
- Incorporating ESG goals into your approach to executive compensation
- Ensuring strategic objectives include ESG considerations
- Educating your workforce on the need to embed ESG across their operations
What’s more, your ESG strategy also needs to fit within your broader GRC (governance, risk and compliance) strategy. GRC is a way of structuring governance, risk management and regulatory compliance to create a more unified approach, often making use of proprietary software to order and manage compliance, risk and governance programs.
Therefore, there’s plenty to think about when exploring the benefits and ramifications of implementing a more integrated approach to ESG.
Benefits of Company-Wide ESG Integration
ESG integration is starting to sound like a significant undertaking. As an organization, you may be wondering, “what’s in it for me?” In fact, there are some compelling reasons for starting on the journey to a more integrated ESG strategy.
- Companies ranked highly for ESG have been shown to perform better than average: companies in the S&P 500 who ranked in the top quintile for ESG factors outperformed those in the bottom quintile by more than 25 percentage points between the start of 2014 and the end of June 2018. Their stock prices tend to be less volatile too.
- Not only do strong company performance and high ESG ratings tend to track in parallel, but the evidence of this is also increasingly transparent and accessible via third–party ESG scores and ratings.
- Investors are paying more attention to these ratings; a 2019 report from McKinsey notes that “ESG-oriented investing has experienced a meteoric rise”; improved ESG, therefore, has the potential to translate into increased investment.
- Intangible assets — such as brand reputation — are growing in importance; KPMG reports that today, intangible assets account for more than 80% of a company’s S&P asset value. An integrated and effective ESG strategy tends to enhance your brand reputation.
- Conversely, so-called “high ESG controversy” events can cause a company’s stocks to underperform in the market for as long as two years.
- When hiring or retaining staff, ESG can be a strong motivator; employees want to work for companies that demonstrate commitment to making the world a better place. As the post-COVID talent war gains pace, your ESG performance might tip the balance when a potential employee weighs up offers.
- Borrowing money can be cheaper if you perform strongly on ESG. Research from MSCI shows that companies with high ESG scores, on average, experienced lower costs of capital compared to companies with poor ESG scores across four years.
- Consumer sentiment is increasingly interwoven with ESG concerns; having the potential to impact the bottom line via greater efficiency, environmental, social and governance matters can directly impact your top line.
- Increasingly, regulators and legislators worldwide are mandating ESG reporting — and while regulations can change dramatically with the arrival of each new administration, the general direction of travel is clearly towards more compulsory ESG reporting. Staying ahead of the game better positions your organization to meet its regulatory compliance obligations.
- The sovereign debt market seems to be “less developed than other asset classes” when it comes to ESG integration. There may be opportunities for governments to benefit from investing in a way that integrates ESG factors.
- Many of the benefits for companies are, of course, also advantages for investors:
- Improved stock prices associated with healthy ESG performance. Whereas poor performance, identified by those with lower ESG ratings, enables potential shareholders to filter out these companies or consider these shortcomings when making an investment decision.
- The increased availability of this ESG data to investors via reporting like that required by the Task Force on Climate-Related Financial Disclosures (TCFD) makes it easier to separate the ESG winners and losers. And as ESG gains momentum globally, the likelihood is that this type of reporting will become more commonplace — a virtuous circle for investors wishing to include ESG factors in their decisions.
- Companies with strong ESG performance are far less likely to go bankrupt. Investors paying attention to which companies had shown below average environmental and social rankings five years earlier could have avoided 90% of the bankruptcies among the S&P 500 from 2005-2015.
- It’s in all our interests to create a world where ESG is a priority, driving improved working conditions, increased sustainability and better corporate governance. Companies that prioritize an integrated approach to ESG are more likely to achieve their aims than those with disparate or disjointed programs.
ESG Risks: What Today’s Boards Need To Know
How To Ensure You’re Successfully Integrating ESG
There are, therefore, some persuasive arguments for a fully integrated approach to ESG. What steps are needed to get there?
1) Identify Your Company’s ESG-Related Strengths and Weaknesses
Taking stock of current performance is always a good opening move. Conduct a gap analysis to understand the ESG risks you are currently facing. Where are you outperforming on ESG metrics, and where are you not so strong?
First things first: Do you have a clear organizational definition of ESG; what it means to your company, your stakeholders and your employees? You cannot identify your strengths and weaknesses if you don’t know what you measure against. Consistency is key.
Also, consider factors like leadership (whether you have robust senior leaders “walking the talk” on ESG action), employee understanding and buy-in, external rankings or ESG performance measures, and stakeholder sentiment. An insight into all of these will help you to measure the health of your environmental, social and governance approach and identify any red flags.
2) Analyze the Current State of All ESG Factors in Your Organization
Due diligence around your current ESG approach means taking a granular look at all the ESG risks you face and your existing strategies to tackle them. Be candid about your achievements and any gaps in your approach.
Many organizations face a fundamental challenge here because they do not have a complete and clear picture of their ESG strategies and performance. Explore the various solutions that can help you to achieve a comprehensive understanding of your current ESG approach, warts and all.
3) Set Priorities Based on Your Analysis and Plan Ahead
Too often, the steps needed to operationalize your ESG goals can be abstract and unclear rather than concrete and actionable. Having a comprehensive understanding of your performance, goals, and gaps in between will enable you to set defined priorities that work towards your objectives.
These priorities will also be influenced by external factors — the ESG Global Standards published last year by the World Economic Forum’s International Business Council, for instance, or the need to comply with reporting requirements such as those defined by the Task Force on Climate-Related Financial Disclosures (TCFD).
Recognizing best practices and working towards them is another crucial stage in prioritizing and planning your next steps. Identifying what ESG best practice looks like is one of the five critical steps in setting an ESG strategy.
Once you’ve identified your priorities, devise a plan that will close the gap between the current and desired state.
4) Implement Controls to Achieve Your Targets
One area that many businesses struggle with is the issue of controls when it comes to ESG integration. The areas you need to monitor for ESG compliance will vary depending on the industry — but across all industries, there are some common issues:
- Organizations often struggle to know where they need to implement ESG controls
- They may already have controls in place but do not recognize them as such
- They may not know how to implement controls for some of their priority areas or have the resources to start building these controls from scratch
Think about the controls you need in the context of your industry and your goals. If your organization has significant environmental risk exposures, for example, you may want to focus on controls that evaluate your buildings for greenhouse gas emissions. On the other hand, a professional services firm may prioritize controls on business travel; for instance, employees must take the shortest route or build a business case that the travel meets a specific business value and/or cannot be achieved remotely.
Good governance is the essential foundation of ESG; if you do not have measurements and controls in place, an effective ESG program becomes impossible to achieve.
5) Define Clear Metrics and Report on Your ESG Progress
For this reason, implementing appropriate metrics and reporting needs to be the next step in your ESG integration journey.
Capturing and analyzing ESG data has historically been another stumbling block for many businesses wanting to improve their ESG performance. While ESG as a concept has gained momentum, the ability to develop concrete metrics has failed to keep pace, making real-time analysis of ESG compliance challenging to achieve.
Putting in place the controls outlined above will help you to identify the non-negotiables in your ESG strategy. It is essential to set objectives — for instance, a defined reduction in your carbon footprint or a measurable goal for increased diversity among your senior leadership.
Then ensure you report against progress to keep yourselves accountable. In some cases, this reporting may be mandated; in others, it will be purely optional. Commit to publishing your goals and your progress towards them. It may open you to scrutiny, but it is vital for transparency and to improve your ESG integration strategy.
Rethinking the ESG Data Challenge
Choosing the Right People, Tools and Processes To Integrate ESG
People: When it comes to the people needed to integrate ESG successfully, there are several considerations. First, the issue of leadership, as we touched on above. You need the right people heading up your ESG integration program.
Your board and senior leaders are central to many elements of your ESG strategy and will set the tone for your entire organization when it comes to compliance. Creating organizational purpose and value; setting your ESG strategy; making decisions around priorities and actions; putting in place remuneration, recruitment and engagement programs that drive D&I — all these fall to your senior leadership team.
Then you need the right people “on the ground” — ESG is a team effort; to succeed in ESG integration, you need to ensure that everyone involved understands your direction of travel and is on board with advancing your progress.
Tools: Having the best tools in place to deliver ESG integration is another imperative. Trying to keep track of ESG measures and performance manually is a recipe for failure.
Fortunately, there are solutions available that can provide a framework for your ESG strategy:
- Tracking your risks, controls and compliance.
- Customizing metrics to the needs of your organization.
This might cover factors as varied as board composition and executive compensation, environmental risks, shareholder sentiment on your organization’s ESG performance, market trends, and upcoming ESG issues that you need to know.
Processes: These tools can also underpin your processes — giving you a defined structure within which to manage your ESG activities. Your processes need to align with external requirements, like the World Economic Forum’s ESG Global Standards we mentioned earlier.
A joined-up strategy here is crucial. In the same way that integrated risk management is now an accepted approach to managing corporate risk, we move towards a landscape where joining the dots on all-things-ESG is becoming recognized as the best strategy.
As Zack Ward, the founder of North Star Compliance Limited, noted at a recent Diligent webinar, “With […] more mature clients […] I think they can see that a trend like ESG is actually the same thing as integrated risk management, so we see them joining up the dots between different functions like internal audit, compliance, health and safety, HR, and other functions.”
How to Achieve ESG Integration
ESG continues to gain momentum. No longer a nice-to-have, ESG is becoming an inviolable element of today’s organizational operations. Shareholders, stakeholders and customers expect organizations to demonstrate ESG commitments. Moreover, external reporting, ratings and scores increasingly play a role in corporate reputation as an employee engagement and attraction tool.
Success here is predicated on integration, making ESG considerations in-built to your corporate DNA, not a bolt-on addition. If you want to find out how Diligent’s solutions can help you document, measure and manage your progress towards your ESG integration goals, you can learn more here.
Learn More About Diligent’s ESG Solutions
Learn how Diligent’s ESG solutions are helping companies operationalize ESG principles, track progress against standards, and monitor stakeholder sentiment.