Posted on April 21, 2022
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In this special episode of the Sustainalytics Podcast, Adam and Shilpi discuss important considerations for any organization starting an ESG program and how to set up your program for success. You’ll hear about gaining leadership buy-in, planning and resourcing your program, meeting reporting requirements, communicating your progress with stakeholders, the role of third parties, plus potential obstacles you can avoid.
As with most projects, good planning and commitment are strong drivers of a successful ESG program. To make the most of their effort, companies starting an ESG program need to have a clear understanding of the ESG issues that affect them, what their impacts are, and how they relate to the business strategy. With this knowledge, a company can effectively address the issues that are most material to the business and confidently and transparently communicate its ESG activities with stakeholders.
Can a firm plan and implement an ESG program on its own – that is, without guidance from an external ESG specialist? Yes, says Shilpi, but it’s not for every company. No third party knows your business like you, your team, and your stakeholders, so there is a lot of valuable ESG information that companies can gather and analyze – if you have the resources. At the same time, ESG specialists have a lot to offer in terms of understanding what actions to prioritize, competitive insights, and credibility.
After you listen, you can download our practical guide to starting a corporate ESG strategy for additional details on the considerations we talked about in the podcast. Discover key action steps for gaining top leadership buy-in, planning and resourcing your program, developing your strategy, and reporting and communicating your progress.
Adam Gorley: Hello and thank you for joining us for this special episode of the Sustainalytics podcast to mark the release of our ebook, Getting Started With ESG: What Every Company Needs to Know. I’m Adam Gorley, Content Marketing Manager with Sustainalytics Corporate Solutions, and I’ll be your host today. I’m talking with Shilpi Singh, Corporate Solutions Director at Sustainalytics. Thank you for joining me today, Shilpi. I’m looking forward to our conversation. But before we get started, can you tell us a bit about your role at Sustainalytics?
Shilpi Singh: Thanks Adam. So currently I’m a director on the Sustainalytics Corporate Solutions team, which is a fast-growing business that provides sustainable finance services for issuers, corporates, and banks, alongside enhancing their understanding of the ESG topics and sustainability activities. So, the key objective of my role really is building and delivering commercialized ESG services for companies. We aim to support them with the ESG data, knowledge, and guidance to structure future strategic road-mapping and risk mitigation through our ESG insights and performance analytics offerings.
Adam: Thanks for that great intro. We’re going to talk today about factors all businesses should consider when they’re starting an environmental, social, and corporate governance – or ESG – program. Like any important business activity, ESG begins with high level buy-in. And it requires planning, resources, expert advice, and an action plan, including how to report the results to internal and external stakeholders. Over the next half an hour or so, we’ll be discussing some of these considerations in greater depth. So Shilpi, to get started, can you tell us about some of the ways an ESG program can produce value for companies?
Shilpi: Certainly. So, it’s been observed over years how embedding ESG is becoming more and more mainstream for investors and is critical to long-term competitive success for corporates that are looking to create a stronger brand. So, for instance, a robust ESG program can really open up access to large pools of capital. There has been a meteoric rise in ESG-oriented investing with global sustainable investment doubling in 2021, for instance, at about USD $35 trillion and it is expected to be close to USD $53 trillion by 2025. This would be almost a third of the global assets under management. That is considerable value for corporates to derive from.
Adam: That’s an incredible number. What are some ways ESG financing is affecting companies?
Shilpi: Innovations like financial instruments, which are sustainability bonds, it could be loans – they’ve been on the rise. Investment funds, and ETFs that benchmark indices using ESG criteria are also deploying significant capital towards companies that execute sound ESG policies. And these are long-term oriented shareholders. Yeah, that can potentially fuel demand for a company’s stock. So, we have observed that investment firms are also incorporating ESG valuations in their portfolio risk management which is ultimately your telling indicator that capital will continue to flow towards companies with strong ESG programs and practices.
Adam: Is there a particular case that stands out to you of a company that has expanded its financing options through sustainable financing?
Shilpi: Allbirds came up and it’s now trading on Nasdaq so in this case, not only did the company review its ESG practices before going the IPO way, they also included the ESG rating by Sustainalytics where they were reviewed on various material ESG issues in their filings and, as acknowledged by their CEO, Allbirds got exposure to a lot more pockets of capital as a result of people seeing their genuine and authentic leadership that they were putting forward on ESG parameters.
Adam: What non-financial ESG factors are creating value?
Shilpi: The hiring and retaining of top talent is certainly a driver for companies when they embark on their ESG planning. Millennials care deeply that the companies that they work for and businesses that they support embrace values that are aligned with their own, which are environmental and social responsibility related. So, given the high cost of employee turnover and ensuring skill talent is attracted by these forward-looking organizations setting up of ESG programs and transparent communication around it supports employees to align values.
Further, effective practices on ESG topics can help companies unlock their competitive value and understand reporting and stakeholder communication expectations also. Companies that examine their ESG strengths and areas of improvement, with respect to competition, they are able to better identify which strategic opportunities are there and also are better prepared to meet competitive challenges.
Adam: And are there ways that companies can set themselves up to get the greatest benefit from their ESG programs?
Shilpi: Yeah, there are some key practices that companies could adhere to in order to fully realize the benefit of a proactive stance on ESG issues. The first one is an identification of appropriate ESG criteria, or material ESG issues as we call them, which are applicable to their industry and then to what extent they are applicable to the company itself, which can vary within the industry.
Adam: Okay, can you give me an idea of how this works?
Shilpi: So, at Sustainalytics, our analysis covers five or ten material issues for each industry to keep it as close and relevant to the company’s business model as possible. From a company’s side, this can be done by conducting a formal stakeholder analysis of various material issues and ranking them on a materiality matrix to finally lead to the ones that the company finds most applicable.
Adam: Thanks! And what comes next?
Shilpi: Once the material issues are identified and are aligned with the corporate strategy, it would put the company on a more robust path to set its short, medium, or long-term objectives, which could be relevant and ambitious and support them in addressing the most financially material ESG issues.
A great way to ensure transparency and progress is actually being able to monitor these objectives and report them on a regular basis. Disclosure of ESG policies related to business ethics, environment, code of conduct, these are areas where we’ve seen that making sure these policies are publicly available and they have that transparency and visibility, provides more stakeholder confidence for a particular corporate. We’ve also seen having that leadership sign-off and direct oversight as early as possible in the ESG program and planning process would really be a key aspect to a successful ESG program for a corporate.
Adam: That’s great. That’s really helpful. And what about early obstacles? What stands in a company’s way when it comes to starting an ESG program?
Shilpi: Yeah, that’s a good question because it can’t all be positive. So, for example we’ve observed that the most common obstacles for companies when starting on their ESG journey are the typical cost and benefit trade-off, limited leadership buy-in, unavailability of ESG teams, especially for small or mid-cap companies. And I think, initially, getting an understanding of where they currently stand on their ESG journey and what is best for a company in terms of material topics is certainly something where they need support right?
Adam: Right. You mentioned before how important it is for companies to clearly understand which issues are material to them. It seems like it would be challenging gathering input from diverse internal teams, each with different priorities.
Shilpi: ESG teams need to bring together input from internal teams, which could be investor relations, health and safety, risk management, marketing, supply chain departments, and many, many more internal departments depending on the size of the organization and how spread out they are globally. So, ensuring that all these stakeholders within the organization, they understand why these ESG teams need to do what they need to do and what is the overall value proposition is a key obstacle that initially we’ve observed companies and their stakeholders face.
Adam: Okay, so a company has figured out the ESG issues that are material and all the teams are on board, what’s the next challenge?
Shilpi: Yeah, for companies to know where should they focus, where should they invest out of the material issues that they’ve identified. Whether something should be included in their roadmap within the two years, or should it be a four year five year project, you are really prioritizing those topics is another obstacle. A company that, for example, spends vast amounts of sums of money trying to address every conceivable ESG issue will likely see that its financial performance could suffer. Whereas companies that focus on material issues that are more relevant to them, they are actually able to outperform the ones that do not.
Adam: I’m interested to hear that those companies that focus on the material issues that are most relevant to them see the best performance in their in their programs. Now I want to turn to four strategic focus areas. For companies when getting started with an ESG program those are gaining buy-in from top leadership, understanding your own situation with respect to ESG, and then developing your ESG strategy, and sustainability reporting. So, let’s get to it. How important is it to have support from the board and C-suite when starting an ESG program?
Shilpi: Yeah, so to that Adam I would say that having the support of senior leadership is really of utmost importance for ensuring a successful ESG roadmap creation also the sooner an organization has its leadership involved, the better and the more effective programs can be created. Right now, board members are being expected to explain their decisions reflecting the interests of their stakeholders, including environment and the long-term sustainability of the organization. And some business leaders are at times facing tough questions from stakeholders about how they are proactively addressing ESG to avoid financially material impacts and controversies.
So really, not only is ESG buy-in from the board and C-suite important internally, but also external validation is becoming more and more apparent. In terms of assessments across ESG methodologies, senior leadership oversight for ESG planning and policies is something that is considered when evaluating a company on ESG practices.
Adam: So, it sounds like companies really need to commit if they want to set up an effective ESG program. How does that leadership commitment support a company on its ESG journey?
Shilpi: This really shows how important it is also for external visibility. In terms of commitments that are grounded in the organization’s business strategy and to show the authenticity to its purpose, it demonstrates to stakeholders that the organization’s leaders have integrated ESG into the way they think about the business. And overall, this would support not only ensuring priorities can be identified and are in alignment with management, but also points to the seriousness of these strategic initiatives.
Adam: That seems to lead me to my next question. It sounds like companies have to understand their own ESG situation before they can make big decisions on programs and actions. What does it mean to understand a company’s own ESG situation?
Shilpi: It primarily means in simple terms reviewing topics that are relevant for your business model and the stage that you are at in your ESG journey. For example, an oil and gas company that is fracking should really measure water and waste management and impacts on scarce natural resources. But companies that are in food retail and distribution, for instance, should include greenhouse gas ambitions, energy management, access, affordability, fair marketing, and advertising. These are differences that exist and need to be accounted for. Similarly, internet and media services, if I take that industry, the list could include a slightly different set of material ESG issues, which would be more around energy management, data security is extremely important there, customer privacy, diversity, and inclusion. So, when a company explores their ESG situation, they will need to account for these differences as well as the priorities for stakeholders.
Adam: Right, each industry faces its own set of issues. What other factors come into play when companies look at their ESG situation?
Shilpi: Where they are at in their ESG implementation journey could really guide this. So, whether they are just starting to focus on stakeholder value which is a step up from focusing only on shareholder value – and this would include sustainability strategy introduction, preparation of CSR reports – which kind of shows that they are at the initial stages in their ESG implementation or whether they have advanced to the ESG risk or financial materiality stage, where they are able to identify that they need to focus on creating system value.
Adam: I see. And is this where a risk assessment might come in? And what does that include?
Shilpi: ESG risk assessment typically involves those earlier mentioned aspects of identifying material issues filtering them in terms of priority. But the risk assessment angle really takes into account an additional step, which is the actual financial quantified impact to a company’s bottom line and that could be positive or negative in nature. So, I mean to not approach ESG parameters as non-financial topics only, but in fact to meaningfully account for the actual riskiness and the impact on the enterprise value that such ESG issues could have.
Adam: What does Sustainalytics’ approach to risk assessment look like?
Shilpi: In terms of what we do here at Sustainalytics, we approach material ESG issues from a two-dimensional lens. It starts with reviewing the exposure, so, where a company’s exposure to each material ESG issue is initially determined at the sub-industry level. This could include betas which are also updated from time to time. It would also involve controversies that companies are part of and that could be again on a dynamic basis.
The second factor is the management dimension where we measure how well the company is mitigating its exposure. And for some companies, a portion of this risk may be considered unmanageable. That generally can happen.
Adam: Can you give me an example?
Shilpi: So, an oil and gas company is not able to fully eliminate all its risks related to carbon emissions so that is factored out of the calculation. This is how generally the risk assessment – the portion of the risk that is manageable – is finally reviewed.
Adam: So, we want to focus on the risks that a company can manage, not the ones they can’t do anything about.
Shilpi: We want to understand how the company’s performance is reflected by its policies, its ESG programs and practices, and the quantitative performance measures.
So really, accounting for those two dimensions gives us a complete risk assessment for a company. This would finally have the typical steps that I mentioned earlier and a risk status where we can take into account what are the various unmanaged risks for each material issue. And leading from that a risk profile of a company can be set up.
Adam: Another aspect of understanding your own ESG situation is the competition. Is it important to understand what your competitors are doing with respect to ESG?
Shilpi: Definitely. The way ESG is evolving, competitive analysis is a great way for companies to learn from the market. They can benchmark themselves and they can keep a tab on emerging regional topics and examples where peers could be leading them in certain areas but also leading the industry.
This is important not only for companies that are relatively new to ESG and looking to set up their ESG programs, but is also relevant for companies that already have that strong ESG leadership or are best-in-class performers. These companies can use peer-mapping as a useful tool to consistently keep their competitive edge. In the risk management area, they could actually identify reallocation of resources and personnel to address core exposure concerns and curb many future non-compliance issues and, overall, improve their managerial oversight.
Adam: Thank you. So now you’ve got leadership behind your ESG efforts, and you understand your company’s current situation. What about developing a strategy? That probably has some people worried. We’ve discussed some of the key elements already, but is this something a company can do on its own?
Shilpi: So, my first response to that is yes. Companies know their own programs better than anybody else. They know their current structures best. But from what we’ve observed, it is certainly helpful to work with specialists. So, those could be external consultants. It could be ESG ratings experts. What they are aiming to get is a team or a stakeholder that can provide them insights about their own organization – not only on their current status, but also the proposed next steps. ESG Ratings providers, they have access to vast research of public and private companies, resulting in data-driven assessments. And the depth and breadth of the ESG expertise can help companies identify their ESG strengths, weaknesses, their gaps, what are the current industry trends, and a lot more.
So, yes, companies can definitely start on it on their own. But I think they’ll know best whether it is something they can internally manage at this stage or they need to draw on the expertise of these ESG research firms, or consulting frameworks from outside.
Adam: Makes sense. And what can companies do to avoid getting stalled during the development of their ESG strategy?
Shilpi: The key thing is to be ambitious, but at the same time be also realistic right? To make sure that there is sufficient transparency is important because that makes them accountable to highlight that performance to their external stakeholders. And at times this progress might not happen as quickly as they might have expected. So, in terms of the roadmap things could have looked different but, practically, reporting and communication delays could have come up, or data tracking, data collection could at times have been a challenge. But the idea is to continue to make progress.
Ensuring that department heads internally – who might not have been directly involved in any ESG topics until now – ensuring that they’re on board with these sort of reporting attempts and the significant amount of time and effort that can be saved. Making sure that these department heads understand why this is being done is also a good way to keep any sort of delay risks at bay and not pause on that ESG strategy and the implementation plan.
Adam: Great. So, we’re getting near the end now. The final focus area is communication and reporting. What do companies need to know about reporting standards? While this is obviously an important factor in an ESG program, I feel like companies shouldn’t let it stand in the way of their progress on ESG.
Shilpi: Yeah, so you’re right there are certainly a lot of global reporting standards that have come up and it should not be a way to actually impede their progress, but actually a way to support companies in reporting. That that is how they should approach it. I mean there are many global voluntary relevant reporting standards in place which are the Sustainability Accounting Standards Board standards (SASB), there’s the Global Reporting Initiative (GRI), there’s the Task Force on Climate-related Financial Disclosures (TCFD). It can get overwhelming for companies to decide which one should they opt for. Some of these standards do include industry-specific aspects or focus on topics which are financially material versus ones that could have external social or environmental impact. Even within the reporting standards, there is a difference as to what they’re trying to achieve. Ultimately, it would be dependent on the company’s size, which industry they’re from, how they are placed geographically.
Adam: So, in terms of reporting are there issues that companies should be looking out for? What are they going to be hearing about from investors and other stakeholders over the coming months?
Shilpi: Given the recent pandemic and certainly the growing importance of the S in ESG, some of the key trends for companies have been to focus on sustainable supply chains, and data privacy, and security. The significance of human rights as well as innovation and product responsibility have become more apparent. Similarly, climate change disclosure, quantified impact of that, and related environmental topics, they do continue to gain momentum and will be something investors and stakeholders scrutinize globally.
Adam: What about disclosure?
Shilpi: For corporates in Europe the corporate sustainability reporting directive, which replaces the Non-financial Reporting Directive (NFRD), that is set to go live in 2023. That targets corporates by introducing updated standards mandating many EU companies to report against ESG metrics.
In March 2022, the US SEC proposed a new climate disclosure rule that is expected to have a major impact on the way companies report their climate risk and it also impacts reporting on scope 3 emissions. It has asked for listed companies to disclose any climate-related risks that could potentially affect their financial stability. This is the first mandatory federal reporting requirement that has been visible in the US.
So, these are regulations that companies should certainly be aware of, depending on how much their market cap is, whether they’re listed, non-listed, and which region they lie in.
Adam: Thanks. Now, I see ESG communication as a process involving ongoing discussions with stakeholders, key internal teams, and the communications department. How should companies plan to communicate their ESG programs?
Shilpi: Yeah, so communication is certainly an important topic, right? Once the company has determined their appropriate criteria for their ESG framework, the next steps are to establish ambitious metrics, measure them on a regular basis, and share progress publicly. This would certainly help avoid any potential greenwashing-related accusations. Overall, companies should be wary of having a PR narrative of high standards for environmental or governance topics, but actually don’t end up walking the talk. This can be addressed by being transparent with stakeholders even if at times you know the performance on certain ESG metrics might not be as good as anticipated.
Adam: So, companies shouldn’t try to sugar coat their efforts. What else?
Shilpi: Keep in mind that investors generally have a number of criteria that they use to determine whether a company is greenwashing or truly integrating ESG policies in their business practices. Companies that are truly committed to executing their ESG policies and to communicate that voluntarily, they should actually be reporting on their progress towards meeting those goals to all stakeholders. That can be done via the annual CEO letter, for example, that some companies do; annual reports definitely are a way to communicate it widely and a best practice; internal corporate communications are also important for internal stakeholders who want to know about how a company is performing on their planned ESG metrics; and annual sustainability reports, which could be on the website or released widely in an integrated format, are another option for companies to communicate very transparently and widely.
Another aspect could be leveraging a recognized third-party rating service which can add credibility to your ESG story. So, these are some of the ways in which companies can communicate their results, their plans, and also their progress transparently.
Adam: Shilpi, thank you so much for this. It’s been very enlightening. Thanks for sharing your insight today and joining me.
Shilpi: Yeah, sure. Thanks Adam. Thanks for having me.
Adam: And thanks to our listeners. I Hope you’ve learned as much as I have. If you want to know more about starting an ESG program, you can visit sustainlytics.com and download our recent ebook called Getting Started With ESG: What Every Company Needs to Know. The ebook looks at what ESG is, why it’s important, the benefits and obstacles, and key actions companies can take.
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