Dr. Kaushik Sridhar

ESG: a material advantage

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First published in Pro Bono News.

ESG investing is all the rage. However, aspects can polarise opinion. One of the most heated corners of the debate is the thorny and slippery subject of performance: does ESG investing result in better performance? A seemingly simple question but sadly there isn’t a simple answer.

As ESG considerations are becoming increasingly important in the corporate sector, information on the “best and worst” global companies is becoming more easily accessible.

The term ESG was first coined in 2005 in a landmark study entitled “Who Cares Wins.” Today, ESG investing is estimated at over $20 trillion in AUM or around a quarter of all professionally managed assets around the world, and its rapid growth builds on the Socially Responsible Investment (SRI) movement that has been around much longer. Today, thousands of professionals from around the world hold the job title “ESG Analyst” and ESG investing is the subject of news articles in the financial pages of the world’s leading newspapers. Many investors recognise that ESG information about corporations is vital to understand corporate purpose, strategy and management quality of companies. It is now, quite literally, big business.

Cynics may argue that ESG is just a fad. But a closer look at the forces that have driven the movement over the past 15 years suggests otherwise:

  1. Technology and the rise of transparency are here to stay. Gathering and processing data will become ever easier and cheaper. Smart algorithms will increasingly allow for better interpretation of non-traditional financial information which seems to be doubling in volume every couple of years.
  2. Environmental changes, in particular climate change, will with scientific certainty put a growing premium on good stewardship and low carbon practices as natural assets will appreciate in value over time.
  3. People everywhere are increasingly empowered by technology. ESG investing allows them to express their own values and to ensure that their savings and investments reflect their preferences, without compromising on returns.

The rise of ESG investing can also be understood as a proxy for how markets and societies are changing and how concepts of valuation are adapting to these changes. The big challenge for most corporations is to adapt to a new environment that favours smarter, cleaner and healthier products and services, and to leave behind the dogmas of the industrial era when pollution was free, labour was just a cost factor and scale and scope was the dominant strategy. For investors, ESG data is increasingly important to identify those companies that are well positioned for the future and to avoid those which are likely to underperform or fail. For individuals, ESG investing offers the opportunity to vote with their money. And for policy makers, it should be a welcome market-led development that ensures that the common good does not get lost in short-term profit making at any cost.

Importance of a ‘materiality assessment’

Materiality is a hot topic among ESG professionals grappling with questions of what to report, and how. A materiality assessment is an exercise in stakeholder engagement designed to gather insight on the relative importance of specific environmental, social and governance (ESG) issues. The insight is most commonly used to inform sustainability reporting and communication strategies, but it also is valuable to strategic planning, operational management and capital investment decisions.

Materiality assessments inform reporting in three key areas – disclosure strategy, content design and stakeholder communications. The process inventories, assesses and quantitatively analyses stakeholder perspectives on a company’s ESG performance. Internally, it’s an important tool for making the business case to senior management on why and how to report ESG and other non-financial data.

The issues identified in a materiality assessment touch every aspect of a company’s business model. Analysing stakeholder agendas quantitatively enables a company to determine if an ESG issue is a risk to be mitigated or an opportunity to be pursued, and consequently it guides strategic planning.

Carbon is probably the most mature example. Despite the lack of regulation, many companies already are reporting on carbon management because they believe climate change is an important issue to their stakeholders. Capturing quantitative stakeholder feedback on carbon can validate or change that reporting strategy, but the value-add is realised when the carbon data is viewed through operational and financial perspectives.

Today, ESG has matured to the point where it can greatly accelerate market transformation for the better. As corporations and investors experience growing influence and power, their actions and decisions increasingly shape the future. Provided that political framework conditions based on openness and global rules do not deteriorate further, market-led changes will act as a force for good on a truly massive scale.

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