Dialogue Q4 2021

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STRATEGY RETHINKING ESG

Cutting through the fog ESG is centre stage in many businesses – yet many leaders are unclear about core concepts. A new framework offers clarity Writing Marc Kahn & Sharmla Chetty

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oday’s businesses ignore environmental, social and governance (ESG) considerations at their peril. Changing consumer demand, investor expectations and regulatory requirements are rapidly transforming the business environment from one in which profit trumps people and planet, to one in which these exist interdependently and in mutual support. Yet for many leaders, ESG remains shrouded in fog. Despite sustainability experts’ best attempts to explain ESG, many business leaders still have limited clarity about what it means for their organization in practice, and what they ought to be doing about it. Businesses with an active and deliberate ESG approach reap numerous benefits. Deloitte research in the UK found that 34% of consumers chose brands with environmentally sustainable practices or values in 2020-21, while a 2019 Schroders survey found that 61% of Generation X always consider

ESG performance shapes how firms compete for customers and increasingly for talent, too

sustainability factors when selecting an investment product. And most leaders are familiar with the power of social media to help ethically-driven movements mobilize rapidly, and to destroy business reputations overnight. Think of the impact of MeToo, or how Greta Thunberg has inspired young people around the world. Not only does ESG performance shape how firms compete for customers: it increasingly affects their ability to compete for talent, as values-driven Millennial and Gen Z employees seek responsible, purpose-led employers with sustainable business models. What’s more, ESG metrics have been accurate indicators of stock volatility, earnings risk, price declines and even bankruptcies. According to research produced by Merrill Lynch, ESG could have helped investors avoid 90% of bankruptcies, and an investor who only held stocks with above-average ESG scores would have avoided 15 of the 17 major corporate bankruptcies that markets have witnessed since 2008. And ESG is increasingly affecting capital flows. The Financial Times reported that responsible investment funds saw net flows increase by 275% in 2020 compared to the prior year, and 2021 looks like it will beat that record. It’s clear that ESG will play a central role in markets in the near future, and access to capital for companies without good ESG credentials will be very limited indeed. Understanding ESG metrics, data and reporting is thus becoming critical for businesses as they engage with stakeholders and attempt to meet their demanding expectations – yet a recent PwC survey found in nearly three-quarters of organizations, leaders are only “in the early stages of their ESG journey”. The report praised the record of companies such as Adobe, Salesforce, Microsoft, Procter & Gamble and Best Buy, and emphasized the importance of ESG to strategic reinvention, business transformation and reimagined reporting. Yet a lack of leadership attention or support was identified as a barrier to ESG effectiveness by 33% of those surveyed. The reality is that many leaders remain uncertain, confused or uninformed about ESG and what it means for their business.

The POPP framework for ESG Through his work at Investec, Marc Kahn has developed a simple ESG framework that has helped leaders cut through that uncertainty and confusion. He had found that many people were making the mistake of thinking that Environment means climate; that Social means people; and that Governance means compliance. Those oversimplifications are ultimately incorrect. The misunderstanding was causing confusion and misalignment between leaders, and leaving members of the sustainability team frustrated. Kahn’s framework addresses this by capturing

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