Environmental, Social and Governance (ESG) and what it means for your business

Environmental, Social and Governance (ESG) are three increasingly popular headings being used by businesses to frame the activities being undertaken to demonstrate they are sustainable, responsible, and well run.

 

ESG is not a fad, it’s here to stay. Not following the principles of ESG will be problematic for long term, sustained business success.

 

 

ESG – Your business driving licence

 

To drive a car, you need a valid driving licence, and you must also follow the rules of the road each time you get behind the wheel. But what are the ‘rules of the road’ to follow when managing a business? And what actions does a business need to take to ensure it not only keeps it’s ‘licence to operate’ but also thrives under the pressure of increasing societal, environmental, and regulatory scrutiny?

 

The table below outlines a synopsis of each of the three headings along with a general description of the typical commitments businesses make to direct ESG action and make progress.

 

Table 1. The 3 pillars of ESG and associated high level commitments.

 

E Environmental	S Social	G Governance
The impact a business and its services have on the environment	The value that the organisation creates for employees, customer, and communities	The system by which all value adding business activities are directed, controlled, and measured
Associated high level ESG commitments
Reduce carbon emissions	Increase customer satisfaction	Generate profit and returns
Use less resources and generate less waste	Enhance the employee value proposition	Minimise risks and liabilities
Minimise biodiversity loss	Generate positive outcomes for communities	Drive a culture of continual improvement

 

If a business can demonstrate it’s making material progress in ESG by investing into and embracing the challenge of being socially responsible and sustainable they can be compensated in many, varied ways:

 

• Reduced costs - by helping to address rising operating expenses (such as raw-material and energy costs).
• Increased trust - when customers trust companies, they are more likely to award contracts to them.
• Employee retention - ESG can help companies attract and retain quality employees and enhance employee motivation by instilling a sense of purpose.
• Reduces absenteeism - safeguarding the health and wellbeing of the workforce reduces absenteeism.
• Build a broader range of customers - an organisation that encourages equality, diversity and inclusion better serves a broader, diverse range of customers.
• Open up new markets - a strong ESG proposition helps companies to tap into new markets and expand into existing ones.
• Enhance investment returns - a well set out ESG strategy can enhance investment returns by allocating capital to more promising and more sustainable opportunities.
• Reduced legal interventions - good governance results in reduced regulatory and legal interventions.

 

 

Is ESG a distraction to the real purpose of a business?

 

ESG and the complementary notions of sustainable development and social responsibility have consistently encountered doubt and criticism from many. Milton Friedman, an American economist and statistician, stated, “there is one and only one social responsibility of business - to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game”. In this article ("The Social Responsibility of Business is to Increase its Profits" The New York Times Magazine, 1970) Friedman goes on to say, “the discussions of the social responsibilities of business are notable for their analytical looseness and lack of rigor”.

 

ESG, along with the inconsistencies associated with its interpretation and application gets in the way of what businesses are supposed to do, which is to make as much money as is reasonably possible. Whilst the above quote is often used to discredited ESG and its relative importance to business, the key point often missed by critics is in the interpretation of ‘staying within the rules of the game’.

 

 

A social licence to operate – the new ‘rules to the game’

 

Activities under the banner of ESG can also be described as a social licence to operate. Organisations don’t just require regulatory permission, but also ‘social permission’ to conduct business or follow the new ‘rules of the game’. A social licence to operate is created slowly and methodically through an organisation building-up legitimacy, credibility, and trust. To maintain this licence a business must ensure that its decisions and actions don’t have negative effects on society and the environment:

 

• Following the principles of sustainable development, including the health and welfare of people.
• Complying with law and being consistent with international norms of behaviour.
• Ethical practices being integrated throughout the business and practised in relationships.

 

The three points above could broadly be positioned as external pressures organisations are compelled to address, crucially these pressures are increasing on many fronts. The requirements placed on medium to large companies around reporting of non-financial aspects are becoming more stringent. Environmental policies, targeted at curbing carbon emissions and biodiversity loss are prevalent, along with greater challenge around social issue such as equity, diversity, and inclusion. These pressures applied through regulations and international norms of behaviour also pervade customer expectations and decision making on the types of organisations they wish to conduct business with.

 

A social licence takes time to build up, but it can be very quickly lost through irresponsible or unethical actions. Customers are less inclined to buy products or services from unscrupulous operators and investors don’t want to be associated with organisations that are repeatedly breaking the law and not following the rules of the game. Social and environmental non-governmental organisations (NGO’s) are also quick to call out such organisations, inflicting harmful negative publicity upon them.

 

 

Obtaining an ‘ESG driving licence’

 

Before you undertake a practical driving test in the UK you must first pass your theory test. Most of the theory test is devised from the Highway Code and helps learners understand the fundamentals of driving.

 

There isn’t a theory test to running a business nor is there an equivalent to the highway code but there are rules and regulations that need to be followed. The fundamentals of running a business are not only dictated by law but also by your stakeholders. Stakeholders are individuals, groups, or parties that have an interest in an organisation and the outcomes of its actions. In the case of stakeholders and understanding the fundamentals, what interest they have in your organisation, is often done through a process described as a materiality assessment which serves as a foundation for a comprehensive approach to ESG because it helps companies understand the issues that are of most importance to its stakeholders.

 

Once the materiality assessment has been undertaken and the key material issues are well understood the next steps are to set out actions against each issue within the business strategy and approach. The integration of ESG into a business strategy includes setting specific targets and goals. In addition, ensuring everyone in the organisation understands their role in contributing towards the successful achievement of the ESG targets that have been set.

 

 

Keeping your ‘ESG driving licence’

 

The final step to obtaining a driving licence is to take your practical exam alongside a driving examiner. Arguably, the true evaluation of good driving isn’t necessarily the exam itself, more following the rules of the road each time you take to the wheel. Bad drivers that don’t follow and the rules of the road and put others at danger can be banned and have their driving licence revoked.

 

Equally, a business’s social licence can also be revoked through irresponsible and unethical actions. To maintain legitimacy, credibility and trust an organisation must continually adhere to its ESG principles. They should measure and report on the progress there are making to their key stakeholders, ultimately demonstrating their continuing commitment to being a socially responsible and sustainable organisation.

 

 

ESG, is here to stay

 

ESG is far from a passing phase – it is at the heart of how better organisations, in every sector, do business. 

 

Rob Macdiarmid 

Head of ESG ReddeNorthgate PLC