by Rabia Farhang, founder, and Johanna Masket, co-founder, bgood collective
ESG is not just another name for Sustainability
Leaders of companies and most executives in a business organization have some familiarity with Sustainability and ESG. As we work with clients and speak to business executives, we have found that the difference between the two terms can get blurred at times. In this piece, we look at what each concept means to a business and the implications for leaders. Let’s first start with this: ESG and Sustainability are not synonymous but rather complementary.
“Sustainability puts specific actions in place to create positive environmental and social impacts; whereas ESG is a tool that uses metrics to measure a company’s Sustainability impact.”
Sustainability is a company’s commitment to reduce its negative environmental and social impact caused by its business operation and a long-term strategy to create a responsible business model. It is the overarching umbrella term and covers a wider scope than the ESG reporting criteria. Sustainability strategies are aimed at creating value for the wider stakeholder group including – employees, communities, customers, suppliers, board members, shareholders, etc.
ESG is a set of specific criteria used as a tool to evaluate companies on their environmental, social and governance impact. It was developed by investors but is now used by many as a key tool in measuring sustainability initiatives. Companies use ESG metrics and data to analyze performance, determine progress and gaps and create internal and external reporting. However, a company with ESG metrics in place is not necessarily sustainable- measuring your impact without a strategy to improve it does not get you to a sustainable business model.
What does Sustainability mean to businesses?
(Value creation and resilience)
“CEOs who understand the virtues of strategic resilience know that addressing immediate hardship and building a sustainable future can — and should — be pursued at the same time.”
McKinsey
Companies implementing Sustainability strategies and programs are creating value and leaders are recognizing it. In a recent KPMG survey, 70% of US business leaders indicated that their company’s sustainability & ESG measures improve their financial performance.
Sustainability programs not only create financial value, but they also help future proof companies and position them for long-term growth by building resilience in a company’s operations. Those companies with strong Sustainability programs in place have been found to create topline growth, reduce cost, build resilience in their operations and increase productivity.
The ESG framework as a tool helps to measure and assess the value created by their Sustainability programs. A McKinsey analysis of more than 2,000 academic studies indicated that around 70 percent find a positive correlation between strong ESG and financial returns.
- Products that are sustainability-marketed grow over 5 times faster than conventional products
- Programs focused on waste reduction, improve operating expenses through improved management of operations and resource efficiency
- Companies investing in climate resistant operations build resilience into their supply chains
- Companies with strong ESG ratings and Sustainability programs have greater and less costly access to capital as well as better relationships with local communities
What is driving the focus on ESG recently and does it matter to you as a leader?
There are a few different movements impacting how ESG is being viewed and influencing a company’s approach: the stricter eye of the investment rating companies on facts vs. Greenwashing, the tighter disclosures being mandated by regulators and the use of political posturing to discredit the importance of ESG.
“We are entering a post-greenwashing era with the necessary shift from talking and measuring to acting for serious”.
WEF
The trend is now shifting from declaring a company’s sustainability goals to taking accountability through measurable actions. Morningstar, an investment ratings company, is one example where after a greater level of scrutiny they moved to increase their ESG criteria and disclosure requirements, removing sustainability labels from 1200 funds. Last year, they also found that 23% of funds in the EU that claim to “promote” Sustainability did not deserve an “ESG” label and did not live up to the EU’s Sustainable Finance Disclosure Regulation.
In the US the Securities and Exchange Commission (SEC) has further enhanced its climate related disclosure requirements by adding more stringent mandates for public companies. These will include reporting on direct usage and indirect emissions purchases of electricity and energy sources (Scope 1 & Scope 2) and also emissions from a company’s 3rd party suppliers, customers and partner activities (Scope 3). This means going forward, even smaller non-public companies will be impacted by this change as they will be under pressure from their larger partners or customers to report, meet and maintain certain sustainability standards.
On a last and more recent note, as interest in ESG moves to become more mainstream, and scrutiny increases on ESG reporting, we are seeing that politics have started to play a role as some in the US have started opposing ESG as part of an ideological anti “woke-capitalism” movement. While for Wallstreet and the investment community, ESG is now a commonsense way of evaluating all aspects of a company’s operations, there is a backlash on ESG in political circles. Regardless of this backlash on the investment criteria of ESG, CEOs must find ways to manage the measuring and reporting on a company’s sustainability strategy going forward.
Where is ESG going reporting?
The future of Sustainability and ESG reporting is becoming widespread in the US. More than 96% of the S&P 500 companies now publish ESG reports, and we expect to see more reporting and a greater level of standardization globally with the creation of more stringent international standards (such as the ISSB).
While currently ESG metrics are more heavily focused on climate, social programs continue to be a critical part of sustainability programs. There is a need to build more robust ESG reporting to measure social requirements around topics such as DEI, racial equity, employee well-being, etc. This next phase will drive the need for more measurable and quantifiable performance metrics to track and report more precisely in these areas.
So, will ESG reporting, and measurement criteria continue as we know it today? The answer may not be clear, but the focus on sustainability will not diminish. Simply put, good sustainability leads to a more responsible business and good financial performance. The performance standards and tools may evolve, the terminology may change but regardless of where the political lines are drawn on ESG, the move towards improving a business’ impact on the environment and social issues will continue to remain critical in the future.