ESG strategies: Time for intentional and collaborative execution
The inherent risk of profit-centred and unethical practices remains high in the Next Normal.
By Roshni Gajjar, managing director, founder StratAstute Consulting.
There is a short road to 2030. Decision-makers in government, business and civil society have eight years to steer economic growth in a more holistic manner, in a way that preserves environmental capital and builds social capital, in the best interests of the planet and its people, so that wealth creation remains possible for the current and future generations.
Economic collapses, oil spills, pandemics, mass job losses and corporate scandals come and go. We read the headlines and follow the related legal cases until the next big story – we believe that “it will never happen to us”. Until it does.
Think about the 2008 sub-prime crisis affecting mostly the western countries versus the current Covid-19 global pandemic (socio-economic), BP’s Deepwater Horizons oil spill in 2010 preceded by the Exxon Valdez spill in 1989 (environmental, governance), the Volkswagen emissions cheating scandal in 2015 and the Daimler recall in 2018 (environmental, governance), Johnson & Johnson’s baby powder safety scandal in 2018, followed by the Purdue Pharma Opioid scandal in 2019 (social, governance). Turning to tech, Facebook became Meta in 2021 and the Theranos “fake blood test” story came to a final fall in 2022. Wirecard, Steinhoff and Enron should have never happened under the watch of highly skilled board members, auditors and lawyers.
But these scandals happened because the numbers looked great and undue trust was placed in the leaders to “do the right thing”.
The inherent risk of profit-centred and unethical practices remains high in the Next Normal – the theory of constraints fuels the natural human instinct for survival, which feeds competition and greed. Leaders are not excluded. Presidents, corporate boards, executives and investment officers serve five-to-10-year terms in well-functioning democracies. ESG strategy, on the other hand, is a long-term game.
Catastrophic events or hard legislation seem to trigger strategic change in the ESG space; it is forced. Granted, the disruptions and challenges facing leaders today are complex, transition strategies are costly and external factors are extremely uncertain. Many businesses do have well-articulated ESG strategies in place and apply good corporate governance principles.
Having led investor relations, ESG and integrated reporting strategies, the reality is that companies issue impressive sustainability reports to key stakeholders, but focus on delivering the best financial returns in the shortest time frame for shareholders. That is how we measure successful businesses.
We are at a tipping point. The economic burden of climate-related disasters has increased by 82 percent over the past two years. At the 2022 Davos Agenda, UN Secretary General Antonio Guterres cited some alarming statistics:
- Extreme weather cost $20 billion in insured losses, killing 10,000 people in 2021;
- Climate shocks caused 30 million people to flee their homes, three times more than the number displaced by war and violence; and
- At the current level of activity, emissions are set to increase by 40 percent in the next decade, a period during which emissions need to be reduced by 45 percent to limit temperature rise to the 1.5°C target.
When future generations study the decisions implemented by leaders today, will they thank us or curse us? The strategic choice rests with those who hold the mandates and the purse strings. We all have a part to play to ensure that leaders act responsibly – in parliaments, in virtual boardrooms and in our home offices.
Purpose versus profits
In his 2021 Letter to Shareholders titled the Power of Capitalism, Larry Fink, chairman and CEO of Blackrock, identified that great companies have a clear purpose, consistent values and recognise the importance of actively engaging with key stakeholders. This is in the pursuit of long-term value creation and sustained prosperity.
“The next 1,000 unicorns won’t be search engines or social media companies, they’ll be start-ups that help the world decarbonize and make the energy transition affordable for all consumers,” he wrote.
Purpose and profit are equally important and mutually supportive, especially if we envisage continuing to live and work on this gentle planet, Earth. Without purpose, an organisation becomes reactive to short-term risks and opportunities. Without profit, organisations and the people they employ stagnate. Organisations will either sink in or sync to this new normal, unless buy, hold or sell decisions are based on more appropriate criteria that give equal weighting to healthy profits and demonstrated evidence of good ESG governance in the investee’s value creation models.
“At this pivotal moment, I see several priorities for the global agenda. We must continue to fight against the global pandemic. We must revitalise the global economy and accelerate its transition to net zero. We must preserve biodiversity by deploying nature-based solutions, and we must know the gap between the rich and the poor, to achieve more sustainable global development,” World Economic Forum founder and executive chairman Klaus Schwab has said.
Legislation, policies and strategies alone will not mitigate ESG risks. A systemic reframing and alignment of purpose is required as it informs boardroom decisions, strategy execution, business models, consumer choices and human connections. Related strategies must be referenced to top global, country and organisational risks to ensure long-term relevance.
The ESG knowledge gap
The pandemic has accelerated the priority for real, impactful action. However corporate leaders admit that they lack the skills to steer the “how”.
During the fourth quarter of 2021, board directors representing 301 companies across 43 countries responded to the survey conducted by the INSEAD Corporate Governance Centre and Heidrick & Struggles. Close to 75 percent of responding companies were based in North America and Western Europe. The results revealed that:
- 75 percent of respondents believe that climate change is important to the strategic success of their companies;
- 63 percent of respondents understand the strategic risks and opportunities presented to their companies by climate change; and
- 72 percent are confident that their companies will reach their stated climate change goals.
Some progress has been made, but the survey results raised concerns about the commitment and ability of boards and CEOs to shape, steer and execute climate change mandates, as indicated below:
- 43 percent of companies do not yet have clear targets for reducing carbon emissions or were unsure about their company’s position;
- 16 percent of respondents indicated that there was no identified person responsible for reporting climate change to the board;
- 84 percent do not have targets for carbon emissions that fall outside of their direct control but which impact their company’s value chain;
- 69 percent of responding companies do not include climate change in the board competency matrix;
- 65 percent confirmed that climate change knowledge was not a formal requirement for CEO selection; and
- 74 percent of companies do not sufficiently integrate climate change into their executive performance measures.
Boards are well positioned to advance climate change commitments, but are not able to deliver on them. If the reported trends continue, the World Economic Forum’s 2050 Net Zero target is unlikely to be met.
The Sustainable Development Goals (SDGs) define the key priorities to sustain lives and livelihood. Providers of capital are in a strong position to influence ethical capitalism, on behalf of stakeholders. Decision-makers across the private and public sectors must do what is necessary to achieve consensus regarding the key strategic priorities, enabling policies, capital allocation models and consistent disclosure frameworks to drive and track progress, consistently. To this end, work has commenced, but the time to 2030 is rapidly ticking and the business-government-civil society agendas remain misaligned.
ESG requires an integrated and collaborative approach
The transition to greener sources of power and fuel is set to cost $3.5 trillion or 1.8 percent of global GDP. Financial capital allocation remains unequal – as at October 2021, the value of sustainable investments reached $4.0 trillion, largely allocated across the developed markets, in accordance with a Morningstar, Simfund, Broadridge report.
An African proverb says, “If you want to go fast, go alone; if you want to go far, go together.” In progressing responsible, purpose-driven ESG strategies, structured, long-term funding will be required to finance related projects, particularly in emerging economies such as Africa.
In a world with fragmented trust in leadership, glaring economic inequalities and the consequences of narrowly targeted recovery plans, constructive collaboration is required to progress ESG strategies that co-ordinate:
- A common vision of the “end-game” among regional and city leaders, aligned with the SDGs;
An appetite for business-to-business collaboration and effective public-private partnerships for scaled impact at a sector level, supported by enabling legislation and policies;
- Accountability measures to track and unlock shared value over the future (<20-year strategies) and the deep future (20- to 50-year strategies) and required upskilling of boards for effective oversight;
- Certainty of funding sources to build, scale and continuously improve future-fit solutions that accelerate reform inclusively, particularly in historically self-funded or under-funded sectors of the economy, such as start-ups, SMEs and the informal economy; and
- Wide access to educational programmes to raise the awareness and frame the relevant context that informs effective ESG forward-planning, using a risk-based approach to formulating and funding ESG strategies.
- “The last two years have demonstrated a simple but brutal truth: if you leave anyone behind, in the end we leave everyone behind,” Antonio Guterres, Secretary-General, United Nations has said.
The ESG problem is too big to leave to a concentrated group of leaders. Collaboration is the key to addressing the underlying causes of the socio-economic turbulence that we have inherited from the previous generation of leaders. Barriers to collaboration in the private and public sector need to be identified and reduced so that courageous leaders can be unlocked from their organisational silos and ivory towers to serve a greater good. This includes legislation such as competition or anti-trust laws .
The United Nations’ Race To Zero initiative is an example of global collaboration among non-governmental leaders in business, cities, asset management and higher education institutions to drive a resilient, zero carbon recovery, aligned to the Paris Agreement, and the initiative is supported by the Financial Sector Expert Group to advise on implementation guidelines in the financial sector. This type of initiative enables scale-up and viable mobilisation of ESG projects outside of government.
From a responsible investment perspective, 70 asset owners, representing approximately $10.4 trillion assets under management have signed up to the Net Zero Asset Owners Alliance (NZAOA), formed under the United Nations’ Principles for Responsible Investment (PRI), to influence the actions of long-term investors to transition investment portfolios to net-zero greenhouse gas emissions by 2050.
This is an important step forward but requires greater traction in the southern hemisphere countries, with only representative organisations in Africa and Australia respectively. The South African PRI office has started with active engagement with asset managers and corporates. The Alliance structure and workstreams support:
- Monitoring, reporting and verification;
- Active engagement between asset managers and corporates regarding transition pathways;
- Policy development and advocacy; and
- Financing technology innovation and solutions.
- Participation and collaboration are strategic choices which must serve the organisational purpose in the long term while supporting profit or funding objectives in the short term.
- Effective collaboration models rely on trusted and committed partnerships where participants share long-term risks for long-term rewards. A defined collaboration framework, transparent performance indicators and comparable reporting enable success.
Progress towards harmonisation of monitoring and reporting frameworks
There is an old adage – what you measure, you achieve. It is no different in the space of ESG strategies. Three ESG reporting frameworks are widely used to aid disclosure and comparability of non-financial performance indicators across companies, in addition to corporate governance frameworks such as the King Codes in South Africa:
- Global Reporting Initiative (GRI) for stakeholder-relevant climate change, human rights and corruption disclosures;
- Sustainability Accountancy Standards Board (SASB) for the disclosure of financially material sustainable information by companies to their investors; and
- Task Force on Climate-related Financial Disclosures (TCFD) for reporting climate-related financial information.
Under the leadership of Bank of America’s Brian Moynihan, the World Economic Forum is working with the International Business Council and the “Big Four” accounting firms towards a single reporting framework.
“As you get these things standardised and investors won't be confused, then society won't be confused. Then people will be able to be held accountable in a consistent fashion, and that's the goal we have,” Brian Moynihan, chairman and chief executive officer of the Bank of America has pointed out.
In South Africa, the Johannesburg Stock Exchange (JSE) has been a leading advocate for ESG reporting since the launch of the Socially-Responsible Investment Index (SR) in 2004. During 2021, it recognised the need for clear reporting guidelines to address the South African context in relation to global best practice and issued the Climate Disclosure Guidance, which closes for comment on 28 February 2022, to:
- Assist local companies to navigate the ESG landscape;
- Reflect South Africa’s sustainability challenges;
- Inform effective ESG performance, accountability and business leadership; and
- Contribute to enhanced transparency and consistency of disclosures for investors.
Policy papers, guidelines and frameworks issued by regulators are helpful and will give momentum to well-meant ESG intentions. However, cohesive public-private partnerships and trust in leadership are vital to progress impactful ESG outcomes by 2030. We must be sure that the leaders we entrust today will contribute and continue to support a long-term plan, beyond their terms in office.
Next generation thinking for Africa
Former president Kgalema Motlanthe delivered a keynote address to delegates at African Corporate Governance Network’s ESG and Stakeholder Capitalism in Africa seminar during January 2022. He spoke about the need to reimagine the concept of capitalism along three axes as are relevant to the needs, challenges and capabilities in each country, without application of a one-fits-all approach, namely:
- Rethinking our way of living in nature;
- Addressing the causes of the destruction of the ecological basis of the planetary commons if we consider the importance of climate justice as a basis of a new ecological constitutionalism for the world; and
- How we manage the world’s resources as a building block for next generation human development.
South Africa is the 12th largest emitter of greenhouse gas, according to the Global Carbon Atlas. On a continent rich in natural resources, good governance and purpose-driven leadership are key to attracting and retaining investments, growth opportunities and future-fit talent. Ethical leadership is an insurance against exploitation and corruption which have, to date, harmed the African investment case. The King IV Guidance Paper on Responsibilities of Governing Bodies in Responding to Climate Change, offers some support to directors in South Africa.
Leaders need to act and serve stakeholders in a way that shifts behaviour – legislation and regulation are merely enablers. The “I” in leadership and investment models will need to shift to the “Why” to deliver on the SDG objectives.
There is a compelling case for inter-generational representation on boards, in policy advocacy groups and think-tanks. If the minds that caused the ESG problem are the same minds that are entrusted to build the “next normal”, we may think we are moving fast, but we are unlikely to get very far by 2030.