Richard Hartung has over 20 years of experience in the payments and consumer financial services industry with extensive experience in the Asia Pacific region. In May, 2002 Richard founded Transcarta, which focuses on assisting financial services companies with strategy, payments training programs, operations process enhancement, merchant acquiring, market entry research and other business practices. He is also a freelance writer for Today, gtnews, Challenge, The Asian Banker and OOSKAnews. Richard has a BA from Pomona College and an MBA from Stanford University. He is active in community organizations, including on the boards of the Metropolitan YMCA and the Jane Goodall Institute (Singapore).
Driven by customers and investors as well as public demand, companies in sectors ranging from air transport and financial services to beverages and mining are putting more emphasis on environmental, social and governance (ESG) initiatives. That focus on ESG has become essential to acquiring clients, increasing profitability, satisfying shareholders and ensuring the viability of the company. Perhaps surprisingly, companies with better ESG practices are holding up relatively well during the current COVID-19 pandemic and may come out of it stronger.
While calls for responsible corporate management date back to the Quakers in the US in the 1800s and escalated in the 1960s as activists demanded better environmental and social practices, the term “ESG” only came into usage about 15 years ago. And only over the past half dozen years or so has it become a clear focus for leading companies.
Companies and consultants alike have gradually joined the shift towards a greater focus on enhancing environmental practices, improving social impact and developing better governance procedures. European banking giant BBVA, for example, said in its 2011 financial report that the integration of ESG variables into the Group’s risk management is a “new element”, although closely related to traditionally managed risks. Following Hurricane Sandy in 2012, MSCI upgraded its annual ESG Update to an annual ESG Trends to Watch Report in 2013 that focused on the top 10 ESG risks and opportunities.
Last year, consulting firm Bain said that more and more people “view existential global challenges such as climate change, plastics pollution, loss of biodiversity, deforestation, social inequality and water shortages as tangible threats.” And an even more impactful wakeup call came earlier this year when Blackrock chairman Larry Fink explicitly said that climate change has become a defining factor in companies’ long-term prospects and that his firm would make sustainability integral to portfolio construction and risk management, exiting investments that present a high sustainability-related risk
While environmental and social impacts may have seemed existential in the past, they have become more real.
Poor environmental practices can, for example, have direct costs. Just weeks after Greenpeace released its Detox Challenge nearly a decade ago, for example, Nike eliminated all hazardous chemicals across its entire supply chain in order to avoid consumer backlash. In 2017, Thames Water in the UK was fine £20 million for emitting an estimated 1.4 billion liters of raw sewage into the river Thames. Last year, Carnival cruise lines settled a case about environmental dumping for US$20 million.
Insufficient preparations for climate change can hit businesses as well. German chemical giant BASF has had to reduce production because low water levels in canals in Europe caused by a drought reduced its supply of raw materials. Around the globe, these and a multitude of other environmental issues are affecting companies’ profitability, and even survival.
While poor environmental practices can have costs, an increasingly large body of research is also showing that a focus on ESG has positive corporate and financial impacts. Investors are embracing ESG principles across the investment value chain, according to Bain, from identifying targets and due diligence to value creation during ownership. They view it as an opportunity to seek out companies where doing the right things adds value by attracting more customers, cutting costs or avoiding reputational harm.
As Harvard University faculty members Michael Porter, George Serafeim, and Mark Kramer wrote in an article published in Institutional Investor last year, there is also compelling evidence that superiority in identifying and harnessing selected social and environmental issues relevant to the business can have a substantial (positive) economic impact on companies and even entire industries.
Research is also showing that the investment returns on ESG leaders are better than for other companies. A meta-review by Deutsche Bank of about 2,200 studies, for instance, showed that the business case for ESG investing is empirically well-founded, with the large majority of studies reporting positive findings. Similarly, the STOXX index of global ESG leaders has outperformed the STOXX Global 1800 Index by 37 percent over the past 16 years. And when BNP Paribas compares the MSCI World Index and the MSCI ESG Indexes, said senior advisor for responsible Investments Kanol Pal, “there is outperformance in ESG. When we do that in emerging markets, there is much stronger outperformance of the MSCI Emerging Markets ESG Indexes.”
While some observers have had concerns about whether ESG practices and investments can hold up in a down market, experience during the current Covid-19 situation so far indicates that better ESG practices can be beneficial.
The MSCI ESG Leaders index had outperformed the EU benchmark by 180 basis points from the beginning of the year through mid-March, according to the Financial Times, while MSCI’s Japan and US Leaders indices have outperformed by 50 basis points. “The evidence so far suggests that ESG has been more resilient,” Morgan Stanley equity analyst Jessica Alsford told the Financial Times. She said the bank also found that ESG funds have withstood the market sell-off better than most others.
Moreover, companies with better ESG practices may be able to leverage the current situation to improve their corporate performance. Research firm Sustainalytics, for instance, said that with supply chains in China and Italy already disrupted, “we believe the coronavirus will lead management teams to better understand the dependencies of their supply chains and generally improve their supply chain management. Hallmarks of an effective supply chain management system include board-level responsibility for supply chain management, engagement with suppliers on ESG issues and the use of targets to drive performance.” Additionally, Sustainalytics said it does not appear that sustained low oil prices would trigger a relaxation in renewable energy support or investor interest, or meaningfully threaten the long-term fundamentals of the sector.
Successful ESG Initiatives
Initiatives by a multitude of firms in diverse industries and around the globe demonstrate how companies are benefitting from ESG initiatives and provide examples that other companies can use to enhance their ESG performance.
Brewing company Heineken, for instance, is heavily dependent on high quality water for its products. Heineken director of corporate relations Zita Schellekens said her firm has reduced the liters of water used to brew a liter of beer from 5.3 to 3.7, has ensured water waste treatment plants are near more than 90 percent of its operations, and is working to protect water resources in water-scarce areas. It has saved €15m through water efficiency since 2009. It has also invested in activities ranging from reforestation and landscape restoration to desalination and water capture, such as an initiative in Mexico with the Monterrey Metropolitan Water Fund to reduce flood risk and increase the water available to recharge groundwater.
Global retailer Walmart says that its environmental initiatives reduced greenhouse gas emissions by 6 percent between 2015 and 2017, and its Project Gigaton initiative helped suppliers avoid more than 93 million metric tons of emissions over the past two years.
In the financial services sector, BNP Paribas said Sydney Airport received Australia’s first syndicated sustainability-linked loan last year, with the interest rate the Airport will pay dependent on an annual assessment of its ESG risk rating. And along with launching Green Bonds and a Women’s Livelihood Bond program, DBS Bank in Singapore is one of many that has ceased financing new coal-fired power plants.
In the private banking sector, banks such as BNP Paribas and Standard Chartered Bank are increasingly finding that the “second generation” that stands to inherit billions is highly interested in sustainability. Some clients prefer investing in sustainable products, Standard Chartered Bank’s Pal explained, since the investments deliver a high financial return as well as social and environmental benefits.
When KKR bought Unilever’s spreads business in 2018, including Country Crock in the US and Flora in Europe, KKR found that company was heavily reliant on palm oil, which poses environmental issues. Rather than scuttling the deal, KKR decided that building a sustainable supply chain was a point of differentiation and could add value, so it set a goal of sourcing 100 percent of its palm oil from sustainable sources, creating goodwill with consumers while also removing risk from the supply chain.
And KLM airlines has launched a Fly Responsibly campaign that highlights how it is reducing the carbon dioxide per passenger by 20 percent, developing a sustainable fuel plant, offering carbon offsets and even suggesting that customers can fly less.
In sector after sector, companies are finding that good environmental practices can attract customers, save money, build new businesses and improve financial performance.
Innovative ESG Startups
It is not just corporate giants that are working on better environmental performance and raising their ESG rating. Innovative startups are doing the same thing.
Award-winning environment-focused startups at CES this year, for example, included the ST Engineering Innosparks Airbitat Compact Cooler, which it says is 50 percent more effective in delivering cool air compared to conventional coolers, and Edgehog’s solar panels, which use IoT sensors in roof-top solar panels to deliver an average of 15 percent higher output.
Hundreds of other startups around the world are innovating for greater environmental sustainability in everything from agriculture and renewable energy to transportation and retailing.
What Companies Need to Do
The opportunities for companies to have a positive impact on the environment while growing their business and increasing their revenue are massive. As Bain also noted, though, a significant number of companies are still doing nothing or taking the “cover your backside” approach by ensuring that they are compliant with existing regulations and doing nothing wrong in the social and environmental arenas.
Companies that want to do more would do well to start with a sustainability audit or ESG assessment. Once they have the information they need, they can develop a strategy for moving forward. Hiring a chief ESG officer to create an ESG plan and spearhead the initiatives can be beneficial.
To help companies with their initiatives, several firms have developed scoring systems that can help organizations evaluate their ESG status and determine how to improve their performance. State Street, for example, has an ESG scoring system that leverages multiple data sources and aligns them to materiality frameworks. It measures the performance of a company’s business operations and governance related to financially material ESG challenges, then provides a roadmap to improve ESG practices.
While companies may have had an option of embracing ESG practices in the past, actually implementing those initiatives is now becoming imperative in a world reshaped by the effects of the global pandemic. Emerging legislation will likely reflect the bipartisan agreement that companies must do the right thing and take care of their workers while adjusting their businesses to support the greater good of the economy and the environment. Learning from leaders and implementing an effective ESG strategy can grow customers, revenue and profits significantly.
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