AS businesses are reshaped in the wake of the pandemic, environmental, social and governance (ESG) performance will be more prominent in investment decisions.
According to the 2020 EY Global Institutional Investor Survey, 98 per cent of investors surveyed indicated that they were adopting a more disciplined and rigorous approach to evaluating organisations' non-financial performance. Moreover, 72 per cent stated that they conduct structured, methodical evaluations - a significant increase from the 32 per cent who said the same in 2018.
Amid the market volatility arising from the Covid-19 pandemic in 2020, ESG-related investments (both funds and indexes) have resiliently outperformed benchmarks. MSCI analysis on an "ESG leaders index" showed continued outperformance.
ESG performance can directly impact a company's ability to create long-term value.
Boards should therefore steer management to chart a course that actively identifies and manages ESG risks and capitalises on potential opportunities. They can do so in three ways.
Assess material ESG risks and opportunities
Organisations should engage with internal and external stakeholders, and look beyond their operations to identify material risks and opportunities. The value chain - including manufacturers, suppliers, distributors, and customers - should be reviewed.
Partnerships with upstream and downstream stakeholders are essential for a holistic sustainability approach. For instance, many Singapore contractors struggled with manpower shortages in 2020, following border restrictions that left their migrant workers stuck overseas.
The rest of the workers had to work longer hours with overtime pay, more subcontractors were used at higher cost, and projects were dropped when companies could not meet their clients' prices.
Emerging technologies can help companies connect more closely with their suppliers, collect more granular data, and achieve greater transparency in their supply chains.
An example is Unilever's partnership with Google to use satellite imagery, cloud computing and artificial intelligence to provide insights on the impact of the company's sourcing activities on the environment and local communities.
Boards can steer the management to prioritise the various risks and opportunities, by considering how likely they will occur over the short, medium and long-term horizons, and the extent of their respective financial, operational and reputational impacts.
Benchmark and measure outcomes
Companies should seek to benchmark their sustainability practices against industry leaders or learn from others in adjacent sectors. Often, it is useful to have a first-mover advantage to gain a differentiated strategic advantage.
Measurement and reporting of outcomes are key to continual improvement and investor communications. Boards should request that management develop and report on ESG performance metrics for material risks and opportunities - and further link these to key performance indicators and executive compensation.
City Developments, for example, links ESG performance to the appraisal and remuneration of its heads of department and line managers.
Setting performance measures to drive behaviour can help to engender greater accountability for an organisation's sustainable goals and practices.
Also, companies that are seeking financing may find the ability to include clear ESG metrics in the terms and conditions of financing arrangements useful.
Some banking institutions are now integrating borrowers' sustainability risk and performance into their risk assessments; companies with demonstrable metrics may then benefit from better lending terms and consequently, enjoy lower costs of doing business.
The World Economic Forum released a universal set of ESG metrics and disclosures to measure stakeholder capitalism in September 2020.
The identified metrics and disclosures align existing ESG reporting standards and allow companies to report on them regardless of their industry or region. This enables them to better demonstrate long-term value creation.
Moving forward, the IFRS Foundation is also exploring how it might contribute to the development of global sustainability standards for ESG reporting.
Integrate ESG into risk management
The pandemic has highlighted the very issues driving ESG concerns - managing resources, sustainability, community impact and wellbeing.
Investors will be keen to know if an organisation's governance frameworks are adequate to deal with crises, how the management is thinking about risk scenarios, and if such thinking is part of the organisation's risk management processes and strategy.
The Committee of Sponsoring Organizations of the Treadway Commission, in collaboration with the World Business Council for Sustainable Development and EY, has released a guidance paper on applying enterprise risk management to ESG-related risks.
In Singapore, the Monetary Authority of Singapore has also issued guidelines on environmental risk management for banks, asset managers and insurers in December 2020.
Climate change, culture, diversity and inclusion, and transparency will remain important, even after the Covid-19 pandemic.
Boards and management will need to revisit their stakeholders' views and needs post-pandemic, and the implications this can have for their business and the ESG issues and actions to prioritise.
Boards should assess if the company has the right culture, knowledge, skills and resources in place to drive the sustainability agenda.
Clearly, ESG issues must be addressed more decisively and communicated more coherently if organisations want to gain stakeholder confidence and build corporate value.
Investors will ask tough questions about the organisation's ESG performance and expect answers to be found in its corporate strategy and execution - and not just corporate speak.
- The writer is a council member of the Singapore Institute of Directors.