Why CFOs need to focus on ESG

TODAY, individual and institutional investors alike are acutely aware of ESG: a company's environmental, social and governance performance. For some, this is a matter of ethics - a desire to invest more consciously. For many others, it comes down to a belief that companies failing to address matters such as diversity or emissions simply cannot survive in today's marketplace and regulatory environment, making them a poor investment.

In the very near future, a company's financing rates will be directly linked to its ESG performance. Up until even just a couple of years ago, if a financial institution was considering making a loan to a company, it would have looked at basic indicators such as revenue, costs, profits, and so forth. Today, ESG performance will inevitably be considered as a key part of that appraisal process, too.

Similarly, as insurance companies are now frequently hit by climate-related claims, their rates are increasingly linked to ESG climate exposure and corporate climate performance. Companies' insurance rates and premiums are starting to be directly linked to their climate and carbon targets.

For these reasons, ESG should be front of mind for every company CFO. This is no longer a marketing or PR concern - although companies that treat their employees fairly, are kind to the environment, and transparent with stakeholders will certainly have significant advantages in branding, publicity and communications.

ESG is a financial matter, something that needs to be accurately tracked and measured, its results quantified. These are areas where the CFO thrives and must take ownership.

In a January 2010 letter to fellow CEOs, BlackRock's Larry Fink stated: "Climate change has become a defining factor in companies' long-term prospects… But awareness is rapidly changing, and I believe we are on the edge of a fundamental reshaping of finance." What Mr Fink meant was that ESG will soon become integrated into all financing.

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That process is already rapidly progressing. In September 2020, one of Asia's most forward-thinking banks, DBS, agreed to convert Swire Pacific's existing five-year revolving credit facility of HK$2 billion (S$341.4 million), into a sustainability-linked loan. This will allow Swire Pacific to reduce the interest rate payable by meeting certain ESG goals in areas including diversity, energy consumption and water usage.

In April this year, DBS's Taiwan arm loaned NT$1 billion (S$47.5 million) to tech manufacturer Wistron Corp, pegging the loan's interest rate to Wistron's sustainability performance.

Clearly, in the short space of time since Mr Fink made his remarks, things have moved at lightspeed. In early 2010, the market was very carbon-focused.

Now, the purview has widened to become more ESG-savvy, looking at aspects beyond emissions. There was a lack of understanding of the ramifications of that broader view, even a year ago, but a good CFO will doubtless understand what ESG truly means now.

The environmental aspect of ESG has been on the radar for many years, but social came into stark focus during the past 12 months. This was especially true in the United States with recent political, racial and gender-related issues, controversy over the source of funding, labour or materials (for example, Chinese cotton, Saudi money, or dealings with Myanmar) and a growing wariness among companies of being targeted by the press or social media activists. These factors are also important in other Western countries, but in Asia, they are less prevalent than matters of governance - the systems, rules, processes and practices of running a company.

Here in Asia, companies tend to take a pragmatic approach to ESG compliance. During my own recent conversations with the CFO of a major Singapore-based company, their fundamental concern was in better tracking and quantifying the company's ESG efforts, as this would allow them to secure improved interest rates on financing.

They probably did care about leaving a better world for future generations. But they were keenly interested in the effect of ESG and its more efficient tracking on their bottom line.

CFOs will appreciate that ESG pays off in a number of ways. When a company can properly track its ESG performance and accurately report results, this will not only help the business secure more favourable financing interest rates and insurance, but also boost customer loyalty and selection, and by appealing to the growing number of ESG-focused funds and investors, improve share price. All these factors are bound to lead to higher executive compensation.

In fact, ESG is being directly figured into pay and bonus calculations. According to a recent study by London Business School and PricewaterhouseCoopers of pay plans disclosed in FTSE 100 companies' 2020 annual reports, 45 per cent of the UK's 100 largest companies now use an ESG measure in setting targets for executive pay.

A similar report, published in June 2020 by advisory, broking and solutions company Willis Towers Watson, showed that about half of S&P 500 companies' incentive and compensation plans incorporate ESG metrics in some form.

Soon, in many countries, ESG reporting will not be a 'nice to have' - it will be essential. Nearly every nation on earth has committed to the Paris Climate Agreement, and governments and regulators are stepping up their actions to meet the accord's goals. In October last year, South Korean President Moon Jae-in and Japanese Prime Minister Yoshihide Suga announced their countries' aims to achieve carbon neutrality by 2050. President Xi Jinping of China, meanwhile, has set a goal of eliminating net carbon dioxide emissions by 2060. Where these industrial giants go, other countries will follow.

Equally, in the corporate sphere, we are seeing the likes of Samsung, Apple, Microsoft and Ikea setting aggressive targets across multiple areas - carbon positive, water positive, forest positive, and so on - and most large corporates will have to emulate these practices eventually.

Major companies are putting enormous pressure on the supply chain, demanding that suppliers improve the way they work and meet ambitious targets, conscious of the fact that environmental issues impacting suppliers may well cause problems all the way down the line.

In parallel with the growing importance of ESG, forward-thinking organisations are beginning to welcome into the C-suite a chief impact officer or chief climate officer, tasked with overseeing these ever more critical areas of a company's performance.

These roles should operate in tandem with the CFO, who with his strategic, analytical mind, is ideally suited to helming a company's ESG initiatives - and their vital financial interplay.

• The writer is CEO and co-founder of Equilibrium World