Investors are realizing the benefits of having access to information on a company’s performance in terms of non-financial topics.
ESG refers to the zoomed out, holistic view of a business and its overall practices, in terms of governance, environmental and social issues. Despite a popular belief that ESG is just the latest fad and will fall out of fashion as quickly as it arrived, there is significant evidence to show the immense benefits that identifying, measuring, monitoring, improving, and reporting on ESG metrics can have on all sectors. According to research conducted by Emerging Portfolio Fund Research, Socially Responsible Investing (SRI) and Environmental, Social, and Governance (ESG) investments recorded increased inflows from $63.34 billion in 2019 to $168.74 billion in 2020 (Rani and Pandey, 2021), indicative of a surge in sustainable investment.
The need for transparency and disclosure in business stems, in part, from the Wall Street Crash of 1929, whereby the U.S. Securities and Exchange Commission was established with the hope of positively influencing corporate behavior and protecting investors. This saw a demand in the need for standardized information regarding a company’s financials, and in a way, financial disclosures can be considered as a foundation of capital markets.
It is in this same vein that investors and trustees are now realizing the benefits of having access to information on a company’s performance in terms of non-financial topics such as governance, social issues, and environmentally sustainable practices. Whilst corporate governance has long existed to give context to financial disclosures and insight to investors on the board, lately there has been a rise in interest in issues beyond corporate governance. Interest has manifested, for example, in how executives and boards of directors are facilitating the reduction of environmental footprints and the upliftment of local communities. Investors are seeing the link between access to ESG disclosures to give context to a company’s performance, and its potential future trajectory. Risks are easily identifiable through the ESG lens which provides a broader view than a pure focus on financial disclosures, in-turn allowing for more informed decision-making.
With the growing knowledge we have access to in terms of environmental and social risks, there is a greater appreciation for open communication and public disclosure of detail around pertinent, material ESG topics. For example, an investment fund may opt to place its money in a mining operation that has shifted to greener energy sources and has found a safe and sustainable manner for recycling its mine and general waste products, as opposed to investing in a mining operation that is currently emitting large amounts of greenhouse gases with limited or no plans for impact mitigation and future sustainable practices.
In addition to responsible investment on a pure morality basis, there are numerous investment benefits. The shift away from traditional financial analysis means that risks not previously identified can now be easily uncovered e.g. the risk that an operation may have to halt temporarily or permanently, and incur high costs due to reduced water availability (Patsky, 2016). The analysis of ESG performance incorporates added objectivity to assess an asset for future vulnerabilities. Henisz, et al. (2019) summarized the investor benefits of ESG into five points:
- Top-line growth – Exploring new markets, and growing markets that demonstrate responsible sustainability practices and good governance via “business-to-business and business-to-customer” attraction.
- Reduced costs – Reduced resource usage through the incorporation of efficiencies to ensure reduced cost and a diminished environmental footprint.
- Reduced regulatory and legal interventions – Increased awareness of ESG risks leads to heightened awareness of potential issues that can incur fines or legal proceedings. This reduces the monetary risk, as well as the reputational risk, that arises with legal contraventions.
- Increased employee productivity – Positive social practices and good governance within an organization will encourage retention of employees, as well as attract new talent. Motivated employees have increased productivity levels and greater job satisfaction (Magloff, 2021).
- Investment and asset optimization – Increase in return on investment through allocating funds to growing companies that are “future-proof” and sustainable over the long-term.
It may appear that adopting these “newer” practices is risky or seems to lack reward, due to the limited history of ESG disclosures or the evidence of material benefits. However, the foresight that ESG disclosure and analysis affords cannot be gained by viewing the financial disclosures exclusively. The implementation of positive ESG practices translates to the financials in terms of profits and cost-saving strategies, but to gain a full picture, must be viewed together with the non-financial disclosures.
Over and above the financial implications of improved sustainability practices, there is an increased moral obligation on companies to leave behind a positive legacy. Improved social awareness, rectification of previous inequalities and community development, reduced impact on the environment, and the implementation of projects that will preserve resources and improve the natural environment are all hot topics that are of interest to investors and consumers alike.
In alignment with the financial disclosures that were traditionally reported on by companies, there are several frameworks and standards that have been established which have drawn from these and created ESG disclosures on financially material topics. It’s now easier than ever for a company to report useful sustainability data that has the potential for economic impact in terms of value creation or reduced costs.
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IsoMetrix offers multiple crucial functionalities for effective ESG management. Overall system centralization eliminates silos of information within an organization and allows you to collect data, report on multiple ESG standards and frameworks, and proactively manage your business risks, all in one place. This holistic view of the entire process of ESG reporting makes it easy to standardize information and analyze ESG data for optimization across different business units.