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How could it be that in a world where most are still thinking that purpose of companies is to make profit, the new buzzword in the business world, ESG, does not have another “E,” Economic, in it?
The term has come about in a world where finance already dominates, and profits are in serious peril if companies are not taking care of their environmental, social, and governance risks.
More recently, in the last three years, the world’s largest institutional investors have started to act on the insight that they cannot sustainably invest their clients’ money, because there is no way to diversify away from ESG risks – the whole world is in peril.
As a result, investors have demanded that their portfolio companies create value beyond profit. So companies must remain profitable, but now profit must be created by generating wellbeing for people and regenerating the environment. In order to achieve profit without harming people and planet, governance provides the framework.
Beyond finance – double materiality
Through governance, you determine what impacts on people and planet are acceptable. You also determine the implication that changes in society and the environment have on the companies’ purpose, how they generate value, and through what strategies you achieve your goals. In this way, boards determine what’s material, or important, in both financial and non-financial terms (eg greenhouse gases, waste and pollution, resource depletion, working conditions, health and safety, employee relations, etc).
In other words, boards determine what risks and opportunities, financial and non-financial, are important and should be acted on – that is known as double materiality.
Relevant? Surely this is a fad
The relentless rise in ESG references, conditionalities for receiving investments, regulations, consumer demands, and high-risk liabilities for directors will only accelerate for the foreseeable future.
Why? Companies’ philanthropic activities – "giving back" to communities – were always welcome, but did they affect the fundamentally unsustainable nature of the core business?
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We are experiencing the results of the unsustainable nature of our growth, consumption and incomplete accounting. UN secretary general Antonio Guterres called on all of us to "get serious" because the recent Intergovernmental Panel on Climate Change report is a "code red for humanity."
Guterres said a recent UN report made it clear that if countries adhere to their present national climate commitments, emissions will go up by 16 per cent by 2030, and that will condemn the world to a temperature rise of at least 2.7 degrees above pre-industrial levels – "a catastrophe."
To have a chance to limit temperature rise to 1.5 degrees, as agreed in Paris in 2015, we need to achieve a decrease in emissions by 45 per cent by 2030!
Gradually and then suddenly
Ernest Hemingway had one of his characters in his 1926 novel The Sun Also Rises give an apt response to the question “How did you go bankrupt?"
“Gradually and then suddenly.”
Even if the Caribbean contributes only minuscule amounts to total greenhouse-gas emissions, our forests, oceans, coral reefs, cities, economies and people are deeply embedded within the world that is heating up.
Hurricane patterns are changing, sea levels are rising, coral reefs bleaching, income inequalities widening, poverty rates remain too large, consumer demands and expectations are changing, the financial system is transforming, energy sectors are on a roller-coaster – this pattern of increasing uncertainty and disruption will not slow down.
Companies, like economies, have a choice – freeze, stare into the headlights and hope the oncoming force will disappear, or change what and how we do things.
How can we get there? If every organisation, every leader, examines how consumer needs, nature and society are changing, perhaps we can uncover the risk and opportunities that change holds.
Bill Gates reminds us: “We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten.”
If you still have doubts
If you still have doubts, consider these facts: inflow to "sustainable funds" increased by 18 per cent year on year in the EU, and for the first time more than 50 per cent of funds in the EU are earmarked for "sustainable" investments.
Financial market regulators are not only increasing ESG disclosure requirements but also issuing warnings to all ESG funds of the need to improve. The Edelman Trust Barometer of last year found that 87 per cent say customers, employees and communities are more important than shareholders to a company’s long-term success.
There are many companies making radical improvements – take for instance, Phillip Morris International, which not only aims to stop producing cigarettes but has a new and bold purpose: to solve societies’ problems from smoking combustible cigarettes. Its strategy is "to unsmoke the world" – "to change society and deliver a better, smoke-free future with no combustible cigarettes" (along with becoming carbon-neutral in direct operations by 2030). The aim is not only to stop selling combustible cigarettes, but to work with governments, regulators, NGOs, and public at large to disrupt the entire industry over the next ten-15 years!
In case you think any new target will do, recall the experience of Shell, the energy company, in May this year: a Dutch court ruled, in a landmark response to a lawsuit brought by climate-change activists, it was not enough that Shell committed to being net-zero by 2050 (in 29 years), but it must reduce greenhouse gas emissions faster – 45 per cent by 2030 (so in nine years) based on 2019 levels.
Dr Axel Kravatzky is managing partner of Syntegra-ESG LLC, vice-chair of ISO/TC309 Governance of organizations, and the co-convenor and editor of ISO 37000 Governance of organizations – Guidance. Comments and feedback that further the regional dialogue are welcome at axel.kravatzky@syntegra-esg.com
 
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