The 2020 EY Climate Change and Sustainability Services (CCaSS) fifth global institutional investor survey found that an overwhelming 98% of investors surveyed evaluate non-financial performance based on corporate disclosures. Among them, 72% said they conduct a structured, methodical evaluation.
Yet, it appears that ESG considerations have not been adequately addressed. Investor dissatisfaction with ESG risk disclosures has risen since 2018 and 86% of investors dissatisfied with environmental risk information received said it is critical for disclosures in this area to improve.
With the growing importance of sustainability in business, corporate executives are hard-pressed to embrace a paradigm shift away from the sole purpose of generating profits for shareholders toward advocating sustainable development and long-term value creation in their organisations.
Integrate ESG considerations for growth, cost efficiencies
The Business and Sustainable Development Commission estimates that the achievement of the UN Sustainable Development Goals could result in at least US$12 trillion ($16.1 trillion) worth of market opportunities a year for the private sector by 2030. This represents about 10% of the global GDP forecast for that year. Corporate executives who succeed in integrating ESG considerations as a core driver of their corporate strategy and differentiating their organisations within the global sustainability ecosystem will be well-positioned to capitalise on these opportunities and generate new revenue streams for their businesses.
The increasing influence of environmental and social factors on consumers’ purchasing decisions has also allowed sustainable companies to charge higher price premiums on their products and services, commanding a greater share of the wallet of existing customers.
At the same time, integrating ESG considerations as part of company decision-making often leads to operational and process efficiencies within the business, thereby helping to improve profitability. This can typically be achieved through better resource management policies to reduce and eliminate wastage, sustainable supply chain management practices to reduce the environmental impact across the value chain and costs, and the cultivation of an innovative culture to reinvent existing processes.
This is corroborated by an EY analysis, which measured the profitability of the top sustainable corporations in the world based on Corporate Knights’ 2020 Global 100 ranking against that of their respective industry medians. Sustainable companies in the ranking outperformed their industry peers on gross profit, ebitda, ebit and net profit metrics. These companies recorded higher ebitda and net profits than their peers for 73% and 61% of the industries analysed respectively, with the extent of outperformance ranging from 3.1 to 6.3 percentage points.
Sustainability commitment and lower financing costs
Another factor linking sustainability to value creation is the impact of corporate sustainability on a firm’s cost of capital. Companies that focus on corporate sustainability tend to be less vulnerable to systematic risks. This, in turn, results in higher risk-adjusted returns for investors.
For example, a company that considers ESG-related metrics in its operations would be cushioned from the impact of increasing regulations due to heightened government scrutiny of the environmental impact of economic activities. Corporate executives in such a company would already have measures in place to mitigate the impact of operations on the environment, thereby reducing the burden of new legislation on the business.
According to Bloomberg, global ESG assets are on track to exceed US$53 trillion by 2025, accounting for more than a third of projected total assets under management for that year. Most institutional investors incorporate ESG considerations in their investment framework and apply negative or positive screening techniques to integrate ESG elements with traditional financial analysis. Against this backdrop, companies that demonstrate a strong commitment to sustainability will be viewed more favourably by these providers of capital, and therefore have access to more sources of financing at a lower cost. Investments in ESG-related initiatives undertaken by companies may also be valued at an “ESG-specific multiple” that is at a premium compared with the rest of the business.
Operationalise the sustainability agenda
Embarking on the sustainability journey entails an end-to-end, iterative process. This starts from board-level conversations of an organisation’s raison d’être, cascades down to the management decisions on their portfolio strategy and capital allocation, and ultimately influences day-to-day activities.
The Long Term Value Framework, conceptualised by the Embankment Project for Inclusive Capitalism, offers a path forward for companies that are keen to articulate a compelling and actionable sustainable value-creation story to stakeholders. Importantly, this would involve the identification, monitoring and reporting of relevant metrics to communicate the organisation’s progress toward its desired long-run outcomes for stakeholders. It would also involve the corresponding augmentation of related IT infrastructure, data collection and analytics capabilities to support such initiatives.
Stakeholders increasingly hold corporate executives accountable for their organisation’s role in sustainable development. Rather than advocating fringe programmes with the sole intent of assuaging stakeholders, companies should drive a comprehensive approach to integrate the tenets of sustainability into the firm’s activities to help maximise long-term business value.
Andre Toh is EY Asean valuation, modelling & economics leader. The views in this article are those of the author and do not necessarily reflect the views of the global EY organisation or its member firms