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Over time, consideration of ‘sustainability’ as an input to business decisions has significantly evolved. Likewise, the acronym describing the ‘framework of the moment’ has evolved including CSR (corporate social responsibility), TBL (triple bottom line), to the current format of ESG (environmental, social and governance). While history suggests there will be another acronym in time, let’s not get distracted by that now.
‘Sustainability’ is, in essence, a company’s efforts to ‘do better’ or ‘do good’. Whereas ESG, despite all the mystique surrounding it, is essentially a discipline or way of thinking around core pillars of long-term value creation, cutting across functions within your business. That’s not to downplay the complexity of integrating ESG with enterprise strategies, governance, and risk frameworks. Done well, it should enable you to make informed investment decisions that will maximise long-term enterprise value and unlock access to capital, markets, and people. Done poorly, you will increasingly be called out for ‘greenwashing’, with the prospect of a knock on the door from the Australian Securities & Investments Commission (ASIC).
One of the most fundamental shifts brought about by the introduction of ESG frameworks is to move sustainability from a self-congratulatory exercise that seeks to mitigate some externalities (with effort often capped at basic compliance requirements) with no disclosures, to internalising the risks and opportunities as part of a consideration of longer-term enterprise value. Environmental and social impacts were historically measured qualitatively as a footnote to financial outcomes, whereas we now see disclosure obligations being developed by the International Financial Reporting Standards (IFRS) Foundation that will require material ESG risks and opportunities to be identified, quantified and captured. These could be in the form of financial statements, independent sustainability reports, or operating or financial reviews.
ESG has shifted the conception of a business’s primary objective from Milton Freidman’s narrow focus of maximising shareholder returns, which often discounted impacts on environmental and social outcomes, to recognising a broader objective captured in the concept of stakeholder capitalism. That is, investors, employees, customers, suppliers, and regulators are all part of the complex stakeholder ecosystem that will determine the long-term value of a business, and environmental and social impacts affecting each of these stakeholders must be weighed and embedded in decision-making.
With ESG currently a hot topic of conversation, we look at three key sustainability themes we’re watching as we move into the new financial year:
Firstly, the half-life of ESG issues is shortening. While climate change has been on the scientists’ radar since the middle of last century (if not before), it’s really only been across the last five years or so that we’ve seen an exponential increase in global ambition at a political and business level around net-zero and the pace of transition. And as we saw in the recent Federal Election, the Australian public is baying for action on climate change, and the new Australian Government appears committed to take action.
Land, water and other natural resources have long been seen as a resource to be exploited as a means to an end. However, now with greater recognition of the value of natural carbon solutions and ecosystem services, we expect that biodiversity will be the next ‘climate change’-esque issue of significance—quite possibly at a faster velocity.
And after a long and inglorious history of engagement with First Nations people, a commitment from the Albanese Government to constitutional reform to reflect the Uluru Statement. This is not to say the journey is complete – in fact, we’re far from it. Now, more than ever, businesses should consider whether the journey of reconciliation together with First Nations people forms part of their sustainability journey.
As we can see, ESG themes will continue to evolve at different paces, and the materiality of different ESG issues will vary across entities and their stakeholders, but the critical factor for success in all scenarios is a business’s preparedness for rapid change.
ESG disclosures are currently voluntary, and there are over 500 different frameworks available globally. However, the IFRS has created a new standard-setting board, the International Sustainability Standards Board (ISSB), which has released exposure drafts for two initial global standards for capturing material climate and sustainability risk in financial statements, with the Australian Accounting Standards Board (AASB) closely following.
If you haven’t already started thinking about sustainability disclosure, or want to mature the depth of your disclosures, now is the time to start. Consider: who is your audience for disclosure? What disclosures and actions are important to your stakeholders/audience? Which framework will you use? How do you prepare for the implementation of mandatory reporting requirements? And how adequate is your current data management, data governance and data security to service these disclosure requirements?
And finally, ‘Green Swans’. Borrowing the concept from author John Elkington ('Green swans: the coming boom in regenerative capitalism.'), ‘Green Swans’ is the idea that unforeseen events or systemic shifts can actually be harnessed to simultaneously deliver positive economic, environmental and social outcomes. The COVID-19 pandemic has often been classified as a ‘Black Swan’ event. But was it really unforeseeable? And if we had foreseen it, what plans or contingencies would we have put in place?
We know that the true worth of ESG practices doesn’t stop at simple reporting metrics; real value for a business is gained through its reputation, risk management, opportunity management, culture and employer value proposition. BDO’s 2022 Middle Market CFO Outlook survey in the US showed that “CFOs are pursuing growth with a lens on sustainability and stakeholder capitalism”. In fact, 64% of respondents believe that ESG will improve their long-term financial performance. Now is the time for Boards and leaders to create the space and governance to encourage truly lateral thinking for the creation of long-term enterprise value.
ESG reporting is more than ticking a box in search of corporate acceptability with investors or fund managers. It is about the discipline to deeply consider ‘E’ and ‘S’ and ‘G’ issues in your investment decisions and communicate these with your ecosystem of stakeholders such that you can continue to access capital, markets and people in a rapidly evolving corporate landscape.