Key ESG practices to watch out for in 2023

Jan 3, 2023

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Introduction

Environmental, Social, and Governance (ESG) are the three pillars of non-financial reporting that aid companies in presenting a holistic view of their operations. They encompass all the risks and opportunities that companies face and the overall impact they create on the economy. Although ESG has been around since the 19th century, it gained momentum in the decade that began in 2010. It was during this time period that Sustainability Accounting Standards Board (SASB) was founded, the United Nations Sustainability Development Goals (UN SDGs) were launched and the Task Force on Climate Disclosures (TCFD) was established. These advancements paved the way for corporates to adopt ESG practices in the 2020s.

As per a working paper published by Harward Business School, which studied the reports of Standard and Poor (S&P), the percentage of firms who voluntarily disclose their ESG practices has increased from 35% to 86% from 2010 to 2021.

This blog looks at exploring key ESG practices and issues that are expected to dominate the ESG landscape for companies, investors, and regulators, in the near future.

Key ESG practices

Climate change

As per a report published by Robeco, in March 2022, it was found that investors view climate change as the most important ESG factor. 24% of the investors surveyed, said that climate change is at the center of their investment decisions and 51% said that it is a significant analytical factor. These figures are up from 26% and 47% in 2021. As climate change becomes evident, an increasing number of investors around the globe are accounting for factors like decarbonization, biodiversity, and active ownership before building their portfolios.

Additionally, governments across the world are introducing stringent climate-related regulations. As a result, companies in all sectors are becoming compelled to commit to net-zero emissions. Proactively addressing climate risks will help companies seize new opportunities and position themselves as climate leaders.

The next phase of good governance

As companies strive to meet the traditional good corporate governance practices like improving the quality of the Board, ensuring shareholder rights, and developing management incentive structures, environment, and social governance will be in the limelight for investors and Boards. Corporate Social Responsibility (CSR) initiatives will no longer encompass solely giving back to society but will also include sustainability practices that enhance shareholder value. Further, as the importance of sustainability for investors grows, there will be formal and harmonized metrics introduced to measure a company’s impact on the environment and society. Sustainability experts will become an essential presence on the Boards of many large corporations.

ESG disclosures

ESG disclosures are soon expected to become harmonized and widespread. Intensified pressure arising from rising stakeholder awareness will serve as a major catalyst for change. Regulatory pressure is also expected to take shape in this segment as the adoption of ESG practices becomes mandatory. Existing ESG standards, including the SASB and the TCFD disclosure, may lay the groundwork for mandated reporting, but they are expected to further develop in the coming decade. Moreover, diligent regulation of the data provided, its verification, and consistent assurance will also play a key role in the times to come.

ESG investing

Thematic investing, which is investments in themes or assets specifically related to sustainability (e.g., clean energy, green technology, etc.), is now widely being considered by investors. As per a study carried out by Robeco, 70% of the investors are currently implementing thematic investing while 22% will consider it in the next 2-3 years.

Changing investor interests will lead to specialist investment advisors transitioning from mere ESG considerations to ESG incorporation. Factors such as materiality assessment, stakeholder engagement, and risk analysis will become crucial for investment advisory and impact the flow of financial capital into companies. Identification of greenwashing will also become a vital aspect for asset managers. Further, regulatory initiatives such as the EU action plan will also play a key role in ESG investing.

ESG engagement

Stakeholders are increasingly engaging with companies to cover different aspects of their activities and ensure that they are ESG compliant. Wealth management companies are now expecting their investment advisors to undertake leadership in undertaking reforms in companies and embedding responsibility in the Boards of companies with respect to high standards of ESG practices. This can be inferred from the recent letters of the CEOs of Blackrock and SSGA which urge their members to undertake a proactive stance and look beyond the company’s actions and systematically measure ESG performance.   

Activism for better governance

While financial factors play an important role in companies’ value, many activists believe that the company’s ability to generate superior returns depends on sound governance practices. Weak ESG practices and poor internal functioning will all be used as arguments against companies that fail to generate adequate value. Corporate governance practices are expected to be given towering importance as activists urge companies to look beyond financial results and focus on the creation of a positive impact.

Data and technology

With modernized technology, companies will be able to measure, calculate and monitor ESG factors and analyze their significance and impact on long-term value creation. Machine Learning and Artificial Intelligence will play a key role in recognizing parameters that lead to better economic performance. Additionally, companies would be able to accurately measure challenging factors like resource consumption and biodiversity.

Diversity and inclusion

It is expected that in the times to come, companies will look beyond boardroom diversity and inclusion and extend it to the general workforce. Factors such as equal pay, equal opportunities, and the general working environment are already aggressively being monitored. Overcoming gender disparity would become an important responsibility for large companies.

Executive compensation

A greater part of executive compensation is expected to move from time-based to performance-based pay and stocks would only be realized post the fulfillment of the given criteria. Compensation assessment is likely to be revised to rely less on proxy advisors/third parties and to account for performance metrics. Going forward ESG considerations are likely to be at the forefront when deciding executive compensation especially when these measures can drive up financial and shareholder returns.

Increased pressure to adopt ESG practices

International and national politics, in addition to public pressure to adopt ESG, will compound together to exert influence on ESG trends. Geopolitical tension across the globe, trade wars, nation-wise sanctions and public pressure exerted via regulators may further weigh down on companies to adopt ESG practices. Companies that fail to inculcate ESG practices within their operations could face monetary fines, reputational damage, and loss of customers. As per a 2021 PWC survey, it was found that 83% of consumers are more likely to buy from companies that are ESG compliant and 76% said that they discontinue relations with people who treat people, employees, or communities poorly.

What do these ESG practices mean for organizations?

The substructure for the adoption of ESG practices and its reporting has been laid out. The pressure to inculcate these practices within organizations is immense and experts expect most of these practices to be mandated in the next 10 years. Companies that adapt ESG practices in letter and spirit, with agility, will likely gain a competitive edge over others.

Showcasing leadership in the ESG domain will enhance a company’s value creation process and allow it to analyze its own risks and build on existing opportunities. This will lead to better access to capital, operational efficiencies, and economic growth.

However, merely adopting ESG practices is not enough. Companies need to be able to communicate them to their stakeholders – effectively and transparently.

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