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Don’t forget the social and governance aspects, when it comes to ESG

In a bid to tackle climate change, companies often forget the importance of the other two letters in that acronym. But that’s all about to change

Climate is critical but organisations shouldn’t lose sight of the social and governance elements of ESG (environmental, social and governance). That’s the clear message from Mazars consulting partner, Liam McKenna. “Climate change and the risks associated with that is probably the topic that most people would pick as the number one ESG issue,” he notes.

“The EU Green deal aims to boost the efficient use of resources by moving to a clean, circular economy to restore biodiversity and cut pollution. But even within this well-known area people may not realise the ambitious targets that have been set by the Green Deal such as 30 per cent of the land and sea area in the EU being protected for biodiversity and so on.”

What people may be less aware of is the social and governance aspects of ESG. “The social element is about fairness, addressing gender pay gaps, supporting a living wage for all, protecting human rights, providing a safe and healthy workplace, treating people right.”

And many smaller companies may not realise what’s coming down the track at them very quickly in that regard, he explains. “For example, Unilever has committed to a living wage for every person in their supply chain by 2030. That means if you want to do business with Unilever you will have to demonstrate that you help it deliver on this commitment. I wonder if small and medium-sized Irish companies are aware of the commitments made by their key customers and if these commitments have an impact on them.”

Access to capital is also becoming more dependent on a company’s ESG credentials. “Approximately 70 per cent of the world’s investment funds worth about $103 trillion is now managed by signatories to the Principles of Responsible Investment (PRI),” McKenna points out. “The PRI website lists all the signatories and about 30 per cent of them signed up in the last year. It’s growing very rapidly. If you are not able to meet the requirements of the PRI, you may limit your access to capital and the value of your company.”

Governance is possibly the least known element of ESG but it is vitally important, as McKenna explains. “It’s about transparency, executive pay, protecting minority shareholders, preventing and tackling corruption, honest accounting, running the business with integrity. As ESG becomes a standard part of due diligence weaknesses in these areas will have significant valuation impacts on businesses. One of the first principles of ESG is transparency. Whether it’s about your people or how you run the business, it’s all underpinned by honesty and openness.”

Sustainability is fast becoming a prerequisite for business success. “We are not quite there yet,” he says. “In five years’ time, it probably will be a prerequisite. There is a small window of opportunity now for companies to catch up. It is clear that the world will be powered, fed and resourced differently in the future. Ignoring sustainability and other ESG issues will reduce access to capital, people and customers while increasing business costs and generating compliance risks. Businesses need to react quickly to remain competitive.”

Regulatory change will play a part in the shift, but not as big as many people think. According to McKenna, the pace is being forced by large global corporations, consumers, and investors who are all asking about it.

“People who are thinking about ESG from a compliance perspective are probably being naïve; compliance requirements will lag behind customer and investor expectations,” he says. “It’s too important an issue to be dealt with like that. ESG makes business sense. I would be concerned for businesses looking at it from a compliance perspective. If they are doing that, they will have already missed the boat. The world will move on and it will be very hard to catch up. Others will have taken their place by the time they do.”

You need to have some sort of policy. You start by looking at where you can have the biggest impact

The agri-food sector is a particular concern for Ireland when it comes to the environmental aspects of ESG, and McKenna does see a willingness to tackle the issue. “Farming communities care for the land and respect it. They recognise the threat of climate change, but they have to protect their livelihoods as well. A new generation of farmers is coming through and they are looking at how to do things differently. There is a willingness to recognise the problem.

“We speak about transition risk and physical risk,” he continues. “The farming community faces significant transition risk. Farmers understand the importance, but they need the transition to happen in a controlled and fair way.”

For organisations starting out on their ESG journey, McKenna says the first step is to understand where the organisation is at present and identify areas for improvement. “There are many frameworks that support ESG and the most well-known is probably the UN Sustainable Development Goals. But there are also frameworks from the PRI, the International Labour Organisation, the UN Global Compact and many others.”

Mazars has built a tool that allows an organisation to self-assess its ESG position. “The Mazars Sustainability ESG Health Check helps companies understand the importance of ESG engagement and measurement and how it can lead to value creation and behavioural change,” he explains. “It’s a 15- to 30-minute online check which asks several questions and delivers a report and recommendations for action based on the answers.”

That report can be used to develop a policy and a strategy. “You need to have some sort of policy. You start by looking at where you can have the biggest impact. Look at those impacts you have and see where you can do better. Those actions could be focussed on electricity or water or other areas. Social and governance aspects are important as well. The policy will drive progress. And there must be recognition that it’s not just about compliance. If you follow that, you will fall so far behind you will quickly become outdated.”

In this series of the Future of Business, Vincent Wall and Mark Kennedy, with the help of several specialist guests will be assessing the growing importance of ESG, that's Environmental Social and Governance issues for businesses. Listen now: