There is a misperception that sustainability is just about climate change and the environment. As Laura Heuston, Co-Founder of boutique sustainability firm Sustainability Works and Module Coordinator for IOB’s Professional Certificate in Responsible and Sustainable Finance, points out, “In practice sustainability is about creating an equitable society, a healthy planet and a thriving economy. While we tend to think first and foremost about protecting the planet when we hear the word sustainability, it is about much broader than that. It covers social, environmental and economic issues and is about the balance of all three.”
The other common myth about sustainability is that it can hurt the bottom line—that for a business to be sustainable, it must favour environmental and social factors over economic return. In fact, there is growing research to suggest that businesses with better Environmental, Social and Governance (ESG) scores record stronger financial performance. “Companies are recognizing that the world is changing and they need to adapt to stay relevant and remain in business,” Heuston says. With the transition to a low-carbon and more sustainable economy estimated to hold trillions of euro in opportunities, sustainability is becoming a tool for companies to grow profitability. Here are seven benefits for businesses that embrace sustainability and align their sustainability strategy to their business strategy.
“There is lots of evidence that good performance on material ESG issues is correlated with good corporate financial performance,” Heuston says. The US ratings agency Morgan Stanley Capital International (MSCI) provides an ESG index which compares the performance of companies with high ESG performance relative to their sector peers. “ESG leaders have outperformed their peers for the last several years. This trend has continued in recent years and throughout Covid-19,” she explains. “MSCI research has also shown that ESG stocks are lower risk, which we’ve seen again during the Covid downturn.”
According to McKinsey, evidence is emerging that a better ESG score translates to about a 10 percent lower cost of capital as the risks that affect your business, in terms of its license to operate, are reduced if you have a strong ESG proposition. This is apparent in both debt and equity capital markets and also in relation to bank lending. For example, green and sustainability-linked lending is on the rise. Pioneered by Lloyd’s Bank in 2016, green loans often have a lower lending rate for companies that commit to improving their performance on sustainability measures. A number of Irish banks and financial institutions have stepped in to the market in recent years with lower cost green and sustainability-linked loans available for businesses.
Risk management is a key aspect of sustainability, so it is no surprise that businesses are using ESG concepts to improve their approach to identifying and mitigating risk. “Traditionally financial reporting has looked backward, now companies must look forward and assess what issues like climate change mean in terms of risk and opportunity over a longer time horizon than would usually be used for business planning” says Heuston.
The rise of environmental risk is a key consideration for companies. By way of example, Heuston points to the global risk register—published annually by the World Economic Forum— which is often referred to by companies to identify about the most pressing external risks. “Over the last 13 years, economic and geopolitical risks are being replaced by environmental. Climate change tops the risk agenda. It is striking harder and more rapidly than many would have expected,” she says. Sustainable companies are not only assessing their impact on climate change, but the impact that climate change will have on their business and supply chains. This month global credit agency Moody’s warned that increasing environmental and social scrutiny by customers and regulators of the apparel industry will create long term challenges. The agency highlighted the need for companies to adapt to sustainability, invest in decarbonization and increase sourcing transparency.
Regulators and policy makers are more interested in ESG because they need the corporate sector to help them solve global challenges such as environmental pollution and workplace diversity. This is driving an increasing raft of sustainability-related legislation and regulation, including requirements around corporate ESG reporting. On 21 April 2021, the EU adopted a proposal to extend the scope of mandatory ESG reporting to a broader range of ESG topics and applicable to a greater number of companies.
New rules to be introduced by banks in July 2021, at the request of the financial regulator, will require banks to consider ESG-related risks and opportunities when granting and subsequently monitoring loans to businesses, thereby putting an onus on borrowers to provide that information. “There is increasing pressure on companies, coming from both governments and financial regulators, to demonstrate the steps they are taking and contribution they are making to sustainability. Transparency and accountability are fundamental to this discussion and companies with clear sustainability strategies will benefit through reduced effort required in the reporting phase,” Heuston says.
As customers become more aware of sustainability related issues, there is an opportunity for sustainable brands to gain advantage over their competitors. For example, Heuston says that Unilever’s ‘Sustainable Living’ brands—those that promote positive change for people and the planet – outperformed Unilever’s other brands. “These brands grew more than 69% faster in 2018 than the rest of the Unilever business,” she says. The push to improve sustainability can be seen among businesses supplying into large corporates as well as those supplying consumers. Large companies are seeking to drive sustainability through their supply chain and so expecting more from their suppliers in terms of ESG credentials. Businesses with stronger sustainability credentials are simply more likely to attract customer loyalty and new customer segments.
A recent study by MMC found that top employers have significantly higher ESG scores than their peers. The findings suggest that ESG performance can help companies attract prospective employees and improve employee satisfaction. The US-based firm predicts that ESG performance will become increasingly important to attracting and retaining talent.
If you were to look at the organizations that truly stand out from the pack today as clear leaders within their industries, they all embrace innovation. These innovative leaders include relatively new organizations such as Amazon and Stripe—which changed processes at the core of their industries in order to disrupt the status quo—as well as stalwarts like Microsoft and Apple, which have been around for decades. The drive to improve sustainability can actually help foster innovation in a company through thinking about how to improve efficiencies, workflows, supply chains and operations in response to sustainability challenges and trends. The transition to a low carbon economy offers great growth and innovation opportunities for business.
The financial reward for sustainability is clear, says Heuston. Most succinctly put by Bridges & Eubank in their 2020 book “Leading Sustainably”, we are seeing businesses embrace sustainability “for profit, purpose, and survival”.
Whether you’re a newcomer to sustainability concepts or an ESG enthusiast, IOB’s Professional Certificate in Responsible and Sustainable Finance will help you understand more about the evolving nature of ESG factors within financial services.