Six Strategies for Building the E in ESG

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Holistic approaches to managing risk, engaging stakeholders, adapting to change and taking on new opportunities are keys to leveraging this business and societal imperative.

Public scrutiny of the way in which corporations incorporate environmental, social and governance (ESG) practices into their business strategies has been rising over the past decade. That scrutiny reached an inflection point in 2020 as the COVID-19 pandemic focused a spotlight on many social aspects of ESG management. Investors responded by pouring nearly $1.7 trillion into funds that focus on ESG issues, driving related assets up by a remarkable 29 percent in the fourth quarter alone.

Coincidentally, the pandemic’s impact also drew greater attention to environmental issues. As a result, business leaders have become hyper aware of the public’s expectations and the role that sound environmental practices can have on company performance, including mitigating risk, creating market differentiation and providing competitive advantage.

More than 85% of companies see COVID-19 as a catalyst to accelerate or materially enhance their approach to ESG and sustainability Source: FTI Consulting Resilience Barometer

Rationale for Good Governance

It’s become evident over the past year that overall concern for the well-being of the environment correlates directly to corporate viability. In essence, societal and business imperatives are intertwined.

Consider climate change. As the world witnesses its negative effects materializing into more-extreme weather patterns, stakeholder scrutiny of environmental issues rises concurrently. Ignoring environmental risk can directly impact long-term financial resilience as it starts to affect access and cost of capital to corporations.

Mismanagement of environmental problems also impacts corporations’ access to talent. New generations want to work for companies whose values are aligned with their own priorities. As a 2018 Gallup poll showed, 22 percent more 18-34-year-olds reported being concerned about the threat of global warming during their lifetimes than those aged 55 or older — highlighting a potential gap between societal trends and business thinking.

The corporate shift toward environmental concerns may be most pronounced in the energy sector, where renewables outpaced fossil fuel growth in 2020 for the first time. Wind and solar energy sourcing have become cost competitive, and alternative and evolving technologies have dramatically ramped up, driven by investments across corporates. Additionally, green hydrogen as a source of power and storage is moving toward mainstream, solar deployments have hit record levels, carbon capture has evolving clout and many countries are pushing regulatory and physical infrastructure in favor of electric vehicles.

Good Governance Is Key to Success

The link between the “E” and business value has not always been immediately clear. But a core tenet of success is the integration of environmental factors into a company’s established risk evaluation process and the ability to set targets and monitor progress against them. Business leaders must evaluate how environmental impact will be perceived, the influence on commercial prospects and the business case for making investments or policy changes to maximize success.

Such a transition cannot happen overnight of course; there are material implications to manage, from workforce dynamics and technology to shifting regulatory structures and operating standards. This is where the governance of an environmental strategy comes into play. Every major decision a company board makes involves risk, and implementing an environmental strategy is no different.

The following are useful considerations for organizations that can address a business and societal imperative without undermining their relationships with stakeholders and their ability to create value. The transition is not about eliminating risk, but rather managing it, taking on new opportunities as appropriate and mitigating threats to business.

Stakeholder engagement must be a fundamental aspect of any strategy to address environmental risk and opportunities. Companies should aim to engage extensively and creatively, listening to stakeholders — workers, suppliers, consumers, regulators, communities and investors — and bring them on the journey in a way that authentically addresses trade-offs and maximizes benefits.

Review and Embed New Policies

Commitments and ambitions on environmental efforts must be accompanied by robust and rigorous policies that are effectively communicated and actioned throughout the business. All employees, particularly those who oversee operations, should be trained and educated on the scope and aims of those policies. Leaders need to ensure that the policy structures of their organizations evolve alongside their operating environments. Sustainability must move from corporate policy to corporate culture.

Optimize Your Operations

Following an authentic path to sustainability is key. That means minimizing energy usage, procuring from low-carbon generating sources and replacing what is used with carbon offset programs, all while minimizing costs and holding business partners accountable. Board and management teams must constantly ask whether energy can be provided or consumed in a more sustainable fashion, which will in turn lead to cost efficiencies and reduced risk over the medium to long term while protecting value.

Be Proactive with Data

The ability to assess progress must be a foundational part of environmental strategy. Without effective target setting and data collection, management will be less efficient in driving behavior. Further, the board’s ability to oversee strategy development will be impaired and will negatively condition stakeholders’ views.

Enhance Education of Your Board

Knowledge of sustainability and environmental risk should increasingly form a part of board recruitment and education. Sustainability as a key success factor is a nascent concept, and a board that does not have a fundamental understanding of this materially new area is at risk of strategic decision missteps. Consistent focus on the skill set of directors is a cornerstone of an effective board, one that is capable of overseeing strategy in a rapidly changing environment.

Drive New Business Strategy

Companies will also benefit by ensuring that directors not only oversee but also drive the company’s environmental strategy. This strategy should be positioned as a core aspect of the company’s vision and values. In addition to managing the risks described earlier amid this mounting pressure to decrease emissions, there is a growing opportunity for companies to capture new value. For some companies this may be about gaining a cost advantage through their own or their suppliers’ energy efficiency improvements. For others it may be about new sales or increased margins from low-carbon products and services, or even more fundamentally, securing a long-term business future, as some products will not be possible in a net-zero world.

Engage Stakeholders and Communicate

As companies assess internal structures and processes as part of a more coherent environmental strategy, additional consideration must also be given to how progress is communicated to stakeholders. In an information vacuum, it is incumbent on companies to progressively fill the information gap and set the agenda with stakeholders on environmental priorities and targets. Omitting this action leaves the narrative to others and may cause a company to miss an opportunity to tout sustainability accomplishments.

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