Part 1: What Makes ESG Data Valuable?
This three-part article series unpacks ESG for procurement and supply management leaders. It will help you understand why and how to use ESG data to your advantage — to build stronger supply networks and help your own business achieve greater resilience and sustainability.
Environmental, social and governance metrics — customarily abbreviated to ESG — have been around for more than a century. ESG primarily originated with socially conscious investors who wanted to align their investments with their values. In the last few years, however, with the emergence of more and better data – plus an increased understanding of the environmental and social pressures of modernity – ESG data has become mainstream.
The pressures that have helped put ESG in the spotlight include macro drivers like increased resource scarcity and impacts on productivity from disaster events, such as the recent winter storm Uri in Texas (deemed the most expensive event to yet occur globally).1 They also stem from increasing expectations that corporations should commit to improving social outcomes – ranging from addressing inequality, diversity representation, and several of the socially-oriented United Nations Sustainable Development Goals (SDGs).2
Environmental, social and governance (ESG) data tends to capture extra-financial factors that were traditionally absent in financial analysis: company management of energy and water use, waste generation, employee rights and working conditions, community engagement, data privacy rights, and more traditional indicators of corporate accountability and transparency. ESG encapsulates almost everything that may reflect how companies are operating within society and the environment, and if that mode of operation is “sustainable” and “responsible.”
ESG factors may be increasing in importance, but how exactly should companies be considering and using them? The answer is as wide-ranging as the data itself, but can be summarized into three main arguments.
1. ESG is a valuable risk management tool
Operationally, this translates to efficient use of resources or saving money by upgrading to more efficient equipment and energy. The data center industry provides good examples, such as Microsoft, which designs its data centers to prioritize water efficiency; it places data centers underwater to avoid cooling costs or chooses air cooling in water-stressed areas like Arizona.
Regulation around ESG has increased dramatically in the last few years, prompting companies to consider ESG risks for the first time. According to the UN PRI responsible investment regulation database, 95% of regulatory policies were developed after 2000, with significant increases after 2010 (see table below).3
Other sustainable investment regulations, such as the EU taxonomy, the Sustainable Finance Disclosure Regulation (SFDR), and Non-Financial Reporting Directive (NFRD) are putting pressure on European companies by mandating disclosures on ESG issues. Finance ministers at the recent G7 meeting threw their support behind mandatory climate reporting for companies4 — in line with U.S. Treasury Secretary Janet Yellen’s support of using the Task Force for Climate-Related Financial Disclosure (TCFD) guidelines for reporting climate-related risks.5
Social-related disclosure is also increasing. Corporate diversity laws enacted in Illinois in 2019 and California in September 2020 aim to increase racial diversity on the boards of publicly traded companies. In March, for the first time, the University of Illinois published a report card evaluating progress in these efforts by public companies headquartered in the state.
Reputational risk is also a driving factor. The majority of companies’ value today comes not from real assets and equipment, but intangible value in the form of intellectual property and brand equity — making reputational management a financial consideration. Recent social and governance controversies from prominent companies across a range of industries6 — and environmental ones, like the response from a top oil and gas company to a Dutch court that had ordered it to slash emissions7 — show that companies failing to adapt to changing expectations can experience a decrease in stock performance as well as brand damage.
2. ESG creates more options for capital allocation and attraction
While focusing on ESG-related issues can result in improved operational efficiencies and risk avoidance, it also can provide new venues for capital attraction. Banks are increasingly providing preferred lending rates to companies with good ESG performance, such as Deutsche Bank, which is offering lower interest rates to lenders if agreed-upon ESG targets are achieved.8 Green bonds have been purchased at a premium by investors who are hungry for sustainability-related investment vehicles. Green and sustainability bonds (bonds that address both environmental and social factors) have also been a helpful financial tool. Apple, Starbucks, Toyota and Alphabet have all issued such bonds to raise capital for their sustainability initiatives.
ESG issues are also increasingly included in credit risk considerations; in Europe, this is being accelerated by new guidelines stipulated by the European Banking Authority.9 These guidelines go into effect this year and require banks to factor ESG-related risks within the financial conditions of borrowers.
3. ESG is becoming an essential part of institutional investing decisions and will increasingly influence other areas of the financial and economic ecosystems
While many companies are learning about ESG for the first time, major financial players have been watching the trends and are already integrating ESG into their decisions. Major asset managers beyond the climate-vocal BlackRock, including CalPERS, Calvert, GPIF, APG, and others are using increasingly sophisticated methods to leverage ESG in their investment decisions. Nasdaq has started to incorporate ESG when evaluating IPOs, and stock exchanges across the world, such as the Hong Kong SAR, Shenzhen, Shanghai and Philippines stock exchanges, are making ESG disclosure a requirement for being listed.10 When the largest investors and companies in the world are asking for this type of information, it’s only a matter of time until the disclosure requests reach into their supply chains and the activities of private companies.
Global complexity is increasing as supply chains become more interconnected, economies grow and develop, weather patterns change, and societies experience and acquire more sophisticated technology. ESG data is an attempt to capture more of this complexity in business decision-making and to assess potential for continued viability in a world that increasingly requires more sustainable outcomes.
Part 2 of this blog series will continue the discussion of ESG as a tool to help you make better decisions about companies you might want to bring into your business network — particularly as suppliers of services and products including direct and indirect materials.
1 Steve Evans, “US Winter Storm Uri Insured Loss to Break Records, May Reach Double-Digit Billions,” Artemis, 19 February 2021.
2 Division for Sustainable Development Goals, “The 17 Goals,” United Nations Department of Economic and Social Affairs (UNDESA).
3 “Policy: Regulation Database,” Principles for Responsible Investment, January 2021.
4 Mark John et al., “G7 Backs Making Climate Risk Disclosure Mandatory,” Reuters, 5 June 2021.
5 “Secretary of the Treasury Janet L. Yellen’s Remarks to the Institute of International Finance” [press release], U.S. Department of the Treasury, 21 April 2021.
6 Karen Firestone, “When Investors Lose Trust, They Can Put Stocks in the ‘Penalty Box,’” CNBC, 9 February 2020.
7 Ron Bousso et al., “Shell Ordered to Deepen Carbon Cuts in Landmark Dutch Climate Case,” Reuters, 26 May 2021.
8 flow Magazine, “ESG on the Ground,” Deutsche Bank, 23 October 2020.
9 “EBA Launches Public Consultation on Draft Technical Standards on Pillar 3 Disclosures of ESG Risks” [press release], European Banking Authority, 1 March 2021.
10 “ESG Disclosure Guidance Database,” Sustainable Stock Exchanges Initiative, 2021.
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