Developments in sustainability management should be good news for risk managers

February 2015 | EXPERT BRIEFING | RISK MANAGEMENT

financierworldwide.com

While every transformational movement in business passes through developmental phases of advancement and contraction, any rumours that sustainability is declining or being sidelined for other priorities are exaggerated at best. One needs only to have attended a few recent conferences to be presented with encouraging evidence that traditionally perceived intangibles, otherwise referred to as ESG (Environmental, Social and Governance) issues, are moving front and centre as concerns for C-suite decision makers eager to drive value beyond simply the financial. Boards are following suit.

At two such events – one hosted by State Street Bank and the Bentley University Center for Business Ethics, the other at the Better Business Bureau of New York – presenters outlined how a new emphasis on materiality regarding the impact of business practices and ESG concerns overall are increasingly seen as tools for improving enterprise competitiveness, financial resiliency and risk management.

For example, a growing coalition of stock exchanges worldwide is pressuring their member companies to report more ESG data, to improve the processes for determining what’s material, and for ensuring the accuracy and reliability of the data. Experts at McGraw Hill Financial noted that ESG data is having an increasing influence and impact upon the cost of capital. Many others observed that a new mindset is taking hold in which ESG factors are viewed as relevant criteria for determining added financial value and, in turn, for maintaining a licence to operate.

After many years of what appears to have been a dormant state of affairs for ESG information – despite the evolution in sophistication of management practices – why are we now witnessing an explosion in the relevancy of this data? Could it be a natural course for any transformational movement where, at a certain juncture, critical mass takes hold in the form of greater consciousness? In this case, it appears to be widespread recognition that ESG issues have real implications for financial performance, competitiveness and risk management.

ESG assets are growing. There are more SRI classified products (defined as ‘Sustainable, Responsible and Impact Investing’) under development and going to market. Asset managers are integrating more ESG data points across wider portions of their portfolios. An increasing number of institutional investors and asset managers are committing to the UN’s Principles for Responsible Investment to advance this voluntary framework, which is aimed at assimilating sustainability issues into investment decision-making and ownership strategies.

According to the latest biennial survey of the Forum for Sustainable and Responsible Investment (SIF), a US-based membership association, total US assets under management utilising SRI strategies grew from $3.74 trillion in early 2012 to $6.57 trillion at the beginning of 2014 – a 76 percent increase. On an international scale, current estimates of the extent in which sustainability or ESG criteria are factored into allocation decisions is at $1.3 trillion in global assets. Such forward-thinking criteria may include compliance with Sudan-avoidance policies and restrictions on investments in tobacco and alcohol, for example.

This year the UN will finalise 17 Sustainable Development Goals (SDGs) to address such pressing concerns as alleviating poverty and hunger along with improving health, education and gender equality. The agenda will also encompass actionable targets for reducing inequality, improving safety in cities and encouraging solutions to the impact of climate change.

Between 2012 and 2014, some 175 institutional investors, 27 investment management firms, and numerous money managers – all representing assets totalling $1.72 trillion – have filed shareholder resolutions involving ESG issues aimed at US companies. Is it any wonder that a growing number of money managers are focusing on shareholder engagement strategies involving ESG-related matters?

Companies are also opening up to the notion of leveraging ESG information as a means to gaining strategic advantage – realising that credible disclosure and accountability practices, exercised judiciously and in compliance with established standards, can be a competitive asset. This is particularly the case with stakeholder engagement and brand building. By shoring up reputational equity through brand development techniques hinged on transparency and accountability, companies may strengthen the resiliency of key relationships the enterprise depends upon for perpetuating prosperity – whether those relationships are with customers, shareholders, employees, supply chain partners or any other essential constituency.

Certainly many will agree that, in the US, the 2002 Sarbanes-Oxley Act (SOX) placed a stake in the ground as a point of no return for senior management and board members regarding their attentiveness to various issues. Designed to address gaps in corporate behaviour around financial reporting at the board level, SOX has also achieved a correlating affect on organisation cultures regarding risk. Companies are now shifting their risk management agenda from reactive mitigation to proactive risk avoidance – prioritising activities that avoid fines and remediation costs while heading off situations that can damage their hard-earned reputation and brand integrity.

Concurrently, the Global Reporting Initiative (GRI) continues to expand its framework for uniformity in quality standards regarding sustainability reporting to reflect the range of contexts specific to certain industries and market sectors. While large-cap public companies are moving rapidly to full participation, due to both internal and external pressures, privately-held entities such as middle-market companies or small to medium-sized enterprises (SMEs) are quickly learning the inherent value of measuring, managing and reporting on their sustainability performance.

Regardless of market position or company size, the full range of business entities will ultimately be factoring ESG issues into their competitive strategy in order to address the myriad external forces affecting areas such as supply chain operations and business continuity that are beyond their direct control. Even municipalities can expect to be directly impacted as ESG factors carry more weight in municipal bond markets.

The world is catching up. As the barriers that distinguish advanced industrialised markets from emerging economies eventually give way, a greater number of multinational corporations are being required to extend their development investments into areas where they may not have anticipated becoming active.

Organisations that seek to enhance the integrity of their business practices – and thereby improve the ability to effectively manage risk – need to focus on the three overriding drivers of credible reporting: materiality; valuation of externalities; and integration.

Materiality requires companies to focus on the essentials: the issues or factors demonstrably relevant to a given situation or claim. By benchmarking initiatives on the basis of materiality, sustainability strategies move from being perceived as window dressing to deliberate acts of value creation with a bottom-line expectation. When calculating externalities from a valuation perspective, companies quantify the real impact of any ESG factors they are involved in for their relationship to the broader ecosystem in which they operate. They become better equipped to integrate any responsibility agenda into the whole business strategy in a way that produces real results.

In many ways more evident than ever before, advanced sustainability management is the path of greatest reward for companies who recognise that the historic notion of business value is undergoing a transformation. Responsibility, therefore, is a viable management mechanism for anticipating and mitigating the many risks to be encountered on the road to achieving financial resiliency.

Nancy Mancilla is co-founder and CEO of ISOS Group. She can be contacted on +1 (702) 430 8985 or by email: info@isosgroup.com.

Nancy Mancilla

ISOS Group