Hiranthi Fonseka – Partner EY/ Chairperson – INED Forum of SLID
As Sri Lanka struggles through an economic crisis and people’s protests intensify across the island, we also witness spectacular instances of environment consciousness, social unity, and calls for better governance from within these people led movements. ESG (Environment, Social, and Governance) issues remain relevant in this time of unrest, an indicator to organizations that even in turbulent times sustainability needs to be a matter of priority.
Certainly, Corporate Social Responsibility (CSR) or sustainability are not new concepts. However, ESG goes beyond by defining a wider range of topics under each of its three pillars.
Environment
Under this pillar attention is drawn to the natural environment in which a business operates, the natural capital that the business affects or is affected by. The E pillar of ESG frames several considerations including climate risks, carbon emissions, energy efficiency, pollution and waste management, use of natural resources, clean energy and technologies, biodiversity loss and restoration. Entities are called to not only do no harm to the environment but to also protect it.
Social
If the E pillar is the element ‘Planet’ of the triple bottom line, the S pillars which comprises of those considerations that affect society is the element on ‘People’. This frame captures concerns such as Human Rights, Human Capital, Labor relations and working conditions, Forced Labour, Child Labour, Inclusivity & Diversity agenda, Employee safety, Product safety, Public Health and so on.
Governance
All Environment and Social commitments would be of no real value if the organization is deemed unethical and its operations are unsustainable. Considerations such as anti-corruption, wrongdoing & bribery, anti-money laundering, business compliance & ethics, risk tolerance, board diversity & composition and management under this pillar seeks to ensure reputability, resilience, and business continuity.
While the dialogue on ESG (CSR or Sustainability) has been ongoing for over three decades, in recent times there has been heightened urgency to ‘walk the talk’. Actors such as increasing Regulatory & Industry standards, Macro-economy & Geo-political trends, Demographic shifts, and Customer expectations have been driving ESG to the limelight while the COVID-19 Pandemic further accelerated concern. According to the inaugural EY 2022 CEO Outlook Survey which interviewed 2,000 global CEOs, a vast majority of businesses (86%) have been impacted by COVID-19. For some (21%) this meant a drastic shift for the worse (operations coming to a halt, severe financial burdens, and in some cases rendering the business model obsolete) In contrast some other industries (13%) have been ‘fundamentally reshaped for the better’. Nearly 5.9% of CEOs have chosen Mergers and Acquisitions (M&A) as their strategic growth driver in these challenging times, up from 49% in 2021. Interestingly, strengthening ESG ranking/ performance/ sustainable footprint was one of the key M&A Activities prioritized by companies, second only to acquisition focused on increasing operational capabilities.
The imminent climate crisis is another major driving force. The latest Intergovernmental Panel on Climate Change (IPCC) Impacts Report finds that global temperatures will surpass 1.5°C by the year 2040. Unless this trajectory is drastically slowed down, the world is set to meet unimaginable catastrophes. Today, at 1.1°C pre-industrial levels the world is experiencing adverse weather patterns not previously known. Disruptions to supply chains, destruction of lives and livelihoods, scarcity of food and water will become inevitable.
All this is to say that ESG needs to be embedded as a core activity in all levels of a business. Being ESG minded is not about meeting the legal minimum. Entities may meet all statutory obligations to its employees; remunerate above the minimum wage, make payments to social security schemes and spend on employee welfare and training. Companies may expertly manage their waste or have even obtained quality management certifications, while also empowering its workforce and community. These are no doubt noteworthy but ESG thinking nudges companies to require such commitments across their entire supply chains, and to be innovative and proactive in meeting ESG targets.
Doing so has obvious monetary benefits as seen in the case of M&As, where sustainability of the takeover is a key factor considered by acquirers. Likewise, before investing in any company, most foreign investors today will review ESG practices adopted by the company, as companies with strong policies and practices are better positioned to manage and mitigate challenges. The strong performance of ‘Green Bonds’ as well as other ‘Impact Bonds’ (sustainable investment instruments) in the financial markets in comparison to their ‘brown’ counterparts, is further evidence to investor sentiment on ESG performance.
Embarking on the ESG journey can seem daunting especially for Small and Medium Enterprises. The wealth of research, the inexhaustive list of considerations, the various standards, regulations, and frameworks can be confusing to navigate. Identifying the need for consensus, the International Financial Reporting Standards Board (IFRS) together with the Task Force on Climate-Related Financial Disclosures (TCFD) and several other entities formed the International Sustainability Standards Board (ISSB) in November 2021. The ISSB aims to deliver high quality, comprehensive disclosure standards that would enable companies to provide reliable and comparable reporting on ESG matters. The adoption of such frameworks should be on a Board of Director’s action plan.
How can Boards get involved?
As with any other transformation, ESG requires the vision and direction of Boards to become an effective strategic matter. To this end Directors are called to:
- Set ambitious targets, especially in terms of achieving net zero targets and social progress
- Identify those ESG concerns that are most relevant and material to its business
- Understand the ESG requirements of investors and other stakeholders
- Identify systematic and transitional risks and opportunities of climate change that the business is exposed to
- Champion the causes that it has thus chosen, while ensuring no significant harm is made in other ESG areas.
- Establish sound policies and practices on anti-corruption as corruption can significantly damage business reputation.
- Convert ESG to a companywide agenda by stewarding a purposeful, measurable and time bound sustainability plan
- Ensure Sustainability reports and communication are not greenwashed
The INED Forum is an initiative of The Sri Lanka Institute of Directors in partnership with EY. It provides an interactive platform for knowledge and experience sharing among INEDs across diverse industries and businesses in both the private and public sectors.