Most investors today have realized that the long‐term sustainability of their investments matters. They have realized that the environmental aspects of a business can have a huge impact on a company’s future. As a result, investors, corporates, and banks alike are increasingly realizing the importance of environmental, social, and governance (ESG) criteria. These factors are becoming important considerations for investors to focus on given their influence on a portfolio’s risk and return profile.
With ESG factors becoming the determining factor for investors, most CEOs and heads are feeling the need to integrate ESG into their organizations. But what is ESG integration? ESG integration is defined as the systematic and explicit inclusion of material ESG factors into investment analysis and investment decisions. The operating word here is systematic. Integrating ESG is not something that can be done in a day or with an ad-hoc approach. It has to be done systematically. If an organization wants to fully leverage the potential benefits of improved ESG performance, they need a robust and company-wide strategy.
How to Integrate ESG?
As I said earlier, ESG integration cannot be done in the spur of the moment. If we want to have a successful ESG program then, it is vital that we fully integrate ESG company-wide. Environmental, social, and governance considerations need to be embedded in the DNA of our corporate strategy.
There are various ways and models to incorporate ESG practices into your corporate strategy, but all those models are based on these 4 steps:
- Understand your current status?
The first thing we need to do is to understand where we stand today by taking a look at our current performance. Identify our strengths and weakness. Conduct a gap analysis to understand the ESG risks we are currently facing. We need to have a clear understanding/ definition of each aspect of ESG. Once we have our definition, we can analyze our current performance in each domain. Due diligence around your current ESG approach means taking a granular look at all the ESG risks you face and your existing strategies to tackle them. It could be that you are already doing well in one aspect of the ESG while the other two need more priority. For example, some companies may already be doing well in governance aspects but lack in environmental and social aspects.
2. Set goals and targets
Once we have analyzed, where we stand. The next step is to set our ESG goals. Integrating ESG is a long-term process. Too often, the roadmap needed to operationalize our ESG goals can be unclear rather than concrete and actionable. To avoid that it is important that we have long-term targets coupled with short-term milestones. Having a comprehensive understanding of our ESG targets also enables us to set defined priorities that work towards our ESG objectives. It allows us to better allocate our resources and efficiently reach our targets. One thing that we need to keep in our mind while setting up our targets is that we should set up ambitious but practical Science-Based targets.
3. Implementing controls and achieving targets
Once we have identified our priorities and devised a road map to achieve our targets, the next step is to implement technology and changes to achieve those targets. Identifying what ESG best practice looks like is one of the most critical steps in setting an ESG strategy. Recognizing best practices and working towards them is another crucial stage in prioritizing and planning your next steps.
One area that many businesses struggle with is the issue of controls when it comes to ESG integration. The areas you need to monitor, and control strategies you need to deploy for ESG compliance will vary depending on the industry. There is no “one solution that fits all” when it comes to ESG.
It is imperative that you think about the controls you need in the context of your industry and your goals. If your organization has significant environmental risk exposures, for example, if you are in the manufacturing sector, you may want to focus on controls that evaluate your buildings for greenhouse gas emissions. On the other hand, a distribution services firm may prioritize controls on the supply chain, while a professional business would look to cut down on travel, for instance, employees must take the shortest route or build a business case that the travel meets a specific business value and/or cannot be achieved remotely.
4. Monitor and evaluate your progress.
Integrating ESG is a circular process. It needs to be worked on continuously. Once we have developed our strategy and begun implementing it, we need to monitor it, and evaluate our progress. Only by regularly auditing our strategy can we understand how well it is performing. What is the shortcoming, which can be further improved?
Analyzing and auditing ESG data has proven to be tricky for many businesses, but it is a vital step. Having a proper ESG audit not only allows us to understand the efficacy of our ESG strategy but also allows our investors to see how well we have integrated ESG into our business.
It is also to be noted that today in many countries ESG reporting has been made mandatory. So having an effective monitoring and reporting strategy also allows us to comply with their norms. We also have to keep in mind that it may open you to scrutiny, but it is vital for transparency and to improve your ESG integration strategy.
ESG integration is a continuous process that needs to be evaluated and updated regularly. Be it our targets, priorities, or control measures, they all need to be updated at regular intervals based on the latest scientific discoveries. The other thing to remember is that initially developing an ESG strategy can prove to be a bit complicated as it has a lot of variables to be dealt with; in such cases, it is always better to seek help from experts and consultants.