Ignore environmental, social and governance risks at your peril

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ESG problems can interfere with high financial performance.

Environmental, social and governance (ESG) concerns can make or break a company. Neglect them, and it can be the downfall of your brand. Just look at the BP Gulf oil spill, which still plagues the company’s reputation eight years later. On the opposite end of the spectrum, ESG issues can define your brand and company values. Patagonia’s identity stems largely from its sustainability practices and the values it embodies. 

Most firms, though, fall somewhere in between. They know managing ESG risk is important, but they don’t let it define them as a company. While I wholeheartedly believe that shareholder value and standards that underlie inclusive growth cannot be separated, not all corporations are ready to integrate positive impact principles into their corporate strategies. For these firms, sound ESG risk management not only can protect their reputations but also help increase efficiency and improve their bottom line.

Why should you pay attention?

As Warren Buffet said, "It takes 20 years to build a reputation and 5 minutes to ruin." While the reputational risks of mismanaged environmental or social issues are clear, the business case for ESG management goes beyond this. Regardless of your company’s size or age, reporting on and effectively monitoring ESG issues can drive value and mitigate highly damaging risks to your operations and bottom line over time.

Companies and investors alike can benefit from adopting ESG standards. In addition to improving customer loyalty, integrating ESG mitigation and management has the potential to create operational efficiencies, lower operational risks and costs, identify potential new sources of revenues, and allow for new market entry. Additionally, establishing environmental, social and governance safeguards and policies could lead to improved ability to attract, retain and motivate staff.

Harvard Business School professors undertook a study to determine if ESG factors have measurable effect on an investment’s financial performance. The answer is, in effect, yes. Using a framework from the Sustainability Accounting Standards Board, they found that firms that performed well on material sustainability issues significantly outperformed firms with poor ratings on those issues.

From responsible investing screens to everyday operations

Going from light-touch ESG due diligence processes to more comprehensive ESG management systems will depend on the scale and needs of a business. As you’d expect, the types of environmental, social and governance issues vary greatly by industry and location. Environmental risks faced by an agribusiness company in Peru are incredibly different from those encountered by a retail company operating in the United States.  

Perhaps because of these varying industry and market risks, organizations such as IFC have published ESG risk toolkits to provide a starting place for investors and companies. The trouble often comes in when determining material factors for each category.

As of 2016, more than 1,500 socially conscious investors and managers, representing about $60 trillion in assets under management, have signed onto the U.N.-backed Principles for Responsible Investment (PRI). In effect, these investors agreed to use specific ESG criteria to screen operations. When incorporated directly into a due diligence process, ESG analysis and screening can spot major red flags in potential investments.

But ESG standards can and should be used for more than investment due diligence processes. In working with entrepreneurs and various companies, I’ve found that many individuals initially see ESG risk management as burdensome — in essence, an unnecessary cost. Once they realize that ESG systems can help them identify opportunities for greater productivity and improved efficiency, they eagerly adopt new systems and policies centered around ESG. 

For instance, I recently visited a small, agribusiness company in Northern Uganda. There, I sat down with the owner and reviewed all the opportunities for him and the company to improve their operations. In the past two months, the company already has improved waste management practices, leading to a new product line, greater revenues and better working conditions for his employees.

What’s more, after seeing the business case for ESG management systems, the owner has incorporated activities to create enhanced environmental and social benefits, and linked these into his core business strategy. Success stories such as this illustrate how imperative ESG management can be.

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