The topic of ESG (environmental, social and governance) principles is back on the agenda as the world witnesses catastrophic flooding and fires not seen in decades, with “climate change” due to environmental mismanagement the seeming culprit.
While sustainability is now a hot topic due to the increasing awareness of climate change and global inequality, at the same time there is a debate that an application of ethical-based investment decisions by society at large can lead to a more sustainable economic and social basis, leading to questions about whether ethical investment and sustainability derived from ESG application are interlinked or separate issues.
There is still no universal definition of sustainability, but many note the seminal UN 1987 Brundtland Report that calls for sustainable development, which, in principle, meets our needs today without compromising the needs of those in the future. Others argue that religion has advocated similar principles, with Islam specifically stating that humans are mere guardians of nature’s wealth and not its owners and should act accordingly in this guardianship role to pass it on to future generations. Thus, the idea of meeting our needs without sacrificing the needs of our future generations is the basis of what the majority of mankind can agree as meeting a definition of “sustainability.”
The definition by default focuses on our planet’s capacity to meet our economic needs, as without a healthy planet, society will be unable to meet sustainable needs for food, shelter, clean air, water and other basic necessities of life. This, however, assumes that all societies accept the same “sustainability” definitions and goals, but in reality there are different opinions as these touch on politics and the degree of economic growth and resource consumption by different countries.
The debate is stark and will not easily go away with simple slogans as it involves those “who have” versus those that “have not,” a “North” vs. “South” debate, or more crudely, stopping a poorer “South” from “having their place in the sun” and in turn asking the “North” to sacrifice more for the sake of global sustainability and equality.
There is growing evidence that companies that take their environmental and social responsibilities more seriously perform better financially, making their shareholders happy and feeling righteous too.
Dr. Mohamed Ramady
The poorer “South” will argue that the “North’s” high-income earners are far more likely to be contributing disproportionately to climate change, while those who live in less affluent parts of the world are more likely to suffer the consequences. They watch in awe and disbelief as multibillionaires spend a few minutes joyriding in outer space at a cost enough to provide whole villages with proper sanitation, health, education and safer transportation, let alone feed hungry mouths.
In practice ESG today refers to the environmental, social and governance information about a firm and there is growing evidence that companies that take their environmental and social responsibilities more seriously perform better financially, making their shareholders happy and feeling righteous too. The bottom line for all is that ESG is good for business. The UN-Global Compact value driver model uses key business matrices common to all industries to determine the return on investments of corporate sustainability activities. These can be best summarized under: Growth (revenue growth from sustainable products); productivity (cost savings from sustainability related innovation); and risk management, all leading to a higher return on equity.
Have these matrices made an impact on corporate performance in reality? In essence companies that follow enhanced ethical and economic sustainability management characteristics have the potential to perform better over time, but the question is where? It would seem that improvements in environmental performance achieved with better technology, leading to cost savings and process efficiency, is one way, resulting in high sustainability companies outperforming their counterparts over the long term, through stock market and accounting performance. Analysis of some ESG-related stock market indices such as the MSCI KLD 400 Social Index, and MSCI Emerging Market ESG Index, seems to support this argument. So, what is missing to implement ESG?
In forthcoming articles, we shall examine the role of sustainability accounting, corporate stakeholders interaction and the need to educate both capital market borrowers and lenders on ESG policies, and on how international ESG regulators have faced this.
• Dr. Mohamed Ramady is a former senior banker and Professor of Finance and Economics, King Fahd University of Petroleum and Minerals, Dhahran.