The pressure on organizations to meet environmental, social and governance (ESG) criteria is more widespread than most finance leaders might realize — 85% of investors considered ESG factors in their investments in 2020. Recent Gartner research presented at Gartner CFO and Finance Executive Conference highlights the importance of managing financial stakeholders’ perceptions of their companies’ ESG performance.
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The evidence is clear on the level of importance financial stakeholders have started placing on ESG. Consider this:
- Media mentions of ESG data, ratings or scores grew by 303% year over year in 2020.
- Approximately one in 10 investors find the ESG information they are looking for in corporate disclosures.
- Ninety-one percent of banks monitor ESG, along with 24 global credit rating agencies, 71% of fixed income investors and over 90% of insurers.
- ESG considerations have driven some insurers to limit coverage or investments in certain sectors.
- Sixty-seven percent of banks screen their loan portfolios for ESG risks.
- Thirty-three percent of private sector rating actions published by Moody’s in 2019 cite ESG risks as material credit considerations.
- Thirty-four percent of ESG-related actions by S&P Global Ratings between April and August 2020 were downgrades.
A strong ESG proposition is a win-win
The reasons investors care about ESG in their investment can be broadly classified into four categories: financial, competitive, strategic and perception. Overall, investors consider ESG investments safer and more stable bets.
The upside of ESG investment is not limited to investors alone. CFOs and organizations can gain access to capital, see improved stock performance, take advantage of cost savings and ultimately experience better customer loyalty for their organization.
A company that improves its ESG performance will also tend to have a reduced compliance burden, see higher levels of employee satisfaction and find talent more easily, in addition to being a less likely target for shareholder activism.
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A framework for discussing ESG
The proliferation in attention toward ESG demonstrates that CFOs need to improve their knowledge of how this information can influence investor decision making.
Here are seven key areas for CFOs to discuss ESG-related topics in an effective way.
No. 1: Company strategy
When disclosing ESG information to investors around company strategy, CFOs should start by demonstrating how corporate strategic goals will drive or align to the United Nations’ Sustainable Development Goals. Companies in a progressive stage of maturity can go further and disclose how ESG supports key value drivers for the business, such as sales productivity.
Firms at the leading edge of maturity are categorized by having direct board-level oversight into ESG matters and communicating to stakeholders how the board is driving action.
No. 2: Products and services
Firms at the elementary stage can highlight how ESG has created brand value improvements for the organization. Progressive groups can showcase sustainable products, while leading-edge companies can point to ESG as a mechanism to preserve market share. Things such as higher marketing ROI and lower customer acquisition costs can demonstrate the valuable relationship between ESG and a company’s products and services.
No. 3: Financial track record
At the elementary stage, firms should demonstrate capital allocation to green initiatives such as lightweight packaging or more efficient offices. Firms at the progressive stage will disclose how environmental efficiency is driving cost reduction and those at the leading edge will demonstrate how they balance profitability and sustainability, for instance by commercializing clean technology.
No. 4: Performance outlook
At the elementary stage of maturity with ESG disclosure, companies should be able to demonstrate an ESG-related ability to attract new customers. At the progressive stage, CFOs can disclose potential ESG-linked industry or market developments that may change the landscape, like shifts in customer behavior or product offerings in an industry.
Leading-edge firms will be able to showcase and quantify growth opportunities at the individual company level that stem from ESG activities.
No. 5: Execution credibility
During initial stages of maturity this is more focused on setting clear goals, but as firms reach a progressive level of maturity they will shift more toward reporting progress against these goals. Leading-edge firms should showcase how they continue to commit to ESG goals even in times of disruption.
Examples include delivering on carbon reduction targets during a downturn or offering programs to support employee mental health during a pandemic.
No. 6: Risk resilience
One of the key reasons that investors and financial stakeholders review ESG disclosure is because it gives good insight into the risks a company faces. At the lowest level of maturity, firms can demonstrate how ESG activity mitigates broad strategic risks such as regulatory intervention or customer retention. As maturity advances, it will be possible to show how ESG efforts are mitigating physical and financial risks as well, such as weather-related supply chain disruption or regulatory fines.
No. 7: Shareholder culture
Organizations can start by demonstrating the relationship between ESG and total shareholder return as a way to tie ESG and shareholder value. More-mature firms will implement policies to protect shareholder rights, such as giving them a say on pay or fairer voting power policies. The firms with the highest ESG disclosure maturity will be demonstrating ESG-linked remuneration policies for senior management and even the board.
The advantage of this framework is that it provides a broader perspective on how to talk about ESG in nonfinancial terms — particularly if the information that investors need to directly link ESG performance and financial performance isn’t readily available.