As corporations' ESG initiatives grow and mature, these commitments are being driven more and more by values rather than by compliance needs
Surging corporate resources dedicated to environmental, social, and corporate governance (ESG) initiatives are mostly being driven by decarbonization priorities. Indeed, this compliance need is a well-known assumption in corporate risk management and sustainability circles. However, peeling back a few layers underneath this supposition among middle market corporations reveals some new insights into the motivations for an ongoing focus on ESG.
The shift from ESG activities being driven by compliance to being driven by alignment with corporate values has accelerated since mid-2020, according to Anthony DeCandido, Partner and Financial Services Senior Analyst at RSM. About 12 to 18 months ago, most corporations that approached RSM and its competitors were doing so because of compliance reasons.
Since then, there has been a seismic shift. “The biggest groundswell change around why this ESG activity is surging is the recognition from boards that [an ESG focus] correlates to improved risk management, thereby demonstrating improved financial performance and non-financial performance,” DeCandido observes.
In addition, this acknowledgment also has quickly expanded beyond the board room to include other financial incentives as the market continues to evolve. Companies that demonstrate better ESG programs, policies and risk management in the near future will receive better lending terms, effectively reducing their weighted average cost of capital (WACC) and subsequentially bumping up their perceived value.
The reasons behind this monumental movement are the convergence of seismic instigators, shifting the conversation from mainly environmental elements to social and governance issues around workplace culture, which include:
- Higher level of corporate executive understanding about real systemic issues that professionals from underrepresented backgrounds face within their work environments and outside of work.
- Pandemic stress testing around whether or not previous risk management approaches actually worked during the crisis.
- Progressive government policy to spur green technologies and investments showing up along with tax policy changes.
Key aspects of corporate ESG investments
Corporations, which have made big public statements about ESG commitments such as the financial pledges made in 2020 after the killing of George Floyd, currently are viewed positively by the public. However, disbursement of these pledges have been slow, and this highlights the current gap in public accountability between words and actions around ESG. This also points to a need for a mechanism to monitor these corporate commitments.
“The spirit of sustainability long-term is the idea that we’re doing good and doing well financially.” — Anthony DeCandido, of RSM
Yet, there is still no easy way for regulators to verify that what corporations are stating about the impact of their ESG program is indeed the actual impact the program is making. Until there is the equivalent of a third-party verified financial statement for ESG, this verification will continued to be a challenge.
The ongoing lack of standardization of ESG taxonomy, disclosure, and reporting standards across geographies and industries is another impediment, although progress is occurring. Indeed, the emergence of an international sustainability standards board driven by the International Financial Reporting Standards is a key indicator, but another dozen or so frameworks still exist, according to DeCandido.
The talent and technology gap
Finding qualified experienced talent is another shorter-term reality that is driving change. Upskilling as a seasoned professional requires a large commitment of 250 to 300 hours, according to DeCandido, and there is a plethora of professionals who are interested doing so. Early career talent is less of a concern because of recent graduates and coming into firms with undergraduate and graduate degrees in sustainability.
Technology solutions in the marketplace are plentiful, but because of the lack of standardization and the number of individualized and customized data sets that are required across corporate functions — such as in human resources, operations, and finance — it is difficult for corporations to ascertain which solutions best fit their needs.
These barriers in advancement are a business opportunity for advisory firms that specialize in ESG and ESG risk management. Indeed, those firms that can help corporations make the connections between certain changes in corporate behaviors and improvements in financial and non-financial performance will fill this need and will likely stick around as the evolution in ESG requirements and expectations continues.
What also is not going away is the larger commitment to sustainability, says DeCandido. “The spirit of sustainability long-term is the idea that we’re doing good and doing well financially,” he says, adding that soon this vision will emerge as a reality.
Learn more about The Rise of ESG Initiatives in the Middle Market in RSM’s Environmental, Social and Governance Special Report