Unpacking ESG: it’s about sustainable business models, not just environmental sustainability

Introduction

As environmental, social, and governance (ESG) efforts gain increasing traction, there is a common misconception that ESG in the design and construction industry is only about “sustainability” in terms of environmentally sustainable design services. However, ESG goes way beyond that—it is about sustainable business models. ESG performance, measured against internationally recognized ESG standards and frameworks, demonstrates how a company may or may not be sustainably profitable in the long term after considering a wide range of risk factors. Let’s delve into ESG a bit further, and how it drives businesses to be sustainably profitable.

Essence of ESG

ESG is a modernized framework for managing today’s emerging risks. The framework expands and deepens the lens from which financial risk can be understood, especially for financial institutions making decisions in their investment, lending, and underwriting. By expanding financial risk analysis to incorporate ESG risk and opportunity factors, financial institutions can gain deeper insight into the companies they work with and their prospects for long-term sustainable profit.

Planning and protection

ESG risk analysis and performance standards involve a holistic approach of wide-ranging risk and opportunity factors that can tell a deeper story about a company’s material risks. The analysis does so by teasing-out how a company proactively manages risks, such as the following:

1. Climate change: how is a company protecting against and planning for the physical and transition risks of climate change, such as extreme weather events and shifting regulations?
2. Environmental risks: how is a company managing liabilities and reputational risks around pollution incidents, resource constraints, solid waste regulations, and biodiversity protection?
3. Work safety standards: how is a company protecting against liabilities related to employee safety and well-being while adhering to appropriate standards and regulations?
4. Civil rights: how is a company safeguarding against disputes, claims, and liabilities related to civil rights, discrimination, and equal opportunities?
5. Ethical violations: how is a company instituting policies and best practices to avoid ethical breaches, fines, and penalties (e.g., corruption, bribery, tax evasion, and other forms of misconduct)?
6. Data security: how is a company protecting against data breaches and ensuring robust cybersecurity measures to avoid liabilities, business interruptions, financial risks, and reputational risks?
7. Talent scarcity: how is a company preparing for growing talent scarcity and the need to upskill their workforce in a rapidly evolving business landscape?

ESG disclosures and the financial industry

The answers (quantitatively and qualitatively as measured against performance standards) to some of the above emerging risks are what would be considered ESG disclosures. These disclosures provide insight to financial industry stakeholders who aim to assess more accurately the long-term risks and potential of companies in which they invest. By broadening traditional financial risk analysis, which has historically focused narrowly on financial statements, financial institutions can assess companies more thoroughly, ultimately leading to better investment decisions and capital allocation and more sustainable business models.

Conclusion

ESG is about far more than just environmental sustainability. Admittedly, it is a critical piece of the puzzle because companies that offer sustainable services will fare better in a transitioning clean energy economy and will serve an important role to help the world adapt to current and emerging climate events. While those services will undoubtedly remain in demand and be viewed favorably by the financial world, the environmental profile of a company’s business model doesn’t quite paint the whole financial picture. Depending on the industry, other ESG risk factors can be equally important to a company’s financial outlook (e.g., how a professional services company manages its human capital).

As ESG continues to gain importance in the business world, it is vital for companies to recognize the broader implications of ESG and integrate ESG principles into their business models. By doing so, companies will be better prepared to face the myriad challenges and opportunities that lie ahead, ensuring long-term success in an ever-changing world.