(Expansion) – In the past, business goals used to be focused exclusively on profit maximization and what happened outside the organization, in environmental and social terms, took a back seat, as long as it did not affect its profitability.
The thrust of regulation on ESG issues (environmental, social and corporate governance for its acronym in English), as well as the generational change of the investing public, have led companies, and even governments, to transform. Even in cases where the transformation has been on their own initiative, they have not been without challenges. On the business side, I mention some of them.
First . On the one hand, and despite the fact that the market recognizes that ESG factors have an impact on the risk management of companies and consequently on their profitability, they are slowly being incorporated into the agenda of the boards of directors.
On the other hand, if companies develop initiatives related to environmental and social impact, they will always be insufficient if they are not integrated into corporate policy, management indicators, variable compensation for employees and the long-term business strategy.
That said, in my opinion, the “G” within ESG standards is the most important element in successfully transitioning to a more sustainable world.
Under these circumstances, we cannot help but think that the incorporation and disclosure of ESG standards, in many cases, may be motivated only by pressure from institutional investors, consumers or the regulator.
Ultimately, some companies may be making these changes due to the demand of certain interest groups and not because they are truly committed to the issue.
Second Another important challenge in this transition is knowing what type of information to generate, process and disclose. The first step is for companies to learn to transparently disclose their internal policies, their metrics and expected and achieved achievements. The market needs orderly, homogeneous and comparable information on environmental and social impact, something that we currently do not have.
Technically speaking, it would be useful to have a universal standardization mechanism for metrics, benchmarks and reporting; so that companies continue to generate value through their activity, but now with a business model that adopts and implements ESG standards.
At the same time, it would be important to develop self-regulation mechanisms that ensure that the information disclosed is reliable and that internal corporate processes really generate ESG benefits. The challenge is huge and not easy.
Third . On the investing public side, they must know how to incorporate such information in their valuation and investment process, for both fixed and variable income instruments.
The market needs analysts who know that it is a green, social or sustainable bond; but who also know how to value assets, companies or other economic entities under ESG standards; in order to build and manage your investment portfolios.
In a scenario where an incorrect financial analysis is carried out (adding to it the probability that the ESG information available is of low quality), we could encourage the growth of a market with business projects and financial instruments with erroneous or false environmental and social benefits. On the business side, misinforming or not knowing how to do it would lead to a situation of greenwashing (or ESGwashing) and, on the investor side (public and private), making wrong valuations would generate investmentwashing .
While we must avoid both situations, as they would undoubtedly weaken the transition process towards a sustainable and low-carbon economy, it is fair to say that the market is still on the way to know how to determine the cost of including ESG standards or not in your investment decisions.
Recent surveys in various countries have revealed that many investors do not believe in companies’ ESG reports. The problem is precisely the one posed here: generation of bad information and limited capacity for analysis. Few people know about the subject and, frequently, companies describe and report purely qualitative evaluations, rather than numerical data.
How can the market ensure if a company performs its operation adequately under ESG standards and correctly reveals its results? Fortunately, within the market the links of a value chain are being formed that work for this purpose.
There are those companies that are building disclosure standards, reference frameworks and questionnaires (TCFD, SASB, GRI, CDP, among others); there are the data aggregators (Bloomberg, MCSI, Refinitiv and more), the auditors (EY, KPMG, PWC and Deloitte) and lastly, the evaluators who are generally rating agencies that are incorporating these topics in their credit analysis or simply generating useful second opinion reports for the investing public.
The objective of all this in the end is that any market participant (companies, investors, regulators, etc.) knows how to embark on the path to sustainability by making decisions based on clear, verifiable and comparable criteria; and that allow it to correctly value both a particular sustainable policy and a financial instrument, avoiding greenwashing and investmentwashing .
Knowing and incorporating ESG standards in our day to day is good business for everyone; as it would boost innovation, productivity, profitability and could even open up new financing opportunities.
Editor’s Note: Roberto Ballinez is Senior Executive Director of Subnational Debt and Infrastructure at HR Ratings. Follow him on. The opinions expressed in this column belong exclusively to the author.
