The buzzwords ESG and Sustainability have been used interchangeably in news reports and government policies nowadays. Both are related concepts, but they differ significantly in scope and connection with business operations.
ESG refers to frameworks that are used to direct a firm’s resource allocation as well as evaluate its performance and impact in environmental, social, and governance areas. Sustainability refers to a broader concept of operating a business in a way that meets the economic, social, and environmental needs of the present without compromising the ability of future generations to meet their own needs.
The overlap occurs when ESG functions as a tool within the broader context of sustainability. A recent whitepaper published by the Sustainable and Green Finance Institute (SGFIN) at the National University of Singapore sheds light on the growing demand for ESG data and the widespread use of aggregate ESG scores from a growing number of data providers. This demonstrates how ESG metrics provided by rating agencies are important and relevant in shaping the public perceptions of a company’s sustainability practices.
However, the sole reliance on ESG ratings/scores may also have some drawbacks, including oversimplification of the challenging and multi-dimensional nature of sustainability. As ESG assessments are becoming more complex due to the rating methodology and lack of standardization, we strongly recommend that corporates move forward with their disclosure of social and environmental commitments and results achieved. Such disclosure helps to facilitate a more thorough analysis and transparent evaluation of corporate sustainability by the public.
Common traps to avoid in sustainability efforts
Avoid a short-term view. It is tempting for firms to respond to a short-term setback in financial performance by compromising on long-term investment in sustainability efforts. Such tradeoff can cause even more financial harm in the longer horizon. As a simple analogy, the regular and proper maintenance of the fire alarm system can be tedious and costly, but such investment can potentially save millions of dollars and precious lives.
Avoid pleasing ESG raters. If managers focus on one area of sustainability and neglect a holistic view, it may also lead to potential losses for the firm. For example, some firms might aim to achieve high ESG scores by targeting a specific ESG rater’s demand. On the contrary, sustainability considerations should be at the core of the business model, rather than just reporting pre-specified ESG metrics.
Avoid compartmentalization. Sustainability is not a standalone initiative, but rather it should form an integral part of the overall business strategy as mentioned before. Hence, the people who are involved in proposing and implementing sustainability efforts should be part of the core decision-making team. Hence, the management team should consist of at least one expert on sustainability.
Not to confuse corporate social responsibility (CSR) with sustainability. While CSR activities, such as philanthropy, employee volunteering, and community engagement, form a valuable component of firms’ contributions to society and the broader sustainability narrative, achieving sustainability requires a more comprehensive and holistic approach to business decisions.
Avoid overclaiming. The lack of reliable disclosure about sustainability practices can potentially ruin the firm’s reputation for its efforts to address social and environmental issues. For example, if a firm decides to label its products as green, it might want to include more specifics such as materials and percentage of such materials. The public and investors are becoming more discerning in differentiating the overclaims made by the producers.
Overcoming challenges in sustainability reporting
Given the limited natural resources and the pressure to reduce negative environmental externality, firms are facing increasing pressure to allocate resources to sustainability efforts. Hence, sufficient information is needed for the cost and benefit of sustainability efforts in the presence of the usual financial consideration for business operations.
Due to a lack of standardization in sustainability indicators, firms are often confused about which reporting standards they must adhere to. The policymakers in Singapore have laid out several reporting frameworks such as Task Force on Climate-related Financial Disclosures (TCFD) for publicly listed firms, and CDP Global (CDP) for big private firms to comply with in the coming years. A large number of Micro, Small and Medium Enterprises (MSMEs) are still unsure of whether they need to make any reporting and if yes, which framework they should follow.
In addition, data quality and availability can be another hurdle for firms to cross. The adoption of automatic reporting can significantly reduce the data collection burden. In addition, periodical data collection can also help maintain the reliability of sustainability data. Essentially, if a firm incorporates sustainability considerations in its business decisions and operations, the business performance will reflect the value and impact of such efforts. Verifiable data sources may also help enhance the credibility of the information reported.
People are the most valuable assets in sustainability reporting and utilizing the reporting process to the advantage of the businesses. Corporate leaders need to be committed to nurturing and empowering the right people to collect relevant data from different parts of business operations. Not only will they have the right expertise, but they can also provide valuable feedback on the results obtained from the data analysis. Such a collaborative and inclusive working culture will provide businesses with sustainability beyond just reporting but also making needed adjustments and improvements.
The integration of sustainability should be captured in terms of an integrated value approach. For example, if a firm’s financial profit stood at $10K with a negative externality for social and environmental impact at −$5K. In integrated value, this firm generated $5K. However, if the firm took an integrated approach in reducing the social and environmental externality, the financial profit might be reduced to $9K, but the negative social and environmental value also came down to −$1K instead. The integrated value after re-strategizing would now stand at $8K. This is a gain of $3K if the social and environmental considerations are integrated by the firm.
Contributors:
Co-authored by Zhang Weina, Associate Professor of the Department of Finance, NUS Business School, she is also the Academic Director of Master of Science in Sustainable and Green Finance and Deputy Director of the Sustainable and Green Finance Institute (SGFIN). Johan Sulaeman, Associate Professor of the Department of Finance at the NUS Business School and Director of SGFIN. Tifanny Hendratama is a Research Fellow of SGFIN.
