The Importance of Corporate ESG

Though businesses have long recognized the importance of being good corporate citizens and supporting their communities, such concerns have historically been seen as separate from the overriding goal of creating value for shareholders. Yet today, companies are increasingly being called upon to serve the needs of all stakeholders as an intrinsic part of doing business.

According to the United Nations, businesses’ role in addressing 17 Sustainable Development Goals covering global environmental, social, and economic challenges is essential. The call for action has only intensified amid the COVID-19 pandemic and rising concern over climate change and social and economic inequality.

As a result, companies ranging from middle market businesses to the largest international corporations are being assessed not just on profitability but on their environmental, social, and governance (ESG) records.

ESG-minded shareholders, inspired by the recent success of activists in gaining seats on the board of energy company ExxonMobil Corp., are increasingly confident in their ability to influence companies. Yet concern over ESG activism is far from the only reason for companies to create a strong, forward-looking ESG strategy. These days, ESG performance may have a direct impact on your ability to attract investors and customers, work with other businesses, hire the best employees, and maintain a strong reputation.

"For just about any business to be successful today, ESG must be central to your operations and to your strategy for the future," says Kevin Khanna, SVP, Head of Corporate Banking at Fifth Third Bank. "It’s no longer optional or something you can put on the back burner." Indeed, companies that commit to strong ESG practices stand to benefit, while others may face an uphill climb.

Here are four reasons to fully integrate and elevate ESG within your corporate strategy:

Reason 1. Build Value and Reduce Risk

"Creating value is a driving concern for any business," Khanna says. In a report from the consulting firm EY entitled "How ESG creates long-term value," the authors write, "Our experience shows that companies that are proactive on ESG have a clear market advantage."

A recent article by Fifth Third Bank drives that point home, noting that "companies that can convince consumers of their commitment to sustainability can see enhanced revenues from a growing consumer base that is motivated to buy ESG brands." Consider the travel and leisure industry. According to Booking.com, 69% of travelers expect the industry to offer more sustainable travel options, while 55% want to know how the money they spend goes back into the communities they visit.

By the same token, companies that ignore these opportunities risk falling behind. As the EY report states, "Failing to take meaningful action at this point can mean leaving money on the table." Such companies, Khanna says, "also risk eroding their value through reputational damage and lost business."

Reason 2. Enhance Company Performance and Stock Price

"Companies with an ESG focus have a unique opportunity to enhance their own financial performance, even as they support a cleaner environment and healthier communities," Khanna says. Among more than 1,000 studies conducted between 2015 and 2020, 58% found that ESG performance corresponds positively with measures such as return on assets (ROA), return on equity (ROE), and stock price, according to a review by NYU Stern School of Business and Rockefeller Asset Management. Only 8% showed a negative relationship, while others were neutral or mixed.

"Even if your financial performance is already solid, failure to prioritize ESG could mean missing out on growing numbers of stock investors for whom such issues factor decisively in where they invest and where they don’t," Khanna notes. Investments in ESG mutual funds have surged in recent years, with CNBC reporting that sustainable-focused assets under management reached nearly $2 trillion worldwide in early 2021.

Demonstrating a commitment to ESG may also make your company more attractive to private investors. A recent Capital Monitor article stated that among private equity firms, "there is a stronger conviction that sustainability will create greater value over time." According to a 2021 EY study, 41% of the largest private equity firms (those with assets of more than $15 billion) identified ESG considerations as a top strategic priority.

Reason 3. Meet Emerging Regulatory Requirements

Amid rising concerns over climate change and other threats, the U.S. Securities and Exchange Commission is planning new regulations requiring companies to disclose the climate risks they face. Globally, the Task Force on Climate-Related Financial Disclosures (TCFD) recommends a detailed framework of disclosures for corporations "that could promote more informed investment, credit, and insurance underwriting decisions." New Zealand has already made TCFD disclosures mandatory, S&P Global reports, and other countries and regions are expected to follow.

While adhering to regulations and disclosures guidelines entails costs, "the benefits of staying ahead of these will likely outweigh the costs," says Khanna. As McKinsey & Co.’s Robin Nuttall, a London-based specialist in regulatory and government affairs, noted in a 2020 podcast, "Evidence is emerging that a better ESG score translates to about a 10% lower cost of capital, as the risks that affect your business, in terms of its license to operate, are reduced if you have a strong ESG proposition."

Reason 4. Maintain and Strengthen Essential Partnerships

The pandemic-related shutdowns and product shortages have underscored just how vulnerable supply chains are to disruption. This time of heightened concern over everything from health to climate to labor practices has "underscored the importance of resilient, sustainable, legally compliant, and ethical supply chains," according to a 2020 report posted on the Harvard Law School Forum on Corporate Governance. Companies that pay close attention not just to their own ESG practices but also to those of the companies they buy from and sell to are likely to recover faster from disruptions, the article suggests.

"By the same token," says Khanna, "vendors hoping to maintain relationships with the businesses they supply are increasingly being held to those companies’ ESG standards." In one high-profile 2020 example reported by the BBC, Apple publicly put one of its iPhone suppliers on probation, saying its labor practices violated Apple’s Supplier Code of Conduct.

ESG is also becoming an important consideration for companies seeking financing for growth. At Fifth Third Bank, "our approach to ESG is focused on doing well by doing good," Khanna says. That includes not just meeting rigorous ESG standards for the bank’s own operations but also conducting due diligence to reduce ESG risks associated with the bank’s business clients. When S&P Global surveyed credit, risk, and portfolio professionals in late 2019 and early 2020, 86% agreed that considering ESG more fully when making credit decisions is "becoming critical." A July 2021 article in American Banker called ESG "the new frontier in risk management."

ESG strategies must be thoughtful and sincere and represent long-term commitments to better practices. While the risks to companies that lag behind seem increasingly clear, "this is really a positive story," Khanna insists. "The flipside of these risks is greater opportunity for companies that pay close attention to ESG factors and follow a concerted strategy that can support the environment and communities while helping to ensure their own future success." For additional information, contact your relationship manager partner or find a banker to learn more.