What’s Going on with ESG Lately?
It’s been about 20 years since the United Nations Global Compact Report that increased global awareness of environmental, social, and governance (ESG) factors. Stakeholder engagement, associated backlashes, and regulatory adjustments to encourage ESG implementation have evolved since then. In Canada, amidst some varied support for regulatory changes, ESG recorded some progress with increased responsible investment among businesses, transitioning corporate focus toward sustainability. ESG factors have transitioned beyond optional sustainability considerations in the corporate world and, by now, represent an essential component of risk management, competitiveness, and long-term sustainability for businesses.
Recent news items about Walmart, Meta and other large international firms reducing or eliminating some ESG investments could look like there’s a world-wide trend away from ESG. Actually, its the opposite.
A number of studies continue to show that commitment to ESG contributes to returns on investment and positions companies to contribute to sustainable development. However, as with many facets of its society, progress with ESG in Canada reportedly sits between the substantial growth recorded in Europe and pushbacks from the US, with room for improvement. PwC reports that less than 10% of Canadian companies attach as much importance to their sustainability as they do their financial reports and that telling the story of ESG investment remains important to investors. Investors continue to shift from the ‘ifs’ of ESG to focus on the ‘how’ for more excellent value and impact. A 2022 survey of Canadian businesses revealed that over 80% of buyers required suppliers to meet at least one ESG criterion, such as reduced greenhouse gas emissions (GHG), diversity, equity, and inclusion or information about procedures for managing environmental risks. ESG remains an important theme for investment (globally and in Canada), and there is a wealth of insights on actionable opportunities for decision-makers in Canada.
What is ESG? Why is it Important?
Environmental, Social, and Governance (ESG) integrate environmental, social, and governance factors into decision-making, influencing everything from investment strategies to corporate operations. ESG ensures that businesses identify and report the effects of their operations on the environment and people involved in their business operations. It also ensures that there is transparency in governance to increase stakeholder confidence. ESG plans help companies be responsible for the 3Ps of sustainability – planet, people, and profit/principle. It is a company’s corporate response to growing global sustainability concerns. The environmental factor, representing the planet, deals with issues such as GHG emissions reduction, efficient water use, biodiversity conservation and other aspects that affect environmental resources. The social factor represents people and focuses on diversity, equity, inclusion, labour rights, health, and safety. Governance in ESG represents leadership, roles and responsibility, accountability and transparency. These factors, despite being different, are somewhat intertwined. For example, climate change mitigation efforts may require efforts towards community inclusion and accountability of a company’s leadership.
McKinsey Quarterly (2019) established that ESG is not just a compliance framework but a strategic advantage for value creation in today’s intricate business environment. The report highlighted ESG’s role in facilitating top-line growth, reducing costs, minimizing regulatory and legal interventions, increasing employee productivity, and optimizing investment and capital expenditures. In a world where sustainability-related concerns such as climate change, rapid urbanization, inequality, and food insecurity are on the rise, ESG redirects the focus of businesses and investors from profit-driven systems to systems that prioritize people and the planet. ESG reporting, as an output of a company’s sustainability strategy, can also serve as a ‘powerful input’ for improving operational performance. However, presenting these reports is better in ways that provide insights to investors through the stories of an organization’s sustainability journey.
The Benefits of ESG for Canadian Investors: Recap
The New Climate shared insights on the emergence of ESG as a response to factors such as growing awareness of the global environmental crisis, increased regulatory pressure, and recognition of the financial benefits of sustainable practices. ESG evolved from basic corporate social responsibility to an integral component of businesses with direct benefits for decision-makers, including Canadian companies and investors. These benefits include enhanced financial performance, risk management and mitigation, a competitive edge in the marketplace, and reassurance of long-term sustainability by attracting top talent. It also supports building a brand’s reputation, building stakeholder trust and attracting investment.
- Enhanced Financial Performance: By integrating ESG principles into operations, businesses increase their chances of accessing investments to ensure sustainability in the long run. In a survey of 100 large companies and over 1,000 small and medium-scale enterprises (SMEs) conducted by the Business Development Bank of Canada (BDC) in 2023, they reported that a third of suppliers engaged in the survey believe that ESG will positively impact their businesses. In a joint publication by NYU Stern and Rockefeller Asset Management on the relationship between ESG and the economic performance of companies, they found that a long-term commitment to sustainability positively correlates with lowered capital costs and an increase in stock prices. Sustainability strategies also increased innovation, improved operational efficiency, and reduced risks, thus strengthening investor trust.
However, reporting these strategies alone did not increase financial performance. The reviews indicated the need to go beyond reporting. ESG’s impact on a company’s financial performance stems from integrating genuine actions into operations beyond disclosing its sustainability strategies for regulatory compliance. An analysis of 1000 studies on ESG and corporate financial performance further confirms this. From the analysis, more than 50% of companies with established ESG strategies recorded increased financial performance compared with 26% of those focused only on reporting. Many other studies have found that a combination of ESG factors implemented as strategies positively and significantly correlates with a company’s value and profitability. This correlation indicates that companies with higher ESG investments are more likely to yield significant financial returns. However, it was also discovered that of the three ESG factors, social and governance factors were more likely to generate higher returns than focusing solely on environmental factors. This disparity may be due to the high cost and longer-term returns associated with environmental issues.
The studies overall, definitively indicate a positive relationship between ESG strategies and attractiveness for investors in the fast-growing ESG-themed market and there is also likely a positive connection to business performance in the longer term.
- Risk Management and Mitigation: ESG is about identifying growth opportunities and identifying possible material risks in businesses. It provides tools to anticipate and mitigate risks such as climate disruptions or regulatory penalties. ESG ratings issued by third-party certification bodies may include either or both enterprise value rating and impact value rating. Either way, ESG strategies help companies identify the risks they are exposed to and/or how they contribute to these risks, making them better risk managers. Identifying and reporting these risks also makes companies better prepared for when they occur, saving them substantial financial losses. The financial reports alone do not often address these risks. ESG reporting provides investors with more detailed information beyond the company’s bottom line and improves their investment decisions. In terms of regulatory changes, companies with existing ESG strategies can better manage transition risks, especially reputational risks associated with lagging in adoption. For instance, companies with robust ESG practices are better positioned to navigate Canada’s net-zero transition policies.
ESG Trends Globally and in Canada
ESG gained a significant profile with the launch of the United Nations Global Compact Report, published in 2004. The report, endorsed by global financial institutions across nine countries, advocated for key stakeholders, including analysts, investors, companies, stock exchanges, NGOs, regulators, pension fund trustees and a host of other actors, to prioritize the sustainable development of cities alongside building more substantial and more resilient investment markets. Below, see the ESG trends globally since the launch of the UN report in 2004.
Global ESG Development Timeline (2004 – 2024)
Source: Modified from TodayESG – Article on ‘Origin of ESG: Global Compact “Who Cares Wins”’
Since the launch of the UN report, stakeholder engagement and regulatory environment for ESG implementation has continued to evolve amidst recent developments. Some of the recent developments globally and in Canada include:
- Stiffer Regulations: According to DiliTrust, 2024 was a remarkable year for ESG, especially in Europe, as several regulatory frameworks became effective. These regulations include the equality promotion directives, the European Green Claims Initiative, and the deforestation-free products regulation. Also worthy of note is the Corporate Sustainability Reporting Directive (CSRD), which, although launched and published in 2023, became effective on January 1, 2024. European companies are required by this policy to submit their 2024 financial year-compliant report by January 1, 2025. The regulation aims to improve the reliability and comparability of sustainability insights provided by over 75% of businesses in the region. All companies operating in the EU, including companies that only have corporate clients, investors, and suppliers in the region, fall under the policy’s jurisdiction. As such, over 1,300 Canadian companies, mainly in the metals and mining industry, must also comply with the CSRD.
In Canada, the Modern Slavery Act came into force in January 2024. The Act focuses on the social factor in ESG by mandating companies to report annually on steps taken to address forced labour and child labour in supply chains. The policy also covers products imported into Canada. In more ESG regulatory turns, the government amended the Competition Act – Bill C-59 – to include new anti-greenwashing product provisions. In line with international standards and methodologies, Canadian companies are legally mandated to substantiate environmental claims on their products. This move by the government has been met with opposing views, especially since it targets mainly products and not false environmental claims by companies. While this is a step in the right direction, addressing concerns about greenwashing by companies beyond their product will significantly benefit efforts toward overall corporate sustainability. The Canadian Sustainability Standards Board (CSSB) also made significant steps in ESG regulations by adopting two sustainability disclosure standards in alignment with the International Sustainability Standards Board (ISSB) frameworks. These standards will help to improve the clarity, consistency and comparability of sustainability disclosures by Canadian companies. The new standards came into force on January 1, 2025.
- Increase in demand for ESG roles: Indicating an increasing commitment to sustainability, 2024 recorded a substantial increase in the demand for ESG and sustainability-related roles. In a recently published LinkedIn report on global green talent stocktake, the demand for green talent increased by over 11%, double the supply of over 5% between 2023 and 2024. In countries such as Portugal, the United Kingdom, and Costa Rica, the demand for green skills surged above 40%. It is estimated that by 2050, the gap in demand and supply will increase by over 100% if talents are unavailable to fill available roles.
Indexed Growth Rates of Green Talents Globally. Source: LinkedIn (2024)
- Decrease in demand for ESG roles in Canada: While other countries have recorded an increased demand for ESG roles, the reverse has been the case in Canada. As of 2023, less than 2% compared with a global average of 11% of job postings required green skills in Canada. Amidst lower demands than the global average, the mining and utilities sectors ranked highest in demand in the country, as 16% of job advertisements required green skills. Below is a distribution of the demand for green talent across key sectors in the country. However, by early 2024, the demand decreased by over 18%. Finland and the Netherlands are other countries where demand for ESG roles declined in 2024.
Top five sectors with demand for green skills in Canada. Source: The Conference Board of Canada, Vicinity Jobs.
- AI and ESG: Digital transformation in ESG has been found to contribute to companies’ high financial performance. Specifically, incorporating Artificial Intelligence (AI) into ESG offers numerous benefits, especially in navigating its complexities. Since AI can generate timely insights from vast amounts of data, it provides the potential to improve sustainability reporting, support compliance with regulations, and improve decision-making by companies and investors. Canada-based platforms such as ESG.AI (see also: AI Integration Roadmap) support businesses in optimizing their ESG reporting processes by analyzing real-time complex data to highlight trends and opportunities and offer actionable insights. In a 2024 KMPG Canada Survey on the use of AI for financial reporting, it was reported that over 80% (approximately 12% more than the global average) of companies in the country have or are piloting AI for financial reporting. According to the report, nearly all the 1,800 companies surveyed want to increase their investments in the technology to predict trends and impact, among other benefits. Despite the benefits of AI in ESG, its disastrously high energy consumption and generation of electronic waste pose social and environmental challenges. Successful integration into ESG relies on balancing potential benefits and negative impacts on businesses.
- ESG Backlash: Despite the relevance of ESG in today’s ‘climate,’ the concept has consistently received backlash. Nearly half of US companies surveyed by the Conference Board in 2023 revealed that they experienced varying degrees of ESG backlash; as such, they had begun replacing ESG with terms such as ‘sustainability’ and ‘corporate responsibility.’ However, in a contrasting report by Reuters, S&P 500 companies that publicly report workforce diversity and GHG emissions data have significantly increased by over 80% from 2019 to September 2024 (see below). Despite the consistent backlash, this increment indicates that companies and investors stay committed to reporting sustainability matters. The general sentiments remain that ESG, considering its relevance, is here to stay. In 2024, anti-ESG cases, such as one in Missouri that tried to limit the impact of ESG on investment advice, were struck out of court – victories for ESG propagators. On the flip side, the Diversity, Equality, and Inclusion (DEI) backlash gained momentum with a decline of over 40% in DEI roles. While companies such as Tractor Supply and Microsoft, Walmart, and Meta made headlines for their changes to DEI policies, President Trump’s recently announced cuts on DEI roles in government institutions has heightened tensions on the topic. Even though most of the resistance has so far come from the US, there is a likelihood of this influencing Canadian businesses and investors.
Trends in Diversity Data Reporting. Source: Reuters (2024)
- Increase in responsible investments: The Canada Responsible Investment Association, in a report published in mid-2024, disclosed that responsible investment by Canadian companies increased by over 70% by the end of 2023. Over 10 years, investments grew from less than $1 Trillion in 2013 to over $4 Trillion in 2023. Age and investor demands were identified as factors responsible for this growth. The role of young investors/plan members particularly increased from 8% in 2023 to 34% in 2024. Responsible investments include environmental, social, and governance factors in their selection and management. As seen below, diversity and inclusion, climate change mitigation, and human rights are some ESG factors that topped investment decisions in the reporting year.
ESG factors considered in decision-making. Source: 2024 Canadian RI Trends Report
Conclusion
In the last 20 years, ESG awareness, regulatory support, and associated backlashes continued. Canadian investors and businesses showed that ESG benefits financial health with continued growth in responsible investment. Beyond its contribution to a company’s financial health, among other benefits, identifying sustainability risks in ESG reporting has also been found to benefit company risk management. While the ESG landscape in Canada evolves rapidly, with stiffer regulations as well as a mounting backlash, it continues to offer investors, businesses, and policymakers the opportunity to drive sustainable growth. There is some progress with the latest ESG trends, but there is still plenty of room to catch up and stay competitive in a globalized economy, especially compared to European countries. ESG, or its other replacement terms, are here to stay because investors will continue to be attracted to the tangible financial results. In future articles, the New Climate Canada will share insights on emerging ESG challenges including the application of AI, regulatory trends/best practices, and shifts in policy perspectives.
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