In the category of addressing global challenges of climate change, social inequality, and corporate accountability, the financial analysis framework, Environmental, Social, and Governance (ESG), emerged for assessing company performance in a way that promotes sustainability. These are times of rapid change and mounting global challenges and Canadian decision-makers will continue to gain significant benefits from fully using ESG. Adopting ESG analysis helps Canadian investors’ financial performance, reduces risk exposure, and maintains competitiveness in the volatile global market. Adopting ESG strategies within companies helps attract capital, retain employees and reduce operational and market share risks. ESG is good for investors and good for business organizations’ long-term success.
The Emergence of ESG
ESG is a set of criteria that measure the sustainability and ethical impact of a company or investment. This encompasses a range of issues from environmental protection to climate change mitigation, social equity, labor rights, and corporate governance. Over the past decade, ESG has grown in influence from a niche concept (that extended from corporate social responsibility and impact investment) to a mainstream consideration for businesses and investors worldwide. Factors that led to its expanded profile include the growing awareness of environmental crisis, increased regulatory pressure, and the recognition that sustainable practices lead to financial better performance. According to a 2020 study by McKinsey & Company, across industries, geographies, and company sizes, organizations have been allocating more resources toward improving ESG. More than 90 percent of S&P 500 companies now publish ESG reports in some form, as do approximately 70 percent of Russell 1000 companies.” There has been continued growth into sustainability funds which gained $120 billion of net new funds in the first two quarters of 2022.
The Direct Benefits of ESG for Canadian Decision-Makers
In a 2018 Responsible Investment Association (RIA) study, Canadian investors reported that the two main ESG considerations they look for are fiduciary duty and risk management. ESG has moved beyond basic corporate responsibility and into the domain of financial performance and a way of addressing enterprise risk.
Financial Performance
The ESG framework is used for assessing investments and for improving organizational footing for investment by integrating ESG principles into operations. Studies have shown that companies with strong ESG performance including a set of organizational actions that improve environmental performance and preparedness, equity and governance are more likely to outperform their peers in the long run. There is a financial value of solid business practices. A 2020 study by MSCI found that companies with high ESG ratings outperformed those with low ratings during the COVID-19 market downturn. By embracing ESG planning, companies anticipate new market opportunities (by taking climate impacts in account for example), increase operational efficiency, and foster innovation. These approaches all contribute to an organization’s bottom line.
Reducing Risk
Incorporating ESG criteria into decision-making processes allows Canadian decision-makers to identify and mitigate potential risks more effectively. In fact, the lack of ESG reporting can result in undervaluation. Companies that effectively manage ESG factors tend to have lower risk exposure, as they are better prepared for regulatory changes, supply chain disruptions, and reputational damage and, have better access to capital due to clearer management reporting.
A 2019 report by the Bank of Canada noted that firms with strong ESG practices are less likely to experience financing risks. By proactively addressing ESG concerns such as changing availability of some supply or being more effective at addressing changing market preferences (supply chain labour issues for example), decision-makers safeguard their organizations against unforeseen challenges and ensure business continuity.
There’s plenty of progress to still be made for Canadian companies in this area. According to an EY’s 2019 survey of global institutional investors on ESG showed that 56% of investors don’t believe ESG disclosures are not yet adequate enough.
Competitiveness
The rapidly evolving global markets present a competitiveness challenge to Canadian investors and company managers. As investors and customers increasingly demand responsible business practices, companies that fail to embrace ESG principles risk being left behind. A 2021 survey by RBC Global Asset Management found that 90% of institutional investors in Canada consider ESG factors in their investment decision-making. By incorporating ESG criteria into their decision-making processes and ESG considerations into operational plans, Canadian companies differentiate, ensure their relevance in the marketplace, attract investments, and build enduring confidence with customers.
A 2022 PWC study found that “one-off and standalone initiatives are no longer sufficient to meet the rapidly evolving expectations of… customers, employees, investors and other stakeholders.”
The story goes similarly for corporate governance and diversity aspects of ESG. According to the CSA’s analysis of the disclosure of 625 TSX issuers, from 2015 to 2022, the proportion of issuers with at least one woman on their board rose from 49% to 87%; in large part due to ESG considerations for better representations on boards.
A further underscoring of this point is made by ISS Corporate Solutions, Inc. (“ISS”) in their review of the boards of the 250 largest Canadian listed companies and the 500 largest US listed companies (by market cap). The review found that both in Canada and the US, significant gender diversity thresholds have been reached in 2023, with women representing 33.7% and 32.3% of board members.
Long-Term
ESG adoption for analysis and investment selection and also for strategic operations within companies, is increasingly being associated with improved financial returns. As environmental and social challenges continue to mount, companies that fail to adapt may face significant financial and reputational consequences. Even in the case of prominent Canadian energy company, Suncor, the recent commitment to a 30% reduction in greenhouse gas emissions by 2030, is a recognition of the importance of ESG in securing stakeholder confidence.
AND… Regulations Are Coming
There’s a lot on the way in terms of regulations and global standards that will increasingly guide ESG behaviour among analysts and companies. Business leaders need to get familiar with these. The UNGPs, and the OECD Guidelines for Multinational Enterprises, give us guides for due diligence on human rights and social issues. The TCFD recommendations, Carbon Disclosure Project, and the Climate Disclosure Standards Board help companies understand how to report climate change information. The Global Reporting Initiative gives assistance to measure environmental, social and governance issues. The IFRS International Sustainability Standards Board, Value Reporting Foundation, and UN Sustainable Development Goals are key references for relevant terminologies. These will all increasingly get utilized by Canadian regulators, investors and stakeholders.
Through 2023 and beyond, the use of ESG principles will continue to help Canadian companies enhance their financial performance, reduce risk exposure, and maintain competitiveness. As ESG continues to gain prominence world-wide, Canadian business leaders should capitalize on the direct benefits of incorporating these principles into their investment strategies and operations. The growing body of research and business practice examples show the importance of ESG for Canadian organizations. Companies that embrace this critical framework will be positioned for enduring success and this will also contribute to broader environmental and social outcomes in an increasingly interconnected world.
