Successful implementation of ESG concept requires a change in mindset

    13 Sep 2021

    In this article on the concept of environmental, social, and governance (ESG), the author from Arab News shall examine the importance of changing the mindsets of corporations and employees to ensure the effective implementation of an ESG program.

    The author is Dr. Mohamed Ramady, a former senior banker and professor of finance and economics at King Fahd University of Petroleum and Minerals, Dhahran.

    There is now a perceptible shift in relations between the public and private sectors on what constitutes “good” sustainable economic development. For the private sector, the choice in the future is simple; economic sustainability is the key to staying in business. This then translates internally into the corporate structure of who is responsible for ESG and more importantly, with whom.

    For investment companies, the various layers of decision-makers are investment managers, investment and governance staff, consultants, and trustees. A change in the traditional operating mindset is required to make ESG successful, as well as more education across the general public as surveys have shown that young people are particularly interested in ESG concepts aligned with their values while older investors tend to look for returns. Investors are increasingly eager to invest in ESG-related companies and fund providers, but many rely on a personal judgment about what constitutes an ESG investment and do not use available research and metrics from ESG-ratings providers. Therein lies a huge opportunity for the financial services industry.

    Thinking outside the box is essential as existing “sustainability” management tools and systems are written by environmentalists and social scientists but in reality are inadequate for actually managing a real business.

    The existing tools are not aimed at economic sustainability managers who have a relatively well-known set of financial indicators to rely on, such as turnover profit margin, market capitalization, and earnings per share. In the current ESG environment, companies that manage financial performance using only these narrow indicators risk premature death, as even excellent social and environmental performance will not help prolong the life of a company that is economically unsustainable. However, a broader perspective on how to manage economic performance is fast emerging, based around the brand, intangible assets, reputation, full cost accounting ability to add value, and the management of knowledge.

    A mindset change is necessary for ESG to be successfully implemented.

    The time involved in decision-making by various actors is a determining factor for success and failure in ESG implementation. Stakeholders’ decision-making time duration often ranges from three months to three years depending on their portfolio and risk aversion.

    Regulators and watchdogs take from two to four years to decide, as they focus on administrative government cycles, with regulators moving on every three to five years.

    Sustainability managers’ timescale is also long-ranging from five to 15 years, as many projects cannot pay off with this duration, while boards usually take from one to 10 years, depending on the average board member’s length of service (three to five years).

    Company staff timescale also differs depending on career aspirations and job satisfaction in that sector.

    A mindset change is necessary for ESG to be successfully implemented. A key is to enable Economic Sustainability Managers (ESMs) to address the need for broader financial and economic measures beyond the profit and loss accounts, and the interdependence of an organization with its local, national, and global economies. This requires ESMs to be the first to attempt at measuring intangible assets, full cost accounting or even making an economic sustainability index.

    The role of ESMs is to make the high-ups understand that good sustainability standards help companies gain access to more capital and also reduce costs.

    How is ESG reporting evolving? There is a current proposal by the International Financial Reporting Standards to create sustainability accounting standards, as at present current accounting systems are inconsistent and incompatible with sustainable accounting information. There has now been a noticeable increase in Voluntary Global Reporting Initiatives as well as new reporting frameworks like the IIRC – the International Integrated Reporting Council, which provide frameworks for voluntary sustainability reporting, and the Sustainability Accounting Standards Board which seeks to provide standards for mandatory sustainability reporting that are integrated in US Securities and Exchange Commission filings. The aim is that sustainable corporate disclosures can then serve as a “differentiator” in global and competitive industries to increase stakeholder confidence, investor trust, and employee loyalty.

    Companies can take concrete steps such as accelerating adopting green innovations and discouraging high polluting technologies. The financial markets can play an important role by changing capital market practices for raising new capital to incorporate long-term environmental and social risks as important measures to gauge economic health. On a macro-economic level, the traditional Human Development Indexes measures success from a per capita GDP perspective, but other factors are equally important such as democratic governance, gender inequality, and poverty, etc.

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