The recent uptick of sustainability bonds from global companies like Wells Fargo, Bank of America, and most recently Amazon sends a strong market signal that focus on corporate Environmental, Social, and Governance (ESG) is no longer just a trend – it’s the new business imperative. In 2021, most businesses understand that consumers are putting their dollars towards brands that align with their values, which often include sustainability and ESG. These consumers can spot greenwashing from a mile away and are demanding complete transparency and data from brands to back up their ESG claims.
In the wake of COVID disruptions and the financial advantage earned by companies focusing on ESG despite major market uncertainty, investors are rapidly recognizing the strategic importance of these metrics as well. While there is a wide range of data covering the ESG initiatives of public companies, it’s becoming increasingly clear that privately held companies must also be able to tell their ESG story to secure funding and enter public markets.
Let’s start by taking a look at how ESG, sustainability, and corporate finance have intersected over the years.
The History of ESG and Corporate Finance
In the early days, most businesses held a Green Vs. Gold mental model, where sustainability and profitability were seen as fundamentally at odds. ESG, in essence, was a luxury, or a “nice to have.”
However, companies soon began to realize that incorporating ESG into their business models was not only a necessary cost of satisfying the modern customer and staying off the radar of prominent environmental NGOs, but brought financial rewards as well. In the last 10 years especially, the rise of the conscious consumer has spurred companies to live up to higher ethical and environmental standards. In fact, nearly 70% of consumers in North America think it’s important for a brand to be sustainable. What’s more, 80% want to know the origin of their products, and 69% of these consumers would pay a premium for brands that readily provide this kind of transparency.
At the same time, pressure from NGOs was on the rise. Who could forget the Barbie deforestation scandal of 2011, when Greenpeace discovered that toy manufacturer Mattel was sourcing packaging material from a supplier clearing rainforests from critical wildlife areas.
Today, while the Green Vs. Gold mental model still holds true for some, there is a significant amount of data that conclusively demonstrates that sustainability and profitability are tightly correlated. For example, NYU Stern’s Center for Sustainable Business recently found that 50% of growth in CPGs from 2013 to 2018 came from products marketed with sustainability. Similarly, Unilever’s purpose-led, Sustainable Living Brands grew 69% faster than the rest of the business in 2018.
Just as Van Halen’s brown M&Ms Rider has become a great metaphor for proxy measures that alert you in advance to poor management practices, companies that focus on ESG are typically in a better place operationally and financially. A great trick to assess the organizational maturity of a company is to ask about their greenhouse gas (GHG) footprint: a company that has proper financial and operational controls in place will be in a far better position to monitor its ESG metrics.
Corporate ESG Reporting Today
As investors and shareholders demand more accountability, we are beginning to see ESG metrics more tightly integrated into corporate reporting metrics. This trend will certainly become more prevalent in the coming years as investors continue to demand ESG accountability as a standard indicator of corporate performance and risk, and as fund managers are prioritizing ESG as a key metric for fund inclusion for public companies.
ESG accountability is closely linked to the concept of “responsible supply chains.” After all, the greatest ESG impacts are found not in direct operations but in the supply chain. When it comes to accountability, prioritizing supply chain ESG performance will be fundamental to meeting the demands of shareholders and investors. There is momentum building around this concept as well. The term “responsible supply chains” did not emerge until the late 2010s but became more mainstream in 2020 with the havoc wreaked by COVID-19. Deloitte’s 10th Annual Chief Procurement Officer Survey mirrors this shift in priorities. Corporate social responsibility (CSR) saw the largest increase of any priority among CPOs (22% increase over 2019).
When it comes to “responsible supply chain management,” ESG is now regularly being discussed at the board level. By 2023 or 2024, we can expect that the concept of responsible supply chains will be integrated into overall “supply chain management” as a normalized best practice. In other words, “responsible supply chains” will no longer just be a trend but rather a core priority amongst procurement teams.
Investment and ESG in the Public and Private Market
In the early days, similar to corporate ESG management, public and private impact investing was recognized primarily for its environmental and social benefits, with a secondary focus on financial returns.
The status quo began to shift in the late 2010s with the rise of the sustainable Exchange Traded Fund (ETF), or the “ESG ETF.” Around this time, markets began to notice that companies prioritizing sustainability were enjoying increased financial performance and profitability alongside brand reputation.
However, corporate sustainability was really brought into focus in 2020. The first major signal came even before the official start of the pandemic, in January of 2020 with the annual Blackrock CEO letter. Larry Fink fired a major warning shot by stating that Blackrock would now be paying full attention to corporate sustainability metrics, since he saw them as part of overall business viability and financial success. He reiterated that commitment at the end of March of 2020, as the pandemic was ravaging Europe and the US.
In many ways, he was eerily prescient. Amid the global COVID-19 pandemic, ESG funds outperformed non-ESG funds by a staggering 4.3%. This was the largest difference in performance recorded since 2004. In 2020, sustainable ETFs also saw record inflows of $75 billion, triple those seen in 2019.
These trends will undoubtedly continue to rise in the near future. Within the next 5 years alone, it is projected that a majority of all European mutual fund assets will be tied to ESG factors. It’s safe to say that ESG investing is shaping up to be the most significant money managing development since the creation of the ETF.
What does this mean for you and your business? Making ESG commitments gets investors excited, and it’s becoming abundantly clear that shareholders are rewarding companies that take public steps to reduce their climate impact.
The Future of ESG
Similar to the notion of responsible supply chains, the concept of ESG will disappear as a “nice to have” in the not-so-distant future. Instead, it will become a standard reporting KPI alongside revenue, COGS, and EBITDA.
Yet, there are a few hurdles to overcome. One challenge is the lack of standardized ESG reporting – currently, there are no uniform standards for sustainability and social responsibility KPIs. Much remains to be seen on whether sustainability measurement and reporting standards can serve not only companies and investors, but also people and planet.
Encouragingly, industry groups are beginning to come together and create industry-relevant standards, and it’s likely that carbon will become one of the few cross-industry benchmarks. As considerations of climate impact and risk continue to drive investor concern, we’re seeing carbon take the spotlight. Shareholders are now using their leverage and voting power to increase executives’ ESG accountability, meaning that global brands can no longer afford to drag their feet on the climate issue.
Similar alliances are taking shape among private equity investors, too. One such example is the Net Zero Asset Managers Initiative, an international group of asset managers supporting ESG investing aligned with the goal of reaching net zero emissions by 2050. To date, this initiative already has 87 signatories and $37 trillion assets under management.
In this day and age, ESG is clearly a critical component of corporate performance in the public market. One additional challenge for private market companies is that there are very few ESG solutions and data collection systems available. But this does not make ESG reporting any less important.
LPs of private equity firms care more about ESG than ever before. When you’re raising your next round of funds, you must be able to tell the ESG story of your entire value chain. Without your ESG story in hand, you may even lose access to certain LPs, as some have ESG portfolio mandates. The same is true for brands looking to go public. Companies entering the public market need to have a plan for ESG performance that is fully integrated into overall corporate reporting.
Whether you’re a business reporting sustainability KPIs or a private equity firm looking to create a more future-proof portfolio, the business case for ESG is undeniable. Yet the key driver (or inhibitor) of your company or portfolio’s ESG performance is the supply chain.
Keep an eye out for an exciting new product launch in the coming weeks that will help investors unlock ESG insights from portfolio companies and their supply chains. At SupplyShift, we are proud to be providing tools for businesses, and soon investors, that enable real progress in supply chain sustainability and ESG investment.
