Updated: Feb 5, 2020
Integration of material environmental, social and governance (“ESG”) factors into investment decision-making is becoming mainstream within the global institutional investment community, as awareness grows of the potential impact of these factors on company value (for more background, see our piece “A Material Difference: The Distinction Between CSR and ESG“).
But is developing an ESG strategy to respond to this investor interest just for large companies who are subject to enhanced scrutiny, or for companies in sectors with major environmental and social impacts, like the extractive industries? We would argue that this is risky thinking, for two main reasons.
1. Even emerging companies can face big ESG risks
Principal Michelle de Cordova often uses the following analogy to explain that ESG factors can be material for a company of any size: Imagine you are on the board of a start-up company with two employees and a couple of computers, that is still operating out of a garage. Could that company be exposed to ESG factors that pose material risk or opportunity to that company, for which you should be providing oversight? Consider these questions:
- Now that the CEO has a subordinate, what policies are in place to prevent harassment in the workplace that could lead to the loss of critical human resources, result in a costly lawsuit, or damage the reputation of the company as a desirable place to work?
- What systems have been put in place to prevent cybersecurity breaches and ensure that customer data privacy is respected?
- The garage is situated in an area where wildfires are becoming increasingly frequent. In a wildfire emergency situation, would electrical power be cut off by the utility company as a precaution, and how would that impact operations? What critical corporate information and infrastructure is stored in the garage and could be at risk if the property were destroyed in a wildfire?
Large companies may have more obvious impact on society and the environment than smaller companies, but the impact on an issuer and its investors of success or failure in managing material ESG risks and opportunities can be highly significant for a company of any size.
2. Some ESG factors are universal or systemic
Many ESG factors are sector-specific or relevant only for companies in specific situations, for example companies that operate in countries with high levels of corruption will be exposed to different material ESG risks than companies with operations exclusively in Canada. However, some factors are so likely to be financially material for every company that we can consider them to be universal ESG factors. In this category, we could include human capital management issues and employee human rights, and increasingly, cybersecurity.
Additionally, climate change is potentially material for many companies: the Sustainability Accounting Standards Board (SASB)’s Climate Risk Technical Bulletin identifies climate change as a systemic risk that will significantly affect almost every industry (or 93% of U.S. equities). Given the ubiquity of climate risk and the threat it poses to the long-term stability of financial markets, a growing number of institutional investors are seeking to understand whether or not climate change is a material issue for each investee company across their portfolios. Every company should be prepared to answer the investor question, “how is your company impacting, or impacted by, climate change?”.
It is never too early to start thinking about ESG and how it impacts your company strategy.