ESG has been called the Mega Trend for the future of business; perhaps also the Mega Risk of the future?
Yes we are in the middle of the Covid-19 crisis but, as ever, the world and all its opportunities and risks do not stand still.
One of those key risks and opportunities that Internal Audit need to consider is the ESG agenda. If any of you aren’t familiar with ESG:
Environmental, social and governance (ESG) criteria are a set of standards for a company’s operations that socially conscious investors use to screen potential investments. Environmental criteria consider how a company performs as a steward of nature. Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights. (Learn more about ESG criteria)
As an example of the issues that can come up under the environmental criteria, the WEF recently published an article focusing on micro plastics in our environment , it does not make for pleasant reading, and it got me thinking on the implications for business and Internal Audit.
How should Internal Audit Leaders be thinking about this issue and the broader ESG criteria?
11 billion tonnes of plastics will accumulate in the environment by 2025. Scientists find plastic pollution in the rain and in the air we breathe WEF July 2020
This article is focused on the perception that these issues create and therefore why the broader ESG agenda is becoming a key business risk and is critical for Internal Audit to take into account. The reason I say perception is that it doesn’t really matter whether you believe in or value all of the issues raised by the ESG agenda, but it does matter if your key stakeholders do and they start to perceive you as part of the problem.
If we take the plastic issue as an example, if your organisation is perceived to be contributing to this problem and is not being seen to be actively working to mitigate it this could create substantive business risk.
Internal Audit must consider environmental impact.
I’m not just talking about reputational damage and the consequent risks to consumer behaviors and income streams. Increasingly investors are taking ESG seriously. It is clear to many institutional investors that the money is already (and will increasingly do so) flowing towards organizations with a strong ESG agenda. Ultimately the wrong perception of your behaviors will likely drive down your share price in years to come.
A clear example of the direction of travel of the ESG agenda is the LTSE (Long Term Stock Exchange) the LTSE lays down the gauntlet for stakeholder capitalism and the broader ESG agenda by focusing organisations on their long term delivery to their stakeholders rather than their quarterly profit figures.
Modern companies measure progress over decades, not financial quarters. Investors who invest long term want to know not just how companies plan to produce value in the next quarter but for years to come. Employees, customers, suppliers, and communities count on companies to uphold their commitments and to do right by society
… So what is my point?
My key point is that some sectors, such as; Tobacco, Pharmaceuticals, Energy, Defence are used to dealing with community resistance to what they do, most are not. What can seem a hypothetical conversation will for many companies very quickly become a critical business risk.
In a world dominated by the speed of social media and dealing with complex issues such as BLM, Covid, Global Warming etc. What might have been a trivial issue a few years ago could very quickly blow up into a critical issue that rapidly drives down your share price, income, profits and staff morale.
Internal Audit needs to be taking the ESG agenda and associated risks seriously and helping their leadership teams to do the same. In doing so there is a bright future for Internal Audit, not only helping to mitigate risks to the organisation, but in genuinely feeling they are making a contribution to society.
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