ESG additionality vs profit: getting the balance right

Environmental, social and governance (ESG) factors have become imperative as activists, government and the private sector grapple with ensuring a sustainable future. 

The global financial crisis has presented a multitude of short-, medium- and long-term threats and opportunities for companies and investors - with the potential to destabilise society and have a huge impact on business sustainability. 

As such, companies and investors need to adhere to regulatory requirements and standards. It is also becoming increasingly necessary for businesses to go beyond compliance and stakeholder relations to look at the implications for their business models or companies they invest in. 

Voluntary standards have been fragmented, causing confusion for users and inconsistency in reporting. In response to this, new efforts of co-ordination are emerging under the auspices of the International Financial Reporting Standards, while building on the work of the Global Reporting Initiative, the Integrated Reporting Framework and the Sustainability Accounting Standards Board, among others.

This convergence will likely aid comparability and compliance. However, given the divergent affects and risk exposures across geographical regions, sectors and companies, the convergence of disclosure standards can never fully address substantive company-specific reporting needs.

A debate has emerged as to whether responses should be limited to maximisation of risk-adjusted return, or some broader responsibility to promote social or environmental welfare and good governance. The concept of additionality - the idea that some additional ESG benefits can accrue to society as an outcome of investing or operating activities - is alluring.

However, this imperative is continuously balanced against profit maximisation, competitiveness and business model sustainability by asset owners, asset consultants and fund managers. 

Whether the aim is additionality or whether ESG is viewed explicitly in the context of risk and return, the first step is to understand the historical context of companies and society's impact on them. This will create a basis for formulation of views and forward-looking strategies to generate additionality. 

An understanding of the interface between companies and stakeholders is necessary, but not sufficient to engage risk- return. Analysis needs to go further by engaging with the proactivity of management and opportunities which come out of the stakeholder interface. 

The disclosure of a company’s ability to contextualise and recognise issues and their defined incentives and accountability mechanisms on addressing these issues is key. 

By responding and reporting within this context, companies can generate return and build resilience into their business models, underpinning financial performance. 

About the author, Waseem Thokan is head of research at Peresec. 

The Sanlam ESG Barometer

As the first study of its kind in SA, the Sanlam ESG Barometer evaluates the state of ESG and assesses how JSE-listed companies are changing their businesses to deliver improved ESG outcomes.

The report, produced by independent research house Intellidex in partnership with Business Day, can be downloaded here.  

This article was sponsored by Sanlam.