Developing ESG framework: What businesses must consider

In today’s rapidly evolving world, businesses must do more than just chase profits and seek expansion on all fronts. The growing perception is that it is not enough to make money, businesses must also be socially responsible and environmentally conscious. In the past, it was customary to pay lip service to ESG considerations.

Now, times have changed and failure to embrace and integrate ESG into the overall strategy of businesses can have severe repercussions for businesses.

ESG factors have been linked to value creation for businesses that are deeply intertwined with environmental, social, and governance concerns. Research weighs heavily in favor of the fact that a strong ESG proposition correlates with higher equity returns and value creation for businesses in diverse ways including higher credit ratings, boosted competitive advantage, increased operational risk effectiveness, lower risk exposure, reduced regulatory and legal interventions, preferential access to new markets, increased employee productivity among others. In a more direct financial sense, ESG integration also opens up novel avenues of accessing funds from sustainability-conscious investors and investment funds to businesses.

In what follows, I undertake a brief overview of the importance of developing an ESG framework, and the elements that must be incorporated in every ESG framework to ensure operational competitiveness.

ESG Integration

ESG integration is an organization-wide process that involves considering environmental, social, and governance factors in the operations and decision-making processes of a business with the ultimate goal of making it more sustainable.

Businesses can integrate ESG considerations into their overall business strategy by developing a framework that sets out their approach to achieving full integration.

The framework must be practical, comprehensive, and tailored to the specific needs of the business and its goals. A well-outlined framework allows a business to position itself favorably in the sight of new-age investors who have an eye for compliance with ESG metrics such as the presence of an overarching ESG Policy, corporate code of ethics, carbon footprint, people diversity, health, and safety events among other important benchmarks.

In developing an effective ESG framework, businesses must incorporate the following elements.

a. The application of materiality assessment b. Establishment of goals and targets c. Establishment of performance metrics d. Integration of ESG into decision-making processes, governance, and culture e. Communication of ESG performance

1. The use of Materiality Assessment

A key aspect in the development of an ESG framework is the conduct of a materiality assessment. An ESG framework for a business should clearly define the factors that are absolutely vital to the company’s operations, stakeholder interests, and goals. Businesses need not find every conceivable ESG issue within their business model.

A materiality assessment is necessary to identify relevant ESG risks and opportunities that are most significant to the pursuit of value creation by the business.

The application of the principle of materiality is relevant, especially for Small and Medium Scale businesses that are hesitant to fully embrace ESG integration due to a lack of resources and an abiding fear that continuous ESG action will not yield significant returns compared to the sacrifice in respect of time and effort that would be made. It bears repeating that investing time and resources, even on a small scale can have a positive impact.

The materiality assessment processes can be undertaken in different ways. The first step in this process involves an assessment of sector or industry-specific needs and best practices, regulatory analysis, and engagement with stakeholders, and making a determination of the social and environmental impacts of the activities of the business on them.

Stakeholders in this context refer to entities or individuals that can reasonably be expected to be significantly affected by the activities of a business, its products, and services and whose actions can reasonably be expected to affect the ability of the organization to successfully implement its strategies and achieve its objectives.

Stakeholders can be internal and external and include but are not limited to employees, owners, investors, lenders, regulators, suppliers, civil society, and political groups.

As part of this initial assessment, a business can also consider the metrics that investors in the industry are concerned about. Additionally, a business can also consider the Sustainable Development Goals (SDGs) and how the short-term and long-term objectives of the organization align with the SDGs and identify the impact areas that can affect its contribution to the SDGs.

Secondly, the business must assess the significance of these issues in relation to the overall business strategy as well as the interests of its stakeholders. In assessing stakeholder interests, it is important to consider their economic influence, social influence, environmental impact, the proximity of the stakeholder and the level of dependence particular stakeholders have on the business.

Finally, the business needs to draw out the priority list of possible ESG issues based on their materiality ensuring that the most significant issues are given attention in its ESG framework.

For instance, a business that provides tech solutions may consider issues such as Cyber Security and Data Protection risks as being of a higher priority compared to low-priority concerns such as litigation and impact on local communities.

Again, a food company may also prioritize issues related to health, food safety, and supply chain due to the potential reputational damage and legal liability that could spring up as a result of neglect of these issues.

The use of materiality assessment to develop an ESG framework can aid companies to reduce risk, enhance their reputation and identify new business opportunities. This assessment can be conducted on a regular basis be it quarterly or annually, to ensure that the framework is in conformity with evolving circumstances and changing stakeholder expectations.

2. Establishment of Goals and Targets

An ESG framework must establish an overarching ESG policy that establishes measurable ESG goals and targets that align with both the short-term and long-term strategy of the business. It is important that the goals must be specific, time-bound, and in line with industry standards and best practices.

In this regard, a business may, for instance, set a goal to ensure that its supply chain meets certain sustainability criteria such as reducing waste and emissions and reliance on hazardous materials.

In its Climate Transition Action Plan (CTAP), Unilever has committed to taking steps to reach net zero emissions within its operations by 2030. In our local context, the Bank of Ghana's solidarity with the “HeForShe” Campaign has committed to increasing the representation of women in its workforce including its leadership positions.

3. Establishment of Performance Metrics

The framework must also define performance indicators that can be used to track the progress of the business toward its established goals and targets. An ESG framework with specific performance metrics can be useful in identifying areas for improvement and communicating progress to stakeholders through reports.

In this regard, it is important to ensure that the metrics in themselves are specific, measurable, and relevant to the goals and targets of the business and must establish a baseline which will serve as a starting point to track progress. An evaluation of the effectiveness or otherwise of the ESG actions taken by a business can be made when this is done.

4. Embedding ESG into Decision-making, Governance, and Culture

The ESG framework must also be integrated into the decision-making process of a business. This involves developing ESG criteria for evaluating investments, acquisitions, and other business activities. A successful ESG integration also requires action beyond the taking of decisions in board rooms.

It requires the buy-in of the employees and directors and a wholesale commitment to achieving the targets set. To ease this process, it is important to outline clear roles and responsibilities to manage the risks and leverage the opportunities that may arise.

The importance of ESG action can be incorporated into employee training and performance evaluations. The Board of Directors of a business can act as a model for the integration process.

A crucial example of this is the increasing linkage of executive pay to ESG goals which serves to motivate directors to be attentive to their responsibilities in managing ESG integration.

5. Communicating ESG performance.

An ESG framework should also outline the means through which a business will communicate its ESG performance to stakeholders. This involves the development of a clear and transparent reporting mechanism that provides stakeholders with accurate and timely information on the ESG actions undertaken by the business and their effectiveness.

CONCLUSION

A business that has a strong ESG proposition will increase its competitiveness and access to a wider range of funding options, resources, and opportunities. Therefore, it is important that businesses respond to the call to incorporate and integrate ESG considerations into their operations by understanding the underlying elements before attempting to design a responsive ESG framework. And the elements discussed in this article are important and must be considered in any design.