ESG and the necessity to adapt

When was ESG introduced?

The term ESG, with the ‘E’ referring to environment, ‘S’ to social, and ‘G’ for governance has risen in popularity tremendously over the past decade. The term was first coined in a 2005 report by the UN Global Compact called ‘Who Cares Wins’ and was later solidified when it was embedded into the UN Principles for Responsible Investment, launched in 2006. In contrast to earlier notions on sustainable development, ESG focusses more explicitly on measurable results. It is also for this reason that ESG is often accompanied by a set of specific criteria or standards. But let’s start at the beginning: what is ESG all about, and why are ESG related matters so pressing?

Environment

The ‘E’ in ESG stands for environment. More specifically, it stands for an inexhaustible set of criteria relating to ways companies affect the environment. Metrics on climate change, depletion of ecosystems and loss of biodiversity are notable examples of what would fall under the ‘E’.

Climate change is arguably the most discussed topic and for good reason. By now, there is a widespread agreement in scientific communities that human influence has warmed the earth and best estimates even suggest that humans are responsible for 100% of the observed warming of the climate system (Intergovernmental Panel on Climate Change (IPCC), 2021)​. This is highly worrying as climate warming threatens ecosystems, leading to habitat loss and species extinction, while also increasing the frequency and intensity of extreme weather events. Rising sea levels further compound the risks, posing a direct threat to coastal regions, such as the Netherlands and exacerbating economic and social challenges, such as mass migration. 

Given the potentially devastating effects of climate change and catastrophic socioeconomic implications, it is important for businesses and society to be aware of its risks. From a climate risk perspective, these risks are often segregated into physical and transition risks.  

• Physical risks can best be described as risks emerging from changing climates and can be acute or chronic. Examples of acute physical hazards are hurricanes, wildfires and heatwaves while sea temperature rise, sea level rise and changing precipitation patterns are examples of chronic hazards.
• Transition risks are best described as risks emerging from the economic transition towards a ‘net-zero’ society. Transition risks are often broken up into categories: policy & legal, technological, market and reputational.  

Both types of risk taxonomies can have severe implications on businesses and may have systemic influence with the potential to severely disrupt the macroeconomy or even society.  

Social

The ‘S’ stands for social and conceptualizes a range of topics, in which people often form the centrepiece. Examples include matters on social issues, labour standards, human rights, pay equality, but also data security and supply chain issues.  

It is tricky to perfectly define the ‘S’, but in general it involves how companies manage their relationships with their employees and broader society. In that sense, it is not only about managing risks, but also about striving for pro-social behaviour in which companies should strive to make the world a better place for everyone.  

A notable difference between the environmental and social pillar is the timeframe by which impact is observable. Where much of the impact classified under the ‘E’ will only be visible in the distant future, the social implications are often happening right here in the present. This is one particular reason why companies should put sufficient emphasis on it. Yet, we see that when being compared to environmental matters, social aspects only get a fraction of the attention. A simple, but disturbing reason for this is that it’s simply easier to focus on the ‘E’. For example, measuring a company’s impact on the climate is challenging, but agreed upon climate definitions and climate risk datasets are emerging at a rapid pace. For the ‘S’, we are in an earlier stage with lacking agreement on definitions and little data available. Consequently, this makes it challenging to quantify progress which puts it lower on companies’ agendas.  

Governance

The ‘G’ stands for governance, corporate governance to be more precise. It includes factors such as corporate structures, board composition, ethics, and anti-corruption.  

Many components that are part of the ‘G’, are already on the corporate agenda and are being disclosed. However, when measuring governance along the lines of ESG, relatively little emphasis is put into it and therefore the role of the ‘G’ within ESG frameworks is unclear for many people. This is a missed opportunity, because proper governance forms a foundation for environmental and social initiatives to flourish. For example, greenwashing can be avoided through good corporate governance, which ensures transparency, accountability, and responsible practices. 

Proper corporate governance policies will also bolster ethics within a company, increasing the likelihood of reliable ESG disclosures. As such, ensuring strong corporate governance is crucial in making much needed impact within the environmental and social domains.   

ESG and the notion of non-linear challenges

Addressing ESG concerns stands as the paramount challenge of the 21st century, demanding immediate action and offering significant rewards. The interconnected nature of environmental, social, and governance challenges magnifies their scope and potential impact, making effective policy formulation exceedingly complex. Moreover, the urgency lies in the need to act now to mitigate future repercussions that may only manifest several decades down the line. Unfortunately, both individuals and businesses often underestimate the severity of ESG challenges, underlining the critical need to raise awareness and mobilize resources. 

To navigate these non-linear challenges effectively, we must acknowledge their complexity and surrender our desire for certainty. Rather than looking at things as they are, we need to consider their context and interdependencies. By embracing this mindset, we can develop proactive responses and manage ESG risks with resilience and foresight.

Join forces with RiskSphere

Taking proactive steps towards sustainability and managing ESG risks is crucial for a better future. At this critical juncture, let us come together to drive positive change. We invite you to join us in this journey, where we can provide comprehensive solutions tailored to your specific needs, including stress testing, scenario analysis, ESG dashboarding and reporting, and sustainability project and change management. Together, let’s navigate the complexities of the ESG landscape, embrace uncertainty, and create a more sustainable and prosperous world.