The hyper-connected 'E' in ESG

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It’s time for South African business priorities to shift from the social to the environmental considerations of ESG.

Delivering on the sustainability agenda is a rapidly growing market force, says former iOCO CFO Jo-Ann Pöhl.

“It’s defining issues of this generation that business must address to have a positive impact on clients, communities and the planet.”

Now an advisor at Kearney, a global management consulting firm focused on driving high-value impact, Jo is working with a team of other consultants, including Matthew Granelli, Devon Leukes, Riaz Adhikari and Jared Pillay, to help South Africa realise the importance of the ‘e’ in ESG.


Early adopters realise first mover advantage

The ESG ‘concept’ provides a framework for stakeholders and investors to consider non-financial factors when evaluating business decisions and investment opportunities. Until recently, measures have been regarded as ‘compliance hygiene’ rather than opportunities to capture a competitive advantage and drive meaningful change.

In South Africa, companies have traditionally placed an emphasis on creating a positive social impact because of the country’s uniquely challenging history of sociopolitical inequality. As a result, local businesses tend to have a mature understanding of the importance of social impact measures compared with their peers in other regions. This has been reinforced through public and private programmes and policies, such as B-BBEE, which incentivise action and innovation. Prior to these explicit measures, companies that lacked action might find themselves exposed to reputational risk and decreased support from sustainability-conscious consumers and investors.

A similar trajectory occurred in the governance landscape prior to the introduction of the King standards. Companies that prioritised good governance had an advantage through operational gains and investor confidence.


Businesses are hyper-connected to natural capital

Traditionally, the approach to environmental concerns has been compliance-led. However, this has shifted in recent years, with sustainable investing strategies growing in the global north on the back of emerging regional trade regulations, environmentally conscious investors, and many companies seeing an opportunity to generate value for both profit and planet.

According to the Global Sustainable Investment Review of 2020, a 55 percent increase in sustainable investment between 2016 and 2020 generated more demand for companies to take meaningful environmental action, creating a burning platform for businesses to understand their environmental impact and the challenges – and to take action.

Forward-thinking businesses keep two environmental components in mind: climate change and natural capital risks (the resources and services that nature provides for free that are essential for human well-being and economic activity). As with any sustainability considerations, these concepts are intertwined as part of a complex system. Business operations are hyper-connected to natural capital as a factor of production, with climate change risks triggering natural capital risks and vice versa.

Thomas Van Viegen, a leading South African sustainability practitioner and managing director of EARTH.INC, shares the example of water scarcity as a natural capital risk: “Water scarcity is a physical risk that translates into food insecurity. In prolonged drought periods, there is a risk that farmers lose their assets as they cannot afford repayments and financial institutions take on a farm they cannot sell, translating into stranded assets. Social issues further develop as people move to areas with food availability, causing involuntary intra-migration,” he says.

“On the flipside of the coin, climate change risks have a direct impact on water availability, triggering cascading natural capital risks. This is the level of hyper-connectedness and complexity that exists between businesses and the environment on multiple levels.”

Natural capital is vital to the top and bottom line of every industry, with knock-on effects on reputation and stakeholder management if not managed correctly. In fact, the World Economic Forum ranks climate change and biodiversity among the top three business risks for the next 10 years. Natural capital is the next frontier in financial risk management. With this in mind, natural capital risk management should be at the top of the C-suite agenda.


Sacrificing E concerns in the short term will hinder value in the long term

The US and the EU are rapidly mandating the latest sustainability reporting standards developed by the International Sustainability Standards Board and the Global Sustainability Standards Board, forcing local companies to push their environmental maturity forward, while South African regulations lag.

The low level of maturity in South African environmental reporting standards creates two crucial issues that can translate into financial risks for business:
It creates a barrier to entry for businesses that rely on exports to the US and EU because of strict environmental reporting requirements.

It increases the risk of monetary loss or degradation of financial assets because of poor risk management, driven by a lack of understanding around the dependencies on natural capital.


The E should be higher up on South Africa’s ESG agenda

The complexity and systems thinking needed to address sustainability and environmental challenges can be overwhelming. However, stripping away the buzzwords, CFOs can help to mobilise the top-down charge and manage growing natural capital risks and opportunities to maintain and grow value in the long term by answering three questions:

  1. How does my business impact natural capital?
  2. How does natural capital impact my business?
  3. How much do I depend on natural capital?

These questions will help CFOs to focus attention on three high-impact areas:

  1. Disclosing environmental indicators that move the needle and comply with the latest global standards
  2. Identifying natural capital risks that may turn into high-impact business risks
  3. Repivoting these risks into material changes that create new business opportunities

Sustainability is a complex and compelling proposition. Managing and alleviating the negative impacts on natural capital can help foster a sustainable future and create value. Natural capital is essential for business, and more companies are pursuing ways to protect, nurture, and replenish it to maintain their operations and their licence to operate. How leaders view and manage this hyper-connected landscape and the related environmental risks will determine the trajectory and the success of their businesses.

Keep an eye out for the next article in this series, which will focus on how CFOs can generate value by proactively addressing environmental risks and sustainability.

The authors wish to thank Thomas van Viegen for his valuable contributions to this article.

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