Tectonic shifts: How ESG is changing business, moving markets, and driving regulation

Foreword

The business landscape today has been transformed by climate change, nature loss, renewed calls for racial equality, a demand for improvements to working conditions, COVID-19, and changing expectations of the role of corporations.

To continue to thrive, companies need to build their resilience and enhance their license to operate through greater commitment to sustainable value creation that embraces the wider demands of people and the planet. The companies that hold themselves accountable to their stakeholders by increasing transparency will be more viable—and valuable—in the long term.

Supported by Deloitte and other leading professional services organizations, the World Economic Forum’s International Business Council has been working together to identify common ground on the environmental, social, and governance (ESG) themes and metrics that matter to enterprise value creation. The aim of the project is to improve the ways companies measure and demonstrate how they are integrating considerations relating to people, planet, and prosperity into the core of their business.

Now we’re ready to take the next step and enhance our collaboration to achieve a foundational set of globally accepted sustainability performance standards, just as we have for financial performance. To achieve this, we need to complete a system change.

We need to adopt a common set of global sustainability standards and endorse them in capital markets. We also need to enhance the effectiveness and transparency of the mechanisms that boards use for oversight, control, and verification of sustainability information, including assurance. Both the World Economic Forum and Deloitte support this goal and the organizations that are working to achieve it, in particular the International Financial Reporting Standards Foundation and the International Organization of Securities Commissions.

The World Economic Forum and Deloitte urge business leaders to pause and consider how ESG transparency and mandatory reporting will impact them, and what they can do to contribute. The shifts taking place today are among the crucial challenges of our time as we work to transition to a sustainable, inclusive, and resilient business world tomorrow.

— Klaus Schwab, Founder and executive chairman, World Economic Forum

— Punit Renjen, Chief executive officer, Deloitte

Why there is no going back on ESG

Across jurisdictions, regulators are finalizing new rules that will require companies to disclose information on their ESG footprint in their annual reports and mainstream regulatory filings. Unlike some regulatory changes, the introduction of ESG data into financial reports will likely make a lasting impact on how business gets done because these signals from regulators respond to a deeper truth about what matters to the world today.

Increasingly empowered consumers and more activism-oriented investors are pushing organizations to address ESG issues concretely and transparently. They are looking for organizations to put purpose at the core of their operations, caring for the issues that concern their employees, communities, industries, and the world at large. They are fueled by the transparency afforded to them in the digital age and they are increasingly putting their money where their values are.

Like the movement of the tectonic plates, these shifts in the operating environment for business have been slow but relentless. Boards and C-suites that can get ahead of ESG disclosure regulation can build a business that meaningfully integrates ESG into its strategic planning and is better poised to manage risks, while also delivering shareholder value and increasing their organizations’ resiliency in a changed world.

Companies today are in a global dialogue with stakeholders about what matters to them

There is nowhere to hide in the digital age. In the past, companies created products for “consumers” who had little to no knowledge of how businesses were being operated and resources consumed in the development, use and, ultimately, disposal of those products. Today, people from around the globe, including employees, suppliers, business partners, members of the community, activists, and society at large, are equal participants—stakeholders—in a direct dialogue with your company about what they expect from your business.

Stakeholders value transparency because it enables them to make informed choices. A recent survey for the Edelman Trust Barometer, covering 28 countries and cutting across age groups, found that almost two-thirds of all respondents said, “CEOs should hold themselves accountable to the public and not just to the board of directors or stockholders.”¹

For the generations who have grown up with the information they need to support their calls for accountability and the channels to amplify them, their expectations are high. According to the Deloitte Global 2021 Millennial and Gen Z Survey, millennials continue to push for a world in which businesses and governments mirror that same commitment to driving positive change for society, putting people and planet ahead of profits.

Perhaps even more profoundly, the global flow of information and digital platforms have helped raise awareness of ecological and social crises around the world.² Climate strikes and other highly visible actions from groups such as Extinction Rebellion and the #MeToo campaign have captured global attention and galvanized opinions. This digitally enabled transparency has been reshaping the business landscape for some time and it has, in turn, caused another tectonic shift: changing societal expectations on how companies should be playing their part in addressing these issues.

As consumers, people increasingly want to purchase products they view as sustainable across the entire value chain, including matters of equity and equality.³ They also want to believe that their consumption habits won’t negatively affect the environment and many of them are fearful of the overall impact of climate change. In April 2020, with the pandemic spreading, a study of citizens across 14 countries revealed that more than 70% of respondents agreed that in the long term, climate change is as serious a crisis as COVID-19.⁴

As employees, people are increasingly concerned with the ESG activities of their employers across all geographies.⁵ Thirty percent of respondents in a 2021 Deloitte survey said they would consider switching jobs to work at a more sustainable company,⁶ and a 2021 Gallup survey shows that seven in 10 US jobseekers care at least somewhat about a potential employer’s environmental record.⁷ And this message is getting through to employers: In a 2019 survey of business leaders by the Environmental Defense Fund, 85% believed their employees would hold them more accountable for their impact on the environment, a 13-percentage-point increase from the prior year.⁸

As these pressures build, an organization’s ability to respond to critical environmental and societal expectations can ultimately affect its social license to operate. In some cases, if an organization’s products, business practices, or brand becomes socially unacceptable to stakeholders, the business model itself could cease to be viable. Modifying existing practices to better address environmental and social sustainability matters is simply good business: It can help win customers; attract and retain talent; reduce costs and increase efficiency; and minimize risk and potential reputational damage. By providing an open exchange of information with the public, stakeholders can see that your business respects their views. This dialogue, in turn, transforms into a new form of market value. It becomes trust.

ESG integration is an opportunity for companies to refine, protect, and create business value

Societal demands and market dynamics may be prompting organizations to re-examine their offerings, but this effort is not about altruism or philanthropy. When a company starts looking at itself through the lens of ESG, it is called to clarify the key drivers of business value, accompanied by an equally thorough effort to measure and report on what matters now.⁹

Leaders who practice integrated thinking set ambitious targets, are prepared to be agile in the way they run their business, and are not afraid to be held accountable. They are also willing to rethink their business models to better respond to new realities or to take advantage of new opportunities, all of which can turn risk into competitive advantage.

As the world begins to decarbonize, for example, new market opportunities will arise for businesses to create products and solutions for a low-carbon world that uses less energy and natural resources, emits fewer greenhouse gases, and can help mitigate climate damage and regenerate natural systems.¹⁰

As organizations have started nurturing new value creation opportunities to address ESG issues, investors are likewise looking for data to help them identify companies that are managing these issues and seizing opportunities. Board members are now being expected to explain how their decisions reflect the interests of their stakeholders (including the environment) and the long-term sustainability of the organization. Setting commitments that are grounded in the organization’s business strategy and authentic to its purpose demonstrates to stakeholders that the organization’s leaders have integrated ESG into the way they think about the business. This authenticity builds trust, and trust is the bedrock of business value.

A significant tectonic shift occurred when ESG started moving money

Investors’ use of ESG data has had a profound impact on the reporting landscape. As organizations have started nurturing new value creation opportunities to address ESG, the investment community has been quick to understand that companies with strong ESG programs can deliver better returns. Investors are now interested in much more of the public commitments and behaviors that directors are expressing to drive competitive advantage.

Shareholders today are interested in a lot more than just the balance sheet. They are also looking for data to help them identify companies that are integrating ESG topics into the core of their business. For this reason, ESG is now commonly included within investment analysis, decisions, and engagement activity.

The Global Sustainable Investment Alliance’s latest investment review shows that global sustainable investment now tops US$35 trillion—up 15% in two years, and in total equating to 36% of all professionally managed assets.¹¹ In 2020, large funds with ESG criteria outperformed the broader market.

Investors are increasingly active and setting out their expectations. Climate Action 100+, a group of more than 600 investors representing more than half of all global assets under management,¹² focuses on engagement with companies that are critical to the net-zero emissions transition. More than 70 asset managers, including BlackRock and Vanguard, have also recently signed a pledge with the Net Zero Investors Initiative, which has been formed to help achieve net-zero greenhouse gas emissions by 2050.¹³

With ESG risks and opportunities driving more investor decisions, expectations are rising for companies across sectors to deliver more robust climate commitments and performance.¹⁴ Investors need consistent and credible information regarding an organization’s ESG efforts if they are to make well-informed investment decisions in sustainable and resilient businesses. To be able to distinguish between companies, and investment opportunities, investors need high-quality, comparable data, and this need is driving the call for global sustainability standards and the regulatory interest in mandatory ESG reporting. Governments and regulators are now stepping in to push further change, faster and with more consistency across the economy than the market alone could do.

The tectonic shifts have set off a chain reaction of ESG disclosure regulations

Without a set of clear, universally agreed upon standards, reporting efforts are limited to those companies that aspire to the leading edge. The limited availability of comparable data makes it difficult for investors to assess performance and has led to accusations of greenwashing by activists. Within the past year, the “economic imperative” of the environmental crisis and societal fractures has started to hit home.

The ESG reporting landscape is now rapidly moving toward globally harmonized disclosure standards. In June 2021, the G7 Finance Ministers and Central Bank Governors clearly committed to addressing ESG challenges and moving quickly toward deeper, multilateral economic cooperation.¹⁵ They endorsed the work to develop global standards that could form a global baseline of sustainability information. A G20 communique in July 2021 further reinforced the importance of these efforts.¹⁶ Another sign of change came in the form of a report by the International Organization of Securities Commissions (IOSCO) that emphasized the crucial role the financial sector has to support the transition to a more sustainable future. The IOSCO reinforced the need for investors to have comparable ESG data, arguing that sustainability reporting standards could meet that need.¹⁷

Putting this into action, the International Financial Reporting Standards Foundation, with the endorsement of the G7, G20, and IOSCO, is preparing to establish an International Sustainability Standards Board to sit alongside the International Accounting Standards Board and develop these global standards that can form a global baseline of sustainability information.

Regulators in individual jurisdictions are also moving. The European Union has been driving forward its work on sustainability reporting demanding more detailed disclosure across a wide range of sustainability matters from companies wishing to operate in or with the European Union.¹⁸ In the United States, the Securities and Exchange Commission (SEC) chairman Gary Gensler has said he wants mandatory disclosure on climate risks, and he wants the agency to move with urgency on this new rule.¹⁹

New proposals for carbon pricing schemes are also gaining traction. This could compound the impact of other climate change–related costs that are already arising through matters such as obsolete assets being written off, the increasing costs of insurance, and the mounting losses from flood or fire damage.

In addition to the efforts of global and major market regulatory bodies, there have also been a number of broad policy responses from individual governments. The emerging landscape of regulation across multiple jurisdictions is at risk of becoming increasingly fragmented, which is already a challenge given the complexity for global businesses and the overall pace of change. That’s why even those who have been proactive in their reporting to date still need to be ready to deal with the new regulatory landscape and why business leaders need to engage with regulators and continue to drive global harmonization efforts.

Adopting a purely compliance mentality is a high-risk strategy

These monumental changes to the business landscape represent more than a compliance obligation, though. They are also an opportunity for companies to make a fundamental choice: Approach emerging ESG disclosure regulations with perfunctory compliance in mind or recognize this as an enduring change to the social conditions, and purposefully adjust.

A purely compliance-focused mentality might appear to be the easier choice but may leave you falling behind your investors’ expectations, your customers’ needs, and your competitors’ actions. Adapting to thrive in this business environment requires incorporating stakeholder feedback into your long-term business plans, recognizing the new risks that could emerge in an era of dynamic environmental and social change, and identifying new opportunities for value creation in a more sustainable future. Stepping up to be accountable now opens the door to the transformations that follow.

Leadership’s role in laying the foundation

To stay ahead of the curve on ESG disclosure regulation, there are a number of foundational steps that a board should take to integrate ESG thinking into how its organization evaluates risk, makes decisions, and identifies new opportunities:

• Give ESG a permanent spot on the board agenda: Does your board of directors understand relevant regulatory requirements? Does it have the data it needs to make strategic decisions with ESG in mind? Is there dedicated time on the agendas for robust discussion of how ESG is affecting the business? If not, you need to work out what is preventing this from happening: Is it resistance from certain board members? Is it a lack of information? Is it the feeling that this is not relevant to this business?

• Engage your board to encourage support for ESG: Does your board understand and visibly support this priority? Have you provided the board with compelling feedback and data to evidence the role ESG matters have on your enterprise value? Each board communication is an opportunity to build trust. Setting ESG commitments that are grounded in the organization’s business strategy and authentic to its purpose demonstrates to stakeholders that the organization has integrated ESG into the way it thinks about the business.

• Dedicate sufficient resources to integrating ESG into the business: Have you evaluated what skills and resources you will need? How integrated is your approach today? Where are you on the journey? Do you have the resources in place to do it? If not, where are the weaknesses? Is this being led by the right part of the business? Is it clear how ESG contributes to your strategy and business model? Are you at risk of being accused of greenwashing?
• Assess the impact of your strategy: Do you know if your business strategy appropriately responds to the new business reality? Where are the areas of opportunity for you to have a stronger impact? If you don’t yet know which sustainability topics are material to you, benchmarking your activities among peer companies, seeking investor and other stakeholder input, and learning from media discussions could all be ways to challenge your thinking and drive change.

• Be clear about how you will measure success: Have you defined what success looks like for your company in the new world? Is there a vision with clear targets and metrics to judge effectiveness? If not, it will be hard to maintain momentum.

For more guidance on how to prepare your organization for integrated ESG reporting, read Living your purpose: A roadmap to integrated thinking and reporting.