Many sustainability and corporate responsibility departments still struggle to clearly convey the business benefits of sustainability integration and get on their board’s agenda. More often than not these departments are seen as cost centres. Conveying a clear set of priorities linked to strategic financial and non-financial benefits to your key stakeholders, including the board, can help address these struggles. But who are your stakeholders? Who does the sustainability department work for?
by Radoslav Georgiev
Identifying your stakeholders
While corporate management is a key stakeholder, the sustainability function should aim to balance the interests of a much wider group of stakeholders including investors, employees, customers, governments, the environment and society at large. The sustainability function should aim to steer corporate management toward long-term value creation for all stakeholders and not just short-term profits and shareholder returns. Even in the most capitalist markets, such as the United States, short-termism and shareholder supremacy are no longer undisputed. And in the Netherlands, the government has made regulatory changes to help corporations fend off short-term activist investors. In resource-intensive and extractive industries, for example, an inclusive stakeholder approach can help secure a social licence to operate. But how do we align the needs of external stakeholders like local communities with the company’s objectives?
Setting the right priorities
In defining a sustainability strategy and setting objectives, it is important to look both inside and outside the organisation. Internally, the sustainability function should look for value-creating opportunities inspired by the company’s purpose, product strategy, business model, geographic and market presence. At ING Group, for example, our purpose to empower people to stay a step ahead in life and in business has shaped our approach to sustainability. We want to help create a healthy planet with prosperous people.
Looking inside
Purpose
Strategy
Business model
Product suite
Geographic presence
When looking outside the organisation, commonly accepted multi-stakeholder frameworks like the UN Sustainable Development Goals (SDGs) can help you identify the “sweet spots” of shared value creation. Corporations no longer need to invest in time-consuming materiality analyses to figure out what external stakeholders and society at large need. The SDGs have undergone the most extensive consultation process in UN history and offer a universal set of goals and targets for governments and corporations alike, in developed and developing countries globally.
Looking outside
Sector frameworks (e.g. SASB, TCFD, UN Guiding Principles)
Global and regional priorities (e.g. SDGs, Paris Climate Accord)
Peer benchmarks (e.g. ESG ratings)
Regulations, sector commitments, endorsements and memberships
For less sustainability-centric companies the easiest way to get started is to map the company’s purpose, strategy and business priorities onto the SDGs and their underlying targets. The more advanced companies typically use the SDGs as a foundation for strategy setting by factoring key value creation risks and opportunities related to the SDGs.
The next step in the sustainability strategy integration journey is to set the right key performance indicators (KPIs). This is indeed a very challenging step as it requires alignment with both internal and external stakeholder priorities as well as a long-term value focus. Fortunately, there are a number of standards and frameworks which can help identify relevant sector-specific KPIs. Less advanced companies may look to the SASB codified industry standards which provide each industry with a set of easy-to-implement ESG metrics with clear links to financial risks and opportunities. The SASB standards come with an implementation guidance, including definitions.
Getting leadership involved
When you’re looking to start the conversation with your treasurer or the board it is a lot easier to approach them with a set of financially material ESG metrics. Financially material metrics will also help you align with the ESG integration approaches of many investors, ESG ratings providers, stock exchanges, as well as help comply with voluntary and mandatory disclosure frameworks.
The growing number of ESG-related inquiries from investors, centrals banks, financial market regulators, industry associations and financial market standard setters has helped us at ING to integrate sustainability into the finance, strategy, product development, regulatory affairs and the communications functions. Sustainability is now a board-level mandate and fully integrated into performance management, board targets, remuneration and incentives programmes. To a large extent, being a global systemic bank with NYSE and Euronext listings has exposed ING to long-term investors like pension funds which expect best practices in sustainability integration.
The expectations of institutional investors, proxy voting advisors, credit rating agencies and sustainability-centric investor coalitions have all contributed to the setup of a sound management and governance approach to sustainability at ING. The board has ultimate responsibility for attaining the corporate sustainability objectives. The global head of sustainability reports to ING’s Management Board Banking. The oversight of sustainability targets lies either with the board member responsible for the business a specific target relates to, or with the board as a whole. For example, oversight of progress on ING’s sustainable finance objectives is vested in the board member responsible for wholesale banking. The board’s responsibility for social and environmental risks and opportunities is also formalised in the executive board charter.
Incentives
Many companies experience a reluctance at the board to make claims or commitments that may appear too ambitious. Quite often, the board may commit to something less measurable or long-term-oriented. It may be then helpful to remind the board about stakeholder expectations and industry priorities. You could use:
evidence of investor requests
evidence of pressure from proxy voting advisors and corporate governance associations
SDG priorities intersecting the company strategy
external rankings (e.g. Sustainalytics, MSCI)
competitors’ best practices
At ING, we’ve tied board remuneration and incentives to the sustainability objectives of the company. Similarly, all headquarters and Netherlands-based colleagues covered by our collective labour agreement receive a one-off annual payout linked to these objectives.
Investor approaches to sustainable investing
As many corporations are stock-listed, ensuring alignment with investor expectations is a key aspect of a successful sustainability integration strategy. Investors are arguably one of the most important stakeholder groups. And an ever-growing number of investors now integrate ESG into their portfolio management strategies. The UN-backed Principles for Responsible Investment (PRI) has grown exponentially, almost doubling in members between 2014 and 2019. When PRI was set up in 2006, its signatories had a combined USD 6.5 trillion in total assets under management (AuM), which ballooned to over USD 86 trillion by 2019. These asset managers and asset owners have committed to integrate ESG into their investment strategies.
While some form of responsible investing has existed at least since 2006, there is still a lot of confusion about what it entails and how many “shades of green” it has. What are the most common ESG integration strategies?
It is really important to understand that responsible investors (RIs) do not use a universal process of ESG integration but a multitude of strategies. And while most of them have created their own proprietary strategies in an effort to improve Alpha (performance of an investment against a market benchmark), they typically follow one or a combination of three approaches – ethical investing, ESG integration and impact investing. The largest pool of assets is managed using the first of these approaches while the smallest is in impact strategies.
The first of these three approaches – ethical investing – focuses on values and beliefs. Ethical funds are all about exclusions. Many of them exclude companies involved in activities that don’t align with a set of values. The most commonly excluded activities include tobacco, alcohol, (controversial) weapons, gambling and adult entertainment. Think of a church investment fund, for example, which will likely exclude activities like birth control products, or an Islamic investor which may want to exclude pork production or banks charging an interest (non-Islamic banks). As investors seek to align with climate and societal goals they have also started to exclude “brown” sectors such as thermal coal production or companies across sectors involved in egregious controversies affecting society.
ESG integration, the second of the three common strategies, can be applied across all sectors. Similar to ethical investing, this strategy focuses on excluding activities seen as unsustainable or risky. Exclusions could be applied across one or more of the Environmental, Social and Governance domains. Historically, most investors started to implement governance factors as there was more evidence of the financial materiality of these factors. As investors’ approaches matured over time, most of them now apply E, S and G factor weights based on their relative sector materiality.
The third and smallest strategy is impact investing. While still small, impact funds have been increasing in AuM in the past years as the urgency around societal challenges such as climate change, resource scarcity and growing inequality gain momentum. These funds seek to include companies which offer solutions to these societal challenges. Think about clean transportation, renewable energy, low-income housing, women-led small business development, etc.
Being aware of these different strategies can help you ensure that your sustainability communications address the needs of these different investor groups. Across all strategies, it is important to “stay out of trouble”. In other words, being in the news for the wrong reasons (controversy involvement) will likely lead to an investment exclusion depending on how serious the controversy is deemed.
Radoslav Georgiev
As ESG Disclosure Lead at ING Group, Radoslav Georgiev is responsible for shaping ING’s sustainability disclosures. He also advises on reputation and ESG risk in wholesale banking transactions. Furthermore, he is a member of SASB’s Standards Advisory Group (SAG). Before joining ING in 2017, Radoslav spent over eight years at ESG research firm Sustainalytics.