Environmental, social and governance (ESG) frameworks comprise of three pillars. The environmental pillar includes business and human interactions with the environment, such as action against climate change and sustainable consumption and production – the planet aspects. The social aspects of ESG focus on interactions with stakeholders, with an ambition to end poverty, promote dignity and equality and a healthy work environment – the people aspects. Governance relates to how businesses are administered, including risk, oversight and ethics, with the goal of organisations defining and embedding their purpose into overall strategy and day-to-day operations.
Of late, we have witnessed the rise of ESG, as it has become a social and business imperative. In fact, a company’s ESG program can have far reaching implications on the growth of their customer base, their ability to attract and retain top talent and their standing with investors and other core stakeholders.
Historically, the environmental (E) and social (S) aspects of ESG have tended to overshadow governance (G) features, for a number of reasons. Most recently, the Covid-19 crisis created a tipping point in favor of sustainability.
In fact, a majority of leaders (71 percent) surveyed in KPMG’s 2020 Global CEO Outlook said they wanted to lock-in climate change gains made as a result of the pandemic. Complementing this shift in thinking, companies are re-evaluating business strategies to deliver upon the United Nations Sustainable Development Goals (SDGs) and United Nations Paris Agreement on climate change.
ESG issues, as well as their associated opportunities and risks, are becoming increasingly relevant for all kinds of businesses. They are no longer just ethical issues but can snowball into economic and existential questions — potentially generating ESG risk. For instance, consumers, investors, and other stakeholders are increasingly urging businesses across the value chain to transition to a low-carbon environment.
However, in an ever-evolving business landscape where governance risks and opportunities continue to increase, focusing on the ‘G’ in ESG is equally critical. In fact, governance is perhaps the most important of the three pillars, as recent history has shown many corporate scandals can be linked to poor governance.
All three pillars of the ESG program must work in tandem to ensure an organisation is well managed and delivers value. Weak governance may have near and far-reaching impact for all stakeholders, including employees, suppliers, consultants and consumers and may also impact environmental and social aspects of ESG programs. For example, if an organisation is poorly managed or has poor governance, it may increase the risk of greenwashing.
Conversely, strong governance is a hallmark of successful organisations—particularly in today’s business climate. It may inform the whole ESG program, encompassing aspects such as gender diversity, fair compensation and sustainable value creation. Integrating strong governance not only helps manage risk but can create new opportunities and serve to attract and retain customers. Additionally, embedding governance into business decisions can be a significant competitive differentiator.
When it comes to corporate governance, one of the challenges faced in the UAE is the relative maturity of the market. There is also a need to drive awareness of related aspects, such as board evaluation and fraud reporting, to prevent future business failures. Common corporate governance shortcomings in the region, found in both listed and unlisted companies, include an absence of whistle blowing and anti-fraud frameworks, wrongly recorded revenues and profits, and a lack of basic internal controls. We are seeing a number of Government led initiatives and legislature around these aspects to enhance the overall governance in the country.
S&P Global research assesses companies’ governance performance by looking at four factors: structure and oversight, code and values, transparency and reporting, and cyber risk and systems. S&P has shown that companies that rank well below average on good governance characteristics are particularly prone to mismanagement and risk their ability to capitalise on business opportunities over time.
The quality of a company’s governance is particularly important as a guide to future returns. Investors cannot make decisions looking at just any one element in isolation. For example, BP had a low ESG score even before the Deepwater Horizon disaster of 2010, which has been described as a “preventable surprise”.
Similarly, governance and labour concerns had been flagged at Volkswagen numerous times before the emission scandal. These examples demonstrate that all three elements, E, S and G, are interrelated and need to work in tandem to achieve the goals related to Planet, People and Profit. By implementing robust governance around ESG, these companies would have been able to avoid intense public scrutiny and billions of dollars in losses.
While each company’s ESG journey is specific to its industry, maturity and unique business and operating models, ESG targets can only be successfully met when all three pillars – environmental, social and governance – are robust. The G in ESG is never silent.
Siddharth Behal, Partner, Governance, Risk and Compliance at KPMG Lower Gulf
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