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Operationalising ESG

Operationalising ESG

Introduction

Most companies now have a genuine desire and imperative to identify, measure and report on ESG.  How to embed and operationalise can leave businesses overwhelmed and unclear as to “the how”, even though they are clear on “the why”. 

In this paper we aim to assist boards and senior executives to identify the key actions and steps they can take to fully operationalise each aspect of ESG within their organisation.

Operationalising ESG: Shifting from “Why” to “How”

Clarity on “the why” should be embedded in the purpose and strategy – and be clearly communicated, internally and externally. Internal communications should clearly define their commitments, goals, and path to achieving them, whilst external communications should be transparent and unambiguous.

As McKinsey say “When a company determines the dimensions of ESG where it wishes to be good and where it wishes to be excellent, it is making important decisions, with broader second- and third-order consequences. Forward-looking companies approach ESG decisions by seeking to gain a deep, evidence-based understanding of their own business and its broader potential effects.”

Integrating ESG into the corporate culture and business model is critical to its successful operationalisation and can generate added financial value.  Approaching it as an organisation-wide, purpose-driven change management program is critical to success. Everyone in the business needs to be clear on the goals, be committed to them and be measured and rewarded accordingly.  This may require changes to remuneration systems and executive compensation.

Use of International Sustainability Standards Board (ISSB)/Global Reporting Initiative (GRI)/UN Sustainable Development Goals are helpful in identifying specific items and topics relevant to your business and then defining the scope of your implementation program, aligned to your assessment of risk and materiality.  This will help categorise and prioritise actions.

Establishing a baseline for the chosen metrics is important as some things may not have been measured before.

Consider the capital expenditure necessary to achieve the overall goals, especially the immediate actions identified as priorities and potential quick wins as well as technology to track and measure.

In time, ESG functionality in technology systems will be necessary to enable the following:

  1. Data will need to be aggregated across business functions/silos and from suppliers. Asset utilisation and attribute tracking will be necessary in some companies. Technology to expedite internal performance will be helpful for monitoring. Integration with supplier and procurement systems will be necessary. Developing online Supplier Onboarding questionnaires to integrate and evaluate.

  2. A central repository for ESG related data that is secure is essential and dashboards that allow access for functions and insights for board and committee members are part of the technology changes that will enable the process.

  3. Measure what matters and focus on goals rather than external ratings – reporting standards and measures are fluctuating, not static as standards and regulatory requirements develop.

Determine whether you have the right skills and experience internally and where you will need to recruit or to hire consultants/advisors.

McKinsey also talks about three levels of ambition: Minimum practice, Common practice and Next level practice. Determining your ambition level is important.

Remembering that ESG is a process not an outcome underpins McKinsey’s suggested process cycle: Mapping, Defining, Embedding, Engaging.

McKinsey defines these as:

  1. Mapping

    1. Considering what stakeholders have at stake

    2. Identifying superpowers and vulnerabilities

    3. Benchmarking regularly and judiciously

  2. Defining

    1. Considering high jumps and long jumps

    2. Thinking systematically about ESG trade-offs

    3. Measuring and assessing

  3. Embedding

    1. Syncing ESG with operations

    2. Following through on initiatives to ensure impact

    3. Discerning what the numbers do—and do not—say about ESG

  4. Engaging

    1. Using ESG engagement to sharpen strategy

    2. Showing investors the business proposition

    3. Making cadence core to the dialogue

Looking at these aspects will help businesses identify where they excel and can make a difference; looking at competitors can help clarify this in terms of competitiveness and where to focus. It will help expose risks and advantages. Looking at the gap between aspiration and achievement helps determine where changes can be made internally such as in operations, financial distribution and reporting lines.

Trade-offs will need to be made in line with strategy and aspirations as companies prioritise investment and focus. Some businesses will prioritise social aspects, for example, affordability and accessibility of product, equity and inclusion internally and in their value chain.

Others will prioritise environmental concerns such as emissions reduction throughout the supply chain, asset renewal and regeneration. Others will have a mixture of E and S. All businesses need to examine the governance issues, including rewards and compensation systems, board composition, leadership capability, reporting and compliance.

Making ESG reporting the focus and communicating data and progress quickly helps all stakeholders and keeps the focus on doing and measuring the right things rather than getting side-tracked.

In late 2022 the Climate Leaders Coalition published an excellent Scope 3 Summary having run pilot programs across five industries: beef, aviation, beer, gas and property.

The resulting roadmap and insights from their collaborations are outlined in their document, alongside a call to action for all CEOs to step up to the challenge.

There are 8 steps in the roadmap:

  1. Define Impact and Intent

  2. Activate Value Chain Collaboration

  3. Agree Boundaries and Data Sharing

  4. Address Commercial Implications

  5. Start Implementing

  6. Support Your Value Chain

  7. Stocktake and Measure

  8. Play Bigger

Operationalising the ‘S’ in ESG

Companies and boards can operationalise the social pillar of ESG by focusing on five key areas: labour practices, supply chains, human rights, community engagement, and diversity and inclusion.

According to the 2022 Spotlight on the ‘S’ in ESG report, there are five key pillars to consider:

Engaging suppliers as stakeholders: Procurement functions are often separate from sustainability functions, which can pose challenges for accessing supplier information and ensuring that social factors are prioritised alongside cost. A starting point can be implementing a Supplier Code of Conduct aligned with an organisation's broader human rights framework, which should outline measures for dealing with suppliers, as well as grievance and remediation measures in the event of an incident.

Involving rights holders: Collaborations between NGOs and corporates can help ensure that the needs and concerns of rights holders, such as employees, customers, and local communities, are being addressed in a meaningful way.

Consider relationships with First Nations communities: Economic prosperity for First Nations should be embedded within employment and procurement business strategies, and outcomes for First Nations peoples should be measured and continuously improved upon.

Have robust processes and controls: Due diligence should be performed on all new business initiatives and suppliers, not just at the initial point of entry, but also through regular monitoring of their progress.

Recognising what is already being done and ESG interdependencies: Existing policies, such as diversity and inclusion, privacy, and compliance with Work Health and Safety legislation, should be brought together under an aligned framework to ensure that all social factors are being considered and addressed.

By incorporating these pillars into their social responsibility strategy, companies can build stronger relationships with their stakeholders, reduce risk, and improve long-term financial performance.

Moreover, companies must communicate their efforts transparently through internal and external marketing to build an online community and engage in authentic conversations. The risk of reputational damage is real if companies are found to be bluewashing or greenwashing, in other words, the practice of overstating a company's commitment to responsible social and environmental practices. This is why companies must measure their ESG activities against validated baseline data and be transparent about their progress, even when targets are not met.

How can Boards ensure they are thinking about sustainable Governance?

Good governance sets the foundation for all other decisions that ensure that the E & S (Environmental and Social) elements are put into practice.

Sustainable governance practices exist in many forms, including the following:

  1. Upskilling the Board: ensuring that all directors have a sound understanding of ESG issues.

  2. Promoting ESG as a collective responsibility: ensuring that ESG is seen as a collective responsibility rather than the responsibility of a sub-committee or individual board member who has ‘expertise’ – and cascading this message and training across the entire organisation.

  3. Diversity: ensuring diversity quotas at board level and across the organisation.

  4. Executive Remuneration: ensuring that all remuneration is linked to ESG-related results

  5. Pay Equity: ensuring that all remuneration is fair and equitable – addressing any gender pay gaps and addressing unfair pay gaps between leadership and employees.

  6. Regulatory and Compliance: compliance with laws, regulations and charitable commitments.

  7. Consistent Policies: ensuring the implementation of and adherence to consistent policies for managing social, environmental and ethical issues.

  8. Processes: ensuring there is a clear process for identifying new opportunities to manage ESG risks & opportunities.

  9. Organisational Structure: ensuring there is a clear organisational structure responsible for implementing best practices in ESG risk management.

  10. Business Ethics: development and implementation of a Code of Conduct; ensuring that all employees are trained in the company’s Code of Conduct; as well as mapping of business ethics risks, implementing anti-corruption policies, vetting third parties or those acting on the company’s behalf, and complying with all applicable sanctions and export controls laws.

  11. Sustainable Procurement: development and implementation of a Supplier Code of Conduct; ensuring that all suppliers are committed to the Supplier Code of Conduct.

  12. Cyber Security + Data Ethics: ensuring that all data is protected and treated with respect, ensuring appropriate mapping of cyber and data risks. 

  13. Citizenship: ensuring that the company is actively supporting the societies in which they operate, through local partnerships and sharing of profit within the community / ensuring tax is paid within the jurisdiction in which it is earned.

  14. Metrics and Reporting: ensuring that ESG-related activities and processes are measured and that reporting is structured so as to focus on long-term results rather than short term initiatives / incentives.

  15. Tax: ensuring full compliance with tax regulations in all countries in which the company operates.

  16. Audit: a commitment to regular internal & external audit, with results available for review.

Common ESG Governance KPIs companies should be tracking include:

  1. Board diversity

  2. Board ESG experience and subject-matter expertise

  3. Management training in ethics, anticorruption, and other key ESG areas

  4. Executive compensation levels and CEO pay ratios (ideally tied to ESG performance)

  5. ESG-related compliance incidents, penalties, and remediation

  6. ESG-related litigation incidents and remediation

  7. Cybersecurity incidents, risk management, and remediation

  8. Financial costs and projected exposure associated with ESG risks

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