Building Value That Lasts: A Playbook
Failing to meet investors’ expectations on ESG priorities puts you at risk of losing access to the markets, your customer base and the very ability to operate.
investors have become increasingly dissatisfied IN RECENT YEARS, with the ESG [environmental, social, governance] risk information they receive from businesses. Our research shows that 86 per cent of institutional investors believe companies with strong ESG performance will feel a significant and direct impact on analyst recommendations. More broadly, 90 per cent cite that since the pandemic started, they attach greater importance to ESG performance when it comes to their investment strategy and decisionmaking. And yet, 51 per cent believe there’s a lack of information about how companies create long-term value (LTV).
Case in point: Ahead of the 2020 proxy season, State Street Global sent an open letter to boards saying it would incorporate performance measures of a company’s business operations and governance related to financial material and sector-specific ESG issues into its engagement and voting priorities. By October 2020, it had followed through, voting against directors at 64 per cent of meetings where it saw room for improvement in a company’s ESG response. A similar commitment to sustainability features prominently within Blackrock’s refreshed investing standards. In the firm’s 2021 letter to CEOS, it reaffirmed climate as an investment risk that it would rigorously address through its decisions.
These are examples of a broader movement. The Net Zero Asset Managers Initiative unites 128 global asset managers that are committed to supporting the goal of net-zero greenhouse gas (GHG) emissions by 2050. They represent over
US$43 trillion in assets under management—and they’re not alone. The United Nations-convened Net-zero Asset Owner Alliance shows united investor action to align the more than US$10 trillion in their portfolios with a 1.5C scenario (tied to Article 2.1c of the Paris Agreement). Investor-led Climate Action 100+ has taken a similar stance, working to ensure the world’s largest GHG emitters are taking necessary climate change action. Last November, governments, business leaders and investors came together at the 2021 United Nations Climate Change Conference of the Parties (COP26) to accelerate global action in the fight against climate change. The list goes on.
In Canada, CEOS of the country’s eight largest pension plan investment managers — representing a collective CAD$1.6 trillion in assets — have similarly committed to creating more sustainable and inclusive growth. They have publicly called for companies and partners to put sustainability at the heart of planning, operations and reporting from here on out. Furthermore, when speaking with Canadian asset managers, they cite ESG as a key tenet of corporate culture and investment belief, meaning that ESG factors should be integrated, at some degree, across all their assets under management.
The financial results we’ve seen over the course of the pandemic show the market supports that rallying cry. Major ESG funds outperformed conventional indices like the S&P 500 during the first weeks of the COVID-19 crisis, while some softened the blow to value loss compared to standard non-esg
benchmarks. ESG now features prominently on regulators’ priority lists. As the U.S. Securities and Exchange Commission (SEC) moves beyond human capital disclosures to weigh common metrics for sustainable business practices, the World Economic Forum (WEF) and its International Business Council (IBC) have published a set of 21 core and 34 expanded metrics tied to the ESG space. Meant to be universal and industry agnostic, the WEF-IBC framework spans four pillars linked to the United Nations’ Strategic Development Goals adopted in 2015. In 2021, 61 global business leaders committed to reporting on these metrics and encouraging others to do the same.
The concept of rewarding corporate citizens who take ESG seriously is also gaining ground among consumers. The EY Future Consumer Index shows Canadian consumer values transformed as the global pandemic surged. Those changes are influencing the brands customers purchase. For instance, some 42 per cent say they’ll pay more attention to the social impact of what they purchase going forward, and 64 per cent of global consumers are prepared to change their buying behaviour to benefit society.
Consumers, of course, also belong to another core stakeholder group that is paying more attention to the way organizations address sustainability: employees. Nearly half of workers — and 75 per cent of millennials — say they would accept a smaller salary to work for a company that is environmentally responsible. And almost three quarters connect the strength of a company’s corporate sustainability efforts with their own likelihood of staying with the employer for the long term.
The train has left the station: LTV matters to stakeholders. The question is, how will you evolve your strategic direction, operations and governance in ways that show you care about sustainability as much as they do? Following are three principles for building value that lasts.
PRINCIPLE 1: RESHAPE YOUR STRATEGY WITH A BIGGER FOCUS ON ESG AND LONG-TERM VALUE CREATION.
Profit is about dollars and cents. Prosperity, though, must include how you’re growing results while also growing the market, innovation, community and the world around you. Your corporate strategy should reflect that, with a clear emphasis on where you’re delivering optimum value — not just financially, but for people and the planet, too. It’s not enough to house ESG in a siloed function. This is about fundamentally transforming what you do and how you go to market, to reimagine a more sustainable version of your organization.
Climate change risk and ESG have always been intimately connected. Corporate sustainability efforts have tended to focus on the more obvious risks: rising sea levels, expanding floodplains, intense storms, excessive heat. Now it’s time to expand that scope to reflect less obvious, but equally important, issues. From drop-offs in biodiversity to the quality and scarcity of our water supply and our reliance on single-use plastics, the everyday decisions companies are making have real impacts on the world. The right business strategy will look hard at how operations affect the planet, identify necessary changes and bake those risk mitigation efforts right into the plan.
This is true, too, for how we address people and the human capital agenda. Our research has time and again shown that organizations that deliberately nurture diversity, equity and inclusion (DEI) achieve better financial results. But a truly strategic focus on people must extend well beyond DEI alone if it’s going to resonate. That means fostering an ecosystem that cultivates DEI while also addressing broader issues like health, safety, mental wellness, employee engagement, social justice and more.
The market is replete with leading-class examples of corporations and governing bodies doing this well. The percentage of Fortune 100 companies voluntarily highlighting their environmental sustainability initiatives and commitments more than doubled from 2017 to 2020. Regulators and governments are embracing the importance of climate change in similar ways. The Canadian Securities Administrators (CSA) confirmed the need to assess climate risks in disclosures where material in 2019. That same year, International Financial Reporting Standards (IFRS) zeroed in on climate change, too. Even the Bank of Canada is showing signs it will at some point require Canadian banks to complete climate change stress testing, and the Office of the Superindendant of Financial Institutions has expressed similar expectations for Canadian insurers.
At the end of 2020, the Canadian government’s climate action plan laid out a path to net-zero emissions by 2050, providing new clarity for companies working to propel progress in this space. Soon after, in January 2021, the Ontario Capital
Markets Modernization Taskforce recommended mandating disclosure of material ESG information related to governance, strategy, risk management and more. TSX- listed companies would need to comply after a two- to-five-year grace period. The Taskforce also encouraged the Canadian Securities Association ( CSA) to align with Ontario and implement similar disclosure requirements nationwide. Just last month, the CSA released its proposed requirements to standardize climate-related disclosures, which closely followed those set out by the Ontario Markets Modernization Taskforce.
More recently the IFRS Foundation announced the creation of the International Sustainability Standards Board (ISSB) at COP26 last November — including locating one of its key centres in Montreal. Further to this, the Accounting Standards Oversight Council and Auditing and Assurance Standards Oversight Council have mutually approved the formation of the Canadian Sustainability Standards Board (CSSB) being set up amid an international push to standardize the reporting of metrics on a range of items, from climate risks to workforce diversity to gender equity.
At the same time, Canada is now the first jurisdiction to require diversity disclosure beyond gender alone. Canadian institutional investors managing more than CAD$2.3 trillion in assets have pledged to promote diversity and inclusion in their portfolios and institutions. Leaders from more than 300 Canadian public and private companies totalling $1 trillion in value, including EY Canada, have signed on to the Blacknorth Initiative to hold industry leaders accountable for reshaping corporate structures that uphold anti-black systemic racism. Public and private organizations from a number of different sectors support the Canadian Council for Aboriginal Business in making Aboriginal businesses the focal point for stronger communities and a new economy based on mutual respect and shared prosperity.
Climate change is a global crisis and we all THE BOTTOM LINE: have a responsibility to address it together. Diversity and inclusion are just as important. But focusing on any one ESG pillar to the exclusion of others could mean losing ground in the eyes of material stakeholders who expect a broader approach to LTV creation. Identifying your greatest risks and opportunities, and then integrating those focus areas into your business strategy, can help you make a more significant impact.
QUESTIONS TO HELP RESHAPE YOUR STRATEGY:
• What is our LTV proposition and organizational purpose? Do we need to adapt it or articulate it more clearly in light of changing market dynamics and ESG priorities?
• Which ESG priorities matter most to us, and how can we change our business portfolio to address them?
• How should we secure and allocate capital in light of new ESG opportunities (for example, low-carbon initiatives)?
• To what extent have we objectively assessed the ways climate change and societal challenges impact our operations, supply chain and overall market demand?
• Are we focused enough on supporting internal innovation that can drive value creation solutions for us, and for the market itself?
PRINCIPLE 2: TRANSFORM YOUR BUSINESS TO EXECUTE ON THAT STRATEGY.
Even the best strategies are only as strong as their execution. Reshaping your strategy means drawing a clear map between what you want to achieve and the tactical steps you’ll take to get there. Your execution should show your progress, reinforcing your commitment to ESG for external and internal stakeholders alike. Anything less could affect your reputation as a corporate brand and employer of choice.
In recent years, initiatives like the Embankment Project for Inclusive Capitalism (EPIC), of which EY is a founding member, have worked to further the conversation around new ways of demonstrating LTV in the financial markets. It’s important to develop future scenarios across the ESG horizon and align your tactics to support those scenarios. Having a good sense of how you’ll adjust course if a given objective is only partially achieved also counts for a lot.
Decarbonization is an excellent example. As Canadian companies take steps towards meeting 2030 — and ultimately 2050 — targets, many are mapping out how they’ll adapt should they only reach 30, 50 or 75 per cent of their objectives. Thinking through a variety of possibilities empowers any organization to stay nimble in execution. That’s why it’s so essential to create an overall execution roadmap and prioritize initiatives in all functional groups, from IT and finance to operations and customer sales to recruiting. With that in hand, you can easily identify
strengths, capabilities and talent gaps where you’ll need to shore up teams and investments to execute effectively.
The world is changing, but the fundamenTHE BOTTOM LINE: tals still count. Skipping the tactical planning means losing out on the multitude of ways the right foundation can buoy your overall success, cementing your place as a brand and employer of choice.
QUESTIONS TO HELP TRANSFORM YOUR BUSINESS IN SUPPORT OF EXECUTION:
• Do we have the right organizational structure, leadership and culture to support the reshaped strategy and ESG objectives?
• What are the most cost-effective ways to operationalize our ESG activities?
• Have we articulated our corporate social responsibility commitments clearly through a purpose that sits at the centre of our business — and LTV creation — strategies?
• How can we make use of ESG data and analytical insights to drive better decision-making?
• Is our human capital approach aligned to our ESG strategy — from DEI to environment, health and safety, and beyond?
PRINCIPLE 3: DEMONSTRATE AND MEASURE YOUR IMPACT CLEARLY FOR INTERNAL AND EXTERNAL STAKEHOLDERS.
Spanning everything from executive remuneration to risk oversight and succession planning, governance matters a great deal in the broader stewardship context. Broadly speaking, 83 per cent of investors say they’re looking for a formal approach to measuring and communicating an entity’s intangible value overall. With 56 per cent of investors telling us they didn’t believe ESG disclosures were adequate, there is clearly room to improve. That sentiment is mirrored in the actions regulators are taking. After years of pressure from investor advocates, in 2020 the SEC launched new requirements for registrants to provide descriptions of human capital resources that are material to an understanding of their business.
The good news is corporations are making progress. Last year’s proxy disclosures show many companies are taking human capital, diversity and inclusion, and the social justice imperative seriously. The percentage of Fortune 100 companies that voluntarily highlighted human capital initiatives and commitments has more than doubled over the past three years, increasing from 32 per cent in 2017 to 77 per cent in 2020. In 2020, the EY Centre for Board Matters found that more companies now voluntarily disclose the board’s racial and ethnic diversity, with half of Fortune 100 companies doing so last year alone. That’s up from 24 per cent in 2017. Similarly, 40 per cent disclosed the level of overall diversity on the board, another significant improvement over 2017 findings.
We’re seeing similar commitments to the climate change agenda. More and more businesses are joining the global race to net-zero, pledging to do their part in reducing their carbon footprint. Earlier this year, EY announced that we’ll become
net zero in 2025 and carbon negative in 2021, which we have successfully achieved. But declaring decarbonization targets is beyond aspirational or reputational in nature; shareholders and regulators are now holding companies to account. Similar to the human capital disclosures, the SEC has formed a taskforce on climate-related disclosures, which will be very active in 2022 to examine public disclosures related to climate risks. In fact, in September 2021, the SEC published a sample comment letter that it’s starting to send to issuers, further showcasing its increased focus on climate disclosures.
Any organization looking to emulate similar momentum around measuring and demonstrating LTV commitments should start by looking inward. You need the right governance structure in place to own the process, track the data, spot anomalies and manage risks. That’s how you begin to develop metrics and reporting that are at once directly tied to your business strategy and clearly connected to key stakeholder outcomes. You can’t report what you haven’t gathered, and you can’t gather without a solid governance framework in place.
Surfacing opportunities to improve govTHE BOTTOM LINE: ernance — from board effectiveness to leadership diversity to risk oversight — can impact how you define good stewardship going forward. Define the governance changes you need to make. Develop metrics and reporting across key stakeholder outcomes, and then communicate the value delivered. Above all, engage stakeholders as you reinvent the way you measure, report and communicate.
QUESTIONS TO HELP YOU GET READY TO MEASURE AND DEMONSTRATE IMPACTS:
• Is our company’s purpose clearly articulated, and if so, how are we holding ourselves accountable to it at the board level?
• How do we assess, measure, disclose and mitigate our ESG risks through enterprise risk management?
In closing
Failing to meet investors’ expectations on ESG priorities through a fully integrated Ltv-based business strategy puts you at risk of losing access to markets, customers and the very ability to operate. This is about boldly doing the right thing, and clearly sharing that story in ways that stakeholders are hungry for. Asking the right questions can be the first step to aligning your business direction with a clearer view and focus on LTV creation. Doing so can fuel a new approach to disclosure — one that shines a greater light on the kind of prosperity your material investors now value most of all. One thing is certain: Getting LTV right will influence perceptions, profits and potential for generations to come.