The ESG wave: Risks and opportunities

As businesses are being hit by the sustainability and ESG wave, they are increasingly being put under scrutiny to disclose the external effects of their business operations. External stakeholders, be it regulators, clients, banks and investors, as well as internal stakeholders (employees) continue to up their demands for ESG transparency (data and disclosures). Regulations such as the upcoming Corporate Social Reporting Directive (CSRD) and the related European Sustainability Reporting Standards (ESRS) address such stakeholder calls.

Inevitably, this means that greater resources need to be channelled towards these areas. As is normal human behaviour, companies will initially resist change, often regarding these new requirements as merely an extra compliance burden and another distraction for administration. Unfortunately, this attitude limits the progress which can be attained on ESG matters, leading to a “do minimum” approach.”

A number of companies are, however, discovering that ESG area can also bring new exciting opportunities for growth. Using the added ESG requirements to understand and revisit business practices and operations can actually lead to positive change, on various grounds. The Malta ESG Alliance (MESGA) has also been set up with this change in mind – founding member companies appreciate that there is risk that needs to be managed, but there are also opportunities.

Reporting sufficiently and adequately will not only make you compliant with CSRD, but more importantly will provide the necessary market signal of your ambitions and strategy. It can be a differentiating factor, not only within a sector, but also within our country’s attractiveness. It will increase innovation, from processes to products to markets.

As companies adjust their strategies and operations, they will be able to be ESG-rated, and eventually work towards improving their ESG scores, thereby maintaining their external sources of funding, and possibly attract new capital at better rates. The EY Global Corporate Reporting and Institutional Investor Survey, published in November 2022, found that 78% of investors believe that companies need to make investments aimed at addressing ESG issues, and 99% of total investors stated that they are making use of ESG disclosures in their investment decision-making.

On funding, banks and financial institutions are also facing new direct ESG requirements, making them inevitably more selective as to how and who to extend credit to. Optimal ESG KPIs might enable businesses to avail themselves from positive discrimination for terms and conditions and interest rates in relation to bank funding.

Although, in the short run, changing operations, collecting the necessary data and having the resources to report ESG matters appropriately is an added cost, in the long run this will lead to long-term value and a reduction in overall costs, as companies seek to be less wasteful, more efficient and less environmentally damaging, and more in-tune with their customers. Furthermore, foreseeing any ESG risks, and including such risks in the firm’s risk framework will ensure that such risks are anticipated and dealt with in a timely manner. Indeed, new ESG risks are increasingly being taken into account. These ESG risks are, however, not a new risk factor to be included in the existing risk framework but rather horizontal risks that are to be integrated into existing risks.

For instance, environmental risks are known to be either i) physical risks (acute and chronic), that is natural changes due to climate change, or ii) transitional risks, being man-made responses to these environmental changes such as technology or regulation. Social risks might include risks related to procurement of raw materials. Governance risks could include inadequate internal controls. Therefore, by identifying and mitigating these ESG risks, the companies will be able to mitigate the amplified operational, credit, reputational and compliance risks as well. Many companies are already undertaking such processes, especially on governance.

It is worth noting that ESG risks hold another level of complexity. Given their nature, as well as novelty, there is a high degree of uncertainty around both their likelihood and magnitude, often leading to scepticisms around their quantifications. Another complexity around ESG is the lack of standardisation. According to an EY Survey, 73% of investors still believe that organisations have failed to create enhanced reporting for financial and ESG disclosures and companies remain selective in their voluntary disclosures. This could potentially lead to greenwashing.

This issue should be solved through the reporting standards being developed. Yet, greater regulations might push companies to rush into being compliant and not developing robust infrastructures for strategy setting, materiality understanding and data collection, choosing only a compliance approach, instead of developing an overall sustainability process ingrained within the company. Indeed, stopping at these regulations might hinder a company’s progress and stifle innovation as importance is placed on achieving ESG minimum requirements, rather than being realistic and ambitious at the same time.

Ultimately, companies who want to be leaders in the markets need to embrace ESG risks, disclosures, and metrics as a future norm, continuously striving to improve such KPIs, not only for the sake of disclosing and complying, but also because there are fruits to be reaped from this new approach to business.

This article is written by Stephen Gauci , Chief Strategy and Sustainability Officer at Mapfre Middlesea and Sarah Bulteel, an economist at EY’s Sustainability practice. This article is part of a series of articles by MESGA members and their strategic advisor.