The creation of sustainability strategies and the integration of ESG criteria within managerial practices

Crafting a new type of competitive advantage for traditional energy companies
By Cristina Cravotto

The acronym ESG (environmental, social and governance) is a frequently used expression to indicate the broad spectrum of sustainable, socially responsible, and mission-driven objectives pursued by a company. This article explores the rise and evolution of the ESG industry. A first section will be dedicated to the factors contributing to the diffusion of ESG metrics; a second to the reasons why ESG investing matters so much for companies and a final one dealing with the impact ESG industry has had on managerial practices in energy companies.

The adoption, by companies and financial players, of ESG logics in performing investment decisions increased substantially in the aftermath of the 2008 subprime, credit and finally debt crisis. The harmful consequences of the crisis played a pivotal role in stimulating the success of the ESG industry.

The graph below offers a snapshot of the global sustainable investing asset growth, 2016-2018 per country showing an overall consistent increase over the years.


Firstly, it has been argued that the crisis pushed financial players, investment funds, bank, institutional investors, and households, to require and introduce stricter ethical and transparent governance systems when approaching a transaction or an investment. A more transparent financial landscape characterized by stricter compliance rules is necessary to guarantee the development of ESG criteria.

According to some scholars (Berrou et al., 2019), the development of the SRI (Sustainable and Responsible Investment) and ESG investing industries and an overall widespread practice of taking into consideration ESG performance in investment decisions, was linked to the subprime mortgage crisis and to the consequent exposure of the great systemic ethical failures of financial markets.

Secondly, the crisis impacted violently corporate realities, whose businesses were damaged and required restructuring to respond to the post-crisis challenges. Supported by this wave of change demanded by both economic situation, societies and financial players, an increasing number of companies and industrial actors have been disclosing annual reports describing their activities in addressing environmental and social issues (Weber and Elalfy, 2019).

After the 2008 crisis, companies realized that having a clear sustainability strategy and a good ESG performance may be beneficial for their business objectives and their profitability scores. Companies realized that to run their businesses properly, it was necessary to respond proactively to the challenges and expectations of both society and the financial landscape. The major stock exchanges started to have dedicated sections for green and sustainable finance and green listing options which proved appealing funding channels for companies that were trying to restructure after the crisis. The attention that companies have devoted to ESG criteria grew with the definition of a new societal role of corporate entities: they started to be recognized as societal actors called to contribute to improving environmental and economic conditions.

The pie chart below shows the proportion of global sustainable investing assets by region in 2018, confirming the pivotal role played by Europe in leading ESG investing initiatives.


The relevant literature on ESG rating focuses on establishing a nexus between organizational structures of businesses and sustainable performance. ESG ratings encourage companies, both early stage start-ups and mature businesses that want to access green financial resources, to restructure their internal governance. In energy, a distinction should be drawn between two types of actors: early stage start-ups and big structured corporations engaged in transitions from brown to greener activities.

This distinction is motivated by the many differences characterizing these two realities in terms of size, type of business, objectives, and resources. Start-ups engage in disruptive innovations and have more difficulties in accessing traditional external financial resources and they are generally engaged in costly R&D activities. For this reason, they resort to the creation of appropriate ESG performance evaluation to show the triple bottom line of economic, environmental, social and governance value creation of their business hoping to attract the investments they need to get started in this way.

The challenge for big structured corporate realities operating in the energy sector is to respond proactively to the challenges related to the energy transition and the risk of stranded assets. Successful corporate transitions require stewardship, corporate vision, and ability to interact with multiple stakeholders (Keijzers, 2002; Loorbach and Wijsman, 2013).

The graph below shows that, in recent years, the bigger chunk of sustainable investments was performed by institutional actors, mainly banks, universities and pension funds.


This complex process relates to the creation of specific internal figures and divisions in charge of defining and implementing the sustainability strategy, establishing partnerships with NGOs and non-for-profit actors, committing to have transparent and user-friendly reporting strategies. According to the Ethical Corporation’s latest Responsible Business Trends report (2018), 69% of business executives surveyed said they are integrating SDGs in their strategies (Ferri and Lipari, 2019). From the business perspective, developing a coherent sustainability strategy allows a company to reduce its exposure to reputational backlashes and the risk of being overwhelmed by regulatory restrictions. Getting ahead of regulation through a forward-looking approach avoids the costs, in operational and strategic terms, of a mere reactive approach to an externally imposed regulation.

Oil and gas companies are integrating ESG metrics in their business models. This catalyzes several trends, including increased investment in renewable energy and measures to reduce carbon emission from oil and gas production (which are listed in corporate sustainability reports). Energy companies are also seeking access to new types of financing mechanisms, in the form for example of credit facilities to support R&D investments and projects supporting local economy development and electrification.

BIBLIOGRAPHY

Migliorelli and Dessertine, 2019. “The Rise of Green Finance in Europe: Opportunities and Challenges for Issuers, Investors and Marketplaces”. Palgrave Studies in Impact Finance. Palgrave Macmillan.http://search.ebscohost.com/login.aspx?direct=true&db=cat06685a&AN=ubba.b1704971&site=eds-live&scope=site

Elalfy, Weber, 2019. “Corporate Sustainability Reporting – The case of the banking industry”. CIGI Papers No. 211. Centre for International Governance Innovation

Climate Bonds Initiative (CBI). (2017, September). Bonds and climate change. The state of the market

Climate Bonds Initiative (CBI). (2018, January). Green Bonds Highlights 2017. London

International Capital Market Association (ICMA). (2018, June). Green bond principles. Voluntary process guidelines for issuing Green bonds. Zurich

Keijzers, 2002 “The transition to the Sustainable Enterprise” Volume 10, Issue 4, August 2002, Pages 349-359. https://doi.org/10.1016/S0959-6526(01)00051-8

Loorbach and Wijsman, 2013. Business transition management: Exploring a new role for business in sustainability transitions”. Journal of Cleaner Production 45:20–DOI: 10.1016/j.jclepro.2012.11.002

Friede, G., Busch, T., & Bassen, A. (2015). “ESG and financial performance: Aggregated evidence from more than 2000 empirical studies”. Journal of Sustainable Finance and Investment, 5(4), 210–233.