With an Industry Focus, Environmental, Social and Governance (ESG) Risks and Opportunities Can Vary Greatly

ESG Under Scrutiny

Organizations across the globe are facing increasing scrutiny around ESG-related issues. It’s a shift driven by several external pressures, including mounting recognition that the world is in a climate emergency, employees demanding better workplace conditions, a desire for more transparent supply chains, new regulatory disclosures in specific regions and more.

While stakeholders expect organizations to have mature ESG strategies, many businesses are still in a process of education and evolution — trying to make sense of what ESG means to them and understand how their business impacts people and the environment.

While grappling with the expectations of shareholders, insurers, regulators, employees, communities and consumers, organizations are also trying to keep pace with a complex and fragmented landscape that is not yet standardized. With regulatory and financial frameworks for measuring ESG across industries either shifting or emergent, businesses are having to navigate the continual evolution and proliferation of ESG terminology and definitions. This makes it challenging for organizations to effectively capture ESG data and measure impact through a lens of sustainability.

Despite the difficulties these challenges pose, a failure to invest time, energy and resources into ESG compliance and standards exposes organizations to increased risk. From investment ratings and access to capital to employee turnover and future value — ESG issues can pose broad and complex risks to businesses, insurance companies and investors that must be addressed.

This article explores how these challenges are explicitly impacting the food, agribusiness and beverage; life sciences; financial institutions; renewables; and private equity sectors. Looking at ESG through an industry lens can help organizations tackle broad and constantly evolving issues to develop a more targeted and effective ESG strategy.

Food, Agribusiness and Beverage (FAB): Feeding a Growing Population, Sustainably

Over recent years, changes in weather patterns and extreme weather events have highlighted the vulnerability of the global food system and the risk that climate change poses to industries across this sector. Between 2008 and 2018, the impacts of natural disasters cost the agricultural sectors of developing countries over US$108 billion in damaged or lost crop and livestock production.¹ Paradoxically, the FAB sector is a significant contributor to climate change, producing more than one-third of global greenhouse gas emissions.² With the worldwide population anticipated to reach almost 10 billion by 2050,³ finding more sustainable and equitable ways to feed a growing population requires urgent action by the industry, which faces increasing pressure to innovate its processes and products.

While the FAB industry has initiated and adopted some sustainability strategies that consider people, planet and purpose, fractions of the sector have also faced significant reputational and financial risks related to “healthwashing”⁴ and “greenwashing.”⁵ From fraudulent recycling claims and misleading labeling to animal abuse exposure and poor workers’ rights — lawsuits targeting the FAB industry have peaked, driving companies to alter how they present products and qualify claims about health, sustainability and ethical practices.⁶

Today, global volatility is compounding the extent of the ESG challenge for the sector, as the cost and availability of ingredients, raw materials, water, commodities, packaging and energy become more unstable. A competitive labor market has also focused attention on living wages and labor rights, but with many regions battling inflation, the industry must balance the impact that increased wages could have on driving prices up further for consumers.

Delivering sustainability and supporting ethical practices is complicated for the FAB industry by the large and complex supply chains it relies on. However, reducing supply chain fragility and improving transparency should be a fundamental ambition of every ESG strategy. In our increasingly connected world, social media and technology have brought stakeholders closer to the supply chain activities of producers and distributors, creating an increased demand for transparency, visibility and stability.

Life Sciences: Why Corporate Reputation Matters

Unlike the media spotlight that has highlighted the FAB industry’s considerable carbon footprint, life sciences companies are generally lower-carbon businesses. However, a study of historical emissions trends has exposed that the pharmaceutical industry may be significantly more emission-intensive than assumed.⁷ While the life sciences sector needs to pay attention to the environment and sustainability challenges, perhaps more pressing is the social component of ESG issues.

A generalized increase in the visibility of social inequities and injustices is having a more profound effect on the ESG landscape — because, despite being a necessity, healthcare disparities across the globe are widening.⁸ Businesses in this sector have a critical role to play in supporting the delivery of universal health coverage and improving the health and wellbeing of stakeholders within their health ecosystem.

These value systems are also closely linked to another challenge for the sector: the intense competition for highly skilled talent that can develop new products, conduct clinical trials, manage government regulations and commercialize new products. Attracting diverse, skilled talent in a competitive labor market requires organizations to have a comprehensive people strategy that aligns with their overall ESG strategy — for example, one that develops and measures diversity, equity and inclusion and employee wellbeing. This will result in stronger workforce resilience to face volatility and uncertainty, such as a global health crisis.

While a global spotlight strengthened the life sciences industry’s reputation during the COVID-19 pandemic, the sector still faces significant reputational threats stemming from the public perception of its focus on profit, high prices, overprescribing medication and lack of transparency in drug development. As consumer trust is so intrinsically linked to purchasing power, organizations must carefully manage their reputations to nurture brand loyalty in an increasingly competitive over-the-counter medicine market. Business reputations are equally at the mercy of supply chain disruptions. With new regulations tackling forced labor in supply chains being rapidly adopted by many countries (see our article “U.S. Uyghur Act Aims to Bridge Supply Chain and Human Rights Challenges” for more information), identifying ESG risk in the supply chain and diversifying suppliers will be more critical than ever.

Financial Institutions (FI): Less Talk, More Action

Whether it’s regulators pushing aggressively for more action on climate change, customers seeking more sustainable investment options, or M&A dealmakers intensifying their due diligence around ESG practices — stakeholders have financial Institutions under a microscope. Pressure is mounting on the industry to respond to ESG concerns and mature their analysis and investment processes, as well as incorporate ESG strategies at pace. While some large banks have made ambitious environmental pledges, there is a significant disconnect between what firms say about climate change and what they deliver. Recent research has discovered that while nearly all of the world’s 30 biggest publicly traded financial institutions have signed up to the Glasgow Financial Alliance for Net Zero (GFANZ), two-thirds have yet to set reliable sustainability goals for this decade.⁹ As shareholder resolutions and activism grow, being an outlier on ESG issues places boards and their organizations at an increasing level of risk, heightening the imperative for public firms to identify and disclose their ESG risk exposures and to demonstrate how they are mitigating these.

Promisingly, ESG is at the forefront of financial product growth, with investments in ESG-based assets expected to exceed $53 trillion by 2025.¹⁰ However, organizations are still struggling to value and assess the financial return on their own sustainability-centered business decisions, despite wide-ranging evidence showing the correlation between sustainability and higher corporate financial performance (CFP).¹¹ It’s a challenge not made any easier by inconsistent and shifting regulations, which make it difficult for banks, asset managers and wealth managers to respond effectively and make long-term investments in ESG-related services.

More than three in four organizations across all industries say that driving diversity, equity and inclusion in the workforce is at the top of their mind when planning for the future of work,¹² yet financial institutions are failing to keep pace. As regulators lay down a clear direction on this issue,¹³ the financial industry risks weakening their ESG commitments if they fail to devise and meet targets that foster inclusivity and diversity of thought. Such failure is a significant risk in a tight job market, where banks are relying on new talent pipelines to power their digital transformation agendas.

Renewables: Gaining the Competitive Advantage

Where once dedicated renewables companies dominated the green energy market, they are now facing growing competition from large oil and gas companies that are also building greener energy solutions. While many of the big players in this sector have mature strategies and disclosures, many small and medium-sized green technology firms have not yet formalized their ESG work beyond their environmental value proposition or optimized their ESG disclosures. It’s a factor that’s inhibiting their ability to attract first-time investors or maintain trust from various stakeholders such as investors and insurers.

In a competitive investment market, failing to build out ESG oversight and strategy puts businesses in a weakened position, particularly in an industry with considerable organizational and operational risks. From sourcing critical materials that are subject to high price volatility to the decommissioning of assets, such as wind turbine blades and lithium-ion car batteries — businesses will need to push towards a circular economy as they look to strengthen their ESG commitments.

Similarly, to satisfy the expectations of consumers, investors and regulators and protect its reputation, the renewables industry must maintain a strong focus on its health and safety practices and its impact on local communities and ecologies. While at the same time businesses must invest in technology solutions that minimize their intensive energy and water inputs in the production process. Building a reputation takes time and investment, but damaging one can be swift and costly. With growing public and political pressure on the energy sector’s perceived failings in their commitment to tackling climate change,¹⁴ reputational crises remain one of the major risks for the industry. Those pivoting their offering toward renewables must reimagine their risk landscape — assessing how it is rapidly changing and identifying how to address these scenarios going forward.

Private Equity: Bringing New Meaning to ‘Investing Wisely’

The trend for ESG-related investing — borne out of concern about the sustainability of economic activity, the impact of climate change, and the survivability of humans — continues to grow along with the returns. Analysis of investment studies exploring the links between ESG and financial performance also shows a positive correlation, leading to improved risk-adjusted returns for ESG investment.¹⁵

Estimates suggest that one-third of all global assets under management will have ESG mandates by 2025,¹⁶ as a growing body of evidence finds that companies mitigating ESG risks create long-term value with better corporate performance and lower risk exposure.¹⁷ Corporate sponsors and regulators are pushing harder for retirement plans that take into account climate risk and drive positive social impact through their investments. Likewise, plan members are increasingly asking for the same and scrutinizing the ESG credentials of the funds and companies in which they invest.

Funds and their portfolio companies continue to establish more robust public-facing ESG requirements, commitments and policy frameworks to be applied across their investment lifecycle. Businesses unable to leverage mature ESG capabilities during M&A, divestitures and initial public offerings are at greater risk of losing out. Any perceived ESG risk by potential buyers carries the threat of lower valuation or overall return on investment or even the complete collapse of a deal. To secure fair value and pricing, dealmakers must identify and mitigate potential risks ahead of time. Nonetheless, the challenge of developing a framework to monitor and measure portfolio company ESG risks and opportunities as they evolve in real-time is not insignificant. Without standardized reporting for ESG measurements and key performance indicators (KPIs) to monitor ESG efficacy, funds and portfolio companies alike have difficulty navigating ESG measurement and performance.

A Rapidly Changing World, Relying on ESG Maturity

Keeping pace with the changing expectations of stakeholders has continuously driven business leaders to build organizational agility. However, in a rapidly changing and volatile world the stakes are high and keeping pace with the shifting demands of all stakeholders has never been more challenging.

Companies that neglect their ESG responsibilities can see a deterioration across investment ratings, access to capital, insurance coverage, employee turnover, future value and reputational market position. To remain competitive, organizations must take their ESG responsibilities seriously and look outside their organizations to assess how well their values align with those in their ecosystem.

Developing an ESG strategy starts by using data, analytics and benchmarking to identify your organization’s standing on the ESG Maturity Curve. From here, you can begin to address ESG risks and seize opportunities — putting governance into action with clear strategies that protect the health and wellbeing of people and the planet.

By formalizing, maintaining and communicating a robust and meaningful strategy, your organization can remain competitive, comply with stakeholder expectations, and create and deliver value or return on investments. When it comes to ESG-related challenges, resilience and growth, and people and the planet, are all equally dependent on leaders taking urgent action.

¹ Climate Change-Related Disasters a Major Threat to Food Security - FAO, United Nations, March 2021
² Food production emissions make up more than a third of global total, New Scientist, September 2021
³ World population projected to reach 9.8 billion in 2050, and 11.2 billion in 2100, United Nations
⁴ 'Healthwashing’ in snacks: ‘We need to protect and educate the public’, Food Navigator, November 2021
⁵ What Is Greenwashing?, Forbes, July 2022
⁶ Food, Beverage Makers Rethink Marketing After Flood of ESG Suits, Bloomberg Law, June 2022
⁷ Carbon footprint of the global pharmaceutical industry and relative impact of its major players, Science Direct
⁸ Why ESG must include health equity, World Economic Forum, April 2022
⁹ Just A Third of Largest Banks Have Set Robust 2030 Climate Goals, Bloomberg UK, March 2022
¹⁰ Aon’s ESG – a new lens for investors and insurers
¹¹ The Return on Sustainability Investment (ROSI): Monetizing Financial Benefits of Sustainability Actions in Companies, Review of Business Interdisciplinary Journal on Risk and Society, 2019
¹² Aon: Over half of UK organizations are reviewing benefits for inclusivity, December 2021
¹³ The FCA, the PRA and the Bank of England have issued a joint Discussion Paper on diversity and inclusion in the financial sector, Travers Smith
¹⁴ Despite shift, energy giants fall short of U.N. climate goals – study, Reuters, October 2020
¹⁵ ESG And Financial Performance: Uncovering the Relationship by Aggregating Evidence from 1,000 Plus Studies Published between 2015 – 2020, NYU Stern, 2021
¹⁶ How ESG investment returns are growing as market evolves, Sustainability Magazine, March 2022
¹⁷ Aon’s Guide to ESG Investing