Sustainability Needs Rebranding
Editor’s Note: This is a comprehensive study by EY. Agree or disagree, it’s a solid starting point for the annual discussion about corporate sustainability and the factors that are driving the movement and the factors that are blocking progress. As the graph below indicates, corporations will make or break the movement and the stakeholders must stay engaged, while defining the competitive edges that corporate sustainability champions will earn in the marketplace.
Our 2013 survey looked at how companies are responding to a wide range of internal and external forces related to environmental sustainability risks and how well companies are prepared to address them. Six trends emerged:
- The “tone from the top” is key to heightened awareness and preparedness for sustainability risks.
- Governments and multilateral institutions aren’t playing a key role in corporate sustainability agendas.
- Sustainability concerns now include increased risk and proximity of natural resource shortages.
- Corporate risk response is not well paired to the scale of sustainability challenges.
- Integrated reporting is slow to take hold.
- Inquiries from investors and shareholders are on the rise.
The survey tells us that companies’ response and approach to sustainability issues are influenced significantly by the “tone from the top” – that is, how and how much senior management is engaged in the conversation. Does senior management see sustainability as a competitive edge? Does the CEO see sustainability as an issue that affects a company’s ability to compete?
Some risks are exacerbated as the role of governments and multilateral organizations shrink in the sustainability arena. The result is a muddled policy environment, making it difficult for some companies to make long-range plans and investments.
NGOs, stock exchanges and investor groups are stepping in to fill the void, often exerting higher leverage than governments to move companies and markets to provide transparency and disclosure. But corporate risk response appears to be inadequate to address the scope and scale of some of these challenges.
Investors and stock exchanges are pressing companies ever harder to assess and disclose sustainability issues considered material, in part by asking companies to integrate financial and sustainability reporting. Companies, however, are slow to do so.
The evolution of corporate sustainability inside companies has shifted the conversation from the margins to the mainstream.
The early conversations focused on regulatory compliance, aligning cost-saving measures with reputation benefits and, more recently, creating value by aligning sustainability with innovation.
The corporate sustainability conversation in a growing number of companies has shifted to another arena: risk reduction and mitigation. This reflects the realization that environmental, societal, and market shifts will increasingly roil everything from commodity prices to natural resource shortages to disease epidemics — all of which can affect business continuity, the right to operate and reputation.
The complexity of corporate sustainability issues, especially when viewed through the lens of risk management, has led companies to understand that sustainability needs to be more tightly integrated throughout the organization: in finance, operations, procurement, facilities, human resources, supply chain, logistics, finance investor relations, marketing and communications, and more.
The result has been that the conversation inside companies is more dispersed, even systemic, well beyond the scope of a single department or business function.
How, and how much, companies disclose their sustainability-related risks provides a good barometer of top management’s engagement in these issues. We asked our survey group to assess how much their company’s disclosure of sustainability-related risks contained in their 10-K filings or annual financial report was aligned with their responses to the Carbon Disclosure Project, Dow Jones Sustainability Index and other surveys.
How aligned is your company’s disclosure of sustainability-related risks published in your 10K or annual financial report with your company’s responses to the CDP, DJSI, and other surveys? Companies that have a greater level of engagement from the CEO and the board have much closer alignment between what they voluntarily disclose (such as CDP and DJSI) and what they are mandated to disclose (such as 10-K filings). When the CEO and the board are involved, there is much greater alignment in risk identification and disclosure. While 22% of surveyed companies indicated total alignment on both mandated and voluntary sustainability disclosures, 36% acknowledge “total alignment,” indicating both a fully engaged board and CEO.
Heightened CEO and CFO attention to sustainability reflects the gradual ascent of sustainability issues within the corporate risk register. C-suite involvement also underlines the growth of corporate sustainability as a strategic differentiator.
For several years now, government’s role in promoting corporate sustainability has been, at best, neutral. Companies need certainty to make investments and other major decisions. The uncertainty that comes from a political stalemate is seen by many companies as detrimental to business planning, risk management, research and development agenda, and corporate sustainability strategy. For many of the world’s largest corporations, this stalemate is a source of endless frustration.
Which groups have a positive impact on advancing sustainability on a global basis? Thanks to politics and obstructionism, the annual series of United Nations-led climate summits known as COPs (for “Committee of the Parties”) has been a globe-hopping failure so far— from Copenhagen and Cancun to Durban and Doha, not to mention 2012’s Rio+20 summit.
What just a few years ago had been a strong sense of optimism that these meetings could push the world’s governments to agreement and action on some of the planet’s biggest challenges has devolved into disarray and disappointment. Nongovernmental organizations (NGOs), for example, have stepped up to prod both companies and governments to take action.
Some NGOs have pushed for transparency and accountability and implemented “name and shame” campaigns that rank companies on one or more issues. Corporate rankings, like those published annually in some magazines, are highly watched, if not always well regarded, by companies.
Some executives also see NGOs serving as an early-radar system, identifying issues likely to rise in public (and media) concern — chemicals of concern, for example, or biological hotspots from which companies may be sourcing raw materials.
And then there are the stock exchanges, which are slowly awakening to sustainability issues and, in some cases, viewing these issues as material to their listed companies. This is on top of the substantial corps of institutional investors that are now screening investments using some sustainability or corporate responsibility criteria. All of these groups comprise much of today’s “regulatory” agenda, an emerging new set of standards to which companies must comply.
Company concern about resource shortages is nothing new, but only recently have companies started connecting the dots to sustainability-related issues.
The inability of governments and transnational institutions to effectively broker international agreements to limited global environmental decline has exacerbated this concern. These issues are left to market forces, which often omit or underprice external costs to the environment and society for the resources’ exploration, extraction and use.
Do you anticipate your company’s core business objectives to be affected by natural resource shortages (e.g., water, energy, forest products, rare earth minerals/metals) in the next three to five years?
Water is an issue of particular concern. Climate change will affect global water resources at varying levels. The world’s water problems and the looming water-security crisis were ranked high by the World Economic Forum (WEF) 2013 Global Risk Survey. WEF calls water one of the most tangible and fastest-growing social, political and economic challenges faced today.
WEF also rated “failure of climate change adaptation” and “rising greenhouse gas emissions” as among those global risks considered to be the most likely to materialize within a decade.
This concern was echoed by our survey participants, who ranked water as the number-one cause for concern among resources “most at risk,” followed by oil and “metals and other materials.” About half (51%) said they anticipate their company’s core business objectives to be affected by natural resource shortages in the next three to five years.
Companies’ concern of the risks sustainability issues bring to their supply chains, reputation and even their right to operate has not been matched by their appraisals of the costs and benefits of various responses.
Our survey found 79% of respondents saying that sustainability risks are incorporated into their enterprise risk management framework. Simply put, that means 8 in 10 companies have incorporated environmental risks into their risk register and that their board of directors has oversight of how those risks are addressed by management.
That struck us as a surprisingly high number, particularly in light of their responses to another question: whether their organization had run scenario analyses considering the availability of key inputs such as water or other raw materials, access to arable land or population shifts. Only three in 10 companies — fewer than half of those saying they have incorporated corporate sustainability into risk management — said they had run scenario analyses; 36% said they had no plans to do so. It is clear that company risk awareness has not translated into preparedness.
The growing interconnectedness of issues —what some are calling the food-energy-water stress nexus — require a scenario-based approach that attempts to anticipate key tipping points that could quickly affect all three. What happens if a tipping point leads to the rapid adoption of carbon pricing or other regulatory responses?
Do you believe your company has the processes in place to anticipate effectively its exposure to increasing environmental, social and governance risk? Most companies do not yet have answers to such questions. And by not doing scenario planning, they are failing to integrate such risks, let alone develop confident appraisals of the costs and benefits of different adaptive responses. To the extent that companies view these things as financially material, it is not being mirrored in shareholder or regulatory disclosures.
The idea of integrated reporting — melding traditional financial reports with key sustainability metrics — is compelling, based on our survey respondents. But for now, its promise remains elusive as companies grapple with whether, when and how to develop such reports. The buzz around integrated reporting has increased significantly in just the past two years.
Today, companies publish more than 5,000 sustainability and corporate responsibility reports a year worldwide, according to CorporateRegister.com. They vary widely in content and comprehensiveness (Editor: most do not address biodiversity and habitat loss, however).
Most aren’t written with investors in mind; they are targeted at a broad range of stakeholders, many of which have a specific environmental, social or governance interest. For the past few years, a growing movement has been pushing companies toward reporting key sustainability data in a much more investor-friendly way.
Among the significant challenges to integrated reporting’s growth (IR) is vocabulary. For example, how to bring concepts like “natural capital,” in which environmental impacts are assigned financial costs, to the CFO in a way that aligns with a company’s current understanding of risk and accounting.
While it may be a while before IR is mandated by regulation, market forces may provide de facto regulatory pressures. Among the sources are stock exchanges, particularly outside the United States.
In our survey, respondents indicated a strong agreement that IR would be a positive influence on their company’s sustainability performance, and would elevate it to senior management. And 43 percent said that integrated reporting would be “extremely” or “very” helpful in such things as breaking down the silos, involving the CFO/finance team in sustainability-related initiatives and reporting, and validating the existence and importance of non-financial information reporting. Only about 12 percent said such reporting would not be helpful.
As demands for disclosure on environmental and social impacts increase, so does the number of surveys, questionnaires and queries to companies. They come from many and diverse directions: institutional investors, customers, media, industry analysts, communities, regulatory and non-regulatory government bodies (at the local, national and international levels), activist groups and various others.
Each seems to want more or different data than the others, or may pose the same questions in slightly different ways. The resulting tsunami has overwhelmed many companies’ ability to cope. We’ve learned that some large companies respond to more than 300 customer surveys each year.
Half of our survey respondents reported that they are receiving an increase in the number of sustainability-related inquiries from investors and shareholders over the past 12 months. That underscores growing interest, particularly by institutional investors, many of which now view corporate sustainability issues as material to shareholder value.
The growth of queries also mirrors the growth of shareholder proposals on social and environmental issues, which now account for 40% of all shareholder proposals. Support for those proposals is growing, too: The average proposal received 21% of investors’ votes in 2011, up from 10% in 2005, reflecting a relatively high level of interest and support.
At the top of the list of shareholder proposals are those focusing on companies’ efforts to reduce energy consumption, an acknowledgment that energy efficiency not only increases competitiveness, but also reduces risks associated with volatile energy prices, as well as carbon taxes or other regulatory schemes. Second highest on the list are proposals addressing greenhouse gas emissions reductions or adoption of quantitative greenhouse gas goals.
Climate and energy will likely remain front and center for shareholders. At the institutional level, investors are getting increasingly organized around these topics.
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