Mon 29 Jan 2018
News - The relation between Governance and ESG - by Corinne Molitor
The relation between Governance and ESG

Corinne Molitor,
Director at Innpact

Governance has an important role to play in the ESG (Environmental, Social, Governance) strategy of a company.
At ILA, we all agree that better governance leads to better financial sustainability of a company. Doing business in a good way, in a good governance way, leads to better financial performance.

But isn’t there another relationship between governance and environmental & social performance of a company? The G is only one letter in ESG, but what about the E and the S, the environmental and social sustainability of a company?

Governance must come from the top, from the boardroom, and the same holds true for environmental and social governance. If the board is not convinced that the extra financial implications of a company’s activities, in terms of social or environmental impact, are important to address, then how could management or staff be? It is the responsibility of the Board to ensure that there is a buy-in from the whole company, as well as a long-term engagement.

ESG is a 360° approach: a company must look at the effects of its activity on all stakeholders, not only regarding financial implications of its activity, but also extra financial implications. For example, if a company is polluting water, this will have a financial implication in the future if the company is obliged to cover water reprocessing costs.

Furthermore, sustainability also relates to financial risk generated by a company’s activity today that may turn into a financial liability in the future. One example are stranded assets, which are fossil energy resources that cannot be taped into because of climate change implications leading to millions of tons of gas and fuel which will become unexploitable. These assets are “stranded”: they are on the balance sheet of the big Oil companies, but the financial value of this assets will “evaporate” over time.

Thus, it seems clear that risks we consider as extra financial today are likely to have financial implications in the future. It is the board of directors’ duty to consider and manage these risks as well as their future implications today.

Are investors considering ESG and sustainability in their investment strategy?

Boards need to be aware that a positive contribution to sustainability is required by a new generation of investors:
  • Millennials are increasingly looking at the level of sustainability of their portfolio.
  • Institutional investors such as pension funds, sovereign funds, family offices have stricter requirements in terms of sustainability of the assets they invest in and the carbon footprint of their portfolio.
  • Insurance companies have a clear focus on extra financial risks, heavily influencing insurance premiums.
  • Governments have national action plans and international commitments in terms of climate change UN sustainable developments goals.

What is the impact of all this?

  • Transparency & reporting: Companies and investment funds become obliged to report on their sustainability approach i.e. The Swedish fund association now prescribes that if a fund distributes its shares in Sweden, it needs to produce an extra financial report on its sustainability approach. At EU Level, various task forces are also working on mandatory disclosure.
  • Exclusion: extra financial sustainability criteria will lead to the exclusion of certain investments as more and more investment decisions are made using a best in class approach: Which company has the least negative impact on the environment? Or, which company makes a positive contribution to environmental and social indicators?

How is the share sustainable investment developing in Luxembourg?

Luxembourg has always been a front runner in microfinance and inclusive finance funds, and since 2009, at Innpact, we have increasingly seen renewable energy and energy efficiency funds entering the market. In addition, since 2014, a number of sustainable landscape management funds, investing in forestry and agriculture, as well as funds addressing a number of Sustainable Development Goals, as defined by the UN in 2015, have been set up.

Today, there is clear and unstoppable trend towards more sustainable investing.

We, as board members, need to be aware that this is not a concern for the CEO or for the management, but that sustainability starts in the boardroom.

It is critical for the Board today to embrace this role, and to build expertise. There needs to be an understanding of sustainability issues, and it is the board that needs to drive and manage this process. Preparing for the concerns and requirements of the next generations is crucial in order to act responsibly and stay ahead of the curve.