How do you know if companies are performing on ESG?
The number of people who want to invest in companies that outperform on both financial and environmental, social and governance (ESG) grounds is higher than ever.
While identifying financial outperformance is well understood, it is less easy to identify the companies leading the way on ESG grounds
It can be challenging to see how targets around climate change and net zero, human rights abuses in supply chains, or gender diversity in boardrooms and company hallways are implemented and embedded.
Progress not perfection
The first thing to understand is that there's no ideal company when it comes to ESG and sustainability. This is all about progress, not perfection.
The second thing to understand is that ESG data, such as measuring carbon emissions, can be a challenge.
Scope 1 emissions include CO2 and other emissions that come directly from company operations. Scope 2 emissions come from the electricity and heat that a company purchases for its operations. Scope 3 is a tricky one - all the emissions that a company is indirectly responsible for, from products from its suppliers, and from its products when customers use them.
Verifying whether actions to reduce modern slavery in supplier companies can be hit or miss.
This was a particular challenge during COVID lockdowns when it was nearly impossible to conduct on-the-ground assessments of factories in developing countries to make sure they were not exploiting workers.
But it is possible to gain insights into whether lofty ESG targets and ambitions will be matched with action.
Ambitions versus action
The first thing is to look at the targets themselves and how companies are reporting on them.
Are net zero commitments backed by disclosure based on the Task Force on Climate-related Financial Disclosures (TCFD) or are commitments certified by the Science Based Target Initiative (SBTi), a rigorous disclosure framework that is based on climate science? That's a good starting point to see if there's rigour around the targets.
Another area to look at is whether companies are committing capital expenditure (Capex) or operational expenditure (Opex) to fund initiatives like decarbonisation.
BlueScope Steel is in a very tricky position in that their products are economically significant, yet they are heavily carbon intensive.
In the 2022 financial year, the company allocated up to $150 million over a five-year period on near-term action on climate change, with that funding going towards accelerating industry partnerships, concept studies, and feasibility studies towards large capital projects.
A third area to examine is whether or not executive remuneration is linked to achieving ESG targets - there's nothing like having a CEO's mind focused on achievement through short and long term incentives. However, it's important to know whether the ESG targets being incentivised are stretch targets and not just business-as-usual.
How companies access capital
Another data point for you to consider is whether a company is tying its action on sustainability to how it accesses capital - through green or sustainability-linked bonds and loans.
One example of this is logistics company Brambles, which has a clearly defined circular economy strategy that is integrated into its business strategy. The company has linked its targets to a green bond, where the use of proceeds is strictly limited to funding environmental initiatives within the company.
Brambles issued the €500 million green bond in March this year, with the interest rate linked to the company's circular business and sustainability performance. If the company fails to implement the changes, they are penalised.
To help identify and celebrate the people within companies that are taking action on ESG, FS Sustainability has launched the ESG Power50 list. It identifies 50 people who are kicking goals on ESG action across ASX-listed companies, as voted on by readers of FS Sustainability, FS Advice and FS Super. Lachlan Feggans, director of sustainability, corporate and Asia-Pacific at Brambles is one of the ESG Power50, while BlueScope's head of sustainability Tim Rodsted and chief executive of climate change Gretta Theobald Stephens also appeared on the list.
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