Sustainable Procurement: Is it worth pursuing?

 

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Introduction

In recent years, with issues such as COVID-19 and with the current volatile market, the resilience of supply chain is deemed more critical than ever. Companies have started to integrate Sustainability into its operations but the focus now is to ensure it is expanded across its value chain or in other words; procurement.

 

Sourcing from suppliers that are sustainable, may help companies to mitigate risks arising from supply disruptions due to environmental events or regulatory changes. Moreover, companies that mitigate social and environmental issues across the value chain will help to mitigate reputational risks.

 

It easier said than done

Integrating Sustainability across the value chain requires a lot of collaborative approach and sound governance and processes – and this is also complex as companies are dealing with shortages in tools, data and internal capabilities. This is backed by the findings from a study by McKinsey. According to this study, one of the exercises indicates that, 70% of the sample informed that their companies is not aware of where Scope 3 emissions were generated in their value chain. Apart from that, 90% of the sample highlighted that they face difficulty in identifying the right actions to move the needle on ESG topics. Also, in terms of target setting, almost 75% highlighted that they face issues in this area.

 

The SMEs are the backbone of the economy – globally they represent up to 90% of businesses. The SMEs are also facing the scrutiny and pressure from all angles to adopt sustainable practices and operations. This is due to their supply chain ecosystem that includes large corporations that are setting higher ESG standards and requirements.

 

Logically, implementing sustainability is always a good cause for any organisation, regardless of their size. While larger corporations have been able to progressively integrate ESG into their business, many SMEs struggle in their journey to do the same, due to a lack of technical skills, knowledge and capital.

 

 Is it worth it?

Not only sustainable procurement results in good reputation for the company, but it can also have a positive impact on the company’s relations with its stakeholders, especially the customers and investors. These two stakeholder groups are now more focus than ever to scrutinise ESG considerations integrated across companies’ supply chain and will support those companies that have a clear and practical sustainable procurement plan and monitoring. Customers and investors would also be more likely to do business (over a longer period of time) with companies which have lower exposure towards non-ESG compliant suppliers.

 

Current and potential employees are also looking into how serious companies are towards sustainable procurement, especially those that value environmental and social responsibility. Employees nowadays do not want to be affiliated with companies with poor sustainability practices in its procurement process and management. Additionally, employees would also expect companies they are working for to also have a sound and robust sustainable procurement strategy and plan.

 

Sustainable procurement is not all just about environmental and social benefits, but can also have potential economic value. Companies with good sustainable procurement practices will have competitive edge, and can reduce costs, improve efficiency, and gain a competitive advantage over their peers in the same sector.

 

On top of that, sustainable procurement would also improve supplier relations as well as business continuity. Early adoption and transition in sustainable practices ahead of mandatory regulations or imposed by specific jurisdictions, can benefit organisations in securing and building networks of quality and sustainable suppliers as part of its value chain.

 

Conclusion

Sustainable procurement is expected to be a norm moving forward. We are seeing more pressure from sustainable companies to embed Sustainability across its business operations. Engagement with suppliers on Sustainability are seen to be intensified and more and more suppliers are also on the look out to obtain relevant certifications, tools and resources towards being more sustainable. More or less, both organisations and suppliers are aware that sustainable procurement will bring economic benefits and would remain relevant and competitive in the market over the long term.

 

All views and opinions expressed on this site are by the author and do not represent any particular entity or organisation 

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The Main Challenges in Climate Reporting and How to Tackle Them

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Companies have been disclosing on how their operations impact the climate and this information is easily accessible in companies’ websites and public reports. But, what about the information regarding the impact of climate risks to companies? Recently, this topic is being discussed at a greater length and the demand for companies to disclose it has risen. This is due to the fact that the direct physical impacts of climate change risks are exposing companies’ operations to complex operational risks. On top of that, this demand is also driven by the indirect and transition climate change impacts, including introduction of new policies and regulatory requirements to shift towards a low carbon economy, as well as changes in customers demand on product and services that are more ‘climate friendly.

Reporting on the impact of climate risks to operations represents how the company is both managing the risks as well as creating business opportunities for the sustainability of the business.

In response, stakeholders are demanding for greater transparency on the climate impacts on companies’ financial performance, including future performance.

Adoption of the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures (TCFD) recommendations is also increasing, and we are seeing this across the world. The recommendations of TCFD have been driving companies to enhance the holisticness of climate disclosures. The TCFD sets out a framework that enables companies to disclose their climate risk profile and integrate it into mainstream filings. This information provides regulators and investors with a meaningful climate-related risk information to better assess how companies manage climate change impact and how they respond over short, medium and long term.

 

TCFD – Current Progress

The TCFD recommendations are widely accepted by organisations from various sectors, including investors, associations, as well as policymakers. All have expressed full support towards the adoption of the TCFD recommendations.

However, the implantation of the TCFD is deemed as the main challenge, from getting started to improvements the adoption. CDP and Marsh & McLennan Companies’ Global Risk Center in its research has reported that the implementation challenges faced by organisations include the following three key areas:

·         Securing leadership buy in for a wider approach to climate risks

·         Overcoming siloed risk-management processes

·         Limited experience with climate change scenario analyses.

 

Securing leadership buy in

The Board and Management need to properly define and evaluate the impact of climate risks to the balance sheet of the company. In order to do so, Board and Management should expand their horizons of their considerations towards climate related issues and trends. It is reported that more than 80% of companies’ Board provide oversight on climate issues. However, it also reported that only 10% of companies actually incentivise Boards to prioritise climate risks, and even lower percentage of Boards consider climate risks as a top 5 risks affecting the company within the next 5 years. This clearly contradicts with the -Global Risk Report by the World Economic Forum which ranks climate- and environment-related threats as the most likely and most damaging over the next decade. 

 

Risk management are working in silos

Conventional risks can be easily isolated and addressed with standard risk-management process, and this will not pose much issues to a lot of businesses. However, it is a totally different ball game when it comes to more complex risks embedded in interconnected systems, such as nature-related risks and climate risks including on risks pertaining the transition to a low-carbon economy.

Climate risks for example, are now considered one of the biggest risk topics being discussed. According to CDP, only 34% and 28% out of more than 1,500 companies, respectively, are linking physical risks and regulatory and transition risks associated with climate change beyond six years.

For investors, organisations and other stakeholders that are assessing the mid- or long-term view, limited and short-term climate change impact analyses will not be adequate in providing them with robust information on potential direct physical and transitional risks from climate change.

This is certainly a complex issue. On top of that, another research has found that the complexity also rises from the lack of stadardisation and clarity on risk definitions, as well as which function within the organisation that is accountable to manage them. Climate risk management should not fall under under the sole responsibility of one individual or a function which in many cases – the sustainability team. Responding to climate risks will require broad ownership, understanding and collaboration across the organisation on climate risks and opportunities and how they relate to financial impacts in the long run.

 

There’s not much experience and cases on climate change scenario analysis

Based on TCFD’s recommendation, companies should describe the potential impact of different climate scenarios, including a 2-degree Celsius scenario, on businesses, strategy and financial planning.

The fact is, companies encounter a lot of challenges and potential barriers in translating climate scenarios to integrated financial analysis. Various types of climate scenarios and widely varied outcomes result uncertainty to determine which climate scenarios are appropriate to use and to translate into meaningful financial impact analysis. Currently, the developed climate scenario models were established mainly for academic and economic use cases, but not financials. Existing scenarios require input and judgment from experts across the organisation but the other challenge is that for many cases, the process involves a lot of very educated guesswork and not everyone guesses in the same wavelength as others.

Companies are required to find ways to integrate the analysis into current strategy and scenario planning and risk assessment. Subsequently, companies are required to provide linkages of the scenario impacts to future business strategy and performance. Data is one of the main obstacles as there is lack in historical and factual data to link climate impacts to financial performance.

TCFD’s recommendations will likely to be via phased approach and require time especially for companies that are new in their overall Environmental, Social and governance (ESG) journey. There is also indeed, the need for a clear and practical reporting framework.

The long-term horizons of climate risks and opportunities typically extend beyond the scope of business planning and one thing that needs to be highlighted is that normally, business works on a short-term cycle, hence, quarterly financial reporting is the common practice. For financial stability, the horizon is extended, but typically only to the outer boundaries of the credit cycle — about a decade. This brings to another concern – by the time climate change becomes the defining issue for financial stability, probably it will be too late for a response, unless, drastic actions are taken right now to evaluate and disclose climate-related factors.

 

Conclusion

Without a doubt, assessing and reporting on climate impacts – risks, resilience, opportunities is challenging. However, by undertaking it, it provides the edge for companies to get the upper hand to face the adversity arising from climate change. This, is key for a truly, sustainable future.

 

All views and opinions expressed on this site are by the author and do not represent any particular entity or organisation 

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Firming Up on ESG Management. Here’s Why Companies Should Not Delay it Any Longer?

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Introduction

Not many years ago, Environmental, Social and Governance (ESG) agenda has always been sidetracked by companies. The importance of ESG back then was not clearly understood and only observed as an addition to regulatory obligations. The lack of awareness by the Board and management of companies also didn’t help to overturn this mentality. However, companies across various sectors nowadays have started to give more attention to its ESG management and performance. More and more companies have shown unique approaches in ensuring ESG plays an integral part of companies’ corporate strategic agenda. With the impact of COVID-19 pandemic, companies are pressured to step up their ESG management and reporting. This article will briefly highlight the approach that companies need to consider in order to meet the increasing ESG expectations.

 

Multi-Stakeholder Management

Stakeholders are affected and also affecting all of the ESG criteria – Environmental impacts, Social impacts and Governance impacts. But as a ‘Stakeholder’, social issues have always been the central focus, ranging from community engagement to subjects related to human rights. Though till now it is difficult to quantify the financial values generated from social issues, but the impacts posed by the mismanagement of these issues are severe as companies would lose the confidence and trust from its stakeholders and eventually have reputational and financial implications to companies. 

Talking about reputation, there is never the best time compared to now for companies to adhere to its corporate principles and progressively revamping its risk management processes and advances reputation. Just by meeting the current demands of internal and external stakeholders is no longer acceptable particularly to key stakeholder groups that are looking at long-term values and gain from companies. So, the demands on future ambition and performance are also vital. For example, COVID-19 has heavily impacted (and still impacting) companies’ workforce across sectors pertaining areas of health and safety, income stability, and overall workforce morale and motivation. Stakeholders are observing how companies deal with these challenges and assuring the best solution are being provided to benefit them during and after the pandemic crisis.

Specific stakeholder groups such as regulators and investors as well as other market participants that include rating agencies, will continue to press companies to place paramount attention to social issues and how companies shows resilience in the competitive and challenging business landscape.

What can be learned from the recent COVID-19 crisis is that the immediate focus on social issues creates an opportunity like never before for companies to relook and improve on its overall stakeholder management and engagement to all of its key stakeholder groups such as its workforce, community, regulators, investors, and also those across its value chain such as the suppliers.

That being said, in allocating the efforts and resources towards managing the critical social issues, companies should not lose control of the continuous enhancement of environmental and governance issues. At the end of the day, ESG issues are interconnected. Apart from that, environmental issues such as climate change imposes great threats and impacts for companies. The impact of COVID-19 pandemic should provide companies the lessons that their business should be prepared at all times of all ESG risks that may affect them in the long-term. 

 

Effective ESG Strategy

ESG is no longer something that is ‘nice to have’, but are now considered as an imperative component of companies’ financial performance and evaluation. For instance, there was an estimated increase of USD$70 billion investment pumped in the 2019 ESG funds. This supports the prediction that ESG investing to top USD$50 trillion in the coming two decades. This trend points out that ESG investing will one day become mainstream and there is a clear opportunity for companies to reap the benefit if they prepare for it from now.

An effective ESG strategy is not only important to help companies to achieve the desired sustainability ambitions, but also provides a clear direction on how they can consistently improve their performance, manage and mitigate its risks and enhance market position.

The progress and outcomes of companies’ ESG strategy should also be communicated to all stakeholders to enable companies to gain the trust and confidence especially from the investors for long-term value creation.

In reaching towards the development of an effective ESG strategy, companies should oversee in a diligent manner on five key components; the companies’ material issues, roles and responsibility of the governance structure, comprehensive policies and innovative programmes, metrics and targets, and ESG communication.

To come up with strategic focus areas, companies should analyse issues that have the most interest, as well as impactful on and towards the business and the key internal and external stakeholder groups. Focusing on financial matters are now redundant as more and more ESG related issues are gaining the interest from stakeholder groups. It is definitely difficult to meet the demands from all stakeholders, as it is also not viable for companies to neglect the business needs. So, companies should have a structured and robust process in place to derive the key issues that have balance significance on the business and also the key stakeholder groups. These are considered as the material issues that should be in reference to companies’ ESG strategy development.

A sound governance structure should also demonstrate accountability and awareness on ESG management from all levels especially the Board and management. The Board and management should be aware of all ESG risks and opportunities relevant to the company and the industry the company is in. There is no template approach in ESG management as companies varies from one another. So, it is absolutely important that the governance structure to carefully formalise the roles and responsibilities that maximises the implementation and monitoring the robustness, effectiveness and the performance of companies’ ESG strategy. It is also important to note, that even though there might be specific functions or personnel that are responsible to oversee ESG management of a company, the ideal approach is for the collaboration of different functions to come together and work on ESG management as one whole unit and to ensure regular and beneficial exchanges of information are feasible. This would allow better risk and opportunities management particularly once companies have define the material matters to companies.

The development of ESG policies and programmes should be well-coordinated and strategically planned out. In order to do so, companies should not envision the short and medium-term outcomes but to also evaluate the long-term outcomes for the companies and stakeholders. In undertaking this evaluation, companies must see the areas that are feasible for them to optimise and capitalise in the specialties and strengths that are unique and aligned to the companies’ values. Most importantly, companies must anticipate the potential changes in the business landscape including the political, regional, regulatory, social and environmental trends that would likely to occur within the proximity of companies’ operations and influence. This would allow the companies to reap the long-term financial returns and remain competitive at all times. Having these understandings, companies should be in a good position to allocate the investments, resources, timeframe to implement the relevant plans for its ESG strategy.

The success of any strategy, including ESG strategy depends on various factors that are controllable and uncontrollable. Companies should always monitor the performance of the developed strategy to analyse the value it brings to be desirable or would actually cost additional effort and unnecessary investments to the companies in the long run. Companies must adapt and be flexible to changes and also must know when. The results from the materiality assessment (to identify the material matters of a company), should be referred to in developing the relevant metrics, KPIs and targets that are achievable and realistic to place companies in a higher ESG management position. Setting metrics, KPIs and targets that are too ambitious immediately may result in early failures that would lead to demotivation to oversee ESG management as a whole. The overall objective is essentially to measure companies’ ESG performance, so companies should be mindful to develop metrices, KPIs and targets based on its ability to improve and that are manageable to monitor over a sustainable period of time.

The progress of companies’ ESG performance provides important data and information for companies to readjust and restructure on improvement approaches. It provides important data and information for stakeholders as well. It is already well known that the access to transparent information on companies financial and ESG performance is key to gain stakeholders’ confidence, trust and loyalty. Communicating ESG performance may come in various ways via companies’ Annual Reports, Sustainability Reports, websites, AGMs and companies may even create specific events to solely discuss and share on their ESG performance and obtain instant feedback from the stakeholders. This would not only provide insights on the rationale and ambition of companies ESG strategy to stakeholders but also provides solid and concrete responses on how certain stakeholders value the ESG strategy that are affecting them. These exchanges of information will further assist companies to develop or redevelop better ESG strategies.

 

Conclusion

Companies’ ESG strategies or framework for continuous value creation should by now be driven by the Board and management that oversee ESG management and reporting as not merely a voluntary approach to one that in some jurisdictions is increasingly subject to mandatory reporting. Companies that have not embarked on ESG integration into their business operations, or companies that have started to, or even companies that have somewhat fully integrated ESG must all understand that the current landscape demands them to always be ready to improve and adapt. There is no room to be comfortable with the current establishment and practices in place would eventually be obsolete without them even realising it.

 

All views and opinions expressed on this site are by the author and do not represent any particular entity or organisation 

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COVID-19 Has Taught Us that Conventional Risk Management is Obsolete. Here’s Why.

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Introduction

The COVID-19 pandemic has indeed shocked the world and are putting many business in a fragile state in being able to sustain in the long term. COVID-19 as the current biggest threats to organisations regardless of their industry and locations, has pressured businesses to reevaluate their priorities and business strategies to strive in the already challenging world but companies has taken a step back to assess whether its current risk management process is robust enough for the business impact from COVID-19 or other external risks.

 

The Rise of Environmental, Social and Governance Risks

The World Economic Forum in one of its recent reports has shared that the biggest risks businesses will face in the next year (up to 18 months) is the prolonged recession of the global economy.  Organisations should be aware that external risks, including the Environmental, Social and Governance (ESG) risks are categorised beyond the fallout of the pandemic; economic risks, societal risks, technological risks and environmental risks and should raise concerns amongst businesses.

Organisations by now should have already looked at the approaches to feasibly integrate ESG risks into its business risk management. Just like the business threats imposed from COVID-19, these ESG risks are not expressed using financial metrics. But as from what has been vivid from the pandemic, they certainly pose great financial implications. Climate change has been under the focus of many businesses nowadays as not only it has gained tractions from regulators, but it has caused social unrest and physical disasters or transition and physical risks to organisations. This also has caused the risk landscape to be changing, and changing drastically. The rise in not only economic, but health, social and environmental crises we all are facing today could only mean that organisations must reevaluate the corporate strategy, reframe their business future ambition and revamp the risk management framework as a whole.

 

New Approach to Risk Management

It has taken the detrimental effect of COVID-19 to coerced organisations’ Board directors and managements to scrutinise external risks (including ESG risks) as the core subject, and relook at the areas lacking in management and monitoring of external risks.  

Just weeks before the pandemic, the result from a survey of 500 Board directors and Chief Executive Officers (CEOs) found that only around one-fifth of Board directors were “very satisfied” with their effectiveness in overseeing changes to the risk landscape and resulted in adjustment in organisations’ risk appetite accordingly. This is also the same ratio that represents that Board directors were “extremely confident” in risk reporting from management on a range of significant issues.

These findings signifies the point that conventional risk management processes should change and improve, and companies are paying attention. The World Economic Forum also provides insights from a published paper on integrated governance that noted the necessity for businesses to also improve in stakeholder engagement in order to manage risk strategically.

One of the six recommendations is to internalize material ESG & Data factors in enterprise risk management and Boards must gain more in-depth understanding of rapidly evolving environmental, social, governance and data stewardship risks.

Recently, COSO launched a report that focuses on the integral components of the Enterprise Risk Management (ERM) framework, the Risk Appetite Framework. The report by COSO highlights the approach on transform business ‘to anticipate and understand their risk when change happens and to better embrace change and be more agile in challenging conditions’.

This is mainly because in complete absence of a good governance of risk management of both from the internal and external stakeholders’ perspective, organisations will not have the necessary resources and capacity to set up a robust external risk management processes. This will also come hand in hand with the fallout from the lack of trust with organisations’ stakeholders. External or ESG risks management do not only require organisations to look at how they can protect shareholder interest but it’s about being prepared and responsive to the societal and environmental needs as a whole.

 

The Limitations of Conventional Risk Management

The survey by EY global risk also shows that close to 80% of Board directors indicates that organisations are unprepared for significant events such as the COVID-19 pandemic. This is probably due to the lack of governance practiced in conventional risk management as only 40% of Board directors and management explained that ERM are effective in managing atypical and emerging risks.

This is contributed due to data management and analysis. We have now seen that the majority of the current risk management processes have become obsolete and are not built to manage the abundance of critical data generated. Without efficient data management and analysis, the typical risk management process may not succeed in extracting meaningful insights and apply the necessary steps to gain the value and benefits from data analysis.

50% of financial leaders concur to the statement that they spend more time gathering and processing data than they do analysing it, yet alone the decision-making process based on through risk data analysis.

Apart from good corporate governance practices, the Board directors have imperative roles in ensuring risk management practices in organisations run efficiently. The power of data should not be overlooked. Obtaining and most importantly, utilising a continuous stream of valuable and latest data and information is paramount in order to gain buy-in at the Board level. Evaluations and understanding of emerging trends, and prioritising the needs and demands of stakeholders are key considerations to ensure organisations to improve in the overall risk management processes and improve the organisations’ performance. Thus, it is absolutely essential for Boards directors to have the support via data analysis to gain the awareness and insights of the impacts of poor external and ESG risk management on the business.

 

Technology is the Solution

The current business environment requires organisations to meet stakeholder demands and expectations. The question is; Do organisations have enough resources and capabilities to meet the demands and expectations? One of the pressing matters to get internal management’s buy-in is the investment in technology. Organisations cannot be both timely and accurate in producing information from data analysis without the very latest technology. Organisations need a defensible, technology-driven process to back that up and to monitor the risk landscape as it evolves.

The business world we are in today are exposed to complex external risk environment that make organisations vulnerable to broader, complicated and often indirect risks that are very challenging to manage and monitor. As mentioned earlier, effective risk management presses organisations to be focus on data-driven approaches that allow organisations to mitigate the external landscape and focus on the risks that are the most material. These insights will provide with strategic considerations to enable a more dynamic business decision making.

Organisations should start to reinforce risk governance and internal controls and these need to be aligned with the areas that are deemed critical to be improved and transformed. Together with adoption of sophisticated technology software and infrastructure, organisations will possess the systems in place to utilise extensive range of data into something useful and viable information to develop business strategies and profitable business making processes, where and when it matter most.

If we revise the impact of the pandemic, organisations should have already anticipated the drastic response from regulators, governments, peers and wider society. According to Datamaran that tracked regulatory and corporate responses to pandemic more broadly by applying Artificial Intelligence (AI) to analyse the COVID-19 specific responses in real-time, the access to information are more accurate and obtained faster that are imperative for data analysis to give the edge to strive during and post COVID-19 crisis.

AI does not only save laborious time for data consolidation, but it is extremely useful for consistent monitoring. This would be beneficial in order for organisations to identify, structure and prioritise specific risks that are the most impactful to them during a specific period of time. With this, organisations will always be flexible and responsive to any external risks impacting them.

 

Communication on Data-driven Approach in Risk Management Processes

Responding to risks is the defensive approach for companies to be resilient. Proactive approach can be taken with embracing data-driven strategies for other external risks that at the moment are unclear, undetermined and uncertain. Leveraging on data with the right systems and technologies should facilitate organisations to be ready when these external risks emerge and impacting the business and the stakeholders within the operational boundaries and value chain.

Organisations’ plans should not be based on subjective judgements. Acknowledging that risk management is core to organisations, investment in resources and capacity needs are crucial to ensure overall business operations are robust and responsive. Organsations should also focus on communicating the outcome of data-driven approach are being taken to its stakeholders. Organisations should provide more information in the content of the annual reports, that include the risk factors and the forward-looking statements (should) be based on and rely on the risk analysis realised through the risk management framework and corresponding processes. Organisations are also encouraged to express how the Board directors and management determine the risk level organisations are ready to accept that are based on data-driven approach (Risk Appetite Framework). Stakeholders that are made aware of when data feeds into organisations’ decision making, will be assured that the overall business’ risk management processes are more robust, thereby increasing confidence in the organisations. 

 

Conclusion

As we look past lockdown to the rest of 2020 and beyond, robust external and ESG risk management is going to be increasingly vital for building resilient businesses and improving the trust of their stakeholders. Organisations should place the right governance and strategies to ensure data-driven approach are integrated into the current risk management processes to ensure responsiveness to the challenging risks to the business.

 

All views and opinions expressed on this site are by the author and do not represent any particular entity or organisation 

 

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The G in ESG Determines the Success of the Overall ESG Performance. Here’s why.

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Introduction

When it comes to discussions with companies on Environmental, Social and Governance, everything was thought to be heavy on the environmental and philanthropic matters. It seems that the ‘G’ topics have always been less focused as compared to the ‘E’ and ‘S’ topics. Well, that may all change and here’s why.

 

Environmental and Social Performance Are Linked to Good Corporate Governance Practices

Companies have now started to pay more attention to climate change (E element of ESG) issues that not only include how their businesses impact to the greenhouse gas (GHG) emissions level, but also how climate change poses risks to their businesses as well. Now that businesses are striving to sustain during the current pandemic crisis due to COVID-19, the focus on the S element of ESG such as healthcare, wellbeing and employee management has risen. What companies need to be aware of is that whilst they are concentrating to manage the E and S elements better, they simultaneously would need to revamp on the G element of ESG; Governance.

According to the Chief Operating Officer (CEO) to one of the world leaders in the food producers industry, Danone, structurally integrating Environmental and Social responsibility in companies Governance is the approach to be more strategic on the E and S elements.

Now that there has been a surged in meeting the demands to better communicate and manage companies’ stakeholders during the current COVID-19 pandemic, there have even been expectations on the potential establishment of new, and more agile corporate governance standards and models. This claim is supported by a project undertaken by the UK’s Institute if Directors with an independent body pertaining the key issues of corporate governance affecting Boards as companies striving from the impact of COVID-19, and at the same time to be able to meet the ongoing expectations such as the United Nation’s SustainableDevelopment Goals (SDGs), stakeholder engagement and transparency as well as investment in new technological infrastructures.

Governments across the world have also been playing their role to reduce the stress of private companies during COVID-19. Capital allocations in the form of bailouts, loans, grants, tax concessions and equity purchases from governments are a precursor for institutional investors to make quick and smart shifts in corporate governance to be aligned and integrated with environmental and social goals as well as in stakeholder management as a whole.

 

Poor Corporate Governance Practices Have Financial Implications

These shifts would realign corporate governance as the reference point of strategic asset allocation (SAA) due diligence and approach. As mentioned in a recent published research by the Principles for Responsible Investment (PRI), sound corporate governance is imperative in the cases studies presented from the investment management industry. In one of the case studies, Aberdeen Standard Investment highlighted that “We think that corporate governance is often largely ignored by SAA. Investors focus on economic growth and valuation, without asking enough about whether the aggregate quality of governance will affect the ability of companies to translate that growth into shareholder returns.” The case study clearly indicates that the global financial crisis was directly due the systematic failure of sound corporate governance in the global financial services industry that include the mis-selling, lax risk controls, and over-reliance on short-term wholesale funding. The global financial crisis resulted in the enforcement of tougher regulations, lower relative returns in the sector, and a steep learning curve for those involved in the business of SAA.

The case study focuses merely on sectorial performance rather than individual companies’ corporate governance practices, where it has been understood by its SAA within the Japanese equity market, an arena where the shareholder returns had been dreary for the best part of 30 years. This is partly resulted from the poor corporate governance practices showcased particularly in stakeholder management. It is said, just 15% of Japanese corporate boards had independent directors to represent the interests of minority shareholders in 2011, most Annual Grand Meetings (AGMs) were held on the same (and limited) days each year, causing the challenge for shareholders for effective and productive engagements with directors.

Apart from that, due to the poor corporate governance practised, it was observed that the effort to promote value for shareholders was inadequate, on top of extremely low profit margins, cash hoarding, and low pay-out ratios. In the end, Aberdeen’s SAA to Japan was relatively low in comparison to its international equity holdings.

In 2015, the necessary shift to adopt a new corporate governance code was established. In turn, 4 years later, around 90% of Japanese companies had appointed independent directors. Apart from that, the scheduling of AGMs were organised to ensure no clashes of events occurred. The rise of shareholder activism was also seen, as well as in the large domestic pensions funds where special attention was paid to regarding shareholder returns. All of this had fruitful consequences where the return on equity has increased due to equity buybacks and payout in dividends. 

Aberdeen’s researchers also noted that Japan isn’t special for this case. It’s is just a mere example. “Governance quality materially affects our assumptions about margins, buybacks, and valuation multiples for several equity markets. And it doesn’t stop at equities. We see governance as a key part of our evaluation of default risk and recovery rates for credit portfolios,” they added.

 

Focusing on Sustainability Budgets

According to another case study from Schroders, ‘sustainability budget’ is the answer to imbed ESG in the SAA process and one element that anchors the process is through corporate governance.

Director of Investment Practices of the PRI, Toby Belsom stated that; “Good governance has been demonstrated to ‘make a significant incremental difference to value creation as measured by long-term risk-adjusted rates of return’. The further along the sustainability spectrum that assets are managed, the larger the governance budget required to manage those assets in a sustainable way.”

And, as the number of asset classes managed sustainably increases, a larger governance budget will need to be assigned. “There is the need for a new framework… a ‘sustainability budget’, alongside a risk budget, so that real-world outcomes might be incorporated into SAA decision-making.”

It’s also interesting to note the highlights made by S&P Global’s Kelly Tang in a study on corporate governance in ESG. She mentioned; “There is already substantial empirical evidence to suggest that the G aspect of ESG ultimately yields better corporate returns. Governance data, unlike environmental or social data, has been compiled for a longer period of time and the criteria for what comprises good governance and its classification has been more widely discussed and accepted.”

 

Conclusion

Companies will soon realise that disintegrating each element of ESG, or placing one element more important than the other, will no longer be ideal to meet future demands and expectations from stakeholders. We have widely seen companies excel in its social and environmental performance, but with limited information on how they are being anchored by a strong and responsible good corporate governance practices. In light of COVID-19, the severity of the pandemic was more related to national and global governance failures, not taking companies accountable. However good corporate governance practices of private companies is much likely to influence returns for decades.

 

All views and opinions expressed on this site are by the author and do not represent any particular entity or organisation  

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