ESG and Sustainability Insights

ESG for corporates: a strong business case for action

10 minute read time

NatWest Markets explores how a green shift in business strategy can address a majority of corporate challenges, while improving business performance and competitiveness.

An environmental focus can revive competitiveness

In 2019, at his annual Mansion House address, Bank of England governor Mark Carney said: “Firms that align their business models to the transition to a carbon-neutral world will be rewarded handsomely; those that fail to adapt will cease to exist.” While it was a stark statement, few corporate decision-makers would disagree with it in 2020.

The environmental performance (as much as the social performance) should be at the heart of every company’s strategy. Corporate decision-makers may have come to this conclusion from different angles: some will simply want to do the right thing and consider safeguarding the environment a key business responsibility. Others may approach green business conduct from a risk management angle, seeking to minimise regulatory, litigation and reputational risks. And some may be driven by the fact that delivering on the ‘E’ in ESG (environmental, social and governance) is key to achieving a higher ESG score, which in turn leads to lower costs of capital and a better share price performance.

No matter which angle you take, a green strategy can deliver on all fronts. But where do you start? The ‘question catalogues’ from ESG investors or ESG data providers and rating agencies can be helpful guides to understand what a green strategy should entail and how to assess the company through a green lens. Such questionnaires also give a very good idea about the green information today’s stakeholders expect and can help businesses to tell their green story more effectively.

Environmental factors in ESG screenings broadly fall into six areas of focus:

  • resource management
  • preventing pollution/reducing emissions and other negative climate impact
  • Seeking to avoid or minimise environmental liabilities
  • Reducing costs and increasing profitability through energy and other efficiencies
  • lowering regulatory, litigation and reputational risk
  • and delivering environmental reporting/disclosure

While company heads are often facing the dilemma of having to make strategic decisions that will affect some business areas positively but others negatively, they’ll find that creating a green sustainability strategy can in fact deliver positive outcomes for all business aspects, including those six areas listed above.

Here are just a few examples:

  • Investing in sustainability reduces compliance and reputational risks and can equally drive innovation. A recent study among 125 CEOs globally found that the majority consider reputational risks and changing customer demand the key drivers for establishing a green sustainability strategy, with regulations ‘inducing’ innovation.
  • Redesigning products to meet environmental standards presents new business opportunities by, for example, appealing to the growing number of environmentally conscious consumers. A consumer survey by Nielsen found 81% of respondents globally declared their expectation that “companies should help improve the environment”. This strong sentiment was shared equally across different generations.
  • On top of evident environmental benefits, opting for resource-efficient, waste-reducing and less energy-intensive production processes helps to reduce costs by paying less for raw material, waste management and energy. It also reduces the exposure to the sometimes extreme price volatilities of raw materials, as well as the dependency on natural resources.
  • At the same time, by helping to combat water scarcity (for example through water recycling, improving farming practices and upgrading sewage systems and desalination plants), businesses can avoid higher operating costs and shrinking margins, which they would otherwise face due to continually increasing water prices as demand outstrips supply.
  • Helping to restore biodiversity not only helps businesses to manage costs and retain high productivity levels, which are at risk with worsening soil erosion, but in fact also ensures the ongoing viability of companies that are reliant on plant and animal commodities, including genetic materials – particularly in the pharmaceuticals sector.
  • Companies who embed green (and social) factors in their corporate DNA have seen improvement in staff morale and an increase in staff productivity, with average staff turnover reducing by 25% to 50% over time, thus also considerably lowering recruitment costs.
  • New revenue sources resulting from product innovations or adaptations, as well as cost savings across the business, help improve your top and bottom line, boosting competitiveness and ESG scores, with all the resulting financial and reputational benefits.

The numbers speak for themselves: our linear economy, based on a high-emission ‘take, make, dispose’ principle, is impossible to sustain and is also not economical for businesses

With the determining factors for a successful green strategy on the table and the promise that these can help revive a business’s competitiveness, the complexity of the next step – to define and to implement environmental measures – can still seem daunting. However, help is at hand, with what many consider the most effective approach to achieving green sustainability on a macro- and micro-economic level: the circular economy concept.

The circular economy: a comprehensive green strategy

The World Economic Forum defines a circular economy “as an industrial system that is restorative or regenerative by intention and design” – an urgently needed approach considering that not only is the world’s supply of crucial raw materials limited, but demand for it has also been accelerating every year since 2000. In 2017, global material consumption reached 92.1bn tons, compared with 87bn in 2015, and up 254% from 27bn tons in 1970.

At the same time, annual waste is expected to jump to 3.4bn tons worldwide over the next 30 years, up from 2.01bn tons in 2016. Aside from accelerating the scarcity of raw material and natural resources such as water, the processes of raw material extraction and waste treatment in typical manufacturing processes account for 20% of the output of greenhouse gases.

The numbers speak for themselves: our linear economy, based on a high-emission ‘take, make, dispose’ principle, is impossible to sustain and is also not economical for businesses. Reducing the use of resources and minimising degradation and pollution throughout the whole lifecycle of products is key.

A circular economy is founded on the idea that waste doesn’t exist. Products are designed for a cycle of disassembly and reuse, which is different from recycling, where large amounts of embedded energy and labour are still wasted. Moreover, to reduce emissions, renewable energies replace fossil fuels.

On a macroeconomic level, apart from reduced raw material use and wastage, which brings its own benefits (such as healthier soil, which improves biodiversity), a circular economy can dramatically cut carbon emissions; for example by as much as 56% by 2050 in the EU’s heavy industry sector.

Companies that follow the circular economy concept distinguish between durable and consumable components to ensure disassembly and reuse: consumable components are predominantly made of biological, non-toxic ingredients while durable components are made of materials such as metals and most plastics. These are designed from the start for reuse.

One element of the circular economy concept is the ‘closed-loop system’, whereby manufacturers reuse waste or by-products within their production systems. Closed-loop systems are becoming increasingly mainstream, with businesses of any size taking to finding creative ways to reuse waste or by-products.

Notable corporate examples of closed-loop systems include Californian brewery Sierra Nevada, which turns waste generated from the brewery into compost and uses that to grow new barley and hops. And global giant Apple’s give-back programme encourages customers to return their old phones, which a special robot, Liam, disassembles so the materials can be reused. Meanwhile, Nike’s Flyknit footwear line reduces waste by 80% compared with regularly manufactured footwear, and is taking the circular economy concept one step further. Since its launch in 2012, Flyknit has fully transitioned from yarn to recycled polyester, diverting 182m bottles from landfills, cutting material costs in doing so and attracting environmentally conscious consumers, who are willing to pay a higher price for such a product – further boosting revenues.

A thriving green applications market

The booming green technology and sustainability market further proves the already strong business case for environmental action.

Applications, predominantly cloud based, that can help with carbon footprint management, smart city solutions, water purification, crop monitoring, air and water pollution monitoring and numerous other sustainability challenges are expected to boost market growth from $8.7bn (£6.8bn) in 2019 to $28.9bn by 2024.

The green technology market has also seen the rise of green algorithms: the patterns and information that can be gleaned from the analysis of huge data sets using artificial intelligence have proven valuable for solving environmental challenges for a plethora of commercial areas. Green algorithms are helping businesses and other organisations to assess the sustainability performance of supply chains, reduce energy use and calculate material efficiency in manufacturing processes.

It is unsurprising that investments in green technology companies have soared from $2.83bn in 2009 to $10.4bn in 2019, with investments in 2018 doubling compared with 2017 – and increasing by over 25% in 2019 compared with the year before. In January 2020 alone, green technology businesses attracted nearly 30 investment events, totalling over $1bn in capital.

Building a business case for hard-to-abate sectors

While the environmental case is clear, it’s certainly more difficult to immediately see the business case for hard-to-abate sectors, which include heavy industry (steel, cement and plastics) and heavy-duty transport (heavy road transport, shipping and aviation). These sectors account for a combined 10 gigatonnes of global carbon emissions.

Yet there are glimmers of hope: several initiatives and pilot trials to unlock the dependency of these sectors on fossil fuel are now in progress. A number of countries have drawn decarbonisation road maps outlining the technical issues and required large investments in infrastructure, as well as the regulatory changes that are needed to support the transition. These road maps are also helping governments to directly engage with the industries themselves to find out what they consider to be the best route forward. One option is to scale up decarbonisation technologies that already exist for steel, cement, aluminium, ammonia and plastics, but are yet to be tested at commercial scale in production facilities.

The Energy Transitions Commission (ETC) also confirmed in a recent report that it’s technically possible to decarbonise hard-to-abate sectors by 2050 for a total cost of far less than 0.5% of global GDP. In order to achieve this, the ETC proposes three lines of action:

  • limiting demand growth via the circular economy
  • improving energy efficiency
  • applying decarbonisation technologies

The report details a number of decarbonisation technologies, which include:

  • electric drivetrains in heavy road transport, with either battery or hydrogen energy storage: electric trucks are likely to become cost-competitive with diesel or petrol vehicles in the 2020s
  • electric engines that use battery or hydrogen energy storage for short-distance shipping and aviation; and bio or synthetic jet fuel for long-distance aviation as well as ammonia or biodiesels for long-distance shipping
  • biomass to produce heat, as a reduction agent in steel production, or as a feedstock in chemicals production.

By NatWest Markets