The 'E' in an ESG strategy: Why it matters and what it means for businesses

The ‘E’ in an ESG strategy: Why it matters and what it means for businesses

As regulatory pressures, consumer preferences, and environmental challenges intensify, businesses that place the ‘E’ at the heart of their ESG strategy will be better equipped to thrive in a sustainable and responsible future. Lauren Hyatt Senior Consultant

Beyond the Acronym: What is the ‘E’ in an ESG Strategy

The ‘E’ within an ESG (Environmental, Social and Governance) strategy represents the natural environment and is arguably one of the most important pillars. This ‘E’ encompasses all elements of the physical world not created by humans, such as landforms, climate, ecosystems, air, water and soil. Businesses rely on the natural environment and the ecosystem services it provides for their business to operate.¹ Ecosystem services can often feel invisible; however, they range from culturally valued landscapes, clean air and filtered water, timber and food. Ecosystem services generate $44 trillion of economic value (over half the world’s GDP).² In this context, it is vital to both preserve and actively restore the natural environment.

Ecosystems are under threat due to human activity and indirect drivers such as climate change. As nature loses its capacity to provide services and is continually degraded, the impacts on business operations and the global economy will be unfathomable. The World Economic Forum’s Global Risks Report analyses global risks by severity over the short and long term. The 2023 report emphasises environmental risks such as natural disasters and extreme weather, failure to mitigate climate change, biodiversity loss and natural resource crisis.³ The construction, agriculture, food and beverage industries are the three largest industries highly dependent on nature and its services. The impact of excluding the environment from their ESG strategies and decision-making threatens their ability to operate effectively.

The ‘E’ as a critical driver of stakeholder satisfaction and success

By embracing the ‘E’ in business practices, companies can make meaningful contributions towards reducing environmental degradation while safeguarding themselves against financial risks and leveraging opportunities. Its win win. Driving environmental considerations within an ESG strategy also reflects a commitment to shared values and stakeholder expectations. Today’s consumers, investors and governments are increasingly conscious of environmental issues and expect businesses to do their part.

For investors, ESG ratings have also become a crucial aspect of investment decisions. Platforms such as Sustainalytics, MSCI and FTSE ESG assess companies globally on their ESG performance and make this data available to their clients. These ESG ratings are designed to help investors identify and understand financially material ESG risks to a business. Companies are evaluated based on publicly available information such as annual reports and earning results, with scores for each material ‘E’, ‘S’ and ‘G’ topic, alongside an overall score.⁴ Investors use these unique scores as a proxy of ESG performance and a way to compare like for like.

Companies that score well on ESG metrics anticipate future risks and opportunities better, are more disposed to longer-term strategic thinking, and focus on long-term value creation. In this vein, stakeholders are more inclined to support businesses that demonstrate responsible environmental practices, creating a competitive advantage for eco-conscious companies.

For governments, they all have duties under international law to safeguard the environment for future generations. To this end, governments worldwide are tightening environmental regulations to address the growing environmental challenges we are facing. With this comes a plethora of reporting requirements for businesses, which are used not just by investors but also by consumers. In Europe, a notable development in this regard is the European Union’s Corporate Sustainability Reporting Directive (EU CSRD). The EU CSRD requires businesses to report on their environmental and social impact.⁵ By focusing on the ‘E’ in an ESG strategy and prioritising environmental responsibility, businesses operating in the EU can position themselves to comply with the EU CSRD’s stringent reporting requirements effectively. The UK is following a similar trajectory and will implement Sustainability Disclosure Standards (SDS) in July 2024.⁶

Putting the ‘E’ into Action

The initial step in safeguarding the natural environment is to identify the pertinent ‘E’ topics influenced by a business. This entails conducting a materiality assessment to gauge the financial consequences of environmental issues and the extent of a business’s impact on them. Depending on the assessment’s findings, the company can then formulate appropriate action plans. It’s worth emphasising that these ‘E’ topics can serve as the cornerstone for implementing frameworks designed to discern, quantify, and address environmental-related risks. Below are the three most prevalent ‘E’ topics that businesses can incorporate into their ESG strategy and convey progress.

1. Acting on climate change

The urgency of addressing climate change cannot be overstated. The 2023 synthesis report from the Intergovernmental Panel on Climate Change (IPCC) warns of dire consequences if global temperatures continue to rise.⁷ Businesses that incorporate climate and carbon elements within their ESG strategy can align themselves with international climate targets, contribute to reducing carbon emissions, and mitigate risks. More importantly, focusing efforts on climate change can encourage businesses to understand and report their climate-related risks as well as opportunities. The Task Force on Climate-related Financial Disclosures (TCFD) plays a crucial role in enhancing the sustainability and resilience of businesses in the face of climate change while also encouraging businesses to disclose physical and transition risks related to climate change. These risks can disrupt supply chains, impact operational continuity, and increase costs. Integrating environmental considerations into risk management strategies is crucial for building resilience. Investors want to know that businesses are preparing for the future now.

2. Protecting and restoring biodiversity

Businesses that incorporate biodiversity conservation into their ESG strategy align themselves with the International Biodiversity Framework 30% by 2030 target, support the protection of ecosystems, and mitigate risks associated with biodiversity loss.⁸ By prioritising biodiversity, businesses can contribute to sustaining ecosystem services and reduce the negative impacts of ecosystem degradation. Moreover, focusing on biodiversity can encourage businesses to understand and report their nature-related dependencies, risks and opportunities, much like climate change reporting through initiatives such as the Task Force on Nature-related Financial Disclosures (TNFD). TNFD provides a framework for businesses to assess and disclose their nature-related risks, offering a standardised approach to understanding the financial implications of biodiversity loss.⁹

3. Managing water and waste

Half of the world’s population could be living in areas facing water scarcity by as early as 2025; this will place considerable pressure on the stability of the world economy.¹⁰ This poses substantial financial risks for businesses, but it also presents notable opportunities. Taking proactive steps to address water-related challenges can lead to developing innovative business models, products, and services with potential for future commercial value. Businesses can begin by conducting a comprehensive assessment of water consumption across operations. This involves tracking usage, identifying inefficiencies, and implementing measures to reduce water consumption. This should be complemented with transparent reporting to showcase a dedication to better water management. This involves not only sharing reduction targets and progress but also revealing the strategies used and their positive outcomes. The Carbon Disclosure Project (CDP) is a prominent platform for water reporting, assisting companies globally in disclosing and addressing water-related risks and opportunities.¹¹

By 2050, worldwide municipal solid waste generation is expected to have increased by roughly 70 per cent to 3.4 billion metric tons up from 2.01 billion tonnes in 2016.¹² This is due to several factors, such as population growth and continued urbanisation, as well as consumer shopping habits. Plastic waste is currently of particular concern and governments worldwide are seeking solutions to tackle the crisis. For businesses, waste management should be considered as equally important as water management. Companies can support global reduction targets by conducting comprehensive assessments of waste generation across their operations and like water sharing, better understand and identify targets and report progress.

The ‘E’ is a blueprint for future success

In a world grappling with environmental challenges, businesses cannot afford to overlook the ‘E’ within their ESG strategy. An unwavering commitment to environmental responsibility is not only a moral obligation but also a strategic necessity for long-term success. By addressing the ‘E’ pillar, businesses can reduce their carbon footprint, conserve resources, mitigate risks, and position themselves for growth and innovation. In doing so, they contribute to a more sustainable and resilient future for themselves and the planet. As regulatory pressures, consumer preferences, and environmental challenges intensify, businesses that place the ‘E’ at the heart of their ESG strategy will be better equipped to thrive in a sustainable and responsible future.

Author: Lauren Hyatt, Senior Consultant, Simply Sustainable

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