Robust Integration Of Sustainability Into Enterprise Operations Is A Powerful Tool For Business Transformation

Rarely a day goes by without the financial news reporting on adverse reactions by businesses, investor groups, trade associations, lobbyists, think tanks and politicians around the world about requirements for commercial entities to file reports disclosing the extent to which their activities are affecting—or will affect—environmental, social and governance (ESG) matters in the national or global economic landscape.

Arguably such sentiments are now strongest in the US following the issuance by the Securities and Exchange Commission (SEC) in March and May this year of two sets of draft regulations for publicly-held corporations as well as investment funds, respectively, for mandatory disclosure of the ESG impacts of their business operations. To be sure, this phenomenon is not unique to the United States. Similar constituencies are voicing similar concerns in Canada, Europe, the UK, Australia, and many other locales.

This is hardly unexpected. After all, these parties generally have an anathema to such government requirements as much as they believe reporting on such actions (or inactions)—to the extent they are judged to undermine fulfillment of ESG objectives or run counter to ESG principles—could adversely affect the profitability of their engagements with investors, customers, suppliers, workers, business partners and other stakeholders on which they depend for their business.

From the public outcry about ESG reporting and disclosure requirements, it is fair to say that such outcomes are assumed to be predominant.

But the converse can also be true: government-required disclosures by firms whose activities are in alignment with ESG objectives and principles would presumably stand to benefit in the marketplace by investors, customers, suppliers and the like. The betting, of course, is that the probability of such a turn of events is deemed to be much lower than the opposite.

This raises two fundamental principles about the modus operandi underlying the rationale for the pursuit of government-mandated ESG reporting and disclosure requirements.

First, there is a presumption that the imposition of such requirements per se will create the necessary incentives for the sought-after changes in the ESG conduct of firms.

Of course, such changes will rarely, if ever, manifest themselves in the short-run within a modern business; indeed, they are usually complex, intricate and multifaceted undertakings. The process tends to be an evolutionary rather than a revolutionary one, particularly in large multinational enterprises, and especially those who provide multiple products or services.

But the central point is this: whatever reporting obligations are taken onboard, there is a strong belief—almost zealousness—that the mandated disclosures and the reports generated therefrom are in and of themselves agents directly propagating fundamental business transformation leading to enhanced corporate sustainability. After all, this would seem to be the raisin d’etre for requiring such disclosures.

Yet even if that train of reasoning becomes a reality, the key conclusion is that mandatory ESG reporting and disclosure simply are NOT substitutes for both embracing and actualizing sustainability in business operations. Sustainability is a market action; it is not a reporting action. In my view, within the plethora of discussions about the pursuit of mandated ESG disclosures among business associations, policy makers, regulators, standard setters, activists—and even in the business literature—this equivalence is assumed.

To be blunt, any backslapping, embracing and handshaking among ESG advocates induced from such disclosure requirements becoming the rule of the day are misplaced—no matter how good they may feel. This doesn’t mean that such requirements are not sound objectives. Indeed, they should be pursued. What it does mean, however, is that they are at their best intermediate step for sustainability practices to become integral to a business’ operations. And a lot can happen along the way to derail such an outcome being a reality.

Second, it is not out of the question to believe that in some cases, the ESG disclosure commitments required to be reported by businesses may well already prove to be in the firms’, investors, ‘workers,’ consumers’ and the society’s own best long-run commercial and social interests?

Put another way, what should be the stance of a public policy that requires ESG disclosure even in cases where businesses already undertake such reporting and disclosures voluntarily or unilaterally—that is absent the regulatory mandates—and whose operations in the market are already infused with sustainability practices?

Arguably the existence of such cases—which in some sectors are likely to be more pronounced than in others—means government regulation for mandatory ESG reporting and disclosure should not be monolithic or a one-size-fits-all. At the same time, public officials may well want to give due recognition to such instances so counterpart firms in that sector, or firms in different sectors can learn how best-practice performance of operational sustainability is executed.

It is hard to overstate this point. It should not be seen as a heroic feat—nor a naïve one—for the C-suite and the boardroom of the modern corporation to fully embrace and execute on sustainability as a core, perhaps the coreoperational mandate of the business for which they are responsible.

What does this mean in practical terms? As I have argued earlier in this space, the pursuit of corporate sustainability entails undertaking operational decisions that lie at the core of a business’s day-to-day functions that, taken togetherserve to maximize the business’s long-run growth as well as assessing them impacts on the firm’s long run performance across an array of dimensions, both financial and non-financial.

The emphasis being placed on taken together and long run is key. Firms who are most effective operating sustainably are those who invariably and consistently make their decisions so as to maximize the long-run commercial and non-economic—that is, ESG-related—returns on the use of their assets, both human and non-human.

There is a major rub here—especially in the case of the US. Our prevailing market policies, institutions and expectations are nested in “short-termism.” The SEC’s requirements for quarterly financial reporting establishes powerful incentives for myopia in business strategy and shareholder expectations. Absent a change in this arena, which many of us have called for, the inertia to overcome and adopt a long-term time horizon is both ingrained and formidable.

If one accepts these propositions, two key insights should leap out.

First, successful attainment of ESG and sustainability goals requires a fundamental understanding that ESG and sustainability are not just matters of engaging in risk-mitigation but also of pursuing growth maximization. In a word, corporate executives, board directors and, investors must think of ESG and sustainability initiatives as opening new doors of opportunities for business growth, not as constraints to abide by with as little effort as needed to fulfill them.

Second, true embrace of sustainability means that C-suites and boards carry out their missions through an integrative lens, one that cuts across a business’ principal functions; its markets, both on the input and output side; and its geographic footprint. Thus, the firm’s Chief Sustainability Officer (CSO) should be located in the C-suite and his/her role should be truly a globally integrated one—in every sense of the word: across product and input markets as well as across geographic markets. It is not too far-fetched to think of the role of the CSO as the “Integrator-in Chief.”

So, too, should be the role of boards’ Sustainability Committees, which, unfortunately, are seen as novelties in the boardroom. Indeed, we in the US are far away (actually very far away) from an SEC requirement for public company boards to have directors who are “qualified sustainability experts” akin to the SEC rule for boards to have “qualified financial experts” engendered by the Sarbanes Oxley statute coming out of the financial crisis of 2007-8. While it may seem extraordinary for US securities law to develop mandates for non-financial experts on boards, we may well soon see one for cybersecurity.

The SEC’s proposed regulations for ESG reporting and disclosure by public companies and investment funds constitute a watershed moment about the growing importance of sustainability in US businesses and markets.

But as salient a development as this is for the globe’s largest economy, it is really just the start of a long list of critical items on the sustainability agenda to be tackled by the US and other advanced countries:

· ESG reporting and disclosure are not substitutes for businesses engaging in meaningful actions to enhance the sustainability of their operations through enterprise transformation.

· At the same time, harmonization of the different sets of existing sustainability standards and reporting requirements around the world is becoming urgent.

· So, too, is the need for C-suite executives and boards of directors to fashion the systemic integration of businesses’ financial and “non-financial” metrics and performance—each of which is of equal importance to the lifeblood of the modern corporation. and the ecosystem in which it operates.

· Equally critical is the global development and education of qualified professionals who are experts in the monitoring and evaluation of businesses’ progress in enhancing sustainability, the skills for which differ markedly from conducting financial audits, which are centered on retrospective evaluations, whereas progress on achieving sustainability is both retrospective and prospective and inherently interdisciplinary.

· The need for a dispassionate forum to foster the exchange of ideas, learning from one another, and forming consensus on ways to discharge common critical tasks.