COVER STORY: Sustainability as a driver of business transformation

Sustainability is a key driver of transformation for business as organisations understand the risks associated with a changing environment, say investment and risk leaders interviewed by Digital Nation Australia.

While shareholders are demanding that businesses engage in environmental, social and governance (ESG) practices and investor dollars are flowing into responsible investment portfolios, businesses are learning that sustainability is no longer a box-ticking exercise.

According to Mary Delahunty, head of impact at industry super fund HESTA, businesses are rapidly transforming as they begin to understand both the business risks associated with climate change, as well as the opportunities that exist in embedding sustainability into the core business strategy.

What is sustainability?

While the concept of sustainability hasn’t always referenced the environment, it has always been used to describe long-term performance.

“We use that term sustainability, but we use it quite broadly,” says Delahunty.

“Before we knew about climate change, what it meant was does this have long-term staying power? And it still really does mean that at some level, but what we now associate sustainability with is an understanding of whether or not that company and the business practices or the areas that they're stretching in to respond to a changing climate, and can help us to arrest that particular trend.”

For companies that are cognisant of delivering long-term value to stakeholders, Delahunty says that sustainability enables for this in a transitioning world.

“Sustainability is a good bet, really, in a company because it speaks to the way they are able to adapt and change to a world that we foresee coming within our investment horizon.”

According to Desiree Lucchese, head of ethics and impact at ethical investment fund U Ethical, sustainability traditionally accounted for incremental improvements on efficiencies for things like materials management and packaging. These days, she says, sustainability has a much broader lens.

“What is now sustainable is really reaching a much broader framework, which is keeping our investments within a climate safe and socially just world,” says Lucchese.

This intrinsically long-term outlook can be a driver of growth and business performance as well as a driver of value creation for businesses.

According to Victoria Whitaker, partner in risk advisory at Deloitte, sustainability can drive value creation across multiple lenses.

“I think sustainability when thought deeply by organisations is really an opportunity to create value by having a broader lens and broader understanding of the relationship your business has with society and environment,” says Whitaker.

Whitaker names operational efficiency, risk management – both from a physical and reputational standpoint – attracting and retaining talent, as well as innovation as the key ways that sustainability drives value creation for business.

“When you start thinking through these lenses, you have the opportunity to think about ways in which you can develop products differently in which you can access markets differently, in which you can look at different types of business models to help generate capital, and we're starting to see that come through.”

Responsible Investment

The United Nations Principals for Responsible Investment names client demand, materiality and regulation as drivers of growth in the responsible investment market.

According to Lucchese, “We have seen not a seismic, but an epochal shift into ESG and green strategies and ESG ETFs. So we've seen a significant flow of capital into new products.”

Lucchese claims that since May of this year global bank loans into companies with an ESG target have increased by 292 per cent, with $52 billion allocated in this space.

“It tells us that we are prepared as a society and as investors to invest in the transition that we need to continue to deliver on social and environmental outcomes, because the world is changing fast and we need to adapt with it,” she says.

“We are starting to realise that it is a risk mitigation, there is a link to good yield over time, and it's just smart business, enabling your portfolio companies or credit recipients to really transition their businesses to lower… risk exposure, and ensure long term sustainability of their operations.”

According to Whitaker, the dominant number of shareholder questions at annual general meetings refer to issues around climate change and diversity and inclusion. Executives are being forced to respond to these questions from their investors and be transparent on their stance on these issues.

“[Companies] are responding to their investors when they're asking about those questions, looking at how they can have further transparency on those things or whether they are as aware as what they need to be to retain that investment dollar of those issues that they're facing into. So I only see it getting bigger and bigger, going forward. And it's not just in investment, either. It's also in the provision of capital,” says Whitaker.

Active ownership

Delahunty describes shareholder action at AGMs as “really sharp”, and outlines how active ownership can reduce this sharpness.

“Active ownership, I think needs to come out from behind the curtain that it's been conducted behind for far too long, in order to give the members of funds the transparency to understand what it is that funds are asking their companies, but also to make sure that we're lifting the system,” says Delahunty.

By actively engaging with companies, and asking questions on behalf of members to deeply understand their sustainability commitments, metrics and targets, Delahunty argues that more transparency can be provided to shareholders, as well as generating genuine transformation.

“If you want to truly change a system, you don't just do it company by company, you might make an example with one company, but actually to make changes to make genuine authentic changes across a system, we sort of need be a little bit more transparent in our active ownership activities.”

Corporate PPAs

One method for businesses to meet their sustainability commitments, and reduce their carbon emissions is through corporate Power Purchase Agreements (PPAs).

According to Aylin Cunsolo, partner in energy and resources at Baker McKenzie, there are a number of benefits for businesses in entering into a PPA, with the two major ones being sustainability outcomes and economic benefits.

“[A PPA] can allow a business to meet their sustainability objectives to reduce their emissions associated with their electricity use,” says Cunsolo.

Traditional PPAs include directly procuring renewable energy. But there are other synthetic types of PPA’s says Cunsolo, which act as a financial instrument, or a hedge. Both methods she considers effective instruments for businesses to improve their sustainable business practices.

“By entering into a PPA with a wind or solar farm, that allows that wind or solar farm to get financed, and therefore constructed, because it's providing fixed revenue certainty, over a long period of time. So in that way, the business can be seen to be supporting new renewable energy projects, and thereby effectively reducing emissions associated with electricity in the in the grid.”

Sustainability KPIs

For businesses that have embedded sustainability into the company’s strategic objectives, key performance indicators can ensure executive accountability.

According to Whitaker, “For most organisations, they've definitely got KPIs around risk management, whether sustainability is listed out as a separate one would only be I think, in the companies for whom sustainability is a deep part of their strategy, that we would see that.”

While not all business are classifying sustainability in this way, she says that the expectation is increasing on executives to uphold an organisation’s purpose and values, whereby sustainability is often a contributor.

“I think corporations, given their higher power status within society is kind of larger individuals have a different type of responsibility to think about the harm that they cause and their role in solving some of these sort of wicked issues that we have as a society,” says Whitaker.

It’s not just a moral obligation, however. Whitaker cautions that businesses who are not considering the sustainability risks on their businesses now, will struggle as regulation is set to tighten.

“There are some businesses out there for whom if they don't act in the next three to five years on issues of climate change, probably even less than that, they will not exist as a business going forward. Such is the threat of climate change that if they don't iron it out, they won't necessarily be impacted physically, but the level of regulation that's coming into play means that the transition risk … becomes so high that they won't actually have a role to play going forward.”