Q&A. How boards are staying on top of ESG key performance indicators
Benefits of transparency seen in how ESG parameters are being used and who uses them
AS head of Sustainable Investments Asia Pacific at DWS, Priscilla Lu has been working closely with global auditors known as the “big four” as well as portfolio companies who are looking to get listed in the next three to four years. As part of the listing requirements for these companies, it is mandatory to track and report on environmental, social, and governance (ESG) related key performance indicators (KPIs) and address various aspects that are part of disclosure requirements. Lu speaks to The Asset on how boards are complying with ESG disclosure requirements.
Q: How are the board directors responding to the stricter disclosure requirements on ESG reporting?
A: What we’re finding is really a very positive trend for governance in the company, not only by the management executive but also by the board members. It is becoming very clear that part of the board’s responsibility are to ensure that their ideas, the set of practices that will ensure that the policies are being adhered to, that there is compliance, and that the company is rigorous in tracking and monitoring the outcomes of the impact that they have with respect to various aspects of ESG.
These include emissions, resource usage, environmental and natural resource management, as well as social in terms of employment, safety, health and training, anti-corruption, and labour standards.
Q: What role do ESG KPIs play in terms of overall management?
A: Having these KPIs and these ESG aspects very clearly outlined, even though it is additional work (for the board), is something that each company has to address. But I think it's all for the best.
We’ve been doing this work for more than three years. We are working with companies that we invest in and I also sit as an adviser to the Green Finance Committee (spearheaded by the People’s Bank of China) which is instrumental in pushing CSRC (China Securities and Regulatory Commission) to basically adapt transparency and reporting for ESG.
We have been successful in terms of green bonds by providing very clear guidance for the green bond criteria issuance by the banks. We have also been successful in convincing the CSRC on the importance of transparency and disclosure of ESG.
Now we’re seeing the benefits of transparency in how these ESG parameters are being used and who uses them. From the management viewpoint these are clear indicators for how the company is doing in terms of its resource efficiency usage.
In terms of environmental impact, the KPIs have to show where there is energy usage, water usage, and waste generated. Also, these impacts to the environment are risk factors and they all contribute in how well the company is performing. That translates to profitability.
A very big part of the ESG disclosure really allows the company to have visibility to understand these factors and how they should manage those risks, whether its reputational risk because of its social impact to the community, or whether it’s environmental risk which would create issues with penalties or that would then impact the non-sustainability of their business. And so, all of that should be built when considering risk management.
Q: Why is disclosure important for risk management?
A: I think that disclosure is very much paired with the assessment of risk and how to quantify that risk in terms of how those ESG KPIs reflect the level of risk associated with exposure to these companies.
One of the things that I think is encouraging and interesting is that when we sat at the Green Finance Committee as advisors, we invited insurance companies to look at how they could look at some of the financial institutions who would look at these ESG parameters to consider the risk of lending money to a company, the cost of lending that they should actually impose in terms of interest rates because of the risk.
Insurance companies, for example, will look at it from the viewpoint of what is the likelihood that you might have significant environmental impact that could create either explosion or so much contamination that they have to incur penalties and make payment to local communities because of the contaminated waste discharges.
And so, the integration of financial institutions whether its banks, financial leasing companies, or insurance companies, is giving the consumers and users of these ESG KPIs the critical part of the positive outcomes that could result from being able to have disclosure.
From the companies viewpoint, for those who are performing well, they would actually get better financing interest rates, even better insurance rates for the insurance that they would need to cover their assets.
So, I think it behooves the company to be compliant and that they are complete in the disclosure because there is always the danger of omission, and the result is that these parameters actually play to their benefits because it will distinguish them and allow them to show how well they are doing in order to earn a better interest rate or better insurance rate. I think that for the companies it is a challenge, but also a benefit.
Q: Will the cheaper financing cost offset the cost of ESG compliance and meeting disclosure requirements?
A: I would look at it this way, there are two aspects that translate to money. One is the cost of money which is the cost of financing and the cost of insurance. The other is the cost of risk.
There are companies that are not compliant and we are working with them because my fund actually invests in green industries that are delivering systems solutions for or to mitigate solutions such as treating hazardous waste or treating basically toxic chemicals that are being discharged by industries.
And if you look at those companies, what they’re finding is that the negligent companies will find that in the longer term the community that is being impacted by the contamination will basically demand that the government take action because they’re finding that their poultry, their farm animals, their communities are getting contaminated and they’re dying.
And so, as a result the cost associated with the penalties that government will impose and that the community will impose on the company is far more significant because it could potentially shut down their business.
So, there are two aspects to cost, one is the financing, insurance policies, but more importantly, the big one is really risk cost.
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