ESG Essentials for Corporates: The environmental angle #2 - The business case for corporate environmental action

04 September 2020

Other insights

View more insights

10 minute read

In the earlier articles of our ESG series we’ve touched upon how climate change already affects businesses and the global economy negatively, how climate regulation worldwide is changing the corporate landscape, but also how the transition to a low-carbon society can boost global growth.

In this article we focus in on the business level and show how a green shift in business strategy can address a large majority of this era’s corporate challenges as well as improve business performance and competitiveness – overall, making a strong business case for corporate environmental action.

Jargon buster

ESG score: The Environmental, Social & Governance (ESG) score is based on relative performance of ESG factors with the company’s sector (for E and S) and country of incorporation (for G)

GHGs: Greenhouse gases trap the sun’s heat, causing the global average temperature to rise and resulting in changes to our climate. GHGs include carbon dioxide, methane, nitrogen oxide and chlorofluorocarbons.

The E in ESG can revive competitiveness

At his annual Mansion House address, Bank of England Governor, Mark Carney, stated last year: “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, hardly any corporate decision maker would disagree with it in 2020.

The environmental performance (as much as the social performance) ought to be at the heart of every company’s strategy. Corporate decision makers may have come to this conclusion from different angles: Some will plainly 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 looking to minimise regulatory, litigation and reputational risks. And another group may be driven by the fact that delivering on the E in ESG is key to achieving a higher ESG score, which in return leads to lower costs of capital and a better share price performance.

No matter which angle, a green strategy can deliver on all fronts. However, where to start?

The ‘question catalogues’ from ESG investors or ESG data providers and rating agencies can be useful 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 stakeholders nowadays expect and can help businesses to tell their green story more effectively.

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

  • Managing resources
  • Preventing pollution/reducing emissions and other negative climate impact
  • Avoiding or minimising environmental liabilities
  • Lowering costs and increasing profitability through energy and other efficiencies
  • Reducing 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 putting together a green sustainability strategy can in fact deliver positive outcomes for all business aspects, including those six areas listed above.

These are just a few examples:

  • Investing in sustainability lowers 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 defining a green sustainability strategy[1], with regulations ‘inducing’ innovation[2].
  • Redesigning products to meet environmental standards offers new business opportunities by, for example, appealing to the growing number of environmentally conscious consumers. 81% of respondents globally voiced their expectation that “companies should help improve the environment”. The strong sentiment was shared equally across different generations[3].
  • On top of clear environmental benefits, opting for resource-efficient, waste-reducing and less energy-intensive production processes helps to cut costs by paying less for raw material, waste management and energy. It also reduces the exposure to, sometimes extreme, price volatilities of raw material as well as the dependency on natural resources.
  • Equally, 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 hence shrinking margins, they would otherwise face due to continually increasing water prices as demand outstrips supply[4].
  • Helping to restore biodiversity not only helps businesses to control costs and retain high productivity levels, which are at risk with worsening soil erosion, but in fact ensures the on-gong viability of companies reliant on plant and animal commodities including genetic materials; in particular in the pharmaceutical sector[5].
  • In addition, companies who embed green (and social) factors in their corporate DNA have seen staff morale improve and staff productivity increase[6], with average staff turnover reducing over time by 25-50%, hence also considerably lowering recruitment costs[7].
  • New revenue sources through product innovations or adaptations as well as cost savings across the business help improve top- and bottom line, boosting competitiveness and ESG scores, with all its financial and reputational benefits.

With the determining factors for a successful green strategy on the table and the promise that these can help revive the company’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 tool to achieve green sustainability on a macro- and microeconomic level: the Circular Economy concept.

The Circular Economy concept – an all-encompassing green strategy

The World Economic Forum defines a circular economy “as an industrial system that is restorative or regenerative by intention and design”[8] – an urgently required approach considering that the world's supply of crucial raw materials not only is limited, but its demand has been accelerating every year since 2000. In 2017, worldwide material consumption reached 92.1 billion tons, compared to 87 billion in 2015, and up 254% from 1970 numbers of 27 billion tons[9].

At the same time, annual waste is expected to jump to 3.4 billion tons globally over the next 30 years, up from 2.01 billion tons in 2016[10]. Apart 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 GHG output[11].

The numbers speak for themselves: our linear economy, based on a high-emission “take-make-dispose” principle, is impossible to sustain and not economical for businesses either. Reducing the use of resources and minimising degradation and pollution along the whole life cycle of products is key.

This is what a circular economy delivers: It is based 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 lost[12]. Furthermore, to reduce emissions, renewable energies replace fossil fuels.

On a macroeconomic level, apart from reduced raw material use and waste, 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[13].

Businesses that follow the circular economy concept distinguish between durable and consumable components to ensure disassembly and reuse: Consumable components are largely 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 strand of the circular economy concept is the “closed-loop system”, whereby manufacturers reuse waste or by-products within their production systems[14]. Closed-loop systems are increasingly becoming mainstream, with companies of any size taking to finding creative ways to reuse waste or by-products.

Prominent corporate examples of closed loop systems include Californian brewery Sierra Nevada, which composts waste generated from the brewery into soil and uses that soil to grow new barley and hops, and global giant Apple with its give-back programme, encourages customers to return their old phones, which a special robot, named Liam, disassembles so the materials can be reused. Meanwhile, Nike’s Flyknit footwear line, which reduces waste by 80% compared to regularly manufactured footwear, is taking the circular economy concept one step further: Since its launch in 2012, Flyknit has fully transitioned from yarn to recycled polyester, diverting 182 million bottles from landfills, cutting material costs in doing so and appealing to environmentally conscious consumers, who are willing to pay a higher price for such a product – further boosting revenues[15].

Green applications create new market

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

Applications, mostly cloud-based, that can help with carbon footprint management, smart city solutions (which we cover in more detail in one of our other articles this month), water purification, crop monitoring, air and water pollution monitoring and many other sustainability challenges, are expected to boost market growth from $8.7 billion in 2019 to $28.9 billion by 2024[16].

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 datasets using artificial intelligence have proven valuable for solving environmental challenges for a multitude of commercial areas[17]. Green algorithms are helping companies and other organisations to assess the sustainability performance of supply chains, reduce energy use and calculate material efficiency in manufacturing processes.

Unsurprisingly, investments in green technology companies have soared from $2.83 billion to $10.4 billion in 2019, with investments in 2018 doubling compared to 2017 and in 2019 increasing over 25% compared to the year before. In January 2020 alone, green technology companies attracted nearly 30 investment events, totalling over $1 billion in capital[18].

The business case for hard-to-abate sectors

While the environmental case is clear, it’s undoubtedly 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 (shipping, aviation and heavy road transport), all together accounting for 10 gigatonnes of global carbon emissions[19].

Yet, there are glimmers of hope, in fact, several initiatives and pilot trials are currently underway to unlock the dependency of these sectors on fossil fuel. A number of countries have drawn decarbonisation road maps, which outline the technical issues and the required large investments in infrastructure and 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 from them what they consider the best way forward. One option is to scale-up decarbonisation technologies that already exist for steel, cement, aluminium, ammonia and plastics, but haven’t yet been tested at commercial scale in production facilities[20].

The Energy Transitions Commission (ETC) also confirmed in a recent report that it’s technically possible to decarbonise harder-to-abate sectors by 2050 at a total cost of well less than 0,5% of global GDP. To achieve this, the ETC proposes three sets of actions:

  • Limiting demand growth via the circular economy concept
  • Improving energy efficiency
  • Applying decarbonisation technologies[21]

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

  • Electric drivetrains in heavy road transport, with energy storage either in battery or hydrogen form. Electric trucks are likely to become cost-competitive with diesel or petrol vehicles during the 2020s.
  • Electric engines using battery or hydrogen energy storage for short-distance shipping and aviation; and bio jet fuel or synthetic jet fuel for long-distance aviation as well as ammonia or biodiesels for long-distance shipping
  • Biomass for heat production, as a reduction agent in steel production, or as a feedstock in chemicals production[22].

Read the other articles in the series:

Green commitments and green legislation

Investing in a smarter and greener infrastructure part 1 – clean energy and sustainable land use

Investing in a smarter and greener infrastructure part 2 – sustainable cities

Sustainable supply chains

“Carbonomics” – the future of energy

 

Corporate clients who would like to discuss this topic further should contact:

Dr Arthur Krebbers, Head of Sustainable Finance, Corporates or

Varun Sarda, Head of ESG Advisory

 

[1] https://globescan.com/wp-content/uploads/2019/11/BSR-GlobeScan-State-of-Sustainable-BusinessSurvey-FinalReport-12Nov2019.pdf

[2]  http://www.lse.ac.uk/GranthamInstitute/wp-content/uploads/2014/11/Impacts_of_Environmental_Regulations.pdf

[3] https://www.nielsen.com/eu/en/insights/article/2018/global-consumers-seek-companies-that-care-about-environmental-issues/

[4] https://globalriskinsights.com/2016/12/economic-cost-global-water-scarcity/

[5] https://www.pwc.co.uk/assets/pdf/wef-biodiversity-and-business-risk.pdf

[6] https://www.scribd.com/document/270293194/Green-Giants-How-Smart-Companies-Turn-Sustainability-Into-Billion-Dollar-Businesses-Free-Excerpt

[7] https://hbr.org/2016/10/the-comprehensive-business-case-for-sustainability

[8] https://www.weforum.org/projects/circular-economy

[9]https://wedocs.unep.org/bitstream/handle/20.500.11822/25764/SDG12_Brief.pdf?sequence=1&isAllowed=y

[10] https://www.worldbank.org/en/news/infographic/2018/09/20/what-a-waste-20-a-global-snapshot-of-solid-waste-management-to-2050

[11] https://ourworldindata.org/co2-and-other-greenhouse-gas-emissions

[12] https://mcdonough.com/cradle-to-cradle

[13] https://www.climate-kic.org/insights/transforming-to-net-zero-emission-economies-circular-business-models-for-systems-innovation/

[14] https://www.pwc.com/hu/en/kiadvanyok/assets/pdf/Closing-the-loop-the-circular-economy.pdf

[15] https://www.scribd.com/document/270293194/Green-Giants-How-Smart-Companies-Turn-Sustainability-Into-Billion-Dollar-Businesses-Free-Excerpt

[16] https://www.businesswire.com/news/home/20190924005777/en/Analysis-28.9-Billion-Green-Technology-Sustainability-Market

[17] https://www.openglobalrights.org/the-new-green-business-and-the-responsible-use-of-algorithms/

[18] https://equalocean.com/analysis/2020020113486

[19] https://www.iea.org/reports/energy-technology-perspectives-2017

[20] https://www.wri.org/climate/expert-perspective/unlocking-hard-abate-sectors

[21] http://www.energy-transitions.org/sites/default/files/ETC_MissionPossible_FullReport.pdf

[22] http://www.energy-transitions.org/sites/default/files/ETC_MissionPossible_ReportSummary_English.pdf

 

ESG/Sustainability


This article has been prepared for information purposes only, does not constitute an analysis of all potentially material issues and is subject to change at any time without prior notice. NatWest Markets does not undertake to update you of such changes.  It is indicative only and is not binding. Other than as indicated, this article has been prepared on the basis of publicly available information believed to be reliable but no representation, warranty, undertaking or assurance of any kind, express or implied, is made as to the adequacy, accuracy, completeness or reasonableness of the information contained in this article, nor does NatWest Markets accept any obligation to any recipient to update or correct any information contained herein. Views expressed herein are not intended to be and should not be viewed as advice or as a personal recommendation. The views expressed herein may not be objective or independent of the interests of the authors or other NatWest Markets trading desks, who may be active participants in the markets, investments or strategies referred to in this article. NatWest Markets will not act and has not acted as your legal, tax, regulatory, accounting or investment adviser; nor does NatWest Markets owe any fiduciary duties to you in connection with this, and/or any related transaction and no reliance may be placed on NatWest Markets for investment advice or recommendations of any sort. You should make your own independent evaluation of the relevance and adequacy of the information contained in this article and any issues that are of concern to you.

This article does not constitute an offer to buy or sell, or a solicitation of an offer to buy or sell any investment, nor does it constitute an offer to provide any products or services that are capable of acceptance to form a contract. NatWest Markets and each of its respective affiliates accepts no liability whatsoever for any direct, indirect or consequential losses (in contract, tort or otherwise) arising from the use of this material or reliance on the information contained herein. However this shall not restrict, exclude or limit any duty or liability to any person under any applicable laws or regulations of any jurisdiction which may not be lawfully disclaimed.

NatWest Markets Plc. Incorporated and registered in Scotland No. 90312 with limited liability. Registered Office: 36 St Andrew Square, Edinburgh EH2 2YB. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and Prudential Regulation Authority. NatWest Markets N.V. is incorporated with limited liability in the Netherlands, authorised and regulated by De Nederlandsche Bank and the Autoriteit Financiële Markten. It has its seat at Amsterdam, the Netherlands, and is registered in the Commercial Register under number 33002587. Registered Office: Claude Debussylaan 94, Amsterdam, the Netherlands. Branch Reg No. in England BR001029. NatWest Markets Plc is, in certain jurisdictions, an authorised agent of NatWest Markets N.V. and NatWest Markets N.V. is, in certain jurisdictions, an authorised agent of NatWest Markets Plc. NatWest Markets Securities Japan Limited [Kanto Financial Bureau (Kin-sho) No. 202] is authorised and regulated by the Japan Financial Services Agency. Securities business in the United States is conducted through NatWest Markets Securities Inc., a FINRA registered broker-dealer (http://www.finra.org), a SIPC member (www.sipc.org) and a wholly owned indirect subsidiary of NatWest Markets Plc.

Copyright 2020 © NatWest Markets Plc. All rights reserved.