As a sustainability professional who has been working in a developing country for over 20 years, what has ever been at stake was a solution to the reality before my eyes: how to incorporate the socioenvironmental variable within decision-making, be it for business or investment strategies.
The socioenvironmental variable is an indicator subject to variations that encompass natural capital, negative environmental externalities, climate and social matters (human rights, labor rules, consumer rules, health and safety rules, diversity, equity and inclusion best practices) and that should be part of macro and microeconomic analysis.
It was crystal clear to me that decisions disregarding the socioenvironmental variable could work perfectly for short term results, leaving the bottom line as shiny as it could, but they could as well jeopardize the survival of the business itself or kill the return of the investment if medium and long terms were taken into consideration. Disregarding such variables ranged from non-compliance (i.e., violations, damages and even crimes) to losing opportunities.
Assessing the different projects, economic segments, size of businesses, corporate governance maturity and even the culture from the geography of origin, I realized the risk perspective would hardly be an effective approach. Be it compliance risks, be it strategic, operational or communication risks within the best practice framework for integrated enterprise risk management, neither each of them alone, nor all combined could they be strong or pedagogic enough to bring the socioenvironmental variable, sustainability itself, to the table.
This context of doing business made me wonder and search for triggers that could unveil how and why the decision-making process should be enriched with the socioenvironmental variable, adding sustainability to the directives of businesses and investments towards the economic transition to low carbon, bio and circular systems. Have no doubt, financial returns are and will continue to be of the essence, sustainability is to be added to such an equation, enhancing numbers, and reducing risks, in a win-win game.
Flow of capital. The most effective trigger I could put together during all these years of work. Once the flow of capital is channeled to businesses or investments guided by the socioenvironmental variable, the market is educated on how to best conduct businesses and qualify for investments. Here are some practical thoughts on the flow of capital triggers.
Sustainable Finance: the credit trigger
Financial institutions have the power to induce, or not, the incorporation of the socioenvironmental variable by their clients, i.e., the whole market:
- Businesses in compliance with environmental and social (human rights, labor, health and safety, consumer) rules and those willing to implement related best practices could be entitled to lower interest rates and/or extended terms. It would work as a premium to best-in-class businesses;
- Businesses willing to reach compliance could be subject to the so-called “transition finance” and receive special conditions to ensure their goal is achieved;
- Businesses in severe non-compliance and/or not willing to correct inconsistencies would not qualify and could be excluded from accessing credit. It would work as a sanction for worst-in-class businesses.
When the flow of capital tells the market that compliance and best practices lead to premiums and that those intending to reach compliance and implement best practices have special means to do so, while non-compliant businesses are excluded from the circle, a powerful trigger is in place.
Although I heard a dozen times during my career that banks were not related to environmental matters, that such due diligence was inconvenient or that there were already lower rates in the ordinary risk assessment system (despite the fact that since 2003 I had published 2 books and articles stating the opposite), I knew my theory was correctly grounded and feasible in practice. Currently, the so-called “sustainability linked loans” materialize this trigger.
In Brazil, the Central Bank published a set of socioenvironmental rules in September 2021 demanding financial institutions to update their prudential risk management systems by incorporating the socioenvironmental variable, with distinguished obligations regarding climate risks. In addition, the rules demand financial institutions to publish a socioenvironmental and climate policy and to yearly report on related risks and opportunities. The interesting factor is that some obligations will cascade to clients from financial institutions, because the latter can only report on risks and opportunities from its operations if its clients supply the correct data.
Sustainable Investment: the equity trigger
Investors also have the power to induce, or not, the incorporation of the socioenvironmental variable according to their decisions on which businesses do qualify to receive capital. If socioenvironmental matters were out of investors screening in the past, this is not the case anymore. Investors are getting educated on respective risks and opportunities and are more and more demanding businesses to update strategies and operating models so that these new directives are duly incorporated, ensuring survival in the long run and financial returns.
From the 2021 annual letter from Larry Fink, CEO from BlackRock, revealing that portfolios would be requested to present climate transition plans, from a risk/opportunity perspective, to the Reenergize Exxon movement led by Engine No. 1 that resulted in 3 new board members at once to ensure energy transition was included in business strategy, or to The Institutional Investors Group on Climate Change from Europe requesting the portfolio to disclose net-zero plans together with identifying the directors responsible and providing a routine advisory vote to ensure its implementation, investors are all over the socioenvironmental variable, being climate in their first tier.
Investors are even refining pressure techniques aiming at businesses to incorporate the socioenvironmental variable:
- Investors pressuring Boards: Client Earth, a minority shareholder of Shell, took legal action against the Board due to alleged mismanagement of climate risk;
- Dutch investors threatened to oppose oil and gas sector executives’ pay plans: if companies failed to set climate change goals aligned with the Paris Agreement;
- Rio Tinto investors voted against financial statements in climate protest: due to a lack of clarity about climate change risks, questioning the external auditor’s capability and the performance of the company’s audit committee.
While financial institutions and investors have a better risk/opportunity snapshot once the socioenvironmental variable is incorporated in their decision-making processes, benefiting their own businesses, they also induce their clients and portfolio to learn about environmental, climate and social matters relevant to their operations and implement them, enhancing compliance, reducing risks, and paving the way to innovative solutions. The flow of capital is, for sure, a major sustainability trigger.
Businesses whose decision-making processes are enriched with the socioenvironmental variable are already having access to more qualified, resilient, and long-term capital at lower costs, having greater chances to lead the transition to low carbon, bio, and circular economy. Thus, they are achieving better financial results than those who will be led.
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Ana Luci Grizzi is a sustainability expert, consultant, and lecturer. She is member of several ESG Commissions in Brazil - Abrasca, Ibrademp, CFA Society and IBGC and she is the Director of the ESG Advanced Program from Saint Paul Business School.