Transforming through an integrated ESG strategy
Climate action is today’s business imperative
Climate change is one of the defining issues of our time. It is also an innovation opportunity to create long-term financial, customer, human and societal value for all stakeholders.
According to the United Nations, shifting to a green economy could yield a direct economic gain of US$26 trillion through 2030 compared with business as usual. In Asean, green growth opportunities will require more than US$172 billion worth of capital expenditure and could create 30 million jobs by 2030. Ironically, only a small number of businesses are well positioned today to reap the benefits of the climate transition that is already under way.
Moreover, environmental, social and governance (ESG) criteria have gained such urgency that businesses that have not adopted a strategic response are vulnerable to controversy and litigation and will face challenges in getting funding. As EY’s Global Institutional Investor Survey 2021 reveals, 78% of investors state that they conduct structured and methodical evaluation of non-financial disclosures. Guidance from Bank Negara Malaysia through its Climate Change and Principle-based Taxonomy (CCPT) and Value-based Intermediation Financing and Investment Impact Assessment Framework (VBIAF) has also prompted financial institutions to enhance their ESG risk management and screening processes while increasing sustainable finance opportunities.
Simply put, the rapid acceleration of climate change has made it imperative for companies to urgently transform into businesses that have a foundation in sustainability. The global transition to a low-carbon economy is a prime example of this disruption.
“In the long history of the corporate world, there has never been a time when business survival is so closely tied to the sustainability of our environment and planet. The urgency and necessity of transforming profit-oriented business models to those that are centred on sustainability and long-term value creation go beyond simply achieving any immediate corporate objective. They are to build a sustainable and resilient future for all stakeholders for generations to come,” says Dato‘ Abdul Rauf Rashid, EY Asean Assurance Leader and Malaysia Managing Partner.
The 12th Malaysia Plan (12MP), tabled in parliament, has laid out the roadmap for changes that must take place to make the country carbon-neutral by 2050 and achieve sustainable growth.
To promote the greening of the economy, the 12MP outlines measures in four pillars, offering growth opportunities for sustainability-focused businesses. These include the reduction of greenhouse gas emissions and a feasibility study on carbon pricing. Firms that are poised to install renewable energy (RE) will benefit from the government’s target of achieving 31% RE by 2025. Likewise, the 12MP’s aim of having 120 cities achieve sustainable city status will spur growth in the sector. The green economy will involve the rollout of the Low Carbon Mobility Blueprint, mandatory adoption of National Green Standards, Government Green Procurement, and more.
Similarly, a raft of programmes covering the circular economy that were presented in the 12MP will drive economic opportunities in sustainability. These involve waste management, water management, business design and processes and others like remanufacturing, green financing and research and development.
“Companies that embrace sustainable business operations and move towards an inclusive business model are best positioned to flourish and scale for growth. By engaging effectively on ESG, companies will attract talent, customers, business partners, investors and financiers who value transparency and sustainable innovations,” says Arina Kok, EY Malaysia Climate Change and Sustainability Services Partner.
However, advancing ESG requires a deeper understanding of the stakeholders’ needs and the impact of the businesses’ footprints. As EY’s survey of the top 100 Malaysia’s public-listed companies (PLCs) found, climate change is acknowledged by corporations but not yet adequately addressed. Malaysia is in the nascent stage of climate risk reporting. Benchmarked against the recommendations of the global Taskforce on Climate-related Financial Disclosures (TCFD), most PLCs in the Malaysian survey have opportunities to further improve their climate risk disclosures, given their overall coverage score of 34% and quality score of only 12%.
Companies need to consider stepping up in several key areas, which include identifying climate risks and seizing new opportunities; setting and embedding resilient ESG strategies; and communicating the climate change risk strategy to stakeholders, customers and communities.
“The recent establishment of the International Sustainability Standards Board (ISSB) at the 2021 United Nations Climate Change Conference (COP26) in Glasgow to drive one common sustainability reporting language is a major step towards achieving relevant, decision-useful sustainability information for market participants that is comparable across industries and jurisdictions. Ultimately, all businesses will be impacted by these standards that are being converged and aligned,” says Arina.
Staying relevant and driving value
The currency of this new marketplace is sustainability-led business propositions. To shift to this mode, businesses need to integrate sustainability into their supply chain networks. This can be achieved by leveraging disruptive technologies and digitalisation.
The results are clear. Sustainable companies outperform their industry peers on key profitability metrics. In an EY study, companies aligned to sustainability goals recorded higher earnings before interest, taxes, depreciation and amortisation (Ebitda) and net profits than their peers for 73% and 61% of the industries analysed.
“EY research shows that investments in sustainable supply chains can add 12% to 23% to value chain revenue,” says Adrian Chew, EY Asean Data and Analytics Leader.
“This demonstrates that ESG performance data needs to be measured, analysed and reported to demonstrate value creation, and leveraged with the help of technology,” he adds.
To ensure that corporate stewards give due weight to their fiduciary duties in this regard, more companies have also started linking their sustainability performance, targets and goals to their board and management’s performance and remuneration.
Rebuilding the entire economy
Admittedly, legacy business thinking is keeping most firms tied up in the status quo. Nevertheless, first movers in the banking and capital markets, real estate, plantation as well as energy sectors are already future-proofing their business models and leading value chain transformation.
Make no mistake — Malaysia’s commitment to achieve the status of a carbon-neutral nation by 2050 will inevitably disrupt business models, business operations and ultimately the entire economy. The country will need all of its talent to pivot towards the green economy by strategically allocating resources in critical growth sectors, with an emphasis on the skills of tomorrow, focusing on data science, development operations and sustainable food systems. Tax incentives for the electric vehicle industry and the Low Carbon Transition Facility for micro, small and medium enterprises (MSMEs) will further support businesses to pivot their business model and build resilience.
To drive businesses towards sustainability, investors, financiers and bankers are increasingly putting their money in funds that include ESG criteria in their decision-making. Malaysia’s oversubscribed US$1.3 billion sustainability sukuk issuance in April 2021 is a clear signal to the market of the growing demand to consider sustainable finance to run businesses.
Sustainable finance is key to empower the transformation towards greening the economy. In Malaysia, the launch of the Sustainable and Responsible Investment Sukuk Framework in 2014 marked a watershed moment in the growth of this sector.
“We see the broader community of business leaders, investors and customers in the region already mainstreaming ESG management across their value chain as an imperative strategy to maintain the social licence to operate, regardless of sector or industry. A critical turning point lies in putting ESG at the heart of decision-making while building an ESG-driven culture,” Arina concludes.
Taking values-based action for sustainability
Inclusive business model. Long-term value creation. Collaboration for transformation.
Addressing climate change and creating a sustainable future are catalysing the organisational transformation needed to unlock new opportunities and meet some of the world’s greatest challenges.
The world’s scientists have unequivocally warned that the narrow window of opportunity to limit global warming to below 1.5°C of pre-industrialisation levels is fast closing. There are worsening scenarios with every increasing fraction of a degree in global warming and the impacts on Malaysia include changes in rain patterns, rising sea levels and related coastal flooding, and extreme weather events that are threatening communities, livelihoods, food security and businesses across the country.
More than ever, climate change needs business action
While adapting to climate change is inevitable, the world needs to effectively mitigate risks by reducing greenhouse gas emissions. Collectively, the business ecosystem has the financial resources, technological capabilities and innovative capacity needed to find solutions for a low-carbon future and avoid irreversible damage to our planet. To drive this, businesses have to adopt environmental, social and governance (ESG) principles, undergo a cultural change and integrate long-term value conversations throughout their value chains, as they reframe their business strategies for post-pandemic recovery. (See Diagram 1)
At EY, we focus on the key drivers to integrate ESG in every aspect of building a sustainable business that creates long-term value:
- Today, societies demand greater responsibility from the organisations they work for, buy from and invest in. Organisations that anchor their strategies to a meaningful purpose, with a focus on creating long-term, sustainable impact across stakeholders, are best positioned to benefit from, demonstrate and measure the value they create.
- Having a comprehensive understanding of the risks and opportunities related to the sustainability transition is key for organisations to accurately assess potential impacts, including the impact on strategy (both positively and negatively). This also presents a huge opportunity for businesses to identify and innovate in transition-crucial technologies.
- Building a strategy for the long-term calls for strategies and capabilities to be developed for future market demands and to deliver long-term value to all stakeholders. This is important to determine how climate and sustainability goals will impact the business model, operations and services provided to consumers.
- Carbon pricing impacts — including carbon tax — is a significant consideration, in light of recent international developments such as the announcement of the EU Carbon Border Adjustment Mechanism (CBAM) and Malaysia’s own commitment to achieve carbon neutrality by 2050, as outlined in the 12th Malaysia Plan.
- Creating a tangible business case with a holistic view of value that can be easily communicated to stakeholders including investors, key partners and suppliers is important. Capital allocation decisions should be broadened to include non-financial value and impacts. In the EY Global Institutional Investor Survey 2021, 90% of investors surveyed say they now attach greater importance to ESG performance in their decision-making than they did before the Covid-19 pandemic; and 92% say they have made decisions over the past 12 months based on the potential benefits of a “green recovery”.
- Financing the transition would be a strategic enabler for businesses to pivot towards a greener and fit-for-purpose model. Two questions in this regard are: “How should climate and sustainability risks be understood and priced?” and “What are the commercial opportunities to finance, invest and insure climate and sustainability risk?”. The rapidly evolving global landscape, including changes to environmental laws, increasing activism and, at the same time, opportunities to catalyse growth, such as the US$100 billion pledge at the 26th UN Climate Change Conference of the Parties (COP26) for public and private capital for clean energy infrastructure in developing countries, need to be considered.
- Integrating the sustainability ambition with the product, channel and customer strategy will be critical for a successful business transition. This ranges from enhancing supply chain transparency, assessing material sustainability risks and setting clear ESG standards for suppliers to adopting disruptive technologies such as blockchain, artificial intelligence (AI) and the Internet of Things (IoT), and embedding sustainability into employee decisions and actions.
- Reporting impact and progress towards sustainability targets will enhance long-term value creation for companies. To begin the journey to sustainability reporting, businesses can assess their current position in relation to their market, the regulatory requirements and industry benchmarks. Businesses will also need to navigate and prepare for emerging sustainability reporting mandates.
- As more reliance is placed on ESG data, organisations can look to the role of internal and external audits, certification and supply chain audits to ensure that non-financial indicators are reliable and can inspire confidence.
Advancing sustainability through collaboration
The involvement of the broader community of business leaders, financial institutions and investors to drive a conducive and sustainable ecosystem requires public-private collaboration, effective funding and continuous learning.
Many businesses are preparing for future sustainability disclosures and committing to transparency and accountability before they are mandated. Now is the time for businesses and their leaders to collaborate with governments, regulators, standard setters and NGOs to achieve consistent standards and contribute to this critical process that will help define corporate reporting and accountability for the next generation. (See Diagram 2)
Leading transformative change
At EY, in line with our purpose of building a better working world, we believe we have a responsibility and vital role to play in leading transformative change to build a sustainable economy, and we realise that these challenges are different and more difficult for certain industries. We are investing in ESG-related capabilities globally as well as in Malaysia to drive effective strategies and deliver measurable value for our clients, our people and society. Our experience stems from the EY global achievement of carbon neutrality in 2020 and carbon negative status in 2021, and our continued focus on reducing absolute emissions, in line with a science-based target to achieve our aim to be net zero by 2025.
By leveraging our global experience, EY helps build local-enabled approaches, and implement and report on global enterprise-wide strategies that address climate action and sustainability.
We collaborate with stakeholders like Sustainability 30 (S30), World Economic Forum, COP26, United Nations Global Compact, World Business Council for Sustainable Development, and Race to Zero campaign to drive change, shape policies and regulations, and find new answers to build a better working world. EY also supported the Institute of International Finance and the United Nations Environment Programme Finance Initiative in producing the Task Force on Climate-related Financial Disclosures report playbook to help guide firms on making consistent climate-related disclosures.
In Malaysia, we have assisted the Joint Committee on Climate Change (JC3), led by Bank Negara Malaysia and the Securities Commission Malaysia, in rolling out a series of capability-building workshops and the flagship conference on climate risk management, governance and disclosures for Malaysian financial institutions. EY has also supported the Malaysian Sustainable Finance Initiative (MSFI), an initiative by Capital Markets Malaysia (CMM), to advance the development of sustainable finance across Malaysia’s financial sector and the UN Global Compact Network Malaysia & Brunei in delivering ESG capability-building workshops for micro, small and medium enterprises (MSMEs).
Every organisation has a critical and positive role to play. We have the means and the responsibility to act together now.