Adopting circular economy thinking with a view towards restoring and regenerating the environment will help organisations ensure that environmental and social sustainability are embedded in all stages along the supply chain in the production of goods.
Global focus drives rapid development in ESG approach and trends
EMERGING from the aftermath of the Covid-19 pandemic which has imparted harsh lessons to people all over the world, global sentiments on bringing about a sustainable, responsible future are stronger than ever.
Rapidly developing in tandem is the approach towards environmental, social and governance (ESG), leading to the emergence of new trends driving the ESG space in 2022.
“Over the last two years, market commentators’ concerns about the Covid-19 pandemic derailing the global ESG momentum turned out to be misplaced as the pandemic’s widespread disruption to the global economic and social fabric has affirmed the need to prioritise sustainable, inclusive and green growth,” said Sunway University economics professor Prof Dr Yeah Kim Leng, who is also a senior fellow at the Jeffrey Sachs Centre on Sustainable Development.
“The pandemic has focused attention on the ‘social’ dimension not only in national recovery and rebuilding strategies, but also among institutional investors and the corporate community, thereby placing the ESG mandate firmly centre-stage in complementary national development and business policies and strategies.
“Overall adoption of ESG-driven approaches in investment, financing, business reengineering, supply chain reconfiguration and organisational cultural change will continue to intensify along with the development of global standards.”
Focus on climate change
Of core importance is climate change, which has emerged as the top concern within the ESG agenda.
The 2022 United Nations Intergovernmental Panel on Climate Change (IPCC) report paints a troubling picture of climate change as a threat to human well-being and health of the planet, as it declared the need to drastically reduce greenhouse gas (GHG) emissions within the next three years to avoid the worst impacts of climate change.
The world faces unavoidable multiple climate hazards over the next two decades with global warming of 1.5°C.
Closely tied to climate change, biodiversity loss is among the biggest threats to human well-being and health of the planet.
Exceeding this warming level would result in additional severe impacts that can be irreversible. These include the quick escalation of risks in areas such as biodiversity loss, drought and floods, as well as food security, among others.
The goal set out in the 2015 Paris Agreement to limit global warming to 1.5°C, compared to pre-industrial levels, was further reinforced after the 2021 United Nations Climate Change Conference (COP26) in Glasgow, Scotland, with higher expectations for COP27 to be held in Egypt in November this year.
“The focus of ESG worldwide has shifted to climate change, which is viewed as an even bigger existential threat to humanity than the pandemic,” said Prof Yeah.
Rising importance of biodiversity
Closely tied to climate change is an increased focus on protecting biodiversity and natural capital from ecosystem collapse.
Biodiversity loss is among the most severe risks on a global scale, according to the IPCC report and the World Economic Forum (WEF) Global Risks Perception Survey 2021-2022, while the WEF’s Nature Risk Rising report revealed that more than half of the world’s total gross domestic product is moderately or highly dependent on nature and its services.
“We expect increasing scrutiny on industries whose core activities are dependent on nature. This includes oil and gas, power and utilities and construction and property sectors, as well as the financial services industry,” said PwC Malaysia chief strategic operations officer and net zero lead partner Pauline Ho.
Heeding the risks, the upcoming second phase of the UN Biodiversity Conference (COP 15) in Kunming, China, is aimed at creating a global biodiversity framework, which would outline a roadmap for global action to maintain and protect biodiversity.
Companies must take action to incorporate ESG into their organisations. It is one thing to recognise the gaps in a company’s practices and another to formalise ambitions via commitments, said Ho.
This comes on the back of the 2021 launch of the Task Force on Nature-related Financial Disclosures (TNFD), which is expected to take the same course as the 2015 Task Force on Climate-Related Financial Disclosures (TCFD) for financial institutions and corporations.
The goal of the TNFD is to develop a risk management and disclosure framework for organisations to report and act on evolving nature-related risks, with the objective of ultimately supporting the shift of global financial flows towards nature-positive outcomes.
Ho pointed to a 2019 National Capital Finance Alliance report that highlights the need for financial institutions to integrate natural capital risk management into wider enterprise risk management frameworks at asset, client and portfolio levels.
“Investing in rapid natural capital risk assessments will enable banks to improve their foresight by uncovering risks they were previously unaware of, such as systemic risk in bank portfolios,” she said.
Meanwhile, KPMG Malaysia head of sustainability advisory Phang Oy Cheng said that importantly, the TNFD does not intend to create a new standard, but will instead align with and draw from existing initiatives, standards and metrics relevant to nature-related risks and opportunities.
“To be ready to adapt to the new TNFD standards of disclosure, financial institutions, asset managers and corporates in Malaysia should proactively start identifying their short, medium and long-term exposure to nature-related risks in their current value chains and portfolios.
“Then, they should begin to consider appropriate metrics, targets and internal reporting mechanisms and be particularly wary of assets that are at risk of becoming ‘stranded’ during the transition towards nature-positive economies,” she advised.
The net zero imperative
Chief among efforts to decrease GHG emissions is the race towards net zero, with governments and organisations worldwide pledging to reach net zero emissions by 2050.
According to S&P Global, however, these commitments lack interim emission reduction targets or plans to curb indirect emissions that occur along the supply chain. Hence, the challenge would be “to develop concrete, near-term plans and begin to act to address emissions across the full value chain.”
PwC Global CEO Survey 2022, for one, shows that although 47% of Malaysian chief executive officers believe that climate change is a risk impacting their company in the next 12 months, only 39% included environmental and social incomes in their long-term corporate strategy.
“Extreme weather events such as the recent once-in-100 years’ flood and new and updated commitments made globally at COP26 reinforced the need for nations to move faster in achieving decarbonisation goals,” said Ho.
She stressed that while there is awareness of climate change as an issue among Malaysian companies, it has not been sufficiently operationalised or embedded in the business strategy.
The pandemic’s widespread disruption to the global economic and social fabric has affirmed the need to prioritise sustainable, inclusive and green growth. — Prof Dr Yeah Kim Leng
“Organisations will firstly need to engage their key stakeholders to define their material issues before embarking on any major shifts in their businesses. Some immediate actions that can be taken include recognising what this commitment means for the business, developing a roadmap with short-term and longer-term actions together with progress reporting and monitoring,” she added.
Phang said that although some companies have made good progress, the majority that have net zero commitments have yet to publish their progress to date.
She opined: “Malaysian companies face obstacles such as the inability to tie their net zero initiatives to their GHG emissions; inability to demonstrate their investment plans for net zero; inability to understand the various new technologies available and how to plan for adoption of these new technologies in relation to net zero and how carbon emissions can be reduced in the long term.
“Companies embarking on net zero have not considered the impact of an internal carbon price to demonstrate financial viabilities of the various reduction options considered.”
Sustainable supply chains
Biodiversity loss and climate change poses significant risks to supply chains, businesses and by extension, the global economy.
Disruptions to the global supply chain as a result of movement restrictions and lockdowns at the height of the Covid-19 pandemic have thrown into stark relief the necessity for resilient supply chains.
“[It has] elevated industry leaders’ concerns over other potential shocks such as extreme weather and global warming that could have a more severe systematic and disruptive impact on production and logistics.
“A reconfiguration of supply chains could mean that production centres will be located closer to the markets. The large Malaysian multinationals in plantation and manufacturing activities will likely incorporate supply chain risks in their strategic plans, but the smaller firms that are part of the regional value chains or production networks will be subject to the decisions of global players that control the supply chains,” said Yeah.
Disruptions to the global supply chain as a result of movement restrictions and lockdowns at the height of the Covid-19 pandemic have thrown into stark relief the necessity for resilient supply chains.
He added that while a more distributed and fragmented supply will likely increase relocation costs, the higher costs could be offset by lower transport and storage costs, as well as reduced risks of supply chain disruptions in the longer term.
To protect against supply chain disruptions, Ho said that there is a need to dive into the operations and perform extensive analyses.“Adopting circular economy thinking with a view towards restoring and regenerating the environment will help organisations ensure that environmental and social sustainability are embedded in all stages along the supply chain in the production of goods.”
This, she said, can be done – within the organisation and across the supply chain – through risk assessments incorporating best practices, defining the characteristics that are required of suppliers, monitoring and managing ESG risks, measuring the financial cost and potential impact of energy consumption, as well as understanding and responding to any exposure to human rights risks.
Increased social focus
Social issues in the supply chain are fast gaining visibility, especially when it comes to efforts to curb human rights abuse and improve labour conditions.
Phang stressed that sustainable supply chains are based on understanding ESG risks and opportunities within the supply chain.
“Companies that take the time to understand these risks and opportunities will be able to work with their supply chain to ensure sustainability, for example, on decarbonisation efforts or human rights risk mitigation.“Companies should also put in the effort to embed ESG principles such as ethical and sustainable thinking principles within their supply chain. Efforts on supplier diversity programmes and the development of a management framework to monitor progress should also be considered,” she said.
Concurring with her view, Ho said that investing in a just transition is crucial in supporting all participants in the company value chain.
“The pandemic made it clear that there are also some structural issues to be addressed by certain sectors such as health and pay conditions of plantation and manufacturing workers,” she added.
There will also be more focus in the areas of diversity, equity and inclusion (DE&I) as diversity has also been included in the 2021 update to the Malaysian Code on Corporate Governance (MCCG), which provides that all boards should comprise at least 30% women directors in three years or less.
Besides gender, Ho said that global data from the PwC Hopes and Fear Survey 2021 shows that there are other issues surrounding equity and inclusion that the pandemic has made more apparent. The report reveals that 50% of workers say that they have faced discrimination at work, 22% were passed over because of their age, 14% have experienced gender discrimination, 13% report missing out on opportunities as a result of ethnicity and 13% report discrimination on the basis of social class or background.
Countries and organisations are facing challenges in turning net zero pledges into short-term action.
“Whilst the data is not for Malaysia specifically, it does show that there’s a real need to open up genuine, fully inclusive conversations on how to build more diverse and purpose-led workplaces,” she said.
“Organisations need to hold a mirror to themselves and consider if they are doing the right thing, which is also good for business. A conscious effort needs to be taken to move the dial in this space.”
For Phang, implementing a robust DE&I strategy is essential to drive the future success of any organisation, as ESG considerations have become more critical to business success across all sectors.
With inclusion and diversity being key pillars within ESG frameworks, she noted that investors, shareholders, employees and customers are looking at how organisations are implementing DE&I strategies when making decisions.
“Gender and ethnic diversity will continue to be embraced, while the emphasis on inclusive growth in the government’s post-pandemic economic recovery and rebuilding programmes are expected to have spillover effects on private firms and government-linked companies,” Yeah added.
Greater clarity, shift to accountability
At the same time, the progression of global standards will continue to intensify and mpact Malaysian organisations as they expand beyond the country to establish a global footprint and become a part of the global supply chain.
A recent development is the creation of the International Sustainability Standards Board (ISSB), established at COP26, to enable the harmonisation of various reporting and disclosure standards – a welcome move.
Via ISSB, the International Financial Reporting Standards Foundation has begun to introduce the concept of ESG financial reporting, meaning that Malaysia will be required to localise these requirements in future.
Locally, Bursa Malaysia is currently enhancing its Sustainability Reporting Framework and Sustainability Reporting Guide, having released a consultation paper on the proposed changes in March.
Apart from that, there is MCCG’s 2021 update and the introduction of taxonomies such as Bank Negara’s Climate Change and Principle-based Taxonomy and the Securities Commission’s upcoming Sustainable and Responsible Investment Taxonomy.
The Joint Committee on Climate Change has also supported the proposal for financial institutions to make mandatory TCFD-aligned climate-related financial risk disclosures from 2024.
As the ESG space continues to grow, there is an emerging shift from disclosure and transparency towards accountability, with new emphasis on impact measurement that will foster greater accountability.
Yeah believes the move is a global trend motivated in part by studies that reported minimal impact of ESG initiatives on addressing global concerns and meeting sustainability goals, alongside greenwashing claims.
In addition, data on increasing investor pressure on boards reinforces the need for ESG issues to be managed effectively at the highest levels of an organisation, said Ho.
“I believe there will be increasing accountability with the update to the MCCG, making it very clear on the need for embedding ESG into business strategies and aligning them with the performance measures of boards and senior management,” she said.
Ho also noted a rise in new ESG growth areas – for instance mergers and acquisitions activities involving ESG sectors, new entrants such as renewable energy operators, increasing investments into the waste sector, as well as the emergence of new circular economy opportunities in the commodities sector and nature-based solutions.
Moving forward, it is certain that the onus will be on how leaders and companies can evolve their strategies to keep pace with the rapidly changing ESG space to achieve a more sustainable, responsible future.
