Reaping better business opportunities with ESG due diligence

While the world celebrates World Environment Day on 5th June every year, this year (2022) came with a new theme, “Only One Earth”, which advocates for transformative environmental change on a global scale. This resulted in a significant shift in the business sector, where an increasing number of companies were seen working to reduce their environmental footprints. Many businesses that participate in high-impact operations, such as the exploitation of natural resources, have shown their commitment to a more sustainable business model that adheres to a higher level of responsibility to the environment, social, and governance (ESG) practice.

The challenges and push factors

In terms of the environment, for instance, one of Indonesia’s integrated energy businesses considers building a more innovative company toward a more sustainable future by striving to be carbon neutral by 2060 as an essential goal. In terms of society, the firm aims to empower the community in a novel and long-term manner. These goals, whatever they may be, cannot be met unless there is a significant presence in the company’s governance.

Given its existing industry in fossil fuel extraction, they are bold and ambitious goals for a developing nation. However, the transition toward a more sustainable business model with a strong ESG adherence has grown increasingly common, not just in developed countries, but also in developing economies. Rising energy costs which are estimated to reach a new high in 2022 as a result of the post-Covid-19 economic recovery and geopolitical dynamics in Europe have generated not only a challenge for businesses around the globe but also a push factor to speed up the transition.

Benefits of the ESG program

There are many benefits of having a business with a strong ESG program. It can set a vision for its environmental and societal influence. On the environmental front, for example, firms may set goals to lower their carbon footprint, decide their sourcing strategies, and create a roadmap to remove unnecessary waste. On the societal front, a company may create a meaningful diversity program, improve employee wellness, and make long-term improvements to the community. A solid governance foundation may assist a company in diversifying its top management team, improving its business ethics, increasing stakeholder transparency, and protecting privacy.

One available incentive is that the financial sector offers an appealing financing plan for commercial projects with a sustainable mindset that aim to reduce their negative impact on the environment and society. In March 2022, the IMF stated that sustainable financing had grown rapidly. Sustainable finance incorporates environmental, social, and governance (ESG) concepts into business decisions and investment strategies, addressing concerns ranging from climate change to labor practices. It has become more mainstream in emerging markets in part because of pandemic-related financing needs, such as healthcare. In addition, there has also been a surge in climate-related loans in developing countries, especially in Latin America.

Aside from the financial incentive, another motivation exists for businesses to adopt an ESG approach to their commercial behaviors. It is important to note that concerns such as child labor, carbon emissions, fair taxation, and corruption (due to a lack of transparency) may pose as complications and risk becoming expensive hazards. The way a company manages ESG issues can affect its long-term success and valuation. Investors who are becoming more conscious of these dangers are seeking investment opportunities that will provide them with a far better method to grow value by doing things differently, i.e., in a more sustainable manner.

Many commercial projects in Indonesia have benefited from long-term funding, making them more economically visible and competitive. Furthermore, many businesses have sought to entice top-notch investors to fund their low-impact business concepts. However, securing such financing facilities or investments necessitates the preparation of a solid strategy that can demonstrate to the creditor that the business operates in line with ESG principles.

ESG due diligence

Typically, creditor or investor due diligence, whether thorough or partial, is required to establish the extent of adherence to ESG principles of a business that they wish to fund or invest in. ESG due diligence can be a deal-breaker in this case. According to a KPMG report, more than half (54%) of private equity partners opted to cut the offer price following ESG due diligence, whereas one-third (32%) raised the bid price.

In addition, the EU has issued the Proposal for a “Directive on Corporate Sustainability Due Diligence” which requires large companies in high-impact sectors (agriculture, mining, textiles, etc.) operating in Europe to conduct human rights and environmental-related due diligence, including ESG due diligence.

While medium and small-sized companies are exempt from this regulation, it should be underlined that the subject companies should ensure compliance along the entirety of their supply chain. This implies that direct or indirect third parties, subsidiaries, and suppliers involved in the companies must consider the impact the regulation would have on them indirectly.

Rahmad

Photo by Zbynek Burival on Unsplash