Investors, lenders, insurers and customers are increasingly demanding that companies they do business with demonstrate proven environmental, social and governance (ESG) performance. Businesses that fail to do so could put their future at risk. ​

“Companies that fail to meaningfully address ESG with actionable strategies and clear reporting will face increased challenges accessing funding,” says Doron Telem, national leader for ESG at KPMG in Canada. “Part of what’s driving this shift is that Canada’s biggest lenders and investors are adopting well-defined ESG mandates and targets, and the compensation of their executives is increasingly tied to delivering on them.” ​

The commitments financial institutions are making to reduce emissions are ambitious. For example, a growing number have become members of the Glasgow Financial Alliance for Net Zero (GFANZ). This coalition represents about $130-trillion in capital committed to supporting the global economy’s transition to net-zero greenhouse gas emissions. ​

According to the CDP, which runs a global environmental disclosure system, lending, investment and insurance underwriting portfolios are by far the financial services sector’s largest source of carbon emissions. ​

"As financial institutions increasingly make funding decisions based on ESG performance, they will play a key role in shifting the allocation of capital to lower-emitting companies and accelerate the decarbonization transition for heavy emitters,” says Mr. Telem. “This will quickly begin to impact all businesses and sectors.” ​

Since a company’s calculated emissions need to also account for those from its upstream suppliers, the initial pressure on larger corporates will cascade to the many smaller private companies in their supply chain, says Mr. Telem. As a result, all businesses should expect to face greater scrutiny on how they plan to decarbonize their operations.​

Leaders and investors in public and private capital markets are analyzing the risks of climate change on all aspects of a business, says Amy West, global head of ESG solutions for TD Securities in New York. “We view it as understanding material financial risks in a client’s business that we didn’t fully understand before.”​

In many cases, what was once considered a remote, once-in-a-thousand-years black swan climate risk is now viewed as a likely risk, one that every client’s business plan must address, Ms. West adds. ​

While climate change is currently a significant focus, Mr. Telem notes that many other social and governance factors will also play a major role in how investors, lenders and insurers are making their ESG assessments. ​

Priority social factors considered by capital providers include management and workforce diversity, workplace health and safety, responsible procurement and community relations. Priority governance factors include ethical performance, regulatory compliance and ESG accountability.

ESG initiatives can create additional capital requirements

Companies will likely need to seek additional capital to achieve their publicly-stated ESG targets. According to KPMG’s annual CEO outlook survey, a fifth of Canadian CEOs say that a lack of budget to invest in ESG transformation is a top challenge. ​

Financial institutions are responding to these capital requirements with investment programs linked to sustainability, where a borrower’s ESG performance will affect their interest rate. ​

Similar considerations apply to equity capital providers. Most institutional investors, including private equity firms, have already embraced ESG as a key factor in their deal-making. ​

“ESG considerations now serve as indicators of a target company’s long-term value potential, and it is vital that companies report on their ESG progress,” says Clark Savolaine, partner in KPMG’s Deal Advisory practice. ​

For now, ESG reporting by companies remains largely voluntary in Canada. But expectations around reporting are evolving rapidly nationally and internationally. ​

For example, in 2023, all of the Canadian securities administrators, the Office of the Superintendent of Financial Institutions (OSFI) and the new International Sustainability Standards Board plan to finalize detailed rules on disclosing climate-related risks, and similar requirements are expected to be finalized in the U.S.

Integrated, business-wide ESG programs are a must

Businesses that have yet to methodically embrace ESG should start developing a foundational ESG program as soon as possible, says Mr. Telem. Those efforts should include key priorities and initiatives based on feedback from major customers and capital providers. ​

In building an ESG program, companies should assess potential ESG-driven changes in end-consumer requirements. Capital providers will inquire about that, and will also look at how procurement, manufacturing and delivery processes can be decarbonized. Another consideration is whether the business model is being adapted to keep pace with new and old competitors. ​

“Organizations that are substantially behind in addressing ESG will find capital more difficult and more expensive to access, potentially putting their future at risk,” says Mr. Telem. “On the flip side, an ESG strategy done right can create a sustainable and recognized advantage over competitors.”

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