ESG Factors, Or are they? 

May 2, 2023 | News

An Investor associate of mine said to me recently, “Our investees in [country], don’t even know what ESG is, let alone how to manage it.” I was shocked at first, but after giving it some more thought – it made sense.  

This investee my associate spoke of, was probably inadvertently managing for ESG, via existing management channels. However, a lack of ESG awareness can leave risks unaddressed and opportunities uncapitalized. What’s more, investees having ESG management systems and procedures in place is increasingly required among investors. So how do we get from ad hoc ESG management, to a practical system that reduces risk, increases positive impacts and enhances business value?     

In my previous article, I discussed the risk of poor risk management – and a 4-step process to responsible risk management. This week, I will unpack a segment of this further – looking at ESG factors, and how they can be cross-cutting with other areas of management. We’ll look at how you can avoid re-creating the wheel – by allowing business units to implement ESG factors as they have been. We’ll focus on the functions of ESG management that can move the needle forward in a forest investment. 

Managing for ESG, without ESG awareness in Forest Investments 

Going back to my previous example of the company who doesn’t know what ESG is – let’s explore how they are likely unknowingly managing ESG. Firstly, a quick refresher on what ESG is. Universally accepted, the acronym stands for Environmental, Social, Governance – what this infers, however is not universal at all. ESG factors refer to a set of environmental, social, and governance criteria that can be used to evaluate the sustainability and impact of an investment or business. These factors include issues such as climate change, pollution, human rights, labor practices, board diversity, executive compensation, and shareholder rights to name a few. 

Let’s consider some common ways our unaware ESG practitioner is in fact considering ESG factors, albeit in an ad hoc way: 

1. Widely known material risk 

A material risk is any risk having a substantial impact on the current and future financial, economic, reputational, and legal prospects of an investment. On the climate change side – this could be increased prevalence of catastrophic fires in some geographies. Here, forest managers would naturally invest into and implement wildfire prevention and mitigation – possibly unknowingly managing ESG risk. 

2. Contextual issue requiring significant management attention 

Forest businesses are shaped by the local contexts in which they operate. For forest companies operating in the tropics, the local context may be characterized by a lack of skilled labor, poor forest governance, and high population density. Any one of these, or others, may become top of mind if they pose a threat to the business. For example, a training program to increase skilled labor, is a need for the company to operate – but is also an ESG impact generator. 

3. Operating within best practices

To be attractive to foreign investors and to secure and maximize long-term financial viability, status quo forest businesses are adhering to globally recognized best practices for forest management. This often takes the form of compliance with national forest legislation and/or achieving and maintaining forest management certification. The latter is particularly effective for managing the ESG issues of forest operation. However, a manager might not even realize that through certification – they are inadvertently managing ESG. 

4. Putting out figurative (and in some cases literal) fires 

When a risk event materializes in a forest business – it gets management attention. If there is a significant labor dispute, a workplace injury, a landslide, or a wildfire – management will be activated to mitigate the risk and put systems in place to reduce the likelihood of it happening again. All the examples I listed fall in the category of ESG, and would be managed by a responsible operator, without even knowing what ESG is.   

How to Manage Cross-cutting ESG Factors Effectively 

At the start of a company’s ESG journey, it is important to realize that it likely is already managing ESG factors. In the previous article, I suggested a brainstorming session with the management team to identify all the risks and which risks are cross-cutting with ESG. I would expand this to also include impact opportunities, where positive environmental, social and governance benefits can be achieved.  

Having an ESG management system or ESMS in place should not recreate the wheel. In other words, if an ESG factor is adequately managed through existing practices, why change it? However, an assessment on whether the management is effective needs to be addressed (I revert to my brainstorming example), and designing and ESG system that captures effective ESG management and builds on it, is what should be the aim. 

Now, let’s assume you’ve carried out this exercise, identified cross-cutting ESG factors with other areas of the business and are at the stage of identifying how ESG factors (both risks and positive impacts) can be captured through ESG management. 

The formalization of the following ESG management functions could transform ad hoc ESG management into a foundation for ESG risk mitigation, impact creation and value generation in the business.

  1. Leading the process on ESG risk and opportunity identification, and setting objectives and targets – ESG strategy is lacking in the ad hoc approach, where without objectives and targets, it is difficult to assess performance and ESG contribution to the business, 
  1. Setting up an Environmental and Social Management System (ESMS) to ensure ESG factors are captured. Ensure its buy-in across the organization and see that it is implemented – ESG management has a risk of being a siloed segment of the business, where because of its cross-cutting nature, it should be integrated across all business units,  
  1. Monitoring and reporting on ESG factors – traditional timberland investment reporting captures financial and operational performance, where sustainability is often siloed in its own qualitative report. Setting ESG objectives and targets (see Function 1), paves the way for measuring and reporting ESG performance,  
  1. Evaluating performance of management ESG factors – With the data on ESG performance, it is possible to assess how well management is achieving its objectives, and if managing to these targets are adding value to the business, 
  1. Support in emergency response – In the event of a cross-cutting ESG emergency, the appropriate business unit will be activated to resolve it. An ESG manager is able to support in emergency response, through guiding the team in executing the designed emergency response plan and providing other auxiliary support.  
  1. Maintaining current on industry standards and best practices for ESG factors – ESG management is a rapidly evolving field, especially as information management improves, and we can now measure (some of) the immeasurable. Further, new Standards and Certification schemes are popping up that are both a regulatory requirement (ie. the EU Sustainable Finance Disclosure Regulation) and a value driver (various carbon certification standards, facilitating participation in voluntary carbon markets).   
  1. Advocating for ESG management – Incorporating ESG factors into investment decisions and management is still misinterpreted. It is important that promoting ESG management is active inside organizations, so that it is not siloed, and outside of organizations – to investors and other stakeholders. ESG Managers need to communicate the risk reduction, impact creation and value contribution of managing for ESG. 

The combination of having targeted business units oversee ESG factors relevant to their aspect of the business (such as fire management with operations, and labor management with HR) and an overall ESG management responsible (person or team, depending on the size of the business) allows for cross-cutting ESG factors to be managed efficiently, and deliberately – such that ESG risks are reduced, positive impacts are created and value is generated. 

ESG Management Design for your Business 

If reading this article had you reflecting that ESG Management in your own forest investment management approach is lacking, please reach out. I work effectively with forest investment management teams to identify how they can improve their ESG integration – in a way that reduces risk, increases positive impact and adds value to the business. 

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