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It's time for a paradigm shift in ESG

02 February 2022 Anna Boyd

ESG is in the spotlight. Around the world and across economic sectors, companies face unprecedented pressure to operate sustainably. A closer look at current practices in the field of social license, the bedrock of the S in ESG, reveals the opportunity to shift ESG from a compliance function to an integral, value-creating strategic asset.

New challenges, new thinking

Social license, a long-standing concept in the extractive sector, is relatively new for industries such as manufacturing, fashion, and renewables. That said, even for oil, gas, and mining companies (who are well-versed in navigating local dynamics in high-risk locations), the pivot towards renewable energy is likely to bring a new set of social license challenges. For example, Europe's green transition will feature wind farm projects in developed countries, which will face opposition from local communities, activist organizations, and national-level political parties. Navigating the ensuing challenges, wherein technology-savvy critics leverage social media and deep financial resources, could prove even more difficult than those attendant to conventional extractive activity in the developing world.

The common thread that unites all social license activity is the need for understanding—which can be developed through community engagement and political trend analysis. But how should these efforts be directed, managed, and integrated? There are no universally accepted ESG metrics for assessing social impact, and different companies approach social impact from widely divergent perspectives. As a result, it is difficult to discern when community engagement efforts are serious, and when they are a public relations exercise. Meanwhile, within companies that have established internal teams or committees to address social concerns, these stand-alone capabilities tend to do just that—stand alone, siloed off from core decision-making processes. ESG has made it onto the corporate radar, but it is still viewed as a cost center, and a set of problems to be managed.

ESG: The missing piece

Collectively, this dysfunction exposes the original sin of the ESG discipline as a whole. We are zeroed in on the impacts that a given company may have on its surroundings. We quantify the risk and harm attendant to those impacts and gauge the company's adherence to certain norms. The mission is clear: we are focused exclusively on what the company may have done, or left undone, and the associated repercussions. But, this is only half the story: local communities and stakeholders also influence outcomes, and we ignore their agency at our peril.

At heart, ESG analysis is contextual analysis. It should be a practice through which we examine a company as an integral feature of the world in which it operates. Such an understanding is, necessarily, dynamic and multi-directional. Yes, corporate activity affects external stakeholders. Those effects can be negative or positive, direct or indirect, deliberate or incidental. Simultaneously, external parties exert influence over corporate activity as well. The same dynamic holds in return.

Understanding our exposure

The give and take between corporate and community is always unique, across and within sectors and geographies. Every company has its own distinct presence, objectives, and behaviors. External stakeholders have their own interests and agendas as well. A tailored approach is needed, which recognizes the interplay between a company and the context in which it operates. This is what ESG and social license analysis should capture: a bespoke, focused understanding of a corporate's touchpoints in the world around it, and the implications thereof.

In the social license discipline, companies need to map the influence dynamics present around their operations—and to recognize that these will change over time. Who holds influence, why, and how are they likely to use it? Under what circumstances could this change? In turn, what are the particular strengths and weaknesses of a company, which others may try to exploit, or which will inform stakeholder perceptions and actions against it?

Integrating ESG

This holistic approach to social license anticipates a paradigm shift in ESG. Eventually, analysis of a given company, of its touchpoints with regard to ESG criteria, and of the factors that shape the strengths, weaknesses, opportunities, and threats that intertwine around those touchpoints, should inform a contextualized strategic framework that acknowledges the multi-directional, dynamic reality of its interactions with communities.

If we approach ESG in this light, it ceases to be a discrete cost center. Instead, it becomes integral to corporate strategy, and to the decision-making processes that drive all aspects of corporate action. If we embrace this mindset, the corporate "ESG team" becomes obsolete—for the simple reason that our entire management enterprise will be integrating ESG considerations into its central nervous system. This is the future of ESG. It is how ESG can evolve from a compliance-oriented function into an integral, value-creating facet of corporate decision-making.

This post was co-written by Dr Nicholas Krohley - Principal, Frontline Advisory

Learn more about establishing a social license to operate. Download our whitepaper

Posted 02 February 2022 by Anna Boyd, Associate Director, Economics & Country Risk, IHS Markit

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