Sustainability pays

Identifying and avoiding risks is a key element in the operations of every business. It enables companies to prepare themselves for potential problems and maintain a focus on liveability in the long term. Sustainability has become an integral part of risk management in recent years, reflecting the fact that ignoring sustainability itself carries risks.

“We talk about sustainability risks, or ESG risks”, explains Bastijn Guns, Product Manager Sustainable and Socially Responsible Investment Funds at KBC Asset Management. “That means all Environmental, Social and Governance risks.”

According to Bastijn Guns, those risks come in very diverse forms. In addition to the risk of reputational damage, there is also a physical risk, such as damage to buildings or infrastructure caused by global warming. Finally, there are transition risks, for example due to changes in climate legislation, use of technology or slower adaptation to a low-carbon economy. Companies which fail to adapt risk paying the bill for this sooner or later.

These risks can be a harbinger of financial damage in the near or distant future. “So much so that it can even completely undermine a company’s financial stability”, warns Bastijn Guns.

“If you analyse from a sustainability perspective how companies engage with the environment and societal issues, you can spot risks that you don’t see if you only look through a financial lens. Oil producers, for example, might have to heavily write down the value of oil and gas reserves in the future.

The more stringent regulations on CO2 emissions mean that climate change is going to come at a high cost for many sectors and companies. Companies that are already taking that into account and consciously taking steps in the right direction, however small, will go into the future in a stronger position.”

In addition, the old, polluting economy will also be much less creditworthy in the future. Bastijn Guns: “The legislator already obliges banks to hold more capital to cover bigger risks. It is highly likely that this will eventually also include the ESG risks.

And if banks have to hold more capital, borrowing will become more expensive for non-sustainable businesses. But those polluting companies will also find it more difficult to raise finance on the financial markets.”

Finally, managing sustainability risks is also important from an ethical perspective. We are talking here about ‘generational justice’. “We make sure that we are not living our lives at the expense of future generations, but that we are supporting them”, says Bastijn Guns.

“It’s based on the firm belief that every generation has a right to well-being and to a good quality of life in a world that is liveable for everyone. The pressure from society on businesses to do good is increasing rapidly.”

Companies which take no or too little account of these sustainability risks are therefore exposed to the risk of financial consequences, which in turn can influence the company’s stock market value .

The impact cannot be underestimated. “The large, international companies appear to have started to make the change”, says Bastijn Guns. “Smaller companies are also aware, but they often have more limited resources and have to prioritise.

The transition of the economy is an inevitability. In fact it’s already happening. Companies either work with the efforts to find a solution, or they will eventually end up being left behind.

Because sustainability will have an impact on every sector. And, as with every change, there will be winners and losers. Bastijn Guns: “Companies which pursue a sustainable business strategy and are therefore joining in the efforts to find solutions, will flourish. Companies which fail to adapt will eventually go to the wall.”

Governments are also doing everything in their power to help companies make the transition, for example through subsidies and renovation grants. Governments are thus not only there to impose stringent measures.

Financial institutions also have a responsibility here. “We take our role in society seriously”, says Bastijn Guns. “We support our business customers in making the transition.” One way that KBC does this is through awareness-raising.

Recently, for example, KBC engaged in dialogue with around 500 small and medium-sized Flemish family firms to gauge the degree to which they apply the ESG principles and their awareness of their impact.

The risks were mapped in detail for eight sectors, including energy, agriculture and transport, fed using specific data. This prompted KBC to begin a collaboration with Encon, a consultancy which helps companies become more sustainable.

In this way, KBC is aiming to offer help in making the risks more tangible. However, sustainability shouldn’t be seen purely as a matter of risk management, as a way of mitigating the harm from identified risks. It can also have a positive impact in another way, on profitability. “At first sight, that might seem to be at odds with capitalism, which is an economic system, not a purely ethical one”, explains Bastijn Guns.

“Not all ESG criteria will automatically lead to better share performance, but that doesn’t alter the fact that certain business activities are particularly relevant for ESG investors and can contribute to the projected return. For example, companies which commit strongly to sustainability generally score highly on research and development and look to be assured of higher average growth in valuation and profitability.”

Guns also points to the impulse from the younger generation. Millennials and the digi-generation increasingly expect products and services to have been developed in a sustainable way. When a consumer has confidence in this, their loyalty to that product will also be greater and they will be more inclined to promote it in their own networks. The new generation of consumers are showing the way.

“These examples demonstrate that sustainability is gradually becoming the new normal”, concludes Bastijn Guns. “That also applies for investments. A new generation of investors want their investments to be in tune with their own values. Naturally, financial return also plays a key role.

Based on almost 30 years’ experience in sustainable and socially responsible investing, we at KBC don’t believe there is any evidence to show that socially responsible investment funds perform any less well than conventional funds over the longer term. In fact, the influence of sustainability on companies’ risk management and consequently on their profitability is set to become ever greater.”

As well as this financial return, there is also the social return. By consciously opting for social responsibility, you are sending out a powerful signal as an investor. Do not underestimate the impact of your money and the vote that goes with it.

If more and more investors reject companies that do not take account of the environment and society, those companies will ultimately have no other choice than to operate in a more sustainable way. As an investor, you can therefore exert serious leverage to influence the policy of companies.