Sustainability breeds robust response to an uncertain world

We live in an increasingly volatile world, with a range of megatrends such as climate change, resource scarcity, migration and urbanisation acting individually and together to make the world a more unpredictable place for consumers, companies and investors.

These megatrends will exacerbate other areas of economic and financial volatility – two of the most obvious recent examples are the financial crisis and the recent plunge in oil and gas prices, both of which are still having repercussions that are being felt around the world.

And at the same time, companies and investors find themselves having to grapple with a world where existing business models are being upturned by technological advances ranging from increasing digitisation and the internet of things to blockchain and energy storage.

One of the ways that businesses can shield themselves from this volatility is by becoming more focused on sustainability, which will make their companies more robust and prepare them for a future where volatility is the new normal.

You only need to look at the current turmoil in industries such as automotive and oil and gas to see that unforeseen incidents can have profound and lasting effects on financial performance.

Taking into account environmental, social and governance (ESG) issues helps companies and investors to identify risks they would not have otherwise considered and it could save them billions of pounds.

Once the risks are identified, they can be avoided. Companies that use renewable energy are not exposed to sharp changes in the price of fossil fuels – instead their costs are fixed. Nor are they exposed to tightening regulations to tackle fossil fuel emissions and the risk of stranded assets that this brings. A growing number of the world’s biggest corporations, from Apple to Walmart, have committed themselves to procure all of their power from renewable sources through initiatives such as the Climate Group’s RE100 and the US-based Renewable Energy Buyers Alliance. Such schemes not only protect the companies themselves from energy price volatility, they also help to speed the roll-out of renewable energy, reducing risks for the business community as a whole.

When, in 2013, it was discovered that horsemeat was present in many ready meals and other meat dishes, McDonald’s was able to assert with confidence that there was no risk to any of its products because it had complete visibility in its supply chain, from field to fork. It wasn’t planning for this event specifically, but transparency about the source of its raw materials left it better prepared to deal with the issue than many other companies. Tesco, for example, was not just shocked to discover that there was horsemeat in its supply chain but also just how far that supply chain stretched.

At the same time, ESG analysis can reveal opportunities that may not have been considered. Many waste companies have switched focus to become experts in recycling as a result of tough regulations designed to reduce the amount of material going to landfill, for example, while pressure to cut greenhouse gas emissions has led to the creation of companies such as LanzaTech, which is looking to create biofuels, including jet fuel, from the emissions of industrial facilities such as steel plants.

The sustainability perspective can also suggest new business models such as the circular economy, which can make businesses more sustainable through its focus on reusing products and materials, the sharing economy and products as a service. By decoupling growth from resource use, the circular economy can reduce volatility in areas such as access to raw materials and supply chain disruptions.

The French carmaker Renault has a unit that takes in its old engines and remanufactures parts to be used as spares for new vehicles. The environmental benefits are clear – Renault says that remanufactured parts uses 80% less energy, 88% less water, 92% fewer chemical products and produce 70% less waste than producing new parts. But, crucially, they are also 30-50% cheaper.

Lights at Schiphol Airport

Meanwhile, Philips last year signed a deal with Schiphol Airport in Amsterdam to provide lighting as a service, rather than lights. The company has installed specially-designed LED lights that will last 75% longer than conventional fixtures and cut electricity consumption from lighting by half. Philips will retain ownership of all the equipment and the airport will lease it for the duration of the contract. At the end of the contract, fixtures will be re-used elsewhere after upgrading, resulting in maximum resource reduction.

And in the sharing economy, platforms such as Uber and AirBnB are allowing anyone with a car or a home to provide a service, which is not only turning consumers into providers but also disrupting the taxi and hotel industries respectively.

For many years, there was a fear that prioritising sustainability came at the expense of profit and shareholder value, but that assumption is becoming less tenable by the day. Consumer goods giant Unilever, for example, recently announced that its “Sustainable Living” brands grew 30% faster than the rest of the business last year [1]. When car manufacturer General Motors decided to make its facilities waste-free, it did so primarily for environmental reasons, but it soon discovered that it could make $1 billion a year from the material it recycled [2].

There is evidence that a focus on sustainability can reduce share price volatility, too, reducing risks for investors. Allianz, for example, says: “Many of the newer research studies show that superior ESG strength in an equity portfolio appears to lower volatility risk, relative to a portfolio of firms with lower ESG scores. In other words: better ESG-rated corporates seem to surprise markets less often.” [3]

2016

On the other hand, increased volatility can also make the transition to more sustainable business models more difficult in the short term because it makes banks less willing to finance the new and unproven business models that things like the circular economy entail. Circular economy models, for example, require banks to value companies and their output differently, focusing more on cash flows, creditworthiness and the strength of contracts and less on the underlying value of an asset [4].

In an age of uncertainty, the tendency is to stick with what has been proven to work in the past, even if it is becoming increasingly clear that it will not continue to do so in in future. But sustainability can help to buck this trend by providing a different lens through which to view investment activity. An increasing number of financial institutions, including ING, are using sustainability to help change the focus of their lending to companies and projects that are more robust over the long term. They are even using it to transform their own financing, through the use of new financial instruments such as green bonds, for example.

They are not doing this simply because they believe it is the right thing to do. They are doing it because they know that in an increasingly volatile and unpredictable world, taking sustainability factors into account helps to reduce their risks and ensure steadier cash flows.

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