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Investing

Unlocking Investment Success through Systematic ESG Management

iStock 1321782740 - Global Banking | Finance

Unlocking Investment Success through Systematic ESG Management

By Dong-Ju Park, Vice President of Portfolio Planning Office at SK Inc

Dong Ju Park - Global Banking | Finance

Dong-Ju Park

Environmental, social, and governance (ESG), a sustainability concept, has rapidly transitioned from discourse to corporate practice, especially in light of recent frameworks such as the UK Stewardship Code and the Financial Reporting Council’s (FRC) renewed emphasis on corporate governance and sustainability. In the face of changing dynamics in the global capital market, ESG has gained significant traction in the UK and globally, now standing as a non-financial metric complementing traditional financial factors in the assessment of corporate value.

In contrast to the enthusiasm surrounding ESG initiatives just two years ago, the current global corporate landscape is characterized by heightened geopolitical tensions and economic uncertainty. The factors contributing to this shift include soaring inflation rates and interest rate hikes by central banks around the world, the war in Ukraine, and the escalating US-China conflict. These geopolitical and economic challenges have created a climate of uncertainty, prompting discussions about economic risks to pivot towards corporate resilience. In light of these concerns, the fervor for ESG initiatives appears to have subdued. The focus has shifted from sustainability and ethical practices to immediate economic challenges, reflecting the evolving priorities in the business world.

Has ESG lost its relevance due to the changing external business environment?

Amid the uncertainties, companies navigating prolonged economic downturns and confronting unpredictable risks must meet dual criteria within their portfolios. First, they must ensure economic sustainability by strengthening business competitiveness. Simultaneously, attention to ESG factors becomes imperative, not only to secure mid to long-term stakeholder’s approval but also to minimize potential negative impact to corporate value.

In essence, volatility in the external business environment does not negate the importance of ESG. Instead, it underscores the need for a nuanced approach—one that balances economic sustainability with a commitment to ESG principles. Companies capable of enduring economic challenges while demonstrating resilience against unforeseen risks will find themselves well positioned in the ever-evolving landscape of corporate management.

For UK investors, establishing a systemic ESG investment framework for their portfolios is a strategic approach to navigating the evolving landscape of responsible investment. This framework not only aids in managing the value of a company’s investment portfolio, a core asset for the firm, but also sets clear standards. This clarity facilitates a better understanding of the company’s strategic direction and performance for both the market and stakeholders, aligning with the UK’s commitment to corporate responsibility and the impending implementation of the Corporate Responsibility and Sustainability Disclosure (CRSD) regulations.

The Three Guiding Principles

Suggested here is a comprehensive three-step approach for investment companies to effectively manage the ESG aspects of its portfolio companies. This three-step approach includes the systematic organization of key management items by industry, customized management based on growth stages, and a phased progression in ESG management practices.

First, the fundamental principle is the meticulous categorization and management of ESG issues with significant implications for corporate value based on industry. Recognizing the diversity across industries, companies need to consider emerging trends within specific sectors, as well as the macro-trends among industry peers. This enables the development and execution of targeted monitoring and response measures tailored to the unique ESG issues within each industry. 

In essence, commitment to ESG principles is not only an internal governance measure but also a strategic effort to align with industry dynamics and peer benchmarks. By adhering to these principles, investors seek to demonstrate their commitment to responsible and sustainable investment practices, fostering a portfolio that not only thrives financially but also contributes positively to the broader ESG landscape.

In the second phase, investors should strive to actualize appropriate ESG value enhancements, taking into account the maturity of the target company. This involves identifying ESG priority management items aligned with the specific business life cycle stage and growth rate of each portfolio company. By placing these priorities at the forefront of the ESG management strategy, investors are able to implement a nuanced and tailored approach, thereby achieving differentiated ESG management based on the unique growth stage of each investment.

Finally, as part of the systematic, phased approach of ESG management, investors need to track the efficacy of ESG management strategies implemented in previous stages. The continuous monitoring and evaluation process allows to refine and build upon the ESG management capabilities of portfolio companies. The goal is not only to meet but also to exceed global standards in ESG management, establishing a robust and adaptive system that aligns with the evolving dynamics of the global business environment.

In short, ESG management should be viewed as an ongoing process of improvement and refinement, where each step contributes to the overall enhancement of the sustainability and responsibility of our investment portfolio. Through such a systematic approach, investors should aim to not only meet the expectations of the stakeholders but also seek to set a benchmark for global ESG standards within the investment landscape.

The Framework

To uphold the integrity of the three-tier management principles, it is imperative to establish a systematic and specific framework at a more granular level. The translation of abstract ESG concepts and principles into practical, business-oriented action items tailored to the distinct business life cycle stages of portfolio companies facilitates a more effective and measurable ESG performance management approach.

In the pre-acquisition investment review stage, a foundation is placed through ESG due diligence. This involves creating a checklist and evaluation items specific to the industry and size of the target company. By undertaking a thorough written diagnosis and on-site due diligence, investors should systematically classify ESG risks and management systems accordingly. Such a thorough process ensures a more accurate reflection of ESG considerations in the valuation of the target company.

At this initial stage, the focus should be on identifying ESG-related improvement tasks during the post-merger and integration process. This measure not only enhances our understanding of potential ESG challenges but also positions investors to implement measures that align with the overarching ESG management strategy.

In the subsequent holding stage, investing companies should advocate for a commitment to continuous monitoring and management, aiming to enhance the ESG value of portfolio companies. This phase serves as the focal point for the application of the three principles outlined earlier. To this end, the implementation of regular ESG inspections with a specific emphasis on climate change risk management is proposed—an aspect widely recognized as paramount among investors within the ESG priorities.

Recognizing the significance of climate risk, investors should undertake an analysis that includes core management areas for each industry. This analysis should be based on a comprehensive examination of high-level factors such as external ESG evaluations and share price correlations. Companies should specifically address the financial impact of carbon regulations and price fluctuations, ensuring that this approach is not only principled but also pragmatic.

Regular inspections and evaluations play a crucial role in the operational framework, as they help monitor the continuous ESG performance of portfolio companies. This approach also extends to cultivating transparent ESG-based communication with shareholders. As an investment company, prioritizing the clear and open communication of ESG-related performance for the investment companies is essential. By engaging with shareholders and key stakeholders transparently, the goal is to optimize both the corporate and investment value of portfolio companies throughout the investment stage.

Effective ESG performance management, sustained through the divestment or exit stage of an investment, is a crucial component for establishing a successful investment legacy as an investment company. As investors approach the exit stage, attention should be directed towards compiling a comprehensive report. This report encapsulates post-acquisition ESG value enhancement, opportunity and risk assessment, along with details of post-acquisition management and disclosure.

Particularly important in this phase is the transparent reporting and disclosure of key elements for potential buyers to scrutinize. This will involve a thorough examination of the target’s compliance with ESG regulations in the market, disclosure of information highlighting areas of exemplary performance, strategies to enhance opportunities in areas requiring improvement, and adherence to responsible investment standards. By actively addressing these aspects, investors can ensure that they fulfill their responsibilities to their investments and shareholders, fostering an environment of trust and accountability.

ESG is not merely an extraneous consideration but an integral element that should be integrated in all aspects of business decisions and actions, including investments. While ESG management may seem cumbersome initially, when implemented effectively, it can serve as an opportunity to enhance the value of both the investment company and its investors. A well-defined ESG management strategy, supported by a robust system, functions as a powerful tool, turning ESG considerations from a potential challenge into a strategic opportunity for investors.

(1) Morrow Sodali Investor Survey 2020

About Author:

Dong-Ju Park is the Vice President of Portfolio Planning Office at SK Inc., leading the company’s ESG strategies. He is working to establish ESG-based investment strategies and systemic ESG management system within SK Inc., enhancing the company’s ESG data disclosure and external stakeholders’ access to these data. 

Dong-Ju was responsible for the launch of SK’s ESG Online Platform last year, which incorporates and visualizes the ESG performance data of SK Group’s core subsidiaries. In 2023, Dong-Ju also led the development of a portfolio management system that brings all investment portfolio companies under SK Inc.’s ESG management umbrella.

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