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The Role of Comprehensive ESG Due Diligence in Achieving Sustainable Investing

As ESG initiatives continue to become a priority for countries around the world, stakeholders of many organizations are now calling for more sustainable and socially responsible investing. However, organizations are challenged to meet the expectations of stakeholders while also driving profit.

Driven by these challenges, organizations or firms may be tempted to rush into seemingly secure ESG-focused or sustainable investments without conducting proper due diligence. This can result in companies investing in organizations that are misrepresenting their sustainability impacts or are not financially viable. Let’s discuss more of the potential pitfalls of lax ESG investing due diligence and what a comprehensive solution can uncover about an entity’s ESG-related non-compliance.

The Landscape of ESG and Impact Investing

Companies are experiencing pressure from regulators, stakeholders, and consumers to shift their investments to make them more environmentally and socially impactful. When it comes to consumers:

  • 23 percent say they will switch to buying products from an organization that shares their values on environmental issues
  • 42 percent have changed consumption habits themselves because of their stance on the environment
  • 21 percent have encouraged others to switch to a company whose values align with their opinion on an issue

Company stakeholders are becoming younger and younger, with the average age being 34. Younger generations are three times more likely to switch brands based on values than older generations; for companies, this means larger numbers of their boards and stakeholders are pushing for environmentally conscious investing. For these stakeholders, impact investing provides opportunities for companies to diversify their portfolios while advancing social and environmental causes and producing impressive financial returns.

In addition, the amount of money in impact investing nearly doubled from $183 billion in September 2020 to $330 billion in September 2021, and that number is only increasing. For younger stakeholders, ESG-focused investing is a still new market with extensive opportunities to help secure their company’s position in the future.

With new ESG legislation around the world, regulators are also putting significant pressure on companies to make the move to impact investing. Some important global initiatives include the 2021 United Nations Climate Change Conference, the EU’s Corporate Sustainability Reporting Directive, and the recently announced landmark Securities and Exchange Commission (SEC) proposal, which would require public companies to disclose extensive climate-related information in their SEC filings. All of this legislation is creating a major shift in how companies proactively participate in ESG initiatives, focusing on the classification of sustainable economic activities, disclosures by investors and issuers, product governance, suitability and organizational requirements, impact reporting, and the quality of disclosure among companies of information on their social impact.

The Importance of ESG Investing Due Diligence

With pressure coming from all angles and the attractive, untapped growth of impact investing, it can be tempting to move forward with a seemingly sustainable investment opportunity without fully understanding some of the risks. Due diligence protocols for ESG investments are designed to expose any information that may leave an investor vulnerable to financial and reputational risks in the future.

Shed light on potential risks

When pursuing sustainability and impact investments, ESG investing due diligence can shed light on potential pitfalls, including risks in the market, supply chain, compliance, and leadership. For example, leadership risks, such as those involving ownership, board members, shareholders, and executives, can result in major reputational and financial damage down the line. If a company invests in a supposedly environmentally impactful organization, but it comes to light that one of the executives has been fraudulent, it can damage not only the organization but also any company that puts its trust and its investments in it.

A real-world example in which ESG investing due diligence would have prevented significant issues is in the SEC’s recent filing against the mining company Vale S.A. The SEC’s ESG task force filed a complaint against the Brazilian company for presenting fraudulent ESG information to investors. Specifically, Vale misrepresented information about the safety of its dams prior to a dam collapse in 2019 that killed 270 people and impacted Vale and its investors with a $4 billion loss. While it is of the utmost importance that companies represent ESG information accurately, this is also an essential lesson for investing companies to perform thorough due diligence before investing in any organization.

Mitigate investment risks

ESG investment due diligence is not only helpful in identifying potential risks but also in understanding how to remediate them. By evaluating potential risks and prioritizing them in terms of impact and cost, companies can set forth a plan to remediate ESG investing risks before moving forward. By first understanding the severity of each risk, companies can then apply mitigation strategies to long-term ESG investment management. These ongoing due diligence methods are not only used for one-time risk remediation but should be able to identify any new risks that arise, preserving sustainable impact long after the initial investment.

Avoid lax due diligence

Taking a nonchalant approach to ESG investing due diligence can have significant effects on the financial return and environmental impact of your company’s investments. For example, 88 percent of companies find it moderately to significantly challenging to find the appropriate capital across the risk/return spectrum in sustainable investing. Lax due diligence during investment considerations will not help companies accurately evaluate the ROI of sustainable investments, landing them in financial trouble.

Another important factor is the lack of effective impact measurement. In fact, 86 percent of companies find it moderately to significantly challenging to accurately measure and track the impacts of sustainable investing. Taking a casual approach to ESG investing due diligence will not be able to quantify the strengths and weaknesses of company investments, which means they could be investing in organizations that have little to no tangible sustainable value.

Regulatory compliance is perhaps one of the most important reasons to avoid lax investment due diligence. Regulators will want to ensure that sustainable investments are placed with organizations that are compliant with relevant ESG legislation and directives, including having proper policies and procedures in place to minimize environmental and social impact. Careless

due diligence will not thoroughly review the organization’s policies and procedures, potentially impacting the investing company’s compliance and putting their investments at risk. For example, Volkswagen paid a $2.8 billion settlement after the Department of Justice (DOJ) filed a 2016 complaint against the car giant for executives falsifying emissions data and destroying evidence. This kind of non-compliance and resulting financial consequences, which have only gotten more aggressive since 2016, extend well beyond the organization itself and are felt by any company invested in it.

What Thorough ESG Investing Due Diligence Looks Like

A solution that performs sound ESG due diligence for sustainable investing includes commercially oriented, evidence-based impact risk assessment, analysis, and reporting to better inform impact investors and stakeholders of material environmental, social, and governance risks and positioning them to achieve sustainability outcomes. ImpactCheck from IntegrityRisk supplies information on:

  • An entity’s non-compliance with environmental standards and regulations
  • Risks associated with a company’s dependence on scarce or vulnerable resources that are likely to fluctuate and affect business operations
  • Supply chains that are extractive, polluting, heavily resource-dependent — or source labor in a country with a history of labor rights abuses
  • How an entity treats its employees
  • How an entity interacts within the communities it operates
  • Potential risks that could materialize into labor law litigation
  • Discrepancies in self-reported/disclosed company operations

An ESG investment due diligence solution like ImpactCheck ensures that companies pursuing ESG and impact investing can feel confident in where they place their trust and their funds for the better of their company and the environment.

Take the Next Step in Investment Due Diligence

While there is significant pressure from regulators, stakeholders, and consumers to refocus investments toward sustainability, it doesn’t mean that companies rush into investments before performing thorough and thoughtful due diligence. In order to responsibly ensure that company funds are achieving the most they can for environmental and social impact, companies need to be 100% aware of potential risks in impact investing. To learn more about ESG investing due diligence with ImpactCheck, contact the experts at IntegrityRisk today.