Consider a coal-powered electricity generation project with the basic ingredients of a successful project – prime location, financial backing, technical capabilities, and government approvals. It is going to be the first coal-powered generation plant in Kenya. It relies on the provision of cheap reliable power as its key selling point.
In comes, the Environmental, Social and Governance (ESG) metric, and the proverbial walls come tumbling down. Following a landmark decision, the courts halt construction on ESG grounds. The court in its ruling nullifies the environmental impact and social assessment licence that had been issued by the regulator. It is found that climate change and adverse environmental and social effects of the project had not been exhaustively considered. In addition, public participation had not been effectively conducted. After the ruling, the project financier pulls out and the government cancels the project.
What lesson can organisations take from the above case?
ESG principles which were previously viewed as non-technical risks are now essential components that must be adequately and ethically considered. The responsibility goes beyond procuring or issuing permits and approvals. It demands high levels of scrutiny and embedding of ESG best practices into organisations’ strategies and cultures.
On the legal front, we are seeing the emergence of new laws and standards, an increased focus on enforcement of existing ESG regulations and a shift in stakeholder expectations. Growing commercial pressures derived from sustainable and impact investment requirements including ESG governance structures, policies, disclosures, risk assessments and reporting as a condition to financing abound for organisations.
ESG now transcends traditional compliance. Organisations are therefore looking to international guidelines, in addition to local laws, when configuring their ESG management systems.
Furthermore, as financiers world-over channel their capital to economic activities and projects that deliver sustainable outcomes, organisations are expected to demonstrate compliance with not just local sectoral policies but other best-practice standards such as the International Finance Corporation Performance Standards, the World Bank Environmental Health and Safety Guidelines and the Equator Principles.
Closer to home, as part of efforts to address climate-related financial risks in the Kenya financial sector, the Central Bank of Kenya issued the ‘Guidance on Climate-Related Risk Management’ in October 2021. This guidance is based on the Paris Agreement of the United Nations Framework Convention on Climate Change, under which countries committed to submit nationally determined contributions and communicate actions they will take to reduce their greenhouse gas emissions.
Consequently, the guidance aims to require banks to embed the consideration of financial risks from climate change in their governance arrangements and make disclosures of climate-related information. We expect climate-resilient projects will therefore be top targets for funding by Kenyan banks.
Separately, responsible corporates are also leveraging good ESG practices to demonstrate social legitimacy and generational equity. ESG is being utilised as a value creation proposition that can improve financial performance by tapping the sustainability-conscious market share.
The above observations suggest that organisations must shift their focus from profit maximisation to a more holistic assessment of their performance. This partly involves the development of a clear ESG strategy supported by functional compliance and governance frameworks.
ESG compliance strategy is three-fold: Environmental compliance is the first pillar. It includes conducting ethical and meaningful environment and social impact assessments, climate change disclosures and resource efficiency commitments such as good waste management and energy consumption efficiency and monitoring.
Social impact is the next pillar. It covers active community engagement, fair labour and supplier management standards, physical and mental health protection, equality, and anti-discrimination.
Governance is the last pillar. It covers ethical and strategic leadership, regulatory compliance, policies and procedures, stakeholder communication, accountability, transparency, and disclosure.
Organisations can create leading ESG compliance frameworks by first coming up with broad ESG commitments, which set the overall cultural tone. The vision should be embedded into bespoke ESG policies, governance structures and contractual language to promote purpose-driven operations when dealing with the market, employees, advisors, contractors, and suppliers.
When it comes to measuring framework effectiveness, timely ESG assessments, legal compliance and governance audits conducted by independent and qualified professionals should be used as an assessment tool, identifying gaps and giving recommendations for improvement.
Voluntary ESG integrated reporting should be adopted to aid transparency in the absence of mandatory requirements. This helps build trust with stakeholders and regulators. Disclosures should be based on qualitative and quantitative data with a focus on broad ESG contributors, for instance, fiscal contributions and community impact.
Needless to say, the propelled importance of ESG is gaining significant momentum. Across the globe, legal, commercial, operational, and reputational risks are increasing for entities lacking a robust and integrated ESG focus. This has been brought about by actions taken by governments, courts, and regulators in responding to community calls and international commitments.
Kabochi, is Head of Indirect Tax, PwC Africa. Ms Kipkulei is Manager, Legal and Regulatory Compliance Advisory, PwC Kenya.