ESG: The (New) CFO Imperative in Life Sciences
May 20, 2022
What used to be a nice-to-have practice, ESG, an acronym for environmental, social and corporate governance, has become a competitive advantage for life sciences companies that are rethinking what it means to attain security and resiliency in the wake of COVID-19. ESG, among other things, can be used to measure how vulnerable a company is to an external threat. Companies that effectively manage their ESG vulnerabilities, risks, and corresponding sustainability opportunities often deliver a long-term financial return. And that’s why ESG and sustainability are beginning to be a top priority for CFOs.
The question remains: What is required to accelerate investment capital, achieve competitive positioning, and mitigate operational risks for companies in the life sciences industry?
Better ESG and sustainability practices can improve access to finance, reduce costs of capital, and open doors to new markets, products, geographies, and suppliers. Managing ESG risks and opportunities means managing the transmission channels between the various and extremely broad ESG risk factors (e.g., climate change, employment practices, corporate governance, etc.) and the effect those bring to the financial planning and strategic goals of the company. In other words, these transmission channels are the cause-effect links that will result in a financial impact, which could be identified, measured, and managed by the CFO.
The first steps in implementing ESG practices in a company are to identify ESG risks and opportunities that would have a material impact on the ability of the company to achieve its objectives. The process of identification and assessment of the company’s risks and opportunities starts with establishing a pool of high priority ESG topics for the life sciences that are material to the company and all its stakeholders, especially to the investor community.
Let us start with the social component of ESG. A major ongoing concern of many life sciences companies is attracting and retaining good and diverse talent. If the company fails to retain or attract people, it will not be able to achieve its objectives in the medium term. High staff turnover and poor employment practices are extremely costly and will impact the company’s bottom line, future cash flows, ability to access finance, cost of capital, and more.
The social component also touches on human capital, including diversity, equity, and inclusion (DE&I). To assist with the identification of these risk factors and the transmission effects to the bottom line, the CFO must formulate a set of key questions related to that ESG topic. In the case of human capital, the company should ask if it has policies and strategies for talent recruitment, promotion, and retention and if there is a DE&I policy and strategy in place. If not, the company should consider implementing those strategies and establish a set of metrics and targets, such as employee turnover rates, voluntary and involuntary, with emphasis on the context of the turnover. Other important metrics could be gender pay equity, workplace stress, and mental health issues.
Another ESG topic that has a material impact in the life sciences companies is clinical trials. The company must be able to describe and disclose its approach to human rights, including informed consent and data privacy. The company must identify metrics for how diversity of the patient sample is being considered in trials and establish ethical standards for the treatment of enrolled patients throughout all the phases of the clinical trials.
Following clinical trials, another ESG major topics for life sciences companies are product quality and patient safety. The main question CFOs should ask themselves to support the identification of the ESG risks and causal relations to the financial statements is: What are the product quality management systems covering product, clinical trials, and patient safety? The company must be able to demonstrate and disclose that there is indeed a systematic process and governance in place for continuous product safety improvements.
There is also the issue of data security and privacy. The company must be able to demonstrate and disclose that it has a robust oversight mechanism for data security, cybersecurity, data protection standards and internal controls. The company should be able to describe and disclose the identification and management of risks related to third-party vendors, and demand that the client’s supply chain abides by the same ethical and governance standards as its own company.
Another relevant topic that has been catching the attention of stakeholders and the investors at large is supply chain management. Companies must be able to describe and disclose their practices toward suppliers and contractors, including policies of responsible procurement, fair competition practices, standards, and business practices. The firms must introduce a supply chain code of conduct or similar document that outlines a series of socially responsible practices including employment practices and environmental, health, and safety requirements. The firms should also create criteria for due diligence in the supply chain and third-party risk management.
Governance also plays a role in life sciences with respect to business ethics, integrity, and compliance. The company must demonstrate that there are policies and procedures in place for anti-bribery, anti-corruption and anti-competitive practices, including marketing practices. The company must be able to capture any event that had a financial impact in the form of fines, penalties, or sanctions.
The Biopharma Investor ESG Communications Initiative sets the best practices to introduce ESG in the life sciences, biopharma industry. According to the version 4.0 of their guidance document, the initiative’s goals are to address the common interest of companies and investors in achieving more effective, efficient, and decision-useful communications about the sector’s most important ESG topics. The guidance follows the same structure as the Task Force for the Climate-Related Financial Disclosures (TCFD) framework. The TCFD framework is designed to serve as a reference for climate-related disclosures, and introduces the four pillars of integration: governance, strategy, risks and opportunities, and metrics and targets. The SEC follows the TCFD framework for its proposed rule as well.
In summary, companies with stronger ESG and sustainability practices will be better positioned to manage their resources more effectively, attract and develop human capital, manage innovation, and get into different markets and geographies, which will have a clear and sustainable influence in the bottom line—also increasing valuation. All paths lead to better and more sustainable financial and societal returns and better valuations in the longer run.
What do strong ESG, and sustainability practices really mean? They mean a combination of complementary factors and initiatives that go from having a robust corporate governance and management structure that enables the company to identify the ESG risks factors and their corresponding sustainability opportunities (e.g., climate change risk factor linked to an energy efficiency opportunity, or the risk of high staff turnover mitigated by a strong diversity, equity, and inclusion policy and practice), and the financial impact of those risks and opportunities to the company’s strategy and business models in different time horizons.
Disclosing those elements to the various stakeholders, including investors, enables those individuals to have a better and much clearer understanding of how the companies sustain results in different time horizons. It provides investors with an opportunity to practice active ownership. That is the reason the SEC has proposed a rule under which public companies will have to disclose climate-related factors that impact their business and strategy.
Implementing better ESG and sustainability practices, as described above, is good for business and for investors. Opportunities to mitigate ESG risks, like being a better corporate social citizen, improving energy efficiency, procuring alternative renewable energy sources, being a better employer, applying high standards of business ethics, having a strong risk management and robust corporate governance, being transparent and disclosing every aspect of ESG integration, including carbon footprint, are not only good for those companies, but also for those that invest in these companies. Better ESG and sustainability practices are good for the planet and, consequently, for our society, today and in the future. And they are also good for your life sciences company.