The challenge for shareholder engagement lies in defining materiality. Which ESG factors are material to operations, reputation or profitability of the enterprise?

As the Chief Sustainability Officer for Nestlé Waters North America, Nelson Switzer is responsible for the company’s approach to water stewardship, responsible packaging and community relations and investment. Through collaboration and enabling constructive engagement, Nelson helps identify issues and matching solutions to complex environmental, social and governance challenges. Nelson has nearly 20 years of experience advising and working in the public and private sectors at the local and global level including leading sustainable business solutions at PwC, head of sustainability at Centrica plc NA and senior manager of environmental affairs with the Royal Bank of Canada. Nelson resides in Toronto with his wife and two boys.

Christopher P. Skroupa: It’s interesting that one of those things we try to do in our convenings is help companies connect the dots between ESG factors and value. How should companies identify which ESG factors are material to operations, reputation or profitability of the enterprise and therefore worth communicating? Which factors help give companies a competitive edge and demonstrate the integration of ESG into value?

Nelson Switzer: Let me start by answering the second of your three questions. First, one must begin with a traditional materiality assessment. That is the common tool used to understand on what the organization should focus. It reflects what stakeholders care about and impacts the company should consider to the business, either operationally or financially or reputational and so on. To answer your first and third question, we need to go further.

After the materiality assessment has been completed, actions are planned and, usually, implemented to manage the issues initially identified. Here is where the rubber hits the road because there is a second assessment that needs to be done—the material action assessment. This allows the company to understand whether the actions planned and implemented made a difference in perception and performance. This allows a company to determine what value was created, if any, and make course corrections or double down on effective programs.

The secret is using these processes to make sure you have identified the issues and actions that actually affect the decision making of your stakeholders. That is how it ties back to that notion of materiality. Moreover, it provides insight into the ability of your organization to operate and create value. What stakeholders are going to be impacted by your operations? Then tying that back not just to the return on invested capital, but the goals you have set as an organization to achieve.

Skroupa: In terms of materiality, what is the process you go about in teasing out materiality and how do you validate or how do you assure what goes into materiality?

Switzer: We can never secure assurance, but we can certainly seek validation, which we do. That means we consult with a variety of stakeholders—those recognized as thought leaders and those who are actually physically or otherwise affected by a particular indicator or operation. We seek to find out what this means to them: How are you impacted by this or what is the benefit that you are actually seeing? Only then can we truly understand. As you know, a traditional materiality analysis is essentially a cross-section between what is the perceived impact, or the level of importance to a stakeholder, and the notional impact to your organization. So when we think about those two, everything is a best guess. You are quantifying based on scales, but even so, each and every one of those is based on perception.

We have a responsibility to try to be as honest as we can with ourselves and to try to validate that material with stakeholders. We do that through a variety of ways. For example, we follow a community relations process that we designed internally. During that process we identify who are our material stakeholders in the local community, and what are the issues they care about? We ask them the questions directly, and we have an interactive discussion.

Skroupa: I guess in a way that was my lead-in to second next question, which you kind of answered. They always say that there’s a connection in performance between those companies with the greatest stakeholder engagement or those with the greatest ability to receive stakeholder feedback on company performance, especially on some issues like ESG and CSR. Do you think that’s true?

Switzer: I think it’s true with a caveat. The fact of the matter is you can engage consistently and regularly with a great number of stakeholders, but it’s not just about how much engagement you conduct; rather it is about the quality of engagement.

So first you have to make sure that the stakeholders with whom you are engaging are those groups or individuals whose decisions actually affect your organization’s ability to create value and to operate. They are your material stakeholders. The second thing you need to do is make sure what you’re getting from them is honest feedback and answers. Just like any survey that you might set up, there’s a science to how you send out a survey to ensure it is unbiased, that you’re getting genuine information—strong and actionable information. So yes, I agree that organizations that have robust stakeholder engagement tend to outperform in a lot of areas; however, only if they do it in a manner which is transparent and as objective as it can be.

Skroupa: I agree with that, and I think most folks who are operating in positions like yours inside of companies want stakeholder engagement to be contextual and more than simply inputs from those around and about. Is there relevance in measuring and reporting on the impact of ESG activities or is there an alternative? What would be an alternative to reporting?

Switzer: Well, let me begin by answering the first part—is there relevance in measuring and reporting? The reason I think about that question often is because so many people say to me, “We’re going to do it because it’s the right thing to do.” And I will admit, 20 years ago when I started in this space, I bought that line and I thought, “You’re right. We should do it because it’s the right thing to do.” However, as I’ve progressed, and I’ve been involved with more and more complex projects at large and small companies, government, etc., I recognize there are only a limited number of resources within any entity no matter how big you are, no matter how successful you are, and prioritization is incredibly important.

So we need to be able to measure not just the impact of an activity, but also the potential of any activity that we might undertake. That allows us to provide information that can inform the decision-making and prioritization of the people who need to consider so many factors, of which sustainability is one.

The next thing, and what also makes it so important, is when you’re sharing that information, how is it going to shape a company’s culture? How is it going to educate and inspire your team to change? The notion of providing people with information often rewires something within them. We want to think about what it is we’d like this organization to do—what do we want it to be—and so you have to be very cautious and thoughtful on that.

To the second part of the question about alternatives to measuring and reporting—the alternative is not reporting. Some have taken the approach that if sustainability is baked into company culture and operations, then it is unnecessary to report. Overall corporate performance will demonstrate the value add. I don’t fall into that camp because it doesn’t allow the level of transparency stakeholders expect nor does it allow us to measure the effectiveness of our programs.

Skroupa: Interesting. What are the most relevant ESG factors and stakeholders for the coming five years? What is changing out there and where will the leverage for accountabilities come from over the next five years?

Switzer: There are a couple of trends we’re seeing. The first trend comes from what we have seen over the last 15-20 years or so. The number of ESG factors being disclosed has become so extensive—the list every year gets longer and longer. CSR tables, sustainability tables, the data tables—they get more and more robust—but now, we’re starting to see gross consolidation. Organizations are recognizing that the number of factors, the sheer quantity, isn’t nearly as important as the quality and materiality of those factors. So what are they and what is the story they’re telling?

So again, the first trend is consolidation. It is important to understand the environmental, social and governance factors that affect the organization, that have an impact, whether it is on profitability, success, growth or whatever the objective is against which they’re being measured.

The second trend that we’re seeing, which I think is incredibly important, is the ability to provide data to people in a manner that makes it engineerable, or even re-engineerable. Not too long ago, people would just publish a number, a series of numbers, and it was difficult analyze those numbers because you couldn’t reverse engineer them. You’re seeing more and more organizations taking that information, pulling it apart and putting it back together. They’re being more transparent.

To more directly answer your question about what are those relevant factors for the coming five years, I’d say it falls into two different buckets. One is on the scale and scope—so those will be global, regional and local. On the other side, it’s about relative impact. To get specific, the factors that are really going to start to matter are those that affect the ability to continue to grow.

There’s an expression, I wish I could claim as my original content because I think it is so smart, but alas someone much more clever than I said that most of Western society right now is in nation-protection mode rather than in nation-building mode. When we’re in growth mode we see incredible opportunities to innovate and be creative—we take risks and that allow us to leapfrog the status quo. That’s one of the reasons we’re not seeing as much innovation these years because most are in a protection mode.

So what we’re going to start to see, I think, are indicators that demonstrate innovation, social prosperity and environmental resource conservation. But I’ll say this: Even though that’s what I think what’s going to come next, what I’m hoping will be the case is that we see people start to think about metrics around either the net value that is created or the net value that is depleted as a result of any entity, whether you are a corporation or government or otherwise. That will truly inform decision-making. Moreover, if that information is publicly disclosed, we will see a different type of investor and investment type emerge.

Skroupa: That’s very interesting. We actually run a conference called the 21st Century Company, which is an outlook on innovation and how things are proceeding and we hear a lot about that. How can a company assure that their ESG messages are able to rise above the din of traditional economic reporting? We usually approach ESG reporting as not moving on par with traditional economic reporting. How do you think ESG reporting can add color and add texture and add flair to a stakeholder’s understanding of company performance?

Switzer: Well, we must recognize they are co-dependent entities, that there’s no such thing as an externality—that is the most important piece. There has to be a very clear mandate within any report that says this is an integrated report with correlating and interdependent factors. The way that a company can really help ensure they rise above the din; however, is first to actually state their ESG indicators and then put them within their annual report or filings. So that notion of integration is a little bit different than just adding them.

What we have seen over the last, I’d say 10 years really, are annual reports containing three to 10 pages that show three environmental social and governance elements: data; risk management (such as you’ll find in the management disclosure) and a commitment from the CEO in their letter in front of that report. It has now become the standard. The distinction with the integrated report is weaving in all of those factors that actually influence your performance into each section. So it’s not just, “Here’s a table of our balance sheet, a table of our assets, our equity and so on.” It is that integrated aspect that shows how, for example, the reduction in greenhouse gas has impacted your profitability, impacted your logistics, your supply chain, your value chain, and so on. I think that’s one of the most potent and powerful things a public entity can do.

The second thing, if we’re going to get a little bit more creative, is each company has an independent purpose. Even though we might operate in the same sectors, we all really do things very differently and each company needs to identify that one thing, or two things, that they do exceedingly well—better than anybody else—and they need to lay that out, take a position on it, get aggressive with it, be inspired by it and inspire others to learn from it. I think a traditional annual report is an uninspired document, and we have an opportunity to reinvent them so they do inspire.

Skroupa: I’m hearing a lot of conversations lately how sustainability and how good ESG is built into the cost of capital and that the regulatory environment, driven by the present political environment, is not going to really affect company commitment to sustainability or to the “E” or the “S” or the “G” in ESG. Do you agree with that?

Switzer: With the current political environment, will the focus on ESG decline or how will it change? I don’t think that it will decline, and I can tell you why.

Let’s think about the last three economic downturns. The first one saw a pretty quick turnaround for some, shedding off various initiatives, many of them within their sustainability fields and ESG activities—a lot more of the “E” and the “S” than the “G.”

And then the second one, not quite so much. People, I think, had enough time working with these things to see the value that was being created for their entities, whether it was customer loyalty, or because they had great cost-reduction opportunities. Whatever it was, I saw that diminish.

During the last downturn, sustainability didn’t go anywhere. In fact, I thought I saw deeper investment because we were looking at so many of these market corrections before as economic events. But, when we look at the last two downturns, they were not necessarily connected to economic events—they were connected to poor governance. Now, we suddenly have this need and this desire to double down on good governance so that we can continue to outperform, and that was an incredible thing to see.

So with the new political realities emerging, a lot of those strong governance procedures and rules and guidelines that were put in place by the last administration to deal with those issues, to prevent it from happening again, yes, many are being stripped away. However, I think companies saw so much benefit from it internally and as a return to their stakeholders and shareholders, I don’t think they’re going to abandon it. I don’t think it would be in their best interest. So I think we will see continued investment—and quite frankly, likely a deeper investment—by those that understand and see the return on investment of ESG.

One of the other reasons they don’t want to see it go is because if it does, it presents uncertainty to them. When you’re in an organization that size, making these decisions is a multi-year—sometimes multi-decade—investment, and certainty is everything.