ESG Wave Helps Businesses Break New Top Line Growth, Improves Resource Efficiency, Undoubtedly: McKinsey & Co

A strong ESG proposition helps companies tap new markets and expand into existing ones. Demand for low-CO2—or “green”—products are ramping up as end customers, manufacturers, and governments push for increased sustainability and circularity.

BusinessToday held a recent discussion with McKinsey & Company Partner Vaibhav Dua (pic) and Associate Partner Rohan Jain, on the need for Malaysian companies to step up the pace of acclimatising with Environmental, Social, and Governance (ESG) investments.

Adopting ESG principles means that corporate strategy focuses on the three pillars of the environment, social, and governance. This means taking measures to lower pollution, CO2 output, and reduce waste. It also means having a diverse and inclusive workforce, at the entry-level and all the way up to the board of directors. ESG may be costly and time-consuming to undertake, but can also be rewarding into the future for those that carry it through.

BT: Why is it important for companies in Malaysia, whether it be a large corporation or an SME, to take on a successful net-zero transformation for their businesses in Malaysia? What are the advantages for doing so?

McKinsey & Co: Our view is that there are five ways in which ESG creates value for businesses. The “E” in ESG stands for “environmental criteria”, of which Net Zero Transitions are an increasingly important part.

Top Line Growth – A strong ESG proposition helps companies tap new markets and expand into existing ones. Demand for low-CO2—or “green”—products are ramping up as end customers, manufacturers, and governments push for increased sustainability and circularity. Our research has shown that customers say they are willing to pay to “go green.” We’ve found that upward of 70% of consumers surveyed on purchases in multiple industries, said they would pay an additional 5 percent for a “green” product if it met the same performance standards as “non-green” alternatives. In addition to a shift in customer preferences, upcoming regulations such as “CBAM” in Europe could directly impact some companies’ ability to grow in some markets, unless they take action to address their emissions. 

Cost reductions – Net Zero transformations lead companies to focus on improving their “resource efficiency” (for e.g., the amount of energy, water, and waste used in relation to revenue). Executing ESG effectively can help combat rising operating expenses (such as raw-material costs), which our research has found can affect operating profits by as much as 60%.

Proactive approach towards regulation – World over, commitments to Net Zero are increasing. Today, over 91% of global emissions are under Net Zero commitments, yet 25% of these commitments are not yet captured in the respective countries’ legislations. We expect an increasing number of these commitments to be captured in legislation, and regulations being introduced to require companies to decarbonize. Companies will benefit from a head start in executing this transition and will be better able to meet regulatory requirements. This can be seen in Malaysia too, where a compliance carbon market is being considered

Employee productivity uplift – A strong ESG proposition can help companies attract and retain quality employees, enhance employee motivation by instilling a sense of purpose, and increase productivity overall. Recent studies have also shown that positive social impact correlates with higher job satisfaction.

Raising financing – Over the past few years, many banks have made public commitments to reduce their “financed emissions,” meaning the emissions they finance in the real economy, is in line with the objectives of the Paris Agreement. This commitment is seen in the number of banks joining the Net-Zero Banking Alliance (NZBA), which grew from 43 to 122 banks, representing 40 percent of global banking assets, in just over a year. This will create direct incentives for companies to reduce their emissions, to continue to obtain competitive financing.

While many of these trends are global, they could, in time, become prominent in Malaysia too.

BT: According to the United Nations, shifting to a green economy could yield a direct economic gain of US$26 trillion through 2030 compared with business as usual. In ASEAN, green growth opportunities will require more than US$172 billion worth of capital expenditure and could create 30 million jobs by 2030. Ironically, only a small number of businesses are well positioned today to reap the benefits of the climate transition that is already under way. Why is this so?

McKinsey & Co: Many developed economies (such as those in Europe) moved early towards climate transition. Even prior to Net Zero targets, European economies were exploring different mechanisms to enable decarbonization, such as creating the EU Emissions Trading System. As a result, these economies had a head start in building capabilities and required infrastructure for the green economy, such as renewable electricity generation.

Take Norway for example. In 2017, Norway had enshrined a Net Zero target into law, being among the first to do so. Norway today not only has the one of the greenest grids (> 95% of electricity production in Norway from renewables) but also has the highest penetration of EVs.

Companies in these economies, similarly, have been able to pivot to green businesses. For e.g., many legacy hydrocarbon-based businesses are today heavily focused on renewable energy, biofuels etc., and are considered leaders in the green economy transition in their respective sectors.

Compared to this, the momentum in other geographies, such as Asia, is more recent. In fact, as recently as 2021, only 2 ASEAN countries had firm Net Zero commitments. There has been an increase in commitments recently, and with that there are multiple opportunities to capture value in green businesses today. There are already examples of local players gaining momentum in businesses such as EVs (2-wheelers, battery manufacturing) in geographies such as Indonesia and Thailand.

We see exciting opportunities, and emerging momentum across themes such as renewable energy, EVs, hydrogen, CCUS, bio-diversity and nature preservation. ASEAN businesses can start their green journeys now by assessing the growth potential in their industries and identifying which opportunities align with their business, strategy, and risk profiles.

BT: As business leaders set increasingly ambitious commitments to their ESG strategies, a voluntary carbon market can help companies and nations to offset their emission footprint and meet their climate-change goals at a quicker pace. How would this be beneficial to companies and the nation in general (in Malaysia and a larger context, in Asia)?

McKinsey & Co: Carbon markets can be an instrument to enable Malaysia to meet its climate targets, create new economic activities in the country, and keep its companies competitive.

Firstly, meeting Malaysia’s climate commitment of carbon neutrality by 2050 will require not only reducing its emissions, but also maximizing the carbon sequestered in Malaysia’s natural environment. Malaysia has more than 18 million hectares of forest cover, which sequesters ~260 Megatons of CO2e (which is ~70% of Malaysia annual emissions). This carbon sequestration can be protected, and increased, through carbon projects, that generate carbon credits.

Carbon markets support these objectives, as the purchase of carbon credits helps capital flow to companies that develop carbon projects, such as nature-based sequestration projects. Voluntary carbon credits direct private financing to climate-action projects that would not otherwise get off the ground. These projects can have additional benefits such as biodiversity protection, flood prevention, public-health improvements, and job creation.

Secondly, generating carbon credits requires a host of new activities, such as developing and executing carbon projects, validating carbon project design, and verifying effective execution of carbon projects (by companies known as VVBs). New services such as carbon financing, trading and advisory would also be demanded. Such services do not currently exist in Malaysia and will help create new capabilities in the country

Benefits to companies: Carbon markets can help Malaysian companies meet their own decarbonization targets, for e.g., by compensating for their hard-to-abate emissions. Making progress towards decarbonization targets can help companies access new avenues of growth, achieve cost reductions, be better prepared for new regulations, have more engaged employees, and better access to financing.

Rohan Jain

BT: What would be the potential for Malaysia – despite at nascent stage to offer up to 40 million tons of CO2 carbon credit annually through its rich forest cover?

McKinsey & Co: While our modelling suggests that Malaysia can generate up to 40 MtCO2e carbon credits annually, achieving this will require both time and effort. Currently, according to our project database, Malaysia has only two active projects that can issue carbon credits. New carbon projects can require up to 2-3 years before they can issue carbon credits. Therefore, to achieve the supply potential for 40 MtCO2e carbon credits, it would be crucial to start efforts to mobilize carbon project developers soon. Achieving the 40 MtCO2e could take over a decade.

To achieve carbon credit generation in line with its potential, Malaysia would need to harmonize the design of voluntary and compliance carbon markets, define clear rules and guidelines for carbon project development, scale up carbon financing, and support building of local carbon project development capabilities.

McKinsey recognises building an effective voluntary carbon market will require concerted effort across several fronts – a resilient, flexible infrastructure that can match buyers and suppliers through sustainability projects. Growing the education and participation among companies can be a gamechanger for Malaysia where such projects holds much potential thanks to its lush forest and strong weather.

BT: With the overall objectives of an effective voluntary carbon market in mind, what are the needed prerequisites and measures to be taken by the local SMEs to ensure, firstly, lessening the carbon footprint in Malaysia, and secondly, a means to profitability?

McKinsey & Co: SMEs should first quantify their carbon emissions and set targets (which could either be voluntary or driven by regulatory requirements).

They should then identify what initiatives could help them abate their emissions to reach their targets. Some of these initiatives could be cost effective (for e.g., improving their energy efficiency) while others may become cost effective in the future

SMEs can then also explore what their interactions (if any) with carbon markets could be – they could be buyers of carbon credits, or they could seek to participate in activities that support carbon credit generation, for e.g., developing projects that can generate carbon credits or providing services to carbon projects.

BT: How can companies benefit from carbon offsets in their decarbonisation journey by supporting climate-action projects take offs?

McKinsey & Co: Firstly, it is important that purchase of carbon credits should not be seen as a replacement for internal carbon emissions abatement. Companies should first maximize their efforts to abate their emissions, and then consider carbon credits for the hard to abate emissions.

Carbon credits can help Malaysian companies in three main scenarios:

If Malaysian companies are subjected to a compliance carbon market, and if carbon credits are admissible in the compliance markets, then carbon credits could be used against their compliance requirements (For e.g., in Singapore’s carbon tax, carbon credits can offset up to 5% of a company’s taxable emissions)

Alternatively, Malaysian companies can use carbon credits to voluntarily compensate for their hard-to-abate emissions, in the journey towards their climate targets

Finally, companies can also consider using carbon offsets to develop “carbon-neutral” products and services

BT: What are the qualities of a voluntary carbon market that is transparent, verifiable, and environmentally robust?

McKinsey & Co: Firstly, Clear, well understood, and widely accepted quality criteria are important to help verify that carbon credits traded in the market represent genuine emissions reductions

Secondly, a uniform set of attributes need to be defined, to help distinguish different categories of carbon credits. These attributes help sellers to better market carbon credits, and buyers to find carbon credits that meet their needs

Thirdly, it is key to create fair and orderly trading rules and have robust clearing and settlement infrastructure to create confidence among the market participants

BT: What are the main guiding principles for companies on their journey to adopt carbon credits in 2023 as Malaysia commits to its 2030 carbon targets?

McKinsey & Co: Purchase of carbon credits should not be seen as a replacement for internal emissions abatement. Internal emissions abatement through increasing sustainability focus and use of carbon credits is not an “or” approach, but an “and” approach. Companies should first maximize their efforts to abate their emissions, and then consider carbon credits for the hard to abate emissions.

Carbon credits could be used to meet part of compliance targets, if the design of the compliance market allows it (the design of a compliance market is yet to be announced for Malaysia)

In addition to compliance requirements, despite best efforts to prevent and reduce emissions to meet voluntary targets, there may be some residual emissions at any point of time that would be either technologically unfeasible or too expensive to mitigate. Carbon credits can be used to compensate for these residual emissions

Carbon credits can be bundled with products and services to create “Carbon neutral” offerings

All carbon credits used should adhere to stringent quality requirements, in-line with globally accepted best practices

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