Environmental, social, and governance (ESG) risks and opportunities are increasingly important to auto dealerships for a variety of reasons. In this article, we will explore what ESG is and why it matters in the industry.
What is ESG?
First, it's important to understand what ESG means. ESG is a risk framework that began years ago when financial institutions began to realize that traditional financial risk models that assessed balance sheets and P/L statements, for example, did not accurately assess long-term risks; they were mere short-term snapshots of a company’s outlook. In recent times with the political polarization occurring throughout the world, but especially in the U.S., there came a realization that financial institutions needed to stop in to stave off systemic risks through, what is now known, as ESG. In a nutshell, ESG is the private market’s response to managing long-term risks and better assessing and seeking-out sustainable investments.
How is ESG performance measured?
ESG risk analysis is conducted through the lens of considering long-term environmental, societal, and governance risks. To help investors, underwriters, and lenders make these risk assessments, there are ESG performance standards and ESG ratings agencies that aid in standardizing a company’s performance outlook on E, S, and G risk factors, which vary in financial materiality depending on the industry.
Generally speaking,
- Environmental risks relate to a company's impact on the natural world and efforts to reduce its carbon footprint as well as the natural world’s impact on business (i.e. increasingly frequent and severe weather events).
- Social risks refer to a company's impact on its employees, customers, and the broader community.
- Governance risk factors refer to a company's quality risk controls, business strategy, transparency, and ethical practices.
For the auto industry there are a number of financially material ESG issues, but at the top of the list would be some of the environmental (E) risk factors and opportunities.
Why does ESG matter to auto dealerships?
Climate change and the energy transition that is underway in the global economy in the “E” of ESG, in particular, can have a number of impacts on auto dealerships. Some of the ways in which climate change could potentially affect auto dealers include:
1. Regulations and policies: Governments around the world are adopting policies and regulations to reduce greenhouse gas emissions, which will impact the production, sale, and use of vehicles. For example, some governments have implemented fuel efficiency standards or implemented incentives for electric vehicles, including the U.S. in a number of recent, large federal infrastructure packages, including the Infrastructure Investment and Jobs Act as well as the Inflation Reduction Act.
2. Consumer demand: As climate change becomes a more pressing concern, consumers may be more inclined to purchase vehicles that are more fuel efficient or have lower emissions. This could impact the demand for certain types of vehicles and the overall sales of auto dealerships.
3. Supply chain disruptions: Anticipated climate-induced weather events will lead to disruptions in the supply chain for auto dealerships, such as shortages of certain materials or disruptions in transportation due to extreme weather events and the well-known supply challenge of semiconductors and microchips, as a result of the COVID-19 pandemic.
4. Physical damage: Auto dealerships could also be at risk of physical damage from extreme weather events such as floods, hurricanes, and wildfires, which are becoming more frequent and severe due to climate change.
It is important for auto dealerships to be aware of the potential impacts of climate change and to consider them as part of their overall business strategy. While the solution for reducing severe weather events is greater than the auto dealership industry alone and will take an “all hands on deck” approach to meaningfully solve, adopting sustainable practices, such as reducing energy use and emissions, and preparing for the potential risks and disruptions that could result from climate change would be wise. In other words, adapting to the change upon us while simultaneously participating in solving the problem is the best way forward.
Read our How auto dealerships can prepare for and manage ESG and climate risks article where we go into more detail on how auto dealerships can prepare for and manage ESG and climate risks.
