Environmental, social and governance (ESG) issues have been moving steadily up the stakeholder agenda for years. Now, the trend has gained new impetus and a slight change of emphasis. For businesses at the forefront of ESG thinking, this represents an opportunity to engage more fully with customers, employees and investors.
The rise of the millennial has changed the way the world sees business. As baby boomers relinquish financial decision making to a younger, more socially and environmentally conscious generation, “impact” has become a buzzword, and companies that fail to consider their effect on the planet and people can quickly find themselves on the wrong side of popular opinion.
According to the New York-based Global Impact Investing Network, the amount of money flowing into “impact investments” has rocketed – more than doubling in the past three years – as individual and institutional investors seek out projects that provide environmental and social outcomes alongside financial returns.
Environmental, social and governance (ESG) investing is a subset of this trend, homing in on companies’ broader sustainability performances, regardless of what outcomes or products they promise to deliver. Having been the preserve of specialist investors for years, ESG investing has moved definitively into the mainstream.
Companies that put staff and customers first as part of a long-term strategy will be the most resilient when faced with challenges
In the second quarter of 2020, for example, inflows into European funds that allocate capital to “sustainable” companies accounted for almost a third of overall fund flows in the region, attracting €54.6 billion, according to financial data group Morningstar.
Tangible financial risks
UK-based ShareAction works with investors and companies on sustainability issues. The NGO’s head of corporate engagement, Simon Rawson, says that climate change is widely considered the most important ESG issue. High on the public agenda, climate change poses tangible financial risks – from changing consumer demand around food consumption and transport to drought-induced water shortages at factories and properties compromised by rising sea levels.
As regulators and investors seek to address these challenges, there are two common demands: that companies disclose their carbon emissions and how they intend to manage the risks posed to current business models. The Task Force on Climate-related Financial Disclosures (TCFD), set up by former Bank of England governor Mark Carney in 2015, is the main framework through which companies report this kind of information. More than 1,000 firms worldwide are now official “supporters” of the TCFD, and it is expected to become a legal requirement in some European and North American jurisdictions.
Alongside TCFD disclosure, companies are being asked to show strong leadership on climate change by appointing experts to their boards, setting emissions targets and factoring climate goals into pay packages. And as climate change reporting becomes more prevalent, the environmental lens is widening to take in other areas. The UK government announced this summer that it was working with companies, investors and international bodies to create a Task Force on Nature-related Financial Disclosures, paralleling the TCFD, to help keep tabs on how companies are protecting or damaging biodiversity.
In recent months, however, there has been a change of emphasis on ESG issues. As coronavirus has upended lives worldwide, the conversation has shifted away from green topics, and social issues have catapulted up the agenda.
“The pandemic has been a wake-up call about our vulnerability and interdependence, exposing risks to our health, society and economy,” observes Rawson. “There has never been more scrutiny of the way companies treat their workforces, for example. Investors are rightly asking questions about how firms are protecting lives and livelihoods.”
As coronavirus has upended lives worldwide, the conversation has shifted away from green topics, and social issues have catapulted up the agenda
Some businesses have been better than others at sensing the zeitgeist and responding accordingly. The UK’s biggest pub landlord, Ei Group, was praised by politicians and media when it agreed to waive hundreds of thousands of pounds in rent for tenants who were unable to trade during the lockdown. In Finland, food delivery start-up Wolt provided additional financial support for drivers that were diagnosed with Covid-19 or had to quarantine, in a bid to minimise the spread of infection. In China, private education provider New Oriental responded to the crisis by creating online training programmes for workers, which for the first time allowed the CEO and other senior staff to share their experiences of the company with workers.
Such moves do not just play well with the general public – they can also build more robust businesses, as Jean Rogers, chief resilience officer at US-based sustainability specialist LTSE, explains. “Companies with this kind of ‘stakeholder focus’ – the ones that put staff and customers first as part of a long-term strategy – will be the most resilient when faced with challenges,” she says.
Corporate value destroyed
Some firms have found themselves on the wrong side of the ‘S’ in ESG. Fast-fashion titan boohoo was holding up well against peers at the start of the pandemic – in part because it sources clothing in the UK, so it can be more responsive to sudden changes in consumer demand. This focus on local, UK employment also made boohoo eligible for investment by a number of ESG funds. But an investigation by The Sunday Times in July alleged that UK factories producing garments for one of boohoo’s brands, Nasty Gal, were paying workers below the minimum wage and were not observing Covid-related safety measures.
Boohoo swiftly issued a statement “condemning the conditions of the workers in the Leicester-based factory” and stating that early investigations showed it was “not a declared supplier”. “We will urgently review our relationship with any suppliers who have sub-contracted work to the manufacturer in question,” it promised. Despite this speedy response, investors were unforgiving. Boohoo’s share price almost halved in the weeks following the accusations and ESG funds abruptly exited the stock.
Elsewhere, the world’s largest rubber glove maker, Malaysia’s Top Glove Corp Bhd, had to repay millions of dollars to foreign workers after US Customs and Border Protection banned their goods, citing concerns over forced labour at the company – despite unprecedented demand for protective equipment.
“The recent high-profile ESG scandals, including boohoo, Top Glove and others, indicate the speed with which corporate value can be destroyed through this potent combination of poor governance catalysed by social media,” says Rogers. “These negative events have serious implications for firms, putting their reputations at risk, undermining the trust of stakeholders and damaging their sustainability ratings, which affect their eligibility for ESG funds.”
Businesses can put measures in place, however, to integrate ESG into their strategy and minimise the risk of damaging scandals.
“Companies need first to think about what their risks and opportunities are, and which environmental and social factors are most material to their business,” says Peter Dunbar, a senior specialist at the United Nations-sponsored international investor network, Principles for Responsible Investment.
Recent high-profile ESG scandals indicate the speed with which corporate value can be destroyed through a potent combination of poor governance catalysed by social media
“Once they have determined what issues are financially material, then the company, hopefully with the help and guidance of investors, can start to put together an ESG action plan on how to address those issues,” he adds.
ShareAction’s Rawson says ESG risks are still developing, and new topics will come into the spotlight over time.
The links between Covid-related fatalities and obesity have, for example, nudged issues around nutrition up the priority list for governments, campaign groups and the media. Rawson predicts that this will lead to health becoming “a material ESG issue in its own right” as laws are introduced to tackle unhealthy food and drink, so creating new legal and reputational risks for manufacturers and retailers in the sector. It may take time, however, for companies to grapple with new social demands.
“Delivering on the increased expectations about the ‘S of ESG’ is going to be difficult. The investment system is still just starting to respond to climate risks, with appropriate policy, frameworks, disclosure and goals. Comparatively, we haven’t even started the journey for social issues,” says Rawson.
For businesses that want to move quickly, the movement around climate change may provide a useful starting point. “We will need to draw on that experience to catalyse a similarly seismic shift when it comes to social issues,” says Rawson.
As a starting point, regulators in Europe have pledged to tackle opacity around social issues, bringing them more in line with climate change. The EU is overhauling current legislation, known as the Non-Financial Reporting Directive, which requires large listed companies to report on issues including employees, human rights, corruption and diversity.
Climate change poses tangible financial risks – from changing consumer demand around food consumption and transport to drought-induced water shortages at factories and properties compromised by rising sea levels
As well as being more prescriptive about how these issues should be reported, policymakers are expected to widen the rules to cover unlisted companies, too.
Keeping up with developments around transparency can curry favour with employees and customers, as well as investors. And Dunbar suggests that robust policies and systems promote positive change as well. “Companies can show leadership on ESG in other ways too, such as the presence of an environmental and social management system, along with various policies around health and safety, whistleblowing and more,” he says.
There is little doubt that ESG issues can no longer be considered as nice-to-have. Already widely discussed before the coronavirus pandemic, they have moved even more into the spotlight over recent months.
Today, the way businesses approach the ESG agenda can materially affect the way they are viewed and valued by key stakeholders. A challenge for laggards, this can also help those in the vanguard to distinguish themselves from peers, benefiting people, the planet and the bottom line n