Is ESG a matter of risk for business or for people and planet?
By Mauricio Lazala, Deputy Director & Head of Europe Office, Business & Human Rights Resource Centre and Johannes Blankenbach, Senior EU/Western Europe Researcher & Representative, Business & Human Rights Resource Centre
The rise of ESG investment appears unstoppable. Investors with more than $100tn in assets, including BlackRock, Vanguard and Amundi, have signed the Principles for Responsible Investment, a commitment to integrate ESG issues into their investment decisions. Meanwhile, the total assets in specialist sustainable investing mutual funds hit a record of almost $1.7tn in 2020, up 50% over the previous year.
However, as the concept gains currency, so too does the parallel risk of ‘greenwashing’ – to the extent that six in 10 institutional investors (59%) view greenwashing as their top concern when attempting to integrate ESG factors into investment decisions. Several popular ESG funds invest in the world’s largest carbon emitters, and the lack of reliable and standardised ESG information makes it increasingly difficult to differentiate between good quality ESG-compliant companies and investment products, and the rest. And our analysis suggests the challenge is even greater when it comes to the “S” in ESG.
Regulators are seeking to rein in green- and social washing through various pieces of legislation, such as the EU Taxonomy for sustainable activities, the EU Sustainable Finance Disclosure Regulation and the EU Corporate Sustainability Reporting Directive. However, it is clear too many companies and investors see ESG purely as a matter of business risk management. A recent FT article noted: “Many fund managers focus on ESG risks. What that means in practice is that ESG is used as a way of spotting previously under-appreciated risks and reducing the chance of losing money. For example, if a government crackdown on its opponents leads to civil unrest, that could hit the price of the country’s bonds…But while focusing on ESG risks can make investment firms appear virtuous, it does not always tackle the underlying ESG problem.”
This approach is upside down. It is these companies’ workers and the communities in which they operate who carry the more significant risks: to their livelihoods and to the land they depend on to work and live. When Belarusians came out to the streets en masse to protest the stealing of their vote, authorities arbitrarily detained thousands and subjected hundreds to torture and other ill-treatment. Yet companies investing in the country (with the exception of just a few such as Michelin) still only looked at how the situation could pose a risk to them and their profits.
In June 2021, accounting firm PwC said it would hire 100,000 employees over five years in a major ESG push, “aimed at helping its clients grapple with climate and diversity reporting.” Based on previous experience, it is not unreasonable to assume PwC’s focus will be on companies’ management of sustainability and compliance risks to their business, rather than on helping companies genuinely improve their ESG performance, behaviour and impacts along supply chains.
It may sound like old-fashioned NGO idealism to expect markets to renounce the supremacy of their bottom-line considerations (the “business materiality lens”), but ignoring the connection between risk to business and risk to people is dangerous. Just ask the cement giant Lafarge, which recently lost a Supreme Court ruling on complicity with crimes against humanity in Syria. In 2013 and 2014, company managers paid jihadist groups to keep its cement factory in northern Syria running during the early years of the country's civil war.
A different approach is not only possible, it also makes good business sense. Choosing sustainable investment does not mean compromising on return and many businesses which do so actually outperform their benchmarks. Moreover, a growing number of companies and investors (over 70 to date, plus many more signatories to joint statements) have publicly supported and endorsed the growing momentum for mandatory corporate human rights and environmental due diligence (mHREDD) regulation and legislation in Europe and beyond. If ambitious enough, it can make a tangible difference to the lives of millions of people around the globe. For companies and investors, it can create a genuine level playing field.
In 2018, the EU introduced ‘double materiality’ into its Non-Financial Reporting Directive, which looked at both how sustainability issues affect a company’s business and how the company impacts people and planet. However, due to weak reporting and weak standards, investors, governments and civil society have so far been unable to determine whether ESG issues are reported as a business risk or because they pose a threat to people and the planet. Civil society and others are therefore calling for better quality reporting, with a strong Corporate Sustainability Reporting Directive and corresponding sustainability reporting standards. Another piece of EU legislation, the Sustainable Corporate Governance initiative including mHREDD and corporate liability, should be the cornerstone of an EU sustainable finance and sustainability reporting architecture: it will have a key role to play in mandating and enforcing EU business action to prevent and remedy harms along global operations and value chains.
Companies and investors addressing the real impacts of their business on people and the planet will be ahead of the curve when these legislations come into force. They will also attract and retain the best talent, pull in cheaper financing, establish a crucial differentiating factor with their competitors and avoid potential lawsuits, backlash, boycotts, delays, protests and supply chain issues. Most importantly, they will make a substantive contribution to the life of millions, to a fast and fair transition towards low carbon societies, to the SDGs, and to a just recovery post-COVID-19.