Boards need to carefully navigate a wild ocean because of COVID-19 – will ESG still matter now?

June 2020 | SPOTLIGHT | BOARDROOM INTELLIGENCE

Financier Worldwide Magazine

June 2020 Issue

Corporate boards around the world are under unprecedented pressure. Many of their members have the right experience and have lived through a previous economic downturn or two (or three) during their corporate or entrepreneurial lives. In fact, some directors will have first-hand experience with major economic crises other than the dotcom bust at the beginning of the century and the 2008 financial crisis. However, the health and public safety aspects of the current coronavirus (COVID-19) pandemic cause the immediate economic fallout to be tremendous in an exceptionally broad range of sectors.

That, in turn, has hit employment hard and fast, in the US but also elsewhere. Among others, travel and leisure businesses (a large part of the ‘real’ economy) are ‘dead in the water’. Many of those businesses will not likely bounce back anytime soon. Social distancing, health and safety concerns, and the lingering effect of lost incomes and investments, will last for the foreseeable future. For now, we can no longer completely fill up airplanes, bars, restaurants, hotels or offices for that matter, even if businesses and consumers would want and could afford to do so.

Although some businesses are doing quite fine during these times (such as providers of IT products and services, as well as healthcare-related businesses), corporate boards now need to fully focus on the crisis at hand. The magnitude of the crisis is such that it justifies substantially increased levels of board activity, comparable to a takeover and other company-critical events. In these times, formation of a special committee of the board is appropriate. Non-executives should now prove their worth, and truly question their company’s executive team, while providing them with solid advice.

Those non-executives should be there because they have relevant experience and varied backgrounds, and can see across business and company lines. They should be able to look at the big picture, monitor the bottom-line and the maintenance of financial rigour, while pointing to best practices they see elsewhere and that might be available for implementation by the company as well. Non-executives not only can, but should, do all that, while at the same time respecting their non-executive role and staying out of their executive team’s way when it comes to actual execution. During this COVID-19 crisis – a truly wild ocean to carefully navigate – who has time to bother with the environmental, social and governance (ESG) issues that were such a big deal last year? Will ESG now simply turn out to be a fad? This is not likely.

Why, even now, boards cannot afford to neglect ESG

For starters, individuals, other corporates and governments expect social contributions from companies worldwide. Boards will need to work out how they can deliver on those expectations without losing their own sure footing. Governments around the world put pressure (sometimes friendly, sometimes less so, and sometimes by naming and shaming) on corporates capable of manufacturing or distributing medical supplies or protective gear (even when that is not their normal business) to do so.

Financial institutions in many countries are being asked not to call in loans where they might actually be entitled to do so due to covenant breaches. Shops selling essentials are to stay open (arguably exposing their employees to serious health risks) while others remain at least temporarily closed (exposing their employees to unemployment risks). At the same time, entrepreneurs and businesspeople are using their personal and corporate resources to simply ‘do the right thing’. For instance, Salesforce.com’s Marc Benioff used his, and his team’s, experience and power in the market to quickly and effectively buy hospitals protective gear from China.

Those actions do not go unnoticed. Apart from the charitable aspects of the efforts made by Mr Benioff, the efforts are likely to reflect favourably on Salesforce.com as well, from customers’, employees’ and investors’ point of view. The same will be true for many other individuals and businesses that step up to the plate during these difficult times.

Earlier this year, people were discussing whether the focus in recent years on the environmental part of ESG (whether or not in response to public pressure) was threatening a loss of focus on the social and good corporate governance aspects of ESG. How the world can change in two months. Although we all were aware of the pandemic reaching large parts of the world by early March, it was not yet clear what type of social commitments would be expected or seen from European and US businesses over the months to come. In fact, somewhat paradoxically, many people are now pointing out how the environment appears to be taking care of itself as people travel and pollute less. Irrespective of the merit of such musings, it seems likely that those people will once again contribute to rising pollution levels in the future when it becomes possible to travel safely again, and economic recovery heads in the right direction.

In short, ESG is very much alive and kicking, and not just something of the quaint distant past when, in mid-2019, the US Business Roundtable, in a high-profile public letter moved “away from shareholder primacy, including a commitment to all stakeholders”, or in January 2020, when BlackRock’s Larry Fink wrote: “Yet, we are facing the ultimate long-term problem. We do not yet know which predictions about the climate will be most accurate, nor what effects we have failed to consider. But there is no denying the direction we are heading. Every government, company, and shareholder must confront climate change”. Now, in May 2020, the Business Roundtable chief executives may have moved on to their response to COVID-19, but in doing so are emphasising a focus “on ways to support employees, customers, communities and the country”.

As the Business Roundtable and Mr Fink illustrate, major corporate chief executives and investors alike are now heavily invested in a commitment to ESG. In fact, public and political sentiment suggest there is no way back. Also, companies heavily hit by the economic consequences of the COVID-19 crisis will need to continue to adjust to ESG requirements and expectations. If not, they risk alienating the customers, employees and investors they so badly need right now.

In legal terms, all of this translates into the protection of ‘stakeholder interests’ and ‘long-term value creation’. It is intriguing to see how those principles, which, for a long time already, have formed an integral part of Dutch corporate governance, now gain more momentum in the US. Although other European corporate governance codes have also for years espoused a strong ‘stakeholder focus, the Dutch code remains particularly explicit on this point (as does Dutch case law).

This is also echoed by the Dutch securities regulator, the Netherlands Authority for the Financial Markets (AFM), and its secretary of the treasury, which recently announced a renewed regulatory and legislative focus, respectively, on the protection of stakeholder interests and long-term value creation. On a European level, this same focus is reflected in the current review of EU Directive 2014/95/EU dealing with the disclosure of non-financial information, which entered into force starting with the 2017 financial year, as well as the European Securities and Markets Authority (ESMA)’s February 2020 announcement setting out its strategy on sustainable finance. In the UK, Mark Carney appears to have been particularly impactful, also among leading fund investors, with his stark warning of a climate crisis that requires action to be taken now.

Frequently, a focus on ESG is publicly contrasted with the ‘short termism’ of ‘activist’ investors. Although it is hard to generalise the point, that characterisation is unfair. Many ‘activists’ actually focus on environmental protection, realise the importance of company employees, look out for customer opportunities, pursue good and transparent corporate governance practices, and serve the interests of retirees to boot. It is also not for nothing that many of the world’s leading institutional investors regularly vote with (and even frequently publicly support) ‘activist’ shareholders in campaigns in which those ‘activists’ seek corporate governance changes (typically focused on increased transparency and shareholder ‘say’) or promote action that might unlock value.

The ‘G’ in ESG continues to stand for governance. ‘Activists’ and institutional investors alike want to be heard by corporate boards. Non-executives will need to make sure that those boards actually listen. And when customers, good employees and investors all care about the protection of environmental and social aspects, there is not necessarily a need for conflict between ESG and creating shareholder value.

In the meantime, with their focus on ESG, institutional and other investors, as well as many corporate boards, appear to be ahead of legislators and regulators around the world. Boards that want to optimise their chances of receiving equity and other funding will simply need to demonstrate to investors that they are serious about ESG as well.

The pressures corporate board members face these days are not to be underestimated. Addressing the threats to their individual organisations posed by the COVID-19 crisis requires their full attention. Although that effort, rightly, takes top priority right now, boards will have no other option than to proactively continue to focus on ESG measures and reporting as well. Like it or not, ESG is good business.

Alexander J. Kaarls is a partner at Houthoff. He can be contacted on +31 6 5165 9263 or by email: a.kaarls@houthoff.com.

Alexander J. Kaarls

Houthoff