Why now is the time to hit the reset button and embrace ESG

November 2020 | SPOTLIGHT | BOARDROOM INTELLIGENCE

Financier Worldwide Magazine

November 2020 Issue

In light of coronavirus (COVID-19), the opportunity may never be greater for organisations to finally cohere around a more socially conscious approach to business that creates greater benefits for all.

If history teaches us anything, choices made during crises can shape the world for decades to come. But the current COVID-19 crisis is alarming, in part because it has several new and unfamiliar features. A global medical emergency caused by a virus we still do not fully understand. A self-inflicted economic catastrophe as a necessary political response to contain its spread.

But while moments of crisis can lead, as we have seen, to heroic and unprecedented actions, the sustainability of those actions is where the true path toward recovery will begin. But the world will only look significantly different this time if, as we emerge from this crisis, the path is paved with not only good intentions, but with meaningful change.

And it needs to change because in less than six months, beyond the devastating human cost, the depth and scale of the pandemic are enormous, triggering seismic economic and societal changes. Moreover, in addition to its twin burden on our lives and livelihoods, it has thrown new light on the profound interdependencies in human and natural ecosystems, sparked civil unrest, raised concerns about economic inequality, and has turned the business world on its head.

So, as the world moves into the next phase of its response to the pandemic, and certainly in the longer term, what can be learned from this crisis and does it present an opportunity for businesses to rethink what they do, the way they do business and the importance of investing in resilience? All of which speaks directly to the environmental, social and governance (ESG) agenda.

In the valley of darkness

At present, the business world is navigating a mad swell of chop and change in which the fortunes of different regions and sectors vary wildly. Companies for which the ill wind of COVID-19 has blown some good have been very much in the minority. The majority are having to contend with looking into the abyss of a largely moribund economy.

Yet even as they walk through the valley of the shadow of darkness, business leaders and their corporate strategists are beginning to look to the post-COVID-19 world to come.

But what will that look like? It is definitely too early to tell exactly what our society and the business landscape will look and feel like in the months, years and decades to come. What we can be certain about, however, is that pandemics can indeed happen. We know that states at least try to take charge when they do. We know, not least, that mustering a concerted and effective global response is nigh on impossible in a world of blustering political orators and cavalier autocrats

We also know that the realities of this crisis, unlike previous recessions and global shocks, will probably have many second order and even longer-term effects on business models, consumer and employee behaviours, national and local policies, and operations. While the first-order effects are evident, the long-term shifts remain shrouded.

It is, therefore, important for the business sector to look at balancing its response to the crisis in the short term with maintaining resiliency to other risks facing business and society in the long term. Thus, while dealing with the immediate business continuity challenges posed by the virus, maintaining strategies and programmes that may reduce risks to other long-term threats, such as climate change, will be important for building long-term resiliency.

James Green, a business continuity expert at SAI Global, considers resilience to be more than just responding to a business continuity incident. “It is about how an organisation mitigates risk, so it never even has to respond to some incidents, because they did not impact the business in the first place,” he contends.

Mr Green believes that sustainability and ESG programmes are key components of long-term value and business resiliency and may help buffer the impacts of the current crisis, hasten recovery, spur innovation needed to navigate a ‘new normal’ and reduce risks to additional global crises in the future. “Climate change is going to continue to increase the frequency and severity of inclement weather disasters, and organisations that strive to minimise their environmental impact are setting themselves up to be less affected by those events,” he adds.

Sticking points

Although organisations may feel they are too busy to focus on ESG decisions and disclosures right now, this is surely the time to reset and integrate ESG considerations into strategic planning and key performance indicators, rather than thinking of ESG as a standalone, nice-to-have area of activity. This is because COVID-19 has focused our collective attention on the many injustices and weaknesses that already exist in how we all live together (if people were blind to these faults before, it is hard not to see them now) and has forced a reckoning for many between the profit motive and a company’s social purpose.

Furthermore, new evidence continues to validate the rationale behind climate investments, sustainable equity funds and bonds as companies with higher ESG ratings are proving that, in many cases, they are better equipped to weather the storm. For instance, research by Morningstar has found that companies that score well on ESG tend to exhibit higher profitability and stronger balance sheets, which make them more durable during times of market stress.

And analysts at Bank of America have established that companies with below-median ESG scores have seen larger downward earning per share (EPS) revisions this year, while Morgan Stanley found that in years of market turbulence, like 2008, sustainable funds’ downside risk was substantially smaller than traditional funds.

But as the demand for socially responsible strategies grows, ESG reporting offers both a fantastic opportunity and a real challenge. Critics say that ESG has significant blind spots and distortions. And they are not wrong; its ratings are not yet ready for the weight they are being asked to bear. And many questions remain on how to address reporting gaps, particularly in the context of the Sustainable Development Goals (SDGs), and improve coordination to support more consistent disclosure.

In a July report about ESG reporting, the US Government Accountability Office (GAO) said that a variety of voluntary disclosure regimes leave organisations unsure about what standards to use. Moreover, because there are different sets of reporting standards depending on what organisations use, the lack of comparability and consistency would make the different ESG reports provided less useful for investing analysts.

But performance metrics for ESG are in their infancy compared with financial statements. “We are still at the very early stages of achieving reliable and easy reporting and we don’t have a lot of resources in that space nor reliable information,” says Michelle Cracknell, former chief executive of the Pension Advisory Service and an independent non-executive director for a number of financial services firms. “There are moves ahead and there are people that are working on this. But I do not think it’s an easy one,” she adds.

Given 245 reporting instruments exist in Europe alone, with an additional 174 in Asia and 47 in North American markets, this lack of standardisation and transparency in providers’ data collection and scoring methodologies poses key challenges for adopting ESG principles and without an industry-wide or business-wide standard, momentum in ESG may stall. But Ms Cracknell cautions that we need to “do it with haste but not with speed because it could so easily have unintended consequences, could go wrong or we could get negative press”.

Ms Cracknell adds: “That negative press takes a long time to recover from and that is why we need to be really careful with trying to get reporting right in all of these issues, particularly around societal impact and governance. It needs to be more than just companies trying to tick boxes to get onto investors’ fund lists. You have to have a really strong purpose and it’s that purpose that leads them to have behaviours towards society and how they govern their company.”

Reach for the reset button

Despite the complexity and the absence of a clear set of globally used standards, as the new normal of the post-pandemic world takes shape, there is little doubt that ESG will grow in importance. Not only are sustainable assets likely to increase, but the materiality of ESG issues will be more widely accepted.

Thus, businesses need to be oriented toward the future, not the past, as business as usual is no longer an option. We need to move away from a reliance on more of the same as it is untenable and ignores the scale of human suffering unleashed by the pandemic. We have an opportunity, therefore, to use this watershed event to reorient broader attitudes about efficiency versus resilience, the future of capitalism, densification of economic activity and living, industrial policy, our approach to problems that affect us all – such as pandemics and climate change – and call for global and collective action.

We are fortunate to have a once-in-a-generation opportunity to press the reset button and rethink the economy of the future and move collective action to build economies that deliver inclusive economic growth, prosperity and safety for all.

Bree Goodall-Beer is managing director at Untaptd Ltd. She can be contacted on +44 (0)7896 834 837 or by email: bree.goodall-beer@untaptd.com.

Bree Goodall-Beer

Untaptd Ltd.