How has the pandemic increased awareness of the ‘social’ in ESG?
The environmental, social and governance (ESG) space is constantly evolving. What began with a focus on governance, then moved to be dominated by environmental issues, is now turning its gaze to social considerations.
The Covid-19 pandemic placed global supply chains in the headlights. The fragility of sprawling global networks of production has been brought into focus, and in doing so, this has brought awareness to the vast number of stakeholders involved in the process. A study by KPMG (2021) of 500 CEOs across 11 markets found that 96% of respondents agreed that the pandemic had shifted their focus to the social component of ESG.
Stakeholder management takes on newfound importance in moments of crisis. Over the course of the pandemic, companies have been scrutinised for their management of supply chains, treatment of staff and for ensuring the safety of their customers. As a result, the dialogue around the social in ESG has broadened. Companies are increasingly bound by the “new social contract”, wherein they are under pressure to ensure equitability and security for stakeholders.
How are social issues being considered by investors?
Given a renewed focus on social issues, there is now an increased expectation for investors to evaluate a company’s record on diversity, equity and inclusion, among other social factors. These should be considered in investment research.
These are not necessarily new themes, but the unequal distribution of the pandemic’s effects has placed them at the forefront of investors’ minds. For example, the evidence that the pandemic disproportionately negatively affected minorities and people of colour has increased awareness of embedded biases and inequality. Additionally, the risks taken by “essential workers” has drawn attention to the critical role that some of the lowest-paid workers play in the economy.
In the US and the UK, structures are in place to quantify workplace diversity and inclusion. For instance, the Equal Opportunities Act in the US requires the disclosure of demographic workforce data for all private companies with greater than 100 employees. In the UK, all employers with more than 250 employees are required to disclose their gender pay gap. Yet data is not reported on a systematic manner across the globe, and this creates difficulties for investors wishing to compare companies.
Is pressure mounting to enhance ESG credentials?
Pressure is mounting on corporate boards and governments to “walk the talk” on ESG commitments. There has been a spree of company commitments to meet net-zero targets by 2050, and efforts by investors to scrutinise these transition plans are increasing. At Ruffer, we encourage a two-way dialogue and we have seen a number of companies reaching out for feedback on their ESG strategy and disclosures.
Shareholder activism is likely to continue to grow through 2022, in the wake of the momentum generated by COP26 around environmental targets. This will also be facilitated by the November 2021 decision of the US Securities and Exchange Commission to rescind Trump-era restrictions on shareholder resolutions. As such, in the upcoming proxy season we are likely to see emboldened shareholders challenging corporate boards and government leaders to progress their ESG credentials and targets.
With regard to real-world reductions in greenhouse gases, investor engagement should focus on ensuring that achievable near-term signposts are stated on the path to decarbonisation. Often, commitments lack interim emissions reduction targets or fail to account for emissions across the value chain. This damages the credibility of transition plans and makes it harder to hold management to account.
How is regulation tackling greenwashing?
It can be challenging to identify genuine progress due to potential greenwashing. In order to allocate capital efficiently, investors must have access to reliable data. At present, ESG-related data is reported under a mixture of frameworks and is unstandardised, making it challenging for investors to compare data on ESG progress.
Regulatory authorities are waking up to the challenge and we expect that the quality and quantity of ESG data will continue to grow in 2022. During COP26, the International Financial Reporting Standards Foundation, created the International Sustainability Standards Board (ISSB). The ISSB is tasked with generating a baseline for disclosure standards, applicable across countries and industries. This will reduce informational obstacles to holding management accountable.
Another key development in 2022 will be mandatory reporting under the Task Force on Climate-Related Financial Disclosures (TCFD) for UK firms, in place from April 2022. The TCFD requires the disclosure of the organisation’s governance around climate-related risks and opportunities. Similarly, we expect that assessing risks to natural capital and biodiversity will continue to gain traction, particularly as the Taskforce on Nature-related Financial Disclosures is developed.
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Lorena Cebuc is Associate, Responsible Investment at Ruffer