In the current economic climate, it might seem somewhat irrelevant to be talking about environmental, social and governance (ESG) issues. But, while corporate heads have been turned towards market turmoil, the resulting mangling of corporate governance and death of long standing companies, makes it a fitting time to take a fresh look at what makes a company, large or small, fit for long term purpose and investment.
The links, or not, between a sound approach to ESG risk and commercial success have been argued over for some time. However, the current market environment raises some interesting questions around both sides of the argument. On the one hand, let us consider Northern Rock or RBS. Both are long standing companies, the former with its roots in the mid-19th Century industrialising north of England, the latter founded in Edinburgh in 1727. Both were taken in a certain direction within the past five years by purposeful chief executives. Both washed up on the shores of the wholesale money markets. Conclusion – failure of corporate governance in questioning the strategy of ambitious and forceful CEOs.
On the other hand, both had good records in relation to environmental management and community engagement. Northern Rock operated its foundation, that was a key player in social support within its north-east England heartland. RBS played the ball on climate change and had signed up to the Equator Principles, produced an annual sustainability report and ticked many of these boxes. Conclusion – there remains a disjuncture between measures of environmental and community engagement and actual company performance.
It does however seem sensible to believe that commercial longevity is more likely to be achieved by those companies that innovate, that are sensitive to the needs of their employees, customers and suppliers, that manage and mitigate their impacts on the environment and whose systems are efficient and effective, that are not afraid of making hard decisions based on a long term view, that enjoy what they do and bring stakeholders along with them. Both Northern Rock and RBS adopted overly ambitious growth strategies, allied to a short term viewpoint that was not adequately questioned by the board and investors. As long as the share price grew – who really questioned the longer-term consequences?
Returning to ESG risk, it’s worth mulling over the question of who drives this agenda. Orthodoxy says that a sound approach to these issues should be embedded within the values of the business and driven from the top. In reality there will be all manner of prods and pressure from customers, peers, regulators, investors, local communities, as well as the management team and, yes, even the CEO. Then we have the activists, non-governmental organisations and elements of the ESG industry. Here perhaps, and this is admittedly a cynical view, the agenda can be less about accountability but more about an aversion to profit and the abhorrent pursuit thereof. Let’s whip the fat cats in their pinstripes and make them atone for their wicked ways!
Being a trendy concept, ESG performance also comes with its own mountain of written material, created by companies, academics, commentators or ESG professionals. Too much of this material can be inappropriate, boring, turgid and seemingly created to satisfy a generic audience that does not actually exist (hence no-one reads, listens or watches). This has a particular relevance in a world where communication channels are globalising and multiplying and ‘audiences’ are disaggregating. While the media and communications paradigm shifts, those wishing to say something about ESG risk need to work that much harder to make their information coherent, relevant and interesting, ensuring that it engages and is tailored for different channels and different recipients.
So where does that leave us? Can and should boards, regulators and investors take ESG risk more seriously? While our economic system dictates that companies must retain a focus on financial performance, given recent events, there is no doubt that ESG issues must take more prominence in corporate risk profiling.
The question then arises as to how investors best take a view on ESG risk when there is no official ‘standard’ against which companies can be measured. The Global Reporting Initiative is useful, but for many companies, even corporates, getting to grips with all of its tenets is a mammoth task. The resulting outputs can also offer a major interpretive challenge, even to fund managers. Third party tools and services are available and can be very useful, but again, they define their own criteria and assessment structures.
Clearly the level of due diligence will vary amongst investors and some will be more engaged with ESG risks than others. At the same time, the investee companies, and this returns to a point already raised, could help themselves through better, clearer information provision in relation to these issues. Put simply, investors need to be more engaged and clued up, while investees need to take ESG risk more seriously and recognise its importance as both a management and communications challenge.
In conclusion; when looking to a globally warmed future, the successful companies will innovate, take a long-term view, manage risk, pursue strong governance and effectively communicate. They will demonstrate an Effective Strategy for Growth.
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