17 September 2021 - Article
ESG is increasingly the buzz acronym when it comes to creating the parameters by which investors and consumers seek to determine what an ‘ethical’, ‘sustainable’, ‘greener’ or more ‘conscientious’ investment opportunity a particular business represents. As the UK government (in partnership with Italy) prepares to host the UN Climate Change Conference (‘COP26’) in November 2021, I believe that ESG initiatives are destined to gain further and substantive traction as key evaluators of the opportunities and risks of investments in both business and countries. One reason for this is the announcement by the UK Treasury on 9 November 2020 that the UK Government will seek to:
(i) become a global leader in green finance;
(ii) issue its first ‘Sovereign Green Bond’ in 2021; and
(iii) make Task Force on Climate-related Financial Disclosure (‘TCFD’) mandatory across the economy by
In the run up to COP26, we will be exploring what the implications of increased reliance on ESG initiatives for our clients and intermediaries might be. But first, I want to briefly discuss the evolution of ESG, including what it is and why the time may be ripe for substantive mandatory reporting of ESG initiatives to happen.
A brief history
In simple terms, ESG is one of the evolutionary pathways of Corporate Social Responsibility (‘CSR’) and is the reporting by generally large multinational enterprises (‘MNEs’) (although this is rapidly changing) of sustainability initiatives and practices. Businesses have numerous ways of describing such reports with some calling them ‘sustainability reports’, others ‘corporate responsibility’ or ‘productivity’ reports. A helpful way to explain how ESG has become prevalent is to consider the recent history of CSR, which has been (and continues to be) the subject of extensive research by academics and business (2).
Up to the 1950s, philanthropy was generally relied upon as the primary measure of business giving back to society. However, in the 1950s and 60s a recognition by business emerged of its effects on the local community. This led to the ‘social contract’ concept of the late 1960s and early 70s in which there was an acceptance that business requires the consent of the public to operate and accordingly, has a basic purpose to serve the needs of society. The 1970s also coincided with a time of cultural change with the environment (for example, Greenpeace was founded in 1971), civil rights, and education gaining importance and receiving extensive public engagement. By the end of that decade, it was being argued that CSR should embrace the economic, legal, ethical, and philanthropic responsibilities of business (3).
The 1980s began the ‘Globalization era’ of business and CSR was tied to social, political and environmental issues with the concept of ‘sustainable development’ being introduced, arguably causing the business ethos of maximising shareholder returns to be toned down. In this respect, whilst the ability of business to create jobs and generate wealth for local communities was welcomed, negatives including the extraction of finite natural resources that can generate adverse environmental impacts on populations gained attention. Therefore, in 1983, the UN established the ‘World Commission on Environment and Development’ (‘WCED’) and in its 1987 report (4), the WCED suggested that the environment be placed front and centre of strategic decision-making processes on development, and in doing so, provided a definition of sustainable development (5). In consequence, CSR began to become something that required a demonstration of a commitment to a more sustainable global world.
From the late 1980s and throughout the 1990s, this vision of CSR led to the establishment of non-governmental organisations and business organisations that provided guidance to business in putting in place particular CSR policies. That resulted at the end of the 1990s and the beginning of the 21st century with the launch of various initiatives including the seminal Global Reporting Initiative (‘GRI’) and the United Nations Global Compact (‘UNGC’). These initiatives, with their focuses on the environmental and social protections that MNEs in particular implement by reference to corporate governance structures and sustainability initiatives, helped CSR as ESG to emerge (6).
In this regard, the GRI was formed by a combination of investors, environmental groups and public interest groups at the time of the Exxon Valdez oil disaster in 1989 and its primary purpose was to create a ‘sustainability reporting’ mechanism (7). While the UNGC (8) was an initiative with the personal backing of Kofi Annan, a former Secretary-General of the UN, and came into effect in 2000. It has ten (originally nine until 2003) principles drawn from commitments provided by UN member states under the: Universal Declaration of Human Rights; the 1992 UN ‘Rio Declaration’; the 1998 International Labour Organisation’s Fundamental Principles and Rights at Work; and the 2003 Convention against Corruption. Such principles include that: business supports the protection of international human rights (principle 1); recognise the right to collective bargaining (principle 3); promote greater environmental responsibility through initiatives and technologies (principles 8 & 9); and work against corruption (principle 10). Businesses are asked to report on their performance of the principles through voluntary participation and according to the UNGC website (9), over 11,500 companies across 156 countries now provide such reports (known as ‘Communication on Progress’ or ‘CoP’) on an annual basis and these are available on the UNGC website. Like the UNGC, the GRI is also voluntary but has had huge uptake and according to its website has over 10,000 ‘reporters’ in over 100 countries (10).
Many other initiatives of ESG seek to and gain the attention of both business and their investors including those of the ‘The International Integrated Reporting Council’ and ‘The Organization for International Standards’. However, the GRI and UNGC are particularly important reference points as they work in partnership and are cooperating on the UN’s 17 Sustainable Development Goals (“UNSDGs”), the intention being to integrate the UNSDGs into business reporting (11).
As ESG has emerged, stock exchanges including the Dow Jones and the FTSE 100 (12) also established indices that track companies with strong ESG and those in turn are used by private and institutional investors to determine ‘sustainable’ orientated investment portfolios. Another, and more crucial development in recent years for ESG, is ‘The Paris Agreement’ (13) and the acceptance by states that climate change requires urgent action. New ESG initiatives that have a particular focus on climate change impacts of business are fast emerging, one being the TCFD (14) that the UK government wishes UK business to adopt and mandatory report on by 2025. It seems inevitable that more will follow.
Bringing this brief history to an end, you may well be asking why set it out? The short answer is that I believe it helps to illustrate that the proliferation of ESG initiatives in the 21st century points to it becoming a normative practice for business, if not already. One arguable consequence of this ‘norm’ is that investors (both private and state) and consumers will increasingly determine their interactions with business by reference to its ESG.
The adoption of ESG reporting by business
Since the beginning of the 21st century, academics, business and those who advise business, have undertaken extensive research into the business case for CSR including ESG initiatives that they report on. In broad terms, themes that emerge include:
(i) cost and risk reduction;
(ii) reputation and employee benefits;
(iii) legitimacy; and
(iv) competitive advantage (15).
Research that supports the emergence of such themes includes research by the UNGC into why business participates. It identifies the top two reasons as being the creation of trust and the universal nature of the principles, with CEOs of UNGC participating businesses also agreeing that sustainability is important for future success and competitive advantage (16).
The immediate big picture point to takeaway is that external influences are increasingly coming to bear on business to ensure it is geared to be ever more transparent to stakeholders including on:
(i) how it operates;
(ii) how it gives back to both the local and global community; and
(iii) how it will future proof itself for a more sustainable world.
What results is an increased ‘accountability of actions’ business reporting framework that presents both opportunities and risks for business and investors.
Does mandatory reporting of ESG initiatives beckon?
Until now, the requirement of business to mandatory report has been elusive and when it does occur, it is very limited in its scope (17). There are numerous arguments that can be made for this that include:
- The expense of compliance and producing the relevant reports;
- The concern by governments that the implementation of highly regulated corporate governance in a jurisdiction could cause companies to move their operations elsewhere;
- That the core fundamental that companies and its office holders are primarily accountable to shareholders should not be substantially disturbed; and
- Some of the areas that ESG initiatives report on such as the commitments of business to human rights must only be voluntary as otherwise it transfers to privately owned companies responsibilities that should belong to government (18).
Such arguments remain compelling even with the increasing prevalence of ESG initiatives. However, recent events could be creating an environment conducive for the UK Government’s particular intention of mandatory TCFD reporting by the mid-2020s to become a reality. In my opinion, the increasing urgency to act around climate change bodes well. The Paris Agreement and the UNSDGs (19) have ramped up pressure on countries to plan for and implement fundamental policy shifts that demonstrate concrete action by governments on sustainability. Importantly, the multilateralism often necessary for such global initiatives to progress may be more forthcoming in the coming years. Also, the Covid-19 pandemic could be used as a catalyst (recent soundbites from both governments and business suggest this) to make economies ‘green’ more quickly.
As regards the UK, with it no longer being part of the EU, it inevitably must find ways to innovate in order to continue to attract foreign investment and business opportunities. In this respect, TCFD mandatory reporting could play to its financial services strengths including that of financial risk and insurance expertise. Furthermore, TCFD as its name suggests is primarily concerned with the risks, opportunities and financial impacts of climate change on business. Therefore, it should be of interest and benefit those who arguably matter most to business, their private and institutional investors. This alone could be why mandatory TCFD reporting has a real prospect and if the UK government does make good on its intention, the transparency around investing in UK companies might result in a competitive advantage given that sustainability will continue to be one measure of a good global corporate citizen.
2021 has the potential to be a year that substantially influences the landscape of ESG initiatives. Outwardly at least, COP26 should be a global forum that will seek to further develop frameworks that hold both countries and business to account on climate change and sustainability. The extent to which this in fact emerges is something that we will comment on throughout 2021.