OPINION: ESG, CSR, SRI – the jargon proliferates. What does it mean for companies to say they’re sustainable or ethical? Do these claims relate at all to reality?
“Better is the enemy of good” is a phrase which has been used when discussing this very topic by The European Federation of Financial Analysts Societies (EFFAS).
Example: the Morningstar Sustainability Atlas 2019 has given oil and gas producer Galp Energia the top score in its ESG ratings for being less bad than others.
It’s okay to recognise attempts to be “better”. But fine gestures can often mask other, more destructive behaviour; it is known as whitewashing or greenwashing.
BP and Shell have invested in renewable energy, and their CEOs have given fine speeches on climate change, while at the same time investing far more cash in drilling for new oilfields or fracking.
The EFFAS working group was looking at key performance indicators for environmental, social and governance (ESG) evaluation by corporations. This is what it came up with:
|Environmental||Social||Governance||Long term Viability|
|ESGs which apply to all industry-groups||ESG 1 Energy efficiency
ESG 2 GHG emissions
|ESG 3 Staff turnover
ESG 4 Training & qualification
ESG 5 Maturity of Workforce
ESG 6 Absenteeism rate
|ESG 7 Litigation risks
ESG 8 Corruption
ESG 9 Revenues from new products
The topic of long-term viability is said to be a proxy for the term “sustainability” which was felt to be associated with Socially Responsible Investment (SRI), green investing or ecologic-ethical movements. It “represents a company’s capability to produce long-term profits without sacrificing assets, skills or resources through short-term exploitation”.
Personally, I don’t think “revenues from new products” quite captures this.
So measures of corporate responsibility such as Morningstar’s just look at snapshots, or small areas of activity, and do not account for the overall impact of a company.
The size of the ESG market
The London Stock Exchange says that once upon a time these factors were a niche interest among asset owners, but now 60 per cent of assets managed for EU investors incorporate sustainable investment strategies and signatories to the UN supported principles for responsible investment (PRI) now represents AU$85.13 trillion in assets under management, up from AU$31.22 trillion in 2010.
The PRI, which has its own reporting tool, has over 1000 signatories, with the USA and UK holding the most and Australia in fourth place. Additional to the PRI, and performing a related job, are The UN Global Compact and the OECD guide for multinational enterprises.
How seriously should we take these figures? Do they mean that everything is okay and we can sit back knowing that the world is safe?
Somehow I don’t think so, despite the fact that The London Stock Exchange’s Report on ESG (link above) contains the strapline “revealing the full picture”. It’s more about making these companies feel good about themselves: recognising “better” rather than “good”.
The ESG Ratings service operated by FTSE Russell identifies 14 themes spread across the three ESG pillars, most of which include several relevant quantitative indicators.
Its methodology includes “exposure”, which categorises the materiality (relevance to business success) of the 14 themes for a particular company as High, Medium, Low or Not Applicable.
Based on a matrix, this categorisation considers business involvement across different countries and sectors; uses a variety of robust, globally-accepted frameworks like the PRI; and can help companies discern which ESG themes they are exposed to, and how to begin reporting on them, and help citizens to evaluate them.
But if you’ve ever watched a conjurer practising sleight of hand, you might have been convinced that a miracle was being demonstrated; but you probably also heard that little voice in your head reminding you how good they are at distracting the audience so it fails to notice what else they’re up to.
It certainly is better that companies are taking into account climate change, human rights and tax transparency. But there is a big difference between avoiding bad and doing good.
Let’s look a little deeper: the Sustainable Development Goals
A precondition of CSR and ESG should be to adopt the Sustainable Development Goals, bearing in mind however that these do not always relate to planetary boundaries – that is, what is actually sustainable in the long term.
The SDGs are a UN call for action by all countries to promote prosperity while protecting the planet.
Their prime motivation is ending poverty, so economic growth is supported in the poorer countries. Social needs are addressed with measures on education, health, social protection, and job opportunities.
Environmental concerns are covered by goals on climate change and environmental protection.
But not all of these goals are this means that related to planetary boundaries it is possible to satisfy some goals, for example access by everyone in a given location to clean water, but not necessarily do so without exhausting local supplies; this would be a topic for further local action.
Many companies have adopted the SDGs. But, as highlighted in CSR Europe’s 2018 White Paper “Collaboration for Impact”, for those companies which have, there are gaps between their good intentions and meaningful action.
While on average 72 per cent of associations say they embed sustainability on a strategic level, only 35 per cent put those policies into practice in the form of impact projects.
For example, beverage giant Pernod Ricard has recently launched a new sustainability roadmap aligned to the UN Sustainable Development Goals. Its 2030 “Good Times from a Good Place” strategy forms part of the group’s Transform and Accelerate strategic plan and sets out eight targets that support the SDGs.
It is already committed to reducing the overall intensity of its carbon footprint by half by 2030, as part of its “Science-Based Targets initiative”. However, compare this to Extinction Rebellion’s claim that the science says we need to move to zero carbon by 2025.
The company is also targeting improved water use in high-risk watersheds, such as India and Australia, and has pledged to replenish 100 per cent of the water used in its production sites. This does sound as though it is measurable and related to ecological boundaries, although it lacks a date.
Pernod Ricard’s vice president of sustainability and responsibility Vanessa Wright says that the company is doing this because of customer pressure: “We know that our customers have now come to expect our brands to be responsible and respectful of the environment.”
Actually, of course, if it destroys the environment there can be no business, so it is naturally in its own self-interest.
Active and passive portfolio managers
Some investors are “active managers”. These use ESG factors believing that it leads to better risk management. Some manage passive portfolios, using ESG factors to better align a portfolio with their own values.
Neither of these are necessarily looking at overall best practice if they still prioritise financial performance in conventional terms.
The often-voiced criticism of capitalism is that it does not factor onto the balance sheet the social and environmental costs (or benefits) of its activities. While ESG and CSR attempt to do this, how can we ever be sure if these are fully quantified?
In other words, how do we scrape off all of the potential greenwash – at least on the environmental side? There is one possible answer: NPV+.
Net Present Value Plus
Companies can manage their capital investments in a fiscally responsible and environmentally sustainable way by using the Global Footprint Network’s Net Present Value Plus (NPV+) tool.
The traditional net present value (NPV) formula used by investors adds up revenue and expenditures over a period of time and discounts those cash flows by the cost of money (an interest rate), revealing the lifetime value of an investment in present terms.
Global Footprint Network’s NPV+ tool adds to this calculation currently unpriced factors, such as the cost of environmental degradation, and benefits like ecological resiliency. All costs and benefits – even those where no monetary exchange occurs – thereby can be seen as “cash flows”, and can be evaluated using different future scenarios.
This can help provide a more accurate and useful guidance on the long-term value of the investment, because it makes reference to the ecological footprint of the project in question.
NPV+ helps to create a more accurate measure of the long-term value of investments in infrastructure and natural capital.
The multiple scenarios that can be generated can provide a basis for capital decisions by allowing more informed assessment of risks and opportunities.
Therefore, by understanding where the best long-term value is, policies can be oriented toward better outcomes, building wealth, avoiding stranded assets and leaving a better legacy for future generations.
Can investors be bothered to do this? Can shareholders? Probably not, but certainly the company directors can. They should take a good hard look at adopting NPV+ as a measure of genuine sustainability, and investors can choose to back those that do.