ESG investing can set businesses apart in showing their solidarity in improving the world around them. This is good, but businesses need to understand the risks and have plans in place to mitigate them, says Randy Sadler, principal at CIC Services
With environmental, social and governance (ESG) concerns at the top of investors’ considerations, it’s no surprise that ESG investing has grown by several trillion dollars in the past few years. In fact, just from 2018 to 2020, investors’ holdings in ESG went up from US $12 trillion to US $17.1 trillion.
McKinsey reported that while the overall online searches for corporate social responsibility (CSR) has declined, ESG searches have grown fivefold since just 2019. Additionally, over 90 per cent of companies on the S&P 500 are invested in ESG initiatives.
A great deal of incentivisation exists for companies to change their practices and attract investors who value ESG; an article from Citco extols the benefits of ESG and mentions that it should be a consideration in vendor procurement. The NASDAQ even has an entire website dedicated to promoting businesses implementing ESG strategies to “attract long-term capital and enhance value creation”.
Not ESG? That may be a problem
Most of the sentiment that exists around ESG is generally positive and suggests that businesses, for the sake of the global ecosystem, should get on board. A report from PwC states that a massive 83 per cent of consumers think that companies should be actively shaping ESG best practices. A further 86 per cent of employees would also prefer to work for or support companies that care about the same issues that they do.
The internal and external focus on organisations’ commitment to social goods has measurably impacted the sentiments that business leaders have been publicly sharing regarding socially responsible investing — 91 per cent of business leaders said that they believe their organisations have a responsibility to act on ESG related issues.
Additionally, 76 per cent of consumers went as far as to say they would discontinue relations with a company over poor impacts on their employees, surrounding communities or the environment.
Considering attracting consumers of tomorrow and those of the millennial generation, younger consumers care three times more about ESG criteria when making purchase decisions. Of millennials, 90 per cent also seek opportunities to invest in organisations that match their values. By not entering the ESG marketplace, there is a real potential for businesses to lose out on their market share and experience a ‘cancelling’ of their brand for not getting on board.
All is not what it seems
With that said, there is still one major problem left largely unmentioned regarding ESG initiatives: environmental, social and governance component standards do not clearly or consistently define what is required to uphold good regulatory standing, and the metrics used for rendering judgements are constantly changing.
Commentators on the subject have also boiled down what alleged ESGs really do — they are making portfolios ‘less bad’ rather than engaging in truly sustainable investing. Without clear regulatory standards or guidelines, firms have been able to feature holdings such as ExxonMobil, DuPont and other traditional energy firms, yet still have their investing considered ESG friendly.
Recently, the U.S. Securities and Exchange Commission (SEC) levied punishments against organisations and individuals heavily involved in ESG centric investing strategies. One example comes from the case of BNY Mellon and one of their investment advisors, who made misstatements on investments relating to ESG and received several charges and a penalty of US $1.5 million.
Looking at a prominent figure in ESG, BlackRock recently rebranded its sustainable investing division following significant losses in ESG portfolios and several dust ups with Republican-led states. Not only did conservative lawmakers challenge BlackRock, but so too did investors for the billions it invested in oil, gas and coal companies, while extolling environmentally friendly efforts.
Entering the fray: what can protect ESG initiatives?
Clearly, this situation leaves businesses and business owners in a bind. Copious reports indicating that consumers and vendors prefer to do business with those involved in ESG put pressure on businesses to enter the ESG market. However, the lack of clear regulations and standards means those who pursue ESG initiatives could face penalties and not even know that they have flouted the rules. Seeing as numerous current investment portfolios still include fossil fuel and environmentally harmful businesses, there is a major question of the validity of the popular arguments tossed around promoting ESG.
Frankly, there isn’t a clear answer or advisory statement that can be given as to whether a business should or should not engage in ESG practices. As it remains a case-by-case basis as to how well the decision to go ESG lines up with an organisation, there are few best practices and solutions that can insulate a business from the threat of unknown regulations in ESG or the possibility of a decrease in sales due to a lack of ESG involvement.
The Harvard Business Review also gave a recommendation to increase the costs non-ESG organisations pay for failing to comply with proposed stricter emissions standards — the antithesis of what businesses not in ESG investing want. This strongarms businesses and business owners to join in on ESG investment and operational practices, or lose out on their livelihoods. This proposal raises the question of whether a business wants to pay now or later as they decide whether to join in with ESG practices.
One solution is that an organisation should bite the bullet and join the ESG industry, which has seen US $2.5 trillion in total sustainability focused investment assets. Unfortunately, the initial costs of becoming more green and practising ESG investing can be costly and maintaining ESG investing and practices sees businesses in the industry expected to pay US $158 billion by 2025. Without a plan in place to make this transition, those that aren’t ESG investing can get frozen out by vendors and customers wanting ESG-focused businesses.
Which leads to the next solution, and that is to remain compliant with emissions standards as well as regulatory requirements of businesses in their respective environments. Deciding if ESG investing is right or not for an organisation is time consuming; remaining within regulatory guidelines for sustainable business practices goes a long way in buying time. This could mean an organisation remains within industry standards and continually updates its risk and crisis management plans but doesn’t invest capital into ESG. Businesses may still face scrutiny for not incorporating ESG, considering the flack and unknowns currently surrounding ESG this solution is perhaps the best option.
Another option that insulates a business from the fallout of ESG regulatory penalties from the SEC, or the unexpected loss of revenues from not joining ESG, and potentially losing business, is captive insurance. With captive insurance filling in the gaps traditional insurance leaves with outdated policies or plans that don’t cover the entirety of the risk a business may face, captives uniquely fit the needs that businesses on either side of ESG need.
For instance, if a vendor were to terminate their contract because a business isn’t pursuing ESG initiatives, the saved premiums in the captive’s reservoir can insulate the business while it seeks a new vendor to partner with. Similarly, if an organisation were to face a steep fine from the SEC due to an unknown violation of the constantly changing and mirky ESG standards, the organisation could draw from its captive to pay the fine(s).
Considering the plethora of questions that remain regarding what truly constitutes an ESG and how much they really do to further stated sustainable investing, the long-term impact of ESGs remains to be seen. One thing is certain presently, though, and that is how they can adversely affect a business today in several different ways.
