Is ESG in danger of falling prey to the box-tickers?

September 28, 2020

Companies have a responsibility to consider the impact of their activities on the environment and society and to operate within a robust corporate governance framework. There is no question about that. ESG is fast becoming ingrained, if it is not already established, in corporate strategy, culture and operations.

It is clear, however, that ESG means different things to different companies. There is no one set of ESG factors which can be applied to all companies. The relevance of and balance between the E, S and G elements will also differ from company to company. For example, drinks, energy, financial, gaming, medical, mining, tobacco and waste management companies will have their own specific but different focus on ESG.

The level of scrutiny and regulation surrounding ESG is increasing. In the UK, legislation requires directors to promote the success of their company for the benefit of its members and, in so doing, to have regard to the impact of the company’s operations on the community and the environment. Investors are looking harder at a company’s ESG policy and track record when deciding whether or not to invest their capital. This makes good sense when ESG is considered on a company by company basis.

However, as seen in relation to (some) investors’ approach to corporate governance codes, there is a risk that, as regulation and scrutiny increases, so does the pressure to find a standard, one-size-fits-all method of confirming compliance. There is some evidence that this process has started in relation to ESG. Proxy adviser, ISS has developed Quality Score, described as a data-driven scoring and screening solution which “provides an indication of relative quality [of environmental and social risk disclosures] compared to industry peers, supported by factor-level data that is critical to the research process”. Government institutions are also seen to be moving towards adopting standard approaches, of which an example is the EU Taxonomy Regulation (12 July 2020) which is designed to create a benchmark for green investments.

Investor support for standard approaches is not unanimous. BlackRock has expressed its opposition to ESG indices. Standard Life Aberdeen is reported to have commented on the EU regulation that “the objective to achieve comparability of financial market participants in terms of their impact at entity level is not realistic at this point in time”. This might suggest that, if the comparability objective can be achieved in future, Standard Life Aberdeen and possibly others, could be in favour of using the benchmark.

For hard-pressed companies and their investors, who have much to deal with and report on, there is an understandable desire for a set of guiding principles to which corporates and their stakeholders can refer. Such guidance should not, however, be used as a shelter from accountability or to avoid taking hard decisions based on engagement and analysis at an individual company level.

One outcome which seems clear is that the regulatory level of responsibility in relation to ESG is going to increase. Companies are already under pressure from corporate governance codes to introduce ESG factors into their remuneration policies. My colleague, Margarita Skripina, has recently written about research MM&K and our colleagues in the GECN Group have undertaken into the ways in which companies across the globe have incorporated ESG factors into their remuneration plans.

As in the case of remuneration policy, ESG transcends all aspects of a company’s strategy, culture and operations. Any company seeking inward investment is likely now to be quizzed by potential investors about its ESG policy and the steps its directors are taking to monitor the impact of the company’s operations on the community and the environment.

FTSE 100 companies will have, or can acquire, resources in-house to absorb increased responsibilities of ESG compliance but smaller companies, also required to comply, are less likely to have in-house ESG dedicated teams to develop and communicate their policy and ensure compliance. Engagement with investors is an essential element of the process. MM&K focuses on the mid-cap and SME market. We should be pleased to help.

For further information or to discuss points or issues raised in this article, please contact Paul Norris.

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