Taking stock of the ‘S’ and ‘G’ in ESG

A heightened awareness of environmental and climate concerns, as well as an acknowledgement of the economic and human impact of the pandemic, is transforming investors’ sense of purpose. Rather than purely focusing on long-term return outcomes, they have become far more considerate of where and how their money is invested.

There has been much discussion about the associated rise of sustainable or environmental, social and governance (ESG) investing practices, but the focus is often on the ‘E’ rather than on the ‘S’ and the ‘G’. Yet, social and governance issues are becoming just as pivotal for investors seeking a ‘just’ transition to a better, more sustainable world, that also tackles inequality and seeks to achieve social justice.

And these concerns are not wholly based on altruism, there are strong economic arguments for why businesses, and investors, should consider the wider systems in which they operate rather than just pure profit making.

Re-establishing the social contract
The notion that business functions and exists because of public consent, and therefore should contribute positively to society, has been around for over a century. This form of social contract can be traced back to the industrial revolution, when business magnates such as Andrew Carnegie and John D. Rockefeller made large financial donations to causes related to religion, education and science.

These days, the term corporate social responsibility (CSR) is used to encompass all the ways in which a company can be socially accountable to itself, its stakeholders and to the public, by measuring and controlling its economic, social and environmental impacts on society – sometimes described as the “triple bottom line”. Going beyond legal and regulatory requirements, CSR represents the corporate initiatives that seek to improve any number of social and environmental issues.

Why does CSR matter?
Although they may not use the term themselves, or even be aware of it, many consumers and stakeholders now prioritise CSR when determining which brand or company to buy from. Research indicates that over 60% of consumers want businesses to drive social and environmental change forward even in the absence of government regulation1 . Separate research has found that 87% of consumers will purchase a product because the company is an advocate for issues they care about, and 76% of consumers will refuse to buy from a company that has supported issues contradicting their beliefs2 .
It’s not only consumers that are interested in CSR, but employees as well. In order to attract the best people for the job, companies need to think hard about their social and environmental image and initiatives.

Companies that have recently fallen foul of CSR issues include mining companies that have failed to respect the sacred spaces of local communities, social media giants who stand accused of placing profits over the safety of its users, and fashion chains that have been found to use sweatshops in their manufacturing processes. And the consequences of these failures can go well beyond negative PR, impacting company management and valuations.

Benefits of identifying those companies that walk the CSR talk.
CSR is a business aspect that investors increasingly need to focus on. A failure to adequately address CSR issues can become a major business risk, that could mark the difference between success and failure.

While many corporate websites will discuss CSR issues as part of their purpose and mission statements, embedding CSR into broader investment due diligence can help identify those companies who are actually walking the talk. It also provides useful validation to investors that a company’s management team recognises the materiality of non-financial issues to a company’s overall business strategy and long-term resilience.

This is having a positive impact on a company’s investment potential as it can increase the likelihood of financial outperformance and can shield it from risk and volatility. Part of this protection comes from CSR’s alignment with long-term investment trends such as the energy transition, as well as government initiatives including building back better, but also that they are less likely to be caught up in damaging publicity scandals or face fines for bad corporate practice.

However, there is little standardisation of CSR practices and how these can be assessed by investors, who often rely on companies being fully transparent about their policies and how they are executed.

Investors empowering CSR
The investment industry is also playing a role in encouraging companies to embrace strong CSR practices as a part of their corporate strategy.

Whether this involves incorporating CSR targets into loan arrangements, otherwise known as sustainability-linked loans, which offer more favourable terms for firms that are reaching their own sustainability targets. Or using corporate engagement (often collectively to achieve greater impact) to influence and change corporate behaviour and establish best practices, such as the setting of internal targets for renewable energy financing or establishing employee diversity targets and ensuring employees have access to training so they have the right kind of skills in a rapidly evolving business environment.

Proxy voting is also increasingly being used to advance sustainability and inclusion initiatives – the 2021 proxy season in the US has already set new records with at least 467 shareholder resolutions on environmental, social and governance (ESG) issues . This marks a significant change in the relationship between businesses and shareholders. Not so long ago, it was very rare for shareholders to vote against corporate proposals, but large, institutional investors are now increasingly expected to use their votes to influence change across topics such as remuneration, the appointment of more inclusive boards, as well as companies’ approaches to broader environmental and social issues.

Taking an extra-financial investment focus
Like many industries, investment is experiencing an age of transformation. The changes are multi-dimensional and include diverse factors such as technological innovations, disruption and an evolving regulatory landscape.

One of the less expected developments has been the shift away from return maximisation to one that includes other extra-financial considerations, typified by the letters E, S and G. While concerns around climate change and dwindling biodiversity have focused investor attention on environmental matters, the need to address social matters has been amplified by the pandemic and concerns surrounding rising inequality.

At BNP Paribas Asset Management, we are proud to have been one of the early movers in embracing sustainability and we incorporate CSR as one of our core sustainable investment beliefs. This means moving beyond simply volunteering for causes in the local community and philanthropic donations (though both continue to be an important part of our toolkit). Commitments to economic, social, civic and environmental responsibility are being integrated across all our business operations to foster an application of comprehensive sustainability practices.

And by embedding CSR as part of our investigative investment approach, we also aim to identify and invest in those companies which share this view and ensure that our sustainable investment portfolios align with the aims of our clients.

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