ESG in Trade & Investment: Substance or Subterfuge?

“The Master said, “If your conduct is determined solely by considerations of profit you will arouse great resentment.”Confucius


Environmental, Social and Governance issues, are the next generation of Corporate Social Responsibility, and have moved decisively from the fringes of commercial and investor consciousness to the centre of evolving corporate conscience.

Is ESG, as some claim, a cynical and self-serving attempt to cover ongoing, fundamental and systemic flaws in the free-market, profit-maximization model, or does ESG represent a meaningful transformation?

Social impact investing, sustainable sourcing and supply chains, fair and sustainable trade – are these aspirations of the fringe, or do they represent a tectonic and irreversible shift in the way businesses operate? Will these redefine how companies are assessed as an investment, and therefore ultimately, through that “voting by investment”, a shift in the way businesses are managed and commercial success is defined?

Environmental, social and governance (ESG) criteria are a set of standards for a company’s operations that socially conscious investors use to screen potential investments. Environmental criteria consider how a company performs as a steward of nature. Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder

Some sober and credible commentators, and senior executives, genuinely believe the CSR/ESG dimension of business is largely an inconvenience, an obstacle to optimal profitability and a sunk cost to the business, with no discernable upside. This view is rooted in concepts of classical economics like scarcity of resources (zero-sum dynamics), rational free markets and absolute/comparative advantage in production as determinants of trade.

Such long-held views were already the subject of tentative debate over a decade ago, but the global financial crisis of 2008 and the decade-long economic crisis which followed have combined to create conditions that have accelerated the debate and led to demands for concrete action to “fix a broken system.” The political crises we face today, epitomized by the state of democracy in the United States and the UK, can be traced directly to root causes that link to the global crisis, and to resentment tied to concentration of wealth and power.

This is not a call for political reform per se, but a recognition that certain dynamics in the commercial, investment and trade environment have contributed to untenable, by most standards, indefensible political postures, approaches and consequences.

There are clear lessons from recent history, there for the learning even if we choose to disregard or mistakenly discount perspectives articulated much farther back in the arc of the human experience. The lessons can be discerned if we choose to detach ourselves from blind, inflexible defense of ideology for its own sake.

  • According to a presentation at UN DESA in September 2018, the top 1% of society have captured twice the income growth of the bottom 50% of the population between 1980 and 2018
  • The benefits of trade, including helping pull millions above the poverty line, have been badly communicated and in any event, are seen to be inequitably distributed
  • Investment is an option available to a relative few, with Family Offices and Multi-Family Offices at the top end managing perhaps $3-4 trillion according to analysis by The Economist

Overall, the distribution of benefits has been so far from ideal, and the systemic imperfections – for example in the architecture for trade – around inclusion have been so material, that they are identified as root causes for the deplorable state of recent political outcomes and discourse. An element of this is, arguably, that we have collectively failed to heed the warnings from Confucius going back 2,500 years.

The market discipline view coupled with focus on the profit-maximization motive – capitalism more broadly - has driven important global progress, however it is clear that over the last several decades in particular there is a growing realization that business and political leaders have a responsibility to do more. Early dialogue on environmental considerations have shifted from the margins, facing active resistance to the heart of discussion, leading for example, to the development of the Equator Principles in the area of trade finance and project financing.

The same evolution can be observed today, proceeding much more quickly, around the importance of ESG and the imperative for company CEOs to deliver robust results, but to do so, mindful of the wider context in which a business operates, has impact, and prospers.

Once a niche practice, sustainable investing has become a large and fast-growing major market segment. According to the Global Sustainable Investment Alliance, at the start of 2016, sustainable investments constituted 26 percent of assets that are professionally managed in Asia, Australia and New Zealand, Canada, Europe, and the United States—$22.89 trillion in total. Four years earlier, they were 21.5 percent of assets.

The most widely applied sustainable investment strategy globally, used for two-thirds of sustainable investments, is negative screening, which involves excluding sectors, companies, or practices from investment portfolios based on ESG criteria. But ESG integration, which is the systematic and explicit inclusion of ESG factors in financial analysis, has been growing at 17 percent per year. This technique is now used with nearly half of sustainable

The time is now to progress beyond the idea of a “triple bottom line” (profit, people, planet), first proposed in 1994 in the UK that was perhaps ahead of its time and able to garner only very limited traction.

ESG is the latest iteration in a long-term attempt by society to demand more from the companies that serve it, and that prosper at its heart.

The time may also be ideal to make an argument in support of ESG because it is simply the right thing to do. Because it reflects the best visions and intentions of those who promote a more thoughtful model for the pursuit of business success, economic value-creation and inclusion. Because doing the right thing should matter, and we, collectively, should have evolved to the point of understanding that, especially at a moment in history where we see, daily, the consequences of losing sight of such fundamentals.

Character counts. Truth matters. Businesses should be about more than profit-maximization.

Perhaps, but for now, let us focus less on philosophy and principle, more on practicality and the imperative to better measure impact and value-creation.

At its core, this is what ESG and its variants aim to do: better measure net value creation. More effectively price the cost of delivery of products and services and better calculate their all-in value to a business, to its investors and to society at large. ESG, well understood and effectively implemented, reflected and assessed, is in fact a natural complement to and evolution of capitalism and market dynamics, not, as some suggest, antithetical to them.

Societal expectations, perhaps most clearly recognized in the shifting priorities of Millennials, have evolved in a way that increasingly looks at sustainability and good conduct as important elements of the character of a business, linked to brand value and financial results.

Companies with meaningful (substantive, not subterfuge-based) ESG programs have been shown to generate demonstrable benefits, measurable, positive ROI and enhanced reputational standing with employees, shareholders and other key stakeholders. This includes defensive or risk-reducing programs and those that proactively seek to integrate ESG into the vision and purpose of a business and to place ESG firmly at the centre of a company’s strategy, approach and priorities.

Table of ESG Risk Events 2001-2015. Average loss to shareholders after 1 year: -64.4%. Source: Bloomberg. Data as of Nov 30, 2016. Past performance is no guarantee of future results.
ESG and the Sustainability of Competitive Advantage, Morgan Stanley, 2018

Companies that lack ESG programs have faced risks – and adverse consequences – that have diluted corporate and financial performance, reduced brand value and trust, and impacted the attractiveness of that company as an investment option when assessed with comparable alternatives.

The global crisis of 2008 has, in addition to refocusing attention on some key lessons from the past, driven renewed attention on “real economy” activities, in contrast to financial engineering and some forms of commodity trade that are fundamentally speculative in nature and do not involve the creation of anything or the movement of goods or services across borders.

Questions of fair trade – distributing benefits more equitably through global supply chains – and sustainable sourcing across a broad range of traded items from cocoa to palm oil, have been in the discourse on global commerce for years, and are finally showing signs of substantive progress based on genuine intent and commercial good sense.

Substance, not subterfuge.

The Banking Environment Initiative at the University of Cambridge Institute for Sustainability Leadership, and the activities of the International Chamber of Commerce Sustainable Trade Working Group are illustrative, seeking ways to integrate traceability, certification and financial incentive in support of clearly demonstrable sustainable sourcing practices. The integration of the UN Sustainable Development Goals across a wide variety of activities – including those of global brands and enterprises is also illustrative.

ESG and its early variants have been with us for decades as a call to action to business and political leaders. The call has been at times tentative, at times muted, but it is finding its voice as well as a far more receptive and thoughtful audience across a widening range of stakeholders. It is here to stay, and will become more important and more central to the measure of business success, the value of trade and the attractiveness of investment options over the next three to five years.

ESG and its coming evolution will, like the flow of a river does a stone, smooth out the rough and jagged edges of a scarcity-based, profit-driven economic model and capital market, forcing both to take account of wider priorities in the human experience.

Substance, not subterfuge.

ESG will inexorably help advance us to the state where “things that matter most are [no longer] at the mercy of things that matter most”, as Goethe might have said.