In this 2-part blog, Claire Thorogood takes a closer look at the “S” in ESG. In this second piece, she explores in the absence of regulation, the direction of travel.
As noted in the first blog, there is a large and increasing appetite for companies to report and be held accountable for their social impact but no universally accepted metric by which to do so.
There are however interesting developments in this space. For example, in 2020, the Law Students for Climate Accountability produced for the first time a Scorecard rating the 100 most prestigious law firms in the US according to their contribution to the climate crisis. The report highlighted individuals’ power (and, in its view, responsibility) to effect change. It called on stakeholders to use the report when making their decisions; on clients deciding on their choice of law firm, on firms deciding to accept particular work or clients and, on law students and lawyers deciding where to work.
The authors called on these ‘stakeholders’ to be on the right side of history and drew comparisons with the firms, lawyers and clients who either supported or opposed apartheid-era South Africa. Further, the report was not focused solely on environmental issues but also on “S”, the impact for example of the climate crisis on communities of colour and indigenous groups.
The report invited Stakeholders to make decisions that aligned with personal values and its authors used various sources of publicly available data to reach its judgements. However, they also devoted an entire chapter to the ‘limitations’ of the data sources and this brings us to the crux of the issue.
ESG data and ratings providers are playing an increasingly important role in the investment process and the UK Government estimates in its Roadmap to Sustainable Investing that this market will “continue to grow strongly …and reach the $1 billion mark by the end of 2021 for ESG data alone.” It’s perhaps no surprise then that in 2019 Moody’s bought a stake in ESG rating agency, Vigeo Eiris.
Financial services firms and large corporates are now required to make specific climate-related and sustainability-related disclosures in their corporate reports and, in the case of the former, when providing specific financial products and services. However, the Government’s Roadmap highlighted the problematic issue of data consistency and comparability and noted the potential for, among other things, the “consumer-harm” of green-washing.
The UK Government has made clear that the direction of travel is, for “E” ratings at least, towards FCA regulation but it is becoming harder to justify treating - as separate and stand-alone - the “E, S and G”. As noted by the authors of a Harvard Law Report:
“..despite difficulties quantifying the ‘S’, stakeholder-centric issues present real risks for companies. While there are myriad of examples of ‘E’ and ‘G’ failures – environmental disasters and governance failings – many corporate crises are actually failures of ‘S’”
Without agreed and integrated reporting standards, the risk is that social-washing simply replaces green-washing. So, in the absence of universal reporting “S” metrics, where to begin?
...it's back to purpose
In our first blog, we began with the premise that a company’s “core values and purpose” underpin its “S” impact and, in his 2019 letter to CEOs, Larry Fink Chair and CEO of BlackRock was clear: companies that fail to fulfil purpose and responsibilities to stakeholders “stumble and fail….[because] profits and purpose are inextricably linked”.
And whilst a more holistic and integrated approach to measuring ESG is arguably needed, perhaps the emphasis on purpose underlines a key difference between the reporting approaches needed for “E” and “S”. Where the impact of “E” is necessarily viewed through the prism of risk, measuring “S” requires something else: an assessment of pro-social behaviour.
Some companies, for example, Patagonia, Body Shop, Lush, Greggs and Timpsons have well-articulated purposes and values - and noticeably, share a common approach in treating their employees as critical to their long-term success.
If Harvard is right and “S” practices are the ‘barometer’ for a company’s corporate culture, then a company’s practices in relation to its employeesare, we suggest, a good starting-point for measuring “S”.
And employee data is actually quite a straightforward starting point for “S” metrics. Most employees already hold information about, for example, workforce composition, attrition rates, pay equity, rate of parental return to work. But at the heart of any assessment of employee data is a company’s policies, procedures and practices in relation to Equality, Diversity and Inclusion.
Larry Fink identified this as key to a company’s long-term success: “a company that does not seek to benefit from the full spectrum of human talent is weaker for it – less likely to hire the best talent, less likely to reflect the needs of its customers and the communities where it operates and less likely to outperform”. In his most recent letter, he was unequivocal:
“Stakeholder Capitalism is not about politics. It is not a social or ideological agenda. It is not “woke”. Itis capitalism, driven by mutually beneficial relationships between you and the employees, customers, suppliers, and communities your company relies on to prosper.”
He also acknowledged that whilst capitalism has the power to shape and positively impact on society, government and regulation will inevitably be needed.
On the evidence to date, “S” regulation will arrive - eventually - but until then, the onus is on Boards to demonstrate that they regard Stakeholders as critical to long-term success and on Investors to hold them to account – and employee data is a good place to start.