Putting the ‘S’ back into ESG

What is ESG?

Environmental, social and corporate governance (ESG) is a widely used framework in business to understand how companies of all kinds can promote benefits and protect people and the planet. ESG is also at the top of the agenda for many charities who want to ensure all their wider work avoids causing unintentional harms, and also want to influence businesses’ ESG strategies to achieve their core charitable mission.

ESG strategies commonly—whether in business or in the larger charities that have them—focus on environmental concerns, a trend enhanced by global events like COP26. The UK corporate governance code has meant there has been some focus on governance concerns too. However, there has been much less focus on the social component of ESG, despite urgent needs thrown up by the pandemic and the cost-of-living crisis.

How has ESG grown?

ESG was fringe 15 years ago, but has seen rapid growth over recent years and is now considered mainstream in the investment community. The number of organisations who have signed up to the Principles for Responsible Investment grew by 53% last year alone. Bloomberg Intelligence estimates that ESG assets—resources held in ESG focused funds—will be a pool a of $40 trillion by the end of 2022.

However, there are concerns that are appropriately raised about ESG, and whether ESG assets are all that they claim to be. Regulatory interest is growing at the moment, and the Financial Conduct Authority is concerned that there could be a miss-selling scandal coming from less scrupulous ESG funds.

Despite ESG being a politically divisive topic, it is important. Issues such as the climate crisis and social inequality are real, growing, and linked to an economic system where profits are maximised and investment decisions focused on short-term returns, with externalised environmental and social costs. However, the definition embedded in the Principles for Responsible Investment is very narrow and has been subject to criticisms of ‘greenwashing’. It is focused on managing the risks to a financial entity of social and environmental problems. The preamble to the principles for the responsible investment states:

“As institutional investors, we have a duty to act in the best long-term interests of our beneficiaries. In this fiduciary role, we believe that environmental, social, and corporate governance (ESG) issues can affect the performance of investment portfolios.”

Principles for Responsible Investment

According to Catherine Howarth, this focus on risks to investment portfolios, rather than the risks to people and planet from reckless investment decisions, should concern civil society.

“This is an extraordinarily self-serving, inward looking and self-centred definition underpinning this 15 year old journey. One of the things we think is needed is a pivot to a more ambitious approach and definition of responsible investment, and no-one but civil society can be the champions of that.”

Catherine Howarth

What about the ‘S’ in ‘ESG’?

The pandemic has started to shift the focus towards the social aspects of ESG, and the cost-of-living crisis will only intensify this gaze. This is a perfect moment for the charity sector to challenge the investment and corporate community on issues ranging from labour practices to human rights.

Currently, 76% of the world’s largest asset managers have a commitment to human rights in their policy documents, but just 4% have a dedicated policy to tackle this. This illustrates the challenge civil society faces.

Common examples of pushback which those trying to bring more of a focus on the social aspects of ESG include:

• The range of issues which the ‘S’ can cover
• The perception that the social impact of companies is less financially material—though this is likely because of the higher profile focus which climate issues have had in the investment community
• Challenges with data and measurement making it difficult to know where to start—though there is a good argument that this is no less true in other sectors

“Of course there are data challenges but this also becomes a convenient excuse… and the art of investing has always been one of making decisions in the absence of perfect data sets—that’s what active management is about: making judgements”

Catherine Howarth

Why is this relevant for charities?

Social change is core to charities mission and what they excel at, and this gives them an opportunity to be leaders in ESG. The current spotlight on ESG means that now is a key moment for charities and other organisations to consider their role in pushing for change, influencing other organisations and sectors, which can improve social outcomes across the country.

“Ultimately, civil society has this role to be guardians of what is best in this economy, and a more just vision of the economy.”

Catherine Howarth

Their own activities

Firstly, charities should first look to ensure that their own performance is up to scratch. As far as they can, they should reduce their environmental footprint and pursue better employment practices. This is both to bring about better outcomes, and to model what best practice looks like for other organisations.

Secondly, charities should identify ESG topics where their organisation has expertise and which is aligned with their mission, and bring this expertise to conversations with businesses and the investment sector. This expertise is valuable, and common complaints from those who do not invest in social programmes is that data and evidence is often about the social aspects of ESG.

Reporting

What companies and charities should be reporting on, and how they should be reporting, is an area of debate in the ESG space. However, it is vital that accountability moves beyond simple financial measures. One promising move is the effort to make reporting more consistent through the likes of the International Sustainability Standards Board. However, the focus on reporting is disproportionate when compared to the amount of discussion that concrete actions get. It can also encourage a tick-box approach, where investors are immediately thinking ‘how can we look like we’re achieving the S’ rather than thinking more holistically about avoiding social harms in all their forms. Thoughtful reporting can of course spur thoughtful action, but you cannot have reporting in the absence of action.

Their investments

If charities have assets, they can use them to achieve their mission by investing them at the ambitious end of the responsible investment spectrum. This should also apply to staff pensions and can be communicated as part of an employment offer to make the charity sector a more attractive place to work.

Charities can also bring their voice to debates at the AGMs of the companies they are invested in, co-file shareholder proposals, and finally speak up in policy forums or with parliamentarians and regulators who make the rules for financial institutions.

How they can influence businesses to consider social concerns

The charity sector is smaller than some, but has great influence and a key role to play in challenging other, bigger actors to do the right thing. ESG is a key framework which civil society can use to do this.

Companies are trying to balance the need to create profits with the desire to achieve social ends and to do so sustainably. Much of the focus is on getting companies to do ‘the right thing’, but there has been less of a focus on convincing companies that their bottom line will be affected in the long-term if they do not. One good example of this is how a good ESG strategy can support a company to attract and retain talent.

This focus on avoiding damage to the bottom line can also help tackle unrealistic expectations around what level of profit can be attained in the short term whilst pursuing ESG investments. It is not realistic to expect the best market returns consistently from ESG investments, and this can lead to best practice being undermined by those seeking higher returns. Seeing ESG instead as something to protect returns over the long-term could lead to better buy-in.

Where can charities look for inspiration?

There are many innovative examples of charities pushing companies to live up to their ESG commitments. One example was the Shareholder Commons, an NGO in the US which was concerned about the potential of antimicrobial resistance to make antibiotics ineffective. As battery farms are one of the most common uses of antibiotics around the world, the Shareholder Commons presented a shareholder proposal at McDonald’s annual stakeholder meeting to study and disclose the external environmental and public health costs of its meat supply chain.

Similarly, the Behind the Barcode Campaign was a successful movement to bring greater focus to companies supply chains and global footprint by Oxfam, grading different supermarkets practices on human rights and labour exploitation grounds.

Boots has had a successful 12 year partnership with Macmillan Cancer Support which has informed some of the company’s products and services and also contributed to training 4200 pharmacists to understand more about how to support people with a cancer diagnosis.

Another example from ShareAction’s experience is the living wage work, which is a partnership with the Living Wage Group. When the partnership began in 2010 there were two accredited living wage employers in the FTSE 100, now there are over 50. This has come about through the efforts of collaborating groups of investors writing to companies to push them to pay their workers a fairer salary. AGM questions have been a vital tool in this campaign, and AGMs are an underused occasion generally for those trying to influence companies. In ShareAction’s experience, questions at AGMs are very effective, particularly when asked politely. ShareAction has recently put forward a shareholder resolution at Sainsbury’s to become an accredited Living Wage employer, which will be voted on in the coming months. Another example is ShareAction’s work with Tesco to tackle obesity, which you can read more about here.

What do charities need to consider?

Unintended consequences

Fund managers who are incentivised to ‘out-perform the index’ may find it difficult to square this approach with more ethical considerations around investing, as it is likely to mean that they will be pushing social and environmental costs elsewhere in their portfolio where they are overlooked. However, not all investment practices incentivise this behaviour, and best practice can be a lesson to regulators and other fund managers.

Charity sector and corporate partnerships are one key way to push forward ESG practice. However, partnerships need to be designed and delivered carefully to be effective. If a partnership is to last over the long-term they need to have short-, medium- and long-term mutual benefits. Both the corporate and charity need to consistently see reasons to continue the partnership. This is also reinforced by good relationships and regular contact between the individuals in those organisations.

The role of government and politics

There is an important role for government in setting the frameworks around ESG to give it structure and consistency. Many investors are also supportive of this regulatory intervention, and are starting to influence policy conversations around minimum standards. The agenda is also being pushed by a new generation of investors who are keen to make more ethical decisions, and is supported by consumers who see this as an important factor.

What should charities do?

Charities who want to make use of ESG frameworks to achieve their own mission first need to ensure they have their own house in order. Ensuring that the organisation pays the living wage, ensuring equality, diversity and inclusion in recruitment and organisational culture, and trying to tackle the organisation’s carbon footprint are all inherently important, but also allow the charity sector to carve out a position from which it can lead others.

When thinking about the target audience within businesses, charities were traditionally focused on the corporate social responsibility of an organisation. With ESG’s focus on investment assets, it is now important for charities to engage higher up in the organisation, ideally with the Chief Financial Officer (CFO), to ensure ESG moves beyond the realm of marketing and PR. In every company, there are likely to be champions who are instinctively bought into this work, so one of the most important things that we can do is ensure that these voices reach the decision makers at the top.

Charities who achieve change via their investments can push their peer investors to speak with a more united voice. CFOs are usually balancing a range of concerns and objectives from different investors, so if charities can help to bring those people and organisations together around a single aim, we are more likely to be successful. This starts with bringing other civil society and charity voices on side, and then moving from there—larger charities in particular can look to how they can work with their peers to influence investment decisions which affect them.

Charities can also use their existing data and research to provide businesses with evidence on social issues. As Catherine outlined, a common complaint by investors is that there is a scarcity of data about social issues. Charities are in a perfect position to tackle this issue head on, and share the breadth of evidence the sector has brought together about measuring the impact of social interventions.

Finally it is important to keep in mind that changes often happen slowly, despite what charities and companies may want. Taking a long-term view and planning with that in mind is crucial to success, even if little shifts day to day. Similarly, many of the most important and effective changes in ESG are preventative, ensuring a poor decision is never taken in the first place. However, this is also some of the most thankless work. Maintaining these efforts, despite their lower profile, is vital to the success of the ESG agenda.