ESG (Environmental, Social, and Governance) funds allow people to invest for the long term, while making sure their money is placed in firms seeking to lessen harmful environmental impact, take a broader view of society and their stakeholders outside of just shareholders, and corporate governance/behaviour. Put simply, ESG is a list of goals investment professionals use to measure company’s ethical impact. This allows investors to make informed investment decisions when building an ethical portfolio. Typically, companies are assessed on how well they do in each ESG category and they’re given a score. The better their ESG rating is, the more positive their impact is assessed to be. Many funds will have a minimum ESG score for a company to be included in their ethical funds. However, firms also need to be assessed by fund managers as a high quality investment to be included in an ethical portfolio or fund.
Over the last few years, climate change has been a central concern in society and many companies have adapted their practices and policies to be more environmentally friendly. This increasing concern for the environment has seen corporations and investment professionals place much of their recent attention on the ‘E’ within ESG.
The current pandemic has brought to the forefront a number of issues within the ‘S’ and ‘G’ categories. As corporations face questions about their place within society and their wider obligations, how they are run (Governance) will only become more important as economies and people rebuild.
Here’s an overview of the potential impact Covid-19 could have on ESG priorities.
How could Covid-19 affect the green economy?
Covid-19 forced governments around the world to mandate businesses to close to support social distancing measures. This has seen more than half the world placed on some form of lockdown and led to a collapse in economic activity, which has also driven energy prices significantly lower. This could potentially impact the adoption of green energy. With lower energy prices, companies, governments, and people may feel that there’s less rush to move to cleaner energy as it’s less economically pressing. But oil extraction isn’t like simply turning a car on and off, so production hasn’t halted completely. Economics aside, it is important to remember that a gallon of petrol burnt has the same environmental impact regardless of the price paid for it. So, over the long-term, we could be missing out on key innovations in the renewable energy sector and the path to a low-carbon economy could be delayed.
Covid-19 has disrupted global supply chains, and this is likely to make producers re-evaluate whether production should become more localised. This could have some positive consequences for people and the environment. For instance, the changes in supply chains could lead to an increase in local jobs and tax revenues for governments, which would benefit the local community. However, this may also increase the cost of inputs due to higher labour costs. On the environmental side though, a more localised supply chain would mean the carbon footprint of goods could potentially decrease as components would not need to travel across the globe.
Because of the pandemic, many airlines have stopped or limited activity, and the aviation industry has lost billions in revenue. We can’t predict the future, but multiple industry leaders seem largely agreed that they do not expect a return to prior “peak aviation” for a number of years. As people are urged to stay at home and limit their travels, we should expect a drop in international tourism. And as a result, we could see CO2 emissions fall in the near future – obviously air travel isn’t the only source, but travel overall is one of the largest contributors. By reducing overseas travelling and favouring staycations and virtual business meetings, we would indirectly help the environment and promote more flexible ways of working, which could benefit the economy and all workers in the long run. But what’s happening to the aviation industry doesn’t necessarily mean the death of tourism – people will still travel when restrictions are lifted, but they might do it in a eco-friendlier way. In fact, sustainable tourism is expected to grow by $338.06bn between 2019 and 20231.
How could Covid-19 impact corporate practices and policies?
The pandemic has had a huge impact on businesses, but the consequences haven’t been the same for every organisation. Many companies have been legally required to close and place employees on furlough, especially in the hospitality and other face-to-face service sectors, whereas other organisations, in particular so called-white collar or office workers, have been able to partially adapt, adopting remote working practices. There are also essential businesses, like supermarkets, which have had to implement rules to protect their employees from potential contamination but also are required to stay open to provide an essential service. Another painful adjustment has seen some areas of the so-called gig economy, where short contracts and freelance work dominate, face a difficult choice between workers placing themselves at risk of infection or sacrificing their earnings according to the World Economic Forum2. This situation has thrown an unfavourable light on the way this sector treats workers since several firms do not classify them as employees, lessening their contractual obligations. But the focus is broadening to be economy wide, especially in light of the shock to the labour market that Covid-19 delivered. There is also an increased risk from the current outbreak accelerating another trend, automation which is anticipated to have the greatest negative impact amongst lower paid workers3 but also reaching into those middle-earners (and consumers) the global economy simply cannot do without4. The rise in e-commerce that social distancing has accelerated the long-run trend towards “clicks over mortar”, but EY reported that 41% of firms across 45 countries are looking to accelerate automation5.
There’s also the question around those firms which may have appeared to benefit from the crisis. In a time where many are suffering from financial hardship, seeing leadership teams or shareholders make considerable gains could almost seem unethical to the wider public and is unlikely to avoid criticism. For instance, although Tesco has been praised for its treatment of sick staff, its commitment to cleanliness, and its willingness to hire and train thousands of additional paid workers, the company has been vilified for paying a £635 million dividend after accepting a £585 million business rate holiday6. As Covid-19 is an “unprecedent” situation there are no well-defined corporate rules for dealing with the fallout. But at present, public opinion would appear sceptical of those firms who are furloughing workers but continuing to pay dividends or maintaining large incentive schemes7. This is clearly a new governance issue for consideration unfolding in front of us and some companies and CEOs are seeking to set an example. For instance, Andy Ransom CEO of Rentokil, has reduced his salary by 35% and donated the remainder to an employee fund8. While these steps are not economically viable for everyone, they do send a strong message from the top of an organisation. ESG professionals, and in particular governance specialists, will need to carry out further research and analysis for the longer-term impact of any dramatic changes. But when assessing companies on their ethical standards, many will no doubt look to the well-publicised corporate behaviour during the pandemic as their starting place.
The pandemic has also brought the best out of companies, with some rallying to produce crucial supplies in the fight against Covid-19. Manufacturers, like Tesla, Rolls-Royce, Ford, McLaren, and Airbus, have adapted their production and are now making medical ventilators for hospitals. Fashion labels, such as Burberry, Gucci and Prada, are helping by making personal protective equipment (PPE) for doctors and nurses. This means employees are learning new skills and doing tasks they’ve never done before, and in the future, we may need work to be more flexible and portable with the workforce transferrable from one industry to another9. These focused efforts are to be applauded, but whether or not the urgency of change be applied to wider ESG targets or the UN’s sustainable development goals10 remains to be seen.
ESG priorities will not change because of Covid-19, but some key issues, like employees’ health, are likely to rise up the priority ladder and see investors demand greater scrutiny. What the pandemic serves to remind us is that ESG investing focuses on long-term broad based returns. The argument for long run investment in those companies committed to placing long economic performance and public health over any short-term relative gains remains the same.
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