Social or stakeholder?

The S in ESG is evolving to encompass more than just social considerations, explains Esohe Denise Odaro, head of investor relations and sustainable finance coordination, International Finance Corporation.

We live in an age where it is entirely natural to discuss social needs and causes alongside future interest rate projections and swap spreads. This development is largely down to the bond market’s stealthy embrace of sustainability, which began more than a decade ago with green bonds and has continued with social and sustainability-linked bond structures. These sustainability-integrated bond instruments have established a model that has been widely replicated by other financial products in a manner criticised by some as excessively rapid, leading to greenwashing accusations.

On environmental, social and governance-related speaking circuits, it is frequently asserted that the S in ESG is difficult to define and monitor for impact. BNP Paribas’ 2019 global ESG survey shows that 46% of investors surveyed deemed the ‘S’ to be the most challenging to analyse and incorporate into investing strategies. I frequently made light of the fact that ‘social’ was the Cinderella of sustainable financing solutions until the Covid-19 epidemic, which demonstrated that positive social outcomes do not require complicated model-derived data, but rather the fundamental yet simple essence of saving lives and enhancing livelihoods.

Globally, the International Finance Corporation’s Performance Standards are acknowledged as the premier benchmark for environmental and social risk management in the private sector. They are reflected in the Equator Principles, which are used by 134 financial institutions in 38 countries and are frequently prerequisites for companies seeking funding from international markets, including 15 European development finance institutions and 32 export credit agencies from Organisation for Economic Co-operation and Development member nations.

At least five of the eight Performance Standards are social in nature. Poor social practices, such as violations of human rights, supply chain problems or a perception that products are unsafe could cause businesses to lose employees and customers. Loss of access to resources as a result of poor community and labour relations is another example of a material social risk.

The S component of ESG is as prevalent as, and in some cases more prevalent than, the E and G factors when it comes to business risk and damage to a company’s reputation. An interesting debate has also been posited as to whether ‘social’ is the correct name for the S in ESG, or whether ‘stakeholder’ would be more accurate.

In 2004, when the United Nations Global Compact and the Swiss Federal Department of Foreign Affairs published ‘Who Cares Wins’, a report in which the term ‘ESG’ was coined, the working group, which included IFC, urged analysts to ‘better incorporate environmental, social, and governance (ESG) factors into their research.’ This was done in order to accurately quantify the value created or destroyed by companies.

Since then, the scope of S has expanded steadily over the past two decades, reflecting the changing corporate environment. ESG assessment has been used as a risk framework for a long time, but the turning point is the transition from a risk instrument to a way of creating value. Improving the management of ESG challenges is increasingly seen as essential to achieving long-term profitability. Several studies indicate a direct correlation between ESG practices and financial gains, which goes beyond cost savings and reputation enhancement. Reviewing 656 companies in its portfolio in 2018, IFC discovered that companies with superior environmental and social performance outperformed those with worse performance by 210 basis points on return on equity and 110 basis points on return on assets.

In August 2019, the CEOs of 181 of the world’s largest firms, as part of the Business Roundtable, amended a position the group had held since 1977 by stating that a corporation’s goal is to produce value for all stakeholders, not just shareholders. This advanced the adoption of the S, whether social or stakeholder.

More investors are turning towards sustainable investing due to the increased focus on ESG concerns to achieve both financial rewards and impact. For some, social or stakeholder considerations continue to take precedence over climate risks. The rising prominence of the Black Lives Matter movement has generated an outpouring of support for robust diversity policy and equitable hiring practices. It is evident that firms will continue to face increasing pressure to enhance the S in their ESG performance in the future.