A series of notable events and developments during the past 12 months is providing cause for optimism around the sustainability / ESG agenda. In this blog we highlight a sample of the socio-demographic shifts, changes in company behaviours and beliefs, and an apparent re-focussing of investors’ priorities which, in combination, suggest we may be moving into a new paradigm for how sustainability / ESG is considered by corporate management teams and integrated within their organisations' strategies and business models. Reflecting on this momentum we also highlight several practical initiatives for Chief Sustainability Officers to consider enacting in 2020 and beyond.
A reformed creed amongst large corporations and investors
Perhaps in response to a frustration with certain governments’ ability to adequately drive solutions to environmental and social issues, in 2019 companies and the capital markets have increasingly sought to address these matters themselves.
Arguably the most significant development for capitalism in decades was the dropping of ‘shareholder primacy’ as the sole purpose of corporations by the US Business Roundtable in August, recognising that all stakeholders are essential, including customers, employees, suppliers, communities, and the environment.
This statement was mirrored by the Davos Manifesto 2020 published in December (which also called for a greater link of executive remuneration to stakeholder performance - only 17% of CEOs currently have their pay and bonuses attached to sustainability targets), as well as the additional emphasis now given to section 172 of the 2006 UK Companies Act in the updated UK Corporate Governance Code, which requires directors to consider the interests of all stakeholders and report on those considerations in the annual report. As if to put their money where their collective mouths were, in April the UN announced that the Global Investors for Sustainable Development, consisting of 30 CEOs, had committed to align sustainability objectives to their business targets to support bridging the $3 trillion per year funding shortfall in investment needed to achieve the UN’s Sustainability Development Goals (SDGs) by 2030.
From an asset management perspective, the updated UK Stewardship Code now requires money managers to formally consider ESG risks in their investment appraisal process, while throughout 2019 a record number of business signatories joined the Principles for Responsible Investment (now over 2,300) and 140 banks also signed up to the Principles for Responsible Banking. Such developments mean more questions can be expected in 2020 from investors to corporate management around their sustainability practices and objectives.
Reflecting this dramatic change in focus, the term ‘ESG’ was mentioned on double the number of earnings calls in Q2 2019 than it was in Q1 2019, with the search term also doubling in popularity on Google since 2018. And it is a trend we expect to continue: millennials (see more below) are forecast to inherit an estimated $30 trillion of wealth from baby boomers in the coming decades (for context, the market capitalisation of the entire S&P 500 is c.$25 trillion). We know that this demographic is more likely to direct their capital towards more sustainably-minded companies and investments.
Initiatives for Chief Sustainability Officers to consider:
Facilitate an exercise amongst senior management to identify the material sustainability / ESG issues and risks facing the organisation (avoiding being too broad / generic in 'doing good'), leveraging guidance and data such as the SASB's Sustainability Accounting Standards and the Embankment Project for Inclusive Capitalism report.
Deliver training, alongside the Investor Relations team, to Board members and executives to improve their fluency in communicating ESG risks to investors, and what the organisation is doing to manage them.
Work with your Corporate Finance department to seek opportunities to satisfy investors increasing demand for 'Green' investment opportunities by developing a revised, more ESG-minded value proposition, which may in turn lead to a lower cost of capital.
Sustainability in popular culture
2019 saw increasing mainstream and social media coverage afforded to climate change rallies / protests (e.g. Extinction Rebellion) and global conventions (see Greta Thunberg’s speech to world leaders at the UN climate action summit in September, and the longest ever conference of the parties, COP25, in December, where albeit only a compromise agreement was possible). Whether you agree with their actions / sentiments or not, these activities have undoubtedly led to environmental issues being more hotly and widely debated among an increasingly informed populace.
Recognising the need to be more responsible and to take greater action, in September, 87 companies with combined annual direct CO2 emissions equivalent to 73 coal-fired power plants, committed to set science-based emissions reductions targets in line with the Paris Agreement's more ambitious 1.5C target, building on the declarations made by pioneer companies such as AstraZeneca, BT and Unilever who had already aligned their emission reduction targets with the 1.5C limit.
But does media coverage and corporate commitments lead to changes of significance in consumer demand and preferences? Throughout 2019, we have seen a rise in sustainable fashion, sustainable tourism and veganism. These issues are disrupting entire industries. Who would have thought, even two years ago, that the $1 trillion meat industry was at threat of disruption? It is now – Greggs has even launched a vegan sausage roll!
Initiatives for Chief Sustainability Officers to consider:
Drive the agenda around setting environmental targets relevant to your industry (e.g. CO2 levels, water pollution, plastic usage etc.) and encourage management to sign up to external declarations (if your company has not already done so).
Get a seat at the table in strategy and business planning sessions, and focus on helping the organisation integrate its sustainability / ESG purpose into its business model and services / product line-up, to help become better aligned to changing consumer preferences and community expectations.
Challenge existing Business Continuity / Crisis Management plans to ensure they have been designed and tested to include office / site closures by demonstrators and that the organisation is ready to respond to sustained negative press / social media coverage and potential boycotting of products and services.
The rise of activist employees, driven by ‘millennials’
Millennials now make up 35% of the workforce. In a recent Deloitte survey, 63% more of this group said ‘improving society’ should be the primary purpose of business than said ‘generating profit’. This is, in part, playing out with the emergence of the ‘activist employee’. In June, employees of Wayfair staged a walk-out over the company’s decision to provide furniture to immigration detention centres. Similarly, at Google, employee protests were held during 2019 over the company’s move to build a censored search engine in China and its decision to bid for a contract with the Pentagon.
These developments may reflect a significant shift in the power dynamic between employee and employer; leadership teams will increasingly need to ensure that ethical values, aligned with changing workforce expectations, are championed and factored into commercial decision making. The employee activism examples above also demonstrate why it is vital to understand and invest in human capital: executives who are taken by surprise and challenged by their staff may appear to have lost touch with their workforce, raising difficult questions by boards, investors, customers and prospective employees.
Initiatives for Chief Sustainability Officers to consider:
Integrate with existing or run a specific organisational staff survey - has the company aligned its purpose to what now matters to its employees, or are your staff increasingly disillusioned?
Assist your executive teams to help communicate the corporate culture in ways which will resonate with the workforce
Encourage employees to speak up if they feel they are seeing behaviour / actions in practice which does not align to the organisation's values or purpose, or contradicts what the company says it stands for.
Work with your HR function to review and adapt the company’s 'Employee Value Proposition' to help recruit and retain the best talent, reflecting on sustainability / ESG relevant areas which are important to attracting the workforce of the future.
Conclusion
On reflection, managing sustainability performance and ESG risks have always been a critical factor in the success or demise of a company – having a happy, productive workforce, avoiding reputational damage, and having a product / service which is aligned to consumer demand and expectations are fundamental to long-term value creation. But they now occupy a much more prominent position in the minds of consumers, employees and investors. This is a welcome development and we sense a significant shift in momentum in 2019. Coupled with guidance and pressure from governments, NGOs and trade bodies, we see the emergence of clear benefits for companies to make a true change; those who do not may themselves become extinct.
Regards
Ross (ross@mercandco.com)