By Adam McNestrie
The dialled-up focus on demonstrating corporate responsibility has emerged from a confluence of cultural and political developments, with activists, regulators and asset managers pressuring the CEOs that have not woken up of their own accord.
The rapidity of the change and the near unanimity with which it has been taken up by public companies gives the impression that we are witnessing a structural shift.
If the building consensus around man-made climate breakdown and demographic shifts are taken as the key drivers of the change, these would point towards a durable new paradigm.
Whereas if it is more a function of the pandemic, money-making creativity within the asset management industry and a series of contingent events, it is possible to imagine the emergence of forces that could pose a threat to this discourse. If these develop in concert, they could provoke a turning of the tide against ESG.
There are three broad headings around which I would organize potential disruptors of the new status quo.
First, it is possible that there is a political backlash against the ideas and values that power the ESG movement.
The idea of "citizen companies" with broader responsibilities to stakeholders has a long history that stretches at least as far back as the 19th Century as a minority approach. But in its current form, it reflects the cultural influence of the left, with the thinking also compatible with the Silicon Valley strand of libertarian philosophy.
The pandemic has clearly played a role in driving the world to the left and ushering in bigger government, along with some shocking events like the murder of George Floyd and the storming of the Capitol.
If a political turn to the right picks up pace, this could potentially take some of the wind out of the sails of the ESG movement.
The emergence of the real costs for individuals of the transition will test the depth of commitment to change
It is also possible to imagine some of the conditions developing for a possible backlash around environmentalism.
It is easy to talk about a commitment to a country becoming net zero by whatever date, but it will be harder to maintain a consensus around delivering such targets as the trade-offs and the costs of transition become clearer.
An early example of this is the energy crisis that has emerged in recent weeks, with wholesale gas prices more than doubling, foreshadowing swingeing increases for consumers. The crisis reflects a complex confluence of factors, but has clearly been exacerbated by a reluctance on the part of energy companies to invest in fossil fuels – married to a shortfall in investment in renewables.
The emergence of the real costs for individuals of the transition will test the depth of commitment to change.
Second, there is scope for a misfiring economy to undermine management commitment to ESG at a macro level, or for a soft market in insurance to curtail action at a micro level.
A major recession, a sustained period of elevated inflation or even a spell of stagflation would increase pressure on management teams to fulfil their primary responsibility of delivering returns for shareholders.
As much as this would push companies to focus on business fundamentals like cost control, it would also put additional pressure on management bandwidth, with ESG initiatives potential casualties (with some precedent examples evident from the global financial crisis).
Spending money on areas with no measurable positive output at a time when a business is under stress is always going to attract scrutiny
Insurance performance does not straight track the macroeconomic environment – although there would be adverse impacts from these scenarios – but the advent of the next soft market could have a similar impact on the sector.
It will always be difficult for companies to calculate the return that they get on ESG spending because you cannot accurately isolate its impact on the share price, or on other areas where you might hope to secure benefits such as staff recruitment or improved employee engagement.
Spending money on areas with no measurable positive output at a time when a business is under stress is always going to attract scrutiny.
Third, a combination of internal ESG fatigue and external awareness of hypocrisy could force it into the background.
The world likes novelty. The component pieces of ESG are not new, but there is something new in the way they are aggregated and presented.
In year three of this movement, an update to the ESG policy is unlikely to garner the same attention. A newly created conference may feel tired. An initiative concerning diversity or community engagement will likely seem like more of the same.
At this point, it may become business as usual, operating under the radar. But equally, some of it may be quietly wound down.
Alongside this, it is possible that cynicism around corporate hypocrisy could neutralize the ESG drive, with the recent lobbying campaign from a number of members of the Business Roundtable against Biden’s domestic agenda (including corporate tax rises) a standout example.
I wrote a piece a month ago in which I stressed that if the industry truly believed its rhetoric it should a) pay its fair share of taxes; b) pay out claims or subsidize cover for socially useful companies; and c) offer pro bono or discounted rates to the same class of firm. (See "ESG: An alternative manifesto")
This wasn’t me issuing a starry-eyed call to arms to the industry (as some interpreted it) – I was making the point that action in line with rhetoric would have resulted in some of these things being done, with an appreciable haircut to returns as a result.
Perhaps too indirectly, I was arguing that the gap between reality and rhetoric in many (but not all) cases is evidence of hypocrisy.
It is widely privately recognized – and relatively little written about – that much of the ESG activity that is seen goes on because the asset management industry has used it to create products on which they can charge fatter fees.
This in turn has encouraged company executives to try and reverse engineer policies that will allow them to fit within ESG indices, driving their share prices higher.
There may come a point at which people start to tire of this dynamic, particularly if it becomes more transparent. And that could either lead to a dismantling of some of what has been created, or a drive to do it right – in a way that is measurable and clearly audited.
Depth of commitment?
I suspect that the clock will not be dialled back fully to before the Business Roundtable's famous declaration that it would seek to balance the interests of all stakeholders rather than simply maximizing shareholder value. But there are foreseeable scenarios in which the ESG movement will be buffeted heavily over the next few years.
If those come to pass we will see just how robust it is, and how deep the commitment of management teams goes.
For further background reading, including an admission of my own politics here, see: "The ESG Awakening – A critique", published in June.
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