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ESG Series: Let’s Do the Right Thing

ESG Series: Let’s Do the Right Thing

Social policies can make a big difference in how Kiwis view and trust businesses, says Victoria Harris of Devon Funds.

25 May 2022

Social change used to be on the margins. Now it’s mainstream.

We’re seeing a renewed focus on environmental, social and governance (ESG) issues in the financial markets.

The urgent demands of climate change and the need for better boards highlighted by the 2008 global financial crash has led to much of today’s focus being on the ‘E’ and ‘G’ factors.

Social factors (the ‘S’) haven’t been given the same attention – until now.

The unequal impact of the Covid-19 pandemic, the Black Lives Matter protests, and the #MeToo movement have each been powerful drivers for an increased recognition of the need for social change.

Factors which fall within the ‘S’ – like customer or product quality issues, data security, community engagement, and supply-chain issues – commonly have a huge impact on businesses and can destroy shareholder value.

Social’s ‘middle child’ label may have been an accurate description until the world changed in early 2020.

Since then, the ‘S’ has quickly moved to front of mind for investors and is high on the agenda for company stakeholders and society.

Businesses are interconnected

We’ve seen the scope of ‘S’ progressively widened over the past few decades, reflecting the evolving business environment of the 21st century now that businesses and markets are more interconnected and interdependent.

Social issues used to be just about human rights, labour issues, workplace health and safety, and product safety and quality, but ‘S’ factors now also include the impact of modern supply-chain systems and even how we use technology.

Take the 2015 Volkswagen emissions scandal in which the company admitted cheating US emissions tests.

Some people would argue that it was more of an ‘S’ issue than an environmental one, because a company’s culture dictates behaviour.

Companies have, for a long time, understood how important it is to engage with their suppliers, customers, employees, and partners.

However, now it’s not simply enough to engage with those stakeholders – you need proof that their views have been considered in boardroom decisions about a company’s growth strategy.

Social factors have become among the most pressing issues for companies around the world.

Take the use of the word ‘furlough’, which used to be largely confined to the airline industry during the boom-bust of their economic cycle.

Over the past two years it has become commonplace across many industries.

Over lockdowns, some boards and executives did the right thing, ‘sharing the pain’ alongside their employees or continuing to pay staff full wages despite significantly reduced revenue.

Entire sectors of the economy, and not just the weakest players, have collapsed or are still facing a stark and uncertain future.

As we look forward, I believe that a company’s reputation will be based on how it engaged with and managed its stakeholders through the pandemic.

Microsoft: A social star

There are some companies that excel in social change. A recent survey by the Drucker Institute says Microsoft scored the highest out of 800 US companies for social responsibility.

In 2019, the company donated over US$1.4 billion to not-for-profit organisations, provided computer science education to more than 12 million young people in 54 countries and spent above $3 billion to help businesses owned by minorities, the disabled, veterans, the LGBTQ community, and women.

This, as well as its stellar financial performance, has led to Microsoft delivering significant shareholder value over the long term. Its share price has appreciated nearly 500 per cent in the last five years.

Difficult to define

There’s been a progressive increase in emphasis on ESG in recent years – by companies, investors, and wider society.

Companies have made significant progress in disclosing their environmental impact and governance standards, but the same can’t be said of social impact and performance.

Many market participants have struggled to grasp precisely what role the ‘S’ should play in company frameworks and how to integrate it into investment decisions.

This is perhaps unsurprising – good governance practice transcends sectors, and an organisation’s impact on the environment can be measured against widely accepted criteria. But what about social issues?

A 2019 global ESG survey by BNP Paribas revealed that nearly half of investors surveyed found the ‘S’ to be the most difficult to analyse and embed in investment strategies.

A lack of consensus in the industry on what the ‘S’ is makes it harder to work into investment strategies, compared to both the ‘E’ and ‘G’. There’s a lack of social reporting from companies, which adds another layer of complexity.

Into the spotlight

In a Covid-19 environment, ‘S’ has been dragged into the spotlight and will now attract significantly greater attention from investors than ever before.

It will also get significant scrutiny from regulators, government, customers, and employees.

There was little focus on and reporting of the ‘S’ in the past, but it will now clearly be an element of the corporate story and a big pillar of a company’s ESG credentials.

It’s crucial for companies to grasp the meaning and implications of a strong social policy and communicate it to all stakeholders.

We could see what used to be an investor focus on reporting issues around diversity, equity, and inclusion become government-mandated reporting.

It’s no surprise that there’s an increasing focus on the environment and climate change, but I predict that social factors will increasingly head to the top of companies’ agendas.

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