Why ESG has to be top of the agenda, and PDQ  

If any business thinks it can afford to ignore Environmental, Social and Governance concerns, it is making a big mistake 

For some, it might represent just another box to tick – at worst, Environmental, Social and Governance (ESG) is merely another form of virtue-signalling, the incarnation of the ‘woke’ agenda in the corporate world. 

However, as John MacKenzie, a Partner and member of Shepherd and Wedderburn LLP’s ESG Advisory Group, points out elsewhere in this issue of The Business, those who think ESG is simply another management buzzword need to think again. 

As the Law Society of Scotland highlighted recently when it convened a seminar on a theme that has attracted the attention of businesses across all sectors: “Considerations around climate impact and carbon emissions, diversity and inclusion, human rights and corporate governance strategies are increasingly informing investment and boardroom decisions.  

“The rise of ESG brings with it increased risk of reputational damage and costly litigation to businesses should they fall behind. It is ever more important for lawyers to bring awareness of ESG factors into their practice” 

It is clear that we are now decisively in the age of the ‘conscientious consumer’, one in which a wide range of stakeholders have serious concerns about ESG and an era in which a growing number of us are willing to pay a premium for healthier, safer, more environmentally and socially conscious products and brands. 

So just what is ESG? Global management consultancy McKinsey provides a handy guide.  

• The E includes the energy your company takes in and the waste it discharges, the resources it needs, and the consequences for living beings as a result.  
• S represents social criteria, the relationships your company has and the reputation it fosters with people and institutions in the communities where you do business. Every company operates within a broader, diverse society. 
• G is governance – the internal system of practices, controls, and procedures your company adopts to make effective decisions, comply with the law, and meet the needs of external stakeholders. 

The increased urgency of the drive towards a net-zero carbon economy and the latest Intergovernmental Panel on Climate Change (IPCC) report detailing an impending widespread climate catastrophe has meant that in recent weeks, the environment has perhaps inevitably been at the forefront.  

Clare Foster, Head of Clean Energy at Shepherd and Wedderburn, agreed that the environmental aspect is easier to explain because there are clear legislative targets in place. “We have the UK 2050 net-zero goal and the 2045 Scottish Government goal, with Glasgow, Edinburgh and other cities declaring climate emergencies and setting their own more ambitious targets. In addition, there has been a lot of awareness generated by Cop26, so it is difficult to ignore this aspect of ESG and many more organisations now have the environment at the top of their agenda.” 

And there’s no doubt that with Russia’s invasion of Ukraine and soaring food and fuel costs bringing real hardship to large numbers of people, the ESG landscape in 2022 is more difficult than ever to navigate.  Executive leadership teams face multiple new challenges in balancing the interests of their shareholders, employees, customers and community. 

“They are asking what ‘social’ and ‘governance’ really means from a board and investment perspective and how they navigate the landscape in terms of voluntary commitments, regulatory regimes and statutory obligations,” said Foster.  

Louisa Knox, a Partner in Shepherd and Wedderburn’s pensions team, said that shareholder activism and pressure is demanding answers to some of these questions. “People are going to be expected to supply more granular detail when reporting their progress on ESG and there is pressure to standardise reporting and set a level playing field.”  

And ESG is here to stay. As Jack Payne, of New Street Consulting Group, said last year: “ESG is now simply considered as good corporate strategy, good business and good economics”. 

In the financial services sector, Alison Rose, chief executive of NatWest Group – to which the Royal Bank of Scotland belongs – is among many business leaders who believe that an important way to drive growth is to reflect customers’ values and aspirations – especially in helping them tackle climate change and the transition to net zero. 

NatWest’s Springboard to Sustainable Recovery report, published in 2021, showed that if small and medium-sized enterprises get the right support, they can deliver a significant amount of the UK’s abatement targets, delivering more than £160 billion in climate opportunities for customers. 

The group is a major advocate of the ‘E’ in ESG which, while once considered a niche market for the largest global companies, has moved into the mainstream and been adopted by smaller, privately-owned firms as well as the public sector. 

According to research by compliance and risk company Perillon, there is a greater breadth of companies embracing ESG, and for good reason. The report says that: 80 per cent of the world’s largest companies are reporting exposure to physical or market transition risks associated with climate change; climate-related weather events are expected to cost businesses £1 trillion by 2026; and 88 per cent of consumers will be more loyal to a company that supports social or environmental issues. 

Some consumers, however, are still wary of ‘greenwashing’ – when a company or organisation spends more time and money on marketing themselves as being sustainable than actually minimising their environmental impact. 

It is a hazard that Chris Tait, chief operating officer of the Edinburgh-based Global Ethical Finance Initiative (GEFI), conceded could undermine the message.  “It’s important to realise that you can no longer just tick the box; robust measurement and reporting is the next major stage in demonstrating the impact of ESG.” 

Encouragingly, in addition to their annual reports, banks and other financial institutions now also produce standalone sustainability reports.  “Yes, they will showcase what they do in terms of their net-zero strategy, but they can increasingly back that up with tangible figures that show what they have delivered,” said Tait.  

Customers have also become more discerning and demanding about the standards delivered by the institutions they deal with. “Digitalisation and social media are informing the way people look at the environment and social justice and they can convey their opinion instantly with the click of a button. They see ethical finance not just as profit – but profit with purpose.” 

Derek Hogg is head of the social housing team at law firm Harper Macleod LLP and acts on behalf of registered social landlords (RSLs) and local authorities. “The formal framework we are developing to monitor and measure ESG targets and outputs is a relatively recent thing for the RSL sector in Scotland, though many of the social and governance aspects of that have long been baked into what they do. 

“They are very focused on providing good quality, energy efficient housing and when it comes to governance they are set up as pretty open, democratic organisations – and it’s already a very heavily regulated sector.” 

However, he adds that RSLs are now looking at how they can move more quickly toward both the carbon neutral ideal in new-build housing and confront the major issue of retrofitting existing housing to achieve the Scottish Government’s net-zero targets.  

“Much of the focus is coming from the financial sector because when raising funding, RSLs are now being asked by the banks they deal with about their ESG credentials and it’s increasingly important to be able to demonstrate that they have a formal policy in monitoring their outputs. 

“They are being explicitly asked to make that linkage and are being offered slightly better financial terms if they do sign up to achieving certain targets on an ongoing basis.” 

The figures 

83 per cent of consumers think companies should be actively shaping ESG best practices 

91 per cent of business leaders believe their company has a responsibility to act on ESG issues 

86 per cent of employees prefer to support or work for companies that care about the same issues they do. 

Source: PwC