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The post-pandemic investment landscape is set to place greater value on environment, social and governance (ESG) disclosures.
In brief
- The COVID-19 pandemic has reinforced the importance of ESG issues and accelerated the transition to a more inclusive capitalism.
- Investors increasingly believe companies that perform well on ESG are less risky, better positioned for the long term and better prepared for uncertainty.
- Companies that realign to the stakeholder capitalism agenda may have a competitive advantage over those that try to return to business as usual.
There has been growing support in recent years for the concept of stakeholder capitalism and a recognition of the importance of creating long-term value. It is a commitment that, surprisingly to some, has remained strong despite the economic pressures that have risen from the COVID-19 pandemic.
Stakeholder capitalism is a philosophy based on the belief that companies have an obligation that goes beyond simply providing returns for shareholders. It suggests that companies should be mindful of, and responsive to, their impact on society and the environment. This can involve: creating secure jobs for employees, embracing sustainable practices, serving customers loyally, cultivating long-term supplier relationships, paying fair taxes or working to minimize the environmental footprint of operations.
This form of inclusive capitalism is not new – it was popular in the 1950s and 1960s – but it is now making a comeback, and this time it is closely linked with ESG issues such as climate change, diversity and human rights. Pre-COVID-19 examples of the move away from pure shareholder capitalism include: the Davos Manifesto from the World Economic Forum (WEF), the Business Roundtable’s Statement on the Purpose of a Corporation, and the Embankment Project for Inclusive Capitalism created by the EY organization and the Coalition for Inclusive Capitalism.
ESG and long-term recovery
There had been fears that with the emergency response to the COVID-19 pandemic, and with many companies facing an existential crisis, the focus would move away from ESG issues. But, in many respects, the opposite has occurred. It seems the COVID-19 pandemic has accelerated the transition to a more purposeful and inclusive capitalism. Although many organizations are in survival mode, ESG issues are likely to remain critical and essential to resilience and long-term recovery.
When businesses discuss economic risk and significant trends, and when they consider specific threats, such as climate change and pandemics, they tend to take decisive action only when they believe that those risks are likely to impact them in the short term. Now that one of those risks has become a reality, that may change.
Encouragement is not lacking for this change of approach. Pressure is mounting, mainly from the public, with people issues (the “S” in ESG) coming to the fore. Companies that have treated their staff and suppliers well during the COVID-19 pandemic have likely improved their corporate reputations, and potentially gained more business.
Some companies, however, abandoned their declared purpose as economies started to dip. Such actions may have eroded trust and damaged reputations. Their actions may be remembered by potential customers and may echo in the minds of employees for a long time. It is likely that those companies that did not stand behind their values may lose business and, when economies rebound, their best talent may be looking elsewhere.
Pressure is also coming from the side of governments. Government responses to COVID-19 in many countries included large stimulus packages tied to “green outcomes,” with specific focus on accelerating the transition to a zero-carbon economy.
There have also been other, more targeted government interventions. The European Commission’s proposed €750b fund to help the bloc recover from the COVID-19 pandemic came with a requirement that 25% be set aside for climate change mitigation.1
There is also pressure from companies themselves. A good example is WEF’s recent white paper Measuring Stakeholder Capitalism: Towards Common Metrics and Consistent Reporting of Sustainable Value Creation, which proposed a set of universal ESG metrics that could be published in annual reports. The metrics were created by WEF’s International Business Council (IBC) of leading CEOs in collaboration with professional services firms.
Another example is the Build Back Better movement, where a coalition of CEOs published an open letter (pdf) calling for the creation of a post-COVID-19 global economy that boosts society, the planet and shareholders for future generations. The CEOs want to promote “purpose-first” businesses as a fourth sector of the economy to join the existing public, private and nonprofit sectors.
Investor pressure
But, significantly increasing pressure is from investors, who are focusing their attention on ESG issues and stakeholder capitalism. In a recently published letter to CEOs, Larry Fink, CEO of asset management company BlackRock, indicated that companies who focus all their stakeholders are going to be the winners in the future. He recently said that stakeholder capitalism is only going to become more important.
The growing significance of ESG issues to investors can be seen in the recent 2020 EY Climate Change and Sustainability Services (CCaSS) Institutional Investor survey. The survey found that, of the 98% of investors surveyed who assess ESG, 72% carry out a structured review of ESG performance, compared with just 32% in the previous survey conducted two years earlier. Moreover, many of those who currently use an informal approach, plan to move to a more rigorous regime (39%).
Institutional investors are aligning their portfolios toward better ESG performance. This signals a different approach from focusing on “responsible funds,” and instead seeing ESG issues as fundamental to the performance for all investments.
In the report, one institutional investor, Vincent Triesschijn from ABN AMRO, sums up the views of many investors. “It is our conviction that companies that perform well on ESG are generally less risky, better positioned for the long term and possibly better prepared for uncertainty,” he says.
Nonfinancial performance is now considered more frequently when investment decisions are made, when compared with the results from the 2018 survey. Around 9 out of 10 investors surveyed say that nonfinancial performance played a pivotal role in their investment decision-making over the previous 12 months.
Looking at the survey findings, it is clear that a focus on ESG performance will likely be critical to success in a post-COVID-19 world. Rather than distracting us from the need to drive a sustainable future, the COVID-19 pandemic has helped reinforce the imperative. The COVID-19 pandemic has demonstrated the possibility for significant carbon emission reductions and rapid behavioral changes.
The transition to a decarbonised future is likely critical to the long-term resilience of companies, the economy and the planet as a whole. Strong ESG strategies and frameworks should be vital to economic recovery and for companies to thrive in the long term.
Energy sector opportunities
Different pressures are now converging to create the market conditions for rapid transformation within sectors. Energy is a prime example. Alongside regulatory support for renewables, and an ever-decreasing cost base for solar, wind and battery-storage solutions, stakeholder forces are focusing on decarbonisation and the realignment of assets toward lower-carbon alternatives.
By 2040, according to the International Energy Agency, over half of all electricity supply will be from low-carbon sources2. With increasing demand for electrification of transport and industrial processes, and greater funding through green bonds and green loans, opportunities for this sector to capitalise on decarbonisation should be plentiful.
Companies that focus on ESG issues and realign themselves to the stakeholder capitalism agenda may have a competitive advantage over those that try to return to business as usual.
This article was first published in Foresight Climate & Energy
Summary
Companies that set an agenda for climate-resilient growth will likely be seen as more attractive prospects by investors. Institutional investors are aligning their portfolios toward better ESG performance, as the COVID-19 pandemic is demonstrating the possibility for significant carbon emission reductions and rapid behavioral change. It is clear that a focus on ESG performance could be critical to success in a post-COVID-19 world.
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