Amidst the COVID-19 crisis, sustainable and responsible business – which integrates environmental, social, and governance (ESG) risks and opportunities into business strategy – has just moved up the agenda. Corporate Citizenship’s 24 years of experience, and conversations with business leaders around the world during the past three weeks, tell us ESG matters today, during the crisis, and will be more important than ever as we build the “new normal.”
We entered this crisis with a near-unprecedented focus on sustainable and responsible business. At Corporate Citizenship, we saw a steady rise in demand throughout 2018-19 from midcap, B2B, and privately held companies – demonstrating that ESG was expanding beyond publicly held consumer facing brands, to their suppliers and privately held competitors. In August 2019, the Business Roundtable redefined the purpose of a corporation based on stakeholder, not shareholder, primacy (and many responded with critiques, including B Corp). 2020 started with Larry Fink, CEO of Blackrock, declaring a fundamental reshaping of finance and asserting they would hold companies accountable for managing climate risks. State Street followed, stating that “ESG is no longer an option for long-term strategy,” and announcing plans to use its proxy power against companies “falling behind” on ESG. The World Economic Forum in Davos focused on stakeholder capitalism and climate change. And we witnessed a slew of net zero commitments from across industries. The debate was already about how far and how fast to integrate ESG – not whether to do so.
But skeptics have long warned that ESG investing and stakeholder capitalism would be tested in a downturn. And in March 2020, we fell off a cliff. Former Unilever CEO Paul Polman asserted that the COVID-19 crisis “represents an acid test for stakeholder capitalism” and JUST Capital CEO Martin Whittaker asked, “Will we go back to 100 per cent of free cash flow going to dividends and buybacks?”
Corporate Citizenship’s two decades of experience guiding companies to embed sustainable and responsible practices into business strategy, and discussions with corporate leaders around the world during the last 3 weeks, tell us this won’t be the case. Sustainable and responsible business matters now – during the crisis – and will grow in importance as we build the “new normal.”
- Expectations for sustainable and responsible business are here to stay.
Our discussions have underscored that the relevance of ESG has been increasing over time, and expectations of business to do right by stakeholders, and to live out company missions and values, will only increase. This has been widely echoed in recent media. And a March global study from Edelman showed expanding expectations of business during the crisis, with 78% of people expecting business to act to protect employees and the local community.
- ESG funds have outperformed, or held steady with, their counterparts – and leading institutional investors are not backing away from holding companies accountable for climate change and corporate governance issues.
We started the crisis with exponential growth in sustainable investing. In the US, net flows into sustainable funds reached $20.6 billion in 2019, more than four times the previous annual record which was set in 2018. Investor relations teams, from Fortune 100 to midcap B2B companies, were increasingly focused on driving ESG conversations with investors and strengthening performance on ESG ratings and rankings. But skeptics continued to ask whether ESG funds, which rose in prominence only after the Great Recession, would survive a downturn. Unequivocally, the answer is yes.
More than half of ESG funds have outperformed the wider global stock index in the market downturn. The MSCI World stock index fell by 14.5 per cent in March, but 62 per cent of global environmental, social and governance-focused large-cap equity funds outperformed the global tracker, according to data from Morningstar. “ESG funds tend towards higher quality companies with a stronger balance sheet, companies that are run better and operate more efficiently,” said Hortense Bioy, director of passive strategies and sustainability research at Morningstar, speaking to the Financial Times.
Similarly, S&P Global’s tracker through March 23 showed that the S&P 500 ESG Index and the S&P Global Large Midcap ESG Index outperformed their counterparts.
Blackrock has made clear that COVID-19 will not impede their plans to hold companies accountable for management of climate change and corporate governance. On April 2, they spelled out engagement priorities and KPIs for 2020, underscoring how they will hold directors accountable for progress on sustainability
“The pandemic we’re experiencing now highlights the fragility of the globalized world and the value of sustainable portfolios. When we emerge from this crisis, and investors rebalance portfolios, we have an opportunity to accelerate into a more sustainable world.”
Larry Fink, CEO of Blackrock
For companies, the implications are clear: expectations from investors to deliver on ESG remain relevant during this crisis, and they will continue to rise as we build toward the “new normal.” As investor scrutiny and sophistication toward ESG grows, Investor Relations, and the C-Suite more broadly, need to be ready to demonstrate clear evidence of ESG performance.
- In the short term – companies continue to allocate capital to ESG based on three factors.
During any crisis, business continuity, employee safety, and cash flow take precedence. Beyond that, corporate decisions to allocate capital to ESG depend on three factors.
First, where there is a short-term business case, companies continue investing. Where a carbon footprint results in tax credits, or resource efficiency saves costs, the business case is clear. As one agribusiness leader said, “Resource efficiency – energy and water conservation – adds a lot of benefits to the bottom line. As long as we continue to see the bottom line benefits, we’ll continue to do those things.”
Second, where immediate ethical or reputational issues exist (e.g. doing right by workers and communities), companies invest. Today, companies have to manage high expectations to pay staff, provide sick pay, guide employees about COVID, and support communities – all while ensuring adequate cash to survive. A recent Axios / Glover Park study shows American voters expect big companies to step up: 82 per cent want them to offer sick pay to their staff and 81 per cent want them to keep paying staff, even if operations stop. Scrutiny from media, employees and the public put several companies in the spotlight for failing to do so. JUST Capital, which with Forbes releases the annual JUST 100 ranking of America’s best corporate citizens, is publicly tracking companies on sick pay, hazard pay, layoffs and community investment. And many companies have earned accolades for critical community support. Corporate Citizenship’s evolving COVID-19 timeline captures many of these actions.
And third, companies invest in ESG now because they are looking ahead, to build a long-term, resilient business strategy. They continue investing in management of financially material environmental, social and governance risks and opportunities because these are essential to long-term value. As a healthcare leader commented, “This crisis has proven the case for ESG as a resilient business strategy in itself.”
- Looking long-term, what ESG aspects will be most important? In these early days of the crisis, here is what is top of mind for business leaders as they plan for the “new normal”.
- All sustainable and responsible business begins with purpose, mission and values. That won’t change. Purpose may be tested through COVID-19. Crises separate those who talk the talk from those who deliver through purpose-driven action. But going forward, all ESG should be grounded in who you are as a company and why you exist.
- The “future of work” is rapidly becoming the present, and the focus on responsibility to workers will continue to grow. The pandemic is catapulting us to a future of flexible, remote work, driven by technology. It is also forcing questions long-simmering under the radar about benefits to employees and freelancers in an economy projected to reach 50% contractors by 2027.
- Climate risks are increasingly urgent, and scrutiny from investors, employees, and customers about how companies manage those risks will rise significantly in the coming decade. For a growing number of firms, the physical reality of rising sea levels and increasing storms, floods and other natural disasters has become undeniable. As noted above, Blackrock and many other investors are keeping the pressure on companies to demonstrate effective climate risk management as a key indicator of the health of the firm. And regulation is in place in Europe through the European Action Plan, which incorporates recommendations from the Task force on Climate Related Financial Disclosures (TCFD), a market-driven initiative to develop voluntary and consistent climate-related financial risk disclosures in mainstream company financial reporting. For North America, the question is when, not if, TCFD will shape regulation.
- Companies are placing a renewed focus on resilient business strategies. From an increased focus on cash reserves, to shoring up risk and crisis management capabilities, to rethinking global supply chains, resilience is top of mind. And more broadly, ESG has proven its mettle for resilience: companies who thrive are continuously anticipating and adjusting to emerging ESG trends that can permanently change the earning power of a business.
- Data privacy and cybersecurity are front and center, and will continue to rise in importance. Longer term, digital ethics around AI and data will be critical. Internal crisis teams are ramping up cybersecurity measures as white collar workers shift to remote work. And data privacy, already in the spotlight, is magnified through this crisis. Zoom, the videoconferencing service which grew from 10 million users in December 2019 to 200 million in March 2020, faced unwanted guests crashing video chats and accusations of unethically sharing personal data. The company earned rare praise for responding transparently. Data privacy and cybersecurity were already a focus as companies digitize; COVID-19’s push to remote work has broadened and heightened those risks.
- Innovation capabilities are the difference between crisis “winners” and “losers”. Responsible innovation will separate those who deliver long-term value from temporary winners. Healthcare innovators are driving toward testing, treatment and a vaccine for COVID-19. Diversified healthcare leader Abbott launched two COVID-19 diagnostic tests within 10 days, including their rapid ID Now test that can detect coronavirus in as little as 5 minutes. The company is focused on ramping up production to meet urgent needs in outbreak hotspots, prioritizing frontline workers and first responders. And Johnson and Johnson recently announced that its COVID-19 vaccine in development (targeted for human testing in September) would be available on a not-for-profit basis. Outside of healthcare, many companies are pivoting to support needs during COVID-19, including factories producing ventilators, apparel and textile companies building protective wear for healthcare providers, and alcohol distilleries producing hand sanitizer. And in a context of intense scrutiny, all must deliver innovation responsibly. “Companies will be split into two camps: those who treated staff and others well, and those who tried to take advantage.”
- And finally – business leaders are investing in ESG to shape the new normal. The Great Recession significantly decreased already-teetering trust in business. Out of this came the rise of ESG investing and higher expectations of business to live out values from all stakeholders – talent, driven by Millennials and Gen Z who want to work for sustainable companies; consumers, who increasingly make purchasing decisions based on alignment with values; and the public, who expects brands to take a political stand – especially where governments leave voids on human rights, equality, and climate change. These trends won’t reverse as we recover from this crisis, but leaders have varying views on the future. Are we building toward a “new New Deal”? A new “social contract” between business, governance and society? A full embrace of stakeholder capitalism? Or even wholly mission-driven business such as B Corps (achieving the twin objectives of profit and societal benefit)? We will continue discussing these questions with business leaders throughout 2020 and into 2021.
A business strategy that embeds financially material ESG risks and opportunities is the only way to go forward. Business leaders have a unique opportunity, in this moment, to build a “new normal”. Those who answer the call to deliver the future responsibly and sustainably, delivering value to priority stakeholders rather than solely to shareholders, will thrive, and we will all be better for it.
