Environmental, social and corporate governance is on everyone’s lips

Everyone is talking ESG…but what does it really mean, and why should everyone, from individuals to employers and advisers, be listening?

What is ESG and why the corporate focus on it?

ESG – or Environmental Social and Corporate Governance – is not actually new. It is, broadly, the umbrella term for a range of legislative, regulatory and societal controls which impact every business everywhere. As a term in popular use, it incorporates 'fair employment', Corporate Social Responsibility and D&I, whilst also catching much more under its umbrella.

The 'environmental' element addresses global environmental goals, as well as national legislation in seeking to drive greener workplaces, a reduced carbon footprint and supply chain transparencies, while still delivering cost efficiency to stakeholders.

What is often overlooked, however, is the 'silent C' in ESG – the ‘corporate’ in corporate governance. It is one thing having great aspirational goals and the accompanying soundbite. But without good corporate governance in the form of oversight, execution and monitoring, the ESG policy is meaningless at best and a serious latent risk at worst.

What are the major risks and opportunities?

The attraction and retention of the best market talent is an exceptionally important driver, since the success of a business is almost always founded upon its people. Almost every recruitment campaign now deals head on with ESG cultures – hybrid working, D&I, neurodiversity and work life balance.

Being recognised as having 'good' ESG puts any business at the top of every graduate recruitment survey. However, there is also a more defensive aspect, which manifests as legal compliance. This is not just an esoteric concern. Compliance with legislation, such as the Fair Employment legislation or the Modern Slavery Act 2015, requires a comprehensive approach to protect both the corporation and the individual.

Likewise, sustainability is now a key concern for customers. Large commercial businesses will have committed to "net zero" or other climate change targets and are increasingly pushing these aspirations down into their supply chains. Public sector organisations now include social value as a large part of their tenders, and generally demand more from their suppliers. This means that suppliers who ignore ESG stand to be less attractive to public and private customers. Similarly, businesses with a strong sustainability strategy have an opportunity to get ahead of their competitors.

In fact, since 1 June 2022 public sector bodies must include a minimum of 10% of the total award criteria for social value reasons. Social value is about maximising the social, economic and environmental benefits through the public procurement process, with a view to delivery across a number of themes with synergies across ESG, namely:

• increasing secure employment and skills
• building ethical and resilient supply chains
• delivering zero carbon
• promoting well-being

Over time, it is expected that the marks awarded to social value initiatives in competitions to award public sector contracts will increase to 20%. Those businesses that lead out ESG initiatives will be better placed to score higher marks and see themselves better placed for these contract awards.

So how do we ensure our business, and that of our clients, is ESG ready?

As we said, ESG is not a new concept and therefore, most of the structures for getting it right already exist in statute. National Minimum Wage, Working Time Directive and Fair Employment legislation put structure around employment principles. In the corporate governance sphere, bespoke shareholder and investor agreements increasingly govern how business is managed – and are scrutinised and scored for 'green credentials' in any funding round.

ESG must also be drafted into the warranties and indemnities within commercial contracts – especially where supply chain transparency is rendered a critical key in the Modern Slavery Act. Collectively, that only addresses 'soft' governance – leaving 'hard' governance to regulators – HMRC and increasingly, banks and venture capitalists when evaluating the 'cost' of lending and debt financing.

Corporate governance frameworks are unattractive, but they are an absolute necessity. Where the link between these frameworks and environmental goals fails is when organisations use such frameworks to advertise sustainability credentials to the market which they simply do not have. The worst instances are often described as 'greenwashing' or 'virtue signalling'. Where the law is often slow to deal with this, the court of public opinion is not and such claims can be fundamentally destructive to a business, its people and its opportunity to raise 'new' finance.

There are two key elements to ensuring a responsible ESG policy. Firstly, responsibility starts with boardroom 'buy-in' and should not be delegated down to a lower level of the management chain. Commitment needs to be immediate, sustained and authentic. It should also be flexible, recognising that if an organisation makes a start, there must be investment and space to learn from mistakes and adapt.

The Modern Slavery Act 2015 is an excellent example of the 'iterative' nature of ESG. Section 54 of the Act deals with corporate responsibilities and sets entry level compliance thresholds but crucially, the legislation anticipates year on year improvement and 'ethical auditing', not just of its workforce, but also that of its supply chain globally. The obligation for corporate Northern Ireland is to embrace the immediate requirements and accept that ESG requires a culture of continuous improvement.

Secondly, we must recognise that policies and protocols are only worthwhile when there is real and sustained commitment from the boardroom. Inauthentic messaging will be seen for what it is - virtue signalling or green washing which will do instantaneous damage to any brand reputation, as well as creating a 'chill factor' for potential future recruits or investors.

What trends and influences do we see ESG having now and in the near future?

When discussing ESG ratings and its scoring, you cannot ignore the practical impact on the cost of money, the cost of lending, and the way banks and financial institutions are approaching investment based on sustainability credentials.

The other side, the real opportunity for societal benefit, is within social value through procurement. This allows large businesses to partner with the organisations that need significant assistance, often in the charitable sector. Some view the marrying of two organisations to ensure the greatest ability to score highly on social value procurement cynically, but it is one of the quickest ways to ensure good sustainability scoring and to materially help those in the community who need it most. This is an opportunity we all need to be more aware of.

Renewable energy

Sustainability strategies are helping firms to consider their energy usage. We have seen companies from all sectors looking at either self-generation by building their own wind or solar, or corporate power purchase agreements to buy green electricity directly from renewable generators. This not only allows them to meet environmental goals, it’s also good business. Firms who generate their own power or buy at a fixed price are less exposed to fluctuations in market prices, which we have seen recently can be significant. Many businesses are also looking to reduce their demand, as the cheapest unit of energy is the one you don’t use.

Green loans

Sustainability-linked loans are becoming more and more common, with the FT estimating that over £20bn worth were issued in the UK last year. These are typically loan facilities for general corporate purposes where the interest rate payable falls as certain sustainability targets are met and increases where they are missed.

Green loans are also increasingly being made available. These are loans made solely for sustainable and environmentally friendly purposes and are seen as another way to encourage the move to net zero.

ESG will, without doubt, remain chief among every business’s priorities in the coming years and is only going to become more prominent as we progress towards net-zero deadlines.  In parallel, we can expect the obligations on business, both required and voluntary, to grow in importance, and the penalties – financial, reputational or otherwise – of not committing seriously to sustainability to become harder hitting.

To speak to a member of our team about ESG and your business, please contact our teams in Employment, Corporate, Energy or Finance.

Date published: 12 October 2023.