By Philipp Aeby, Member of the Board and CEO of RepRisk
ESG has firmly moved into the mainstream. Awareness about issues, such as climate change, human rights, plastic pollution and deforestation, has skyrocketed. Consumers, investors and regulators are demanding more transparency from companies on these topics and the bar is set ever higher.
After the predominance of shareholder capitalism in the last century, which some have argued has led to today’s social and ecological challenges, we are moving into the era of stakeholder capitalism, which takes into account the interests of a broader set of stakeholders and companies think longer term.
With this, it is clear that environment, social and governance (ESG) concerns are becoming a mandatory part of the boardroom agenda and ESG is firmly established as a board’s fiduciary responsibility. Today, it is key for the board and the executive management of a company to oversee the integration of ESG into the company’s vision, strategy and business activities. If the role of the board is to protect reputation and manage risks, then ESG is non-negotiable. The tone must come from the top when defining the company’s ESG approach.
Corporate social responsibility (CSR) can be traced back to the 19th century when philanthropists started calling for better factory conditions in Europe and the United States. However, it was not until after World War 2 that social reformers began raising questions about a corporation’s responsibility towards society.
Initially, most business leaders saw CSR as a drain on their company’s financial performance. In 1970, the economist Milton Friedman famously stated that a corporation’s only social responsibility was to increase profits for its shareholders. It was not until environmental and social legislation was introduced in the late 1970s that boards began to actively assess their organisation’s ethical behaviour.
A series of corporate scandals in the 1980s, including Nestle’s baby milk scandal, which promoted expensive bottle feeding over breastfeeding in third-world countries, and the 1984 explosion at Union Carbide’s Bhopal factory in India, caused public outrage and prompted many companies to embrace CSR practices.
Over the last 30 years, CSR – now ESG – has primarily been governed by voluntary initiatives, from over-arching ones like the United Nations Global Compact (UNGC) Principles and the Organisation for Co-operation and Development (OECD) Guidelines for Multinational Enterprises, to sector-specific ones such as the Equator Principles for banks or the Extractive Industries Transparency Initiative.
These issues are increasingly being cemented into hard law. The EU, for example, is taking a leading stance with a suite of new regulations, including its Non-Financial Reporting Directive (NFDR) and Sustainable Finance Disclosure Regulation (SFDR). There are also changes underway in the US. US Securities and Exchange Commission announced the launch of an Enforcement Task Force to focus on climate and other ESG issues.
Organisations that have embraced ESG have seen employees and communities become emotionally vested in the future of the company and advocates for its activities. A company’s ‘social licence to operate’ is intangible, but it is essential for companies seeking to avoid social conflict, and damage to the company’s reputation – both of which can impact its profitability. When the board and management prioritise ESG, being socially responsible can lead to innovations and opportunities, rather than being an unavoidable cost.
Almost all the big scandals in recent years have been ESG-related, and many companies have realised that such scandals lead to reputational, compliance and financial risks. However, few companies have the necessary ESG expertise to gauge the credibility of public information and analyse the severity of risk incidents. “Today, it is key for the board and the executive management of a company to oversee the integration of ESG into the company’s vision, strategy and business activities.”
“Today, it is key for the board and the executive management of a company to oversee the integration of ESG into the company’s vision, strategy and business activities.”
Boards require timely, reliable and actionable data so that they can spot trends before they become major problems. For example, allegations linking Volkswagen to the emissions fraud surfaced in September 2014, a full year before the scandal hit the mainstream news and the company’s stock price collapsed. Boards need early warning of emerging scandals, such as slave labour allegations against the fashion retailer Boohoo, and the accounting fraud that caused Wirecard’s collapse, so that they can take the best financing, investment and overall business decisions.
But although ESG governance is now an established imperative for boards, it can be challenging for board members to make sense of the noise. It is crucial to look beyond company disclosures, which are often unreliable and incomplete, and understand how companies are managing ESG issues on-the-ground around the world where they operate.
That’s where a data science firm like RepRisk can help. RepRisk has been providing its clients with a suite of tools to conduct due diligence and risk monitoring of ESG risks for the past 15 years. Today, artificial intelligence and advanced machine learning allows huge sets of documents to be processed at speed across a wide range of languages.
However, meaningful machine learning requires large training data sets generated by human analysts. And human intelligence also allows data to be curated and ultimately delivered to corporations in an easily digestible format. Advancements in technology are allowing access to new datasets such geographic information systems (GIS), which can be used to map the coordinates of infrastructure projects to their respective GPS locations to show whether they are located on or near a designated protected area or UNESCO World Heritage Site.
There are signs that Covid-19 has accelerated the focus on ESG – as people, in a tangible way, have experienced the interconnectivity between our society, our environment and the economy. Companies are becoming aware of the need to move towards a more sustainable future. Now is the time for boards to move away from considering ESG as just another CSR activity and to embrace it as an essential part of risk management and a long-term value driver for their business.
About the Author:
Dr Philipp Aeby is the CEO and co-founder of RepRisk. He is an expert in business conduct risk management, with a special interest in machine learning. Before joining RepRisk in 2006, Philipp served in various managerial positions across Europe at Amgen, a global biopharmaceutical firm, and worked on a broad range of international assignments with the Boston Consulting Group. He started his career as a visiting scientist at the International Centre for Tropical Agriculture in Colombia. Philipp holds a PhD in Environmental Physics and a Master’s degree in Climatology and Hydrology from the Swiss Federal Institute of Technology (ETH) in Zurich, Switzerland, where he earned the ETH Medal for outstanding research that involved applying neural networks to pattern recognition.