The New ESG: Engaged Societal Guardians
Welcome to this week’s edition of Powering Prosperity Weekly.
This weekly newsletter looks at issues relating to the Global Economic Transition that will play out over the coming 20-30 years (see my April 13 introductory article on LinkedIn for additional context).
Last week, Shelley Goldberg and I talked about ESG investing's lack of impact. In Part II of this series, we focus on a model of partnership between investors, businesses, and governments working together as ‘Engaged Societal Guardians’—a paradigm for the ‘New ESG’. The Covid-19 crisis has put societal repair on a critical path to survival for all three groups creating an opportunity to fashion a new collaborative model borne out of enlightened self-interest.
Investors – A shift in focus?
Before the Covid-19 pandemic, climate change was the single biggest focus for ESG investors. However, the balance is now tilting towards the ‘social’ pillar since the pandemic has amplified pre-existing social problems that were blighting our societies. However, to amplify direct impact and exert greater control over their investees, ESG investors should also consider ramping up active engagement with large cap holdings, as well as deploying more capital to sustainable infrastructure, corporate credit, and smaller disruptive companies through private equity, venture capital, and crowdfunding.
On the active engagement front, asset manager Trium Capital targets companies in high emissions industries like oil and gas, utilities, and mining and works collaboratively to help them transition to higher growth, lower emission, ESG leaders. Some leading pension funds are also waking up to this trend by organizing collective action. The New York State Common Retirement Fund, the third largest US public pension fund, plays a leading role in Carbon Disclosure Project’s Carbon Action initiative of 304 investors representing US $22 trillion that lobbies for company action on emission reduction and energy efficiency.
Sustainable infrastructure offers a good fit for institutional investors like pension funds since they provide long-term, contracted cash flows to help with matching pension liabilities and offer an alternative to holding hydrocarbon assets which are at risk of becoming ‘stranded’ should tighter carbon emission regulations be introduced. Canadian Pension Plan Investment Board, for example, has formed a joint venture with Brazilian energy generator Vortarntim Energia to fund the development of Brazilian wind farms.
Corporate credit may be more effective than equity in driving ESG specific outcomes and can be tied to loan covenants and conditions. By contrast, it more difficult to implement such conditionality and even attempts at active engagement can be diluted by new share issuance or share buybacks.
Smaller companies face measurably constrained funding environment, which has only been exacerbated by the crisis. Funding for US start-ups fell 16% in Q1 2020 compared to Q4 2019. Furthermore, VC-funded start-ups do not qualify for support under current US stimulus programs for small businesses.
Capital infusions into smaller companies and start-ups—especially those directly targeting sustainability issues—are much more likely to have a rapid additive impact because many would otherwise disappear for lack of capital. A new breed of VC and PE funds like Berlin-based Moonfare offer exposure to smaller, disruptive ESG companies to mass-market investors that may lack access to the premier funds. Moonfare sets its ante at 100k euros which can phase in over four years spread over a number of funds.
Business – Addressing All Its Stakeholders
In August 2019, the Business Roundtable, a group of chief executive officers of nearly 200 major U.S. corporations, issued a statement declaring a new definition for the “purpose of a corporation” as being to serve all its stakeholders, not only to maximize financial returns for shareholders. In our new paradigm for ESG, businesses must deliver on this commitment. Here are 5 examples of how they can do so.
Workforce: Retain and Repurpose
A knee-jerk corporate response to an economic crisis is to retreat and downsize. However, many companies are showing that a crisis can be an opportunity to create new revenue streams by repurposing physical and human assets to immediate social needs.
First, HanesBrands responded to the urgent shortage in PPE by retrofitting its production lines and redeploying its workforce to produce medical gowns and face coverings. By retaining and retraining its workforce, Hanes played its part in shoring up aggregate demand in the economy while strengthening its brand reputation. Second, many professional service firms are keeping workers engaged remotely, while finding cost savings in other areas such as office space. Third, retailers and B2C firms are expanding their digital commerce and redeploying in-store staff to online marketing and customer service teams. For example, in a sign of increased demand for their services, Walmart announced a partnership with Shopify, who make software to help main street businesses move their storefronts online. Fourth, some businesses are tapping into non-traditional labor pools with excess capacity allowing waiters to perform delivery functions, graduates to accelerate their workforce readiness, and retirees to return to work.
Customers: Increasing Safety, Affordability and Accessibility
The economic hardship imposed on consumers by Covid-19 is encouraging business to innovate by making products safer, more affordable and more accessible.
First, some companies are striving to retain customers and gain market share. For example, Honda is providing a 90 Days to First Payment program to help its customers make car purchases.
Second, circular economy businesses, such as HYLA Mobile, which repurposes used mobile phones are gaining adoption as consumers seek lower price products. Such strategies also reduce waste, help the environment, create jobs, and put money back into consumers pockets ($2.4 billion in 2019).
Third, due to heightened concerns over disease transmission, contactless products such as motion-sensitive faucets and keyless entry, manufactured by companies like Bradley Corporation and ASSA ABLOY, are gaining rapid adoption.
Fourth, companies like Lululemon are creating new business lines to address growing customer needs. The athletic-wear company has not only grown sales of its garments to home-bound workers but has also added online digital fitness to its platform.
Supply Chain: Localize the Physical, Globalize the Digital
Supply chains efficiency requires localizing physical inputs and globalizing digital commerce. Businesses must shorten and diversify supply chains, particularly considering the recent escalation in Covid-induced trade restrictions against a backdrop of the US-China trade war. Localizing suppliers increases resilience, lowers transportation costs, and enhances oversight of potential abuses such as child labor. Cash-rich businesses can go further to finance suppliers, keeping them afloat while benefiting workers.
On the other hand, companies should make their digital infrastructure global to minimize risk and spread transparency and inclusion via big data and AI. IBM systems enables businesses to turn unstructured real-time data into insights to predict disruptions and vulnerabilities. Meanwhile, digitizing supply chain information makes wage rates more transparent, decreases costs-per-unit and increases flexibility, bringing together buyer and seller. Great access to customer data will also help companies better support underserved individuals and businesses in their supply chain.
Investor: Expect the Best, Prepare for the Worst
A crisis demands transparent investor communication to build trust and credibility. Bottom lines have been compromised and companies may have to pare back dividends and share-buybacks, while drawing on credit lines and issuing new debt. Companies need to communicate a clear strategic plan that explains how they will return to higher profitability while being prepared for the next crisis.
Community: Equality in Opportunity
The pandemic and the protests following the killing of George Floyd have exposed the lack of basics like education, healthcare, fresh food, financial services and broadband internet in lower income communities—especially those with a concentration of African Americans and other minorities. It’s time for businesses to deploy radical business models to address these gaps in the market.
Finance is a key sector which would benefit from such a shake-up. For example, companies such as Apple, Unilever, and Bank of America have issued green bonds to finance emissions-reductions projects. There’s also been a wave of fintech disruption from payments and e-commerce platforms like PayPal, OnDeck, and SoFi. By providing personal, student, and home loans, as well as small business financing, SoFi has tapped into huge underserved markets. These smaller players have pushed big banks to be more financially inclusive. JPMorgan Chase, for example, now partners with OnDeck to approve business loans of up to $200,000 within 24 hours.
The food sector is also ripe for disruption. Some communities otherwise lacking access to fresh, nutritious, and affordable food are benefitting from community gardens, farmers markets, soup kitchens, and gleaner (food rescue) facilities. The Fresh Stop Bus, in central Florida functions as a mobile farmer's market, and addresses a market of 90,000 residents who live in food deserts—illustrating the demand for new impact business models in the food sector.
Government as the Catalyst
Governments will need to play an increasingly crucial role in catalyzing private wealth to plug the SDG funding gap. They are uniquely placed because they can absorb the risk of making large-scale, early-stage, long-term investments that help de-risk projects and thereby ‘crowd-in’ private capital. Through conditionality and standard setting, they can also set the rules so that capital is most effectively channeled into sustainable impact.
Covid-19 recovery programs are an opportunity for governments to integrate ESG into public financing and create more resilient societies. This can be done via prioritization, conditionality, and standard setting.
Governments can make smarter investments decisions by steering scarce public funds into areas like renewable energy and 5G communications infrastructure and away from away from fossil fuel-based energy infrastructure. The EU’s €750 stimulus program should steer investment in this direction. And rather than offering billion dollar tax breaks to the likes of Amazon to locate in Long Island City, local government could prioritize job creation and retraining-redeployment programs. They can support the creation of online job exchanges to enable workers to redeploy, paired with funding for training to learn new skills. Singapore has done this by ramping up funding for lifelong learning accounts it provides to each Singaporean, including providing 20% salary support to companies which hire through the program.
Public financing could also be tied to environmental conditions. Germany and France’s proposed €500 billion recovery package for the EU mandates emissions reductions of up to 50% and green recovery plans for every industry. Canada’s bailout package stipulates that any company receiving funds must follow carbon emissions reporting standards.
Finally, governments can use the crisis to set the rules of the game of ESG. For example, the EU has introduced a taxonomy defining what can be determined as a sustainable investment. This will help crackdown on greenwashing and attract more financing into sustainable investments.
The New ESG: Engaged Societal Guardians
The New ESG is a wake-up call to investors, businesses, and governments. As Engaged Societal Guardians, investors, businesses, and governments act as participants, but owners and leaders of the system—a three-legged stool which falls if any one of the three disengages.
Covid-19 was an X-ray into our system, exacerbating the long-term systemic fractures in our healthcare, food security, education, and social structure. The New ESG calls for radical and rapid change in a mission-critical time. It still addresses and benefits the environment, and social and governance issues but it beckons a call for immediacy, addressing urgent and overlooked needs. It emphasizes preparedness, agility, resilience, and flexibility.
In the new ESG, reporting standards are sharpened and standardized, investments flow to the disruptors driving ESG additivity, and investors have more control over their investment decisions enabling immediate impact. Businesses, as stewards of capital, address all their stakeholders and take advantage of disruption to innovate and redeploy assets. Governments, with political will, direct funds toward addressing immediate and long-term needs of its constituents. The new, collaborative ESG is better prepared for events that don't happen rather than unprepared for those that do.
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Dr. Indranil Ghosh
CEO | Tiger Hill Capital