CORPORATE BRIEFING
Environmental, Social, Governance January 2022
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CORPORATE BRIEFING
Environment, Social, Governance As we enter a new year, environmental and social responsibility becomes an ever brighter light on the radar of business. A series of diverse drivers have converged to ensure that ESG (Environmental, Social, Governance) has become or is fast becoming a top priority for businesses across the globe. For many the need to transition to new operating models incorporating greater ESG responsibility has already become an imperative. This transition will represent a complex challenge but also a significant opportunity. This article looks at the background to the development of ESG as a commercial issue, why it matters and what steps businesses can take to keep pace with this fast-changing environment. Johnathan Rees Partner | Head of Corporate & Commercial & ESG Group johnathan.rees@laytons.com +44 (0)20 7842 8000
Corporate Briefing | Environmental, Social, Governance
What is ESG?
Why has ESG become important?
ESG is a term used to refer to how a company manages its environmental, as well as social, aims and responsibilities. Originally used in the financial sector (particularly by pension funds and private equity houses) it is increasingly used by companies across the business community distinct from “corporate (social) responsibility” and “corporate governance”.
In addition to a fast developing regulatory framework there are a wide range of social, economic and commercial factors which mean that ESG will remain at the forefront of the corporate agenda for the foreseeable future:
Stakeholder awareness Increasing environmental and social equity awareness
As a much broader concept, ESG has become an umbrella
amongst consumers, investors and other stakeholders
term for a broad range of environmental (e.g. pollution,
are forcing organizations to address ESG issues both
waste and energy efficiency), social (e.g. diversity, equal
substantively and transparently. These pressures and
pay, working practices and stakeholder engagement) and
influences - reinforced by the transparency afforded by the
governance (e.g. executive pay, bribery, corruption and tax
digital age - require businesses to put purpose at the core
transparency) factors against which stakeholders can assess
of their operations, demonstrating how they are addressing
a business’s performance.
issues that concern their wider stakeholder communities. The ESG research industry is flourishing with standards setters, data aggregators and rating agencies ranking businesses from an ESG perspective. Agencies are used – and ESG credentials are assessed - by a variety of entities from a business’s competitors to its investors, shareholders and customers. In particular, businesses should anticipate suppliers checking credentials as part of any tendering process.
Great expectations In addition to increased awareness other factors are shifting perceptions and expectations amongst businesses in the ESG sphere. These include: • investor pressure (financial institutions themselves have come to better understand the risks to 4 | laytons.com
Corporate Briefing | Environmental, Social, Governance
investments associated with ESG issues) • changes in marketplace behaviours
Communication
• social issues and stakeholder activism
Information flow and digital platforms will help maintain
• a desire amongst workers for their business to be
awareness of ESG-related issues. Businesses will need
seen to “do right” and not simply “do the right thing”
to be agile in responding to national and global issues
(comply)
and campaigns capable of impacting their stakeholders’
• the Covid-19 pandemic which has led to an increased
expectations. Similarly, businesses will need to be able to
focus on business resilience - now inextricably linked
deal swiftly and transparently with any adverse publicity
with good ESG management – not to mention an
posing reputational risk.
increased sensitivity to worker well-being on the part of employers
Risk
Opportunities • Leaving aside the ethical and commercial imperatives there is significant evidence connecting sound ESG
ESG related issues pose a variety of risk to businesses and
management and long-term value creation – an
boards must understand how these might affect their
attraction for any business. Embedding ESG into its
business’s long-term resilience. These risks include:
model will enable a business to protect and create value. It is well established that a focus on ESG issues
• Litigation: this can emanate from a multitude of
can improve a business’s performance by enabling
sources e.g. a failure to manage climate change
sustainable growth, recruitment and retention of
related events to supply chain related claims
talent, enhanced brand and reputation, access to
involving a supplier’s breaches of human rights or
wider and cheaper capital and business cost savings.
environmental compliance • Physical: flooding, contamination or health and safety
• For businesses looking to raise finance the good news
• Commercial: loss of business and supply chain
for those who are ESG-compliant is that they should
• Reputational: this could be linked to any of the above
choice. Conversely for non-ESG compliant companies
disruption
enjoy lower costs of capital and access to greater
risks. A negative ESG perception can have dramatic
access to capital is likely to become restricted and
consequences - Boohoo experienced significant falls in
more expensive.
its share price as a result of supply chain and working conditions related issues in 2020.
Compliance
ESG is not a passing trend but rather a fundamental and permanent shift in the tectonic plates of commerce. ESG will continue to transform the business landscape driven by a broad and diverse range of socio economic issues
As we explain below, businesses live in a world where across
and an increase in the awareness and expectations of their
jurisdictions rules and regulations are being implemented on
stakeholders.
a regular basis impacting the responsibilities and liability of corporates in the sphere of ESG.
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Corporate Briefing | Environmental, Social, Governance
ESG Drivers A variety of events and issues have driven and will continue to power change in the ESG arena: COP 26 For many professional observers, one of the key take-ways of the recent international climate change conference held in Glasgow was less the formal decisions made by nation states but rather the broad range of commitments made by the private sector outside the formal normal framework. The degree of engagement by businesses at senior level impressed many observers. Having made a range of commitments the next (challenging) step for many businesses will be developing the roadmap to achieve them. The presence of investors representing £trillions in capital reinforced the net zero commitment and delivered the clear message that longer-term value creation will acquire a greater focus in future investment processes.
Capital Markets • In addition to The London Stock Exchange’s ESG reporting guidance, the final report of the Financial Stability Board's Taskforce on Climate-related Financial
• The UK government is consulting on draft regulations which will amend the UK Companies Act and require UK-incorporated large companies to include TCFD climate-related disclosures in their strategic reports. • The FCA published its ESG strategy on COP26’s finance day reaffirming its commitment to existing enhancing climate-related financial disclosures and transparency. • The 50% surge in Tesla’s share price in 2021 was due to more than supply chain issues affecting the rest of the automotive sector. Investors increasingly look beyond the balance sheet to how companies integrate ESG into the core of their business. Investor need for quality and comparable ESG data to distinguish between companies will continue to drive reporting standards and transparency – adding further pressure for businesses to integrate ESG policies into their working practices and management reporting.
EU legislation
Disclosures (TCFD) set out information that companies
The Commission has established an EU framework placing
should disclose to enable investors to better
ESG at the heart of the financial system to help transform
understand how companies oversee and manage
Europe's economy into a greener and more resilient system.
climate-related financial risks. The UK’s Financial
The EU has recently sought to address the inconsistencies
Conduct Authority has made reporting in line with
in sustainability-rating schemes by the introduction of new
the TCFD recommendations mandatory for listed
labelling system (“Taxonomy”) which will sift economic
companies (in the case of standard listed companies
activities by environmental sustainability – clarifying what
for accounting periods beginning on or after 1 January
counts as “green”. This is intended, amongst other things,
2022).
to help investors and businesses disclose with greater consistency what share of their activities or investments are “green”.
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Corporate Briefing | Environmental, Social, Governance
Whilst there has not been a comprehensive onshoring of these regulations as part of the Brexit process, nevertheless the UK government has committed to matching the EU’s sustainable finance action plans ambition and is expected to adopt similar principles. (See references elsewhere in this briefing to TCFD and the UK government’s recent green finance policy paper.)
• Anti-corruption and bribery
The UK Bribery Act 2010 prompted commercial organisations to assess whether they have adequate procedures to ensure that they are not involved in bribery and corruption. Most major companies already have in place an anti-corruption policy that should be reviewed regularly to ensure that it is fit for purpose.
UK legislation
As mentioned the UK government is following fast in
Recent changes in domestic UK law have also increased
announced the establishment of the Green Technical
the requirements on companies across different ESG areas. Examples include: • UK climate change legislation.
In 2019, the UK set itself a statutory net zero carbon target for 2050. Key areas of regulation to drive progress towards that target include the EU Emissions Trading System and UK Emissions Trading Scheme, the climate change levy, climate-related disclosures (in particular, as mentioned above increased alignment with the TCFD recommendations), the Energy Savings Opportunity Scheme and energy efficiency in buildings and products.
• Modern Slavery
The Modern Slavery Act 2015 includes an obligation
the EU’s “green” tracks. In June 2021 the UK government Advisory Group which will provide independent nonbinding advice to the government on the development and implementation of a UK green taxonomy. This was followed in October by the UK government policy paper “Greening Finance: A Roadmap to Sustainable Investing” which amongst other things sets out the government's ambition to green the financial system and align it with the UK's net zero commitment. In addition, there are non-statutory codes and various UK Companies Act provisions which may have direct or indirect ESG application and to which larger and listed businesses need to have regard including the UK Corporate Governance Code and UK Stewardship Code.
on large commercial organisations that carry on
The UK’s current legislative framework is inadequate for its
business in the UK having a turnover of £36m or more
international and domestic carbon targets. Consequently,
to publish an annual modern slavery statement on
more legislation in the ESG arena is likely to be both
what action they have taken to ensure their business
inevitable and swift meaning the level and pace of change
and supply chains are slavery free.
required could be extremely disruptive to UK businesses. Regardless, commercial imperatives will help ensure that ESG
• Gender pay
compliance becomes increasingly mandatory.
The Equality Act 2010 provides that large employers (at least 250 relevant employees) are subject to mandatory gender pay gap reporting.
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Corporate Briefing | Environmental, Social, Governance
Impact of ESG for business The ESG lens will force companies to better understand their key value drivers and adapt their business models to the realities and demands of the ESG sphere. Businesses will need to be agile and embrace accountability and transparency - these businesses are likely to be both more viable and valuable in the long term. These factors raise a number of issues and considerations for businesses: Executive remuneration
and operations. A thorough understanding of suppliers and customers and where potential ESG risks might arise becomes essential - particularly where those entities are located in sensitive industries. Similarly, the form of contractual protection sought by buyers needs to be tailored to address those risks.
Corporate Group Liability: Multinationals The increased complexity of ESG compliance has led inevitably to increased litigation risks for companies. This has become particularly relevant to companies with overseas interests. While previously the English courts were reluctant to take jurisdiction over claims involving overseas activities
As ESG issues become prominent in companies’
and entities, recent cases including a 2019 case (Vedanta
relationships with stakeholders, executive remuneration
Resources) have demonstrated that an English parent
is being adapted to align with expectations in this area.
company may be liable for the activities of its overseas
Companies are increasingly incorporating the management
subsidiaries where its oversight has been negligent.
of material ESG risks and opportunities into their long-term strategy and incentive plans.
Core Metrics Businesses will need to identify a range of performance measures – from governance to people and prosperity - as part of any ESG disclosure exercise and consider what is achievable (not least from the perspective of generating the
Businesses are increasingly expected to identify, manage and remedy any adverse ESG impacts of their activities across the group’s value chain. Those operating across borders must consider the risk of the ESG impact of their subsidiaries’ operations - local communities, the environment and human rights – and take steps to mitigate risks.
relevant data).
Private Equity: Investor expectations
M&A
In the last couple of years vast sums have been raised by
As part of their due diligence exercises, buyers are taking
on ESG metrics. Private equity institutional investors have
an holistic approach to targets and their stakeholders
over recent years become very alert to ESG matters. These
focussing on potential supply-chain related issues. Due
influence not merely the investment decision but also the
diligence needs to be bespoke and adapted to the
conduct of the investee during ownership and preparation
specific circumstances of the target and its businesses
for exit.
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investors and ear-marked for businesses which score well
Corporate Briefing | Environmental, Social, Governance
The link between ESG compliance - management of nonfinancial risk - and superior long-term financial performance
Business Adaptation
is well established. In short, ESG compliance has in many
Businesses will need to understand their carbon foot-print
respects become synonymous with effective management -
and identify what is possible for them to change. Similarly,
ESG factors can have a material impact on returns.
stakeholder pressure will require businesses to be able to explain their purpose beyond the economic and engage
Many investors integrate sustainable investment practices
with employees and other stakeholders. Recruiting and
across their investment process and most have detailed
retaining talent is also likely to be affected by a business’s
ESG policies setting out their ownership and governance
purpose and ESG awareness. Business is likely to experience
strategy.
a significant increase in the creation of “green” jobs and the up-skilling of workers and management in matters ESG.
ESG has become a specific non-financial portfolio review issue for many investors. As with capital markets this in
The ability of a business to transition to the new low carbon
turn has led to an increase in the quality and quantity of
economy operating model will be key to its future success.
ESG-related data required by private equity investors. PE
That transition will encompass a range of factors impacting
backed businesses are expected to demonstrate not merely
not just how a company does business but where and with
an understanding of their ESG risks but also how they
whom. It will also involve a review of corporate practices,
will identify them, manage the risk and to provide data in
policies and strategy across multiple fields as part of the
support.
business’s review of core ESG metrics referred to above.
Stakeholder Engagement
Businesses need to rethink their priorities and wider purpose
It is essential for businesses to understand what matters
communities and beyond. Central to this exercise is the need
to their lenders, investors customers, workers, business
for reflection by corporates on their “purpose” – identifying,
partners and wider communities - and their expectations.
and perhaps redefining, their priorities, targets and objectives
Surveys and data indicate an awareness and concern
to ensure that ESG is integrated into their business model and
amongst workers and job seekers about a business’s ESG
strategy.
in society while considering their broader impact on their
activities. Add to this the fact that the digital era can throw a bright – and immediate - light in the corner of any facility anywhere in the world and the need to facilitate an open dialogue with stakeholders in the widest sense becomes clear. As part of any ESG roadmap businesses will also need to understand their supply chains and identify steps to address any weaknesses or risks from an ESG perspective.
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Corporate Briefing | Environmental, Social, Governance
How we can help For many businesses the development of ESGrelated policies and strategies and associated road-maps may be well in hand. For those who are closer to the start of the process the prospect, and knowing where to start, can be forbidding.. In practice, the materiality of individual ESG factors will differ by company, sector and territory. There is no ‘one size fits all’ approach to an assessment of materiality of ESG issues which should be tailored to the circumstances of the particular business. The development of an ESG action plan and roadmap will be more efficient if part of a holistic review of the business’s wider risk and compliance. Delegating the exercise to a person (or more likely, team) will help – the work involved should not be under-estimated. Any strategy will need to involve the fundamental question of its corporate purpose, relevant metrics (what data do you measure?), risks and opportunities, goal-setting and how performance will be reported. Engagement – within and outside the business – will also be key. As explained there are a multitude of factors and risks falling within ESG. We can help your business manage these risks by providing support in a variety of areas including: • Risk assessment across ESG policy areas • Regulatory compliance • Opportunities for relevant ESG related certifications • Management training and awareness • Supply chain due diligence (including a review of procurement policies)
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• ESG strategy and related policies and procedures (a comprehensive ESG strategy will help a business to assess risks and opportunities) • M&A support including due diligence • ESG disclosure • ESG related litigation If you would like to discuss anything arising from this briefing please get in touch.
Johnathan Rees Partner | Head of Corporate & Commercial & ESG Group johnathan.rees@laytons.com +44 (0)20 7842 8000
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