The Intersection of ESG and Compliance

By Thomas Fox ,The Compliance Evangelist, Author

I recently read a Harvard Business Review (HBR) article, entitled “Social-Impact Efforts That Create Real Value” by George Serafeim. Although not the focus of the article, it reminded me of why environmental, social, and governance (ESG) is something that every Chief Compliance Officer (CCO) and compliance professional needs to be aware of and move towards.

 

Serafeim posits that companies with robust ESG programs are “likely to be more resilient in the face of unexpected shocks and hardships if they are managed for the long term and in line with societal megatrends, such as inclusion and climate change.”

 

This proved to be true during the first week of the Coronavirus health crisis, where Serafeim “found that the ones the public perceived as behaving more responsibly had less-negative stock returns than their competitors.”

Finally, Serafeim only believes these trends will continue as “the crisis is likely to increase awareness that companies must consider societal needs, not just short-term profits.”  

Black Lives Matter is leading a discussion on stronger diversity policies and fair employment practices in corporate America and compliance, as the corporate caretaker of institutional justice and institutional fairness needs to be a part of this internal corporate discussion going forward.

 

In many ways, ESG is where compliance was in 2005-2010, a check the box exercise.

The reason it was done in compliance is because in that time frame, compliance was lawyer driven and seen as a legal response to the legal issue of increased Foreign Corrupt Practices Act (FCPA) by the Department of Justice (DOJ). Serafeim believes companies have embraced “a “box-ticking” culture that encourages the adoption of increasingly standardized ESG activities, many of them created by analysts and consultants who rely on industry benchmarks and best practices.”

The challenge for many corporate leaders is that they do not know how to move past this simplistic approach. Serafeim believes such business leaders “lack understanding of exactly where they should be focusing their attention and how they should be communicating their ESG efforts. Many executives incorrectly believe that simple actions will suffice: improving ESG disclosures, releasing a sustainability report, or holding a sustainability-focused investor relations event. Some companies take those actions, fail to see a benefit, and grow disappointed or frustrated.” Of course, there will always be a class of shareholders who will criticize any ESG efforts as they do not believe such initiatives will benefit the stock price.

 

Serafeim lays out four reasons he believes that ESG matters.

 

Serafeim lays out four reasons he believes that ESG matters. I found them to be highly persuasive for every compliance professional. ESG, like compliance improves corporate culture because it drives “prosocial behavior.”

Moreover, and once again similar to compliance, “there are very real payoffs for focusing on ESG issues. And those extend beyond the benefits companies might enjoy because of productivity increases due to higher employee engagement, or sales increases due to more loyal and satisfied customers.”

First, an ESG focus can help the corporate books by reducing capital costs and improving the firm’s valuation. Serafeim found this was because “investors look to put money into companies with stronger ESG performance, larger pools of capital will be available to those companies.” Furthermore, he found such a correlation in “not only in equity markets but also in loan markets, where some banks are linking interest rates on loans to ESG performance.”

The second related to the increased social awareness of corporate stakeholders as both “positive action and transparency on ESG matters can help companies protect their valuations as more global regulators and governments mandate ESG disclosures.”

The third reason is that shareholders are demanding that companies and, more specifically, Boards work to ensure sustainable practice. Serafeim noted that “as more investors with more assets under management commit to ESG investing, they will have more voting power to effect changes” and this means that “management needs to be proactive about addressing ESG issues.”

The fourth reason, and once again one clearly complimentary to compliance, is that “ESG practices are part of long-term strategy, and every company needs investors who support management’s vision and plans for the future.” 

Moving from intention to results is the next evolution for ESG. Serafeim ended his piece by stating,

“The only way to outperform in this new era will be for companies to make material ESG issues central to their strategy and operations, to go above and beyond their competitors, and then to measure and communicate their superior performance. Global society faces enormous challenges. But if companies are bold and strategic with their ESG activities, they will be rewarded.”

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