Putting the "R" in "ESG" by Kristina Touzenis, Director Social Sustainabilty at plus305

by Kristina Touzenis, former Head International Migration Law at International Organization for Migration in Geneva

A powerful metaphor for environmental issues (E) is a polar bear on a melting ice cap. Everybody understands this image and understands the urgency to DO something to, at this point, not only prevent, but reverse, the climate crisis and global heating. That is if we want to hand over a livable world to the next generation. In addition, it is also – relatively – “easy” to measure environmental impact, or at least, it is easier to simplify the issue even if it doesn't always do E measurement justice either.

Governance (G) criteria can be discerned from general corporate governance principles and an extensive experience in the field. But the social part of the equation (S) often has a harder time becoming concrete.

After all: how do you measure impact on society? On individuals and groups?

For the S, the indicators are often too diverse and fragmented because of the way in which the S is conceived by different data providers and often lack a common principled basis. But what is the equivalent to the polar bear image for S? How can we break down something as complex as society and social impact? Is it the picture of a child who works in a mine? Workers in sweat shops? Maybe, but the S is broader than that and we will probably have a difficult time finding the ONE representative image. What we can do though is linking the S to very solid rights. Rights which at times are considered as fluffy as the S but which really are quite extraordinarily concrete.

Addressing systemic rights issues is crucial

ESG from an investor perspective is a translation of the Sustainable Development Goals (SDGs) engagement of a company into what financial analysts measure as ESG performance, and it is clear that investors have a growing appetite to benchmark companies against each other in terms of that performance.

There is a recognition of the fact that there is no reaching the SDGs without a rights based approach.

This includes taking action to address systemic rights issues in the workplace, value chains, and society in which they operate, sell and invest. Companies can lift people out of poverty, discrimination, and abuse. Anchoring the S within a rights language and a rights-based approach also helps us understand what the S in ESG actually is. As with the SDGs, there can be no real ESGs if we do not put the Rights squarely in the middle – or rather squarely establish them as a foundation. 

Human Rights are the basis of Sustainability

At times, human rights are listed as only one point under “S” instead of being understood as the foundation for social sustainability and really sustainability as a whole. Human rights and a rights-based approaches must be understood as underpinning the efforts made both on E and S and incorporated into G.

Rights can therefore not be an isolated pillar but must be connected throughout the ESG discourse.

Even if it would be meaningless to disassociate it from the E and G – people live in the Environment and influence the Environment. Furthermore, it is clear that in countries in which living standards are high, there is an increased focus on how to be ecological, how to recycle, and how to buy more responsibly. When people don't only have to focus on how to get the next meal, they have the time and capacity to think about the environment. They get the necessary education to make their own choices and have the possibility to say “no” to jobs in industries that damage the environment and can even influence political decisions on whether such industries can operate in their society and how. 

For any company focusing on social equality (S) means focusing on all of their stakeholders, including in their supply chains; this means workers, customers, people in affected communities etc. – the communities in which they operate both when producing as well as selling. Any social issue is about human beings – individuals, groups, and societies so the guidance on how to promote S is always linked to respecting human rights.

Countries with higher degrees of respect for rights experience higher economic growth rates and higher levels of human development.

Broadly speaking, human rights standards also set up a framework which protects consumers, including by guaranteeing participation and socio-economic rights which underpin prosperous and safe societies. Respect for rights is important both for good production conditions as well as good consumption conditions.

Businesses are leading the way

BlackRock CEO Larry Fink and Bank of England Governor Mark Carney have underlined that maximizing shareholder value is vastly insufficient if not destructive as a business model. They both emphasize that companies must serve a broader social purpose. In Fink stated in his 2019 CEO letter:

“Purpose is not a mere tagline or marketing campaign; it is a company’s fundamental reason for being – what it does every day to create value for its stakeholders.”

And in 2020, BlackRock clearly made sustainability a part of their investment strategy. For a business to be sustainable, its purpose needs to reflect concern not only with financial capital, but also its impact on human capital, social capital, and natural capital. A corporation has to be reconceived as an entity forming an integral part of society – not only a contract between the private parts of the firm aiming at making short-term profit.

Respecting rights is a form of Risk Management

Insurance companies also note how respect for rights are good business, Allianz has stated how many of the direct human rights risks and issues faced by the finance sector are generic to all businesses, such as the treatment of its own employees. But as an investor into public and private entities and an insurer of multinational corporations from various sectors, the insurance industry also plays an active role in the global economy.

The insurance company Allianz has realized how failure to respect human rights exposes the insurance industry to reputational, legal, and transactional risk.

Stakeholders, including civil society and policy makers, have rising expectations of how companies should be approaching the topic and their responsibility. Operating in locations prone to human rights violations for examplemay attracts criticism from non-governmental organizations as well as employees, and customers. Human rights standards are increasingly being built into international agreements and local regulations. Furthermore, there is often a strong correlation between respecting human rights and the quality of the insured risks. On the investment side, investors who take environmental, social, and governance (ESG) considerations into account in their investment decisions, experience improved risk-adjusted investment returns in the long term.

Unilver CEO Paul Polman launched a “Sustainable Living Plan” including addressing wages and job security at the group's facilities, and enhancing agricultural livelihoods by investing in training small holder farmers so they can bring their products to the quality standards that enable Unilever to buy them. It includes raising public health awareness, creating employment opportunities for women and addressing sexual harassment, addressing forced labour in agricultural supply chains (note the broader scope that is not only focusing on child labour) as well as reducing its water consumption, packaging, and greenhouse emissions.

Unilever has been adamant that this is an integral part of the business model, not philanthropy, or CSR.

Indeed, having a rights-based approach is not about doing the right thing from a moral standpoint or about being “philanthropic”. It is about implementing law, but it is also in the investor’s own financial interest. Considering ESG enables investors to identify new sets of financial risks and opportunities. Investors who consider ESG criteria have a more profound insight of an enterprise’s operations, since the due diligence process will take into account a much broader range of information. This allows investors to better manage the risks linked to human rights violations. Such risks can often result in significant financial impact, including potential impact on the reputation and brand of a company, with repercussions on sales, and legal sanctions on companies and their suppliers. And there is of course also a broader impact on societies when rights of individuals/groups are being denied. 

Covid-19 reveals lack of respect of human rights

This effect has become excruciatingly clear with the covid-19 pandemic. The effects of a lack of universal health care, of living wages, of social security, of land respect for workers’ rights has been clearly exposed. And this in turn affects the inequality of the recovery of societies and economies. Those spiraling quickly into poverty because they had already lived in insecurity without effective respect for their rights will not be able to quickly bounce back and take active part in the recovery of the economy. These days, many people talk about building society up better after the crisis.

The covid-19 crisis did not create these inequalities – it merely exposed how bad they are for everyone in a society; including investors.

Building back better does not mean reinventing the wheel – it means putting the rights squarely where they belong, underpinning all decisions made at the political, corporate, and investor level. And realizing how putting the R in ESG makes the S a lot less fluffy but rather something that can be measured and something that has very serious consequences if neglected – including for medium-/long-term financial gains.

Interestingly, at the moment of writing this during the pandemic when markets overall have taken a downturn, the Financial Times just stated that ESG investing has been less impacted: “The evidence so far suggests that ESG has been more resilient. ESG funds have also withstood the market sell-off better than most others.”

The Wall Street Journal has noted that “environmental, social, and governance investing was growing in popularity before the virus began to circulate, as investors flocked to companies that have taken steps to manage nonfinancial risks related to matters such as climate change, board diversity, or human rights issues in the supply chain.

A group of 300 mutual funds that integrate ESG factors into their investment decisions attracted $21.4 billion in new money in 2019, compared with $5.4 billion a year earlier, according to data from Morningstar Inc.. Citigroup Inc. meanwhile, said in a note to clients that investors are asking more questions about issues such as employee benefits and mortgage relief, with the goal of identifying corporate strategies to limit the economic damage from the pandemic.”

Putting Rights as a foundation for ESG and understanding how they make the S much more concrete will not help us find the equivalent of the polar bear… there are too many facets and too may pictures that could show what happens when rights are NOT being respected. But it means making the S concrete; do people have a level of education that makes it possible to make informed choices, and to have choices in the first place? Do people have access to health care? Do people have access to food? Do people have access to housing? Are people participating in political processes? Are there mechanisms in place to address violation of rights and are they accessible? Human Rights standards provide a basic list of potential indicators. The S is not abstract. Nor are rights. And investors are showing an increasing understanding for how concrete the S squarely founded on rights can be for them and the societies in which they live.

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