2020 was a year of reckoning. Alongside the COVID-19 pandemic, the world experienced an unprecedented call to action in the fields of sustainability, human rights, and corporate accountability. This desire for social responsibility has evolved into a demand for investors and corporations to put their money where their mouths were.
The pandemic brought a preview of what kind of calamities and financial disruptions future sustainability crises, such as climate change, could bring. The pandemic also functioned as a case study for how essential to risk management sustainability considerations really are.
What is Environmental, Social, and Corporate Governance (ESG)?
ESG is a form of sustainable investment that takes into account ethical considerations in the areas of environmental, social, and corporate governance. It entails taking into account issues under the three umbrellas of environmental, social, and corporate issues.
Environmental considerations may include taking into account matters such as clean energy, emissions, regenerative agriculture, recycling, and sustainability, amongst others.
Social considerations may include issues of race, gender, sexuality, as well as key social concerns like affordable housing, the wage gap, healthcare, and others.
Corporate governance is often relates to issues of company structure, leadership organization, management, and responsibility to shareholders.
Criteria for Environmental, Social, and Corporate Governance (ESG)
A key set of criteria to consider for socially responsible investors is Environmental, Social, and Corporate Governance (ESG). Within the ESG framework, environmental factors include externalities such as a company’s emissions, pollution, energy usage, and sustainability practices. The social aspect champions diversity, employee welfare and treatment, consumer protection, and impact on local communities. Governance takes into account transparency and legality of company practices, lobbying, donations, and management structure.
By referring to ESG, an investor can better measure the sustainable and social impacts of a company. In his 2020 letter to CEOs, BlackRock CEO Larry Fink underlined the investment risks of climate change and advocated for “accountable and transparent capitalism,” seemingly heralding in a new era of corporate sustainability.
However, the use of ESG spans beyond ethical considerations. The more pragmatic (capitalist) thought behind sustainable investing is that, alongside the traditional financial factors, ESG allows investors to anticipate and avoid long-term risks.
Sustainability crises carry real investment risks, seen in cases such as ExxonMobil’s climate change cover-up controversy or Volkswagen’s emissions scandal. Both of which tanked the companies’ respective stocks and resulted in investors filing lawsuits. In his 2020 letter to CEOs, BlackRock CEO Larry Fink underlined the investment risks of climate change and advocated for “accountable and transparent capitalism,” seemingly heralding in a new era of corporate sustainability.
Despite the rise in popularity of ESG, the movement has also received backlash. The traditional argument against ESG refers to Milton Friedman’s claim that the social responsibility of a business is to increase its profits. Friedman’s premise is that a businesses’ moral obligation is to further its shareholders’ financial interests, suggesting that companies should prioritize profitability even at the expense of sustainability or social issues. The argument here is that individuals can devote their resources to “social” causes on their own time.
Even if we do consider ESG adherence to be the best practice, the remaining concern is that companies are adopting ESG policies solely for profit rather than a genuine interest in sustainable operations in a ploy known as “greenwashing.” It is profitable for companies to make misleading or even false claims about environmental policy that paint them in a more flattering light to socially responsible investors.
Impact of the Pandemic on Investment
The COVID-19 pandemic signaled a paradigm shift in the way that governments, companies, and investors think about investments, making the ESG movement more relevant than ever before. ESG is no longer an afterthought to profitability, but rather a key financial factor itself.
Amid the turbulence of capital markets during the pandemic, stocks with higher ESG ratings performed comparatively well, signaling a higher resilience in the face of uncertainty. This can be attributed to better client relations, or positive corporate culture (an effective board and satisfied employees).
On the environmental front, according to the World Economic Forum’s 2020 Global Risks Report, $44 trillion of the world’s total GDP is dependent on nature, further signaling that environmental issues pose massive economic risk.
Outside of purely investment risk-based considerations, the pandemic raised broader issues of social responsibility. As early as March, the internet was inundated with buoyant news and videos of now-pristine Venice canals and boars wandering the streets. Though many of these stories were likely exaggerated, they exhibited a wide-spread hope in nature’s ability to recover and showed a refreshing focus on sustainability.
The pandemic has also highlighted vast disparities in how countries and individuals have been able to weather a sustainability crisis, with richer countries and people having more resilience. The resulting divide has been especially stark in countries like the US, where healthcare access is not guaranteed.
During COVID, companies were scrutinized for how they treated employees, such as whether they implemented work-from-home policies, or whether they provided healthcare. Amazon received major criticism for a lack of COVID safety measures, and multiple companies such as Taco Bell, Patagonia, and Darden Restaurants implemented paid sick-leave policies in response to the pandemic.
COVID-19 was a wake-up call. The pandemic showed us the existing cracks in our system, cracks that would be hit again in future sustainability crises. There is hope for the future. Millennials, historically more socially conscious and diverse, are making money.
Millennial investors are more likely to hold companies accountable to ESG criteria, emphasizing corporate social responsibility and ethical spending. It is in the interests of the environment, social justice, and, yes, profit, for investors and companies to implement ESG policies. If we don’t address these issues now, they will only get worse.
Thank you to Irina Likhachova, Senior Operations Officer of the International Finance Corporation, for her input and guidance in the preparation of this piece. IFC—a sister organization of the World Bank and member of the World Bank Group—is the largest global development institution focused exclusively on the private sector in developing countries.