Maintaining an ESG focus in times of crisis - Climate Change

Despite COVID-19, climate change and environment organisations remain attentive, and the public's preference for carbon-neutral industry continues to rise. Corporations cannot allow their environmental, social and governance (ESG) agenda to stagnate in uncertain times.

The current market disruption resulting from COVID-19 presents an opportunity for companies to assess their ESG standing, implement and expand their corporate ESG policies and take action to improve their resilience to future crises.

Increasing shareholder activism is just one reason an ESG focus has merit for companies. In March 2020, the Rainforest Alliance Network (RAN) released its 'Banking on Climate Change' report into the financing of the fossil fuel industry by 35 private-sector banks. It found that since the Paris Agreement in 2016, a number of the banks had funded US$2.7 trillion worth of fossil fuel projects. RAN has now called for an immediate end to the financing of fossil fuel expansion and real commitment toward the phasing out of fossil fuel financing.

According to Stockhead, the incidence of shareholder activism in Australia doubled in 2019. Already this year, shareholder advocacy groups – including Institutional Shareholder Services (ISS), the Australasian Centre for Corporate Responsibility (ACCR) and Market Forces – have brought several resolutions calling upon Australian corporations to set Paris Agreement-aligned emissions reductions targets, particularly in the area of scope 3 emissions.

While few climate-related resolutions have found favour with the majority of investors, support is growing and the status quo is shifting. Turning up the temperature, the Australian Securities and Investment Commission (ASIC) announced in December 2019 that it would begin targeting ASX-listed companies that fail to adequately report on their exposure to climate-related financial risks.

Emerging crises

Shareholder activism aside, future crises are plainly on the horizon. Health experts and economists predict that pandemics of COVID-19-like proportions will become more frequent. The EcoHealth Alliance, a US-based non-profit research group, has found that pandemics could cost the world as much as $23.5 trillion over the next 30 years.

In a number of countries, climate change has aggravated bushfire conditions, exacerbating the overall level of bushfire-related damage and increasing the economic fallout. In Australia, initial estimates of the tangible costs of the 2019-20 bushfires suggest they could be as high as $100 billion. This qualifies as Australia's most costly natural disaster to date.

To survive and thrive, corporations will need to be proactive in preparing for the shocks generated by future crises and other known risks.

There is an upside

As the most recent global economic downturn, the 2007-08 global financial crisis (GFC) represents a relevant yardstick in analysing the relationship between business survival during crises and their management of ESG issues.

A 2016 study by Harvard University found that American companies with good ESG policies achieved 'above average' financial performance for the 2008-9 financial year. They experienced a 40-45% lower cost of debt than their counterparts. The study suggested that companies with a strong ESG focus did not experience the significant declines in share price their industry peers did during the crisis, and were better prepared for sudden industry changes. In 80% of the companies studied, there was a clear link between sustainability practices and increased share price performance.

Perhaps more importantly, the GFC refocused individual and shareholder attention on corporate ESG responsibilities. This is demonstrated by the significantly increased popularity of ethically managed funds following the GFC, with assets under management in ESG portfolios growing by 25% in 2014 and 2015 to an estimated US$23 trillion by the start of 2016. It would be reasonable to assume that the same dynamic will play out as a consequence of the current COVID-19 pandemic.

Improving resilience

The market disruption caused by COVID-19 presents an opportunity to implement and expand corporate ESG policies.

The fragility of supply chains could not have been more starkly demonstrated than over the past few months of pandemic-related disruption. For this reason alone, companies should use this time to review, identify and mitigate against strategic and operational risks. From a supply chain perspective, human risk factors and issues such as natural resource depletion, human rights violations and corruption are increasingly subject to regulator and consumer attention. Now is the time for corporates to align their assets to organisational values, minimise their headline risks and enhance their reputations.

Companies that incorporate ESG principles reduce and manage risk by investing in activities with long-term growth prospects that can withstand future potential crises, such as climate change or the next global pandemic. An analysis undertaken by investment bank HSBC has revealed that shares in ESG-aware companies have outperformed non-ESG companies during the COVID-19 pandemic by as much as 7%. In the aftermath of the current economic downturn, investors will be looking to see how businesses have identified and mitigated future risks in order to preserve and enhance their value.

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With the public's increasing preference for carbon-neutral industry, the current market disruption provides an excellent opportunity for businesses to review their compliance practices and ESG policies to take competitive advantage. Perhaps even more significantly, updating these policies and ensuring there is no loss of focus on the compliance framework is critical in developing companies' risk tolerance and resilience. Communities, regulators and shareholders are unlikely to be particularly forgiving of those that allow their compliance focus to slip.

This article is part of our publication Continuity Through Crises: Perspectives on business risk, resilience and recovery in uncertain times. Read more here.

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