What are the implications for companies which fail to adequately address ESG issues?

It is no secret ESG factors have become a business imperative over recent years. Investors have certainly become increasingly alert to the fact that a greater emphasis on ESG can positively impact returns. However, perhaps the greater driving force behind the integration of ESG factors into investment decisions is the risk management piece. The risk categories for companies which fail to adequately address ESG concerns can be summarised into two main groups:

(a) action from groups holding substantial “soft” power (e.g. consumers, potential investors and existing shareholders)

(b) risk of non-compliance with existing and future legislation and regulation.

Although the issues covered by ESG are broad, reputational concern can be seen as the golden thread running between them, and many companies prioritise ESG issues primarily because of the potential liability for reputational damage, which will in turn, weaken investor confidence. A positive performance in ESG metrics is closely aligned with a strong brand reputation, which unlocks consumer loyalty, stakeholder support, reduced business volatility, and easier access to new business. Companies have suffered serious reputational damage by falling short of accepted ESG standards, especially with investor behaviour of recent years being increasingly influenced by a more socially-conscious public.

The reputational risk of failing to address ESG concerns was well evidenced by Deliveroo’s initial public offering in March 2021, which was said to have “bombed purely for the ‘S’ of ESG”. The company’s share price plunged by 26 per cent when it floated, primarily due to concern about the ethical treatment of its workers, as expressed by several large investors. Aviva turned down the chance to invest due to a combination of investment risk and social issues. David Cumming, Chief Investment Officer for Equities at Aviva, confirmed that Aviva would not be investing for several reasons, with workers’ rights being one of them. He highlighted the significant difference which employers like Deliveroo could make to workers’ lives if they were to guarantee working hours or a living wage, showing that companies’ behaviour is becoming increasingly important from an investor viewpoint. Aberdeen Standard Investments (ASI) echoed these concerns about Deliveroo’s employment practices. Aviva and ASI have also been vocal about other ESG issues, particularly climate action.

Taking no stance at all, or making an ingenuine statement on an ESG matter, can also cause reputational damage, as evidenced by the backlash against those companies which did not comment upon the Black Lives Matter movement, or those which publicly celebrated Pride week, while quietly donating to lawmakers who opposed legislative changes that would increase the statutory protection afforded to the LGBTQ+ community. In certain industries – especially retail – there is a growing public need for businesses to be proactive in all ethical endeavours, regardless of whether they relate to their business product. This represents a marked shift from a more traditional laser focus on profitability.

Taking stock of the Deliveroo disaster, companies seeking future investment would be well-advised to address any ESG issues pre-emptively, and to implement a system of independent checks and balances on ESG performance. “Private equity has realised you can’t IPO a business unless it’s got a really strong sustainability or ESG story,” said Sarah Galloway, co-leader of Russell Reynolds Associates’ sustainability practice.

Whether considering a listing or not, taking proactive, practical steps provides a company with an insurance policy to limit the potential of future fines, reputational risks and even litigation in the event of strict regulation emerging for the marketplace. The most forward-looking businesses will continue to prioritise ESG integration, moving beyond existing legal frameworks and minimum regulatory compliance, and instead embracing ESG issues in a transformational sense.