ESG debates should not distract from business fundamentals

Nicholas Panes

In the past few years there has been a healthy and positive shift in public consciousness towards environmental, social and governance issues, driven by a number of factors, chief among them: social media.

These shifts have prompted investors in key markets – Europe, the US, the UK and Australia, among others – to ask questions of the companies they invest in and the businesses that manage those investment activities.

Add in high levels of liquidity and discretion on the part of these investors, and you spur competitive pressure among corporates and investment managers. 

Throw in a regulatory domain that is seeking to keep pace with these changing requirements – and the potential risks it presents – and the operating environment becomes even more complex. And this is before you consider the complexity that current geopolitical tensions generate for all these stakeholders.

The result is great tension in the system.

Importantly, the players in this system tend to move at different speeds. Large, public companies need time to address systemic questions around sustainability and resilience, to allocate the necessary human, technological and financial resources to drive those strategic choices, while also retaining profitability.

Regulators also need time to consult industry participants, draft policy, secure approval, promulgate and then enforce. However, investors – whether retail or institutional – have discretion to move capital rapidly to companies and fund managers that attend to their current investment goals.

By extension, fund managers and advisers need to move quickly to outpace their rivals in attracting these funds, often by creating and promoting new products that seemingly attend to the investment zeitgeist.   

But short-term imperatives do not always align with long-term planning, and the divergence in those time horizons creates both opportunity and risk for companies. The regulatory environment (and by extension, associated reporting requirements) is adjusting to these new demands, the ESG lexicon remains open to definition and therefore interpretation, and companies and fund managers are under pressure to retain existing investors or secure new ones.

It is perhaps not surprising then that in this context the risk of greenwashing has materially increased, and as a consequence enforcement agencies must respond. 

Enforcement action

We have seen this trend before. An extended period of global economic growth and perceptions (or reality) of an uneven playing field in terms of business practices, prompted the US Securities and Exchange Commission and US Department of Justice to start actively enforcing the US Foreign Corrupt Practices Act in the late 1990s (a law originally passed in 1977), which provoked a seismic shift in the anti-corruption and anti-bribery landscape.

Attitudes to behaviours that had previously been deemed acceptable changed overnight, with the role and size of legal and compliance functions given new importance. 

Similarly, the global financial crisis of 2008 exposed practices that had been masked by economic growth, with some infamous Ponzi schemes perhaps the poster children for that era’s excesses.