Addressing the Basics of ESG

You may have heard of Greta Thunberg. She’s 16, wears her signature plait and has berated world leaders for a lack of action on climate change. While scrolling through social media you may have come across photos and videos of burning trees – your friends and influencers heavily spreading awareness on the Amazon fires. If you live in Singapore, you wouldn’t miss the hazy view that greets us every few years.

Is there really a cause for concern though? Oh yes there is.

ESG, a new buzzword?

As an investor, you would have heard about the use of such a framework or investing principle by asset management firms. Exchanges such as NASDAQ and NYSE have published voluntary guidelines for listed companies who wish to share their sustainability practices. Others such as the Singapore Exchange (SGX) and Hong Kong Exchange have taken it a step further – comply (with compulsory reporting) or explain.

The SGX began with voluntary guidelines for sustainability reporting in 2011. Taking into consideration the growing demand from investors for a more transparent view of listed company’s sustainability practices, they announced (in 2016) that SGX-listed firms must issue their first sustainability reports by 31 December 2018. Within these reports, firms are required to choose a reporting framework to identify their ESG impact.

Let’s get to it – what exactly is “ESG”?

Environmental, Social, Governance

When paired with the term “investing”, these are the three aspects that are used to measure the sustainability and ethical impact of investing in a company or a business. In very simple terms, ESG can be understood as such:

Currently, there are different organisations (including companies of varied industries, asset management firms, associations and non-profit organisations) who have developed their own guidelines and framework on how E, S and G aspects should be viewed and ultimately measured.

While some companies refine and develop better practices in accordance to the various frameworks to assess ESG impact and sustainability, there may also be some businesses that lapse into poor practices or disclosures, garnering attention from the investment community as they raise red flags over the doubtful practices when evaluating how sustainable such business are.

In view of increasing regulatory requirements and scrutiny from investors, most companies try their best to comply with the measures and provide sufficient disclosures related to the various ESG factors. Nonetheless, companies who excel in all three are no doubt difficult to pinpoint. Here are some real-life examples who fall short on meeting ESG frameworks and hold a dismal track record, which may result from either insufficient or negligence in disclosures, or lapses in their business processes and operations.

Environmental: 7 years of manipulation to hide environmental waste

Earlier this year, one of the United Kingdom’s largest water companies was ordered to pay £126 million (SGD 214 million) in penalties for breaching their duties on sewage treatment. Southern Water supplies drinking water and treats water for 4.2 million customers. The company has been flagged out and fined by regulators at least 4 times for:

• Manipulating water samples for 7 years to hide “true performance” of their sewage treatment works;
• Irresponsibly releasing waste water (which were not fully processed) into the environment;
• Deliberate misreporting of data; and
• Flooding the Kent coast with raw sewage and shutting down neighbouring beaches for 9 days

Social: Nike’s infamous child labour practices in the early 2000s

Aside from their athleisure apparels and trendy sneakers, Nike also became infamous for their child labour practices back in the late 90s and early 00s. It sparked outrage when photos of children as young as 10 stitching footballs and clothing were circulated. While such practices have since been mitigated, this case became a classic example of a large MNC not doing enough to look into aspects related to the well-being of their employees (whether outsourced or not), and the negative impacts they have brought upon these communities.

While this scandal happened nearly two decades ago, it goes to show how such poor publicity can persist in the minds of the public for a long time.

Child labour continues to be an issue in the manufacturing, agriculture and mining industries, amongst others, accompanied by a range of other issues like unhygienic or unsafe working conditions, forced overtime and low wages. Other multi-national companies such as Swedish fashion retailer H&M and China’s largest cobalt producer Huayou Cobalt have also been called out by human rights groups for a lack of compliance with international due diligence standards.

Governance: WeWork – forced to change corporate governance practices

Once regarded as a unicorn, WeWork has fallen from grace. After filing the paperwork of their (now called-off) IPO, questionable practices were sieved out by discerning financial reporters and analysts.

Without the establishment of proper internal controls, it was found that:

• Founder and CEO Adam Neumann privately owned the “We” trademark and then sold it to WeWork for USD 5.9 million;
• Neumann made arrangements where he borrowed money from WeWork on interest rates that were below the market rate;
• Neumann’s wife, Rebekah, would have the sole discretion (instead of the board of directors) to direct the CEO succession process should he become permanently disabled or deceased; and
• Company coffers were used to fund Neumann’s pet projects and his love for surfing, including a USD 32 million investment into a start-up Laird Superfood by surfer Laird Hamilton.

With the growing knowledge that sustainability practices weigh heavily on a business’s ability to grow over the long term, it is clear that the emphasis on ESG is here to stay and will only grow in importance going forward. If you have not already caught on, it’s not too late to get yourself familiarised with this increasingly prevalent approach to assess the investment thesis and sustainability of individual companies.

This is why we will be starting a brand new series on understanding ESG investing. In the upcoming articles, we will also be sharing with you on the following topics:

• Why ESG has grown in popularity;
• How ESG can impact a firm’s bottom-line;
• Who is influencing and driving ESG; and
• How you too, can get in on ESG investing.