By Dan McDermott & Lyndon Park
The COVID-19 pandemic brought about unprecedented changes to business and life in general. As companies, leaders, and investors navigate these volatile and uncertain times, an opportunity has emerged to examine how companies with strong environmental, social, and governance (“ESG”) practices have fared. Are these companies better able to weather such economic storms? And, if so, how will that impact the adoption of ESG practices once the pandemic has passed?
The ESG Factor
ESG factors were steadily growing in importance to investors prior to the COVID-19 outbreak. In January 2018, BlackRock CEO Laurence Fink used his annual letter to investors to warn organizational leaders that they should contribute to the social good or risk losing the investment firm’s support. In 2019, a group of 300 mutual funds that integrate ESG factors into their investment decisions attracted $21.4 billion in new money, compared with $5.4 billion a year earlier, according to data from Morningstar Inc. And, in February 2020, CNBC reported that the “green investing megatrend” had staying power and investors would continue to demand ESG options.
Now, the COVID-19 pandemic may provide insight into whether such practices make a difference in the face of disaster. While it is too early to make definitive judgments, emerging evidence suggests that sustainable funds with a focus on strong ESG profiles and less exposure to energy outperformed their peer groups in this difficult first quarter, and more than half of ESG funds outperformed the wider MSCI World Index. As the more ESG-progressive regulations like EU Taxonomy continues to even further promote the flow of capital to more sustainable companies and ESG strategies continue to become mainstream portfolio strategies, companies committed to ESG factors will likely benefit from this tide.
How ESG Impacted COVID-19 Response
While companies are still in the trenches of responding to the COVID-19 pandemic, strong ESG practices are aligned with strong long-term planning and business continuity practices. ESG-focused companies are likely to have:
Disaster preparedness and business continuity plans. Companies focused on ESG are committed to ensuring their business operations continue during natural and other disasters. Boards of directors should include ESG factors in its enterprise risk management. This serves employees by maintaining as many jobs as possible, and benefits the community by factoring in potential risks and environmental factors. Such plans often have options for redundant operations and remote work, which ensure that the business can continue to operate, even if its primary location is inaccessible.
Employee protections. ESG-focused companies may be more likely to have employee offerings, like remote work options and paid sick leave,that became essential lifelines during the COVID-19 outbreak. As furloughs and layoffs may be a necessary solution to COVID-19 disruptions, how companies proactively mitigate long-term effects of these solutions will impact employee morale.
Stakeholder Communications. How a company responds to COVID-19, and communicates how it helps its customers and society will affect the company’s reputation, and also influence the ESG assessment by its investors.
Supply chain management practices. Managing a company’s supply chain, as well as its reliability and risk, is an important metric in the Sustainability Accounting Standards Board (SASB) framework, which is used in measuring and reporting a company’s ESG factors. Boards that nimbly managed and prioritized supply chains to address the greatest areas of need would impact how investors view the company’s sustainability and governance ratings.
Agile and nimble teams. Because they invest in their people and understand the importance of good governance, ESG-focused companies are more likely to have engaged employees and committed boards that could pivot quickly in response to the pandemic. Being able to adapt to change quickly and effectively — restaurant chains adding delivery services during social distancing or fragrance companies making hand sanitizer to meet burgeoning demand, for example — is essential for business longevity.
How COVID-19 will Affect ESG
The COVID-19 pandemic has already mobilized some of the largest institutional shareholders to even more strongly commit to integrating ESG factors into portfolio strategies and risk models. The striking convergence the market observed even amidst the trying times was that both the pandemic and an ESG risk (e.g., climate change) are global, borderless catastrophes which require a systemic preparedness but non-routine, large-scale response. In this current environment where adopting ESG factors in portfolio strategies has become the norm for the investors and not the exception, investors like State Street has already published a letter redoubling their commitment to incorporating non-traditional ESG factors as one of their lessons learned from the COVID-19 pandemic. As the pandemic caused destructive market disruption and exposed the vulnerability of our financial systems, the European Commission selected BlackRock to oversee its study on how it could systematically integrate ESG factors into the EU’s banking sector.
The COVID-19 pandemic also laid bare the fragile and woefully underprepared infrastructure that was not equipped to provide healthcare, safety and financial security to the general populace. The mainstream media covered in detail a significant drop in greenhouse gas emissions when the world moved to social distancing and quarantines, showing, albeit over the short-term, the positive impact that de-carbonization can have on the environment. Barclays has summarized all of this eloquently, stating that “COVID-19 will accelerate this trend [towards ESG] even further – creating a greater sense of urgency and responsibility toward everything from consumer behavior to climate change, supply-chain practices… and potentially alter the nature of the investment process as a result.”
Practically speaking, affected companies must emerge from the pandemic and have a chance to evaluate this period’s long-term impact. The way in which they were prepared to respond and protect their stakeholders — including customers, employees, suppliers, and others — during a period of capital constraint will affect both their ESG metrics and the overall view of whether ESG should be prioritized by more investors.
Once companies move past the crisis, they should be prepared to articulate how they responded to COVID-19 in alignment with sustainable development goals. They should also review their remote work policies and practices. Remote work options are not only a coveted employee benefit, but telecommuting capabilities allowed many companies to remain operational. In a post-COVID-19 era, remote options can decrease office space requirements and related costs. But companies must also manage the heightened cybersecurity risks and productivity concerns that go along with it as part of the overall risk management discussion.
As companies update their sustainability reports for ESG-focused shareholders, they should be sure to include HR policies that were implemented to mitigate COVID-19-related risks. These may include:
Companies that successfully implement emergency policies in response to COVID-19 and properly articulate those measures will receive credit from ESG rating agencies and investors. And, if evidence shows that ESG practices align with best practices in business continuity and disaster recovery, investors will continue to prioritize ESG in making critical investment decisions. If you have additional questions about prioritizing ESG within your business, please reach out.