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The mixed fortunes of ESG: Will we see a rebalancing after the crisis?

13th July 2020, 11:49 am

This was supposed to be the decade to save the planet. At the start of 2020, and with the earth literally glowing from the terrible bushfires in Australia, it seemed that this decade would be defined by the global climate movement and the government’s effort to achieve net-zero carbon emissions by 2050. As such, environmental considerations took centre stage for companies and investors and public pressure was being applied based on the impact companies had on the natural world.

Fast-forward four months and the world is a very different place. Environmental considerations are, of course, still vitally important, but the coronavirus pandemic has shifted the public narrative significantly. Social and governance considerations have dominated the response to the crisis and, in my view, will create a long-term rebalancing in the way the public and investors scrutinise corporations to assess their sustainability.

Re-writing the rulebook

The pandemic has rewritten the rulebook of financial markets; particularly so in the oil market. The price of oil – the one-month West Texas Intermediate (WTI) – has fallen into negative territory as physical storage space ran dry and demand reduced to an all-time low. On the surface, this may seem like good news for the alternative energy sector, but the reduced oil price could hamper the further development and adoption of alternative energy as it becomes relatively less competitive.

For companies, the lower oil price will make it more economical to fund existing fossil-fuel intensive projects rather than raise capital for new green ventures. For individuals, any incentive to switch to electric vehicles has just reduced considerably; and for cash-strapped governments faced with skyrocketing budget deficits, support for expensive renewable projects will be at an all-time low. As a consequence, as investors we need to make sure that companies’ stick to their environmental agendas and that developments in alternative energy continue apace.

Shifting public focus

Before the crisis, companies faced significant public scrutiny over their environmental credentials and their impact on the natural world. In London during the summer of 2019, it was not unusually common to find a climate protestor glued to the offices of certain companies. The awakening of the public conscious in regards environmental concerns (please take a bow David Attenborough and Greta Thunberg) did lead to concrete action, for instance the high court ruling that Heathrow’s third runway was illegal, and the shareholder scrutiny of Barclays’ financing of carbon-intensive activities.

However, as the world has reacted to the pandemic that is covid-19, public attention has shifted and is now dominated by the role and contribution of companies within society, and social and governance considerations have been vastly more important than environmental considerations in providing the public and investors with a lens to scrutinise company behaviour during this period.

As we talk to companies about how they are operating in this new environment, it is clear that they believe public perception on whether they have had a ‘good’ virus will be an important factor in future buying decisions. Instead of ‘daddy what did you do during the war?’ it is a case of ‘senior management what did you do during covid?’.  The gap between those businesses responding positively and those appearing to exploit their employees or government support has been cavernous and we believe that this will not be forgotten by consumers in a hurry.

Public focus has also shifted to executive pay. Before the crisis, the expectation that company executives should be ‘in it together’ with their employees was, except in a few organisations, pretty much non-existent. The vast gap in pay ratio between CEOs and the average employee is an acute reflection of this, although recent moves in the UK to align pension allowances has created a chink in the armour of unequal pay.

Now, there is a growing expectation that management remuneration should be appropriately aligned with the experience of the wider workforce and executives and board members will be expected to lead by example, particularly if the business has utilised any government support during the crisis. In the UK, since the government has effectively nationalised a significant chunk of the private sector wage bill, we expect the government and select committees to be scrutinising executive pay and good governance like never before. The recent decision from IPSA to allow MPs an additional £10,000 allowance for working from home may make this difficult, however.

The fear after any global crisis is that any difficult and expensive projects are pushed to the bottom of the agenda. This was certainly the case with ESG investing after the 2008 financial crisis, but there are promising signs that this time may actually be different and that ESG will remain at the top of the agenda for the long-term, albeit with a shifting focus for the public, and shifting priorities for investors. We believe that the regulatory changes as well as public perception will make it different this time. Investment managers must recognise these shifting priorities and the mixed fortunes of ESG, and ensure that companies are contributing positively to the post-pandemic world.

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