Behind the ESG boom

Greater focus on non-financial information, in all its forms, is changing governance.

Is Corporate Social Responsibility (CSR) dead? Has it been subsumed into the boom in Environmental, Social and Governance (ESG)? Is the notion of “sustainability” now redundant? And where does corporate reputation and trust fit into the ESG boom?

These are important questions for directors who feel baffled by the market’s surging interest in ESG. Understanding how these pieces fit together – and where this trend is headed – is vital as the market puts more emphasis on ESG in broader company performance.

 Dr Ulysses Chioatto's view on CSR and ESG

The Governance Leadership Centre (GLC) asked Dr Ulysses Chioatto for his view on CSR and ESG and how boards should respond to growth in these areas.

Dr Chioatto is an adjunct Associate Professor of Law at Western Sydney Univeristy, a former head of Institutional Shareholder Services in Australia, and a leading consultant on ESG and investor-engagement issues. He is writing a book on CSR and ESG, to be published in 2019.

Here is an edited extract of his interview with the GLC:

GLC: Ulysses, CSR seems to have been around for decades. What are its origins?

Ulysses Chioatto: The concept of corporate social responsibity stretches back to the ‘60s. There was an emerging view in academia that companies that were socially responsible would perform better. CSR gained traction over the ‘70s, ‘80s and ‘90s, particularly after corporate scandals in those decades. There was pressure on companies to be better corporate citizens.

There have been lots of CSR definitions over the years, but it is essentially about organisations doing the right thing by society and stakeholders. In reality, CSR was little more than a marketing or public relations exercise for many companies – and for some, still is.

GLC: We saw strong growth in corporate sustainability reports in the ‘90s and beyond. Was the focus on sustainability part of the broader CSR movement?

UC: It was. Essentially, the market wanted companies to provide data on their corporate social responsibility initiatives and performance; sustainability reports were a way to do that. But there was a view that much of the information in sustainability reports was meaningless for investors. Many companies did not know how to provide this data to the market, or which data should be disclosed and whether it was comparable with that of other companies.

GLC: How does CSR differ to ESG?

UC: CSR is fundamentally about corporations being moral and relies on self-regulation. ESG assesses organisations through the lens of their ESG performance, is based on hard and measurable data, and is used in investment and other capital-allocation decisions. The decision by Australia’s big banks not to lend to the proposed Adani coal mine in Queensland is an example of ESG assessment at work. In contrast, investors do not use specific CSR information in investment decisions.

GLC: Some governance observers say CSR is the ‘S’ in ESG. Is that correct?

UC: No. CSR is broader than the Social lens in ESG. CSR can range from company supply-chain issues to the sourcing of raw materials, environmental issues and so on. But unlike ESG, it’s not providing hard data for the market to factor into investment decisions.

GLC: There seems to be much greater focus on corporate trust these days. How does that fit into CSR and ESG trends?

UC: Corporate reputation and trust are just a part of CSR. Although it’s interesting to look at ratings of how the community trusts different organisations, the data cannot be used in investment decisions, so has limited value.

GLC: What was the genesis of the boom in ESG data?

UC: It began in 2000 when the United Nations launched the UN Global Compact (a framework for companies committed to sustainability and responsible business practices). That led to the launch in 2006 of the Principles for Responsible Investment. The principles outlined the need to incorporate ESG issues into investment decisions and ownership policies and practices.

Principle 3 talks about seeking appropriate ESG disclosures. Essentially, the Principles encouraged global investors to factor ESG into their decisions, which in turn meant companies needed to disclose more ESG data.

GLC: How does growth in ESG relate to the rise of proxy advisory firms in Australia?

UC: The big global proxy advisers have been researching Australian companies since the early 2000s, but their analysis was initially done from offshore. They did not have a local presence so it took time for Australian companies to learn how to engage with them. The proxy firms started to build their local presence around 2005. The Principles for Responsible Investment encouraged institutions to be active owners and incorporate ESG decisions into their ownership practices. Proxy advisory firms helped institutions do this.

GLC: When did ESG analysis start to ramp up in Australia?

UC: By 2006-7, we saw the emergence of an industry of specialist ESG data providers in Australia. Large asset managers started to hire ESG analysts, as did investment banks. Institutional investors that had one employee analysing ESG started to build ESG teams.

Also, the third edition of the ASX Corporate Governance Principles and Recommendations said listed entities should disclose any material exposure to ESG risks and how they intend to manage those risks. The result was companies disclosing more ESG data, asset managers hiring specialist staff to analyse the data, and institutional investors assessing companies on ESG criteria as part of their investment decisions.

GLC: Is Australia lagging Europe and the United States on ESG analysis?

UC: ESG has been growing rapidly in those market since 2000. Australia is probably five years behind. We will almost certainly follow Northern Hemisphere trends in how companies disclose ESG data and how asset managers analyse it. We’ll see a lot more consistency and comparability in ESG data that Australian companies release, as is the case offshore.

GLC: Where will the ESG trend head over the next five years?

UC: ESG is going to get a lot bigger yet. The incredible growth in asset managers signing up to the Principles of Responsible Investment in the past few years suggests much more capital will be put through ESG filters when investment decisions are made.

GLC: Are boards on top of these ESG trends?

UC: Some are, and some aren’t. I’ve interviewed the Chairs of many of Australia’s largest listed companies and they make all the right noises about ESG. But, to be frank, many directors do not have detailed knowledge of ESG issues. That will change as the market does more in-depth comparisons of ESG performance across companies and sectors, and as that performance has a greater impact on share-price performance and capital-allocation decisions.

GLC: Is there an ESG skills gap in terms of board composition?

UC: There’s a glaring gap, in my opinion. ESG is becoming one of the biggest issues for investment markets and for governance, yet many skill matrices that companies publish show boards have limited skills and experience in ESG. Boards of large listed companies need directors who understand ESG and how organisations should engage the market on it.

GLC: What is the benefit of ESG data and analysis for boards?

UC: As ESG data becomes more standardised, boards will start to use it as a risk-mitigation tool. For example, a board will compare its ESG profile to its nearest competitors here and overseas, to understand where performance is leading or lagging. If the board sees the organisation is relatively weak on an ESG issue, it can take early steps to address the issue.

GLC: Should ESG information be audited?

UC: That’s a good question. Unlike financial information, audit firms do not test ESG data that companies report. As asset mangers increasingly factor ESG into their decisions, it’s reasonable to ask about the veracity of that ESG data. I support the idea of audit firms looking at ESG. Auditors want good-quality data and clear standards against which to audit. The involvement of audit firms in ESG would add more rigour and robustness to ESG data.