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Three key factors are coming together and impacting the way directors should think about their role and the decisions they make as part of a board.

1. Capital markets have accepted, and are now driving, the idea of ‘moral money

For years, we’ve heard about the rise of ESG and sustainability as principles for investment, however 2020 proved that this way of thinking about money is set to be the norm of the future. This means that companies wanting to raise capital or be supported on the stock market will need to meet ESG and sustainable criteria, or as Mathew Nelson, EY Global Climate Change and Sustainability Services Leader puts it, “Companies failing to meet investor expectations on environmental, social and governance (ESG) factors risk losing access to capital markets.

U.S. Sustainable Funds had net flows of $51 billion in 2020, this was more than double the total for 2019 and nearly 10 times more than 2018. Investors put $20.5 billion into ESG funds in the last quarter of 2020, setting a quarterly record and doubling the previous record for a quarter, as reported by Morningstar. This wasn’t a one-off reaction to global events. BlackRock’s Global Client survey, released in December 2020, revealed investors representing US$25 trillion in assets, planned to double ESG assets under management by 2025. This is seen as the beginning of a ‘sustained shift’.

The myth of a performance penalty for investing responsibly and incorporating ESG standards, has been well and truly ‘busted.’ Long-term performance of a sample of 745 Europe-based sustainable funds showed that the majority have done better than non-ESG funds over one, three, five and 10 years, according to Morningstar. Even amid COVID-19, ESG funds outperformed the S&P 500. Simon O’Connor, CEO of the Responsible Investment Association Australasia states, It is a long out-dated myth that financial returns must be sacrificed to invest responsibly or ethically. The performance figures and trends we are now seeing each year are telling us the opposite story.”

Blackrock CEO, Larry Fink, in his annual letter to CEO’s, made the point that the story goes deeper, “It’s not just that broad-market ESG indexes are outperforming counterparts. It’s that within industries – from automobiles to banks to oil and gas companies – we are seeing another divergence: companies with better ESG profiles are performing better than their peers, enjoying a “sustainability premium”. 

‘Moral money’ was once considered an oxymoron, and not an issue for the boardroom, but in a sign of how much things have changed, now even The Financial Times has a dedicated section, platform and newsletter named just that.

As Martin Skancke, Chair of the UN Principles for Responsible Investment stated, “There is increasing willingness in the global finance community to acknowledge that there are some sources of revenue which might be considered illegitimate.” It is now up to boards to determine which is which.

2. Regulations and standards are lifting the baseline to a more ‘ethical’ position

We’re seeing increased demands for transparency, consistency of metrics, comparability of ratings methodologies and alignment with financial materiality.

Europe is setting out to “reshape the opaque world of sustainable investment” through mechanisms such as the Sustainable Finance Disclosure Regulation (SFDR), Non-Financial Reporting Directive (NFRD) and EU Taxonomy. We’re also seeing collaboration and standardisation of voluntary frameworks with five leading voluntary frameworks and standard-setters (the CDP, Climate Disclosure Standards Board (CDSB), Global Reporting Initiative (GRI), International Integrated Reporting Council (IIRC) and Sustainability Accounting Standards Board), committing to working together.

In July 2020, the Sustainability Accounting Standards Board (SASB) and the Global Reporting Initiative (GRI) announced they will collaborate to help consumers of sustainability data understand the similarities and differences in the information created from these standards. In the same month, the European Financial Reporting Advisory Group called for recommendations on a possible European Non-Financial Reporting Standard.

The CFA Institute is also developing a voluntary, global industry standard for asset managers in order to provide greater product transparency. A consultation process commenced in August 2020, with submissions closing in December. At the same time, the Sustainability Accounting Standards Board (SASB) released proposed revisions of their Conceptual Framework and Rules of Procedure.

In September 2020, the Big 4 Accounting Firms with the World Economic Forum announced they had developed a set of metrics for companies to use for ESG reporting internationally, building on the Embankment Project for Inclusive Capitalism (EPIC). There is also a push to make such reporting mandatory as indicated by the New Zealand Government.

The standardisation and formalisation of reporting across the globe will serve to lift standards, raising the baseline and forcing companies towards a more ethical position.

3. Legal cases are redefining the role of business in society

In 2015, three tobacco companies were ordered to pay CA $15.5 billion – the largest award for damages in the country’s history – to Quebec smokers. This marked the first-time tobacco companies went to trial in a civil suit in Canada. In the settlement they asked for additional non-monetary outcomes such as an obligation to reduce demand of the product. In 2019, Brazil launched landmark legal action against big tobacco with the calling for accountability between head and local offices – this action was supported by the WHO.

The rapid demise of Purdue Pharma in 2019, following legal claims for their role in the opioid crisis, indicates that the tolerance for the impact of business and the practice of externalising costs to society whilst privatising profits is under question. Again, it’s the detail in the settlement that is telling of the changing nature of retribution for wrongdoing by corporations. Settlement demands included a provision stipulating the transformation of Purdue Pharma into a public benefit pharmaceutical corporation (PBC) structured to maximize public health, rather than profits and to be bound by a charter to expend its resources in the public’s interest. This case also extended to their advisers, McKinsey.

Boards have already been the subject of a series of class actions, across sectors. However, the dismissal of class action proceedings against Worley in December 2020 was seen as sending a signal to boards and directors that they may successfully defend class actions if they can show they took reasonable steps to determine how decisions were made, including a paper trail. This makes good decision-making practices essential for boards.

As the above factors continue to converge and shape our idea of trust, boards will face increasing pressure to embrace their broader obligations to society. As Antoine Harary, President of Edelman Intelligence has said, “Trust is undeniably linked to doing what is right. The battle for trust will be fought on the field of ethical behaviour.”