Why COVID-19 Makes the Case for Strengthening the “S” in ESG

Karen Kramer, contributing writer for SILA Advisory

23 April 2020 / COVID-19

Why COVID-19 Makes the Case for Strengthening the “S” in ESG

23 April 2020 / COVID-19

COVID-19 reveals the paucity of companies’ social preparedness.
The massive disruptions to business caused by the COVID-19 pandemic has entailed not only the abrupt layoff of millions of employees, but also the wide-scale cancellation of contracts along supply chains, affecting millions of workers around the world.

Huge numbers of people have also been critically affected by the widespread lack of paid sick leave and health insurance. Indeed, the implications of business practices and economic policies that have left people and communities brutally exposed in the wake of the pandemic have been laid bare.

This state of affairs is notable given the exponential increase in ESG investing—which ostensibly seeks to advance the responsible environmental, social and governance performance of businesses. ESG assets now account for nearly $31 trillion of all assets under management worldwide, experiencing nearly a fourfold increase over 2019. The influential Business Roundtable, an association of CEOs of major U.S. corporations, issued a statement in 2019 declaring its commitment to focus on the needs of all stakeholders, including employees, customers and suppliers, and Blackrock, the world’s largest asset manager, last year decided to increase by tenfold the number of sustainable assets they manage. 

The need to strengthen the “S” in ESG

Yet while there has been a huge increase in attention to ESG performance, the COVID-19 crisis has revealed that businesses were singularly unprepared for the social impacts of a crisis that global health experts had warned for decades would come. Given what we are seeing, it appears that few businesses had policies in place to help them responsibly navigate the impacts such a crisis would have on workers, customers, suppliers and communities, who are the focus of the social or “S” aspect of ESG. Many companies, especially in the U.S., have in fact taken actions that have been deeply harmful to these stakeholders.

Social performance has long been considered the soft underbelly of ESG investing. Less amenable to hard data and assessment than, for example, a carbon footprint or the diversity of board members, it seems harder to quantify and measure. Yet if we are not able to effectively identify and manage social performance, this calls into question the efficacy of the prevailing ESG framework. At a minimum, the current crisis has brought into sharp relief the urgent need to strengthen attention to the “S” in ESG.

Stakeholders will now be watching

There is ample reason to presume that stakeholders will be expecting business to do exactly that. Business publications, mainstream media y NGOs have all been assiduously reporting on companies’ behaviour during the crisis, which may well impact brand reputations and customer loyalties down the line.

Investors are also taking note: 286 institutional investors, representing over $8.2 trillion USD in assets under management, have signed the Investor Statement on Coronavirus Response, calling on companies to provide paid leave, prioritise health and safety for workers and the public, maintain employment and supplier/customer relationships, and exercise financial prudence by suspending share buybacks and limiting executive and senior management compensation. Morgan Stanley notes, “the coronavirus pandemic will put more companies under scrutiny for decisions that impact employees, customers and society.” Bloomberg reports leading financial managers have seen a sharp increase in client queries on such issues as independent contractor rights and sick leave, and note these managers are stating they will be paying increased attention to the “S” in ESG, including the treatment of employees, contract workers and suppliers, and the provision of medical insurance.

Developing the “S” with the UN Guiding Principles on Business and Human Rights (UNGP)

In order to better identify, measure and address the social impacts of business decisions and activities, businesses can turn to an essential tool—the UN Guiding Principles on Business and Human Rights. This is the international standard on the corporate responsibility to respect human rights, and the framework that should be underpinning all ESG practices. The UNGPs draw on internationally recognised human rights, as delineated in the International Bill of Human Rights and the ILO’s Fundamental Principles, to guide businesses’ (and states’) activities and define their responsibilities.

The UNGPs state business should “identify and assess any actual or potential adverse human rights impacts with which they may be involved,” and that this assessment should be undertaken prior to major changes in the operation and include direct consultation with affected stakeholders.

In the current crisis, this would mean at least an initial assessment—before quick decisions must be taken—of the impacts on stakeholders of reducing or shuttering operations, ending payroll and health benefits and cancelling supplier contracts. The UNGP stipulation that businesses mitigate or remediate any impacts, would require, for example, consideration of decisions to maintain payroll, benefits and supplier contracts, provide and/or extend paid sick leave, establish remote working options, provide protections for essential employees, and enable the continued provision of essential goods and services.

The UNGPs state business should pay “special attention” to impacts on individuals or groups that may be at “heightened risk of vulnerability or marginalisation.” Accordingly, the profound impacts right now on the huge numbers of workers who are lower down company supply chains (and often women), as well as migrant workers, should be carefully assessed and addressed.

The accumulating reports of desperate employees, independent contractors, supply chain workers and stranded migrant workers who have been abruptly cut loose indicate little if any impact assessment has happened. Moving forward, this makes clear the responsibility to have in place processes to address the social impacts that slowdowns, temporary closures or permanent exits will entail.

The UNGPs are also clear on a company’s responsibility to avoid or remediate negative impacts even when it has not contributed to the impact, but is directly linked to the impact through its operations, goods or services. It states: “If the business enterprise has leverage to prevent or mitigate the adverse impact, it should exercise it. And if it lacks leverage, there may be ways for the enterprise to increase it. Leverage may be increased by, for example, offering capacity-building or other incentives to the related entity, or collaborating with other actors.”

In the present context, leverage would mean directly engaging with stakeholders—for example, with supply lines regarding contracts and with governments regarding the coordination of relief—to mitigate and remediate the costs of the crisis. While we are in uncharted territory with COVID-19 and companies will need to make difficult choices, any decisions should still be guided by the UNGPs.

COVID-19 crisis makes clear the urgent need for better measurement of social performance

The pandemic has mercilessly exposed the fact that the efficacy of ESG ratings are deeply compromised without a more rigorous approach to assessing social performance.

The first step towards building meaningful rigour into the “S” is recognising the tools we already have. Human rights due diligence, as envisioned by the UNGPs, is critical to that assessment. We now need significant investment in research to build on the UNGPs and establish common standards and meaningful tools of measurement for the “S.”

The COVID-19 crisis is still unfolding, and impacts are still being shaped. So far, even with deeply lacking social impact assessment, the ESG ratings of firms have positively correlated with their market performance during the crisis. Businesses that are able to fully grasp the central importance of social impact mitigation and remediation may well find they have not only navigated the crisis in a stronger position, but that they also benefit from a society whose health and strength was prioritised.