- Head of Business Advisory at Howard Kennedy
Environmental, Social and Corporate Governance, or ESG, is not a new concept, but the increasingly central role it is playing in the decision making of policymakers and business leaders is a more modern phenomenon.
An umbrella term, ESG is used to cover a broad range of issues. To some ESG is synonymous with environmental measures driven by ever increasing concern as to effects of climate change and the need to promote sustainable business activities. Others stress the social element, pointing to a post Covid-19 world that is putting increased value on data privacy, diversity, social inclusion, health, and well-being. Underpinning all is the need for good governance, with leadership, strategy and culture developed within a framework of structural and performance oversight, robust and effective risk management, agile management, and lastly transparent decision making and accurate reporting.
There are numerous reasons why retail businesses are putting ESG at the heart of decision-making; the need to comply with legislative and regulatory changes, to enhance business reputation and brand proposition, to preserve customer loyalty and build market share, to attract investors and satisfy lenders, and to recruit and retain staff.
The relative importance of each of these elements will vary from business to business and this was reflected in the results of a survey Howard Kennedy in partnership with TRI Strategy conducted in late 2022.
The survey specifically focused on:
The participants in the survey came from a range of sectors including retail, with just under two-thirds of the surveyed businesses indicating that they have an existing ESG policy. A third had a dedicated ESG officer, with a particularly high percentage found among the professional services and the financial sectors.
Across all sectors ESG was seen as especially important when it comes to recruitment. Factors for this could include the increased awareness in ESG among graduates and younger generations, who place greater importance on ESG concerns and, in turn, expect their employers to hold the same values.
For retail businesses it was marked that social responsibility was seen of greater importance in respect of its impact on consumer opinion and behaviour; with the risk to brand and reputation being of particular concern.
With the Environment Act 2021, Cop26 and Net Zero commitments and the influx of policies and regulations that came with them, it was interesting to see that “environmental” considerations were of lowest concern to the survey respondents. This is perhaps surprising in that environmental factors are increasingly seen as likely to be the most legislated and regulated area of business activity.
In the retail sector it is noted that impressive sustainability credentials have proved to be successful marketing tools, with sustainability becoming increasingly important to consumers and investors. This trend has however led to accusations of so-called ‘greenwashing’.
On 25 October 2022 the FCA launched the CP22/20 consultation on Sustainability Disclosure Requirements and investment labels with the aim to tackle greenwashing. Significant new disclosure requirements are proposed where sustainable labels are being used by investment funds. Accessible consumer facing disclosures will be required to enable consumers to understand sustainability-related product features, as well as more detailed disclosures targeted at a wider audience such as institutional investors, and a general ‘anti greenwashing’ rule. There will be no obligation to use the label describing investment opportunities as ‘green’ or ‘sustainable’ but where they are used, naming and marketing restrictions will apply, limiting how investment products can be described. The final rules will be published at the end of June 2023 with the greenwashing rule having immediate effect and the disclosure requirements being phased in from 30 June 2024.
At present directed at the financial services sector and FCA regulated firms these measures will penalise those making exaggerated, misleading, or unsubstantiated sustainability claims about their financial products. It will be a small step to see such legislation complementing current advertising standards and consumer protection legislation and regulation, so reaching further into the retail sector
From the survey it was clear that social responsibility was of great importance to retail businesses; a good record of diversity and inclusion and high standards of workplace health and safety being regarded as essential to retaining staff.
It was noted however that what may be regarded as unethical today, may well be regarded as unlawful in the future. This can be seen in the fields of Human Rights and in particular the blight of modern slavery.
The Modern Slavery Act 2015 seeks to ensure supply chains are free from trafficking and slavery, and a much heralded although delayed amendment to the Act will make it a criminal offence to give statements falsely claiming compliance with Act and criminal penalties for the continued use of supply chains that fail to show minimum standards of transparency and/or a lack of effective monitoring. In the US and EU legislation is afoot which will ban the import of goods where the suspected use of forced labour is involved in any part of the supply chain.
The impact on retail businesses and supply chain management is already being felt and will continue to intensify.
The need for compliance with statutory regimes is a key driver for change. In 2023, the Economic Crime and Corporate Transparency Bill, the second part of a legislative package designed to prevent the abuse of corporate structures and tackle economic crime, will be front and centre for directors.
The Bill introduces reform of identity verification requirements for new and existing company directors. Existing directors will have a period within which to comply and failure to do so could result in criminal proceedings, a civil penalty and/or disqualification. The Bill also creates a new offence for an individual to act as a director unless the relevant company has notified Companies House of the appointment and confirmed that the director’s identity has been verified.
Mere compliance with legislative and regulatory provisions is not however enough; and a robust governance structure, which allows for agile and effective decision making within a framework of effective oversight, transparency and accountability will hopefully ‘future proof’ the business and ensure its success but also guard against a director personal liability in the event of business failure.
60% of survey respondents confirmed that they understood how their businesses ESG policy was an essential component of their duty as a director under section 172 of the Companies Act to promote the success of their company. The survey indicated that there is awareness that if directors want to effectively manage ESG risk, they will need to meet the expectations of a range of stakeholders, not simply have compliance in mind.
The scope of a director’s duty to promote the success of the company under section 172 of the Companies Act 2006 was considered in the recent Supreme Court case of BTI v Sequana. The case has instigated commentary on not only a director’s duty to creditors, but also in what circumstances the exercise of a directors’ fiduciary duty to the company will entail consideration of the interest of additional stakeholders, beyond shareholders.
Sequana could thus mark a tipping point where the political and socio-economic pressure on directors to promote long term value creation entails environment, social and governance considerations over and above the idea of shareholder supremacy.
The fact that S172, in particular, compels directors to have regard to factors including the impact of the company’s operations on the community and environment has been used by activist shareholder, ClientEarth.Org in its action launched in February 2023 against British-Dutch multinational oil and gas company, Shell Plc. The claim is heralded as the first lawsuit in the world that will seek to hold directors personally liable for failing to prepare their company for the transition to net zero. Net zero being a global policy adopted by 196 state signatories to the Paris Agreement of 2015 at the UN Climate Change Conference (COP21).
ClientEarth, while only a token shareholder, is supported by a group of pension funds and institutional investors who similarly contend that Shell is failing to move fast enough towards the net zero commitment by 2050, in that it continues to invest in the development of new fossil fuel projects and is paying insufficient attention to sustainable investments. This they claim fails to promote the long-term interests of the company.
While undoubtedly the claim is motivated by a belief in the ‘triple bottom line’ of people, planet and profit, and a belief that long term sustainable economic development requires an equal balance of all three, the derivative claim rests on the breach of statutory duties owed by a director to promote the success of the company. The claim rests on the premise that the failure to adequately address known long-term obligations imperils the success (and profitability) of the company in the future, even if it is for short term gain. It is argued that Shell’s transition strategy to net zero is fundamentally flawed and, as a result of failing to manage the risks faced, the directors are in breach of their duty to the company.
Shell will undoubtedly vigorously resist the claim, relying on the not currently unreasonable proposition that they are abiding by current legislative and regulatory requirements. However, calling directors to account for failure to abide by more general environmental objectives can already been seen in a 2021 Dutch Court judgment, again against Shell. Here Shell faced a lawsuit brought by Friends of the Earth, six other bodies and 17,000 Dutch citizens that alleged that Shell were guilty of climate inaction. The claim resulted in an order that Shell cut overall omissions by 45% by 2030 (relative to 2019 levels). This order (which is being appealed) relates to the global commitment to be reached in 2050 and shows how directors could increasingly be judged on the appropriateness of their ESG strategies.
As we are seeing a potential move from shareholder primacy to all-encompassing stakeholder decision making, we asked our survey participants whether their company has “adopted a ‘triple bottom line’ approach (profit, people, planet) to measuring business performance.” Reflecting the “Better Business Act” campaign which seeks to propose legislative change to s172 that would require directors to seek to align the interests of wider society and the environment alongside the interests of shareholders.
While the vast majority of participants answered “no” to this question, there is significance in 18% of survey respondents treating profit, people, and the planet in equal regard. Without the cultural and social impacts arising from the Covid-19 pandemic, a ‘fourth industrial revolution’ in tech/communications and the growing impact of climate change, there may have been a belief that ESG stood in the way of profit. Today, it is likely that we will see an increasing number of businesses viewing profit through the prism of long-term sustainability, achieved by considering the effect that economic activity will have on people and the planet.
Although the uptake of the ‘triple bottom line’ approach among the survey participants is reasonably low, on a greater scale, we have seen a significant rise in interest in the B-Corp movement; the stakeholder-led driving force behind the campaign that businesses impact and serve more than just shareholders.
Last year alone, 50,000 new companies registered to use the B-Impact Assessment to understand how they measure up against high environmental and social standards – almost a 40% increase over the two years prior. Additionally, there are now over 4,300 certified B-Corps on a global level, with 30 public companies now being certified (15 of which had their IPOs in 2021), reflecting the growing conversation in the financial sector around wider ESG principles. It is of note that a number of prominent retail businesses have become B-Corp business and use this as a significant marketing tool.
The world is changing and ESG is now an important measure of business performance. It drives investor and consumer confidence, as well as influencing investment strategies. It is also an important consideration for boards from a risk management perspective, as well as being directly relevant to successful recruitment and marketing strategies.
The survey has shown why ESG policies are important to recruitment and retention, as employees are demonstrating an ever-greater desire to work for employers whose values align with their own. The same can be said for consumer and investor behaviours on a global scale; if businesses do not adapt and embrace sustainability to match, if not exceed, consumer and investor expectations, then they are likely to see a drop in demand for their goods/services in the long term.
In difficult economic times and with insolvency numbers expected to increase in the year ahead, we are likely to see greater scrutiny of directors’ decision making, more shareholder activism and more businesses failing where ESG risks are a contributing factor.
This article was written by Vernon Dennis, partner and head of business advisory at our Meritas partner firm, Howard Kennedy.