Building Back Better

The defining issues of 2020 were a stark reminder that capital markets and real-world events are inextricably linked. Climate change, social justice issues and a global pandemic underscored the importance of mitigating, rather than simply minimising, environmental, social and governance (ESG) risks. 

We believe those themes will continue to have an outsized effect on conversations between investors and companies in the year ahead.  

Putting the S back in ESG

The S in ESG has, historically, been the poor cousin of the trio. 2020 changed that. The global pandemic exposed the degree to which a sustainability crisis can decimate economies, businesses and societies. Social and racial inequality stole the spotlight, as the recession laid bare segments of the economy where employees have few protections and the Black Lives Matter movement swept the globe. 

There are two key ramifications for businesses. Employee welfare will be a priority in the wake of the crisis, as companies seek to protect their workers. Expect greater investor focus on business ethics, treatment of the labour force, and mental health. Diversity, particularly at a board level, and particularly in the US, will also garner attention in the wake of Black Lives Matter. 

It doesn’t stop at employees, however. Companies will also face pressure to take greater responsibility for the communities in which they operate and their deeply complex supply chains.  

When (according to the International Labour Organisation) only a fifth of the global workforce has emerged from the pandemic unscathed, suddenly shareholder primacy seems outdated. Sustainable capitalism will be a dominant driver in 2021 and beyond. 

 Changing perspectives on climate change

Despite the dramatic drop off in fossil fuel demand and the coming and passing of peak oil, 2020 was still a record year for heat, wildfires and hurricanes. Climate change remains at the top of the agenda for investors and regulators (and therefore companies), with two updates for 2021. 

First, the coordinated, international response to COVID-19 was a lesson in how innovation could swiftly eviscerate problems that were or are environmental in origin. Climate-friendly investing has, to date, largely been an exercise in excluding fossil-fuel stocks. In 2021, investors are likely to become more selective: directing their sights towards technology and renewable companies that offer a solution instead of just avoiding an issue.  

Second, climate change will expand to include biodiversity risks. As MSCI points out in its outlook for 2021, “the virus has reminded us of what we’ve unwittingly lost: nature, critical… for sustaining the global economy. In 2021, policymakers and investors will heed the alarm on biodiversity loss, adapting a playbook they had established for measuring and managing climate risk.” While measuring biodiversity is more complex than measuring carbon emissions, Fidelity suggests ‘big data’ will make it easier to assess multiple inputs. The asset manager anticipates “risk disclosure frameworks similar to the Taskforce for Climate-related Financial Disclosure to emerge for natural capital.”

When it comes to policy and regulation, Europe may be leading the charge, but certain parts of Asia are catching up. And a Biden administration from January means the US isn’t far behind. 

 Making sense of the alphabet soup

 It’s all very well saying companies need to flex their social and environmental credentials. The question is, how exactly do you do it? 

On that front, 2021 is likely to be a pivotal year for sustainability disclosures. Companies and investors have, for many years, been forced to navigate a painful “alphabet soup” of reporting frameworks, standards and surveys. (You know it’s a problem when there’s a parodic Twitter account dedicated to the issue.) 

We saw early progress in 2020. Marking their very first attempt to simplify the field, the Big Four accounting firms unveiled ESG reporting standards in September. The framework was informed by the Sustainability Accounting Standards Board (SASB) and Global Reporting Initiative (GRI), which had themselves entered a collaboration earlier this year, to “help stakeholders better understand how the standards may be used concurrently.” SASB and the International Integrated Reporting Council (IIRC) went one step further by merging into a unified organisation. Most recently, the International Financial Reporting Standard (final acronym, IFRC) proposed a consultation to roll out a global standardisation framework. 

Don’t expect harmonisation on a silver platter anytime soon. But if the confluence of regulation, adoption and consolidation continues at the same pace of the last two years, we’re hoping to make some sense of the chaos in 2021. 

The ball starts rolling in January, when the European Financial Reporting Advisory Group, at the direction of the European Commission, delivers its first recommendations for an EU-wide non-financial reporting standard. 

What comes next

ESG issues have been on the radar of investors for over a decade now. When it comes to communicating their positions, however, companies have historically been a step behind. That’s about to change.

The next year will see companies asked to do more to meet the ever-growing needs of investors, regulators and stakeholders. You will need a clear understanding of where you sit in the eyes of the buy side and a focused communications strategy to cut through the noise.

While meeting shareholder expectations is no longer enough, there are tools and tactics you can use to better report and communicate your sustainability credentials to an audience that’s wiser, yet more overwhelmed than ever. Want to hear more?