The United Nations Sustainable Development Goals include aims to eradicate poverty, address climate change, tackle rising inequality and reduce unsustainable production and consumption. Global leaders will be drawing the post-pandemic roadmap for achieving such goals at the ongoing UK G7 summit, and the 26th United Nations Climate Change Conference later this year in Glasgow.
The body of climate change laws and policies passed since 1999 have reduced global emissions with variable success between countries, depending on their acceptance of the rule of law and the likelihood of legal provisions being followed – as discussed in this article by the London School of Economics. This nuanced international picture makes it clear that ESG-goals will not be achieved through legislative change alone.
In recent years, there has been a rapid and far-reaching increase in the awareness and understanding of the climate and social impacts that businesses can have. A 2016 research report by the MIT Sloan School of Management found that 90% of corporate managers saw a sustainability strategy as essential to remaining competitive.
Businesses are therefore increasingly working towards achieving the Sustainable Development Goals through a mix of practices that were historically the preserve of Impact Investing funds, as discussed in this article. These include changing their own internal approaches to ESG and imposing contractual obligations focussed on promoting good ESG on their clients, suppliers and other third-parties.
In this article, we explore recent legislative changes around the world in relation to ESG and consider some of the lessons learned from Impact Investing.
On 18 November 2020, the UK government published its Ten Point Plan for a Green Industrial Revolution. Point 10 focuses on “Green Finance and Innovation” and calls on the UK’s world class innovators, entrepreneurs and finance institutions to act as catalysts in the global movement toward a sustainable, decarbonised economy.
In the investing space, the UK announced it will be the first country in the world to make climate-related financial disclosures mandatory and the FCA is to follow the European Union’s MIFID 2, by requiring advisers to ask clients about their sustainable investing preferences. Additionally, the UK Stewardship Code 2020 is designed to ensure that asset owners and managers place sustainable benefits for the economy, the environment and society at the forefront of decision-making.
The UK Corporate Governance Code 2018, which applies to public companies and large private companies, requires boards to take into consideration the interests of employees, business relationships with suppliers and customers, the wider community and the environment as part of their decision-making process. Under the Code, boards must, in their annual report, evidence engagement with stakeholders and explain how their decision making has been influenced by such engagement.
The European Union’s Sustainable Finance Taxonomy Regulation sets uniform ESG benchmarks and establishes a list of sustainable economic activities. This attempts to deal with “green-washing”, which has become all too commonplace as a result of a lack of standardisation around measuring and monitoring ESG, and an inability to find a universally accepted definition of “sustainability”.
On the other side of the pond, we saw Joe Biden’s America return to the Paris climate accord in one of his first acts as President, and CNBC have reported that a Biden presidency could be a “game-changer for impact investing”.
Despite the above, national and international legislative promises often fail to address the discord between progressive ESG legislation and countries where local laws fall behind the curve. With globalisation at the forefront of the world economy, such digressions can minimise the impact of positive legislation in one country when doing business with another.
Most recently, for example, we have seen 30 countries impose sanctions on Chinese officials over human rights abuses against the mostly Muslim Uighur minority group.
In contrast, the global equitable vaccine programme, COVAX, is an example of the power that positive ESG initiatives possess – as it continues to address the imbalance between wealthy nations and others by providing access to life-saving treatment.
Promoting and protecting ESG via several methods has been the mainstay of Impact Investing funds for decades. These have included:
The starting point to achieve these ends has almost always been through enshrining the various principles in the relevant key investment documents. This approach enables the investor to dictate the ESG standards required without having to rely on potentially less stringent standards set by local statutes or regulation. This also means that an investor can utilise the flexibility of contract law to impose and maintain their minimum required standards across all of their investments, irrespective of the location / jurisdiction.
Through a mixture of warranties about the historic operations of a company and forward-looking undertakings, our Impact Investing and Commercial teams are now increasingly advising non-Impact Investing businesses on adopting and introducing ESG-focussed clauses in their trading and supply contracts, shareholders’ / investment agreements and constitutions etc. Some of the key clauses and concepts are considered below.
Contracting parties involved with Impact Investing funding can be required to:
Investment agreement clauses will often specify the implications for failure to adhere to ESG targets. These can range from requirements to rectify the issue within a fixed period of time to, in the most extreme cases, a breach so serious that the investor is able to request repayment and/or withdraw their investment.
The “S” in ESG covers, but now goes above and beyond, human rights, labour issues, health and safety and equality. It is the area where successful companies will be guided by its stakeholders and society as a whole.
In light of the global pandemic, echoing the requirements of the UK Corporate Governance Code 2018, Legal & General has encouraged companies: “to focus on all stakeholders, especially their employees, supply-chain relationships, the environment and communities in which they operate.”
Impact Investing businesses will usually require investee companies to conduct a thorough review and update of their social policies in order to:
Our study on Millennials, Money and Myths found that there is ‘value in having strong values’… across all age groups, more than 70% of those surveyed felt it was important that the way their money is managed reflects their values and is used to positively impact the world.
Beyond environmental and social matters, businesses can also look to carve out unacceptable practices and behaviours in their agreements. These can help to safeguard compliance with the business’s core ‘shared values’, which are so fundamental that a breach by a contracting party would go to the root of the contractual relationship.
The approach taken by Impact Investing funds includes setting out clauses in investment agreements and contracts which impose stringent requirements and restrictions on such matters as:
The steps taken by Impact Investing funds naturally come with the added benefit of ensuring that, in most cases, they are able to maintain a positive reputation. Business reputation can be severely impacted as a result of poor ESG management, as was highlighted by the accusations of modern-slavery against fast-fashion business Boohoo.
As part of our own commitment to improving ESG, Michelmores is supporting initiatives to encourage the adoption of ESG laws and contract clauses, such as the Chancery Lane Project (CLP). The CLP is a not-for-profit collaboration of lawyers from around the world whose stated aim is to use the law to create and develop market norms that reverse climate change and enable business to have a positive impact.
The Project’s “Climate Contract Playbook” (now in its 3rd Edition) is free to download and contains 50 precedents for use in a range of agreements, including commercial contracts, supply agreements, company constitutions, corporate transactions, finance documents, leases, construction projects, public procurement tenders and dispute resolution protocols.
The term ESG has traditionally sparked fears of additional costs and administrative burden as the historic concepts of ESG and sustainability were somewhat more nebulous than they are today. However, in recent times, there has been a widespread change in attitude and perception around the role that businesses play in managing ESG. For the most part, businesses are embracing the changes required to evolve their businesses and take ownership of the responsibility they have for ESG repercussions.
McKinsey view ESG as a value-creation tool – possessing the power to attract loyal customers, improve government and public body relations, increase employee productivity, prevent damage to reputation and create sustainable long-term growth.
With Aviva’s recent promise to pour £10 billion of pension funds into ‘green investments’ and the media rife with ESG scandals, businesses should be prioritising ESG, using their position and influence in the market to create and uphold baseline unified ESG standards.
From our experience, the changes in attitude toward ESG are here to stay. Today’s businesses are more focused on the impact that they are having beyond their core operations. We have seen time and again the success which follows our clients who are at the forefront of embracing ESG – whether in being able to successfully tender for contracts or in attracting good quality staff who, in both cases, are increasingly insistent on understanding businesses’ ESG credentials.
This article was written by Jack Kewley. If you would like to discuss the issues raised in it, please contact the Impact Investing team.
