Environmental and social governance – Navigating between the carrot and the stick

Andrew Rosenbaum is the Business Editor of the Cyprus Mail and Editor of Cyprus 4.0.

The literature on human motivation is rife with platitudinous academic works – research invariably rhyming with solipsism – informing us that the carrot is better than the stick.

Certainly the “carrot,” meaning performance and return on investment, has helped to drive the stratospheric ascent of Environmental and Social Governance (ESG) as reforming corporate behaviours and determining institutional investment in the past 10 years.

In 2020 alone, $152 billion of new money poured into ESG-labelled products and the total global assets in these products hit more than $1.6 trillion the Financial Times reports.

More than 2000 studies have shown that “the business case for ESG  the business case for ESG is empirically very well founded.” Roughly 90 percent of studies find a positive relationship between ESG adoption and  the bottom line, according to the School of Business at the University of Hamburg.

“The young are all over it. A new survey from Montfort Communications, a PR company, and Boring Money, a financial news website, makes the point. In a poll of retail investors, some 63 per cent of 18-34-year-olds say they would choose a new fund manager based on their approach to ESG. That falls to 67 per cent among the 35-54 age group and about a third of the 55-plus group.”

That’s a mighty big carrot.

However, the “stick,” which in this case refers to a raft of legislation and regulation obliging boards of directors to adopt sustainable practices and investment, has also had a determining effect.

There have been a series of EU directives, for listed companies, stock exchange regulations, and for financial services companies, both EU and national regulations on ESG.

“There is a clear and consistent expectation that environmental, social and governance issues, including climate impact, are included in stewardship and investment decision-making,” Sir Jon Thompson, chief executive of the UK’s Financial Reporting Council.

And, in case that wasn’t clear enough, Deutsche Bank chief executive Christian Sewing has warned that lenders “risk losing their licence to operate” if they fail to make green finance a priority, as the group raised its own targets.”

Companies, however, find that their shareholders and investors, including private equity funds which go to unlisted companies, are demanding that their boards adopt an ESG perspective. That’s also part of the ‘stick’ side of  this issue.

The challenge, for companies navigating between the ‘carrot and the stick,’ is identifying real ESG investment prospects.

“We are supportive of a common set of global standards for non-financial reporting, particularly Environmental, Social and Governance (ESG) reporting, that unites the wide array of frameworks currently in operation and emerging internationally. In our view it will be important to establish these global standards before determining how the information is ultimately shared with stakeholders,” warns Julia Wilson, chair of the 100 Group which brings together financial directors from the FTSE 100.

Or, as, columnist Merryn Somerset Web puts it: “In general, if you buy an ESG labelled fund, the odds are you’ll get a quality growth fund probably with a bias to tech with a lot of blurb in the marketing about ESG.”

This indicates the challenge for most Cyrus companies who most just at the stage of developing an ESG strategy: There are still not a clear and universal set of criteria to distinguish real ESG investment from what is called ‘greenwashing.’

But Cyprus companies are already taking on these challenges, as our report shows.

In Cyprus, moreover, there is considerable development in the area of Corporate Social Responsibility (CSR). This kind of sustainable action preceded ESG, and has since become part of it.

CSR is marketable, because it enables even very small companies to do good while reaping a well-deserved bonus in public relations.

As a result, CSR is widespread in Cyprus, and our report shows just how well-developed it can be. Companies with CSR programmes did a great deal of good on our island during the pandemic, so it should be understood that CSR is real and meaningful.

Making ESG meaningful is an ongoing process. The most immediate effect is to move investment funds away from “sin” companies – fossil fuels, guns, etc. – regardless of the return they provide. The next step will be to actively support sustainable causes, and this transition is proving difficult, but not insuperable.

It’s all part of stakeholder capitalism, and that seems to be the theme of business in the 21^st century. Perhaps, after the dismal record of the 20^th century, we are actually getting somewhere?