ESG And War: Leave? Stay? or Invest in Defence?
Since the term ‘Environment, Social and Governance (ESG)’ has been used in the 2004 UN Global Compact report, it began to spread rapidly especially by the capital markets. Ever since, the demand for businesses to be transparent about their ESG performance has been rising.
Following COP26 in November 2021, ESG became one of the most hotly discussed topics in boardrooms around the world. However, in the days following the NATO crisis and the outbreak of war in Ukraine, never has the philosophy of corporate ESG been pressure tested to such a degree. To most companies it was clear that a robust response was required but the fallout has revealed enormous social concerns and divided boardrooms on the attitude to Russian corporate, financial, and retail markets. In his letter to BlackRock shareholders on 24 March 2022, Larry Fink (CEO), made it clear that the era of globalisation is over, and that the consequences of the conflict will be felt for decades by the corporate community around the world. Which raises an important question on the continuing role of ESG in these unprecedented and fast-changing circumstances?
ESG metrics failed to predict the catastrophe.
One may wonder why timing matters and why ESG was meant to predict unsuccessful investments? The answer is that now, when sanctions have been imposed and Russian corporate and financial markets have been isolated from the outside world, the liquidity of Russian assets has been targeted. The lessons that must be learnt here are that (i) detailed disclosure rules will play a major role in the transparency of investments in the future and (ii) companies that operate under conflicting nations will obtain respective ESG rankings to flag risks to investors far in advance.
ESG is a driving force for companies leaving.
The exact reason for leaving the Russian market is unclear. Is it ESG and ethical concerns? Problems with logistics and supplies? Or even legal threats (i.e., sanctions, KYC procedures, compliance)? Most likely it is the combination of all these factors after the Ukraine-Russia crisis erupted into war on 24 February 2022.
The very fact that companies factor in ESG and ethics is rather surprising, especially in the UK, where shareholder primacy is embedded in corporate culture and the Companies Act 2006 (i.e., famous Section 172). Maybe, this attention to social tragedy can be explained by the fact that CEOs and directors understand that without democracy, global international order, and human rights, there would be no place for global business, international trade, access to resources, and talent.
Is investment in defence acceptable under ESG?
The ESG is more deep, complex, and nuanced than just investing in green projects and publishing anti-slavery statements. Now, numerous states and companies are worried about security threats and sustainability. How should they balance the two? The major shift in the European arena happened when Germany decided to invest €100bn into its military, sidelining its non-escalating policy. The same approach has been followed by Sweden and Finland who may consider joining NATO this Spring. This is not only limited to states, according to the Financial Times, some companies have begun changing their investment policies. SEB, one of the largest banks in Sweden, has vetoed its previous ESG policy that prevented its funds from investing in the defence sector due to ‘the serious security situation and growing geopolitical tensions in recent months’.
One may argue that it is totally unacceptable for ESG funds to invest in a defence sector as it does not correspond to the idea and spirit of ESG as a concept. The response may be that the ability of European states and the UK to provide a high level of security to their citizens and ensure economic and political autonomy can certainly qualify for a social element in ESG. Financial Times cites a Bank of America analyst who said that the war in Ukraine just ‘reminds us that, like most things in investing, ESG is complicated and nuanced’.
By Roman Tokaryk