The Covid-19 pandemic has raised fundamental questions about the nature of the capitalist system. Environmental, social and governance (ESG) issues had increasingly been coming onto the corporate radar; but Covid-19 has shown how a health and environmental issue can become a profound social problem and cause material governance challenges. It also highlights that such issues do not respect national borders.
In effect, Covid-19 has created an ESG stress test for the global economy. As the world looks towards its post-pandemic future, the evidence appears compelling that ESG will form an integral part of the new normal ahead.
From an environmental perspective, the impact of Covid-19 globally shows the impact a natural disaster can have on economies. For now, governments are understandably prioritising social and economic considerations, but environmental risks cannot be ignored indefinitely.
The failure to address carbon emissions, for example, could cost between US$149 and US$791 trillion by the turn of the century, far exceeding losses expected from Covid-19 – estimated at over US$4 trillion in March 2020. Environmentally, the whole of civil society will face more flooding, more fire, more drought and famine – drastically changing human life as we know it.
The pandemic itself is expected to result in a drop in atmospheric carbon dioxide (CO2) of around 8% in 2020, according to the International Energy Agency – much greater than the slump seen in the global financial crisis. This, however, only buys a little more time on the current warming trajectory. If governments want to rebuild economies in a more sustainable way, bailouts of energy intensive sectors, such as oil and gas, autos, chemicals and airlines, should be conditional on them transitioning towards a lower-carbon future.
When it comes to the S in ESG, the long-running debate about the purpose of a corporation has been reinvigorated by Covid-19. Are they here solely to generate profit, pay tax and distribute the remainder to shareholders? Or should they pursue loftier goals, serving or even improving society?
Some firms are starting to lean towards the latter. In pharmaceuticals, for example, public and private resources have been pooled to try to find vaccine candidates, test them and bring them to market more quickly. Companies such as GlaxoSmithKline do not expect to profit from these collaborations, but instead feed any short-term gains back into research and treatment for some of the world’s poorest.
In finance, the crisis has given banks an opportunity to put their campaigns on corporate purpose and stakeholder capitalism to the test; going beyond merely supporting customers to promoting financial inclusion. Some have partnered with charities to provide tablets, training those without access to digital banking, and opening dedicated phone lines to support elderly customers.
Given these examples, Covid-19 will likely change how company behaviour is evaluated, with investors and consumers becoming much more vocal about companies that are perceived to be failing to take their social role seriously.
Governance issues – the G in ESG – have also been central to the crisis. How are companies treating their employees? What might the reputational and legal damages be for companies that fail to address the risks?
During the crisis, key workers on the front line have predominately been those in lower-paid roles. As we emerge from this, companies will need to reflect on how value is ascribed to an individual’s economic and social contributions and, in turn, how fair compensation is determined.
Some have already sought to respond through directors’ pay. Actions have ranged from those that have cancelled all forms of pay to those that have simply delayed salary increases and bonuses, but others have felt it appropriate to take no action at all.
Covid-19 has also shown there are material financial consequences for companies deemed to have fallen short in how they are being managed. For example, the Carnival Cruise Line was paying a low single-digit tax rate in the US, which precluded it from state aid and forced it to seek other more costly forms of finance.
This feeds into the wider debate about playing by the rules. Companies overseen by or associated with conspicuously successful people that have sought state aid have received uncomfortable negative attention, playing into wider conversations about inequality, how benefits are being distributed and whether society is structured to take everyone’s needs into account.
In a post-pandemic world, good governance will likely differentiate between companies that understand material risks and are taking appropriate steps to mitigate them, and those falling well short on both counts.
Until now, companies that are resistant to change or looking for an excuse have had Covid-19 to hide behind, but those with a more enlightened view will likely have heightened awareness of the social and financial costs associated with the systemic nature of ESG issues. Time will tell whether Covid-19 truly proves a watershed for ESG, but the evidence suggests it will.
Steve Waygood is chief responsible investment officer at Aviva Investors.