🤿 Sunday Deep Dive: The ABC of ESG

Aug 28, 2022

It used to be easy to be a “good person.” Say please and thank you. Don’t break the law. Maybe help the occasional old lady across the street. Now we have to worry about how far our avocados have traveled to get to our toast, whether the farmers who grew the beans for our coffee were fairly compensated, and whether the tip we leave the server is dependent on any underlying prejudices. And that’s just breakfast. The standards are getting higher for businesses too.

Corporate accountability programs are not a new invention but there is a new kid on the block: Environmental Social Governance. ESG can be described as a way to measure whether a business is a “good person.” Blame globalization. Blame the internet. Blame millennials. Whatever the reason, it’s becoming more and more important for businesses to show that they are at least trying to up their ESG credentials.

What does the legal department have to do with it? You’re about to find out.

First, the basics

The idea behind ESG is that metrics for good (ethical, eco-friendly, fair) business practices are used alongside financial metrics to measure the value of a business. One lawyer talks about something they call the “grandma and media test.” When the business asks the legal department for advice, you should ask not only whether an action is within the law but whether you’d be happy to tell your grandma about it or have it visible on social media for years to come. That’s useful but kinda vague. Let’s get a bit more specific.

🌲 E is for environmental. If it keeps David Attenborough up at night or sets Greta Thunberg’s teeth on edge, it falls into this category. In practical terms, improving your E creds could mean reducing food waste in your office cafeteria, cutting down on business travel, or changing the way your products are packaged.

🤝 S is for social. This is where we (hopefully) show that we’ve improved a bit since the Dark Ages. Tackling the S could involve choosing suppliers that provide good working conditions for their workers, protecting your client's data, reporting on the gender pay gap, or making sure your delivery drivers are obeying the speed limit.

💼 G is for governance. Here we’re talking about what the suits get up to behind closed doors. Nepotistic hires, suitcases of money exchanged in hotel rooms, backstage passes to Michael Bublé gifted to regulators right before some allegations disappear. Well, not all governance matters are quite so juicy. G covers everything from board structure to ethics policies and anti-bribery and corruption measures.

Why is there a spotlight on these three areas? Well, there are a bunch of reasons but the scary reality of climate change and the flourishing of global activism following the murder of George Floyd definitely played a part.

The Boohoo boo-boo

One reason why legal should get involved with ESG is that it involves a lot of risk management (and we all know lawyers and risk go together like PB & J). Companies with bad ESG risk serious reputational damage that can translate to revenue loss. Those risks come from four main sources.

Regulators

Take Boohoo for example. In 2020, the UK-based fashion retailer was found to be associated with factories that used slave labor (“boo-boo” is a major understatement here). Overnight, their share price crashed by 20%. Now they're facing a ban on imports to the US, which may affect over a fifth of their revenue.

Laws that deal with hiring practices, bribery, and other ESG areas have been around for ages but regulation in this area is climbing across the globe.

Examples include:

California’s Climate Corporate Accountability Act
The SEC’s proposed climate disclosure rules
The EU Taxonomy (also a climate disclosure rule)
Germany’s Supply Chain Due Diligence Act which requires companies to root out human rights abuses in their supply chain.

Potential Investors

VCs have hopped on the ESG train too. Last year Uber Eats competitor Deliveroo had “one of the most disastrous IPOs in memory” (ouch!) after investors noted that its employees are “treated as disposable assets.” Some private equity companies, such as BlackRock, insist that their portfolio companies have ESG creds. The UN Principles for Responsible Investment has 7000 corporate signatories in 135 countries. Number one of its six core principles states: “We will incorporate ESG issues into investment analysis and decision-making processes.” In other words, if you’re failing the grandma test, good luck raising capital.

Existing Shareholders

The number of shareholder activist campaigns with ESG objectives doubled between 2016 and 2021. Take the shenanigans at ExxonMobil for example. In 2020, a hedge fund called Engine No 1 bought 0.02% of the company and launched a campaign to change the company’s approach to the climate. After winning over larger shareholders, they ended up with several seats on the board and a mandate to set sail for a greener destination. Similarly, shareholders booted the CEO of Rio Tinto after the mining company damaged a site of Australian aboriginal cultural significance. Shareholders care about ESG and they will rock the boat if the company is off course.

Client, consumers, and employees

An ESG PR disaster is the business equivalent of that nightmare where you realize you’re at work with no clothes on. When the public learns of dodgy dealings or planet plundering, it can lead to lost clients, consumer boycotts, social media scandals, employee walkouts, and lawsuits. On the other hand, good ESG creds can help you attract and retain employees, make employees feel more fulfilled at work, and create a loyal consumer base.

Think about:

Netflix’s commitment to share stories about Black and LGBTQ+ characters
Ben & Jerry’s social justice-themed ice cream flavors (Change the Whirled, anyone?)
Mercedes Benz’s decision to stop launching gas and diesel vehicle models by 2025
Airbnb’s offer of free temporary housing for up to 100k Ukrainian refugees

Compare that to:

United Airlines’ violent removal of a passenger from a flight
VW cheating on emissions tests
Purdue Pharma’s role in the opioid crisis
McKinsey’s corrupt contract in South Africa
And Facebook’s use of data (76% of Americans think Facebook is making society worse.)

Suffice to say, ESG is about so much more than warm, fuzzy feelings. It’s about who a company is. And the consequences are concrete. But don’t take our word for it. Larry Fink, CEO of BlackRock, recently wrote, “We focus on sustainability not because we’re environmentalists but because we are capitalists and fiduciaries to our clients.” And according to the experts at McKinsey, better ESG scores correlate with a 10% lower cost of capital because of lower regulatory, environmental, and litigation risks. They should’ve taken their own advice.

How to get started

At Lawtrades, we’re all in favor of taking ambitious steps to make the world a better place. But how the heck do you get started? For those of you at companies that are yet to jump on the ESG bandwagon – or are still in the early stages of that journey – here’s our five-step guide to building an ESG strategy.

1. Get together.

Find the people who are interested in getting involved and start a conversation. It might be someone on the board, one of the founders, or a project manager in another department. These things have a way of stagnating if no one takes ownership so seeking out some enthusiasm is a great first step. If you can get someone in the leadership team excited, all the better.

2. Decide on a vision.

Are you in this just to mitigate risk and tick the boxes? Or do you want to make a real difference? Do you want to future-proof the company or be reactive? Is there a specific area where your company is having a negative impact that you’d like to change? How ambitious do you want to be?

In an ideal world, this should be a long-term vision that the company adopts across all departments and at the highest level. If you don’t have that kind of influence, start small and focus on what’s realistic – even if it’s just those annoying sensor lights you have to wave at if you’re still for too long.

3. Evaluate.

This is where things get really tricky. Before you try to cut your emissions or push for diversity, you need to evaluate how you’re doing now in a quantifiable way. For the environmental category, that means measuring scope 1, 2, and 3 greenhouse gas emissions.

Scope 1 and 2 emissions are those that come directly and indirectly from the company – like emissions from its factories or from turning on the lights at the office.

Scope 3 emissions are those created by people up and down the supplier chain. It’s how people dispose of the batteries in your products and how your suppliers’ suppliers commute to work. These are super tough to measure and really important. It’s estimated that the average company’s total emissions are 5.5x higher than just their scope 1 and 2.

If a professional ESG auditing service is out of your company’s/department’s budget (sigh), start by putting in place procedures for gathering more easily accessible data such as the average salary for employees of different races. You could also gather information by talking to members of your team about how they experience working for the company or set up a Google Form where staff can submit details about how they commute.

4. Set targets.

Set measurable short and long-term targets. Don’t be scared to be ambitious. BP has plans to get to net zero by 2050 – and they’re an actual oil company. If you don’t have the buy-in for something on that scale, start with low-hanging fruit. Projects like cutting down on printing or electricity use have an associated cost-saving which makes them easier to motivate for. Get your team involved in brainstorming so you have buy-in from the get-go.

Figure out your strategy for reaching those targets and who is going to do what. This is where someone with project management skills (ahem, legal ops) will come in handy. Make sure you have a way to monitor how things are going.

5. Be Honest.

Get with the times! Let your employees, shareholders, consumers, and even the public know how things are going. Being transparent about your ESG failings shows a willingness to change. Plus, reporting on carbon emissions is fast becoming de rigueur. Check out how Slack and Salesforce report on their diversity progress here and here, or take a look at the global Reporting Initiative.

The role of legal

ESG and legal happen to make quite the fitting match. Not only is ESG a risk-mitigation tool, but it’s also an opportunity for the legal department to embed itself into the core operations of the business, collaborate with other departments, play a role in establishing the identity of the business, and add even more value (go legal!).

Here are just some of the ways that legal can take ownership of ESG:

Risk mapping: Do a full assessment of the ways that your company is vulnerable to ESG-related risks so you can nip them in the bud.

Due diligence: Incorporate ESG into your due diligence when you’re checking out possible new vendors and partners.
Contracts: Write contracts that hold your supply chain accountable to your ESG goals. The Chancery Lane Project has loads of templates of climate-aligned clauses for your use.
Upskill: Educate yourself about ESG. Christine Uri, who is the GC and Chief Sustainability Officer at Engie Impact, writes regular helpful content on LinkedIn with the hashtag #sustainablecounsel. You could take time to read a book about anti-racism, or gender bias.
Join the dots: Legal deals with every department so you’re well placed to act as a liaison. Use that power to connect every part of the business to the overall ESG goals.
Liaise with industry: ESG is still a kinda vague space without standardized expectations of how far companies should go. Engage with other companies in your industry and with others in the legal field to stay on top of ESG best-practice. B Corp certification is one attempt at standardization that’s worth looking into. You can also read sustainability and diversity reports from other companies to see what they’re up to.

Liaise with the board: In order for an ESG strategy to really succeed, it needs to be on meeting agendas. There need to be people (or even a dedicated committee) on the leadership team who are invested in the goals. Some companies even link executive compensation to ESG metrics.

Write living breathing policies: Do what you can to make sure ESG policies written for the company aren’t a load of legalese that rots away in a drawer. Create a readable summary or even a video. Distribute them to staff. And put them somewhere easily accessible.
Practice what you preach: You can apply ESG principles to the everyday running of the legal department. That could mean remembering to wish a colleague of a different faith happy holidays or choosing meat-free catering for a department event.

It all comes out in the (green)wash

Going green can help you bring in the “green.” But doesn’t that set up some perverse motives? Mark McAteer writes in The In House Lawyer, “Excuse me for sounding a little jaded. It’s just that we’ve been here before with the three little letters: CSR [corporate social responsibility]. At first, that was all about good intentions … but it soon descended into a cynical PR exercise.” There’s certainly good reason to be skeptical. One study found that fund managers who signed the United National Principles for Responsible Investment attracted an influx of investment as a result but did not follow through on their commitment to ESG.

There’s also a risk that companies are tempted to overstate their ESG credentials. Pretending to be greener than you really are is called greenwashing and it’s a really bad idea. The Securities and Exchange Commission has a newly formed ESG Task Force which is prioritizing investigations into false ESG claims. The Federal Trade Commission also has its nose to the ground. In April, it hit Walmart with a $3m penalty over false claims that some textile products were made from bamboo. And in July, German police raided the offices of Deutsche Bank over accusations that it exaggerated the ESG creds of its investment portfolio.
It’s also worth mentioning that not everyone thinks ESG is a good strategy for making the world a better place, even if companies don’t cheat. Tariq Fancy, an ex-BlackRock investor turned outspoken anti-ESG commentator, calls ESG “a dangerous placebo that harms the public interest.” His arguments are lengthy but the core idea is something like “Nice idea. Doesn’t work.”

While we’re being negative, sticking to good intentions is only likely to get harder. Part of the downfall of CSR was the global financial crisis. It’s tough to think about the larger community when you’re struggling to survive. And let’s be honest. Surging oil prices and high-interest rates aren’t helping the case for current ESG funds.

Being a good person is not always easy (sometimes you’ve gotta put your chair all the way back on a flight even if the guy behind you is an NBA shoo-in). Neither is a large-scale rejigging of your supply chain or a sustainability-focused product overhaul. But sometimes the toughest things are the best things for the business. Legal gets that. Legal departments can think long term, anticipate risk, and take note of all the stakeholders – even when stocks are tumbling. They’re well placed to take on the role of moral compass.

The ESG trend may or may not last. But doing the right thing never gets old.

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