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​What COVID-19 Teaches Us About ESG's Importance

Understanding the connection between the two may be key to corporate resilience.

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They say that even a kick in the rear is a step forward, and COVID-19 has delivered one mighty kick to corporate posteriors around the world. Now one question is whether boards will lurch forward — on, of all things, environmental, social, and governance (ESG) issues.

The ties between COVID-19 and ESG performance are more direct than one might assume. The virus has forced organizations to consider a host of specific questions, but the deeper, existential questions boards face are two: How can we preserve sustainable operations amid unpredictable circumstances? And, how can we hold all our stakeholders together and continue to create value?

Well, ESG issues ask those same questions. So boards that have considered how to fit ESG into corporate governance may be better prepared for the crisis.

“It’s absolutely an accelerator, what’s happening right now,” says Daniela O’Leary-Gill, who sits on the board of the Museum of Science and Industry in Chicago, as well as the board of BMO U.S. Funds, a mutual fund run by BMO Financial. O'Leary-Gill views COVID-19 as a test of corporate resiliency. Strong ESG governance fosters resiliency by driving the company to focus on issues such as sustainable supply chains, trust in the organization, and reliable governance that transcend any specific CEO or board directors.

That resiliency can then prove invaluable during extreme risk events. O’Leary-Gill says organizations ignore the connection between ESG and resilience at their peril. “The current situation is a lesson in priorities,” she says. “Organizations are well-served to put ESG on the ongoing agenda versus an occasional discussion. That kind of preparedness provides greater resiliency to the company’s operations.”

ESG AND SOCIAL JUSTICE

COVID-19 isn’t the only urgent concern for boards these days. This spring also saw throngs of people take to the streets in the U.S. and around the world, protesting systemic racism and social injustice.

It’s another example of how attention to ESG issues can better position a company for swift, unexpected disruption. “It’s a double whammy of ESG issues corporations should pay attention to,” Bonime-Blanc says.

Since the protests erupted in late May, organizations have rushed to support the Black Lives Matter movement or — as happened with the CrossFit fitness company — to part ways with chief executives who inflame the situation with racist comments.

The Black Lives Matter protests do raise a challenging point. Social questions — the “S” in ESG — are the most fraught issues to address, with substantial reputational risk. At the same time, they have the least guidance about what boards should do. (Compared to environmental regulations, for example.) “The spotlight will be on the S,” O’Leary-Gill says. “Not to take away from the importance of E or the G … but I think the S is the part that is least prescribed, and the least standardized across companies.”

So how can companies systematically measure corporate culture, or equity in the workforce? “That’s where the focus needs to be,” O’Leary-Gill says.

The Relevance of ESG

It might seem strange to talk up ESG these days, given the economic calamity and operational crisis all around us. When you examine the component parts of ESG, the relevance of those issues to the COVID-19 crisis becomes clear. Consider:

  • Environment. One pillar of good environmental stewardship is using as few natural resources as possible, and generating as little waste as possible. That implies an efficiency of operations that’s welcome in a cost-sensitive environment. It’s also a nice hook to woo environmentally conscious consumers.
  • Social. This can include everything from workplace safety, to paid sick leave, to workforce development. Regulators are already watching companies’ commitment to safe work environments in the time of COVID-19. Sick leave, worker training, and similar policies about human capital also can prove valuable to help companies keep employee sentiment on their side.
  • Governance. This principle encompasses the board’s oversight of corporate conduct, shareholder rights, executive succession, and similar issues. First, the risk of corporate misconduct rises during difficult times, so a board skilled at risk management will do a better job policing against that threat. Second, a rigorous board, committed to good governance, is likely to stay on the right side of investors and root out organizational shortcomings more quickly.

More broadly, boards should pay attention to ESG because investors, employees, business partners, and other stakeholder groups still consider ESG important — especially now as COVID-19 and the ensuing recession drive people to question what role companies should play in society.

Investment dollars, for example, are still gushing into ESG funds. According to Morningstar, ESG investment funds worldwide saw inflows of $45.7 billion in the first quarter of this year, while the broader investment world saw net outflows of $384.5 billion. Exchange-traded funds had been briskly marching toward all-time highs in 2020 until early March, when they tumbled by 30% or more. Now the largest of those funds is already flirting with its all-time high again.

“The shareholders are going to be better off because of this,” says Andrea Bonime-Blanc, a former board director of the Ethics and Compliance Officers Association and a current director for the National Association of Corporate Directors, New Jersey Chapter. “Maybe you can’t measure it quarter to quarter, but over the long term, you definitely can measure the progress.”

She, like O’Leary-Gill, stresses resilience. “To me, the best argument isn’t that the regulators are coming,” she says. “The best argument is that you are building organizational resilience that allows you to survive and thrive in good times and bad.”

Putting It Into Practice

Boards that want to leverage ESG issues for long-term resiliency need to start with a direct question: Is the necessary experience in the boardroom? "To meet this crisis, boards should have more people who are not chief financial officers or CEOs,” Bonime-Blanc says, “but chief risk officers, chief ethics and compliance officers, and chief corporate responsibility officers.”

Likewise, O’Leary-Gill asks, what is the fluency on the board in ESG issues generally, as well as the specific ESG issues that might be most relevant to each board’s organization? That is, manufacturing companies might need more expertise in environmental sustainability. Software companies, in contrast, might want expertise in workforce diversity and pay equity.

From there, the work might start to sound familiar. Boards must decide which ESG issues are most important to their stakeholders, which key performance indicators (KPIs) match those issues, and what sustainability frameworks could help the organization steer those KPIs in the right direction.

This is where a strong audit function can assist. Frameworks need to be reviewed; metrics need to be developed and translated into policies, procedures, and internal controls — which will then need to be tested.

How well will all that effort pay off, with a vibrant organization that can weather difficult times? That’s hard to say.

Then again, COVID-19 is only the crisis of the moment. Boards also need to consider climate change, social inequity, and other crises after that. Resiliency will be crucial to all.

Matt Kelly
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About the Author

 

 

Matt KellyMatt Kelly<p>​Matt Kelly is editor and CEO of RadicalCompliance.com, an independent blog about audit, compliance, and risk management issues, based in Boston. ​</p>https://iaonline.theiia.org/authors/Pages/Matt-Kelly.aspx

 

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