Navigating the ESG maze

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29-Aug-19

Tom Butler
CEO

Last week the Business Roundtable of almost 200 American CEOs (including the CEO of Freeport, one of ICMM’s members) re-wrote their definition of the purpose of a corporation, which since the 1990s has stated that corporations exist principally to serve their shareholders. In the new definition, shareholders no longer have primacy and are put on an equal footing with communities, workers, customers, and suppliers.

This is a significant signal, reflecting growing societal concerns about inequality, and an acknowledgement that some rebalancing of the capitalist model is needed in America if it is fairly to serve all elements of society. Their statement also reflects the growing importance to these CEOs of managing the environmental and social impacts of their businesses, with an explicit commitment to “respect the people in our communities and protect the environment by embracing sustainable practices across our businesses”.

Perhaps some of those CEOs had read an article published in the June 2019 Harvard Business Review (“Sustainability – the Investor Revolution”) in which the authors pointed out that although American firms estimated (when surveyed) that only 5% of their shareholders apply Environment, Social and Governance (ESG) criteria, the actual number in the US is 25%.  And in case a carrot is needed as well as a stick, the article also pointed out that based on a study carried out by Nordea Bank, between 2012 and 2015 firms with the best ESG rankings outperformed the worst by as much as 40% in financial terms. 

The percentage of investors applying ESG criteria in Europe is undoubtedly higher. Some European governments are even considering mandating that pension funds should formally assess ESG aspects for all their investments. Globally, the number of signatories to the UN-backed Principles for Responsible Investment (PRI) has multiplied more than tenfold over the last 12 years, to almost US$90 trillion under management as of their last annual report.

However, assessing compliance with ESG commitments, whether they have been made by investors or companies, is far from easy. For most companies, the process begins with a determination of which ESG issues are material to their particular business, and then many of the subjects treated, for example human rights, are hard to assess. The process can be very subjective, which is why companies engage third party assurers or auditors to scrutinise their self-assessments and disclosures.

As for investors, while they increasingly demand more transparency, detail and disclosure from companies, their own internal processes are often opaque, and their disclosure lacking. This matters because it undermines the desire of an increasing number of retail investors to support businesses with good ESG performance. The term ESG seems to have unfortunately become a marketing tool for some fund managers, some of whom seem to apply rather “light touch” due diligence. To give just one example, a major fund manager was caught out recently holding stocks in sectors incompatible with its ESG fund description.

An additional complication is that companies – and investors – are often unclear about whether ESG assessments should be used for risk management, or for assessing positive social impact. This matters because most institutional investors tend to focus on risk management, while retail investors often want to see positive social impact as well. The sustainability ratings agencies have traditionally focussed on risk management. ICMM’s members, and no doubt many other companies that face the numerous risks in more challenging countries, feel the rating agencies penalise their ESG scores for the inevitable controversies that can arise in such countries, without assigning any benefit for the positive social impacts they may have. To give just one example of what I mean by social impact, a mine in Africa typically generates 25 indirect jobs for every direct job in the mine, versus 3 to 5 in developed countries such as Australia. A number of organisations are trying to agree more consistent ways to measure social impact (see https://impactmanagementproject.com) but there is still a long way to go.

The drive to disclose ESG performance is largely a listed company phenomenon, and in that context the much reported shrinkage of the public capital markets is also a concern. This is significant because it is becoming easier for weak ESG performers to evade scrutiny by going private.  The shrinkage is mainly driven by the relative cheapness of debt, but as one leading investor said recently in the FT, “it is no coincidence that those markets shrinking fastest are the most accountable to shareholders”. He was not talking about ESG accountability specifically, but I suspect it is not a coincidence that a number of the most controversial companies and projects in mining have recently ended up in private hands, or listed on “lesser” exchanges.

This is not to say that all privately held companies are less accountable or have lower standards, but the values of the owning family or private equity firm come into play a lot more when there is less public scrutiny. Private equity firms are not known for their transparency, or for being subject to shareholder activism, at least not of the ESG sort. Forcing listed companies through shareholder activism to divest coal into private hands is unlikely to result in less coal production, and in fact probably offers economic rent to private equity firms.

In the context of mixed signals from investor groups about what constitutes good ESG performance, and the subjective and complex nature of ESG assessments, how should an industry group like ICMM respond? Last year, our members signed up to a comprehensive set of 38 granular commitments, which we are calling performance expectations. Implementation starts next year and will apply to all ICMM company members, who manage almost 650 assets in over 50 countries.

This will be the most far-reaching voluntary initiative to advance environmental and social performance in the mining industry. The performance expectations are grouped under ICMM’s 10 founding principles and establish comprehensive requirements on issues such as labour rights, resettlement, local content, gender, access to grievance mechanisms, biodiversity, mine closure, pollution and waste that will be validated at the asset level, including by independent third-parties, with the results publicly disclosed. This is very much the same direction of travel as the US Business Roundtable’s announcement. We hope this will bring some further clarity in the metals and mining sector as to what it means to “respect the people in our communities and protect the environment by embracing sustainable practices”, and to mine with principles.