by Steve Waygood, chief responsible investment officer, Rick Stathers, senior ESG analyst and climate specialist, Mirza Baig, global head of governance all at Aviva Investors
The outbreak of a global pandemic raises many profound questions. It is impossible to look at the global health crisis and its knock-on effects, without considering environmental, social and governance (ESG) factors.
It is not possible to answer the myriad of environmental, social and governance questions that arise from COVID-19 while the debates are in their infancy. In the meantime, however, we look at whether COVID-19 will accelerate or decelerate progress and focus on ESG’s constituent parts.
Environment: Still the largest elephant in the room
Before COVID-19, the European Insurance and Occupational Pensions Authority (EIOPA) already had ESG in its sights – a way to ‘operationalise’ sustainability.[i] The pandemic has intensified the scrutiny.
“What COVID-19 shows is how a health and environmental issue can become a profound social problem, causing material governance challenges for companies and countries alike,” says Steve Waygood, chief responsible investment officer at Aviva Investors. “It shows how such challenges do not respect national borders. It’s an ESG stress-test for the global economy.”
COVID-19’s origins are fiercely debated; it’s one of a growing cluster of zoonotic diseases (conditions passed from animals to people) that have resulted from humans coming into close contact with other forms of life.
“The relentless incursion of human systems into the remaining natural world is forcing wild animals into ever closer contact with us, and hence us into contact with the viruses and diseases these animals may carry,” explains Rick Stathers, senior ESG analyst and climate specialist at Aviva Investors. “But with only 23% of the world’s land mass remaining as wilderness, and only 5% of animal biomass being wild (95% is humans or domesticated animals), these species increasingly have nowhere left to run.”
In the first phase of the COVID-19 response, few governments have grasped the opportunity to pivot towards a greener recovery immediately. The initial wave has included support for carbon-intensive sectors. “Governments need to ensure that we build back better from this crisis,” says Waygood. “For example, bailouts of energy intensive sectors such as oil and gas, autos, chemicals and airlines should be conditional on assurances of a commitment to transition towards a lower carbon future.”
Having fallen down the list of priorities for policymakers and companies for now, the question is whether decision-makers will prioritise sustainable initiatives as economies move into the recovery phase.
Social: Inching towards more inclusive capitalism
When it comes to social considerations, the long-running debate about the purpose of a corporation has been reinvigorated by COVID-19. What are companies for? Are they here solely to generate profit, pay tax then distribute the remainder to shareholders, as Milton Friedman famously suggested?[ii] Or should they pursue loftier goals, serving or even improving society?
During the crisis, collaboration has been the name of the game. In pharmaceuticals, public and private resources have been pooled to try to find vaccine candidates, test them and bring them to market more quickly. Notable corporate announcements include one from GlaxoSmithKline’s Chief Executive Emma Warmsley, among the FTSE 100’s top paid female leads, that the company ‘does not expect to profit’ from a range of collaborations during the pandemic.[iii] The plan is to feed any short-term gains back into research and treatment for some of the world’s poorest.
Ultimately, moves like this might result in commercial pharma separating activities of high social but low commercial return from their broader business. “At the moment, commercial and non-commercial parts are all mixed together in a single entity,” says Mirza Baig, global head of governance at Aviva Investors. “The current aggregated approach means that low returning units act as a drag on group margins and ultimately valuations.”
The debate over the contribution of banks, who can play a vital public service role by keeping liquidity flowing and businesses solvent, is also complex. This time, regulators in the UK and Europe have sought to freeze dividends and share buybacks to shore up capital. (The same is not the case in the US.) While such measures enhance banks’ ability to underpin the financial system, they have widespread implications for pension funds and other long-term income seekers. Pausing the flow (€45 billion of 2019 dividends not-yet-paid from European banks[iv]) will be painful for some.
Before COVID-19, several banks had already launched campaigns and strategies based around corporate purpose and stakeholder capitalism. In short, one consequence of COVID-19 is that the ‘s’ in ESG is finally getting the attention it deserves.
Governance: Managing through the crisis
In the eye of the storm, governance issues are central. How are companies treating their employees? If airlines carry someone infected with COVID-19, how much risk should cleaning staff reasonably be expected to take?[v] What responsibilities do food processors have for their packers[vi] or fulfilment companies have for their stock pickers?[vii] And what might the reputational and legal damages be for companies that fail to address the risks? Industrial action has already highlighted the pressure points, with US food and healthcare workers leaving their posts or joining ‘safe distance’ picket lines.[viii]
“The key workers who are out on the front line, effectively keeping the lights on, are predominately fulfilling relatively lower paid roles,” Baig says. “Hopefully, coming out of the COVID crisis, there will be a period of reflection over how we ascribe value to an individual’s economic and social contributions, and in turn how we determine fair compensation.”
A look at the top of the corporate hierarchy shows some marked divergence in the response reflected in directors’ pay. “In the FTSE 100, for example, the actions range from those that have cancelled all forms of pay (no salary, no bonus, no share awards), to those that have simply delayed salary increases and bonuses, while others felt it appropriate to take no action at all,” adds Baig.
“We are looking at mapping that against companies that have furloughed staff, companies that have cancelled dividends and companies that have sought state aid. When all those dynamics play out, shareholders will start forming a view on who were the responsible players during this crisis, and who were not.”
Significantly, there have been material financial consequences for companies deemed to have fallen short in how they are being managed, including how they address tax issues. For example, the recognition that the Carnival cruise line was paying a low single digit rate in the US precluded it from state aid, forcing it to seek other more costly forms of finance.[ix]
Companies overseen by or associated with conspicuously successful people that have sought state aid have received uncomfortable negative attention.[x] This plays into wider conversations about inequality, how benefits are being distributed and whether society is structured to take everyone’s needs into account.
What does that mean for anyone looking for corporate winners? Essentially, what COVID-19 has done is highlight the importance of good governance. It has differentiated between those companies that understand material risks and are taking appropriate steps to mitigate them, with those falling well short on both counts.
A watershed moment?
Time will tell whether COVID-19 proves a watershed for ESG. On the evidence of what we have seen so far, the answer would seem to be a qualified ‘yes’. Crisis conditions have boosted the importance placed on ESG metrics and served as a powerful illustration of why a holistic approach to investment risk matters.
“Those that are resistant to change or looking for an excuse have COVID-19 to hide behind,” Baig believes. “But those with a more enlightened view will likely have heightened awareness of the social and financial costs associated with the systemic nature of the ‘e’ and ‘s’ issues that need to be addressed. Of course, there will be competing interests in the near term. But over a longer horizon, we expect this experience to galvanise people’s commitment to dealing with them.”
[i] Bridget MacDonnell, ‘EIOPA proposes changes to Solvency II and the IDD on climate change and sustainability for life and non-life insurers’, The Business of Risk. February 11, 2019. https://www.thebusinessofrisk.com/?p=4348#sthash.Co3VhgC8.dpbs
[iii] Martin Vander Weyer, ‘Will GSK show us what ‘purpose before profit’ really means?’, The Spectator, April 25, 2020. https://www.spectator.co.uk/article/will-gsk-show-us-what-purpose-before-profit-really-means
[iv] Margot Patrick, ‘Europe’s banks urged to cut dividends to shore up capital’, Wall Street Journal, March 31, 2020. https://www.wsj.com/articles/europes-banks-urged-to-cut-dividends-to-shore-up-capital-11585665244
[v] Angus Whitley, ‘Qantas passengers face virus risk as inadequate cleaning exposed’, Bloomberg, March 5, 2020. https://www.bloomberg.com/news/articles/2020-03-05/qantas-inadequate-cleaning-may-have-exposed-travelers-to-virus
[vi] John Johnson, ‘What the FDA requires for food safety during the COVID-19 pandemic’, JD Supra, April 20, 2020. https://www.jdsupra.com/legalnews/food-beverage-litigation-update-april-19409/
[viii] Robert Combs, ‘Covid-19 has workers striking. Where are the unions?’, Bloomberg Law, April 14, 2020. https://news.bloomberglaw.com/bloomberg-law-analysis/analysis-covid-19-has-workers-striking-where-are-the-unions
[ix] Joshua Franklin, ‘Cruise operator Carnival pays high price to get credit investors on board’, Reuters, April 2, 2020. https://www.reuters.com/article/us-health-coronavirus-carnival/cruise-operator-carnival-pays-high-price-to-get-credit-investors-on-board-idUSKBN21K07H
[x] Rupert Neate, ‘Richard Branson facing backlash over plea for UK bailout of Virgin’, The Guardian, April 12, 2020. https://www.theguardian.com/business/2020/apr/12/richard-branson-facing-backlash-over-plea-for-uk-bailout-of-virgin
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