Why ESG is Key to Reputational Risk Management & Long-Term Sustainability: Q&A with the World Bank’s Climate Investment Funds

Environmental, Social and Governance (ESG) principles have been a central theme of the last two years of the World Economic Forum's annual meetings at Davos in Switzerland. Employees, customers, regulators,  investors and NGOs increasingly expect companies to have a positive impact on society - from addressing environmental and social justice issues to implementing risk-aligned due diligence to demonstrate a commitment to compliance.

Companies that focus on ESG in their business operations and investments can expect to see the following benefits:

• A more positive reputation, and an ability to spot reputational risks early.
• Better preparedness for regulatory compliance, because companies that carry out due diligence on the ESG record of third parties are more likely to spot other misconduct such as bribery and corruption.
• Resilience because ESG can promote more sustainable growth.
• Potential for accelerated future growth because surveys show that younger people prioritize ESG considerations.

2020: The year of ESG

In the last year, ESG has gone from being the ‘next big thing' to the ‘big thing’. ESG investment hit record levels during the pandemic. For example:

• $51.1 billion of new money was invested into ESG funds in the United States in 2020, according to Morningstar. This is more than double the previous year and represents a quarter of all investments into US stock and mutual funds last year.
• 505 new ESG funds were launched in Europe and 253 funds changed their strategy and investment profile towards sustainability in 2020, according to the Financial Times.
• ESG’s rise is expected to continue in 2021, with a recent report by Moody’s ratings agency forecasting “strong returns” and “growth among asset managers with a stronger emphasis in ESG products”.

"The experience of 2020 will help remove investors' worry that ESG investing means giving up returns, which has been a widespread barrier to growth in ESG products," said Stephen Tu, vice president and senior credit officer at Moody’s.

Reputation risk driving ESG

A primary driver of the rise of ESG is that companies have realized the importance of reputation, and the need to mitigate reputational risk. Companies are regularly praised—or criticized—for their ESG track record in newspapers around the world. For example:

• UK media outlets including The Independent and City AM have been covering a campaign against UK bank Barclays over its lending to fracking, coal power and tar sands companies.
• Japanese automotive firm Mitsubishi has faced global media scrutiny, including from Nikkei Asia, after youth climate activist leader Greta Thunberg criticized their investment in a coal plant project.

The world's most influential newspapers, including the Financial Times, regularly cover criticisms of the 'gig economy’ in which major firms choose to classify workers as ‘self-employed’

Adverse media monitoring supports ESG assessments

Failure to heed the rise of ESG is a clear reputational risk for companies, but it also carries financial, strategic and legal risks. Companies should therefore ensure they are making a positive impact on ESG issues and demand the same of their third parties and suppliers.

But how can you tell if a third party - or an investment prospect - is genuinely committed to ESG? Some of the best ways to monitor companies’ ESG credentials are:

• Screen all prospective and current third parties against global media sources. Media articles do not only demonstrate a company’s reputation, but they are often the first place where suspicions or accusations of ESG failings will surface. In addition to conducting initial due diligence, organizations can implement ongoing risk monitoring across PESTLE categories to improve awareness to emerging red flags..
• Use an adverse media feed to power predictive analytics or integrate into risk management tools to gain valuable insights into potential regulatory, reputational, financial, and strategic risks facing companies. If a firm has been criticised for its labour practices in a particular country, for example, this might call its ESG commitment into question.
• Review Critical Mention broadcast content to capture the full context of a company’s position on ESG issues. While a newspaper headline might cherry-pick a single quote from a CEO, a transcript of the full interview may help establish the extent of a company’s ethical commitment.

Q&A: The future of ESG

Mafalda Duarte is Head of the $8.3 billion Climate Investment Funds (CIF), which is housed in the World Bank. CIF invests in initiatives to counter climate change in low and middle-income countries. We interviewed her about ESG during this year's Davos Agenda:

ESG was one of the main themes of the Davos Agenda. What have you observed?

“ESG and ESG investment is undoubtedly a major trend. Sustainable funds outperformed the market in 2020—the two US equity funds with the strongest returns in 2020, which have tripled in value since the start of the pandemic, are both invested in clean energy. All the signs suggest this trend will continue to accelerate in 2021 and beyond. Indeed, BloombergNEF predicts that half a trillion dollars will be invested in the transition to renewable energy this year.”

What trends should companies be aware of?

“An important and exciting trend is that the next generation cares deeply about the environment and climate change. Not only do they care, but they expect and demand that governments and CEOs take action against climate change. I attend conferences all over the world where I meet young leaders and I can assure you that Greta Thunberg and the Sunrise Movement are no exceptions.

Some companies might say, why does this matter for my bottom line? But don’t forget, today’s youth are tomorrow’s politicians, regulators, investors, employees and consumers. More than any previous generation, this one wants to work for, invest in and buy from companies that make a positive impact on the world around them. If companies fail to align with the climate goals, they will be ignored and rejected by the next generation. Inevitably, they will go bankrupt.”

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