The 'S' in ESG and what it truly means for corporate sustainability
The social pillar in ESG is critical because it both reflects the 'how and why' of a company, and social movements are the only real way to create the positive and lasting change the planet needs
Environmental, social and governance (ESG) frameworks are based on the principle that these three factors are critical to a more holistic approach to corporate financial performance. So when companies use ESG, it means they are using these factors – environmental, social and governance – to evaluate how advanced they are with sustainability. The ESG framework can also assess the performance of countries and investments more generally.
Research shows solid ESG practices by companies result in better operational performance. So it comes as no surprise that more companies would want to practice ESG reporting or that more people would want to invest in ESG-minded companies, which is precisely what’s happening today. Recent reports show the total assets overseen by ethical investment funds on behalf of Australian investors increased 30 per cent in 2020, worth $1.28 trillion, and account for 40 cents of every professionally managed dollar. Other reports show ESG gaining widespread attention among investors of all age groups.
“ESG is now common parlance across all sectors of the economy (current ESG assets under management total $37.8 trillion and are projected to hit $53 trillion in 2025)," says Luke Riboldi, Program Manager at Australian Ethical Investment, and a current MBA student at UNSW Business School. "Without a doubt, the environmental movement has stolen the headlines with the rise of climate action support, Greta Thunberg, the IPCC’s 6th Assessment Report (August 2021) and the upcoming COP26 in October to be held in Glasgow,” he says.
But incorporating ESG into investment decisions is not to be confused with ethical investing per se, says Mr Riboldi. “Ethical investing takes a values-based approach to capital allocation and goes beyond traditional ESG considerations by applying certain principles towards investments,” he says. But perhaps there is another critical distinction to make. Alongside the environmental and corporate governance factors lies the social component of ESG, explains Mr Riboldi, and the ‘S’ is the lesser-known of the three (for now).
Unpacking the ‘S’ in ESG
“There is so much more to the social side of ESG than we dare [or care] to realise, and it’s likely to be the next big thing," says Mr Riboldi.
"You might know it in the form of diversity and inclusion (gender, race, religion, geography, age, sexual preference and other identity markers)," he explains. “But it also includes the supply chains we participate in, the people we employ, how staff are treated, and the conditions organisations create to bring out their human best (including those employee surveys you complete)."
In practice, he says the social element can be measured by the increased production of corporate Sustainability Reports. For example, Australian Ethical’s Sustainability Report highlights metrics beyond employee engagement scores and gender diversity to include advocacy work, capital funding towards social initiatives (grants and foundation) and alignment with the UN Sustainable Development Goals (SDGs).
But this is not without challenges and limitations. “The industry continues to grapple with impact measurement for what will always be invaluable such as the lives freed from modern slavery or liberating minority groups and providing level playing fields for all citizens,” says Mr Riboldi.
“Social is about health and safety in the workplace and beyond that, helping our staff adapt and evolve to a dynamic environment and new technologies such as remote working. It’s about the attitudes our governments and we have towards the indigenous people of the land we inhabit yet rarely think of,” he adds.
While the social element is essential to ESG, the interdependency between all three factors, environment, social and governance, cannot be understated. “It’s the delivery and foundation of strong social movements that have supported and contributed to the success of shifting the climate discussion towards positive action," he says.
What are some examples of the social factors in ESG?
Sybil Dixon, Governance & Sustainability Manager at UniSuper, says the social component of ESG is made up of four categories:
- Staff: diversity, retention, training.
- Safety: managing safe workplaces, measurement, tracking – both of employees, but also of customers.
- Supply chain: modern slavery assessments, occupational health and safety management of suppliers, fair pay.
- Community: managing relationships with the communities that the company operates in, including human rights and traditional landowners/First nations, keeping work practices aligned with evolving community standards.
But the exposure to these risks varies from sector to sector, she explains. “For example, worker and community safety is an area where we have a very low tolerance for failure. For companies that face higher risks – for example, in our timber plantations, we have appointed directors to apply a more robust approach to OHS management.” On the other hand, she says modern slavery requires a more systematic approach, which is supported with legislation and requires all companies to consider its supply chain and areas of potential risk.
Governance, she says, is the most crucial factor in ESG, as it amplifies or detracts from the approach to the environmental and social aspects. “For example, poor governance structures can incentivise misreporting of 'bad information', whether that is not reporting safety breaches due to concerns about missing bonuses, or prioritising sales growth over appropriate consideration of serviceability (as was seen in the Banking Royal Commission),” she says.
But you can never really have one factor without the other. The social factor, she says, is critical for all companies as it reflects in the “how and why we do things the way we do”. Ms Dixon also says the more recent focus on the environment reflects the critical challenge facing the world and that all companies have a role to play, to varying degrees, and a social responsibility to take action in any way they can.
The intersectionality of social with environmental and governance
The social component of ESG looks at all elements of business strategy and organisational architecture related to people. This brings us to a crucial point: humans can no longer ignore the urgency of the climate crisis, and this has brought the ‘E’ to the forefront of ESG for most organisations, says Michele Roberts, Associate Professor and the Academic Director of AGSM at UNSW Business School.
“It feels at times as though the S and G are taking a back seat right now,” she explains, citing research from Australian Ethical and Investment Trends earlier this year found that 71 per cent of ESG investors intend to invest in environmental factors in the next 12 months, compared to 26 per cent who intend to invest in social issues.
“But it’s really much more complicated than this because the E, S and G are intersectional – it is impossible to separate the social from environmental and governance issues,” she says. “What I mean here is that people and organisations are deeply concerned about the environment right now and much of this concern is driven by concerns about the social impacts of the climate emergency. The world’s poorest workers, who live in the world’s poorest countries, will bear the worst effects of climate change and they are least able to invest in prevention and preparedness solutions to protect against these effects.”
Climate change requires a paradigm shift from corporates on ESG
The effects of global warming are truly ‘global’; burning fossil fuels in one part of the world is felt by all those sharing the same atmosphere, explains A/Prof. Roberts. And these effects aren’t just impacting the environment; they are impacting people. Even in Australia, there are already immediate social issues at stake in the climate crisis. So the 'S' in ESG can no longer take a back seat to the 'E' as they are inextricably related.
“We have rural mining towns in regional communities of Australia who are highly dependent on coal and LNG and could be disproportionately impacted by the global shift away from fossil fuels as action is taken to meet the emissions reduction targets agreed to under the Paris Agreement. These communities need support as we transition to clean energy,” explains A/Prof. Roberts.
So what can companies do? "Our most sustainable organisations have now aligned their strategy to the UN SDGs, and this leads them to consider a much wider range of social factors, including equal opportunities and pay; health and safety issues and good health and wellbeing for employees and customers; quality education; sustainable communities and elimination of poverty.
"These factors are critical enablers of ESG – without good health and education and decent working conditions, the people working for our corporations and nations simply cannot perform at their best," she says. "The most successful leaders, like Mike Cannon-Brooks and Andrew Forrest, understand that their employees and customers want them to take a stand on environmental issues and social issues like modern slavery. They are demonstrating that these issues have a role to play in value creation and competitive advantage."
Michele Roberts is an Associate Professor and the Academic Director of AGSM at UNSW Business School. She is also the Business School’s Faculty Representative on the UNSW Sustainable Development Goals Steering Committee, and a member of the Digital Sustainability Research Hub, where she investigates how digital technologies can help organisations to become more sustainable, transition their business models and develop a sustainable strategy. Luke Riboldi is a Program Manager at Australian Ethical Investment who is currently studying an MBA at the Australian Graduate School of Management (AGSM) at UNSW Business School.