Businesses face contradictory environmental and social pressures. Solutions demand patient, iterative engagement with stakeholders.
At the World Economic Forum in Davos in May 2022, the US Climate Envoy John Kerry urged the gathered business leaders not to let short-term concerns sparked by Russia’s invasion of Ukraine derail their commitments to long-term environmental goals. While many countries – particularly in Europe – are deeply worried by rising energy prices, policymakers and businesses have to avoid making the mistake of a dash for fossil fuels, he argued. “We should not allow a false narrative to be created,” said Kerry, “that what has happened in Ukraine somehow obviates the need to move forward and address the climate crisis.”
Kerry’s remarks highlight one of the two most acute challenges facing business leaders in relation to their ESG strategies. One relates to metrics and measurements of ESG performance, and how they shape businesses’ access to capital; the other relates to the difficulty of balancing complex interconnected priorities, as vividly illustrated by the repercussions of the conflict in Ukraine.
Repercussions of the conflict
The war shines a light on the tension between the long-term climate change agenda and immediate and urgent socio-economic needs and concerns.
Energy prices have spiked as a result of the reduced availability of Russian gas and oil. While ending the use of coal is a vital part of net zero plans, the prospect of citizens facing winter energy shortages and businesses shutting down is deeply unpalatable. European countries, in particular, have had to suddenly reconsider plans to phase out the carbon-intensive fuel.
Many emerging economies around the world are equally caught between apparently competing environmental and social priorities, even if they are less directly affected by the war. Take South Africa. It is a resource-rich country with low levels of economic growth (the ‘paradox of plenty’), and huge inequality, with the highest Gini coefficient in the world. Coal is both a major source of employment and fundamental to the nation’s energy supply – fossil fuels make up 86% of the energy mix, of which 69% is coal. This presents a real challenge when it comes to curbing carbon emissions, if reductions are seen to come at the expense of socio-economic sustainability.
Resolving the complexities
How then can nations resolve these complexities? The science has not changed: bringing down carbon emissions remains imperative. But pursuing net zero with no regard for the socio-economic consequences is clearly unacceptable. Both nationally and globally, solutions need to support a just transition.
This affects businesses as well as governments. At Investec, it is our ambition to manage our fossil fuel exposure toward net-zero. But how quickly should the company move? How can immediate socio-economic challenges be appropriately tackled in the face of the tremendous long-term costs of inaction on climate change?
Such questions now confront organizations around the world. My view is that resolving them means reframing these apparently competing considerations and resolving them together. They cannot be seen as two sides of a binary argument: there is just one side, a transition to net zero that is socially just. Leaders need to be imaginative and creative in finding principles-based solutions, and balanced in making investment decisions on a case-by-case basis.
Measuring ESG performance
A further challenge is found amid growing criticism of how companies are evaluated by ESG rating agencies. One of the most prominent critics is Elon Musk, who in 2022 decried ESG as a “scam” after Tesla lost its place on the S&P 500 ESG Index – while ExxonMobil was ranked among the Index’s top 10 constituents by index weight. Tesla board member Hiro Mizuno added that “current ratings often overweight reduction of negative impacts while neglecting positive impacts.”
The change to Tesla’s position, explained S&P, was the result of the range of metrics considered in its rankings, which include factors like employee safety. But Musk and his colleagues surely have a point: positive impact needs to be recognized appropriately. We are still in the early days of ESG metrics and it seems right for today’s standards and frameworks to keep evolving to build the most accurate possible picture of a company’s ESG performance. As it stands, there is potential for companies to work with the trade-offs in scoring between the metrics in the respective indices – completely within the rules – and offset negative aspects of their positions in a way that arguably distorts the picture in their favor, when the reality of their contributions to the change agenda may be less attractive.
Given that ESG indices increasingly influence the flow of capital to companies, this is a serious issue, for businesses and for investors alike. In the case of Tesla and ExxonMobil, the result is that capital flows associated with ESG-informed investing move away from Tesla, the world’s most significant electric car company, and toward ExxonMobil – one of the world’s most significant fossil fuel companies, which has been accused of funding climate change denial for many years.
What can leaders do in the face of these complex challenges? Despite the criticisms, ESG methodologies are not the enemy. The complexity of balancing all the inter-related people and planet challenges we face is enormous. Measurement of progress is therefore tricky and impossible to get right every time. Yet we still must do it, for without it we will surely fail. Can we improve approaches? Yes – and the industry is learning and getting better every day. But business leaders cannot simply write off ESG as too complicated and too uncertain.
While business leaders typically avoid complexity and look for simple solutions, the world’s sustainability challenges are inherently complex. We must persevere through the complexity of the challenge. Action is urgent – and the path to action is defined by engagement and cooperation. Engaging across interest groups and stakeholders, understanding different perspectives, and continuously iterating is the only way to help solutions emerge.
Can the world’s leaders, across governments and businesses, rise to the challenge? The jury is still out. The reality is they have no alternative but to come together, across interests and agendas, and cooperate to shape our shared future in the face of potential catastrophe. It is the only way.
Dr Marc Kahn is chief strategy officer at Investec and chair of the company’s ESG Executive Committee. He was speaking to Patrick Woodman, editor of Dialogue.