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ARTICLE

Five ESG Assumptions That Deserve a Closer Look

David D Adeleye, Scott Chinn, and Julian Harrell

Summary

  • ESG will fade if the SEC’s proposed climate-related risk disclosure rule is overturned.
  • “ESG investing” and ESG corporate strategy are synonymous.
  • Global and federal standards are the only important ESG drivers.
  • Implementing ESG strategy requires acceptance of climate change or other potentially polarizing topics.
Five ESG Assumptions That Deserve a Closer Look
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With fast-paced changes affecting environmental, social, and governance (ESG) developments, developing ESG strategy is more nuanced than ever. Our clients face increasingly complex scenarios impacted by volatile economic and emerging political forces. The spectrum of ESG risk and opportunities certainly includes “win/loss” situations. However, in some instances, decision makers will need to weigh the “least bad” choice between competing stakeholder demands. Addressing these issues deserves strategic thought partnership and a closer look at potentially risk-laden assumptions. What follows is a high-level “pressure test” of five assumptions.

1. ESG will fade if the SEC’s proposed climate-related risk disclosure rule is overturned.

The Securities and Exchange Commission’s (SEC) proposed climate-related risk disclosure rules loom as a top priority for many decision makers. And there is an emerging consensus that the proposed disclosure rules will be challenged if the SEC adopts a final version. But assuming the proposed rule never surfaces (which is not guaranteed), the proposed climate disclosure framework and the fast-evolving, intersectional nature of ESG are here to stay. The implications of this “new normal” permeate risk and opportunity management.

In this regard, examining global financial trends is critical. For example, a recent Bloomberg article projects that assets under management (AUM) that incorporate ESG factors will exceed one-third of AUM globally (approximately $41 trillion by year-end, and $50 trillion by 2025). The Climate Bonds Initiative also recorded $417+ billion of ESG-related debt issuance in the first half of 2022. These developments, coupled with increased regulatory and multiplying stakeholder demands, will keep expanding even without a final SEC rule. Various forms of opposition to ESG will surface, but we anticipate this opposition will ultimately result in stronger ESG-related standards and business practices.

2. “ESG investing” and ESG corporate strategy are synonymous.

While ESG investing (i.e., integrating ESG factors into investment management decisions) is a significant piece of the ESG puzzle, it is not the entire picture. Conceptually, ESG corporate strategy is wide-ranging compared to ESG investing. ESG corporate strategy involves the implications of a company’s decisions to identify, adapt to (or ignore), and manage the global departure from “business as usual.” This “Great Transition” includes human capital management, biodiversity impacts, cybersecurity, and a host of other corporate activities intersecting with potential ESG risks and rewards.

3. ESG is “one size fits all.”

Working through ESG issues is challenging, but it is relatively clear that ESG strategy is not a one-size-fits-all phenomenon. For example, a health-care company could have unique ESG priorities as compared to a manufacturing or logistics company. In addition to industry segmentation, variables like geography, regulatory environment, stakeholder influence, and corporate mission may require somewhat individualized ESG decision-making. That said, evaluating ESG activities within a particular industry can facilitate analysis of one company’s performance against another. Additionally, ESG benchmarking can help develop industry-specific insight about fast-changing ESG risks and opportunities. Conversely, an aimless benchmarking exercise can exacerbate business risks, especially as the litigation bar focuses more on ESG issues (e.g., greenwashing, antitrust, consumer protection, etc.). Accordingly, mature ESG strategy can resemble a “unique corporate personality” that ideally reflects corporate innovation and engagement geared toward sustainability.

4. Global and federal standards are the only important ESG drivers.

This assumption has some veracity, but exceptions apply. For example, increased state attorneys general (AGs) and consumer advocate activity is impacting how companies manage their ESG strategies. Many AGs are focused on ESG-related antitrust issues, truth in disclosures, “scoring” methodologies, the integration of ESG factors into investment processes by investment managers, and the interplay of ESG investment strategies with long-standing notions of fiduciary duties. This scrutiny may put companies between the “push” of the desire to expand ESG benchmarks and the “pull” of punitive governmental reaction for the same activity.

5. Implementing ESG strategy requires acceptance of climate change or other potentially polarizing topics.

Because of the diverse nature of ESG, each company has to own where it is in the ESG journey. Companies should self-reflect on their progress on the ESG spectrum and work with outside counsel who can provide solutions that would help them improve their responsibility to their stakeholders. Counseling on ESG matters should be objective and dispassionate. Furthermore, companies should look to develop and manage their ESG-related governance policies with outside counsel, including climate-management policies, ESG investing strategies, and charitable and philanthropic engagements. ESG is complex, multifaceted, and ever-changing. Therefore, the timing, type, and magnitude of risks and opportunities are case- and company-specific.

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