In the last few years, we have seen a shift in public consciousness concerning climate, environmental, social, and governance issues. This has been propelled by several factors with burgeoning social media usage as a critical component.
These shifts have prompted investors in key markets – Europe, the US, UK and Australia, among others – to ask questions of the companies in which they invest and the firms that manage those investment activities. Throw in high levels of liquidity (albeit impacted by recent tightening in monetary policy) and discretion on the part of these investors, and a high-pressure, competitive environment is created for corporates and investment managers to operate in.
Add to this a regulatory domain that is seeking to keep up with rapidly changing requirements – and the potential risks it presents – and the complexity of the operating environment increases even more. This is all before you consider the complications that current geopolitical tensions bring for all these stakeholders.
Participants in this system tend to move at different speeds, and the divergence in these timelines creates great tension as a result. Large, public companies need time to contemplate questions around sustainability and resilience, to allocate the necessary resources to drive those strategic choices, while also remaining profitable.
Regulators also need time to consult the industry, draft and deliver policy and then implement.
In parallel, investors act with discretion to promptly reallocate capital to companies and fund managers that match their current investment goals. By extension, fund managers and advisers need to move at pace to compete with their rivals in attracting these funds, often by creating and promoting new products that seemingly match the investment mood of the day.
Short-term fixes, however, do not always align with long-term planning. The regulatory environment and associated reporting requirements are playing catch up with new demands; and while ESG vocabulary remains open to definition, and therefore interpretation, companies and fund managers will remain under pressure to protect their existing investor base or attract new clients. “Greenwashing” is but one early symptom of this gap and, therefore, enforcement agencies must respond.
This is not a new or unique trend. The Foreign Corrupt Practices Act in the late 1990s – a law originally passed in 1977 – was prompted by a period of global economic growth and feelings of an uneven playing field in terms of business practices. The Act, when it was enforced by the SEC and DOJ, sparked an overhaul of the anti-corruption and anti-bribery landscape. Overnight, behaviors that had previously been deemed appropriate were forced to change as the role and size of legal and compliance functions were given more resources.
In a similar vein, the global financial crisis of 2008 exposed practices that had been disguised by economic growth, and several infamous Ponzi schemes became emblematic of that era’s excesses. Those fraud cases, in conjunction with important global security incidents, provoked a seismic change and strengthening of anti-money-laundering and terrorism financing rules and standards, with Know Your Customer (KYC) checks taking on new meaning.
These periods, where favorable economic conditions ebb and/or regulatory agencies catch up with new trends or products, suggest that ESG related litigation and enforcement risks will rise for companies and fund managers alike, regardless of whether it was a marketing misstep, confusion over new and evolving reporting requirements or deliberate slanting of data and evidence to lead an audience to a false conclusion.
Learning from history, it is important that we resolve the common pull felt between fear of missing out (FOMO) and risk management. Executives that give sales teams an objective to grow, to secure market share, to aggressively pursue profits will always run the risk of people evading or bending the rules – especially if those rules are vague and their enforcers are seen to be catching up. But recent developments from regulators in the US, Europe and the UK surrounding greenwashing, climate-related disclosures, transparency, due diligence, accountability – among many others – all reflect the direction of travel.
Today’s operating environment is complex, to say the least. However, for as long as compliance and risk management are perceived as constraints to innovation and growth, their potential as enablers of
sustainability and resilience may not be realized.
The debate over ESG will continue for some time while we determine what it represents, how it is measured and how related activities are enforced. It should not distract, however, from certain fundamentals. Sustainable, resilient, profitable companies consider risk in its entirety – not just the ESG subset – and on a continual basis.
They determine their risk appetite and design structures that align with that threshold. Their policies and procedures provide parameters for their employees to operate within and safeguards for the organisation. And they regularly and routinely review their risk exposure to ensure they adapt to changing market conditions.
Robust risk management may not be the most exhilarating of topics, but it should make for a compelling story to investors, an endorsement of a company’s values – key to employee retention – and, ultimately, a good night’s sleep for company leadership.