ESG stands for “Environmental, Social, and Corporate Governance,” which represent three criteria for measuring corporate sustainability and social impact. Though it first emerged over a decade ago, it has gained recent prominence and will likely play a key role under the new administration. Businesses large and small should understand its implications.
Perhaps most important, this movement does not appear to be a trend. It differs from past efforts to make companies conduct themselves responsibly in environmental, social, and corporate governance causes in that it is founded on the premise that these issues are financially relevant.
Much of the momentum for the ESG movement emanates from younger generations who are more apt, both as consumers and employees, to value environmental sustainability. That is, they want to buy from, and work for, companies that demonstrate such values.
This article focuses on the “E” because, from the perspective of one who has practiced environmental law for more than 30 years, it has the potential to fundamentally change the way environmental issues are viewed and addressed by governments, businesses, and the public. While the environmental component of ESG is broader than one issue, climate change has been and remains the primary driver. In this context, the movement gained significant attention last year as its financial implications took center stage.
BlackRock is the world’s largest asset manager, with approximately $7 trillion under management. In January 2020, its founder and CEO, Larry Fink, made clear in his annual letter titled “A Fundamental Reshaping of Finance” that ESG will be a primary investment consideration moving forward.
Fink noted in his letter that “climate risk is investment risk,” and that investors are increasingly concerned about modifying their portfolios to minimize this risk. This awareness will lead, “sooner than most anticipate,” to “a significant reallocation of capital.”
Fink called on companies in which BlackRock invests to publicly disclose the risks that climate change poses to their operations, and to identify their efforts to ensure the sustainability of their business practices. Such risks include both the physical hazards of climate change as well as the ways climate change policy will impact a company’s business model. BlackRock will use these disclosures to evaluate “whether companies are properly managing and overseeing these risks within their businesses and adequately planning for the future.”
BlackRock intends to hold companies accountable for not effectively managing such risks. Fink stated that BlackRock “will be increasingly disposed to vote against management and board directors where companies are not making sufficient progress on sustainability related disclosures and the business practices and plans underlying them.”
Against this background, the Biden Administration will bring a dramatic change in philosophy to environmental issues compared to the deregulatory push of the Trump Administration. How that philosophy translates on the ground to actual programmatic changes may be somewhat more restrained.
It appears Biden will be the first Democrat since 1884 to enter the Oval Office without having a majority in both houses of Congress. While this will not prevent Biden from effecting significant change, it will present more of a challenge, and require a more nuanced and selective response to the Trump regulatory rollbacks.
Among other things, look for Biden to leverage the market forces growing behind the ESG movement. The most direct way to do this is to require, and establish standards for, companies to make the disclosures sought by BlackRock and other investors. This would provide a tool for the Biden Administration to significantly change the environmental behavior of businesses without making direct changes to the environmental regulations themselves.
Mandatory reporting could have profound impacts across the economy. For one, it will raise the number of companies making such disclosures (which has been increasing but is not yet universal). It will also allow investors to make apples-to-apples comparisons of companies within the same industry sector and thereby identify those better equipped to weather turbulent times (and thus more deserving of their investment dollars). Moreover, it will likely lead to cheaper capital for companies who compare favorably to their peers.