Environmental, Social and Governance (ESG) stands for three essential requirements advanced organizations must firmly establish to effectively generate long-term, competitive financial gains and positive societal impact.1 ESG has become increasingly important today. It is now a dominant theme for business and government alike while our world becomes increasingly interconnected with enlarging social challenges becoming transnational and pervasive. But organizations must do their part to make the world a more habitable and equitable place. ESG is key to getting there, but we must do a better job of understanding how ESG works and knowing how to leverage it equitably into our day-to-day operations.
ESG considerations have too often been ignored or misunderstood and therefore misused because of the common tendency to accept -- without doing due diligence -- the definitions of “wrongs” preached by certain political or social groups. People impose standards on their contracting counterparties that apply indirect or irrelevant importance to their commercial relationships -- including standards they do not even use in their own day-to-day operations.
So, are we ready for the ESG revolution – or not?
Consider the recent pandemic and the COP-26 environment agenda! 2 Because ESG criteria represent non-financial profitability for improving a company’s operations, investors need to increasingly apply all three ESG qualities to identify material risks and growth opportunities, specifically we need the…
- environmental criteria to evaluate how your company performs as a steward of nature;
- social criteria to examine how your company manages relationships with employees, suppliers, customers, and the communities where it operates; and
- governance to evaluate your company’s leadership, executive pay, audit, internal controls, and shareholder rights.
Throughout my career to date, I have spent many happy hours encouraging suppliers and contracting partners to stay up on their game in ESG performance, -- especially the E part. I have worked in energy, infrastructure and engineering-led firms considered most profitable as buying organizations who have powerful presence in the media and set the tone for much of the rest of their industry sector -- especially suppliers.
Environmental management’s purpose is to encourage suppliers to work toward ISO 140013 outcomes. ISO 1400 is the international standard that explains requirements for environmental management systems organizations should use to improve environmental performance by efficiently reducing adverse environmental impacts while gaining competitive advantage and stakeholders’ trust. ESG is part of the pressing agenda for sellers and buyers alike, meaning this is urgent for all of us.
Recently I have been tasked to produce ESG policy documentation in the areas of:
- modern slavery;
- corporate social responsibility;
- unconscious bias (more of that follows); and
Involving ESG within our commercial relationships
We know businesses are all about serving their customers and supplying goods and services that the world wants and needs. They are not about changing the world for good. Although this might be controversial, it is widely accepted truism. But just as importantly, businesses -- including central and local governments-- are genuinely in a good position to positively influence the behaviors of suppliers -- particularly on a transnational basis. Therefore, we can help suppliers meet relevant higher standards. Where necessary we may need to stop working with suppliers who consistently refuse to move toward better standards.
Broadly, then, within commercial relationships, our task is to make ESG requirements a part of our overall business case for dealing with suppliers and different (or diverse) commercial sectors, and to point such suppliers towards best practices and, where relevant, to international standards like ISO as a basic requirement for doing business.
Influencing our trading partners
Increasingly today, businesses under mainstream-media and social-media spotlight are happy enough to look several times at business partners -- both sellers and buyers. But obviously, buyers have more direct influence on trading partners’ behaviors. Broadly, ESG standards can become part of a customer’s requirement; therefore, our trading approach should first ask three questions as a first step toward meeting those ESG requirements:
- what do I want to buy?
- which terms am I prepared to do business?
- which ESG standards do I want my suppliers to meet?
When done correctly, you put yourself in control by avoiding inadvertently helping suppliers take over and focus on what customers and stakeholders care about most. Many pressure groups unfairly influence businesses to promote their narrow campaigning agendas. Bluntly, businesses cannot dance to a cacophony of irrelevant tunes dictated by external third parties. If they do, they will sacrifice a competitive edge and instead find constantly increasing financial overheads that drive them to bureaucratic, marginalized, and unprofitable practices. I see a clear dividing line between doing the right thing and adopting every latest promo campaign fad!
Don’t overdo it!
My policies contain a statement regarding value creation designed to create value using the economist’ classic definition – “all those things that collectively meet the needs and wants of society and that have been created by economic processes”.4 The point being that businesses (including governmental organizations) are mission-driven and have a job to do. Anything that helps my organization create value and do it is part of my organization’s raison d'être (reason why it exists).
This helps us focus on what is important (even vital!) and not get sidetracked into pursuing other people’s agendas. Arguably, getting it right (e.g., environmental policy) contributes to value creation, for buyers and sellers. Our commercial contracts then can reflect our broad corporate values but not make them a direct contractual obligation unless meeting such standards is part of doing the job correctly. In other words, the policy goes to the root of the contract and is a condition rather than a warranty.
Remember that a condition in a contract, which is a demand or requirement related to a breach of a condition, gives a right to terminate the contract and pursue the offending party for that breach by optionally terminating the contract and/or pursuing compensation for financial damages.
A warranty, by contrast, is an important secondary requirement to the main purpose of the contract and a breach of a warranty gives right to financial damages but not the right to terminate the contract. In 90% of cases, breach of an ESG provision would likely be breach of a warranty, not breach of a condition, although I recognize that this can be a moot point, depending on precise circumstances. (As they say, “each case must be judged on its merits”).
Therefore, be careful when preparing ESG policies. Make sure you know which ESG policies are to be regarded as warranties under the contract, and which are to be regarded as conditions. If they are seen as conditions, be prepared to defend that position, and make sure your own organization lives up to the same standards.
As commercial practitioners then, and as contract creators and contract managers, we need to ensure that ESG provisions are seen for what they are and managed as such. Also, any ESG provision we attempt to impose on our suppliers should also be a standard that we apply to ourselves.
Unconscious bias is an example. We can all recognize the idea of bias, whether this may be conscious or unconscious. Not all biases are bad! If I want to buy the services of a brain surgeon, I am naturally biased towards finding the very best brain surgeon out there! When I select a commercial contractor, I am always biased towards the one I consider the most competitive!
The trouble with so-called unconscious bias policy is that moves to eliminate ‘unconscious bias’ may be a knee-jerk response to things that some external pressure group wishes to define as social “wrongs.” During human interactions when we may encounter bias most frequently, how do we truly and effectively define what can be unconscious behavior?!).
My policy documents seek to define this closely, partly with the intention of excluding or eliminating third party pressure groups’ ideas that, ironically, may be highly biased! As businesses we cannot forever be dancing to someone else’s tune, and I think this is one problem with a broad ESG agenda – it can promote partisan, and even divisive, agendas.
Four current issues
For a company to have a defendable organizational policy framework in the ESG arena it will probably need discrete policies covering at least these six areas:
- Environmental issues
- Anti-bribery and anti-money laundering
- Corporate social responsibility
- Modern slavery
- Unconscious bias
- Anti-harassment and anti-discrimination
These six are the bedrock of ESG and, apart perhaps from our corporate mission statement and/or vision statement, all six are probably the best public statements as to our overall value system.
Perhaps the last four have the most current focus because of human trafficking and ever more porous5 international borders, coupled with huge humanitarian problems internationally -- so, people are on the move, and in vast numbers.
So Corporate Social Responsibility has therefore become increasingly relevant, as has modern slavery. Any business with an international operational footprint will be at the forefront of encountering problems. Think especially of so-called “sweat-shop” labor.
Harassment, discrimination, and bias -- conscious instead of unconscious -- are present dangers involving vulnerable people with few or restricted legal and employment rights. That is why the last four policy areas require accurate managerial focus. And, in turn, this focus will influence the way we do business and the types of contracts we sign and enforce.
Do what’s right ….
Beware -- when used improperly, ESG can set traps for the unwary commercial practitioner by making several unrealistic demands like demanding that you must:
- accept without adequate investigation or due diligence the definitions of so-called wrongs suggested by certain political or social campaigning groups; and/or
- accept standards that have only indirect importance to the commercial relationship on our contracting counterparties. Moreover, some demands apply to standards we
do may not use in our day-to day operations.
I encourage you to work out what’s right and necessary for your business, set only policy terms you need and stick to your policy position. Do not try constantly to emulate what others are doing (or say they are doing). Any policy framework will have review and update practices defined within, so expect your policy framework to develop over time.
Policy statements to consider
If you’re looking for some policy statements for guidance, follow the first link below then consider the remaining links as well.
- CFA Institute CSG Investing and Analysis article. See also Wikipedia Robeco article titled What is ESG? See also definitions of terms environment, social sustainability, and corporate governance.
- PWC article Are You Ready for the ESG Revolution? June 15, 2021 by Peter Gassmann, Casey Herman, and Colm Kelly; Ref: COP26 event - 31 Oct to 12 Nov 2021
- ISO standard 14000 Family – Environmental Management (International Standard for Organization)
- See also Economics, A-Z terms beginning with S, The Economist
- Porous border defined
ABOUT THE AUTHOR
Peter Sammons is a lead trainer and commercial manager at Procurement Central, UK, with heavy emphasis on procurement. His special interest surrounds all aspects of intellectual property. His specialties include technology procurement, from sourcing to integration plus contract negotiation and management; knowledge procurement; sourcing from third-party entities with ock on knowledge. His professional services include engagement, management, and successful disengagement.