Article / 2 Mar 2022
Environmental, Social and Governance issues are high on the global agenda and in an increasingly-connected world are not going away anytime soon.
We explain the importance of ESG factors when investing internationally, and how companies can create value by acting in sociably responsible ways.
ESG stands for Environmental, Social and Governance. These are non-financial factors that are analysed by investors to help identify potential risks and opportunities.
As well as companies, their boards and shareholders, ESG issues interest governments and ordinary citizens. They concern businesses acting ethically – doing the ‘right thing’ – rather than merely adhering to minimum legal and regulatory standards. Most people would generally want to avoid any negative ESG practices, even if legislation were not there to prohibit them.
Moreover, social media has made it increasingly difficult for companies to hide any unethical behaviour, even when it occurs on the other side of the world. Information can be disseminated quickly and with dramatic effect; a single tweet has the potential to send share prices plummeting if it states that a well-known company is complicit in or indifferent to human rights violations, environmental issues, corruption or fraud undertaken on their behalf.
The Xinjiang Province is a region in China where many global manufacturing supply chains start from. The region supplies cotton as well as other materials crucial to many industries. In a large number of publications, this province is known for use of forced labour. When customers buy the end product, they are usually unaware of the source material’s origin. However, the use of forced labour in their supply chains is something companies should know about and take action to avoid. For example, the United States has recently enacted legislation (the Uyghur Forced Labor Prevention Act) which obligates companies to proactively prove that for any products or services sourced from Xinjiang Province, forced labour was not used.
This example illustrates that global supply chains tend to be complex, and that it may be challenging for companies to trace materials back to the initial manufacturing facilities.
The legalisation of cannabis in Canada in 2019 has led to investor interest in the industry. There are now two co-existing markets – the legal market and the illegal ‘black’ market. It is increasingly difficult to establish if the product is sourced from a legal or illegal supplier due to the markets being interconnected. Thus, when entering this market, investors risk investing in ‘black’ market cannabis, which is often associated with other criminal activities and harder drugs. Even where the cannabis is from a legal source, there are frequent damaging environmental violations related to its production, particularly related to the disposal of hazardous waste.
This example illustrates that unless you know the market incredibly well, it can be hard to avoid inadvertently becoming involved in illegal or unethical practices when entering a new market.
Gold is a highly valuable commodity, sought after all the more in times of economic uncertainty, including the global Covid-19 pandemic. Gold mines are often found in emerging economies subject to political turmoil where the rule of law is weak. Mining operations in such countries often involve unethical practices such as deforestation and displacement of indigenous peoples, as well as the use of hazardous chemicals such as cyanide and mercury1. These chemicals are not only dangerous to the miners themselves, but they also enter the river systems and cause catastrophic damage to the environment and communities downstream. When illegally mined gold is melted and combined with legal sources, you cannot trace its origin.
For multinational companies, as well as investors, banks and private equity firms, doing business internationally may mean stepping into the unknown. Organisations cannot afford to be negligent or indifferent to what is happening on the ground; they must do their homework and know how the industry/ supplier/ region operates in order to avoid any potential issues arising later on. More than just adhering to relevant legal frameworks, organisations must apply an ethical approach in their business dealings, particularly when they are more complex due to being international.
Companies who conduct insufficient due diligence when dealing with foreign M&A targets, new business partners or new industries face numerous potential risks.
Companies need to know about any risks associated with their business and any new unknown elements in the form of international markets, partners or targets. This comprehensive fact-finding is called due diligence.
In this context, due diligence means learning how things work in the new geography/ market/ industry. What rules, regulations and expectations govern the market? What are the particular key risks and specific issues that the company needs to know about?
Undertaking detailed due diligence and instilling a comprehensive ESG programme encompass more than avoiding risks and preventing losses; they are about creating value. There are many financial and non-financial benefits that flow from a proper ESG program. For example:
An ESG programme can help a company create value. In fact, industry research shows that businesses who do well in ESG, tend to perform well on the stock market and vice versa.
Companies who do international business are often faced with navigating uncharted waters by getting into places, geographies or industries that are not familiar and where information may be difficult to obtain. This can be problematic and time consuming at the very least. Professional experts in due diligence can save time, money and hassle.
[1] For example: https://www.hrw.org/news/2020/02/04/venezuela-violent-abuses-illegal-gold-mines; https://www.globalforestwatch.org/blog/commodities/arco-minero-venezuela-gold-mining/; https://freedomhouse.org/article/illegal-mining-venezuela-exacerbating-violence-ecocide-and-global-corruption-international.