Guide

More than just numbers – businesses must do their ESG checks to create value when investing internationally

Gateley Omega

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Environmental, Social and Governance issues are high on the global agenda and in an increasingly-connected world are not going away anytime soon.

Mikhail Lastovskiy and Emily Kupers explain the importance of ESG factors when investing internationally, and how companies can create value by acting in sociably responsible ways.

What is ESG?

ESG stands for Environmental, Social and Governance. These are non-financial factors that are analysed by investors to help identify potential risks and opportunities. 

  • Environmental criteria concern issues including sustainability, climate change and pollution.
  • Social criteria deal with how a company treats its employees, suppliers, customers and the communities based in the regions of its operations.
  • Governance criteria relate to accountability and transparency, and examines a company’s leadership and structure. 

Why do ESG issues matter?

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.

Examples of international ESG issues

The below examples showcase how ESG issues are global in nature and affect different industries and geographies across supply chains:

1. Modern slavery in supply chains

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 used1.

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.

2. Legalised cannabis and environmental and drug violations

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.

3. Gold mining’s associations with environmental breaches and displacement of indigenous communities

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 mercury2.  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. 

Why do ESG issues matter for international investments?

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. 

What are the risks for international investors associated with ESG violations?

Companies who conduct insufficient due diligence when dealing with foreign M&A targets, new business partners or new industries face numerous potential risks.

  • Legal risks – They may inadvertently break laws or regulations resulting in fines or regulator actions against them.
  • Reputational risks – Any violations or reckless corporate behaviour may be uncovered and made public.
  • Financial risks – Stock values may decrease if investors divest from the company after learning of ESG transgressions.
  • Operational risks – For example production may be halted by a striking workforce protesting bad treatment.

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?

What are the benefits of an ESG programme?

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:

  • Relationships – The company will enjoy better relationships with its stakeholders, including its employees and the society around the particular areas of operation.
  • Increased government support – They are more likely to be selected for new investment opportunities or public-private partnerships.
  • Attracting talent – Senior employees are more likely to want to be associated with the company. 
  • Financial uplift – Companies that invest in ESG tend to experience a financial uplift due to having a better reputation and having less government interventions/ fines. They generally have higher credit rating as well. 

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 versa3.

How can Gateley Omega help with international investments?

Gateley Omega can assist companies to avoid risk and create value throughout the whole deal lifecycle, including:

  • pre-deal investigative due diligence
  • post-deal company health check
  • detailed investigative supply chain audit
  • ongoing regular company risk assessments.

We seek to find out our clients’ objectives at the outset – what are their priorities and key areas of focus? We believe it is important to provide our clients with specific actionable next steps as well as comprehensive detailed analysis. 

In conclusion

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.

Do you need advice on ESG issues?

We have extensive experience undertaking investigative due diligence and advising companies on investing into new markets and geographies.

To find out more visit our Gateley Omega company page. Alternatively, if you would like to speak with someone please contact our experts below.