Try typing ‘ESG Report’ into Google and you will see the vast amount of time and resources being put into educating businesses on the importance of environmental, social and governance (ESG) practices. Every fund manager and investment bank worth their salt have published endless tomes on the topic, highlighting the intensifying focus on ESG for institutional investors.
This ever-increasing focus has serious implications for today’s CFOs, whose smorgasbord of KPIs seems to grow by the week. If ESG factors are not integrated into a corporate’s performance metrics, then pressure will come from institutional investors obliged to meet their own sustainable investment targets. As this pressure builds, it has the potential to lead to divestment by institutional investors which will in turn cause other shareholders to start asking questions.
Institutional investors lead the way
In his most recent annual letter to CEOs, BlackRock Chairman and CEO Larry Fink states that “companies perform better when they are deliberate about their role in society and act in the interests of their employees, customers, communities, and their shareholders”. With a causal link between ESG and financial performance, we can expect to see sustainability criteria having an ever increasing influence on investment decisions.
In Fidelity’s sustainable investing policy they speak of their belief that “a company that manages its supply chain in relation to social and environmental matters can add competitive value and improve its organizational performance in the long run” and that they expect companies to “practice fair treatment” of suppliers.
Meanwhile, Vanguard have published their responsible investment policy across their fixed income and equity investments and have put together a senior cross-functional team, headed by their CEO to ensure ESG integration across the business.
These three giants of asset management hold around $21trn in assets under management, equivalent to the entire GDP of the US.
Driving value for shareholders
Earlier this year, Terry Smith, founder of Fundsmith Equity Fund and major shareholder in Unilever, said in his annual newsletter to investors that the consumer goods company is “losing the plot” by putting too much emphasis on sustainability at the expense of profit.
Whilst he may have a point, there is a stronger argument that the two should not be seen as adversaries. ESG integration, when done correctly, can have long term financial benefits for shareholders. A new study by the Morgan Stanley Institute for Sustainable Investing has found that bonds issued by companies that rank highly on inclusive growth metrics had lower credit spreads and were considered less risky than bonds issued by low scoring peers.
Deloitte’s article ‘CFOs find benefits from ESG investing’ draws attention to the fact that 59 percent of businesses are seeing a positive impact on revenues and 51 percent are seeing a positive impact on profitability. Combined with the value add of improved customer satisfaction, better recruitment, and the positive impact on the physical environment, it’s not a bad result all round.
Rethinking the S in ESG
It was the Harvard Law School Forum on Corporate Governance that wrote it’s ‘Time to Rethink the S in ESG’. They wrote that the S in ESG being something of a ‘middle child’ often overlooked and misunderstood. In fact, they went as far as to propose that ‘Stakeholder’ might be more appropriate. This certainly resonates when you consider the complexities of global supply chains. Once the preserve of a back-office function, supply chain challenges are now making headlines off the back of geopolitical events and the pandemic.
As the world begins to emerge from the pandemic, demand is accelerating, and many suppliers are facing cash flow challenges as they look to ramp up production. Strong partnerships between corporate buyers and their suppliers can mitigate some of these challenges. However, this isn’t being put into practice.
Corporate responsibility
Large corporates hold the power in the buyer-seller relationship. They drive down unit price and dictate payment terms. In 2019, The Hackett Group found that upper quartile companies converted cash three times faster than median performers, collected from customers 19 days faster and yet paid their suppliers 20 days slower. In their latest report, they highlight that companies have dramatically slowed payments to suppliers.
These findings may not be surprising, but the question to ask is how this poor treatment of suppliers aligns to a corporate’s ESG strategy? If this crucial group of stakeholders are already being forced to agree to lengthy payment terms, only then to be paid late, then surely this amounts to a dereliction of duty when it comes to a corporate’s ESG standards. No amount of ‘instagramable’ team away days planting trees will distract from this fundamental problem. Perhaps, when the world’s biggest institutional investors start asking questions, the treatment of suppliers will move up the CFOs priority list.
Please contact us for more information on how we can help you and your suppliers optimise your working capital.
Tony Duggan is co-founder and CEO of Crossflow. He served as Supply Chain Director at Wickes and B&Q prior to serving as Product Development Director at SWIFT, the global banking network. He also managed an outsourced fintech development project for HSBC in Hong Kong.
