Why sustainable governance and corporate integrity are crucial for ESG

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.

Author: Gabriel Cecchini, Director, ESG Integridad, Rachel Davidson Raycraft, Judicial Law Clerk, US District Courts, Jane Nelson, Director, Corporate Responsibility Initiative, Harvard Kennedy School of Government, Carlos Santiso, Director for Digital Innovation in Government, Development Bank of Latin America

• The momentum around environmental, social and governance (ESG) factors is rapidly evolving as ESG frameworks continue to grow in influence and impact.
• However, there is increasing recognition that the ESG revolution must more meaningfully consider sustainable governance – the G in ESG – and corporate integrity in particular.
• Corporate governance that is grounded in the principles of transparency, accountability and integrity needs to be understood as a prerequisite for achieving the entire spectrum of ESG goals.

How should we define and assess the G in ESG? Where does anti-corruption fit within emerging ESG frameworks? And can a company or investment fund be considered “sustainable” if corporate integrity is left on the sidelines of certification criteria and reporting priorities?

Answering these questions is becoming increasingly urgent. The momentum around environmental, social and governance (ESG) factors is rapidly solidifying into influential corporate rating frameworks, investment criteria and binding law despite relative inattention to the G in ESG. At the same time, the war in Ukraine and the response from companies and investors has added additional weight to the meaning and implications of ESG investing and thrust corporate purpose, values and integrity into the spotlight. As the impact of ESG frameworks and standards continue to grow, we must prioritize sustainable governance and corporate integrity within the ESG agenda.

Surging interest in ESG

Investors, corporate boards, senior executives and government leaders are lasered in on ESG factors as a means for building a sustainable future. Although ESG entered the world stage in the early 2000s, interest in mobilizing non-financial corporate performance standards has surged in recent years amidst the climate crisis and COVID-19 pandemic. Many view ESG as essential to achieving a just energy transition and mitigating societal inequalities that were exposed and exacerbated by COVID-19.

As a result, ESG has transformed into a mainstream investing strategy and a priority among leading corporate actors worldwide. For example, in 2020 the World Economic Forum’s International Business Council developed a set of ESG-based stakeholder capitalism metrics for sustainable value creation.

Meanwhile, key government agencies and oversight bodies have launched ambitious legislative and standard-setting programs that would place ESG risks at the heart of financial services regulation and corporate disclosure requirements. Some of the most notable such initiatives include the EU Sustainable Finance Disclosure Regulation and other ESG-related proposals in the EU, proposals under consideration by the US Securities and Exchange Commission, and the anticipated disclosure standards of the International Sustainability Standards Board.

Moreover, the new concept of “double materiality” extends corporate disclosure obligations beyond a company’s own financial performance to include those ESG factors that affect economies, people and the planet.

The missing G in ESG

However, there is increasing recognition that the ESG revolution must more meaningfully consider sustainable governance – the G in ESG – and corporate integrity in particular.

The ESG wave has grown in conjunction with global momentum on combating climate change. While corporate related human rights risks have recently grabbed the attention of regulators and international organizations, there is a need for a comparable push behind governance risks.

“Robust corporate integrity is absolutely key to the realization of human rights and environmental sustainability,” explained Anita Ramasastry, Henry M. Jackson Professor of Law at the University of Washington and member of the United Nations Working Group on Business and Human Rights.

In addition to being one-third of the ESG equation, sustainable governance should be understood as a prerequisite for achieving the entire spectrum of ESG goals. Behind each breach of a company’s environmental or social commitments lies ineffective corporate governance, be it inadequate anti-corruption practices, perverse incentive structures, contradictory lobbying activity, ineffective board oversight or ill-equipped leadership. In sum, sustainable governance factors at the heart of the ESG agenda.

Sustainable governance takes centre stage in Davos

At the World Economic Forum’s annual conference in Davos in May, the Partnering Against Corruption Initiative (PACI) raised the profile of the G in ESG through a public session on the importance of investing responsibly in sustainable corporate governance. The panel discussion explored why and how investors should centre corporate integrity beyond compliance within their own practices and the corporations in which they invest.

From corporate purpose, values and effective stakeholder engagement to anti-corruption, transparency and accountability, sustainable governance is central to building trust and maintaining a social license to operate. ESG-based shareholder activism has also accelerated in recent years, demonstrating a clear desire to better align investment practices with broader societal goals and values. Through open communication, thoughtful monitoring processes, rigorous metrics and analysis, and increasing attention on the G in ESG, investors and companies can work together to build sustainable value for businesses, stakeholders and the planet.

In particular, the panelists highlighted integrity-centred stewardship as a powerful yet often undervalued mechanism for promoting sustainable business. While divestment captures the public’s attention, and is sometimes the only appropriate option, active ownership, engagement and observation allow ESG-minded investors to use their leverage to help shape a better future.

“Divestment should be considered a sort of last resort action and one that could be avoided if the G of ESG has been properly addressed,” advocated Nicola Bonucci, Partner at Paul Hastings, Paris.

Investing in integrity in an increasingly complex world

Further amplifying the G in ESG, the Global Future Council on Transparency and Anti-Corruption recently released a community paper titled Investing in Integrity in an Increasingly Complex World: The Role of Anti-Corruption amid the ESG Revolution. The paper makes the case for placing corruption risks at the heart of investor decision-making processes and corporate ratings, with a particular focus on the growing prominence of ESG.

To invest in integrity, investors and standard-setting organizations must more effectively embed governance concerns and corruption risks into ESG investing frameworks. They also must overcome existing hurdles, including inconsistent terminology, framing and reporting recommendations, as well as the over-greening of ESG relative to other material risks and opportunities.

Corporate integrity ought to be core to every aspect of the ESG agenda. Although directly measurable within the G, it is foundational to the realization of both the E and S. It is also essential to the ethical pursuit of ESG standards and the transparent and accurate reporting of ESG metrics.

3 recommendations to factor corporate integrity into investment decision-making processes

To more adequately incorporate corruption risks into investor decision-making processes and frameworks, the Global Future Council makes the following recommendations:

1. Investors should systematically embed integrity within their own commitments, processes, policies and incentives. This includes internal practices and outward facing initiatives, such as company engagement and stewardship.

2. Corruption risks must be integrated into reporting and rating frameworks in a coherent, comprehensive and standardized manner. This should include a core, common set of indicators to promote cross-sectoral, cross-framework comparability and reflect the reality that some risks (and corruption risks in particular) are universally relevant.

3. Investors should drive additional collective action on the mainstreaming of corruption risks within investor decision-making processes, building on existing industry-, sector- and place-based initiatives. Such alliances can create platforms for industry dialogue and coordination, as well as a mechanism for engaging new voices – including consumers and affected communities – towards systemic change.

Prioritizing integrity-centred corporate governance

Integrity-centred corporate governance is key to ensuring that ESG enthusiasm translates into concrete action and the sustainable, inclusive future towards which we strive.

Although ESG is now a widely recognized concept, its definition and, even more so, its impact are still to be determined. As key regulators and standard-setting organizations undertake the process of publishing and imposing ESG frameworks and baseline requirements, it is essential that corporate integrity lies at the heart of these initiatives.