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Do – and Should – Asset Managers Care About the ‘S’ in ESG? – Part 3

Dr Anthony Kirby, Head of Regulation and Risk for Asset Management and Capital Markets in Europe at EY, says the materiality of social issues to enterprise value will drive deeper integration.

The first part of this article considered key social themes influencing investors and regulators – human and worker rights, diversity and inclusion, health and safety among them – while recognising their interconnectedness with environmental and governance themes. The next focused more deeply on the rising profile of social factors, driven partly by the development of the sustainable investment regulations and frameworks around the global. This final article focuses more deeply on the social value(s) within ESG investing, emphasising that social issues are material when considering the current and future importance of enterprise value, making a deeper integration of social factors into investment processes more inevitable over the short to medium terms.

Impact of social capital

According to McKinsey, social capital—or the presence of networks, relationships, shared norms, and trust among individuals, teams, and business leaders—is the glue that holds organisations together. Access to social capital varies sharply by industry; only 11% of women in McKinsey’s research base (compared with 17%) commented that their network had grown over the past two years or so. Only 16% of women (compared with 28% of men) reported feeling more connected, and only 12% of women (compared with 24% of men) report having more contact with their networks. In part, this could have reflected the additional demands placed on women during the COVID-19 pandemic. Meanwhile, only 9% of frontline workers reported feeling more connected with their networks over the past few years, compared with 22% of middle managers and 45% of senior leaders.

The Social Value Portal was a pioneering ESG initiative associated with the 2012 Public Services Social Value Act in the UK, which focused on how to measure the positive value businesses create for the economy, communities and society. The UK government required that social value be evaluated as part of the tender process for most of its biggest outsourcing contracts – some worth billions of pounds. When scoring bids, the UK government awarded up to 10% of marks for social value, benchmarked against National Themes, Outcomes and Measures (National TOMs) as well as metrics built using ‘proxy’ values, informed by data from official sources such as the Office for National Statistics (ONS).

Social capital also ties in closely with social value and self-esteem, which has a bearing on the drivers and implications of low levels of social value among workers in supply chains. The US National Library of Medicine identified a positive correlation between self-esteem and productivity, where significant differences have been observed depending on the age and seniority of the teaching staff. Their research contributed to the achievement of Sustainable Development Goals 3 (SDG3) (good health and wellbeing) and 4 (quality education), in addition to highlighting the importance of universities ensuring the self-esteem of their teachers, having a very positive impact on the education received by the students, on the quality and prestige of the teaching centre, and society, increasing academic research and educational quality. Similarly, the authors argued that the results achieved could be extrapolated to other sectors.

Social value from supply chain procurements

Procurement processes provide public authorities with opportunities to design social value objectives which are relevant to their specific local or strategic priorities and to implement these objectives into contracts in ways which are tangible and measurable.

According to Bird & Bird, social value has formally been a part of the UK procurement landscape since the Public Services (Social Value) Act 2012 (the Act) came into force. The Act requires public authorities [and their supply chains] to consider not only cost when commissioning or procuring services but also how the public authority can make a positive economic, social and/or environmental impact through the commissioning / procurement process. Public procurement amounted to approximately £379 billion from 2021-2022 which demonstrates the significant contribution public procurement can make to achieving social value.

Bird & Bird regard social value as an umbrella term which covers a broad range of objectives. Social value can be considered at multiple stages of a procurement process within a Social Value Model, most commonly through use of evaluation criteria at tender stage. This typically includes testing bidders’ proposals for delivering: (i) specified wider benefits alongside the core contract deliverables; and (ii) contract objectives in a way that respects and adheres to broader social value commitments. For example, standalone, social value focused questions on how a bidder proposes to meet sustainability objectives during contract delivery are very common in the procurements we advise on.

Additionally, social value may be woven into the contract specification so that any proposals put forward by bidders are evaluated for compliance with a specification which has delivery of social value as a core objective. This includes the pre-procurement and selection stages. If evaluated as standalone questions, typically the maximum weighting afforded to social value objectives is in the region of 10%.

Social issues – impact on ratings

Fitch’s ‘ESG in Credit – Exposure to Social Impacts’ report issued in May 2022 assessed the impact that customer welfare, labour practices, human rights, employee wellbeing and exposure to social impacts has on issuers’ corporate ratings relevant for a variety of industry sectors. The report focused on the ‘exposure to social impacts’ general issue within Fitch Ratings’ ESG Relevance Scores (ESG.RS) materiality and relevance framework and scoring templates.

Fitch’s report argued that while social issues are only ‘minimally’ relevant to credit ratings, they were likely to move up the agenda for disclosures and looked set to become more important as society demands more evidence on sustainability and fair treatment. The report argued that secular shifts in societal norms were a key driver in determining a firm’s exposure to social impacts, illustrating the same with a transmission mechanism table illustrating the dynamic from social impacts issues through to social impact credit risks via social impact credit issues. The report also suggested that as trends towards wellbeing and sustainability expanded, sectors that were currently minimally affected would face rising pressure and greater impact on their credit ratings.

The Fitch report also suggested that non-financial sectors such as pharmaceuticals, energy, natural resources, and tobacco sectors were more highly or moderately impacted by social issues. Fitch explained this is because these industries had been at the forefront of regulatory action to manage social impacts or faced a level of social resistance. Mining companies, for example, were found to be exposed to a higher level of social resistance to projects or operations which could lead to delays and cost increases. In summary, the Fitch report explained that much of the social issues it explored stemmed from external factors which could not be mostly controlled by business decisions.

We have also seen evidence of IPOs struggling or failing due to social concerns. UK-based online delivery firm Deliveroo failed to recover from disastrous IPO in June 2021 as investors shunned shares over governance and labour concerns. According to Morningstar, just four out of 18,000 mutual funds on the continent invested in Deliveroo since it went public, and only one in the UK. This was reflected in Deliveroo’s share price, which nosedived 26% in its first day of trading, leading analysts to dub it the “worst IPO in London’s history”. It is highly likely therefore that as the drive towards sustainability, wellbeing and fair treatment continues, credit ratings will need to further take social credibility into consideration the impact on operations, revenues, and profitability.

Social issues – impact on mental health and neurodiversity

Evidence shows that creating an environment that is inclusive and supportive of mental health conditions enables employers to be more productive, creative, and collaborative. The World Health Organisation (WHO) offers a perspective of mental health as “…a state of mental well-being that enables people to cope with the stresses of life, realize their abilities, learn well and work well, and contribute to their community. It is an integral component of health and well-being that underpins our individual and collective abilities to make decisions, build relationships and shape the world we live in”. The WHO argued that mental health is a basic human right, crucial to personal, community and socio-economic development.

The WHO adds that, “throughout our lives, multiple individual, social and structural determinants may combine to protect or undermine our mental health and shift our position on the mental health continuum. Individual psychological and biological factors such as emotional skills, substance use, and genetics can make people more vulnerable to mental health problems. Exposure to unfavorable social, economic, geopolitical, and environmental circumstances – including poverty, violence, inequality, and environmental deprivation – also increases people’s risk of experiencing mental health conditions”.

Further, the WHO asserts that mental health is more than the absence of mental disorders. “It exists on a complex continuum, which is experienced differently from one person to the next, with varying degrees of difficulty and distress and potentially very different social and clinical outcomes. Mental health conditions include mental disorders and psychosocial disabilities as well as other mental states associated with significant distress, impairment in functioning, or risk of self-harm. People with mental health conditions are more likely to experience lower levels of mental well-being, but this is not always or necessarily the case”.

Given the notion that mental health and well-being exists on a complex continuum, which could be experienced differently from one person to the next, the concept of neurodiversity – a collective term that recognizes an individual’s unique strengths and their challenges – is important.

According to Kendel Shepherd of Walker Morris, the word neurodiversity recognises the infinite differences in an individual’s brain function and behavioral traits – like biodiversity in nature – people experience and interact with the world around them in several different ways. Neurodiversity recognises how individuals are wired differently and how each person may move, communicate, process information, and think differently to one another. Frequently neurodiverse conditions are classed as disabilities under the UK’s Equality Act 2010. However, employers should remember that a diagnosis does not need to exist for reasonable adjustments to be made.

  • Autism and ADHD
  • Dyslexia – commonly affects learning with reading, writing, and spelling
  • Dyspraxia or DCD – disorder affecting movement and coordination
  • Dyscalculia – difficulty with numbers and arithmetic calculations
  • Dysgraphia – difficulty writing and with memory processing
  • Tourette’s Syndrome – condition causing involuntary movements and/or sounds (called tics)

The above are simply medical labels attributed to an individual to explain the diverse way in which they may behave, communicate, move, learn and/or think.

Reputational issues and social-washing risks

Moving forward, taking social value and values into account at macro- and micro-levels has an important bearing on transparency, but also regulatory perception, particularly around social-(green)washing. Social-washing can convey a false impression that a company or its products are environmentally conscious, or friendly, and social washing occurs when companies try to cover up their negative social impacts by promoting themselves as socially responsible and ethical. In effect, social washing is the practice of trading off perceived or advertised social credentials which are not reflected in the way the business operates – a failure of the ‘say-do’ principle.

According to RepRisk’s “Navigating the Wave of Greenwashing and Social washing” report issued October 2023, “Social washing takes place when companies paint themselves in a positive light by obscuring an underlying social issue to safeguard reputation and financial performance. As with greenwashing, social washing is driven by multiple interconnected factors, which can include changing consumer expectations, increased competition, and an evolving regulatory landscape”.

RepRisk tracked 1,116 social incidents globally linked to both misleading communication and a social issue over the five-year period to September 2023. Examples of social washing practices included selective disclosures, empty green claims and policies, misleading narrative and discourse, dubious certifications and labels, and corporate political actions such as workplace discrimination or occupational health and safety issues, (or externally, as with social discrimination or impacts on communities). Incidents of social washing affecting community relations were greatest in the extractive (mining) sector and relatively low in the technology sector.

The Advertising Standards Agency (ASA) in the UK has already identified several environmental claims to be misleading and other regulators such as the Competition and Markets Authority have warned businesses that they must avoid inaccurate greenwashing. With growing awareness globally and concern over several ESG issues, businesses are having to re-think the way they approach their supply chain design – with some playing safe by underplaying their ESG claims – a practice known as green-bleaching or social-bleaching. The UK joins regulators in the US, Australia, Germany, and Switzerland who are actively looking to clamp down on the practice to deter firms from effecting intentional greenwashing or social washing. Watch this space!

Dr Anthony Kirby is writing in a personal capacity and his views on this subject do not reflect those of EY. 

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