The response of corporates and investors to the invasion of Ukraine suggests both need to overhaul their due diligence processes.
More than 500 multinational companies have withdrawn from Russia following its invasion of Ukraine last month. Yet far from representing a calculated mass exodus, evidence suggests a more haphazard scramble for the exit.
A list of companies with interests in Russia compiled by Yale Professor Jeffrey Sonnenfeld shows that in the week commencing 28 February, only several dozen companies had announced their departure. The huge subsequent increase in withdrawals followed a series of social media campaigns to highlight the reluctance of some international companies to disband their operations.
PepsiCo, which has 15 subsidiaries in Russia and is ranked by Investment Monitor as the sixth most exposed company to the conflict, took until 8 March to suspend its operations. The beverage company endured a sharp fall in its share price since the start of the conflict when it was at US$168.38, bottoming out at US$153.73 on 11 March, climbing back to US$169.76 on 1 April.
Heading for the exit
PepsiCo is just one of many corporations – see also McDonald’s, Starbucks, Société Générale and Renault – that delayed their exit from Russia, not only forcing a drop in share price, but also continuing to contribute to the coffers of an aggressor nation.
And it is not just corporates that are distancing themselves from Russia. Asset owners are getting out, too.
The National Employment Savings Trust, which looks after the pensions of millions of auto-enrolled workplace savers in the UK, quickly announced it would start to pull its investment from Russian stocks, while the Church of England Pensions Board is putting pressure on companies with Russian exposure – such as TotalEnergies – to pull out or face a sell down.
Meanwhile in the asset management sector, Legal & General Investment Management said it would divest from Russian sovereign debt and the manager has reduced total exposure to 0.1% of AUM or £1.3 billion.
DNB Asset Management has fully divested of Russian shares; abrdn has been reducing its Russian exposure since January, but still has £2 billion in holdings, representing 0.5% of AUM.
A report from US investment bank Jeffries says: “The [Russia/Ukraine conflict] has thrust social factors to the top of the agenda almost overnight, and ESG investors are grappling with highly political considerations, for example the importance of democracy and the rule of law.
“We suspect that ESG-focused asset managers will be driven largely by the desires and actions taken by their clients. In turn, asset managers will expect corporate responses to align with the level of action they have taken.”
Too little, too late
For some commentators, however, the drawdowns from Russia come rather too late and do not reflect a suitable amount of ESG due diligence.
Julia Otten, Policy Officer at law firm Frank Bold, which focuses on raising awareness for companies’ environmental and social risks, says: “We can see, not just from the example in the current Russian invasion of Ukraine but more generally, that companies are not yet paying enough attention to conducting proper due diligence. Otherwise, we wouldn’t have seen such last-minute, cut-and-run scenes, but EU companies would have scrutinised their business relationships in Russia from an environmental and human rights perspective, especially with the Russian state-controlled companies.”
James Lockhart Smith, Vice-President of Markets at ESG ratings provider Verisk Maplecroft, says the late departures demonstrate a lack of robust ESG process.
“It’s not just money sovereign emerging market asset managers have lost because of Russia’s invasion of Ukraine. With stakeholders and observers asking why funds were significantly exposed to Russia in the first place, the credibility of their overall ESG commitments has also been thrown into sharp relief. “
David Wille, Principal Analyst of Financial Sector Risk at Verisk MapleCroft, adds: “This miscalculation doesn’t entirely land at the managers’ feet though. The capital markets ecosystem as a whole was drastically wrongfooted by the war, as shown by a slew of retrospective reassessments of Russia by banks, ratings agencies and index and data providers.”
With many providers of sustainable investment solutions looking compromised, recent events present what Matt Vogel, Head Strategist at emerging markets manager FIM Partners, calls a “much-needed wake-up call” for the investment community, particularly the biggest managers.
“The very large managers have to be exposed to everything, which means they might not be doing ESG with integrity. It is difficult to do it in an authentic way and do it properly at that size.”
Since conflicts, human rights and social risks are not confined to Russia and the spill over effects from the war – notably the exacerbation of the global food crisis thanks to the impact on grain supplies – will be felt profoundly for some time to come, Vogel says managers and asset owners will need to improve their due diligence.
“There were clearly advanced warnings about the risks of investing in Russia. I wouldn’t say [managers] were looking the other way, but it comes back to checking the integrity of all the billions of positions to which you’re exposed. Asset owners will need to ensure their managers are not using a simple quantitative framework to assess ESG risk and going about it in a passive way,” he says.
Improving the ESG ecosystem
Efforts to reinforce due diligence by corporates include the European Commission’s planned adoption of a proposal for a Corporate Sustainability Due Diligence Directive, details for which were released this February.
The Commission says the legislation “would help companies to better manage sustainability-related matters in their own operations and value chains as regards social and human rights, climate change, environment”.
According to Otten, the new rules, which the EC says will ensure businesses “address adverse impacts of their actions, including in their value chains inside and outside Europe”, are sorely needed.
However, during a consultation period which ends on 23 May, Otten would like to see the Commission do more to align with the UN Guiding Principles on Business and Human Rights.
“The due diligence obligation, which is at the heart of the directive, should be aligned with UN Guiding Principles and the OECD Guidance that have already developed as a standard. We want to see the scope [of the directive] broadened to make it more risk-based so that companies understand their entire operation including supply chains.”
To better enable companies and investors to assess human rights and social risks, particularly in times of conflict, it requires high-quality ESG data and enhanced ratings.
In a recent blog, Nathan Fabian, Chief Responsible Investment Officer at the UN-convened Principles for Responsible Investment, said: “Some ESG data providers have been issuing warnings on Russia since the annexation of Crimea and again in the weeks before this invasion, especially those focussed on controversy monitoring and market sentiment. But equally, political risk and international conflict were not being systematically assessed as priority issues using an ESG lens.”
He added: “If ESG is to be the framework used for assessing these non-financial risks, then a wider and systematic scrutiny of potential ESG drivers and consequences of conflict is likely to be needed.”
There is evidence of improving range and sophistication in the tools used to assess corporate ESG-related behaviour and performance. A number of these use innovative technologies and methodologies to provide new insights into firms’ governance and decision-making processes.
EthicsGrade, for example, rates and scores companies on technology governance, with a particular focus on artificial intelligence (AI). The firm uses multiple data inputs to analyse the way social media platforms drive behaviours and opinions, but also how social and governance issues interact with decision-making across sectors. This can be particularly significant when information is an integral part of modern political conflict.
Charles Radclyffe, Partner at EthicsGrade, says: “We are trying to understand how mature corporate governance is around digital strategy. When that digital strategy goes wrong it can be very damaging.”
Radclyffe points to Nestlé, which had a large exposure to Russia and subsequently suffered a 10GB data leak of commercial information. The leak was attributed to hacker group Anonymous as punishment for continuing to do business in the country, although Nestlé denies it was hacked, claiming it accidentally leaked the data itself. Nevertheless, the reputational damage was significant.
“If I was another company with exposure to Russia that was named in shame by a hacking group, then I would probably be thinking quite carefully about what I am going to do next,” Radclyffe says.
Businesses’ and investors’ scramble for the exits in the wake of Russia’s invasion of Ukraine suggests that due diligence by both remains shaky. Efforts to enhance the regulatory landscape and a growth in data analysis and tools cannot come to soon if asset owners are to avoid nasty surprises in future.