Nathan Fabian, Chief Responsible Investment Officer, PRI, says investors should undertake systematic scrutiny of the potential ESG drivers and consequences of conflict.
It’s been over two weeks now since the world woke up to the news that Russia had invaded Ukraine. In that time, we’ve watched with profound concern a human crisis unfolding. The human cost of the war is horrifying, with over three million displaced, thousands killed or injured and neighbourhoods destroyed.
This loss of life and communities is devastating. The PRI joins with people around the world in deep compassion for all who have been affected.
And while this is a regional attack, it is fundamentally a global issue – with broad reaching implications for global markets and international relations.
ESG frameworks and inter-state conflict
Geopolitical risk and inter-state conflict have traditionally been treated as risk factors for emerging market allocations within asset allocation strategies. But the prospect of a less stable international order will change investors’ outlook on environmental goals, energy policy, human rights and global governance. ESG frameworks and analysis can help make sense of the world investors now find themselves in and guide their actions in the months ahead. In addition, responsible investment can help investors navigate the urgent questions in front of them today.
Are geopolitical risk and inter-state conflict risk ESG issues?
Since the end of the Cold War, the accepted orthodoxy in international affairs and markets was that interdependence of economies and trade were positive forces for international stability and the orderly distribution of wealth. Now with war in the east of Europe, where economic inter-dependence, especially in energy, becomes leverage in a strategic conflict, investors will need to reassess.
The massive sanctions introduced by Western governments in response to the conflict have abruptly forced a new approach to Russia. The question over whether the prospect of economic and financial disruption in response to international conflicts should be anticipated and tracked through ESG frameworks will now receive much more attention.
It is easy in hindsight to say that ESG frameworks should include international conflict and retaliatory sanctions as investment risks as a matter of course. 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.
The key question arising for investors now is whether the world is entering a period of geopolitical disruption and what should be done in terms of managing investment risk in potential hotspots, and separately whether these might lead to wider regional or global conflicts.
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.
What ESG consequences arising from the conflict should responsible investors address?
Conflict between nations is not under the direct influence of investors, but there is still much that investors with an ESG approach can do in relation to drivers and consequences arising from armed conflict. These include multiple ESG factors, from energy policy, to human rights, to corruption and global governance.
The human cost of war is staggering, not only in Ukraine, but also in conflicts such as those in Syria, Yemen and Kashmir. By the end of 2020, 82.4 million people were forcibly displaced by conflict, hunger and desperation around the world.
The severe impact of the Ukraine conflict will raise it to the top of investor priorities on human rights. Whether investors are connected via sovereign debt holdings, or exposure to companies with operations or links to the territories now affected, they now will be expected to conduct due diligence with heightened attention to magnified risk and social impacts. Given the constantly changing landscape of impacts, investors may complement company information using analysis from the UN, civil society, and human rights organisations delivering insights from the ground.
There are also far-reaching consequences for energy and climate policy. In the near term, the imperative to reduce dependence on imported natural gas is likely to require the utilisation of all available energy resources. Yet, in the mid-to-longer run, the national security co-benefits of the shift towards net zero are powerful new drivers for accelerating this transition.
Weak governance, lack of transparency, corruption, and allowing money to be cycled through financial capitals without sufficient controls are potential contributing factors to this conflict. They all facilitate abuse of power which can fuel disputes and the decline of democratic institutions.
Responsible investors have a key role to play in the fight against corruption. They can seek to reinforce international norms such as the United Nations Convention against Corruption and align with frameworks including the UN Global Compact 10th Principle and the ICGN Guidance. They can also be prominent voices in global efforts to tackle illicit financial flows and secrecy jurisdictions, including the lack of beneficial ownership transparency.
These are all essential areas of focus for ESG investors. Now that the conflict is underway, responsible investors are also grappling with what else they should do now.
What should responsible investors do now?
The immediate decisions of the Russian government are not likely to be influenced through many of the tools traditionally used by responsible investors.
The scope for stewardship activities with Russian corporations are clearly limited, as is the influence of these companies on their current government. Direct policy outreach to an aggressive authoritarian government is unlikely to bring an immediate result either. Under these circumstances, investors may be forced into more definitive positions on their one remaining lever, to change their risk weightings and withdraw or withhold investments. If done at scale and collaboratively, this can be powerful.
Responsible investors have a duty to incorporate ESG issues into investment decisions. The ongoing war has huge impacts on people, but also on the environment, and is a major breach of international governance1.
The war presents challenges not only from an investor duties perspective, from sustainability outcomes and goals perspective, but also from an ethical point of view. On Russia, investors can change their investment view now that the evidence has changed.
A decision-making hierarchy that investors could use now, beyond the requirement to observe government sanctions is:
- What do my clients, beneficiaries or stakeholders expect of me in countries that use force against the territorial integrity or political independence of another state?
- Could my investments exacerbate conflicts directly or indirectly?
- Should I avoid future investments that may support aggressive authoritarian governments?
- Which ESG consequences arising from the conflict should I assess, prioritise and respond to (including human rights, climate and energy, maintaining global governance and institutions)?
- Will I need to make changes to my investment approach to maintain my sustainability commitments?
By using a responsible investment approach, investors can make the short-term decisions to navigate the current conflict. ESG frameworks can help us build a wider framework to address the drivers and consequences of conflict and their impact on sustainability.
In the coming days, the PRI will share further reflections on the role of investors in conflict via a series of blogs, as well as facilitate signatory dialogue to hear signatories’ experiences and actions they are taking via a webinar.
This article was originally published by the Principles for Responsible Investment.