END of ESG

END of ESG

Introduction:

Depending on whom you speak with, ESG is either touted as the sole solution for companies to contribute to a better planet or dismissed as a mere distraction from more pressing issues. The truth likely lies somewhere in between. Sustainability is not a new concept for companies or individuals. We have historical records dating back to the 1800s that discuss the importance of sustainable practices. The oil of today was once called blubber, and the rise of the modern oil and gas industry was essential in saving a species from extinction. What we are trying to emphasize is that ESG or Sustainability has been older and usually moves with the way we as a society have evolved and hence our priorities keep shifting. This illustrates how ESG and sustainability have evolved alongside societal priorities, shifting focus from social issues like worker rights to environmental concerns and, more recently, corporate governance.

In the aftermath of the recent US elections, ESG has become a subject of intense debate, with both supporters and critics present across various industries and academic circles. While some criticisms are valid, the tendency to paint ESG with a single brush, either as entirely good or bad, hinders constructive dialogue. This polarization often leads to a disconnect between the ESG commitments made by companies and governments and their actual actions.

Let's examine the framing of ESG in the context of the US elections. Two key themes have emerged that have fuelled scepticism about ESG: the promotion of trade tariffs under the guise of industrial localization and a renewed emphasis on traditional fossil fuel industries.

The most significant changes will come in the form of industry localization, which is normally done so operations can be more efficiently managed without relying on globalized supply chains, be it easier access to local resources, or safer management practices.

For instance, the state of Michigan is often called the American hub for automobiles for a number of reasons, including its centralized location making shipment easier. Going forward, new and emerging businesses will look to replicate this same model, prompting those all over the world to follow. And looking through the lens of ESG, there are some key benefits to be found.

In this paper, we have tried to build up the context of a few areas where there could be benefits to ESG and other areas where we will see significant challenges.

Positive 1: Resilient Supply Chains

Since the advent of globalization, companies have invested endless resources to optimize their supply chains, with the objective of having the lowest operating costs. This has led to major changes in industry with traditional industries moving from Europe to Asia, which provided significant arbitrage with lower cost of capital, cheap labour and endless subsidized land. Over the last 10 years, this has led to pushback with the EU and USA. A lot of policies being decided in these regions are also reflective of this. If the US style tariffs are meant to bring jobs back to the USA, the EU led CBAM and proposed carbon tariffs are as much about improving the competitiveness of local production as it is about reducing the carbon footprint of products.

One immediate benefit is how their industries can be better protected from global disruptions. The COVID-19 pandemic is the perfect example of a recent global event that disrupted every industry, halting the flow of material, causing delays in production. Localizing their supply chains was one of the ways organizations were able to navigate through the pandemic, since they were able to be in a better position to ensure full transparency.

But even without the pressure of such large-scale global disruptions, localized supply chains should still have increased transparency due to fewer actors enabling closer relationships. Since most materials are from local regions, this should allow for controversy-free material sourcing. The closer proximity to suppliers and workers should also enable better monitoring of working conditions and labour practices, which helps in creating safe work environments by identifying high-risk areas and prompting mitigation practices, saving penalty fines and damage costs. And since there’s fewer players, there can be added measures in place for data protection and privacy.

Positive 2: Reduced emissions from logistics

Logistics as an industry is going to have emissions. A true Net-Zero supply chain does not exist. We would go as far as to say that “The cleanest shipment is one that does not have to be shipped at all”.

In an industry where margins are wafer thin, the only incentive for innovation especially in clean technologies is in reducing the cost of transport. Alternately we need to therefore look at how the overall distance in shipping is minimized. This is where the linkage with GHG emissions and how optimization of one can lead to reduced shipment costs makes sense.

When discussing GHG emissions, the first step is figuring out how to track and calculate them, which helps in setting decarbonization strategies in place. With the new policies of having industries be localized, there will normally be fewer actors involved than in a globalized one, cutting down the distance travelled, and conserving both time and resources. This automatically reduces the GHG emissions for the logistics sector, which contributes 11% of all global emissions. Data collection and analysis will be easier as this practice enables closer connections between the relevant parties, yielding more precise results that could lead to better and more informed decision making on what to improve upon.

This also has a direct impact on manufacturing, which contributed to about 12% of America’s GHG emissions in 2021. From an ESG perspective, one of the most significant improvements will come by way of more optimized production cycles, which should make measuring ESG metrics easier. With decreased outsourcing, materials could move at a faster rate, especially if they are in closer proximity to their primary raw materials. This allows for better allocation of money, labour, and time, improving precision and implementing more quality checks to reduce margin of error. All this contributes to a manufacturing cycle that should deliver higher quality products in a shorter timeframe. In theory, this will significantly reduce waste production, energy demand and consumption, as well as the carbon footprint of their products, offsetting their GHG emissions dramatically.

Positive 3: Local Development

The new policies might pave the way for more Small-and-Medium Enterprises (SMEs) to develop at a faster rate. This can mostly be attributed to reduced legal regulations, since the new changes eliminate the worry of international disputes to focus solely on domestic regulations, allowing for safer and more ethical operations. Simplified regulations can be a win-win for both businesses and governments, as businesses can allocate more resources towards innovation, R&D, and strategic partnerships, leading to new products, services, and technologies that can improve people's lives and drive economic growth, while governments can streamline bureaucratic processes and reduce unnecessary red tape to focus on developing policies that support business growth, attract investment, and create jobs.

But there is a downside to this. If an industry is too localized, it could create a lopsided economy where only a handful of regions develop while others are neglected, as well as heightened dependency on that particular region upon the industry, making it extremely susceptible to collapse, in the event the industries shut down.

And here’s where we get to the challenges of the new policies, because for every action, there is an equal and opposite reaction: a law of physics as well as life. Looking at it from the lens of ESG and Sustainability, we can see there are definitely areas where America’s new policies will negatively affect the world, and in serious ways.

Challenge 1: Pulling of Diversity, Equity and Inclusion (DEI)

America has always been a hub of diverse cultures and people, always co-existing, but not in harmony. Decades of civil rights movements, the overturning of Roe vs Wade that took away abortion rights, and most recently, Walmart announcing their pulling of DEI initiatives. All this underscores the obvious: we’re not there yet.

This isn’t a failure of DEI as a whole, but rather its misuse by people as just a checklist, which breeds tokenism – putting on a show of inclusivity, rather than actually putting in the work. And the work can only be put in through that last 2 parts: equity and inclusivity. Diversity is just having a group of people from diverse backgrounds and personalities in one place, while equity is ensuring fair opportunities, and inclusion means creating an infrastructure where they feel valued at all times.

At the risk of getting too preachy, DEI works best when approached as a constant, consistent effort. This leads to more natural investment and attraction by creating a space at every level from top management to ground-level, for meaningful exchange of ideas, encouraging new solutions and approaches. It’s only through this that DEI can be used to its fullest as a proper metric for growth. A Harvard Business study found that with diverse leadership, teams are 19% more likely to achieve above-average profitability. Probably, a key challenge to improving DEI, is that while there are several studies touting improved DEI to innovation and other metrics, not much analysis has been done on the direct contribution of DEI to the P&L of the company. We believe that companies will invest in DEI if they feel that DEI can help them engage better with their target segment or learn on how to improve their customer interactions.

Challenge 2: Climate breakdown

As mentioned earlier, 2024 is the first year that passed the 1.5oC mark set forth by the Paris Agreement, and subsequent years are estimated to cross this figure as well. Any further GHG emissions will only worsen this already precarious situation. So, while America’s localized industry means that the country’s overall carbon footprint could decrease, that of a select few areas will likely increase drastically. And this has dire consequences.

In 2023, America experienced 28 natural disasters that each cost $1billion dollars or more in damage, setting a new record, and this year so far has seen 24. While not all of them were climate-related, studies have shown that a person born in North America after 2020 will experience more climate hazards in their lifetime than those born in 1963. Additional studies have shown that the world’s natural carbon sinks, namely the oceans and the forests, weren’t able to absorb any carbon dioxide in 2023 because of 2 key reasons:

●       Increased rate of GHG emissions weakening their ability to absorb carbon dioxide

●       Current predictive models not factoring in the impact of natural disasters like forest fires, that add to the carbon cycle

This has caused the total emissions of countries like Finland to remain unchanged, despite them changing their practices that reduced their emissions rate by 43%. These changes are regional, and it hasn’t affected America yet. But this isn't cause for celebration, and since forest fires and hurricanes are caused by elevated temperatures, the frequency of which has been increasing steadily, their government must take decisive action.

One or two years that exceed 1.5oC does not automatically render any climate relief efforts meaningless, and it here that ESG needs to adapt the most, evolving from reporting statistics to a tool that can leverage said statistics to form improvement strategies. China is a good example of this. In the early 2010s, some of their cities once occupied the top spots in the world’s most polluted lists. In response, they employed several practices, including a nationwide monitoring system able to calculate their country’s air particulate content. By making this data public, everyone was able to understand and make the necessary changes, whether that is phasing out old, polluting cars, or shutting down industries that exceeded the emissions limit. As such, by 2021, their pollution rate decreased by 43%, extending the average citizen’s lifespan by 2 years. So, instead of spending billions of dollars every time a natural disaster occurs, implementing such measures right away can help avoid such high spendings.

Challenge 3: Changes in Global Aid

Between 2017 and 2023, 43% of the World Bank’s climate fund disappeared, and recently, Oxfam reported that $24–41 billion dollars of climate financing went “missing”. This was supposed to be used for addressing climate crisis around the world by:

●       Building renewable energy infrastructure in vulnerable regions.

●       Supporting communities to adapt to climate-induced disasters.

●       Funding initiatives to reduce carbon emissions globally.

●       Protecting ecosystems vital to climate resilience.

While we cannot prove whether this was accidental or not, these situations do reveal how reliant certain sections of the world are on more developed countries to meet their targets, and sometimes even their basic needs. Prior to 2017, the American government was scheduled to donate $3billion to the Climate Green Fund. Only about 1 billion was able to go through before the rest was cut off following the 2016 election. This was followed up by a withdrawal from the Paris Agreement. And with the same government now back in charge, history is likely to repeat.

Both situations jeopardized and crippled any efforts made towards global aid, and highlights the failure of accountability and transparency, either intentionally or otherwise. Such sensitive and large amounts of capital must be handled with utmost care, and ESG must evolve to do so. This is important not just to ensure such money gets to where this is supposed to, but especially for directing them towards helping the underprivileged of the world, ensuring their communities don’t get destroyed.

CONCLUSION

For all the guesses and predictions we can make, it is impossible to predict the future. But we know one thing for sure: ESG and sustainability must look to adapt if it means to have a say in what’s to come. And to do that, we must look at ESG from the nuanced lens that it deserves. Each of us looks at it from our own subjective vantage, and this will include our morals and bias. In all probability, the only metric that can explain sustainability is an economic lens. Data coupled with this understanding will probably be the next step ESG has to take from being a niche product to a universally accepted framework for Risk and Performance. And we at Impactree will continue to do just that. Not through polarization and hyperbole, but through reason and understanding.