There is a world I have been discovering as of late – a world that is much wider than the Canadian “Industrial Technological Benefits” world, but one that has absolutely incredibly interesting crossovers, particularly for the publicly traded, international defence contractors that often work in Canada. This “world” that I’m referring to is called “ESG,” which stands for environmental, social and governance standards.
The ESG market has been evolving and growing rapidly over the past 20 years. The bulk of the global investment dollars in publicly traded companies are made through at least 30,000 global Asset Management Firms that invest at least $100 trillion USD on behalf of investors. Blackrock is the largest, with over $6 trillion under management. Of that $100 trillion invested, a report from the U.S. SIF Foundation suggests that by the beginning of 2018, at least $11.6 trillion in assets were chosen according to ESG standards. In other words, senior-level boards, management and investor relations teams at large, international and publicly traded companies all care about ESGs in order to drive their stock price. I believe this is the ultimate leverage for companies to make changes within their supply chains. Changes that are not too dissimilar from the way global offsets and Canada’s ITB’s have tended to be managed across the international defence industry. As hitting ESG targets throughout supply chains becomes more and more critical for companies, they will start to hit various offset objectives as well.
So, let’s break down each individual pillar of ESGs. Asset managers, analysts and ratings agencies look at a number of local and global factors when assessing a company’s integration of ESG risks and opportunities.
When it comes to the environment, the focus could be on climate change, waste, pollution, natural conservation or a poor record with animal welfare. Cruelty-free should be the norm. Going eco-friendly and green is the way of the future. Solid procurement strategies take sustainability seriously for long term returns and growth prospects. Is a company working on reducing greenhouse gas emissions? Is its product or service at risk of becoming obsolete due to limited raw materials? Does it know where it stands today, and does it have a plan for the future?
Personally, I like climate change strategies that including sourcing from more innovative cleantech businesses where possible. I believe that when companies see “environmental” as a way to save money by reducing energy consumption, we will see sustainable, long term changes. There are also examples of defence contractors that end up offering energy-related products to their government clientele. Just look at Lockheed Martin’s Energy division, which boasts services that range from energy management, storage, nuclear and bio-energy (converting waste to energy).
Social capital can drive value. When human resources are diverse, companies are better equipped to innovate and attract more customers. Companies that are better to work for also make more money – they attract talented people and improve productivity and efficiency. Social issues can include anything from child labour, slavery, occupational hazards, the effects a company has on local communities, and consumer protection. Lawsuits cost money and so does bad press.
Making sure that a company and its suppliers don’t infringe on human rights is central to mitigating risk. And it’s not just your “tier 1’s” that put you at risk: it’s becoming increasingly important to understand the lower tiers of your supply chains and who is operating there. The same goes for companies operating in regions or countries with oppressive policies. Corporate social responsibility also extends to doing more than the bare minimum. Actively improving the communities producing and using a company’s products and services reflects favourably on a company.
Corporate governance concerns revolve around transparency and organizational culture. Corruption and collusion are labels best avoided. An investor is typically thinking about the company’s accounting, gender pay equity, stakeholder relations, and how they may handle conflicts of interest.
All of these factors then get pushed down the supply chain: a company must know how their suppliers stand up against this framework.
Overall, incidents like the 2013 Savar building collapse had ramifications all the way up the ESG market pyramid. Companies, asset managers and investors have been exposed to risks they were not aware of or prepared for. This fact has encouraged the growth of supply chain sustainability assessments. Avoiding general risks all the way down supply chains is one motivator for driving ESGs in supply chain.
Another motivator is public relations. The Joe Fresh supplier building collapse in Bangladesh comes to mind here. PR clippings on companies are now being searched automatically by companies with AI techniques to determine news that may be positive or negatively connected to the corporation (it is more often negatively correlated from what I can see).
Lastly, and possibly my favourite, is the “carrot” of driving ESGs. Some investors believe that companies who have a strong handle on the wider positive environmental, social and governance benefits that their suppliers bring, are ultimately an indicator of how innovative and “high quality” suppliers maybe. This is the type of argument you hear from many international governments about sourcing from them because of offset obligations. Israel comes to mind: a country with a very high concentration of innovative suppliers, particularly in the cyberspace. Sourcing from innovative suppliers should, in the long run, give a much bigger competitive advantage to the corporation than not. So, while they may be “contractually forced” into it via offset, in the long run, it should be quite beneficial to them.
This is ultimately a multi-dimensional approach that recognizes the triple bottom line. When people and planet are dealt with morally, profits follow. After all, trust and a good reputation have always meant more dollars. As a new generation of selective investors and customers comes of age, organizations lagging in this area will feel the negative effects. But it’s not just the court of public opinion that needs attention. It’s the inherent risk to equity value when the prevailing conditions for doing business are not sound. There are practical advantages to making changes beyond fiduciary duty and compliance with government regulation. But more often than not, it means a business model overhaul that begins primarily with re-evaluating procurement.
My advice to big, global, publicly-traded corporations is that they should think about the merging of their global offset strategies alongside their ESG strategies. It could be a win-win that ultimately supports companies’ bid/capture and keeps sold strategies (i.e. global offset strategies) with driving maximum equity returns for shareholders. I am certainly excited about what is to come in this space, especially as it transforms relationships with suppliers around the world, incentivizing procurement from companies that can demonstrate who their suppliers are and the long term environmental, social and governance implications from sourcing from them.