Over the past ten years, environmental, social and governance (ESG) issues have moved from the fringe to the centre stage – both amongst emerging market focused private equity investors and amongst businesses themselves.
These issues have emerged as a material concern as result of various factors – including the need to manage reputational risks associated with investments, opportunities to boost the value of investee businesses through proactive approaches to labour relations or energy efficiency, and the benefits of better corporate governance. And underpinning this is a growing number of international standards, covering environment, social, human rights, governance and business integrity issues that define good business practices.
So how is this playing out across a broad and complex set of investors and businesses?
Firstly, at the company level, good ESG practice is moving from being a philanthropic and often marginal corporate social responsibility activity to a more strategic issue. Depending on the industry sector, scale of operation and location, businesses are recognising that ESG performance is an important factor in their success. It affects access to markets and capital, staff productivity, as well as operating margins and costs.
Of course, this is all happening in the context of increased pressure on global brands to demonstrate their responsible behaviour. The recent example of Adidas cutting business ties with 13 of its Asian suppliers following non-compliance with the company’s workplace standards, is just one example of that.
Social media and smart phones are also playing their own role in creating pressure and change. In a world where it is very easy to take and share a photo documenting working or environmental conditions, it has been possible to raise the global profile of issues that affect people who previously didn’t have a voice.
Finally, private equity funds are increasingly expected to demonstrate that their investments satisfy the requirements of their investors, many of whom have adopted responsible investment criteria (such as those championed by the UN Principles for Responsible Investment, which influences over US$59 trillion of investment across public and private equity).
However, whilst global standards have been established, and awareness amongst investors and businesses about the importance of these standards is increasing, the pressing question is how these standards can be met in emerging markets. Both investors and businesses want to know how they can translate global standards into something that feels relevant and tangible at a local level.
This is no easy task, and businesses in emerging markets face barriers in making this a reality. At CDC, our experience as a long-term responsible investor has provided us with insights into these challenges, as well as the benefits that good ESG performance can generate. One of the key areas we focus on is labour practices. In part this is because we are a development finance institution and creating good quality jobs is core to our mandate. But equally, because of the consistent and clear evidence across all industry sectors and scales of operations that if you treat employees well, protect their safety, improve their livelihoods and economic well-being, you have a more productive and committed workforce. Some companies now see this, others are learning, and the next challenge is to rollout this mind-set across third party contractors and supply chains – which admittedly, is no small task.
CDC is increasingly being asked for practical guidance on how best to implement these global standards, given the challenges that investors and companies face at a local level. That’s why we’ve recently published an updated toolkit for fund managers, to help them assess and manage ESG risks, and to make improvements to benefit the business.
On the positive side, there is growing evidence that responsible investment and responsible business can lead to improved business performance. Beyond the labour practices case above, there are a range of other opportunities. For example, more efficient use of resources such as energy and water and reducing the cost of doing business by eliminating bribes and facilitation payments can all be closely linked to improved business performance.
Vlisco, a company which designs, manufactures and distributes fabrics across West Africa, highlights how responsible practice can lead to improved business performance. The company has made a strategic decision to build a sustainable and localised supply chain, with good labour and health and safety standards. On the development side, there has been a positive effect on local communities as the company has provided employment opportunities to underprivileged women and delivered training to local communities. These changes have also had an impact on business performance too, as a localised supply chain has improved its operational efficiency and reduced costs.
The adoption of globally recognised standards can also improve business performance, as a result of cost savings from better use of resources, access to broader markets, and increased staff productivity. One example is the Forest Stewardship Council (FSC) certification, which certifies forests all over the world to ensure they meet the high environmental and social standards. One of CDC’s investee companies, a forestry business in Uganda, recently decided to adopt the FSC framework. As a business which supplies the local rather than the international market, this decision was not due to demand from its customers to become certified, but because the framework could help it to become more efficient in the way it manages its business – including its approach to environmental management, community relations, and worker training.
These examples demonstrate that, despite the real challenges that come with implementing good standards for responsible business in developing countries, when it’s approached strategically, the impact can be significant.
