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It pays to be responsible environmentally, socially and in governance

Words:
Brian Green

It is the financial imperative rather than high-mindedness that is driving greater economic, social and political responsibility among corporations. Brian Green explains

No firm is an island when it comes to Environmental, Social, and Governance reporting as each one is responsible for the actions of its supply chain, though to subcontractors and suppliers.
No firm is an island when it comes to Environmental, Social, and Governance reporting as each one is responsible for the actions of its supply chain, though to subcontractors and suppliers. Credit: Shutterstock

There is a tendency common among leaders in construction to over-emphasise the potency of technology and under-estimate the power of social, economic, and political factors when considering what drives change.

This is to be expected. The higher education of many industry leaders will be built on a foundation of natural sciences, applied mathematics and mechanics. The beauty of mechanics is that its use of assumptions cuts away nuance, leading mostly to tidy solutions that align closely to the real world. Any errors in the fit are easily fixed by applying, for instance, safety factors.

But ignoring nuance and messiness when it comes to people is a mistake, especially for those tasked with creating the built environment. Physical structures, such as building and infrastructure, just like social or organisational structures, are created primarily for the benefit of humans. They seldom behave consistently as physical matter such as steel or concrete might.

Social change

Why is it important to appreciate this? Well, because a huge wave of change is confronting the construction sector that is not easily fixed by technology. At its heart this change is economic, social, and political.

This change comes with three initials, ESG – Environmental, Social, Governance. In many ways it is a repackaging of old ideas generally understood by three other initials – CSR, Corporate Social Responsibility.

But ESG is, potentially at least, an upgrade. It is underpinned by metrics, so nods heavily towards positivism, mathematics, and the rigour of natural science. Firms will be obliged to prove their worthiness rather than feel their duty is done by providing a few highlighted good deeds publicised in greenwashing articles in annual reports and glossy brochures.

Importantly too, its force emanates largely from the financial community rather than simply political or social pressure. And, to reframe the cliché, it is advisable to follow the money. If you are not given to unthinkingly following the money, then it is worth noting that ESG also has powerful backing from a raft of major international and non-governmental organisations.

With the financial sector pushing socially positive changes, governments will find it easier to back those changes with regulation and legislation.

ESG is not brand new, it has lurked around for a decade or so. But recently interest has exploded, as Chart 1 shows. The rise in interest among google search users is huge, not just in the UK but globally. The growing interest seems to coincide with two likely prompts – the pandemic and the lead up to COP26. But it would be brave to suggest that this is a passing fad. Talk to 20 executives running major business and they are likely to say otherwise as they increasingly invest in people and resources to underpin their ESG credentials.

Many architects will be conversant with ESG. Many will be cheering its progress having been aligned with the underlying principles well before the initials ESG cluttered corporate speak or became a hashtag on social media.

Some, possibly among those employed within large practices, may even be wearied by the deep investigation of purchasing and processes that the non-financial accounting of ESG demands. Others may be puzzled and concerned over how they should embrace this fast-moving trend and what they need to do.

While the adoption of ESG is one thing, its wider implications for construction another. These go beyond how many firms and individuals sign up for ESG and the potential good this means to humanity. They go beyond developing ways to positively influence climate change, inequality, LGBTQ+ rights, recruitment, human rights or how they provide transparency throughout their business affairs.

Keep with the programme

The consequences of embracing ESG creates potential for a major shift in construction industry structure and business relationships. It will also affect what is built, why, by whom, and in what way.

That at least is one message from a report prepared by Barbour ABI for this month’s UK Construction Week. It suggests that firms that do not embrace ESG may find themselves out in the cold when it comes to dealing with clients that have wholeheartedly bought into it. This could in effect create a two-tier system within the supply chain, with good ESG credentials acting effectively as a licence to trade with many large clients.

The report highlights the remarkable speed of acceptance of ESG into management given the long history of corporate social responsibility, which is generally seen as having emerged as a concept in the 1960s. The report also points to how ESG could profoundly alter the culture within the industry, reshaping relationships along the supply chain and disrupting existing business models.

It highlights that the immediate pressure for major firms to adopt ESG as a means of quantifying their sustainability credentials is now coming more from financial institutions and investors than from political demands. Financial institutions see ESG in terms of measuring and managing risk. For instance, insurance business, with twin roles as both insurers and investors, will see ESG as a way to make their investments more secure while reducing the potential losses that would flow from social, corporate, and environmental failures.

Like other investment funds, they also see a growing demand for ethical and socially responsible investments. This has led to a mushrooming of ethical investment funds which comfort investors with proof rather than ‘greenwash’. Also, the range of business types that are engaging has created a proliferation of measurement frameworks used to gauge businesses on their governance, social responsibility and environmental impact. This is to be expected as the world of ESG is still in its infancy, being tested and evolving. But the bar of proof is increasingly being raised.

It is easy to become overwhelmed by the various frameworks and metrics available and with agencies such as Moody’s, S&P, and Fitch also providing ESG ratings. But increasingly, resources are emerging to assist. ESG Book, for instance, has been created by a global alliance of financial and other institutions as a free-to-use resource to bring more accessibility, comparability, and transparency to the world of ESG.

Today businesses that are looking for easy access to investment and to attract a wider pool of shareholders have major incentives to respond to the ESG agenda. This involves creating systems for non-financial accounting and using these to improve their performance against ESG measures alongside traditional financial accounting. This is increasingly determining the level and quality of investment available to them.

But ESG is not all about collating data for the sake of it or as evidence of virtue. The measurement of non-financial metrics is seen as beneficial in understanding and improving the overall performance of a business. Indeed, the evidence points to a correlation between good ESG and good financial performance. This too is exciting investors.

Read carefully

To gauge the speed of change within the built environment sector for its report, Barbour ABI measured the use of key words in annual reports. These increasingly elaborate documents are created by company management to project the agenda they seek to pursue, both to shareholders and the wider world. The words chosen by executives and their advisers in annual reports provide an insight into the collective minds of the management. The frequency of key words reveals much about the aspirations and thinking of any given company and what they see as important to project to their audience.

Barbour ABI measured the appearance of more than 30 key words relating to ESG in the latest 11 annual reports of around 40 public listed companies active in the built environment, including contractors, house builders, clients, and investors.

This measurement of key words in annual reports illustrates how fast ESG has emerged, as Chart 2 shows. But it also illustrates the difference in timing of rising interest between different groups, reinforcing the view that the primary prompt comes from the financial sector. When interest in ESG began rising three years ago, investors and developers appear to be the first to respond, followed house builders who have a far closer relationship with financial markets than contractors. The latter appear to have seen most growth in interest a year or so ago.

The process of ESG, however, demands that any action a business takes needs to be considered. It cannot subcontract out its responsibilities. No firm is an island when it comes to ESG. It is responsible for the actions of its supply chain. As ESG spreads, more attention will be paid to subcontractors and suppliers. They will need to produce the metrics and assurances to their clients.

This will involve both rigour and trust. This will almost certainly force a rethink of relationships and structure of the industry. Contributing her thoughts to the report, Ann Bentley, global board director at Rider Levett Bucknall and a member of the Construction Leadership Council, believes this could lead to a two-tier supply chain within construction, and possibly three tiers, with an elite cohort of firms in the upper tier.

That suggests a potential split – between those firms that engage with ESG forming much tighter bonds where quality and performance trump price, and other firms, many operating in the repair, maintenance and improvement sector, which work with perhaps less attention to ESG and more on winning on price.

In other industries moves to drive ESG deeper into the supply chain are under way and the pace is likely to accelerate. In April US motor manufacturing giant General Motors, as part of its ESG drive, asked its whole supply chain to sign a pledge. It was to commit to ‘achieving carbon neutrality for Scope 1 and 2 emissions and confirm they have advanced management systems in place for labor and human rights, ethics and sustainable procurement practices through a third-party assessment by EcoVadis’.

As a casual conversation or a show of hands at any construction conference might reveal, the understanding of ESG among smaller businesses within the supply chain is low. For many there may be trouble ahead as they rush to get their houses in order.

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