The meaning of “S” in ESG

The meaning of S in ESG

What is the meaning of “S” in ESG? The “S” is an abbreviation for the social factors in Environmental, Social, and Governance (ESG) investing. The term covers the key social factors used to measure the non-financial risks and social impact of investing in a company.

 

Social factors include a broad range of issues related to how a company interacts with and impacts its stakeholders, including its employees, customers, suppliers, and the communities in which it operates. Social factors can encompass issues such as labor practices, human rights, diversity, equity and inclusion (DEI), and community engagement and impact.

 

"S" for Social Impact in ESG​
The meaning of S in ESG

The “S” in ESG has been gaining more attention in recent years. One of the key reasons for this trend is the growing awareness among investors that companies that prize good reputations in ethics and social responsibility may be more likely to be sustainable and profitable in the long term. This is because companies that prioritize social responsibility are able to attract and retain talent, build strong relationships with their customers and suppliers, and maintain a positive reputation in the communities in which they operate.

 

 

“S” for Social Risk in ESG

 

Another reason why the “S” in ESG has become more important is the increasing awareness of social risks to companies’ profitability.

 

 

Social risks can refer to the potential negative impacts that a company’s social practices can have on its reputation and profitability. These risks can arise from a wide range of issues, including exploitative labor practices, human rights violations in supply chains, discrimination, and negative community relations. One of the key ways in which social risks can impact a company’s profitability is through reputational damage. News of a company’s socially irresponsible practices, such as allegations of using sweatshops, can spread rapidly through social media and other channels, leading to negative publicity and damage to the company’s brand. This can result in a loss of customers, reduced sales, and ultimately, lower profits.

 

 

In addition to reputational damage, badly managed social risks can also lead to regulatory and legal jeopardy. Companies that fail to comply with social and ethical standards may face fines and penalties, as well as legal action from social stakeholders and regulatory bodies. These risks can be particularly significant for companies operating in industries with high levels of consumer scrutiny, such as the food and beverage industry, pharmaceuticals, the apparel industry, and the tech industry.

 

 

An extreme example is Purdue Pharma. It faced legal action from multiple stakeholders, including government agencies, due to its role in the opioid epidemic in the United States. The company was accused of downplaying the risks of their prescription painkiller, OxyContin, and aggressively marketing it to doctors and patients. This was alleged to lead to widespread addiction and overdose deaths, which resulted in a public health crisis in the USA. Multiple lawsuits, regulatory investigations, fines and penalties led to the company declaring bankruptcy.

 

 

Social risks can also refer to risks beyond a company’s direct control, such as the risks of a pandemic like COVID 19, or a rapid deterioration in human rights and conflict in a country where a company operates. These risks can result in the abrupt closure of operations and major economic losses.

 

 

When it comes to social risk, investors want to know the magnitude of a company’s exposure to excessive social risk, and what risk mitigation systems the company has put in place. To mitigate social risks, companies must take steps to ensure that their practices align with their legal responsibilities, ethical values and the expectations of their stakeholders. This may involve implementing strong human rights and labor policies, engaging with affected communities, and investing in improving the social responsibility of their supply chains.

 

 

“S” Standards in ESG

 

Governments have set some of the most important standards for the “S” in ESG. Crucially, they define laws and regulations for labor practices in national jurisdictions and the European Union. These set rules for familiar areas such as equal opportunity, anti-discrimination, equal pay, health and safety and other important labor conditions.

 

Governments around the world also agree voluntary international norms on “S” issues. The OECD (a club for rich countries) and the UN (for all countries) have issued norms, guidance and recommendations related to social responsibility for companies.

 

For example, the UN has agreed international labor standards and the Global Compact’s Ten Principles encourage companies to prioritize human rights, labor rights, and environmental sustainability in their operations and supply chains. The UN has also developed the Guiding Principles on Business and Human Rights, which outline the responsibilities of companies to respect human rights, and provide guidance on how companies can effectively address human rights risks in their operations and supply chains.

 

Companies have also been encouraged to think about how they make positive contributions to achieving the UN Sustainable Development Goals (SDGs). A number of the global goals relate to social impact, including:

 

Goal 1 No Poverty: This goal aims to eradicate poverty and reduce inequality by promoting inclusive economic growth and social protection programs.

 

Goal 3 Good Health and Well-being: This goal aims to promote access to healthcare and support systems, in order to improve health outcomes and promote overall well-being.

 

Goal 4 Quality Education: This goal aims to ensure that all individuals have access to quality education, in order to promote lifelong learning and skill development.

 

Goal 5 Gender Equality: This goal aims to promote gender equality and empower women and girls, by addressing gender-based discrimination and violence, and promoting equal access to education, healthcare, and economic opportunities.

 

Goal 8 Decent Work and Economic Growth: This goal aims to promote sustainable economic growth and productive employment, while ensuring that workers have access to safe and decent working conditions.

 

Goal 10 Reduced Inequalities: This goal aims to reduce inequalities within and between countries, by promoting social and economic inclusion for all individuals and communities.

 

The meaning of “S” in ESG: The UN SDGs

The meaning of S in ESG

Overall, the UN’s guidance and recommendations emphasize the importance of the social and environmental dimensions of development, and provide “S” standards and principles for companies to incorporate into their ESG considerations.

 

There are also initiatives aimed at consolidating “S” standards. For example, the Global Reporting Initiative (GRI) proposes sustainability impact reporting standards for general use and for specific sectors, which includes reference to “S” issues. The Sustainability Accounting Standards Board proposes risk maps and reporting standards for specific sectors, including “S” issues. As you will see from some of the examples below, industry groups are also developing their own “S” standards.

 

 

Examples of “S” Practices in ESG
 
Combatting Modern Slavery

Modern slavery is a global issue that affects an estimated 25 million people worldwide, with many of these victims being forced to work in industries such as agriculture, construction, manufacturing, and hospitality. In response to the problem, governments around the world have implemented legislation aimed at combating modern slavery and ensuring that companies are taking steps to eradicate forced labor and human trafficking from their supply chains.

 

 

One of the most significant pieces of legislation is the UK’s Modern Slavery Act 2015. This law requires all companies with an annual turnover of more than £36 million to publish an annual statement outlining the steps they have taken to identify and address the risks of modern slavery in their operations and supply chains. The statement must also be approved by the company’s board of directors and must be made publicly available.

 

 

In addition to the UK, other countries, including Australia, France, and the Netherlands, have also implemented laws aimed at combating modern slavery. Many of these laws require companies to disclose information about their supply chains and the steps they are taking to address modern slavery risks.

 

 

Companies that fail to comply with these laws may face significant legal and reputational risks, including fines, legal action, and damage to their brand reputation. However, by taking proactive steps to identify and address modern slavery risks, companies can not only comply with the law but also build stronger relationships with their stakeholders and protect their brand’s reputation.

 

 

Some of the steps that companies can take to address modern slavery risks in their supply chains include conducting due diligence assessments, engaging with suppliers, implementing robust supplier codes of conduct, and providing training to employees and suppliers on modern slavery risks and prevention measures. By prioritizing these efforts, companies can play an important role in the global fight against modern slavery and build more sustainable and ethical supply chains.

 

Supplier Codes of Conduct

A supplier code of conduct outlines the expectations that a company has for its suppliers in terms of social, ethical, and environmental practices. This may include requirements related to labor practices, human rights, and anti-corruption and carbon emissions. By requiring suppliers to adhere to these standards, companies can try to ensure that their supply chains are more sustainable and socially responsible. Lots of multinationals corporations now have such codes. For example, Intel publishes a code, handbook and training for its suppliers.

 

Given the dominance of China as the global manufacturing hub, many supply chain initiatives have emerged that focus on promoting social responsibility in China. Many companies are now implementing social compliance programs aimed at ensuring that their suppliers in China and elsewhere are adhering to ethical labor standards. These programs typically involve regular audits and assessments of supplier factories, as well as the implementation of corrective action plans to address any identified violations. For example, Apple’s Social Responsibility Program claims to incorporate a compulsory Supplier Code of Conduct and Supplier Standards which Apple says are verified through third-party assessments in China and other supply countries.

 

Transparency Initiatives

Many companies are now implementing initiatives aimed at increasing transparency in their supply chains. For example, companies such as Walmart and Procter & Gamble are using blockchain technology to promote more transparent supply chains that allow stakeholders to track products from the source to the consumer. This can help to prevent issues such as forced labor, and can also promote greater transparency for investors and consumers.

 

Certification Programs

There are a number of certification programs available that can help companies identify and work with suppliers that meet certain sustainability and ethical standards. For example, the Responsible Jewellery Council (RJC) certifies companies that adhere to social and environmental standards in the jewelry supply chain. Another example is the  Kimberly Process Certification Scheme, which certifies that diamonds are not “blood diamonds” from conflict. B CORP certifies companies who achieve their best practice standards in ESG.

 

Labor Rights Initiatives

Companies can also work collaboratively with suppliers, industry groups, and other stakeholders to identify and address social issues in their supply chains. This may involve engaging in dialogue with suppliers to understand their practices and identify areas for improvement, or collaborating with industry groups to develop standards and best practices that promote sustainability and ethical practices.

 

The garment industry is one of the largest and most complex industries in the world, with global revenues estimated at over $2.5 trillion annually. However, it is also an industry that has faced significant challenges related to ethics and social responsibility.

 

One of the key challenges facing the garment industry is labor practices. The industry is known for its widespread use of low-wage labor, particularly in developing countries, where workers may be paid as little as a few dollars per day. In addition, there has been rampant labor exploitation, including forced labor, child labor, and unsafe working conditions. These issues have resulted in physical harm to workers and negative publicity and reputational damage for many companies in the industry.

 

A number of “S” initiatives are aimed at improving labor rights and working conditions in the garment industry. For example, the Fair Labor Association works with companies to identify and address labor violations in their supply chains, while the Ethical Trading Initiative promotes ethical standards and practices in global supply chains. The Fair Wear Foundation works with member companies and governments to promote better labor standards in the garment industry. 

 

“S” Initiatives by Investors

Investor involvement in “S” issues has a long history. For centuries, many investors have refused to invest in “sin stocks” such as tobacco, firearms and gambling, both on religious grounds and because of the harm to society.

 

These days, asset managers and activist investors often engage with company boards on important “S” issues. For example, shareholders frequently make proposals to publish pay statistics, to conduct DEI audits, or to conduct reviews of labor or human rights practices. Some investors are motivated by promoting social change, while others are concerned about mitigating social risks to profitability or promoting social opportunities that improve a company’s reputation and financial performance. In recent years, publicly-owned companies in the U.S. have faced an exponential increase in socially-motivated shareholder resolutions, from liberal groups and then more recently, from conservative groups’ “counter” proposals against ESG. No business will thrive in the middle of partisan warfare and so many of the main U.S. asset managers removed their support for ESG-related shareholder resolutions in 2023.

 

ESG products based on “S” issues are also available. For example, investors can track indexes such as the S&P 100 Gender, Equality and Inclusion Equal Weight Index, which includes companies that have high S&P gender diversity scores.

 

 

Emerging “S” issues in ESG

 

The social dimension of ESG is rapidly evolving alongside our societies, and there are a number of issues that have emerged as priorities for companies.

 

Diversity, Equity, and Inclusion (DEI): There is growing recognition of the importance of DEI considerations in the workplace, and companies are increasingly expected by activists, employees and some regulators to prioritize these issues in their ESG strategies. This may include efforts to promote diversity in hiring and leadership, address systemic bias and discrimination and unequal pay, and create more inclusive workplaces. The merits of meritocracy and equal opportunity enjoy a lot of consensus. However, at the same time, there is also a significant backlash in the USA against DEI, with detractors arguing that it is a far Left-wing or Marxist-motivated ideology that seeks to achieve the reorganization of society. Regardless of the merits of any of these arguments, DEI has become a term marred by controversy and it is not yet clear how companies will decide whether and how to walk this tight-rope.

 

Mental Health and Well-being: The “great resignation” during the COVID-19 pandemic has highlighted the importance of mental health and well-being in the workplace. There is growing recognition of the need for companies to prioritize these issues in their ESG considerations if they want to attract and retain talented staff. It is hard to find a job advertisement in a major company that does not reference some kind of mental health benefit. This may include efforts to promote employee well-being, flexible working arrangements and child care, address mental health challenges, and providing support for employees during times of stress and uncertainty. With job growth continuing, the upper hand remains with employees to insist on mental health considerations in the workplace.

 

Human Rights and Indigenous Peoples: There is growing recognition of the need for companies to effectively manage social risks related to human rights and indigenous peoples. This may include efforts to address land rights issues, promote community consultation and consent, and effectively manage risks related to indigenous peoples’ rights and interests. Failing to properly address these social issues causes reputational damage and can attract regulations and lawsuits which are costly to companies.

 

Time will tell how successful these many initiatives area. Overall, the S in ESG is a rapidly evolving and sometimes tricky and sensitive area. There are a number of emerging priorities that companies and investors should be aware of in order to effectively manage social risks and opportunities. By considering these issues, it is hoped that companies can meet the expectations of their stakeholders, and also build more resilient and profitable businesses over the long term.

 

If you found this article helpful, why not learn about the “G” in ESG too? You can  listen to our podcast about building a good governance strategy for your business. You can also learn more about the “E” in ESG in our breakdown of businesses’ environmental risks and impacts.

 

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Tags :
Community impact,Conflict,DEI,ESG Basics,Human Rights,Labor practices,Social,Social Risks,Supply chains
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