ESG and the risks of digitalisation

Charles Radclyffe at EthicsGrade argues that technology might not be the universal force for good it has always assumed to be and contends that businesses need to understand sustainability risks stemming from their supply chain

 

It wasn’t that long ago, in 2016, that Facebook founder, Mark Zuckerberg, was hauled in front of Congress to answer questions about the Cambridge Analytica controversy: Facebook had been accused of colluding with a start-up allegedly paid to manipulate voters, something with the potential to change the outcome of elections around the world. Technology was seen as something that could be a force for harm as well as good.

 

For big tech, 2016 might be the equivalent to 1985 for heavy industry: the year the ozone layer hole was discovered. That was the year when we were shown that the industrial era wasn’t without existential consequence. 

 

The social harms of big tech are clear, thanks to the Cambridge Analytica controversy. But what of the environmental harms? Is digital technology really a factor in ESG factor?

 

The growth of ESG

Environmental, social, and governance (ESG) information helps investors and employees identify sustainable and responsible companies based on their corporate policies. Although ESG investment has only been widely discussed in recent years, the discipline began a quarter century ago. 

 

Investors started to realise that, while taking shortcuts on corporate governance might convey short-term benefits, it was highly destructive of capital value in the long-term. It was also realised that firms that factored in environmental harms and mitigated them, outperformed their peers, as did those that had a strong sense of social justice integrated within their operations.

 

ESG led to materiality assessments. These are assessments of the extent to which an organisation is exposed to risk by a particular factor relating to sustainability. 

 

An example would be a casino operator on the Miami shoreline compared to its equivalent in central Paris. If ocean levels were to rise by half a meter in Florida, it might have some impact on footfall – but at two meters greater, it would be existential. For the Parisian operator – neither scenarios would have much consequence.

 

However, this understanding of materiality is problematic. It is inward looking and profit based: it doesn’t account for any harm caused by the company. 

 

Consider another example: a chemical company and the issue of river pollution. Dead fish might not be a financial factor that the chemical company needs to consider. But the risk of the chemical company causing pollution would be a material risk to the company’s sustainability. The potential to experience litigation and regulatory intervention would add to this material risk.

 

This is the crux of ESG: what are the external factors (broadly laid out along lines of environment, social and governance), which need to be layered on top of the company’s financial reports and projections, to better model its future performance. 

 

This is not just data that investors need to make more informed decisions. Companies also need it to understand the risks stemming from their operations, including their supply chain. And so do consumers: we can use ESG data to understand the alignment of organisations to the causes we follow, whether that be environmental harm mitigation, the promotion of social justice, or the implementation of best practice towards corporate governance.

 

The ESG risks of digitalisation

Digitalisation can have a major impact on ESG risks.  For Facebook (now Meta), the initial impact of the Cambridge Analytica scandal was a staggering $37 billion loss of market value in one day. Highly material for investors, in other words.

 

Facebook’s business model isn’t everyone’s business model. Yet the risk of investment harm applies across all companies embarking on digitalisation. 

 

This has been evidenced by numerous incidents. International Distribution Services plc (aka Royal Mail) were unable to provide any international distribution services over the 2022/23 New Year owing to a cyber-attack. British Airways had to negotiate down a record GDPR fine for data privacy violations in 2018. And the TSB were given a £48 million fine for IT system failures (on top of nearly £300 million of losses relating to an outage in 2018).

 

In these cases, and in many others, it is corporate governance that proves to be the largest ESG factor. And yet in recent years, the boring matter of “G” - corporate governance - has been largely overshadowed by the positive virtual signalling of the “E” and the “S”.

 

Taking shortcuts in corporate governance is disastrous from a capital value perspective. And yet in many cases, especially with tech companies (for example Wirecard) ESG analysts have overlooked governance risks because they were tech companies.

 

And there is an important lesson here: just because companies are in the technology sector, it doesn’t mean that they have strong ESG credentials.

 

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Charles Radclyffe is CEO at EthicsGrade and a member of Project ESG at The Payments Association. 

 

Main image courtesy of iStockPhoto.com