10 November 202210 minute read

Tech Index 2022: Sustainability and ESG

Making the leap from compliance to performance

Environment, social and governance (ESG) issues have risen quickly up the boardroom agendas of companies across almost all sectors — and in a remarkably short space of time.

But engagement with the ESG agenda varies significantly between companies. Many are focused on compliance at a minimal level; relatively few are showing true leadership in this critical area.

That divergence of approach is not surprising, given that relevant regulation is relatively under-developed in many jurisdictions, leaving companies struggling to find their bearings.

That’s certainly the case in the US where, in the absence of hard law, the companies with the most advanced ESG agendas rely on private governance initiatives rather than regulation.

“Two-thirds of our respondents said they saw business opportunities around the ESG agenda, including one-third who see significant opportunities.”

But even in Europe, where regulation is much more advanced (though still evolving), there is a clear divide between companies that approach ESG from a basic compliance stance and those that see a real business opportunity in adopting a more strategic, performance mindset.

 

A question of priorities

This dichotomy is, to some extent, evident in the soundings we have taken for this latest edition of the Tech Index, where we asked several new questions to gauge where ESG matters currently sit on boardroom agendas.

Two-thirds of our respondents said they saw business opportunities around the ESG agenda, including one-third who see significant opportunities. Only 7% saw ESG as either a moderate or significant threat.

Business opportunities in ESG

Business opportunities in ESG

When asked to rate how high a priority ESG issues were for their business, nearly half of respondents rated them between 8 and 10, with 10 being the top priority. On average, companies rated the priority level at 7, clearly suggesting that this issue is front of mind for most companies.

Prioritization of ESG issues

Prioritization of ESG issues

But when asked whether the level of priority given to ESG matters had changed since the start of the COVID-19 pandemic, the results were far more mixed and, perhaps, more revealing.

Here companies were evenly split among those that said the priority level had increased, those that said it had remained the same and those who said ESG issues were a lower priority compared with other concerns.

Covid-19 and ESG issues

Covid-19 and ESG issues

With companies continuing to recover from the shock of COVID-19 only to find themselves rocked by a whole new set of economic and political headwinds, it’s perhaps unsurprising that some are reducing their focus on ESG.

But the trend is worrying when extreme weather is making the impacts of climate change so immediately evident and when the pandemic has exposed levels of social inequity that must be urgently tackled.

 

Levels of ambition

In working with clients, we typically see them at four levels of ESG ambition.

The lowest level is about achieving compliance, with companies asking: what is the bare minimum we must do to meet existing regulation?

Other companies are making exaggerated claims or greenwashing their achievements in this area, writing “cheques” in their marketing or investor relations communications that they may not be able to cash. In extreme cases, companies can find themselves being investigated by market authorities or regulators and even heavily fined when making unsubstantiated claims.

At the next level, some companies are beginning to benchmark themselves against market-leading organizations to see where and how they can improve their own performance.

Finally, some companies are showing genuine ambition and achieving real competitive advantage by being first movers in the field. Often, these organizations are not merely following the regulation. Instead, they take their cues from multilateral institutions like the United Nations and the OECD to guide their actions on issues such as climate change, bio-diversity loss or broader definitions of human rights, including the right to a healthy environment.

 

Regulatory certainty

Regulation also plays an important part in driving change. But these regulations take time to develop and are continuously evolving.

Since the Paris Climate Accord was adopted in 2015, the EU has focused regulation on financial institutions, seeing them as among the most powerful agents of change in private industry. These regulations challenge institutions to examine the sustainability of their loan or investment portfolios.

EU regulations on taxonomy, sustainable finance disclosure and benchmarking are all helping to drive change in this respect. More recently, we’ve seen the European Central Bank using stress tests to determine whether financial institutions are prepared for climate risks to their own operations and to their clients.

UK regulation is developing separately, with the government promising to publish an updated and more detailed version of its 2019 Green Finance Strategy later this year.

Other jurisdictions are much further behind, but we see increased action by authorities in some.

In the US, for instance, the Securities Exchange Commission has yet to finalize ESG disclosure rules for listed companies. But even without those rules, the SEC has been aggressively probing issuers over the past year on their approach to climate change in what looks to some like a back to front process.

That’s proving a challenge for large-cap companies in the US at a time when the federal government’s approach is diverging from that of some conservative states, whose legislators are pressuring companies to focus on delivering straight shareholder value rather than broader ESG outcomes.

But regulation can be a blunt tool and it takes time to develop and refine. Boards are thus often left to decide for themselves what action to take as part of a fiduciary duty to balance a wide range of different stakeholder interests.

 

Legal and reputational risk increase

Regulation is not the only source of ESG risk for businesses. With public pressure building for action from business on climate and other ESG matters, reputational risk is an increasingly important concern for many companies.

Litigation risk (which carries with it reputational risk) is mounting too, as illustrated by, to give one high profile example, the Hague District Court’s 2021 decision that Shell must cut its emissions by 45% by 2030 (albeit that this decision is subject to appeal). The risk of businesses facing legal challenges relating to (and aimed at changing) their approach to ESG is increasing significantly.

 

Meeting challenges in the tech sector

It’s clear from our survey that companies in Europe’s tech sector are taking action to address sustainability concerns.

Demanding more accountability from suppliers and working towards carbon neutrality by 2030 continue to top the list of actions they are taking, with both increasing marginally in importance in 2022 compared with 2020.

Investment in energy efficient technologies remains important but has slipped down the list of priorities, from 61% in 2020 to 52% in 2022.

Actions to address environmental sustainability

Actions to address environmental sustainability

Nearly all companies (98%) also say they have started taking action to address ESG concerns.

Having a board representative for sustainability issues, working with NGOs to achieve socially desirable sustainability, and working towards becoming fully carbon neutral by 2030 lead the list of actions companies are taking.

Actions already implemented

Actions already implemented

Around half of our respondents say they have put a comprehensive governance framework in place to manage ethical risks around the deployment of key technologies, covering areas such as privacy, cybersecurity, AI and freedom of expression. And nine out of ten companies say they have at least an emerging framework in place.

 

Delivering additional benefits

The tech sector continues to face pressure over its own carbon footprint and some of the industry’s largest players are being urged to play a bigger role in reducing emissions.

Tech giants like Google are among the biggest purchasers of renewable energy to power their data centers.

Given their financial strength, they are under pressure to pay more for their energy to help develop new wind and solar projects, and to demonstrate that, in doing so, they are creating benefits, not just for themselves, but for the wider community as well. Some are seizing this opportunity to improve their environmental credentials.

Environmental challenges are also significant in the cryptocurrency segment, particularly around bitcoin mining, which is highly energy intensive.

Climate change is having an immediate impact on this activity. In a prolonged heatwave this summer, many bitcoin miners in Texas shut down their operations as the state’s electricity grid struggled to meet a huge spike in demand. There were similar shutdowns in winter during unprecedented cold weather.

Concerns over bitcoin’s carbon footprint are also making it hard for other, less energy intensive blockchain or token-based crypto asset systems to make a credible environmental case based on their own science-based net zero targets. But such systems are likely to prove very useful in helping companies meet ESG-related objectives, such as building green supply chains, not just as a cost, but based on a business case delivering a real and measurable return on investment.

Given the growing focus on ESG issues by regulators and market authorities, tech companies are likely to feel growing pressure to demonstrate they are taking this agenda seriously. And with technology likely to play a key role in tackling the climate crisis, we can expect ESG issues to continue climbing up boardroom agendas in the coming years.

Our survey suggests that companies are well aware of this. Almost all our respondents (99%) make it absolutely clear that the tech industry is not yet doing enough to tackle sustainability challenges, up from 96% in 2020.

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