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Employment Law Digest Summer Edition: Environmental, social and governance: ESG, what is it and why is it important for employers?

ESG is something clients are asking us about more and more. This increase in enquiries reflects the increasing importance of ESG credentials and a shift in expectations from employees, investors, customers and regulators for businesses to act ethically and responsibly.

Apart from being a zeitgeisty buzzword, what is ESG and why is it important for employers?

Corporate social responsibility is not a new concept. For many years businesses have been keen to demonstrate their credentials in this area, and for good reason. For many businesses, an ability to do so is crucial to their brand perception, attractiveness to customers, employees and investors, their ability to recruit and retain talent, and ultimately overall business success. For some businesses it is more important than others: for those who are particularly dependent on stakeholders, where there is a close proximity to the end user, where there is potential for creating social or environmental damage, or where there is a high level of product/service differentiation, this is a crucially important issue and those businesses who are unable to effectively demonstrate their ethical credentials will lose out as a result.

Recent global events, such as the covid pandemic, the #MeToo and Black Lives Matter movements, have brought ESG into sharp focus, and it is a concept that continues to gain momentum. The term is used to refer to a broad range of environmental, social and governance factors against which businesses are measured in order to determine their sustainability credentials. Job applicants and employees are increasingly interested in the performance of their employer or potential employer when deciding where they want to spend their working lives.

ESG can be broadly broken down as follows:

Environmental: This is a measure of a company’s impact on the natural environment and takes into account factors such as its carbon footprint, impact on biodiversity and its production of wastes and pollution.

Social: This is a measure of how a company treats its workforce, customers, suppliers and the wider community. It encompasses its approach to gender, diversity, pay, equality and human rights, and how it engages with its workforce and includes them in decisions that it makes.

Governance: This measures how a company operates in terms of leadership, executive pay, audits, internal controls and shareholder rights.

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Businesses who have been recruiting in recent years will have realised the importance for millennial and generation Z job applicants of the businesses they work for having strong ethical values. A high proportion of the job applicants we see are keen to demonstrate their own ethical values and contributions and expect this to be reciprocated. Conversely, the reputational damage caused by poor ethical values can have a significant negative impact on the workforce, as well as more broadly on customers and clients, and those who may fall into these categories in future.

A significant amount of ESG falls to HR teams to deal with, including:

  • Equality, diversity and inclusion (EDI)
  • Employee wellbeing
  • Whistleblowing
  • Pay and pay gaps
  • Employee engagement

These all fall under the social aspect of ESG and this is the element that tends to have the most significant and obvious impact on the workforce. We are all familiar with the commercial benefits of a more diverse and inclusive corporate culture: improved employee retention, increased ability to attract the best candidates, an increase in motivation and productivity and enhanced reputation. Businesses are also increasingly aware of the risks of getting this wrong: an increased risk of Tribunal claims, lower staff morale and productivity, which ultimately impacts profitability.

Similarly, we are all aware of the benefits of good employee wellbeing and mental health to businesses. Research undertaken by Deloitte found that the cost to business of mental ill-health in 2020-2021 was £53-£56 billion. On the other hand, the average return on investment of workplace mental health interventions in the same period was £5.30 for every £1 invested (a 430% return on invested capital), gained by reducing the costs associated with absenteeism, presenteeism and staff turnover.

Businesses are moving away from the concept that ESG concepts such as EDI and staff wellbeing are “fluffy” ideas that have no meaningful impact on the bottom line. We have come to recognise over recent years that the oppositive is true- the ability to demonstrate real commitment to the workforce has tangible benefits for businesses and for those businesses who are prepared to invest their time in this area. All indications are that broader ESG strategy will continue to be a crucially important part of business growth and success and those organisations that can demonstrate their commitment in this area are likely to reap significant benefits. It is also likely that over time the obligations in relation to ESG on business will become more regulated, for example on 23 February 2022, the European Commission adopted a proposal for a Corporate Sustainability Due Diligence Directive. The proposal introduces a sustainability due diligence duty on large EU companies and non-EU companies with significant EU activity. The new due diligence duty will need to be integrated into corporate policies and will require companies to identify, prevent, mitigate, minimise and end adverse human rights and environmental impacts in their own operations, in their subsidiaries, and in their established direct or indirect business relationships. The proposal also introduces new directors’ duties to take into account the human rights, climate and environmental consequences of their decisions and the likely consequences of any decision in the long term, as part of their duty to act in the best interests of the company.

All indications are that the importance of ESG is set to increase and employers should be considering their strategy on this carefully. This is unlikely to remain an area where employers can choose whether or not to get involved: those businesses who aren’t able to demonstrate their sustainable credentials are unlikely to be able to continue to ignore the growing swell of popularity in this area whilst at the same time remaining competitive. For further advice in this area, please contact our expert Employment Solicitors.