Welcome to the New Normal

First published in Süddeutsche Zeitung May 2021

Those who thought the debate surrounding the sustainable transformation of the German economy during the coronavirus pandemic would eventually lose momentum have been proven wrong in recent weeks. Indeed, driven by a ruling of the Federal Constitutional Court, the German government has decided to tighten its climate targets.

Meanwhile, the European Union (EU) aims to ensure that at least half of the funds from its coronavirus aid programme are put toward modernisation measures that will serve both the environment and social balance while streamlining its administration.

The EU has also introduced its taxonomy regulation, which is designed to make it easier for financial service providers, for example, to understand the criteria they can use to assess the sustainability of their investments.

Game changer

"Today's new rules are a game changer in finance," according to EU Commissioner Mairead McGuinness. "We are stepping up our sustainable finance ambition to help make Europe the first climate-neutral continent by 2050. Now is the time to put words into action and invest in a sustainable way."

What’s most remarkable about these events is the lack of opposition. Even staunch capitalists, like Stephen Schwarzman of the investment firm Blackstone Group, are now calling for all money flows and business decisions to be made from a sustainable perspective.

Investing in the spirit of ESG, i.e., the environment, social justice and good corporate governance, has become the new normal. But what’s driving that?

Regulation is advancing

Around the world, governments are ramping up pressure on companies. The Sustainable Finance Disclosure Regulation has been in force in the EU since the beginning of March 2021 and is intended to lead to more transparency across all ESG financial products. The initiative is a component of the Action Plan for Financing Sustainable Growth adopted by the European Commission in 2018.

Over in the US, the incoming Biden administration has wasted no time in getting the country back on track in terms of sustainability, after Joe Biden's predecessor, Donald Trump, neglected to place the issue high on his administration's agenda.

Both an ambitious climate package and a fundamental reform of social systems in the US are on the agenda, and the US has also re-signed up to the Paris Climate Agreement. The plans also involve the US Securities and Exchange Commission, which is expected to promote measures for more ESG investments.

Even China has fixed climate targets: by 2060, the People's Republic wants to be at net zero, in other words it aims to emit no more CO2 than it can remove from the atmosphere.

This kind of global action is sorely needed. We know, for example, that sustainability measures work best when they are coordinated at an international level, particularly when it comes to areas such as improving living conditions or protecting the climate. Quite simply, action to reduce the global threat of climate change can only be successful if CO2 emissions are reduced across the globe.

Improving living conditions is one reason why many industrialised countries have been working for years on what are known as supply chain laws. Germany, for example, has recently passed a law to this effect, and the EU Commission is preparing to propose one as well. The laws aim to prevent Western companies from tolerating human rights violations committed by their suppliers in third-world countries.

Data is improving

Data is crucial to enable relevant stakeholders – governments, customers and investors – to reasonably assess a company's sustainability efforts and compare them, but it’s been an area that’s often proved difficult in the past. Varying standards and questions around the reliability and accuracy of data have proved challenging.

But that is set to change thanks both to stricter legal requirements and the demands for greater transparency from financial market participants.

Professional investors such as fund managers and private equity investors can only provide their clients with reasonable justification as to why they are investing in a company when they have the numbers to back them up. In future, therefore, companies will have to prove in hard metrics the extent to which they comply with sustainability requirements.

One big step in improving the quality and availability of data is the recently announced cooperation between five of the most important standard-setters: the Carbon Disclosure Project, the Climate Disclosure Standard Board, the Global Reporting Initiative, the International Integrated Reporting Council and the Sustainability Accounting Standards Board.

Together they intend to create a comprehensive reporting standard for companies. In addition, there are a number of young start-ups that aim to make data collection and processing easier for companies with the help of new software solutions.

The financial market offers more instruments

If they provide the necessary underlying data, companies can reasonably hope to enter the market for ESG-compliant capital. Interest and availability of green bonds, social bonds, ESG-linked bonds, loans, or promissory note loans is growing.

These instruments' interest rates are linked to attaining measurable targets, such as an ESG rating. If a company fails to meet the standard, the interest rate increases. Exactly what this ESG link looks like can be negotiated individually between companies and capital markets.

The pharmaceutical company Novartis, for example, has issued a sustainability-linked bond. The Swiss company is committed to providing people in poorer countries with access to innovative therapies by 2025, and they also aim to reach around 50 per cent more people with their programmes to fight malaria, leprosy, Chagas disease and sickle cell disease. An external auditor is charged with monitoring whether these goals are achieved.

Companies are following suit

Few companies operating today can escape the debate surrounding social responsibility, and many are searching for a purpose that goes beyond pure profit-making. Responsibility is no longer a ‘nice to have’; instead, a company faces not just the potential of reputational damage, but also limited access to capital if it ignores issues such as ESG.

The British fashion retailer boohoo is a classic example of what can go wrong. When it emerged in 2020 that boohoo still relied on exploitative working conditions to produce clothes, its share price plummeted by 40 per cent. The lessons were swiftly learnt by others, both in the sector and beyond. Even, fast fashion chains like H&M and Primark now disclose their supply chains.

The automotive industry, too, has accelerated its departure from the combustion engine in the recent past. Volkswagen aims to become a pioneer in electromobility, while suppliers such as Continental are increasingly bidding farewell to divisions that now promise little or no profit in the age of alternative fuels for drive systems. At the same time, firms are increasingly directing their focus toward new business areas such as autonomous driving.

With mounting pressure from stakeholders, increased regulation and a growing range of accessible solutions, the economic imperative for governments, financial services providers, and companies to embrace ESG in both words and actions is clear. Nobody can afford to ignore the new normal.