Let's Focus on the 'S' in ESG to Improve Social Outcomes

Let's Focus on the 'S' in ESG to Improve Social Outcomes

This article was published in The Jakarta Post paper edition, 15 March 2022, written by Bahtiar Manurung and Yogi Bratajaya

In less than two decades, the focus on environmental, social and governance (ESG) issues in capital markets has moved from a niche concern to the mainstream. This shift is reflected in the amount of capital being invested in ESG-oriented investment funds, which totaled US$649 billion in 2021.

The private sector’s consideration of ESG issues will continue to grow as customers, investors, governments and civil society groups demand more transparency and improved performance in how businesses address the environmental and social impacts of their operations.

The growing market for ESG investments has amplified the corporate commitment to the environmental pillar of ESG, particularly regarding climate change. As of today, 683 of the world’s 2,000 largest publicly traded companies have committed to a net-zero strategy, according to the Net Zero Tracker. Additionally, the financial sector is increasingly investing in renewable energy and reforestation projects through the establishment of sustainable funds.

Companies are also making efforts to improve their performance relating to the governance pillar of ESG, by establishing internal corporate governance codes and enacting policies. However, the social (S) pillar of ESG, which covers a wide range of issues that include human rights, workplace health and safety, diversity and inclusion, employee engagement, business ethics and community engagement, has not received adequate attention in comparison to the other two pillars of ESG.

The lack of focus on the social pillar is due to many factors. One is the belief that improvement of the “S” pillar of performance is at odds with financial returns, as it will impose an unnecessary burden. However, this view is unfounded since improving the “S” pillar of performance promotes responsible business practices and acts as a risk mitigation mechanism, which in turn strengthens stakeholder trust.

Another factor is the notion within the investor community that assessing social performance is difficult since its indicators are not as straightforward as the other ESG pillars. This notion is not entirely true. For example, the baseline standards for business and human rights are clearly defined in the United Nations Guiding Principles on Business and Human Rights (UNGPs).

The World Economic Forum (WEF) has also issued stakeholder capitalism metrics that include social aspects, such as diversity and inclusion, pay equality, wage level, workplace health and safety and continued development of employees. The lack of focus and effort to improve the “S” pillar is reflected in the World Benchmarking Alliance’s (WBA) 2022 Social Transformation Baseline Assessment. The assessment found that out of 1,000 of the most influential companies across 68 countries, including Indonesia, only 1 percent met the majority of the core social indicators, which covered human rights, decent work and ethical conduct. In addition, only 7 percent of the 1,000 companies met all the requirements of the WBA’s human rights due diligence (HRDD) indicators.

According to the UNGPs, companies are expected to carry out HRDD to identify, prevent, mitigate and account for how they address their impacts on human rights.

Similarly, a study of 2020 sustainability reports of all Indonesian public companies by the Foundation for International Human Rights Reporting Standards (FIHRRST) found that only 2 percent of 121 sustainability reports assessed had disclosed information about the company’s human rights policies.

There are many reasons why companies and investors need to focus on and improve their “S” pillar of performance. First, the social pillar is closely intertwined with the environmental pillar, as demonstrated by the race to net zero. Renewable energy projects, such as wind farms and solar farms, require vast amounts of resources and land to operate, which could in turn harm surrounding communities, especially indigenous peoples.

Second, the negative socio-economic impacts of the COVID-19 pandemic emphasize the importance of the social pillar. For example, the pandemic has left millions of workers without any savings to fall back on, increasing the pool of workers vulnerable to debt bondage and other forms of forced labor. The pandemic has also exacerbated gender equality as women have been disproportionately affected. According to the WEF’s 2021 Global Gender Gap Report, the pandemic has set gender equality back a generation. 

Embracing the “S” pillar means that businesses and investors must identify and prevent the adverse human rights impact of their activities. HRDD is the main tool that businesses can use to translate their human rights commitments into concrete actions.

The key to ensuring that HRDD can effectively identify and mitigate the most salient human rights risks of a business’ operations is through meaningful stakeholder engagement. Stakeholder engagement enables a company to identify what human rights impacts may arise from their operations and how significant those impacts may be.

To support companies and investor efforts, governments should also enact policies that focus on the social pillar of ESG. The past few years have seen a wave of mandatory HRDD laws in European countries, including France, the Netherlands and Germany. In addition, the European Union Commission has recently published a legislative proposal for a directive on corporate sustainability due diligence.

This directive represents an increased emphasis on the social pillar of ESG, where it mandates that companies included in the legislation’s scope identify and manage risks related to human and labor rights, equality and inclusion, women’s empowerment, anti-corruption and business ethics within their own operations – and throughout their value chain.

In view of this, Indonesia, as well as other countries, should follow suit and enact their own mandatory HRDD legislation to ensure that businesses in their countries can continue to be part of the global value chain.

Stock exchanges also play a vital role in encouraging companies to improve their social pillar performance. In Indonesia, the Indonesian Financial Services Authority (OJK) should consider enhancing the sustainability report requirements for public companies by including more social aspects, such as human rights, diversity and gender equality.

Lastly, multilateral platforms such as the Group of 20, which will hold its summit in Bali later this year, should also focus on social issues. Indonesia’s G20 presidency this year presents an invaluable opportunity to accelerate measures to encourage companies to improve their social performance. This can be done through the Working Groups (WGs) on several issues related to the social pillar, including anticorruption, employment, health and women’s empowerment.

As well as the WGs, Engagement Groups (EGs), including the Business 20, have also been established. We urge the WGs and EGs, particularly Business 20, to discuss and formulate plans to further advance corporate and investor focus on the “S” pillar of ESG to improve social outcomes around the world.  

Bahtiar Manurung is the operations director and Yogi Bratajaya is a business and human rights specialist at FIHRRST.

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