As we await further details about the UK’s Innovation Strategy I ask, what role might ESG play in its implementation, and why is ESG important for innovation?
The ABCs of ESG
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The ‘E’ in ESG refers to environmental factors that relate to the natural world. The recent United Nation’s IPCC Climate Change Report ‘code red’ and the upcoming United Nations Climate Change Conference (COP26) highlight the importance of the ‘E’ in ESG.
The ‘S’ in ESG refers to social, factors that affect the lives of humans. An example of a social factor is the pandemic’s disproportionate impact on groups of population with socio-economic disadvantages.
The ‘G’ in ESG refers to governance, factors that involve issues inherent to the business model or common practice in an industry. Governance causes can focus on ethical corporate governance measures, such as anti-corruption and capped executive compensation. Some businesses choose to connect their ESG efforts to the UN’s 17 Sustainable Development Goals (SDGs), an activity called impact investing.
The right policy environment for creating our future
In July 2021 the Department for Business, Energy and Industrial Strategy (BEIS) released the UK Innovation Strategy setting our ambitions for an innovation-led economy.
Its objective is to boost private sector investment across the whole of the UK, creating the right conditions for all businesses to innovate while backing technologies of the future. This will be achieved by focusing activities around the four pillars of:
- unleashing business
- people
- institutions and places
- missions and technologies.
The ‘what’ and ‘how’ of ESG
ESG is the ‘what’ and ‘how’ of business activity. It’s an approach whereby investors explicitly acknowledge the relevance of environmental, social and governance factors in their investment decisions. While the concept isn’t new, the scale of uptake is.
Today there is $103 trillion of assets invested with funds that have signed up to the UN’s principles for responsible investing. This is good news for both people and planet.
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This demand is driven by:
- investors seeking greater transparency about how and where their money is being invested
- the increasing view from regulators that incorporating ESG factors is part of investors financial legal and ethical duty to their clients and beneficiaries.
The overwhelming weight of accumulated research finds that businesses that pay attention to ESG concerns do not experience a drag on value creation, in fact, quite the opposite. Embedding ESG can reduce risk and enhance investment returns. This point is key: ESG factors are material business issues.
ESG is important for innovation
So why is ESG important for innovation plans such as the UK’s Innovation Strategy? I want to highlight three reasons why ESG is key to incentivising innovation towards longer term prosperity.
It’s about the long game
I spent a number of my formative years working with indigenous communities. So, when I approach innovation I’m aware that I’m talking in a space with a long history. Humans have been making innovative technology and therefore creating their future for a long time.
Duration is also a key point in the UK’s Innovation Strategy, in its leadership in transformational technologies, helping to ensure the UK can enjoy unrivalled growth, security and prosperity for decades to come.
ESG investing also recognises that long-term sustainable returns are dependent on well-functioning, social, environmental and economic systems. It’s a shared recognition by both ESG and the UK’s Innovation Strategy that we are in it for the long haul.
In theory, this sounds straight-forward, what ESG brings is a dose of pragmatism. It recognises that while asset owners with long term liabilities are well aligned with long term investing, in practice they at times help create the problem by rewarding managers and businesses for short-term behaviour.
This myopia can affect both the public and private sectors and is often caused by implementing business metrics and controls in a way that reinforces short-term thinking and behaviour.
In addition, the UK’s Innovation Strategy quoted the Economist’s much-repeated phrase:
The world’s most valuable resource is no longer oil, but data.
We know that data is vital and can be powerful in a beneficial way. But did you know that this increased access to data has in some cases resulted in more frequent, short-term investing?
For example, today in the stock market investors hold stocks on average just under six months. In the 1950s it was an average of seven years, and before the 1987 crash it was two years.
Increased information and data in many cases means investors now change their minds more frequently rather than gaining more conviction in their decisions. So yes, “data may be the new oil”, but it has also brought a new challenge of short-termism investing, of which the public sector is not immune.
Addressing the agency problem
In my previous blog, I talked about ways to avoid an apocalyptic technological-guided future. This is a question of where we perceive agency to lie. Likewise agency through free, prior and informed consent (FPIC) is a key concept for indigenous communities. The aim is to establish bottom-up participation and consultation of an indigenous population prior to the beginning of development on ancestral land or using resources in an indigenous population’s territory.
The agency challenge is also part of ESG and the business world. Agency problems arise when the interests of the managers may not always be wholly aligned with the interests of the owners of the business.
The agency problem is an evitable consequence of the separation of ownership and control and is magnified for larger companies. It’s also a concept relevant for the public sector as well when programmes seek to align public spending with priorities of the populace.
From systems theory to novacene
The UK’s Innovation Strategy tag line ‘leading the future by creating it’ highlights the importance of feedback loops, non-linear and systems thinking. Similarly, ESG seeks to retain this open feedback loop evoke where and humans, technology and the environment all interplay.
What does this mean for innovation? Many of the governing norms and intuitive habits employed in business are built on an unconscious method of thinking.
Mark W. Johnson has termed this ‘present-forward’. Quite literally, this takes present-day truths and assumptions and projects them into the future in a linear fashion. This is appropriate for business operations and decision-making that is predictive and near-term.
It’s not so effective for developing a positive version of what James Lovelock termed novacene: a hyper-intelligent age that meets the needs of both people and planet. For this we need to empower long range, disruptive changes that invite productive discomfort, diverse voices, and allow questions to remain unanswered. Which are many of the features of highly successful innovation and research and development programmes.
Final thoughts: we need ESG for sustainable innovation
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The rise of ESG represents an exciting paradigm shift. ESG and the UK’s Innovation Strategy in many ways share the same value and objectives. What remains an ongoing challenge is building a relationship of strategic complementarity between the two, in a committed and transparent way.
The post COVID-19 pandemic challenges centred around triggering a boost to a social and economic recovery that is more innovative, greener and fairer means ESG is at the centre of innovation. We cannot be innovative without being sustainable.
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Sarah’s work focuses on how digital ethics can make a direct and positive impact on economic growth, quality of life and the environment. She is passionate about integrating environmental, social and governance factors into the investment process to achieve sustainable innovation.