ESG exposure to Russia — it’s complicated

What is the true exposure of ESG funds to Russia? The answer is both higher than is stated but less than you might think, and there is a lesson for business too.

As ever with all things ESG, reality is complicated. And while Twitter is awash with claims that ESG has failed to factor in Russian involvement with companies, the truth is simultaneously good and bad. It is good because it turns out ESG investing is not a bad way to reduce exposure to Russia; it is bad because, well, because it is complicated.

Bloomberg cites research from Morningstar that about 14 per cent of sustainable investment funds are exposed to Russia.

CNBC was all over the story, too, likening links to Russia as the new tobacco and saying, “now we realise how many ESG funds are exposed to Russia.”

Yet, when you dip into the Morningstar website, you find an article stating, “Russian companies tend to have high levels of environmental, social, and governance risk and fossil fuel involvement, which preclude most of them from sustainable fund portfolios.” It says that more by accident than by design, ESG funds represent a good way to reduce exposure to Russia.

So, you get the famous Russian companies: the Rosneft’s and Gazprom’s or indeed Lukoil PJSC; these companies never were exactly popular with the ESG fraternity anyway.

Nuance

Sometimes it seems as if the word ‘nuance’ is the most important word in the ESG lexicon. And it is important again.

So, apparently, ESG criteria is not a bad way to reduce Russian exposure…except.

Except that is, the real world is far from simple, and both companies and investors have complexity to think about.

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The intractable problem of the supply chain

“The supply chain itself is an incredibly complex web of intertwining parts,” said Oliver Chapman, CEO of supply chain specialist, OCI Group, which recently gained position number one for UK companies within the FT’s list of Europe’s fastest-growing companies, “He added:

“companies have to check if there are any links to Russian companies, even though they don’t deal with Russian companies directly.”

And that is the point; the supply chain is like an intricate web. Somewhere lurking within it, there might well be a Russian company. For that matter, there might well be another company that has a poor ESG reading for another reason.

So, you have this requirement not only for companies to audit their supply chain but also for auditing (in some form or another) the supply chain pertaining to every company in their supply chain. And then there is a need to audit the supply chain of every company in the supply chain, of every company in the original supply chain — and so on.

Of course, there are shortcuts. You don’t need to literally audit everyone; all you need is confirmation that your direct suppliers have been audited and that each audit took into account that their suppliers had been audited, etcetera, etcetera.

Russia

But add Russia to the mix, and it can get more complex?

Yet, for business, this is a major concern. Companies face the fear of financial penalties because of some Russian link they were unaware of.

According to Oliver Chapman, “banks are asking customers to review their client and supplier list,” and “there are also concerns regarding payments, from legacy transactions dating back to before the Ukrainian crisis involving Russian companies.”

Minerals and metals and sustainability

Metals such as palladium, often mined in Russia, are important ingredients in hydrogen generation while it, along with other platinum-based metals, have applications in catalytic converters for cutting carbon emissions in cars.

Russia is not the only location where platinum mining occurs; indeed, the sector is even bigger in South Africa, but you are probably getting the point.

Even in areas that are popular with the ESG community, such as hydrogen as a carrier of energy or in catalytic converters to reduce carbon emissions, Russian companies will no doubt appear in the supply chain.

Know your supply chain

To reduce current risk and mitigate against future risk, there is very little companies can do other than ensure they know their supply chain.

And this is, in any case, good ESG practice.

The ecosystem

Developing an ESG friendly ecosystem is an important part of good ESG practice. It also confers an important advantage on companies that do this — because rivals who are late to ESG might find it near impossible to create a comparable ecosystem before competitive pressures become overwhelming.

But transparency in this ecosystem is an important element.

The ESG critique misses the point

ESG is not a catch-all practice — it can’t eliminate risk altogether. But it can reduce risk.

And ESG is not a one-off thing. On the contrary, applying ESG is an ongoing consideration; it is, as they say, a journey, not a destination.

And good ESG practice does not eliminate the risk of exposure to Russian companies, but creating transparency in the supply chain makes it easier for companies to adjust.

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Funds and business

ESG funds do not represent a foolproof way of eliminating Russian exposure for investors. Furthermore, we know that not all ESG funds are quite as ESG friendly as they suggest — greenwashing is not uncommon. Nevertheless, for investors, looking at ESG credentials of a company is not a bad way to reduce Russian exposure.

And for companies nervous about the broader disruptive implications of the Ukrainian crisis, good ESG practice can at least help mitigate against risk

Article originally appeared at GRC World Forum.