The unprecedented response to Russia's invasion of Ukraine and the global outcry from consumers, lawmakers and government officials may signal a shift in how corporations should be evaluated on environmental, social and governance criteria, observers said.
Investors and regulators need to emphasize adaptiveness and flexibility in ESG "screening" and metrics so that companies can be held accountable to future geopolitical conflicts and other issues that may emerge as top of mind for asset managers and shareholders, they said.
Some 400 companies have either announced they will stop investments in Russia or cease operations and sales altogether, researchers from Yale University's Chief Executive Leadership Institute found. Those that remain face mounting pressure from consumers, employees, shareholders and countries doubling down on economic sanctions since President Vladimir Putin launched an assault on Ukraine last month.
"It's not just golden rule statements. It's not just philanthropy or trying to compensate for misconduct, but it's actually being responsible on so many frontiers," Jeffrey Sonnenfeld, founder and CEO of the Chief Executive Leadership Institute and a professor at the Yale School of Management, said in an interview with CQ Roll Call.
Many of the companies' decisions to leave Russia have occurred in the past two weeks thanks to multiple sources of pressure, said Sonnenfeld, who is leading the effort to track companies' decisions on Russia.
Industries that have historically been more resistant to ESG have been some of the first movers on divestment, he said. For example, oil giants BP PLC, Shell PLC and Exxon Mobil Corp. were, in late February and early March, among the first major companies to nix projects and investments in Russia, acknowledging that those divestments will mean billions of dollars in losses over time.
Meanwhile, consumer goods have been a mixed bag, with handfuls of companies either being latecomers to the corporate exodus from Russia or still navigating the complicated decision to exit the country that could affect their sourcing of materials, employees and other assets. At press time, Sonnenfeld and his team found that 37 major companies had yet to disclose what actions, if any, they would take.
Not a litmus test
"I wouldn't want this to be viewed as a litmus test for companies' ESG initiatives overall, because as important as this is, you wouldn't judge a company based on a single issue that plays out differently at each company," said Paul Washington, executive director of The Conference Board ESG Center. The nonprofit business and research group counts more than 1,000 public and private corporations and other organizations in 60 countries as members.
"In some ways, war transcends ESG," he added. "This is such a significant moment that it is a transcendent moment for companies. The issue goes beyond what we've seen about taking stands in the U.S. on various issues."
As more companies mull whether and how to shrink their business footprint in Russia, investors also face a conundrum on reducing their exposure to securities tied to the country. Asset managers including BlackRock Inc. and State Street Corp. said they'll curtail Russia's access to capital, while The Vanguard Group said it would cease operations in the country.
Republican and Democratic treasurers from 36 states, the District of Columbia and U.S. Virgin Islands said last week they support shifting state treasury and pension funds they oversee away from Russian-domiciled companies "as soon as possible" to put additional pressure on the country's economy. The entities control trillions of dollars in funds.
"These actions are not only morally imperative, but the current crisis also constitutes a substantial risk for states' investments and our economic security," they said in a statement. "We cannot continue to invest funds in a way that runs counter to the foreign policy and the national interests of the United States. Moreover, we choose to stand on the side of freedom and security for free and independent democratic countries."
Congress is weighing other methods that would discourage Putin from continuing the war on Ukraine. Sen. Marco Rubio, R-Fla., introduced a bill that would bar U.S. institutional investment in securities issued by Russian entities to ensure pensions and retirement accounts no longer have investments tied to the country.
Despite the unified effort, the pathway to fully divesting from Russia is murky. The country has taken steps to shield itself from U.S. and international sanctions on its economy, and it is unclear who would purchase Russian assets that get put up for sale.
In the future, screening U.S. and international companies for ESG issues — including climate change, racial equity, human rights violations and corporate governance — needs to become more nimble so markets can have more information at their disposal to respond to sudden ESG risks, Yale's Sonnenfeld said.
Investors have already seen the issue in the past year with concerns surrounding Americans' voting rights and forced labor of Uyghurs and other ethnic minorities in China.
"The challenge with ESG is 100 percent the ESG screens, even by the early funds in the space, and the metrics and tools miss something like what we're watching right now," Sonnenfeld said. "The ESG movement has become paralyzed by its own bureaucratic metrics and organizations. This is a reminder that it has to become more fluid and entrepreneurial and responsive to society needs and not organizational agendas."
"That's not to say that climate change isn't top of the list, but it isn't No. 1 at this moment," he said. "It’s not mutually exclusive. We can work on multiple fronts."
Financial regulators still need to be mindful of how they proceed with new rules or disclosure, whether it relates to Russia or any emerging ESG risk, said Washington of The Conference Board.
The recent exits from companies show that firms can react accordingly to market pressures and opportunities, similar to how they have acted on climate issues to mitigate risks as well as have a positive impact on the environment, Washington said.
Regulations need to provide consistency and comparability in companies' reporting, like the anticipated disclosure rule from the Securities and Exchange Commission, while allowing firms to retain some flexibility, he said.
"It's really good for policymakers to take a close look at what the market practices already are and to weigh the costs and benefits of imposing an additional level of required consistency and comparability onto what's already being done," Washington said. "You want to make sure the disclosure rule reflects that environment in a careful cost-benefit analysis rather than jumping out and saying, 'Let's go require an additional disclosure in this area,' without having a chance to see what markets do over time and think it through."