The evolution of ESG

ESG (Environment, Social and Governance), about which so much is written today, had a difficult birth. Back in the 1970s the doctrine was one of pure capitalism. Make as much money as possible without worrying about being socially responsible; which was seen as the job of government.

by Sir John Royden

Head of Research


“A man cannot have two masters” was a popular chant. You can’t work for maximum profit as well as maximum societal benefit.  Investment managers needed clarity which came from the common law doctrine that profit maximisation alone was the fiduciary duty of a fund manager. We were actually taught that the costs of behaving in an ethically responsible manner would outweigh the benefits. Capitalism should always trump philanthropy for the benefit of overall society. Capitalism generates the wealth which individuals can then charitably distribute if they so desire. 

But then came some exceptions. In the late 1970s, it became legally permissible to decline investment opportunity in Apartheid South Africa for moral reasons. This was perhaps the first example of morality taking precedence over the common law doctrine of profit maximisation. At the same time there emerged the concept of social capital. A firm that invests in the well-being of its local community could do better on the back of a strong local community than a company that did not. However, the concept was still rooted to the idea of maximising profits.

A firm that invests in the well-being of its local community could do better on the back of a strong local community than a company that did not.


In spite of some nascent progress, the progression of ESG took a step back in the case of Cowan v Scargill (1985). Scargill, the then President of the National Union of Mineworkers and also a trustee of the National Coal Board’s £3 billion pension fund wanted the pension fund to (patriotically) get out of overseas investment and stop investing in businesses (like oil and gas)  that competed with coal. Cowan was part of the management team which opposed Scargill. The judge said that the best interests of the beneficiaries are normally their best financial interests and that you can’t deviate from profit maximisation without the consent of the beneficiaries.  

By the turn of the millennium, climate change was making headlines and we started to see the emergence of the idea that the “interests of the beneficiaries” or, in our case, our clients, might include having a planet fit for life. Interests thus grew in breadth to incorporate the E of ESG, alongside optimal profits.

Altruism and maximising profits appeared to be mutually linked rather than facing each other as adversaries.

The E and the S of ESG moved forward when empirical evidence began to emerge that companies that scored highly on environmental and social metrics actually produced enviable returns for their shareholders.  Altruism and maximising profits appeared to be mutually linked rather than facing each other as adversaries.

This led to a Freshfields paper in 2005 which provided a legal opinion that there was a fiduciary duty to incorporate ESG metrics into investment analysis; a view that the Law Commission endorsed in 2014 and which a 2016 UN report echoed, saying that “failing to consider all long-term investment value drivers, including ESG issues, is a failure of fiduciary duty”.

Investors have changed as well, with some research showing that the majority of investors would contribute more to portfolios doing social good rather than otherwise.

In the UK, the “G” or governance debate grew on its own with numerous codes of conduct.  The main problem as I saw it, was that back in the 1990s the Takeover Code’s Rule 9 had the unwanted side effect of silencing shareholders by effectively preventing them from speaking to each other about poorly run companies for fear of having to make a cash bid for the company being discussed.  With weakened shareholders, standards of corporate governance waned; which the City tried to cure with a succession of codes of conduct and reports. 

Cadbury (1992), Greenbury (1994), Combined Code (1998 and later frequently revised from 2003), Turnball (1999) and then the Corporate Governance Code of 2018 will be remembered by many, but particularly remembered by me, for addressing the symptoms rather than Rule 9, the actual source of the problem. The primary source of the ill has since been addressed with shareholders now more easily able to discuss poor corporate performance.

During this time we also saw an increase in mandates that positively screened out businesses that killed or harmed people. Arms, guns, tobacco and sometimes alcohol were popular restrictions although engagement was still in its infancy and many investors simply attempted to avoid the most controversial sectors without much interaction with offending companies to try and improve their behaviour.  

Attempts to quantify and measure governance now include board diversity, executive and employee pay, ownership and control, and how the board of directors oversee the interests of stakeholders. These issues overlap with our understanding of what metrics to use for a high “S” score.  A diverse set of employees is likely to reach into a deeper pool of talent. There are few of us who would want to be seen to be supporting an exploitative supply chain built by child labour or derived from miserable animals; just as the UK’s PPI banking scandal leads us to want to see a responsible and mildly paternalistic attitude towards customers.

Environmental issues mostly concern climate change and the finite supply of natural resources as outlined in the Stern Review of 2006 whose conclusion was that benefits of early action on climate change would outweigh its costs.

Strong shareholder value creation is increasingly aligned with ESG metrics.

Pulling it all together in a quantitative fashion so that comparisons can be made is not without its challenges.  Databases that seek to quantify ESG scores are helpful to a degree. But at the end of the day nothing quite beats meeting management face to face and being able to take an honest opinion as to whether the company is self-indulgently green-washing itself or is genuinely committed to making the world a better place and its shareholders richer in the process. I must also add that the overlap of ESG due diligence with mainstream due diligence is high. None of us would be rushing to invest in a country with an oppressive military regime or where management were earning outsized salaries compared to profits. Much of what we talk about now with ESG would have just been proper due diligence before.

My own thoughts on ESG are that strong shareholder value creation is increasingly aligned with ESG metrics;  after all, new world technologies is where the growth lies and a focus on ESG tends to attract forward looking, caring and entrepreneurial cadres of younger managers and employees; which in turn drives operational efficiencies.  Consider this:  A bright young graduate with a first from Oxford; do you want to join a tobacco company or one making wind turbines? The alignment has meant that I have never been put in a position where I have felt the need to allow my aspirations for wealth creation to be trumped by green credentials. I hope and trust that this will remain the case for the foreseeable future.


Illustration by Asa Taulbut

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