Introduction: There have been many discussions over the years regarding Environmental, Social and Governance (ESG) issues at the international level. For the majority of domestic companies, the initial concept of ESG issues occurs when they are facing ESG due diligence initiated by overseas suppliers or, as a target company, they are accepting investment or financing, or there has been a failure in obtaining a well ESG rating. This then has an adverse effect on their business partners and/or investor relationships. Like the topic of the Environment, Health, and Safety (EHS) on which we have been working on for many years which originated outside China, the concept of ESG originated outside China as well. Where did ESG originate?
The opinions expressed in this article are not intended to be legal commentary, nor an overview regarding specific ESG standards and their applications (which will be discussed in subsequent research newsletters). We hope this article will stimulate more discussions on ESG topics.
I. Where did ESG come from?
ESG has undergone an evolution, beginning with the early days of Corporate Social Responsibility (CSR), when the public perception of CSR was more like that of a charity, with concerns about the environment (E) (pollution, plastic waste, greenhouse gas, etc.) and society (S) (safety, forced labor, etc.), and then to more awareness of the importance of governance (G) in achieving the goals of the Environment (E) and Society (S) (here the emphasis of governance was on a rule-based governance system that ensured the achievement of environment (E) and society’s (S) goals; and, for investors, property rights, the protection of minority shareholder’s interests, the right to a fair trial, etc.). The awareness of ESG is growing, and as a result we have noticed that some companies (particularly, listed companies) have begun to publish social responsibility reports, sustainability reports and/or ESG reports.
II. Who drives ESG?
Greenhouse gas emissions have become an increasingly urgent task in context of the Paris Agreement and carbon peaks and carbon neutrality, and the COVID-19 pandemic have led to discussions about “the community of life” (as opposed to “the community for mankind” or “anthropocentrism”) and social inequality, highlighting the role of ESG. ESG relies on a philosophy of “living for the good” and, in a sense, the concept of ESG is somewhat equivalent to the theories of “sustainability”. Under the criterion of “sustainability”, we expect that society will have a governance system that respects the laws of nature, and enterprises will have a rule-based governance system. Unlike flowers that can be picked in a garden, ESG is more like reaching for the stars in the sky. The process of reaching for the stars is a way to become a “great” enterprise.
III. Why Does ESG Matter?
When we are talking about a “great” enterprise, there is actually no agreed definition about the word “great”. The classical economist Adam Smith believed that wealth is not the only goal, and happiness and harmony are the other goals of human economic behavior. The philosopher Jeremy Bianchin once said, “the maximum happiness of the majority of people is the criterion by which right and wrong are judged”. Bianchin’s utilitarian principle emphasizes maximum happiness and self-interested choice, and the binding force of the principle comes not only from the human body and religion, but also from politics and morality (the public). From an utilitarian principle, we can reach the conclusion that a great company shall be able to make self-interested choices which are bound by politics and morality, and shall, in the long run, commit to achieving the maximum happiness for the people and use it as a criterion for judging all its activities and rules.
The difficulty in achieving the goal of “the maximum happiness of the majority of the people” is that there is no single standard for assessing enterprises in different regions and industries. However, measuring the value of an enterprise solely based on their traditional financial data may not achieve the target and, in some cases, may even lead to the reverse. Extending from this point, concepts such as social responsibility, sustainability and ESG investments have emerged in the field of investment. These concepts find their roots in utilitarian principles in classical economics. The challenge in achieving the goal of “the maximum happiness of the majority of people” also lies in the fact that an enterprise needs to care not only about their own status and development (it is not only about financial returns), but also about feedback from stakeholders (e.g., customers, suppliers, consumers, employees, governments and communities), especially in supply chain management. The concept and practice of ESG is consistent with the goal of “the maximum happiness of the majority of people”. Certain ESG disclosure guidelines, ratings and investment guidelines that have been formed in the international community, seem to help enterprises and investors find some path to “greatness”.
IV. ESG and EHS
For the manufacturing enterprises that we serve, their ESG management concerns material issues regarding the environment and safety. Environmental and safety accidents or emergencies might have a direct impact on the public. For example, a toxic gas leak from a carbide factory in India in 1984 killed 20,000 people and hospitalized 500,000, and an ammonium nitrate explosion in Lebanon in 2020 killed more than 100 people and injured more than 4000. From this perspective, it is evident that Environmental, Health and Safety (EHS) compliance and related supply chain management are important parts of the ESG practice of manufacturing enterprises. Moreover, from the environmental (E) perspective of ESG, all types of enterprises or legal entities (not just manufacturing enterprises) should pay attention to the topic of climate change and energy management. However, ESG is not the same as EHS and it has a broader scope than EHS (which also includes other issues in social and governance areas; typical topics include anti-corruption and board diversity – atypical ones are industry and business specific, such as conflict minerals).
V. How to Reach the Other Side?
A journey of a thousand miles begins with a single step. Bentham once said, “Stretching his hand up to the stars, too often a man forgets the flowers at his feet”. For most Chinese companies, the journey toward ESG improvement is like reaching for the stars in the sky. Based on an understanding of international ESG standards, and familiarity with the domestic regulatory and disclosure requirements, this process requires enterprises to assess their own ESG performances. Enterprises need to understand their differences between peers, identify shortfalls and make targeted breakthroughs in key areas in stages based on the existing products, technologies, organizational structures, operations, management systems, compliance systems and their unique operations.
For the funds and investors that we serve, risk always accompanies opportunity. In general, ESG value should follow the logic of “investment for goodness”. We expect that investment decisions will incorporate ESG considerations, among which, the development of suitable models of “what is good” and use of such models to identify valuable investment targets. We expect that post-closing, investors will become active investors (even without majority equity interests) and incorporate ESG issues into their policy related to equity governance and practice, and influence the management of portfolio companies, particularly the establishment and operation of governance systems (especially, the rules of governance).
ESG due diligence is an effective approach for investors to screen valuable investment targets. ESG due diligence is not a new topic and it is consistent with the duty of diligence exercised by investors in the investment process. As an upgraded service to our traditional M&A business, we have cultivated and attempted to extend legal due diligence in M&A to customize ESG due diligence and have addressed the findings of ESG due diligence in the transaction documents.
We believe that our persistent efforts in ESG will enable us to accompany our clients (regardless of whether they are funds, investors or companies) to sail through the waves and reach the shore of success, i.e., to become “excellent” and even “great” investors or enterprises that can be recognized in the international community.
About JunHe’s ESG team: JunHe, with over 900 professionals, is one of China’s largest full-service law firms with an international reputation for providing high quality legal services. As one of the pioneers in the practice area of ESG in China and with one of the largest teams of Environmental, Health and Safety (EHS) lawyers in the country, JunHe provides enterprises with a full range of ESG legal services. JunHe is sustainability- oriented and relies on different legal and compliance teams (including ESG, EHS, labor and HR, IP, trade and data, finance and taxation, business and criminal compliance and other professional teams related to ESG) to provide ESG due diligence services in M&A matters. The team cooperates with enterprises and third-party agencies in drafting ESG reports and provides services which include specialized ESG related legal and compliance diagnosis, the drafting and reviewing of ESG related terms in contracts with business partners, and ESG system construction and enhancement in connection with the daily operations of enterprises.
For further information, please contact:
ZHU, He (George), Partner, Jun He
zhuh@junhe.com
