Environmental, social and governance (ESG) issues are becoming mainstream, yet businesses still largely associate ESG with climate change and reporting obligations. In the past year, the social aspects of ESG have been brought to the fore, due in no small part to labour challenges in the context of the Covid-19 pandemic — a crisis that has resulted in a dramatic increase in the number of people vulnerable to labour abuse.
Integrating ESG in the corporate space has been largely positive and well received, but it is important that all three aspects of ESG are given equal focus. To address the “S” in ESG, companies need to be able to manage their relationships with their workforce and the societies in which they operate. Beyond philanthropic initiatives, organisations now need to consider how their trust levels and reputation, as well as financial performance, will be impacted by social factors such as workforce composition, health and safety practices, supply chain exposure to geopolitical conflicts and shifts in consumer preferences.
This is especially critical for those whose operations span borders. Aligning with ESG principles becomes even more important, considering regulations and policies on issues that intersect with ESG. Legislations to address human rights and labour rights issues, such as the US government’s Trafficking Victims Prevention Act (TVPA) predate the emergence of ESG, having been around for at least 20 years. This act sought to drive sustainable change to improve human rights and labour rights all over the world.
The intersection of labour and ESG
The July 1 announcement that Malaysia had been downgraded in the 2021 Trafficking in Persons (TIP) ranking to Tier 3 (the lowest tier) is significant. The US Department of State ranks countries in Tier 3 for failing to comply with the minimum standards for eliminating trafficking or making significant efforts to comply.
The downgrade marked a return to its 2014 standing. Much of the intervening time since 2014 had been spent on the Tier 2 watch list (with a promotion to Tier 2 in 2017), but it seems the US Department of State may have decided that only a downgrade to the lowest tier can act as a catalyst for meaningful change.
The fact is, businesses cannot afford to ignore this development as it will have a material impact on access to the US market, whether directly or indirectly. According to the US Census Bureau, bilateral trade between the US and Malaysia in 2020 was worth nearly US$60 billion, and figures from the Malaysia External Trade Development Corporation (Matrade) puts the US as the country’s third largest trading partner. The TIP rankings over the years may also be a contributing factor in the flow of net foreign direct investments in Malaysia over the same period.
The issue of forced labour in supply chains is not new. The US Customs and Border Protection (CBP) have used legislative tools to take enforcement action for over 90 years via Section 307 of the Tariff Act of 1930 (19 U.S.C. § 1307), which prohibits the import of merchandise mined, produced or manufactured, wholly or in part, in any foreign country by forced or indentured labour — including forced child labour.
We can already see the impact of increased scrutiny on worker rights and supply chain integrity with the CBP taking more active steps. A number of companies in Asia have found themselves the subject of CBP sanctions as a result of labour abuse allegations in recent months. It is clear that an increasing number of people are no longer willing to overlook low prices at the expense of the well-being of those who produce the goods.
Businesses should also be aware that Section 18 of US Code 1589 “prohibits any person from knowingly benefitting from forced labor” — with the potential of a hefty prison sentence for those who choose to ignore the fact. At the very least, this demands improvements in supply chain due diligence, coupled with enhanced governance and monitoring. Simply saying “I didn’t know” will most likely no longer cut the mustard.
And it’s not just the US that is increasingly active — the EU is in the midst of finalising legislation to implement a ban on import of goods produced using modern forms of slavery and forced labour, including that of children. This too will undoubtedly place more scrutiny on businesses.
There can be no denying that markets and consumers are demanding greater accountability from businesses and trust them to do the right thing. The latest findings according to the Edelman Trust Barometer 2021 suggest that business is not only the most trusted institution among the four groups that form part of its study (the others being government, non-governmental organisations and the media), but it is also the single most credible and trusted source of information for most Malaysian employees.
As sustainability gathers long overdue momentum in the wake of the pandemic, business can no longer afford to ignore the issue.
Boards in particular have a duty to champion ESG among the key considerations as addressed in section 2.6 of the Securities Commission Malaysia’s (SC) recently released Malaysian Code on Corporate Governance (MCCG) 2021, to “strengthen Board oversight and the integration of sustainability considerations in the strategy and operations of companies”.
What needs to be done?
Businesses and investors have woken up to the need for their operations and investments to be sustainable, for their raw materials to be managed responsibly for future generations, for workers to be rewarded appropriately and treated with dignity, and for companies to accept responsibility and demonstrate they can be trusted.
None of this may be new but it is no longer just regulation that is driving improvement, and consumer expectation has never been more critical in decision-making. Society is assigning an increased level of importance to sustainability and ESG — for example, in PwC’s Global Consumer Insights Pulse Survey (June 2021), 61% of Malaysian respondents said they bought from companies that were conscious and supportive of protecting the environment.
On top of increasing consumer pressure, businesses may find themselves struggling with the challenges of meeting the expectations of their investors and supply chain/business partners. Knowing where to begin and prioritising an organisation’s next steps can be difficult. In our modern, hyper-connected world, that can be costly.
When it comes to ensuring that supply chains are not exploiting workers or undermining your ESG efforts, we believe there are a number of actions that businesses can start taking now.
1. Risk appetite — Do you have a clear ESG risk appetite statement? How does ESG fit into your business strategy?
2. Risk assessment — Do you fully understand the ESG risks in your business operations and in your relationships with your suppliers and business partners? What controls do you have in place to manage those risks and how do you disclose ESG risks in your reporting?
3. Due diligence — Do you have the necessary independent validation on your operations, as well as that of your suppliers and business partners in line with international standards?
4. Collaboration with civil society — ESG issues are complex, and no one party is expected to solve them alone. Bringing together the right community is the key. Civil society not only has a wealth of knowledge and experience but also is often in a better, more trusted position to engage with workers.
5. Operational effectiveness — Policies and procedures are essential but translating these into operational effectiveness will always be a challenge. Testing and flexibility are needed when designing controls and deploying them, but more importantly, the right culture needs to be in place so employees and suppliers are supported in their efforts to do the right thing. Business leaders play a key role in setting the right tone for the organisation.
6. Technology — While data and analysis can help you focus on those areas of real need, technology can also assist with monitoring, communication and other aspects of supply chain integrity to allow decisions to be made quickly in real time.
The global pandemic has brought about much change, some temporary, while others will almost certainly become permanent fixtures. Regardless, the focus on ESG is here to stay. Businesses will need to find the right balance in making trust the cornerstone of their purpose and demonstrating to society that they are committed to “doing well by doing good”.
Critically, there is a need for business to come together and demonstrate to regulators, consumers and other stakeholders that they can be trusted. This stance is no longer a “nice to have” but a “must have” as every action needs to contribute to achieving sustainable outcomes and make a real difference.
Andrew Chan is sustainability and climate change leader and Michael Sprake is financial crime unit leader at PwC Malaysia