is one of the hot-button topics of our time, and companies the worldsa over are increasingly considering environmental issues in their strategies. We’ve seen widespread uptake of decarbonization and CO2 reduction initiatives, and incentives to implement green energy. But as ESG gains traction, do we risk neglecting the “S” and the “G”?
The cost of cutting social costs
On a very basic level, there are social metrics to consider, such as the treatment of workers and remuneration throughout the value chain. Companies that are found to pay less than their country’s minimum wage, practice discrimination or treat workers poorly can face severe consequences – and not just reputationally. Even companies with a massive turnover can find their credit rating affected, and their credit risk uninsurable.
But social responsibility extends well beyond simply treating employees properly. It encompasses the activities that a company undertakes in order to “give back.” These might range from financial investments in charitable programs to community involvement. Whatever a company chooses, its approach should be holistic and comprehensive.
Social issues can also have a direct impact on a company’s ability to access finance. During the pandemic, for example, many airport workers were furloughed, made redundant, or even fired. Now borders have reopened and everyone wants to travel – but many airports are lacking staff. If we were to underwrite for an or travel company, this would be a risk consideration. We would ask, “Why would they announce a full flight schedule without the staff or adequate supply chain to fulfill their obligations?”
The financial impact of improper governance
A company’s governance credentials can have a significant impact on its audit opinion on financial statements. These are directly considered during underwriting risk analysis and can affect credit limit approvals. Let’s look at an example of a giant back in 2019. After their auditor resigned, the company struggled to find another firm to take over due to well-publicized issues in their governance. For underwriters, this kind of disinclination to engage by an audit firm is a major red flag – you have to ask “why?”
The type of audit opinion a company obtains is another key indicator for us: is it qualified or unqualified? A qualified report indicates that the auditor believes a company’s financial statement does not show a true and fair view of the state of the company’s affairs. This can affect a company’s credit rating, and in some cases, it even points to non-compliance or fraud. A company receiving this kind of report would find their credit rating downgraded to an 8, which means distressed – or worse.
The accuracy and quality of auditing in non-financial reporting is also necessary when establishing the green credibility of a company. In the credit insurance industry, referral processes form an important element of the governance, when considering the underwriting of deals with environmental or societal potential risks.