Photo: Alex Eckermann / Unsplash Photos
The adoption of Environmental, Social, and Governance (ESG) practices for guiding corporate decision-making and managing corporate risk has advanced significantly in recent years, principally in Europe, North America, and East Asia. The COVID-19 pandemic and the increasingly urgent threat of climate change have clearly demonstrated both the direct relevance of the global ESG risk factors as well as the world’s interdependence in facing these ESG risks.
Like much of the developing world, Latin America has lagged significantly in awareness and implementation of ESG practices. In view of the well-known institutional weaknesses that have long characterized Latin America—weaknesses that have only increased amid the pandemic—business and government leaders need to recognize the importance of the ESG framework for addressing this broad range of risks and for moving towards a new “stakeholder” business paradigm. To meet this goal, private and public sector actors must work together to develop a long-term strategy, consistent with the ESG framework, to address the existential challenges facing Latin America.
This paper lays out a brief assessment of the global efforts to date to define and implement an ESG framework, with a more detailed look at the limited progress made so far in Latin America. The paper then offers concrete recommendations on how businesses can build on this progress, both in their response to the pandemic and in addressing long-term challenges. Business leaders must play the lead role in this process, recognizing both the costs to their own firms of ignoring ESG factors and the concrete benefits of defining corporate value in a comprehensive way. Executives should follow the principle of enlightened self-interest: a properly implemented ESG framework increases the likelihood of sustainable development in the country where their company operates. Government and civil society leaders must also be closely engaged in this process if it is to be successful.
ESG in the World
The ESG framework that is fast gaining traction in many parts of the developed world aims to integrate environmental, social, and governance considerations into the decision-making and risk management processes for lenders, investors, and firms. This effort is driven largely by rising concerns about climate-related physical risks—where weather and natural disasters, such as hurricanes and wildfires, disrupt economic activity and destroy capital—and about the losses that may result from a shift towards a low-carbon economy. A generational shift, changing views among business leaders, and rising consumer and investor demand for ethical business practices also play a role in promoting the ESG movement. In 2020-21, the devastating impact of the pandemic and related social unrest, especially in Latin America, has made ESG all the more pressing.
There are still those who view ESG as little more than an exercise in public affairs and a distraction from each company’s fiduciary responsibility to maximize rates of return for their investors. The increasingly accepted view, however, is that ESG captures the urgent imperative for business and investment leaders to understand, acknowledge, and manage their activities in a way that reflects an undeniable truth: businesses operate in a wider context and have an impact, for good or ill, in the communities in which they are active.
While the jury is still out on whether businesses and investments aligned with ESG outperform others, it is clear that there has been a large and growing inflow of funds into ESG-aligned businesses and portfolio investments in the capital markets of the developed world. Sustainable finance is another component of the trend toward ESG. Global sustainable finance reached almost $1 trillion in bond issuances in 2020, with Japan, the European Union, and the U.S. leading the way. Similar progress on ESG alignment is also present in trade and global supply chains, where firms are increasingly scrutinized.
Governments, firms, and other organizations have already done a significant amount of work on frameworks for approaching ESG. In November 2020, the United Kingdom became the first country to mandate that its companies disclose their exposure to climate-related risks by 2025. The EU has made serious advances to establish an official ESG-based regulatory structure, the so-called EU Taxonomy. After several years of serious political distraction from a constructive private-public debate on climate change, economic equity, and transparent governance, on May 20, 2021, President Biden launched a comprehensive U.S. government initiative to factor climate-related risks into financial risks. The initiative is led by the Financial Stability Oversight Board, building on efforts earlier in the year by the Securities and Exchange Commission (SEC).
Beyond these government efforts, the UN, the Financial Stability Board, independent standard setters, the World Economic Forum, credit rating agencies, and numerous ESG-focused advisory firms have developed a wide array of ESG standards, ratings scales, and methodologies over the last five years. Sorting through this interlocking web and agreeing on internationally accepted ESG reporting standards—as corporate financial performance indicators were long-ago standardized into widely accepted international accounting standards—is one of the most important challenges facing the ESG effort in the next few years, together with the need to continue to expand commitment to reliance on ESG-based decision-making and risk management.
ESG in Latin America
Latin America and most of the developing world have lagged significantly behind countries in Europe, North America, and East Asia in advancing an ESG framework. At best, the public and private sectors of Latin America have undertaken scattered, inconsistent, and unsustained efforts to understand the ESG framework and to implement this approach to business decision-making and risk management.
Just as European countries were among the earliest adopters of ESG principles in their own businesses, today they are behind efforts to encourage awareness of ESG in Latin America, including technical work with the leading stock exchanges of the region and in some cases with national regulators. Lately, business associations in the region have also organized ESG-focused activities to raise awareness. Leaders of some of the region’s “unicorns” and IT firms who have emerged as some of the most articulate “champions” of ESG.
Consideration of ESG issues has been of secondary importance in a region where short-term concerns over profitability, productivity, bureaucratic red tape, and the ever-present challenges of corruption and insecurity have dominated over medium- and long-term considerations like ESG factors. This became even more clear in 2020 as the COVID-19 pandemic spread rapidly throughout the region, exacerbating some of the region’s chronic weaknesses and resulting in an economic contraction in Latin America and the Caribbean twice as large (-7 percent in 2020) as the global contraction (-3.3 percent in 2020). While it represents only 8 percent of the world’s population, the region had accumulated almost 30 percent of global deaths from the virus by the end of 2020. Rising rates of poverty, inequality, unemployment, corruption, and crime in 2020 accompanied these discouraging figures, and 2021 already promises to be another difficult year. For the time being, survival has become the leading concern in the Latin American corporate sector, with hundreds of thousands of firms facing severe financial difficulties; many have already gone bankrupt.
Efforts in Latin America to launch sustainability-based financing have been limited to date, accounting for less than 2 percent of the cumulative global issuance of such bonds. Those countries leading in issuance to date have included Chile, Brazil, Mexico, Peru, Argentina, and Colombia. Financing from banks, institutional investors, private equity, and multilateral financial institutions is increasingly linked to ESG risk criteria. Some local banks in the region are already integrating ESG risk assessments into their lending decisions, but here the issue becomes one of the ESG-guided banks remaining competitive.
Another factor that will provide an incentive for the integration of ESG considerations into business decision-making and risk management in Latin America will be a potential shift of North American supply chains from China and elsewhere in East Asia to locations in the Western Hemisphere. In recent months, as relations between the U.S. and China have grown more tense, there has been more serious discussion of how “near-shoring” of some supply chain production to Latin America could become a promising source of investment, jobs, and growth for the region. The potential of these supply chain opportunities remains unclear. Looking to the future, the Latin American region also has potential to increase the contribution of its trade and exports to the structural changes that are essential to attain low-carbon production and consumption patterns.
The adoption of integrated ESG-based decision-making and risk management in Latin America will involve an extended transition phase. Furthermore, regions like Latin America, which are late adopters to ESG,s, have the opportunity to learn and to “leapfrog” based on the experience of countries that blazed the trail, adapting the evolving ESG framework to the region’s reality. Nonetheless, there are limits to how much time the region can take. Trade and investment flows are already being significantly and materially shaped by ESG and sustainability criteria.
Recommendations on ESG for Latin America
- Business leaders in Latin America must proactively lead private-public efforts to implement an ESG framework and take the initiative in defining roadmaps for integrating ESG considerations into their own corporate strategic decision-making, planning, and risk management;
- While governments have a responsibility for negotiation and compliance with international agreements on a range of environmental, social, and governance issues, their role in the process of ESG adoption is to facilitate and engage with the private sector to ensure that public policy objectives on regulation, commerce, trade, taxation, and investment are consistent and conducive to early and effective adoption of ESG practices;
- Civil society leaders who promoted environmental, social, and governance reforms long before these issues became mainstream must be open to closer cooperation with business and public sector leaders in the more collaborative context of a new ESG-based business paradigm; and
- Business, government, and civil society leaders in Latin America must work together to develop an effective format for close private-public consultations and decision-making in this evolving process, with the ability to learn from successes and failures in countries that started earlier in the ESG process. Regional and international organizations, as well as Latin America’s bilateral partners, can and should play a supportive role with Latin American countries in this effort. The 26th UN Climate Change Conference of the Parties (COP26) in Glasgow, Scotland in November 2021 and the next Summit of the Americas (likely to take place in the first half of 2022 in the U.S.) offer two high-visibility opportunities to turn attention to this important issue for Latin America.
The challenges of this kind of significant, systemic reset and paradigm shift should not be underestimated. However, the trend is already clear and irreversible. Factoring ESG considerations into decision-making and risk management will increasingly be an integral part of the fabric of business and investment leadership. Latin America will be ahead of the game if it proactively promotes this new, more responsible “stakeholder” paradigm of business, based on internationally defined parameters of Environment/Social/Governance factors (ESG). The decision for Latin America is whether to embrace the ESG process at an early point or to wait for investors, trade partners, and others to impose ESG-related expectations and requirements for them. While finding the necessary focus and attention will not be easy—especially in the midst of the pandemic—the advantage of being at the forefront of this rising tide should be made clear for responsible private and public sector leaders with a long-term perspective and with the best interests of their countries in mind.
Alexander Malaket is a Managing Director at ESG Validation Ltd. Michael Matera is a Partner at Global Outcomes LLC. Silvina Vatnick is a Managing Partner at Global Outcomes LLC.
