Geopolitical Uncertainty Highlights Corporate Responsibility of ESG

On February 24, 2022, the Russian Federation initiated military action against the sovereign nation of Ukraine. The outbreak of hostilities occurred despite weeks of effort to reach a diplomatic solution. The United States, the European Union and its member states, the United Nations, and countless others had taken part in the dialogue. The efforts have so far been largely in vain.

The speed of escalation and the resolve of the combatants have caught many by surprise. However, the seeds of the Russia-Ukraine conflict have been growing for years as a pattern of escalating risk events.  As of this writing, there does not appear to be a clear path to end hostilities. Nevertheless, lessons are already emerging that should inform how coalitions, nations, citizens, and companies can navigate an increasingly complex geopolitical stage. Those lessons tie directly back to the Environmental, Social, and Governance (ESG) factors already shaping our world.

For the purposes of this analysis, ESG factors refer “to a collection of corporate performance evaluation criteria that assess the robustness of a company’s governance mechanisms and its ability to effectively manage its environmental and social impacts.” Whereas the "E” has focused on issues of climate change and decarbonization, and the "S" on social issues, the "G" has traditionally revolved around the pursuit of corporate profits in accordance with things such as regulations, reputational concerns, and adherence to laws and general principles of business ethics. However, the recent outbreak of Russia-Ukraine conflict is putting a fresh spin on Governance as a mitigation strategy for geopolitical uncertainty. It asks the question: How does an effective Governance approach speak to the types of actions we are seeing as the Russia-Ukraine crisis unfolds?

The Russia-Ukraine conflict represents the first major military test of peace in the region since the Soviet Union collapsed, maybe even to the founding of the European Union (1958) or earlier to World War II. The economic blowback has been swift, as nations moved to levy sanctions against Russian interests, politicians, and citizens.

On February 21, the US placed severe restrictions on trade with the Donetsk and Luhansk regions and against two large Russian banks. The next day, Germany halted certification of the Nord Stream 2 Baltic Sea pipeline, which would have doubled Russian gas flows to Germany. By the weekend, the UK was sanctioning Putin-aligned oligarchs, and several Russian banks were removed from the SWIFT network, the critical infrastructure for international capital flows. The Russian stock market was halted repeatedly, as the value of the Ruble crashed to less than $0.01 USD. The steps taken at national levels have had devastating effects. However, the response of the global business community has been perceived as equally swift and breathtaking in span and scope.

On February 27, BP announced it was abandoning one of Russia's biggest foreign investments, its 19.75% stake in Rosneft, which analysts predicted could mean a $26 billion hit for BP in exiting Russia. On February 28, Shell (UK) said it would dump investments in multiple major projects, including a 27.5% stake in the Sakhalin-2 liquified natural gas facility. By March 1, Visa and Mastercard halted processing payments for Russian banks. As of this writing, companies such as Equinor, Daimler Truck, Volvo, Renault, and many others are publicly exploring divestment measures against Russia. Meanwhile, online pressure campaigns have begun to target major international retail brands, including numerous globally recognized brands in the food and beverage industry, major fast-food chains, even cosmetics companies and pharmaceutical firms.

Russia-Ukraine Crisis

That is not to imply the corporate reaction is limited to multinational, publicly traded companies either.  Media worldwide is flooded with footage of customers and owners of small- and medium-size enterprises—restaurants, liquor stores, and bars and clubs—pouring Russian-made vodka onto the streets and sidewalks in a display of solidarity with Ukraine.

Governance has traditionally focused on respect for the needs of a company's stakeholders—customers, suppliers, employees, shareholders, and regulators—while recognizing that the company is operating in a social and environmental context. However, in the context of what we are witnessing in Europe today, Governance must include strategies such as:

  • Risk & Crisis Management: How do companies react to volatile, fast-moving geopolitical events or proverbial “black swans”? What does an expedited decision-making process look like within a company during high-velocity situations? How does a focus on reputational impact affect this?  And does the Governance model seek out different opinions and dissenting voices, to mitigate “groupthink” or strategic lock-in?

  • Resource Management: Do companies have a handle on where they invest capital and resources? What is the integration of their global supply chain? If geopolitical instability occurs, what are the risks posed to their workforce? To overseas investments?

  • Portfolio Management: What are the international business relationships between companies and countries? How resilient are they in the face of growing international and customer pressure? Are assets held in financial institutions that could be subject to seizure or sanctions?  As the potential for instability rises, should companies move proactively to untangle investments or partnerships? Under what circumstances, and at what legal or financial cost?  Could doing so inadvertently trigger greater instability? How quickly can a firm move to divest an investment with minimal risk to their overall portfolio?

  • Reporting: Just as protesters can take to the streets, in a social media-driven marketplace, activist investors, shareholders, and customers can mobilize boycotts quickly and publicly. How should companies proactively communicate steps they are taking?

  • Technology Risk: The reliance on technology means that a new vector for warfare is targeting critical infrastructure (e.g., internet, water, power). Are companies preparing resilience and continuity strategies that will be ready for media blackouts, utility service cutoffs, etc.?

  • Sanctions: Sanctions have been evolving, with new restrictions approved by national and supranational authorities on an almost daily basis. How quickly can firms implement sanctions?  How are firms managing their vendors to ensure third parties they rely on for sanctions screening are responding appropriately? How are firms testing that their sanctions controls are working effectively? What are the risks of non-compliance?

  • Supply Chain Resilience: What shocks will sanctions pose to global supply chains? For example, how do import restrictions—for instance, on Russian crude—cause price spikes in energy markets? How do those unanticipated supply constraints impact domestic utilities or energy producers? How quickly can suppliers source alternative raw materials and feedstock? And how do short term measures quickly amplify into larger policy discussions, (e.g., brewing tension between calls to boost domestic fossil-fuel production, versus the longer-term agenda toward renewables and energy transition)?

This list is not exhaustive, by design. It is intended to provoke a broader discussion. But politicians, corporate leaders, employees, and stakeholders should begin thinking in these terms. Eventually, the Russia-Ukraine conflict will reach a conclusion. But there remain many pockets of geopolitical tension (e.g., East Africa, Syria, South China Sea) where a similar escalation could breed conflict. And political tensions may be heavily influenced by climatological risk factors, as well, where disagreements shift from historical contexts to battles over scarcities of resources, food, and water.

And specific to this Russia-Ukraine conflict, the long-term effects on the Russian economy are unclear. It is also too soon to tell what opportunities the economic reshuffling might create. For instance, if a company such as BP removes a multibillion-dollar investment from Russia, will they pivot to put that capital to work in another company? Another country? Another industry? Are there ESG factors that might influence that reallocation? A company might remove money from Russia and decide to invest it in a domestic company. But what if that domestic company kept doing business in Russia during the conflict? Are they now tainted in the eyes of the investment world? Does that make them a less attractive option?

More such questions will emerge in months to come. For now, the immediate focus of the global community should be on ending bloodshed. The scale of human suffering demands action. But, in time, the Russia-Ukraine conflict will be seen as an example of a new form of sociopolitical multilateralism.  Nations will reflect on their efforts to pursue peace through diplomacy. But companies will also reflect on their part in this story. How in this time of uncertainty, corporations stepped in to play a new, very public role alongside governments, helping encourage stability and punish bad actors through their own collective action. And this new form of corporate Governance may well set a model for how nations and companies collaborate to avert similar events in years to come.

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