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Since its inception, ESG has always been a nebulous concept, involving the juxtaposition of environmental, social and governance issues in a single marketable package despite the many contradictions between them. That is not to say that ESG’s elements are constantly at loggerheads with each other, but rather that they do not always sing from the same hymn sheet. For many years, this problem has been brushed under the carpet due to the fact that the E in ESG has generally taken precedence over the other two letters, both the S and G either being insufficiently fleshed out, treated as an afterthought or merely tacked on as a general by-product or minor actor in the general move towards sustainability and better corporate governance outcomes.

However, recent happenings in world affairs over the past year, including the ongoing Ukraine conflict and the ensuing cost-of-living crisis, have raised questions over whether environmental, social and governance issues can be reconciled, or whether addressing one is often at the expense of at least one of the others. For instance, how does a company balance the considerable short-term costs of implementing a business transition to net zero against the need of its consumers for reasonably priced products at a time of economic uncertainty as costs spiral all around them?

This is just one example of the many possible scenarios that force a contradiction between the letters of ESG. These contradictions, at best, prove a tightrope for issuers to contemplate a balancing act between its letters and, at worst, an irreconcilable chasm that itself demands a rethinking of the concept. It is beyond the scope of this piece to attempt an unbundling of ESG. However, it would be helpful to examine in some detail specific case studies when contradictions arise between ESG’s component parts and when they do not.

Rio Tinto’s ESG perfect storm

During H2 2022, Market Tracker analysed Rio Tinto plc (Rio Tinto) twice, as the beleaguered Anglo-Australian miner struggles to diversify its commodities beyond iron ore in order to escape a geopolitical balancing act between Australia’s Western-facing security interests and the company’s economic reliance on China. For more information, see: Rio Tinto treads carefully amid frosty geopolitical relations and Rio Tinto diversifies into greener pastures amid market uncertainty. However, this piece will ignore Rio Tinto’s recent geopolitical struggles and instead concentrate on an earlier perfect storm for the miner that played out during 2020.

Back in May 2020, Rio Tinto’s decision to destroy two sacred rock shelters in Juukan Gorge, based in the Pilbara region of Western Australia, as part of an iron ore mine expansion, represented a rare dovetailing of ESG red flags. Following outcry from the local Puutu Kunti Kurrama and Pinikura people (PKKP), as well as internationally, the miner that ‘the recently expressed concerns of the PKKP did not arise through the engagements that have taken place over many years under the agreement that governs our operations on their country’. Shortly after the destruction of the rock shelters, the Juukan Gorge incident was referred to the Standing Committee on Northern Australia by the Australian Senate for an inquiry. On 19 June 2020, Rio Tinto began a board-led of its heritage management processes, which, when on 24 August 2020, discerned the following:

‘The board review concluded that while Rio Tinto had obtained legal authority to impact the Juukan rockshelters, it fell short of the Standards and internal guidance that Rio Tinto sets for itself, over and above its legal obligations. The review found no single root cause or error that directly resulted in the destruction of the rockshelters. It was the result of a series of decisions, actions and omissions over an extended period of time, underpinned by flaws in systems, data sharing, engagement within the company and with the PKKP, and poor decision-making.’

In the aftermath of the review, investors, indigenous leaders and the public more generally were outraged that Rio Tinto’s senior executives had only seen their short-term incentives cut after the incident (for more information, see: Rio Tinto’s destruction of heritage landmark excavates directors’ bonus). Subsequent pressure eventually forced the miner’s chief executive, Jean-Sébastien Jacques, as well as its head of iron ore, Chris Salisbury, and head of corporate affairs, Simone Niven to . On 3 March 2021, more scalps were claimed after it that the three departing senior executives were gifted considerable payouts by the Rio Tinto’s remuneration committee. Chair, Simon Thompson, as well as senior independent director and remuneration committee chair, Sam Laidlaw, subsequently that they were not seeking their re-election to Rio Tinto’s board in advance of the miner’s 2021 AGM.

The brief summary above represents perfect storm for ESG issues, with environmental damage going hand-in-hand with social outrage and governance failings galore for all to see. In this case study, the ESG concept makes perfect sense, with its three components working in harmony. However, as the below example will demonstrate, it is not always that simple.

FW Thorpe’s ESG conundrum

FW Thorpe plc (FW Thorpe), a specialist in designing and manufacturing professional lighting systems, emphasises its sustainability-conscious business model on its . It has a substantial corporate responsibility section and its stated vision is to ‘maintain a consistently respected and profitable organisation with an environmental conscience’. Moreover, its highlighted its ESG activities prominently on its fourth page, including tree planting, investment in solar panels for its UK, Spain and Netherlands manufacturing facilities, the monitoring of its carbon emissions and work for local charities.

However, if we zoom in on FW Thorpe’s investment in solar panels, a common contradiction between the E of ESG and its other two elements emerges. A 2021 by Sheffield Hallam University found that 95% of solar modules rely on polysilicon, 45% of which is manufactured in China’s Xinjiang Uyghur Autonomous Region. According to the report, millions of indigenous Uyghur and Kazakh Chinese citizens are coerced into surplus labour or labour transfer programmes due to the ever-present threat of re-education and internment by the Chinese Government for those that do not comply. Some FTSE 350 companies, including and have specifically removed their supply chains from the Xinjiang region due to the ongoing human right abuses taking place there. However, for sustainably minded energy companies, the question remains how do you balance the governance risks and social issues arising from China’s forced labour and human right abuses against its people in Xinjiang province with the need for the polysilicon that is mined there for solar panels and the energy transition more generally? This conundrum is aptly summarised in the risk section of Atrato Onsite Energy plc’s IPO :

‘Articles in the UK press earlier this year commented that approximately 40 per cent of UK solar projects were built using panels sourced from leading Chinese firms that are now being linked to the use of forced labour in the Xinjiang region, reports of which first began emerging in the years following the apparent commencement of the systemic detention of the Uyghurs in 2016. Whilst the Company and the Investment Adviser have procedures in place to combat forced labour, human trafficking and child labour concerns, the due diligence undertaken in respect of the procurement process may not identify some or all cases of modern slavery associated with the production of component parts for the Clean Energy Assets. Adverse press coverage relating to the supply chains for component parts of Clean Energy Assets, including solar PV panels, which may be involved in the use of forced labour or other examples of modern slavery may have an adverse impact on investor perception of the UK clean energy (including solar) market generally and its participants, including the Company, which in turn may have a material adverse impact on demand for the Company’s shares and the price at which the Company’s shares trade.’

Human rights and reputational damage are not even addressed in FW Thorpe’s , which suggests that this may be a governance blind spot for the lighting company. However, government legislation or policy is mentioned as a principal risk, which may come back to bite FW Thorpe, as well as many other FTSE 350 companies reliant on solar panels, in the future. For instance, the implementation of the in the US since 21 June 2022 has seen considerable numbers of solar panels detained at the US border despite the country’s solar industry facing widespread supply shortages. In the UK, the , which would have prohibited the import of products made by forced labour in the Xinjiang Uyghur Autonomous Region, fell on 24 April 2022. However, this does not mean that similar UK legislation will not be implemented in the near future.

The case of FW Thorpe therefore provides an example of when the E of ESG is in direct conflict with its S and G on specific issues. However, in this case, it does not seem to be affecting the company too much. Following the release if its on 11 October 2022, FW Thorpe’s shot up 25.3%, the document noting that ‘the next challenge for FW Thorpe, which is certainly topical in its industry, is the global one of sustainability’. In keeping with the company’s earlier disclosures, no mention was given to S and G elements. Indeed, it seems that many companies simply select the letters of ESG that they can safely incorporate within their wider business model, which do not damage their financial performance too much. In general, little thought or long-term planning seems to be done in relation to ESG’s separate elements and how they should interact with each other.

The concept of ESG

As a marketing goldmine for companies, it seems likely that the concept of ESG is here to stay. However, that does not necessarily mean that the way the concept is analysed should stay the same. Instead of a juxtaposition of general considerations to keep in mind beyond financial performance, perhaps it would be more useful to conceptualise the three elements of ESG as disparate entities constantly in a state of flux, sometimes working in concert, sometimes working against one another. It would then be left to companies to balance the trade-offs between the letters and/or find innovative solutions to remove the contradictions that often form between them.

In the case FW Thorpe, this should be quite straightforward, as exclusively procuring solar panels from regions outside Xinjiang should not damage the company’s financials too much and would hand it a marketing coup. However, for companies that are more reliant on the energy transition, overwhelming reliance on the solar industry may require technological solutions to wean them off their reliance on Chinese polysilicon.

Market Tracker will continue to examine ESG concerns in the FTSE 350 and AIM 50 as they develop.