Практика МСФЗ 25 квітня, 2022

Ukraine-Russia: ESG

Is doing business in Russia compatible with the sustainability or ESG agenda?


Alain Deckers, Head of unit, Asset management, European Commission
The views set-out in this article are exclusively those of the author.
They do not represent the official position of the European Commission,
nor the views of individual Commissioners or other officials of the European Commission.

Many foreign companies have announced their withdrawal from Russia since Vladimir Putin authorised an illegal war of aggression against Ukraine. Others have decided to maintain, at least partly, their activities in Russia. For example, some foreign companies have suspended new capital investment in Russia but have maintained existing operations. Several recent press articles have pointed to the fact that investment funds labelled as «ESG» have exposures to assets of companies that still maintain operations in Russia. The question therefore arises: in the current circumstances, is doing business in Russia or maintaining an exposure to Russian assets compatible with the «ESG» or, more generally, the sustainability agenda?

I put «ESG» in quotation marks because not everyone understands this term in the same way. Some use it to refer to the way in which the environmental, social or governance factors impact a company’s financial performance. This is the so-called outside-in direction of materiality, i.e. financial materiality. From this perspective, it is clear that foreign companies operating in Russia have already taken a financial hit from the actions of the Russian state. Some have already written off billions of dollars’ worth of Russian assets. The unprecedented economic sanctions that have been imposed on Russia by the European Union, the United States and others will entail a significant negative impact on the Russian economy, and possibly a sovereign default by Russia. This will further reduce the attractiveness to foreign companies of doing business in Russia. Moreover, foreign companies that chose to maintain their activities in Russia may face significant reputational risks — perhaps eventually magnified by consumer boycotts across the Western world. These reasons alone should lead foreign companies to reassess their continued presence on the Russian market. It should also lead investment funds to reassess their exposure to companies that maintain a presence in Russia. This seems particularly relevant for funds that claim to pursue a focus on ESG but it is arguably a fiduciary duty for all company boards and financial intermediaries.

The second dimension of ESG materiality is the so-called inside-out dimension, i.e. the impact that companies’ activities have on environmental, social and governance factors. War is always a profoundly destructive process from an environmental, economic and social point of view. Russia’s war of aggression against Ukraine in particular is therefore fundamentally inimical to the objective of sustainability that lies — or at least should lie — at the heart of the ESG investing agenda. The International Court of Justice has already found that Russia’s actions against Ukraine «appear capable of falling within the provisions of the Genocide Convention». While this finding is set out in a preliminary order on interim measures rather than in a judgement on merits, it should give any foreign company still operating in Russia — and any investment fund still exposed to such companies — serious pause for thought. This is especially so considering the widespread and credible allegations of war crimes perpetrated by Russian forces in Ukraine. Moreover, the fact that the Russian Federation maintains its military operations in Ukraine in breach of the ICJ’s order represents a flagrant and unacceptable breach of public international law that has consequential spill over effects to municipal laws. As result public and private parties should adapt their policies and businesses accordingly.

Foreign companies that continue operating in Russia also need to consider that they could in practice facilitate the Russian war effort. For example, they may pay taxes to the Russian state, provide Russia with foreign exchange earnings, or — directly or indirectly — otherwise provide material support to Russia’s war effort. None of these seem consistent with standards of good governance that should prevail in any business purporting to pursue a positive environmental, social or governance agenda.

There is no need to engage in detailed legal analysis to reach most of the preceding conclusions. It is simply a matter of having the judgement to tell right from wrong. However, the preceding considerations also find support in certain international standards of good corporate governance and in provisions of EU law. For example, the UN Guiding Principles on Business and Human Rights state that «the responsibility to respect human rights is a global standard of expected conduct for all businesses wherever they operate» that «exists over and above compliance with national laws and regulations protecting human rights» (emphases added). In light of the order of the ICJ referred to above, and of the widespread and credible allegations of war crimes committed by Russian forces in Ukraine, foreign companies have at least a moral obligation to consider whether their continued operations in Russia are consistent with the expectations set out in the UN Guiding Principles. Similar considerations apply, for example, for the UN’s Sustainable Development Goals.

Turning to EU law, the EU’s Sustainable Finance Disclosure Regulation requires a range of financial intermediaries to disclose how sustainability risks are integrated into their investment decisions. In light of the scope and magnitude of the environmental, economic and social impacts of Russia’s war of aggression against Ukraine, it is difficult to conceive how a financial intermediary could fail to consider these impacts where it manufactures or distributes financial products that entail an exposure to companies operating in Russia or to other Russian assets. Moreover, the SFDR states that funds may only claim to pursue sustainable investments if their investee companies follow good governance practices. This suggests that pointed conversations should currently be taking place between financial intermediaries and any of their investee companies that chose to maintain operations in Russia. Unless the latter can unequivocally be shown to follow «good governance practices» — a dubious proposition at best for any company that directly or indirectly facilitates Russia’s war effort — they must not be included in financial products that claim to pursue sustainable investment policies or objectives.

Companies should also carefully consider whether their continued presence in Russia is consistent with the criteria of the EU Taxonomy. This includes the requirement that their activities must meet minimum social safeguards, including the aforementioned UN Guiding Principles, to qualify as taxonomy-aligned. A failure to comply with these safeguards could mean that revenues and investments associated with Russian assets and activities may not be aligned with the Taxonomy — even if all other requirements in the taxonomy, such as those linked with environmental performance, are met.

In short, foreign companies that maintain activities in Russia face significant financial, reputational and potentially even legal risks. Investment funds exposed to such companies — especially those that claim to pursue an ESG or sustainability focus — need to carefully consider whether such exposures are consistent with their investment policies and mandates, as well as with international and European norms. Having said that, sustainable finance policy was not designed to tackle acute geo-political crises, nor their associated risks, such as Russia’s illegal war of aggression against Ukraine. Sustainable finance legislation provides a useful prism through which to assess the current crisis, but the latter raises much broader political and economic questions. It would therefore be illusory to consider that sustainable finance legislation is the primary tool through which to judge or regulate the continued presence foreign companies in Russia.

№ 4, 2022  (с. 22)
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