What is not green is made green

The advancing social and political paradigm shift is reflected in the growing interest of investors and consumers in sustainability, environmental protection aspects and social responsibility. ESG (Environmental Social Governance) is on everyone's lips and refers to corporate orientation towards criteria of environmental protection and social responsibility as well as honest corporate governance beyond the legal minimum. The individual aspects of ESG are briefly explained below:

Environmental (E)^[i] − climate and environment friendly: Green assets are booming, sustainable funds have more than doubled their inflows globally since 2019, from USD 285 billion in 2019 to USD 649 billion in 2021^[i]. ESG funds currently account for around 10 per cent of the total market. According to the Global Sustainable Investment Alliance (GSIA)^[ii] report, USD 35.5 trillion was in sustainable investments, according to Bloomberg Intelligence even USD 35.9 trillion – with a strong tendency to rise to an estimated USD 53 trillion^[iii] by 2025. Society, the market, and regulators are key drivers of far-reaching ESG campaigns worldwide.

„It’s so green“ – also in reality?

Shares of the world's largest oil and gas giants such as Saudi Aramco, Royal Dutch Shell, BP, ExxonMobil, Total, Chevron, Gazprom or OMV are all represented in so-called “sustainable funds”, along with coal giants and mining operators such as Rio Tinto, Vale or BHP – despite their alleged responsibility for numerous environmental disasters and no less criticism from human rights organisations. No company or industry is excluded per se from the “sustainable circle” here, but often tolerated according to the best-in-class principle. For example, the top “green” quartile of companies in the underlying index is inevitably reflected as “green” in the ESG-listed funds. For this, it is sufficient if a company produces few CO2 emissions in comparison to others. It remains questionable to what extent sustainability and resource conservation are taken into account in the business model in absolute terms. The evaluation in relation to other index companies and a high tolerance threshold for undesirable sectors (up to 35%) are striking weaknesses for a comprehensive realistic sustainability rating. IT and digital service providers also not infrequently boast of being particularly energy-efficient and thus environmentally friendly by advertising increased computing capacity per second (FLOPS^[iv] rate), but ultimately causing more overall consumption. This rebound effect is detrimental to nature, as only the absolute consumption figure would be crucial for it. In addition to the electricity consumption, the enormous water consumption for the cooling of server centres does not contribute to the sustainability of the IT multis either. Microsoft, for instance, shines with an AAA rating (source MSCI) with reference to its low CO2 emissions and its positive contribution to the maximum 2-degree Celsius climate warming target.

The EU and EBA^[v] also initially focus more on risks from environmental factors as part of their broad ESG campaigns, especially from climate change. “Social” factors are only to become a stronger focus of European regulators in subsequent years. The EU Green Deal^[vi] states that companies making “green claims” should back them up with a standard methodology to assess their impact on the environment. The EU Circular Economy Action Plan 2020^[vii] requires companies to substantiate their environmental claims using product and organisational procedures for their environmental footprint.

Information on the environmental performance of companies and products across the EU should therefore become reliable, comparable and verifiable. Reliable environmental information would enable market participants – consumers, businesses and investors – to make greener choices and avoid greenwashing. A new EU taxonomy^[viii] now regulates for the first time, among other things, the difference between “light green” and “dark green” investments^[ix]. However, there are no uniform designation standards or labels worldwide, so the EU's initiative is to be welcomed.

Social (S) – socially and labour friendly: Apple Inc. shares are represented in numerous global sustainable tech funds, despite criticism around supplier countries with questionable human rights situations and low labour protection standards. How humane and fair are working conditions in mines, warehouses, manufacturing or subcontracting and along the entire supply chain? What proportion of suppliers can Apple trace on its own and what proportion of suppliers are from which companies in which jurisdictions/regions? Is Apple at all willing to monitor compliance with its own Code of Conduct and take appropriate action if there are anomalies or warnings from the supply chain? Rating providers such as Sustainalytics, Bloomberg ESG-Measure or MSCI largely exclude the supply chain/third-party supplier problem in their assessment and still focus on emissions and the direct corporate contribution to global warming. In our opinion, this is clearly not enough.

In its original version, the German Act on Corporate Due Diligence Obligations in Supply Chains (2021) was supposed to examine all supply chain members, but in its final version, it was limited only to direct suppliers. In the broader sense, this follows international standards such as the FCPA and UKBA. The idea behind it: Everyone is part of a supply chain and if everyone takes care of their immediate suppliers, the entire chain is covered. Thus, multiple sub-sourcing abroad is not directly in the scope of application – conflict materials as in the area of trade in goods are of course excluded and have to be considered accordingly. It remains to be seen whether the law will be reformed again with increasing EU regulation in line with the “social” factor.

Governance (G) – Corporate governance: “Good governance”, i.e., good, honest corporate governance that goes beyond merely managing potential risks from violations, meeting the minimum regulatory requirements, and relying as conservatively as possible on tried and tested procedures. Instead, governance reflects the ethics of the individual company and should set the culture in practice for the future with “tone from the top”. Negative examples of “tone from the top” were provided by the VW exhaust gas (Dieselgate) or works council affair, as well as the Wirecard case including the subsequent audit mess - they too were considered “sustainable investments” and failed due to disastrous management, scandalously flanked by gross breach of duty in office and insider trading by public officials on the part of the national supervisory authority.

The tension field of corruption

If ESG ethics already raise questions among DAX companies and German regulators because it is too vague, and if greenwashing allegations affect DAX corporations, as in the cases of DWS and VW, one may ask how the issue fares internationally along global supply chains, especially in countries with higher corruption rankings according to Transparency International.

Corruption – in all its forms – is one of the biggest challenges of ESG compliance and a truly material problem for investors, especially in times of crisis. It comes in many forms: bribery of public officials, taking or granting benefits, embezzlement, nepotism and finally frivolously working officials and lax or absent control structures. The latter pave the way for unfair dealings and illegal private arrangements by deliberately undermining independent audits, verifiable documentation and government bodies, or by condoning violations and their consequences. At its most extreme, it is systematic government official corruption that brings entire jurisdictions into disrepute. Inadequate governmental institutional integrity not only results in a loss of business and public trust but also in drastic environmental destruction, illegal wildlife trafficking, money laundering, terrorist financing – even modern slavery, child labour and human trafficking.

Corruption is capable of undermining all pillars of ESG. Therefore, effective ESG implementation along the supply chain and especially in the area of supply chain compliance requires an effective anti-bribery and corruption strategy. This applies in principle and is intensified in the international environment, especially in countries with a high structural state and private sector corruption risk.

Corruption has many faces

Corruption is very diverse, and money is not always involved. It does not follow the same patterns, which makes it all the more difficult to detect. 

• Cash is truth: Direct cash payments were and still are tried and tested and difficult to detect
• Hospitality, travel and entertainment (e.g., pleasure trips by works councils)
• Gifts and gratuities: often undetected or dismissed as trivial, including non-monetary ones
• Favours for family or friends (e.g., the internship for the niece)
• Assurance of privileges, contacts (special permission, establishment of business contacts)
• “Media Bribe”: mutual favours between media/press representatives and politicians during election campaigns (e.g., positive media coverage in exchange for politically induced market power while distorting competition in the news or newspaper industry)
• Hush money: for not reporting, advertising, publishing
• Bribe, acceleration, or facilitation payments
• (Hidden) bribery in the form of charitable donations, also for third parties (charity, NGOs)
• (Hidden) bribery in the form of political donations, also for third parties
• Bribery in the form of commission payments
• Benefits and non-market conditions (loans, real estate, luxury goods, leisure activities, etc.)
• Bribery of public officials (in connection with, among others, tender fraud, authorisation, access to benefits)
• Misappropriation of state or company property
• Failure to comply with auditing, record-keeping, reporting obligations
• Procurement of fictitious services from shell companies (letterbox companies, also offshore)

Statistics

The current scale is estimated at USD 1.75 trillion^x] in annual corruption payments and the resulting damage at USD 2.6 trillion (5% of global GDP).

In the health sector, corruption kills 140,000 children annually.

Up to 25% of public funds are lost annually because of corruption.

Governments pay USD 7.5 trillion annually for global health care, but corruption causes USD 500 billion (7%) to be lost. According to the World Health Organisation (WHO), USD 370 billion would be enough to ensure access to health care for everyone in the world.^[xi]

The World Bank and the World Economic Forum estimate that corruption increases business costs by 10% worldwide. According to Principles for Responsible Investment (PRI) and Transparency International, corruption increases contract costs in developing countries by 25%.

The UN report on corruption and the Covid pandemic at the G20 Summit in Riyadh warned that corruption remains a major threat to containment efforts, stating: “It is generally accepted that corruption thrives in times of crisis due to the conducive environments that are fed by disorder and confusion. [...] International bodies and institutions, including, the International Monetary Fund (IMF), the Organisation for Economic Co-operation and Development (OECD), the World Economic Forum (WEF), the World Health Organization (WHO), the World Bank, the Council of Europe's Group of States against Corruption (GRECO), the European Ombudsman, as well as the United Nations Office on Drugs and Crime (UNODC) called for countries to strive towards increased global vigilance and the integration of anti-corruption programming.”^[xii]

A solution approach: business partner due diligence & anti-bribery & corruption (ABC)

• “Good governance” is important for investment in all industries and markets. Demonstrated culture and robust clear, segregated roles and responsibilities, a control design with adequate IT tools, up-to-date policies & procedures^[xiii], as well as training tailored to the business help increase sensitivity to suspicious behaviour in organisations.
• The individual rating is important before aggregation to the overall rating in a fund/portfolio assessment. Each service provider contributes to the institution's overall ranking. The rating can include diverse data sources and risk assessments and aggregate these into a weighted score.
• ESG factors and the adequate handling of resulting risks must be integrated into business strategy, governance and risk management. For this purpose, the EBA for the first time gives uniform general definitions of ESG risks (EU Taxonomy Regulation) and identifies assessment methods for effective risk management.^[xiv]
• Especially in countries and industries with known corruption problems, ABC prevention is an initial prerequisite for the effectiveness of ESG
• Focus on the culture in practice and ethics of the company and on the individual risk exposure of all its bodies, employees and third parties rather than on minimum regulatory requirements to avoid fines and other sanctions: Holistic risk management instead of exclusively legal compliance risk management!
• Implement whistleblowing systems that guarantee anonymity. The majority of tips come from internal and external whistleblowers.^[xv]
• The maxim is:
  
  

 
Warnings & red flags

In addition to whistleblowing systems, conspicuous behaviour by the counterparty itself or transactions associated with it can provide indications of corruption. Know-your-customer/counterparty (KYC/KYX) and transaction monitoring systems should therefore be regularly checked for indicators, so-called “red flags”, with regard to anti-bribery and corruption, and should be re-parameterised or readjusted as necessary. Relationships between companies and traders must also be scrutinised. 

• Counterparty receives disproportionate commissions (“fees-on-the-side”)
• Implausible payments for contingency fees (purpose, amount, place, principal, beneficiary, etc.)
• Receipt of implausible discounts (deviating from market conditions)
• Provision of alleged “consultancy services” to legitimise fictitious payments (vague description of the service provided or to be provided), business intransparency
• Implausible industry connection between principal and beneficiary
• Counterparty has business or close family ties to foreign officials or a Foreign Public Officer (FPO) or even a Politically Exposed Person (PEP) or their close associates, so-called “Relatives & Close Associates (RCAs)”
• Property purchase with unusual or no financing
• Overbilling (potentially with withholding of the difference)
• Payments for fictitious services to shell companies
• Request for transactions to offshore banks
• and many other

Conclusion

There had been allegations of corruption and abuse of office against members of the German Bundestag several times last year. Some Union politicians are alleged to have been involved in brokering activities and to have collected high commissions in deals with medical protection masks. In addition, there is a complex affair involving alleged bribes from Azerbaijan. The recent 2.4 million euros bribery allegation at BMW (2.7 million euros damage) involving a former executive for embezzlement and commercial bribery by a consulting firm also testifies to the topicality, extent, and drastic nature of bribery in Germany - in both the public and private sectors of the economy. In this regard, the Council of Europe said that recommendations from its 2014 evaluation report on the prevention of bribery and conflicts of interest had largely not been implemented, according to interim reports in 2017 and 2019. Overall, efforts in Germany had been assessed as “not satisfactory”. It remains to be seen whether the planned lobby register of the Bundestag for the often-criticised non-transparent dealings of lobbyists with politicians will remedy conflicts of interest in this course.

 

^[i] Source Reuters

^[ii] GSIA | (gsi-alliance.org)

^[iii] www.bloomberg.com/professional/blog/esg-assets-may-hit-53-trillion-by-2025-a-third-of-global-aum/

 ^[iv] Abbreviation for Floating Point Operations Per Second, the number of floating point operations that a computing unit (processor or entire computer system) can perform per second 

^[v] See EBA Report on Management and Supervision of ESG Risks for Credit Institutions and Investment Firms (Jun 2021) and Sustainable Finance Disclosure Regulation (SDFR), incl. funds categorisation light green/dark green article 8 + 9 and Regulation (EU) 2020/852 Sustainable Finance Taxonomy

^[vi] The European Green Deal

^[vii] https://ec.europa.eu/environment/topics/circular-economy/first-circular-economy-action-plan_en

^[viii]  EU Taxonomy according to Regulation (EU) 2020/852, anchored in the EU Sustainable Finance Action Plan, which aims to allocate more capital to environmentally sustainable activities

^[ix] Sustainable Finance Disclosure Regulation (SDFR), incl. funds categorisation light green/dark green article 8 + 9 

^[x] http://transparency.org.uk/corruption-statistics

^[xi] http://transparency.org.uk/corruption-statistics#_edn1

^[xii] https://www.unodc.org/documents/corruption/COVID-19/G20_Compendium_COVID-19.pdf

^[xiii] „Policies & Procedures” Frameworks for ABC, Fraud, Code of Conduct, Business Ethics, Conflicts of Interest

^[xiv] The EBA report on Management and Supervision of ESG Risks for Credit Institutions and Investment Firms provides comprehensive recommendations such as ESG factors and ESG risks, in particular in relation to counterparties, to be integrated into the regulatory and supervisory frameworks for institutions and investment firms. In doing so, the report emphasises the importance of a holistic, forward-looking perspective and proactive approach by banks and supervisors. Starting with impacts of ESG factors and their implications for financial risks, it explains assessment methodologies for robust business models, risk monitoring indicators and effective ESG risk management, and identifies remaining data gaps and methodological challenges.

^[xv] See EU Whistleblower Policy