The rise of ESG has growing implications for the tech industry

The importance of environmental, social and governance issues is growing across the economy, and a confluence of factors is driving the importance of ESG in the technology sector in particular. Regulators are calling for companies to put more metrics around their ESG goals, and more customers and employees are demanding businesses take a stand on these issues. Technology companies have found themselves in the spotlight given their dominance in the market, sizeable valuations and ever-growing reach into people’s daily lives. Big technology companies have led the way in recent years on ESG issues such as climate commitments, diversity and inclusion efforts, and global governance initiatives, paving the way for the rest of the tech sector to follow along. Investment capital earmarked for ESG assets, calls for workplace equality and equity, and a level global playing field are driving tech leaders and entrepreneurs alike to examine ways to bring ESG into the core of the enterprises they run. In a historically white- and male-dominated field, the employee base is now more diverse, necessitating more intentional inclusion efforts and highlighting the sector’s reliance on H-1B visas, which draw foreign workers. As ESG issues have come to the fore, tech companies that may have been lagging on the human capital side have been forced to adapt. Technology companies have a significant opportunity to differentiate themselves from their peers and align with customer preferences. Adopting a strong ESG strategy now will also put firms in a better position to navigate regulatory and policy responses from governments across the globe in the future.

Actions taken

Many events of 2020 provided the technology community with the opportunity to showcase its commitment to core components of ESG; the climate crisis was a key issue in the presidential election and the pandemic highlighted a range of social issues. Many companies took a stand and implemented initiatives and changes to their core businesses to address ESG issues. According to an October 2020 study from the Taskforce on Climate-related Financial Disclosures (TCFD), 60% of the world’s 100 largest public companies support increased disclosures outlined by the taskforce and 42% of companies with a market cap in excess of $10 billion disclosed at least some information in line with the TCFD framework. U.S. tech giants have all made net-zero or carbon neutral pledges to eliminate their carbon emissions by as early as 2030 in some cases and 2050 in others. Commitments like these will require vendors, suppliers and key partners to also dramatically decrease carbon emissions in order to meet targets, bringing implications for those other parties as well. And finally, ESG capital allocations have swelled to record levels, now making up $17.1 trillion of $51.4 trillion in total U.S. assets under management, according to Bloomberg LP, and those ESG assets are expected to expand to $50 trillion by 2025. Access to the capital markets will be essential as businesses grow and scale, and lack of a clear ESG strategy may hinder companies’ ability to attract investors.

New regulations

Global regulators and equity exchanges are also honing their focus on ESG, establishing standards and reporting requirements focused on such issues. Tech companies will need to identify the data required to measure and report on the progress of ESG initiatives if they want to meet the parameters set in these initial standards. Especially notable on the regulation front is California’s Assembly Bill 979, which went into effect in 2020 and requires publicly held technology companies headquartered in the state to have a certain number of board members from underrepresented communities, based on the overall size of the board. Boards with fewer than four members must have at least one such member, boards with five to eight total members must have two diverse members and boards with nine or more members must have at least three members from an underrepresented community. This bill expands the diversity categories from a similar 2018 bill requiring a certain number of women to have board seats on California-headquartered public company boards. In many ways, California has established an example for other states and even the federal government to follow, much like the state led the way with vehicle emissions standards that have been adopted across the country. Beyond individual states, the technology-heavy Nasdaq exchange earlier this year won approval to require companies that trade on its platform to appoint two diverse directors to their boards, one of whom must identify as female and another who identifies as a racial or ethnic minority or as LGBTQ+. Companies that do not meet this benchmark will be required to publicly disclose their inability to appoint the diverse directors. This new requirement is significant considering that more than a third of the companies trading on Nasdaq lack a racially diverse director, according to a study conducted by ISS Corporate Solutions and reported by Bloomberg. Of the 300 Nasdaq-traded companies with fewer than six board members, 64% lacked a diverse director and 44% lacked a female director, the study found. These new rules will likely require tech companies of all sizes to rethink the size and makeup of their boards. Finally, Securities and Exchange Commission Chairman Gary Gensler has commented that ESG reporting is also of interest to the agency, saying “the SEC hopes to bring some consistency and comparability” to what companies report. This effort is in its early stages as the agency seeks input from the public on key metrics, with a focus—at least for now—on climate and diversity disclosures.

Stakeholder demands

Capital allocations with an ESG focus across investment classes—whether in the form of capital or debt—have ballooned to record highs and now make up a third of all assets under management in the United States. This trend remains true for private companies with an attractive ESG positioning as private equity and venture capital investors continue to close a growing number of funds deemed “impact funds.” Such funds are marketed to investors as funds that will use the capital raised to achieve both financial returns and a measurable impact on social or environmental issues. A younger demographic of investor is also coming to the table, with greater ESG awareness and desire to “do well while doing good.” In a 2019 survey completed by Morgan Stanley, 85% of individual investors said they were interested in sustainable investing and 95% of millennials said they were interested in sustainable investing, up 10 and 9 percentage points respectively compared to a similar survey from 2017. This younger generation of investors believes strongly that their investment decisions can make an impact and are not only looking for careers that make a difference but are looking to invest their earnings in assets that align with issues they care about most. There is plenty of opportunity for firms that adapt to these shifting priorities, a recent RSM US report on ESG shows, and ESG awareness is growing: “Familiarity among middle market executives with the use of ESG criteria to evaluate the performance of businesses, organizations and/or investments rose significantly in the third quarter of 2021 compared to the fourth quarter in 2019,” according to the third-quarter RSM US Middle Market Business Index survey, which polled executives in July on ESG and climate change-related questions. What’s more is that “a majority of survey respondents indicated that their organizations are taking action to incorporate these issues into their operations,” according to the report. Tech companies need to consider their priorities and focus areas for their ESG strategy and assess what data they need to capture and report to ensure that strategy is effective. As consumers and investors continue to prioritize ESG issues and as more standards are put in place, tech companies will find an ESG strategy quickly evolving from a nice to have to a must have.