As Kermit (and others, more recently) famously sung, "It's not easy bein' green; it seems you blend in with so many other ordinary things." So it is with ESG factors: there is undeniably a growing focus on businesses' sustainability credentials, but this is just one dataset among many that boards take into account when making critical business decisions.
More fundamentally, it's not necessarily clear whether for-profit companies can legitimately choose to implement more expensive (or less profitable) solutions on sustainability grounds. Viewed through a corporate tax lens, a particular question arises as to whether the allocation of revenues and costs between members of a multinational corporate group (which is generally required to be done on an arm's length basis under transfer pricing ("TP") rules) should take account of ESG factors alongside the more hard-nosed commercial considerations required by the OECD TP guidance.
Disclosure is only part of the puzzle
Of course, disclosure alone does not drive corporate decision-making. As Illycaffè CEO, Massimiliano Pogliani, says:
"A company, as rule, sits at the centre of its own universe. It’s not that the firm’s external stakeholders don’t matter, but it does tend to hold them at a distance, like planets orbiting a sun. [...] A company-centric view makes an inaccurate assumption that a brand’s path towards sustainability is linear and that every consumer is equally interested in its progress."
That said, consumers and other stakeholders are increasingly interested, and increasingly using disclosures to drive change. In its recent guidance on climate-related disclosures, BEIS suggested that "As it becomes easier to compare companies’ exposures to climate-related risks and opportunities, investors will be better equipped to incorporate these risks into their investment and business decisions". That requires not only data, but simple, accessible means of understanding that data. Otherwise there is a risk that climate credentials may be lost in a growing swathe of information published by companies, without any real scrutiny over the choices companies make, and why. And while there are all sorts of products out there designed to help individuals quantify and mitigate their own climate impact, comparing companies' ESG impacts remains far from simple.
Green swans: can profit and sustainability coexist?
In the TP context, one might argue that this increasing public, regulatory and governmental focus on sustainability provides a compelling commercial rationale for choosing a sustainable solution, even at additional cost. Shareholder activists and key investors, such as pensions funds, can also generate real pressure.
There is also growing evidence that ESG factors not only inform credit risk (that's been evidenced since at least 2008) but also have a real impact on the bottom line. Supported by the newly-consolidated ISSB, companies are increasingly treating ESG metrics in the same way as more traditional "results" of their business, including them in annual reports, and using them to attract funding in the same way as financial metrics. The market, in turn, is responding not only with green bonds, but broader sustainability-linked instruments, such as social bonds for gender equality.
On the flip side, research from S&P Global Ratings revealed that that potential downgrades influenced by ESG factors were more than twice as likely to lead to a downgrade in 2021 than other potential downgrades, with "social" concerns responsible for 85% of the downgrades.
A new approach?
Against that backdrop, I was disappointed, but not entirely surprised, to see that this year's update to the OECD TP guidance made no specific reference to ESG factors.
That's not to say that ESG considerations cannot form part of a robust TP policy. There are clearly defensible commercial drivers for preferring sustainable and responsible options, whether in a financing or supply chain context. However, they are not the only commercial drivers in play.
Nor are ESG considerations themselves straightforward. Those ESG factors that the market deems significant may not represent all of a group's "actual" ESG impact. In that scenario, there is a real question as to whether each constituent company can take into account all of its ESG metrics, or only those that represent measures of financial risk. Boards will also need to balance the certainty of long-term contracts against the need for flexibility to respond to changes in the data. Rather than a one-time conclusion that in-house provision is more sustainable than third-party alternatives, in reality this is likely to need periodic reevaluation if not ongoing monitoring. The key, as always for TP, is to ensure that decision-makers are fully informed and engaged, that they revisit the position regularly, and that the discussions around any decision are properly documented.
The Dasgupta Review, published by the UK Government last year, calls for change in how we measure economic success, noting that "our economies are embedded within Nature, not external to it". We are not there yet, but that's not to say corporates cannot take meaningful steps in that direction. To finish as we began, “I am green and it'll do fine; it's beautiful, and I think it's what I want to be.”
[This post also appears on the European Tax Blog]