ESG criteria to condition EU recovery

, 18/06/2020

In the context of the Covid-19 crisis, it is highly foreseeable that European member states will spend and invest large sums of public money. Part of that money will go to strengthen the health and social protection systems, and the other part will be employed to the support the social and economic recovery. In fact, both the EU and its member countries have started to draw up their recovery plans, which will be applied in phases as the lock-down is relaxed.

The use of conditionality in the Covid-19 crisis

In relation to the social protection of the most vulnerable groups affected by the lock-down and that might be affected by the foreseeable reduction in activity in later stages, in some countries (for instance, Spain) temporary basic incomes are being considered. Such provision of income will have a triple objective: first, ensuring material living conditions; second, avoiding the spread of the pandemic by reducing the pressure to leave the house seeking subsistence means; and third, sustaining internal consumption. Accessing this basic income is subject to a series of conditions as: being part of the active population, the level and period of income loss, personal wealth, family structure, and other social variables.

Conditionality is also attached to aid to companies that face a reduction in activity. In Canada[1], Denmark, France and Poland[2], for instance, companies that are registered in tax havens will not be allowed to access public aid that is being granted to protect the supply of goods and services at the national level, protect jobs, and maintain tax revenues. In Portugal, although no concrete measure has been presented so far, both government and opposition have argued publicly that banks should not make a profit during the years 2020 and 2021, and that they should increase credit provision to support the economy in return for the bail-outs that they received after 2008.

This last case points to the main bias of the recovery policies after 2008, which was that conditionality was omitted in the transfer of public money to ‘too-big-to-fail’ agents (Financial, Insurance and Real Estate corporations). The asset prices of the FIRE sector were reassured through new indebtedness assumed by states and households, which imposed few to no constraints related to social, environmental or governance responsibility. This has had a large negative impact in the form of inequality, environmental crises, corruption, lack of public control and accountability, and in turn, a large damage to democratic legitimacy.

Conditionality based on ESG criteria

In a scenario of -3.8% of GDP in the EU in the first quarter, governments should aim at reactivating the supply of goods and services, at avoiding the destruction of the productive tissue and laying the foundations for a new and more resilient production model. The consequences of this crisis will favor a re-localization and re-industrialization of European economies to reduce dependence on global supply chains, especially in the sectors most sensitive to domestic security (health, food, energy, etc.).

As has been mentioned before, generally, nation-states will attach conditionality to public aid within their borders, either in their direct income provision to the population or other different types of aid to enterprises and banks. The sums of this expenditure will be very high, so high should be the degree of responsibility demanded to agents receiving this money, specially the most powerful. Responsibility should not only be demanded as a short-term condition until the crisis has been overcome, but as a permanent set of conditions that allows for the generation of more resilient and sustainable production-consumption models.

In recent years, environmental, social and governance responsibility criteria (ESG) have become part of the usual vocabulary of institutional investors, both public and private. The ESG approach is a system of assessing the impact of business practices from environmental, social and governance (ESG) perspectives.

The Ekona Center of Economic Innovation, based on these general premises, has developed an ESG Certification system that targets the real economy, including the SME system. Its aim is to assess the commitment to responsibility of enterprises. The certification provides an objective measurement of a representative set of variables associated to the environmental, social and governance areas of companies, which produces a composite indicator. This model allows, on the one hand, to measure current performance in ESG responsibility, and on the other hand, the detection of possibilities for strategic development regarding ESG responsibility. The advantage of Ekona’s model compared to self-declarative Corporate Social Responsibility (CSR) reporting lies on its objective measurement and absence of conflict of interests.

As is shown in Figure 1, this model allows public and private fund providers to identify responsible enterprises through the rating obtained in the process of certification. With this information, public administrations can direct their effort through public procurement or other aid, which places them in a very advantageous position of influence in improving the responsibility of the economy[3].

Source: own elaboration

Precisely in the period prior to the Covid-19 crisis, the use of ESG criteria was growing rapidly, as climate change was generating public pressure for both public administrations and the private sector to act accordingly. In fact, ESG concerns are rapidly shifting from the field of impact investing into conventional investment practice, as climate risks become increasingly apparent. Currently, the global responsible investment market is several billion euros in size, and is growing at a double-digit annual rate, despite the fact that so far it has been focused on large companies rather than on small and medium-sized companies, which have not yet found a method to be included in the ESG investment category. The growing importance of these new criteria is evident at institutional levels such as that of the European Union, which has developed an Action Plan for Sustainable Finance[1], which will serve as the basis for integrating ESG criteria in the evaluation of financial risks, as well as the United Nations Working Group on Transnational Corporations and Human Rights[2].

Ekona’s approach to the ESG criteria responds to social, environmental and governance concerns, but also to concerns related to an efficient distribution of available resources, a reasonable investment return and with an structured and sustainable re-localization of the economy. These principles will be especially valued in a scenario in which there is a need for guidance for large public investment initiatives that are responsible, efficient, localized pervasive, sustainable over time and which generate virtuous processes. As such, we believe that we need to apply this type of tools to the productive economy of small and medium size, majoritarian in the European territory, fundamental in sustaining employment and one of the most important social backbones.

Recovery based on ESG criteria

By the time we reach the phase in which public money begins to flow as established by the recovery plans, the conditions for the use of that money will be defined. The success of the recovery plans will depend on the nature of those conditions. The use of the hereby proposed ESG Certification model allows for the design of an incentive system necessary to efficiently allocate resources, and also to correctly assess the social, environmental and governance returns of public investments. The effectiveness of the ESG criteria is based on the following main pillars:

Public procurement: the recovery plans will take into account the potential that procurement policy has for all administrations as an engine for directing public investment and expenditure. The economic volume of public procurement amounts to 2 trillion euros in the EU, a 14% of the EU GDP. Such relevant amount will play a key role in the process of improving the business fabric associated with recovery. In this sense, the inclusion of prerequisites related to ESG criteria constitutes an efficient tool to achieve the greatest possible harmony between the different programs included in the recovery plans.

Pre-conditionality: companies may be considered eligible for public funding in relation to their relative degree of responsibility in their economic sectors, measured using ESG criteria. Such assessment of eligibility for public funding must occur prior to the launching of the recovery plans and independently of it. It will provide guidance for efficient resource allocation processes and incentives to entrepreneurs to enhance the quality and responsibility of their projects under ESG criteria, which in turn will help re-localize supply chains. Thus, the introduction of this new tool within the framework of the recovery plans will facilitate its management.

Continuous certification: there is a need to establish a harmonized responsibility accounting systems that can interact or even integrate within current accounting methodologies. The system hereby proposed, based on ESG criteria, entails a periodic certification of companies. The introduction of the hereby proposed ESG certification as an official method to assess eligibility throughout the recovery plan will expand the number of companies using the hereby proposed ESG accounting system, consequently, improving the responsibility and resilience of the public investments of the recovery.

Institutional granularity: the recovery plan needs depth and width, which means that it needs wide extension with a high degree of institutional granularity. To be successful in this regard the effort of the recovery plan must be distributed among the different levels of public administrations, with a special emphasis in local administrations, which should see their funding and policy-capacity increased. For that, applying our proposed ESG model would substantially improve the probability of success. The new model would give incentives to enterprises to make strategic bets for the fulfillment of the sustainable development goals coherent with our proposal. In the short run, we would see that local responsible enterprises benefit from this new procurement approach. In the medium term we would see that new enterprises have been created from origin in coherence with ESG principles. Long established firms will have to adapt to the new conditions or cease to provide services to the public administrations.

This model could be adjusted and reinforced through complementary policies coherent with local needs and resources. In this sense, local policy could be even more successful to the extent that supporting services were provided by public institutions to entrepreneurs that wanted to use our proposed ESG model, such as those related to business mentoring, credit provision and concertation/consortium-building between local stakeholders. In this way, possible obstacles or deviations could be corrected during the introduction to the proposed ESG model along the execution of the recovery plan.

Article originally published in German at Makroskop:





[3] A wider explanation is available at: