Sanctions from an ESG Perspective – Are social responsibility considerations overtaking sanctions co

Sanctions from an ESG Perspective – Are social responsibility considerations overtaking sanctions co

Sanctions from an ESG Perspective – Are social responsibility considerations overtaking sanctions compliance over the Russian invasion of Ukraine?

The tragic invasion of Ukraine and the sanctions imposed on Russia and Belarus have had a significant impact on business worldwide. A number of businesses found that some clients, individuals and companies had been designated and all commercial activities had to be halted and funds had to be immediately frozen. This in itself was a test for governance arrangements.

But the need for a business response is not just about the sanctions. The government has asked UK companies to “think carefully” about making any investment in Russia which would support the Russian Regime and openly stated that the government supports “signals of intent”.

Boards therefore are further considering how to respond to the crisis in Ukraine from an ESG, values, and culture perspective. Already over 500 large companies have withdrawn from the country, whilst others are suspending activities temporarily.

For these firms, it is not just about regulatory compliance but doing the right thing and meeting social standards and ethics whilst preventing reputation risks for being seen as a firm that is indirectly benefiting from working with Russia or Belarus.

ESG responsible investment

The FCA recently reminded market participants that the financial sanctions imposed on individuals and business in response to the Russian invasion of Ukraine by countries worldwide will have multiple impacts on companies with securities admitted to UK markets.

Whilst it was predicted for many years that ESG was growing in importance at the time of making investment decisions, the crisis has accelerated the implication.

Investors, especially those who prioritise ESG factors, are having to take a closer look at the stocks and other assets they hold, whether individually or through funds, to identify their exposures and any risk of stranded assets.

Actions of responsible investors who add ESG factors into their decision-making have already resulted in disinvestment and Firms like BlackRock have reported that, proactively, it advocated with index providers to remove Russian securities from broad-based indices.

Impact of sanctions on achieving Net Zero

On the 9th of March, the UK’s Business Secretary Kwasi Kwarteng announced the halting of oil import from Russia by the end of 2022 (about 8% of UK’s total oil demand) and plans to reduce UK’s reliance on Russian gas (less than 4% of UK’s supply).

While the UK has been reducing dependency on Russian oil and gas for some time, the energy crisis and the decision to halt Russian oil mean that oil production elsewhere is set to increase, for example in the North Sea. In addition, we may see an increase in carbon emission if the government decides to  keep coal-fired power stations which were set to close, open longer to ease the energy crisis. Other countries are facing similar dilemmas, an in some cases the shift away from Russian energy will be difficult and painful.

In this scenario Banks, and financial institutions will need to consider how these changes will impact their own Net Zero targets and metrics for scope 1, 2 and 3 GHG emissions specially category 15 for investments. It may be possible also that Firms will need to update their scenario analysis to a different trajectory, either because the business is expanding on renewable energy or because it is keeping fossil fuels dependency longer than planned.

Boards that are further considering ESG -and not just climate change - may see that different decision making outcomes may arise when social drivers to address inequality and social injustice are part of their discussions.

From a regulatory perspective

The pace and scope of the Russian sanctions is unprecedented and makes risk management and due diligence more important than ever. Some of the most common challenges reported by clients relate to due diligence checks to confirm if an individual or entity has been sanctioned given that even if an individual or organisation is not on the UK sanctions list, it does not mean that they are risk-free, as they may be on another list such as OFAC.  Another challenge is understanding aggregation impacts as individuals may be minority shareholders in a firm below the 50% threshold, which, in principle may be permissible but could have connotation from a control perspective. Linked to this, identifying prompt and recent changes in ownership and control to family members and close associates by sanctions targets and taking appropriate measures to freeze these funds has been reported as difficult by some. Lastly, firms are needing to quickly understand general licences and when these apply and request specific licences which are required for example when derivative positions are crystallising after the sanctions.

Overall, taking decisions to de-risk is not straightforward. Our recommendation as risk advisors is to first evaluate the exposures and the impact of any measures on the business and the communities where it operates. Whilst business should be aware of the reputational risks of not being seen as doing ‘the right thing’ any decision should be made based on an informed assessment to avoid negative unforeseen consequences.

How can BDO help

We have helped a number of clients with respect to their ESG exposures in many ways, such as:

  • Advising on the format and content of the ESG strategy and associated documentation
  • Providing support with risk assessments, scenario analysis and stress testing and the treatment in your capital adequacy assessments.
  • Providing ESG and Climate change training for Boards and the three lines of defence.
  • Supporting with carrying out a training needs assessment, and with developing of a training programme and content to enhance the understanding of ESG risk and for opportunities maximisation.
  • Advising on sanctions’ governance arrangements and risk management considerations
  • Helping to implement and / or enhance the quality of disclosures and reporting in line with the Task Force on Climate-Related Financial (TCFD)’s recommended disclosures, UN Sustainable Development Goals (SDG), and the UN Global Reporting Initiative and any other relevant requirements and standards.

If you have any questions or would like to find out more, please contact Richard Weighell, Adam Soilleux or Gloria Perez Torres.