PMI CSO: ESG reporting risks becoming ‘moot’ if corporates keep hiding their ‘elephants in the room’

Pictured: A tobacco farmer working in PMI's supply chain

Earlier this year, Philip Morris International (PMI) published its third annual integrated report, posting financial results alongside progress made in fields such as environmental impact, social impact and collaboration with staff and suppliers.

The report notably provided an update to PMI’s environmental, social and governance (ESG) framework and strategy, which was first launched in 2019. A major change is the separation of issues relating to products and issues related to business operations. There is also more clarity on ‘double materiality’ – the impact the business has externally, and the impact that external factors have on the business – with more specific targets.

As a tobacco major, PMI operates in an industry where the impact of operations is vastly outweighed by the impact of its upstream and/or downstream activities. It is the sort of company that many vocal critics of the current landscape of ESG metrics and funds would argue should, based on its business model, not be eligible for listing or inclusion. The tobacco industry is regarded as a ‘sin’ industry for many reasons. Chief among them is the impact of its product on consumer health, but attention has also been drawn to cigarette butt pollution in marine environments; human rights abuses and deforestation in supply chains.

But should a business get ESG points for exiting the sector that results in these negative impacts upstream and downstream?

Even before Jennifer Motles was appointed as chief sustainability officer (CSO) at PMI in November 2020, taking the reins from Huub Savelkouls after his 25-year tenure at the business, it had outlined a vision of a ‘smoke-free future’. This vision was built upon in March 2021 with a commitment for more than half of PMI’s total net revenues to come from smoke-free products and other smoke-free activities by 2025.

Enhancing ESG

The integrated report confirmed that 29.1% of PMI’s net revenues in 2021 derived from smoke-free products and that more than 99% of the business’s R&D expenditure last year went to smoke-free products. Alongside developing smoke-free products, a key focus was scaling recycling for their end-of-life stage.

Speaking exclusively to edie, Motles explains that the business conducted an updated materiality assessment in late 2021 partly because “the pace and scale of the smoke-free future transformation has accelerated radically”. She also says, more broadly, that “the world has changed a lot since 2019” due to the pandemic, with the ‘Blue Planet 2 effect’ slowly fizzling out and with growing stakeholder awareness of issues relating to public health, diversity and inclusion, social equity and biodiversity.

“Any company that updates materiality should re-think their strategy and, as materiality assessment is a dynamic process, they should really be redefining and recalibrating based on which ESG issues are most material every few years,” Motles summarises. Findings, she argues, should not simply be communicated in reports, but used to inspire strategies which result – if necessary – in significant changes to product and service propositions.

This gap between reporting (ticking boxes) and changing strategies, she believes, is where many businesses get stuck, and where much criticism of ESG stems from. This may be due to a lack of targeted understanding of current inputs and outputs compared to desired or required inputs and outputs, due to the use of data that is not “robust, meaningful or relevant” – or the use of ESG frameworks and ratings that encourage a tick-box approach.

The Financial Times has described the intense criticism that ESG frameworks, ratings agencies and funds have come under this past year as a “reckoning”. Investors and members of the general public alike have questioned why good ratings, and selection for thematic funds, have been the reward for businesses implicated in issues like armed combat, garment worker exploitation and fossil fuel pollution. There is also the persistent debate around whether ‘E’, ‘S’ and ‘G’ are being appropriately balanced – and whether carbon tunnel vision is preventing a holistic approach to the ‘E’.

“Being candid,” Motles tells edie, “traditional ESG metrics sometimes don’t cover significant problems your company is creating, or your most material issues.

“Because ESG disclosures are so comprehensive, you can tell many stories and, in many cases, avoid addressing the elephant in the room. For example, tobacco companies can sit with you, or report to you, on what they claim is ESG. But it is all on decarbonisation, without any mention of the most negative impact they create, which is borne from the products they sell.

“When that is the case, I think it’s very important that companies step in and commit to reporting not only against a set of metrics provided by standard-setters. In addition, they should recognise that transformation is bespoke to each company’s value proposition and strategy, and add further tailored metrics.”

The general consensus seems to be that 2022 presents an opportunity to improve ESG – standardising definitions and metrics and offering more transparency – rather than doing away with it altogether.

Embedded approach

Whether ESG frameworks are good, bad or ugly, using the findings of measurements to inform meaningful transformations of business models is a step few organisations have announced (other than PMI, the case study that springs to mind is that of Orsted, formerly Danish Oil and Natural Gas).

This is doubtless because transformation is no mean feat. Those in a stakeholder capitalist mindset will be loath to move away from a model that ultimately harms people and/or planet to some degree while it is still profitable (but they may wish to consider that 15 of the 17 S&P 500 firms that filed for bankruptcy between 2005 and 2015 recorded poor ESG credentials).

Once a business has stated an intention to transform, there are all manner of challenges, ranging from engagement with groups likely to be affected such as suppliers; to investment in new equipment, infrastructure and business functions.

This is a stumbling block in some ‘sin industries’. An exposee published by Channel 4 News this week stated that collectively, Europe’s four largest oil and gas companies, are investing just 5% of their profits in clean energy.

With this in mind, Motles’s team has worked with PMI’s financial team and other internal departments to draw up and report against a set of ‘transformation metrics’. These include changing where R&D expenditure is allocated; hiring more R&D experts; changing manufacturing lines; upskilling workers; launching new products and encouraging customers to change their habits.

The transformation metrics inform a ‘Business Transformation Financing Framework’. In short, PMI is recognising that its ability to secure capital in the future will be dependent on its achieving its ‘smoke-free future’ vision, so it is changing the way it issues financing instruments now. The metrics also inform KPIs which are linked to 30% of the remuneration for executives.

While an ever-increasing cohort of large businesses are linking ESG performance and top-level pay, few have begun reporting against transformation metrics or similar. However, the practice could well become prolific in the coming years in the UK, with the phasing in of a net-zero transition mandate from 2023, beginning with the largest firms in the highest emitting sectors. Some firms have already produced these plans on a voluntary basis, including Centrica and SSE, but may need to update them once the Government finalizes requirements intended to ensure credibility.

And other nations may well follow the UK in this approach as they are doing regarding mandatory climate risk disclosures.

Motles believes there is also a role for voluntary action from businesses as regulatory approaches evolve. PMI has made its ESG KPI Protocol open-source in the hopes of assisting other businesses to implement a similar approach. She said she hopes that other firms will also share ideas and case studies to provide a better chance of “moving the needle”, and noted that firms which do this must be open to feedback and discussion.

When asked whether she also sees the potential for a voluntary corporate collaboration on going beyond ESG tick-boxing, like the Race to Zero for climate targets or EV100 for fleet electrification, she said: “I think that creativity and ingenuity know no limits and that what you’re suggesting could be good.”

Crucially, she concluded, investors can prove just as effective at pushing companies to act as regulators or action from their peers can in some cases. “Investors need to become better informed about materiality, so they don’t just approach this as a box-ticking exercise,” Motles says. “They need to know what a good net-zero transition plan looks like, for example, or an effective diversity and inclusion approach. They need to consider business model transformation.”