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War's ESG dilemma for investors: Solve short-term needs or confront long-term goals

The human cost of the war in Ukraine is already staggering, but it could get much worse as economic ripple effects spread.

The longer the war drags on, the more complex it makes private equity investors' duty to their LPs and other stakeholders to stay on track with their ESG commitments.

So far, efforts have mostly involved leaving Russia and cutting off money and support to Vladimir Putin's regime where possible. According to data published by the Yale School of Management, over 400 organizations have either scaled back their Russian presence or left the country entirely. The list includes asset managers like BlackRock, which has restricted Russian clients' capital market access, and advisory firms like Accenture, which has moved its operations out of the country.

While these actions are prudent from an ESG perspective, they're only short-term solutions. The war has forced the world to confront a new set of challenges, like the need for greater energy security and more investment in renewable alternatives.

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These won't be tackled by knee-jerk reactions alone. It will take the kind of long-term ESG planning that has arguably been lacking until now.

"The thinking on ESG is very different in a globalized world than it is in a world driven by geopolitics," said Steve Okun, a former director of public affairs at KKR who now runs ESG advisory firm APAC Advisors in Singapore.

Okun noted that PE firms and their portfolio companies are facing increased scarcity of raw materials and severe supply chain problems. The question is whether these pressures will make investors deprioritize their ESG goals. Related Pitch
Book research: How private markets are navigating an ESG risk framework.

One of the biggest global challenges is a shortage of raw materials, especially food. Together, Ukraine and Russia are estimated to produce nearly 30% of the world's wheat. In Ukraine, some of that is unreachable, while the rest will be untouchable because of Russia-targeted sanctions. Shortages of potash, which is used in fertilizer, will add further pressure on businesses that rely on agricultural products.

And then there's energy security. Sanctions on Russia's oil and gas exports have highlighted how dependent the world—and Europe in particular—has become on Russian fossil fuels.

On the face of it, the war has had a beneficial impact in that it has drawn attention to the need for renewable alternatives, not just for the environment but to reduce the current dependency on Russia. Some hope it will spur private investment in sustainable energy sources, a sector that until now has remained somewhat niche.

"I'm sure there'll be voices saying we need to get back to sourcing more traditional, trusted fuels, but I don't think they are being taken very seriously, " said Patrick Sheehan, who co-founded ETF Partners, a firm that focuses on sustainable technologies. "This is a wake-up call of the most shocking sort."

But even the renewable energy sector depends on materials from Russia and Ukraine, which are major exporters of neon—found in a range of technologies such as the semiconductor chips used in clean energy alternatives like solar panels—and cobalt, a component of rechargeable batteries. Even if there are reliable alternative sources for raw materials, it could present new ESG risks.

"People are thinking it will speed up the energy transition, but are you just trading off one risk for another?" said Okun. For example, if a company was to source cobalt from the Democratic Republic of the Congo, it could face a whole other set of ESG headaches.

Nevertheless, these new realities will go beyond challenging the priorities of ESG-conscious investors and the companies in their portfolios. They will also highlight the role ESG could have in preparing the asset class for the future. Sheehan remains optimistic.

"One of the fears that I had of this was that people would say, 'Let's put aside ESG because there's a real crisis to address.' And I've been pleasantly surprised that hasn't happened," he said. "If anything, it's the reverse, and there is a realization that values matter."

Featured image by Jorge Juan Perez/Getty Images

This article originally appeared on PitchBook News