Technology firms are often favoured by ESG funds because of their ostensibly clean, asset-light business models. But investors need to look deeper and challenge unethical and unsustainable practices across the industry, argue Louise Piffaut and Charles Devereux.

Communications technology was a lifeline for many people during the darkest months of the coronavirus pandemic. Video calls and messaging platforms kept families connected and businesses were able to continue operating as workers decamped from office suites to kitchen tables.

Information technology was the sector with the largest allocation among the 20 biggest ESG funds

Thanks to soaring demand for their products, technology giants such as Alphabet, Facebook and Microsoft have seen their market valuations soar over the past 12 months. And this has boosted many environmental, social and governance (ESG) funds, which tend to have large exposures to the technology sector. A recent study found information technology was the sector with the largest allocation among the 20 biggest ESG funds tracked by MSCI.1

On one level, the tech bias among ESG investors is understandable, and not simply because the industry offered societal benefits during the pandemic. Technology offers vital access to information and education for many communities, especially in poorer countries. Unlike manufacturing or energy companies, most tech firms do not have an obvious environmental footprint, and consequently sidestep the exclusionary barriers used by some ESG investors.

But fund managers should always be wary of focusing on business models while disregarding the impact of business practices – and the business practices of many tech firms warrant closer scrutiny.

Data’s carbon footprint

Start with environmental impact. Perhaps surprisingly, given the intangible nature of the digital world, tech companies are either directly or indirectly responsible for significant carbon emissions.

It is true digital solutions are often cleaner than the alternatives: for example, by speaking over a video call rather than meeting physically, we avoid transport-related emissions. Nevertheless, every online activity – from sending an email to streaming a Netflix series or Spotify track – uses a small amount of energy. Repeated and multiplied on a global scale, these emissions add up.

The ICT industry contribution to global greenhouse gas emissions could hit 14 per cent by 2040

An academic study published in 2018 found the relative contribution of the information and communication technology (ICT) industry to global greenhouse gas emissions could hit 14 per cent by 2040, or around half the relative emissions of transport, as of 2016. Electricity used to power smartphones accounts for a large proportion of the projected increase.2

These striking findings illustrate a salient fact: data is not environmentally costless. Sprawling, temperature-controlled data centres are required to process and manage the vast amounts of information produced by an ever more densely interconnected world.

Obtaining accurate figures on the energy usage of data centres is difficult, but some recent estimates suggest they accounted for one per cent of global electricity consumption, as of 2019, equivalent to 18 million US households. Demand for data processing is only set to grow further in the era of cloud computing and the Internet of Things.3

Many data centres still run on electricity from non-renewable sources

Tech firms such as Alphabet and Microsoft have made efforts to source renewable energy to power their data centres in recent years; both firms have also announced new innovations such as storing these facilities underwater to keep them cool, saving on power.4 While these are welcome initiatives, many data centres still run on electricity from non-renewable sources.

As of 2019, renewable energy accounted for only 12 per cent of the power used by some of Amazon’s largest US data centres, and its cloud services operations were expanding without any corresponding increase in the use of renewables.5 Tech firms ultimately have a responsibility to find cleaner, more efficient ways of running their businesses.6

Tax and the social fabric

Tax is another major issue that should be on tech investors’ radar. Many multinational companies are adept at what’s known as base erosion and profit shifting (BEPS), exploiting mismatches in international law to ensure their liability falls in lower-tax jurisdictions, and tech firms are among the worst offenders.

The Organisation for Economic Cooperation and Development estimates governments lose out on $100-240 billion every year due to BEPS, money that could be spent on education, healthcare, infrastructure, or solutions to the climate crisis.7

Tax avoidance has a profound impact on communities

The basis of ESG investing should be to reward companies that contribute to the creation of shared value. By depriving nations of tax revenues that should be available to fund vital services, BEPS schemes violate this principle; in that sense, tax is a social issue. Tech platforms may seem detached from the real world, but tax avoidance has a profound impact on the communities their employees, customers and stakeholders inhabit.

G7 policymakers are thrashing out the details on a coordinated plan that aims to close the relevant loopholes and force large companies to pay tax in countries where they take large profits, whether or not they have a physical presence there.

The Biden administration is also pushing for a global minimum corporate tax rate of at least 15 per cent.8 Such moves are to be welcomed, provided the resulting revenues are fairly distributed between high and low-income countries. Additional tax revenues could be used to invest in programmes that strengthen the social and economic fabric, improving our collective resilience for when the next global crisis hits.

Governance and inclusion

A third key concern relates to the ‘g’ in ESG. Many firms have so-called dual-class share structures, which effectively allow the founders of these companies to retain significant control; for example, Facebook’s Mark Zuckerberg and Alphabet founders Larry Page and Sergey Brin have majority voting powers.

Pressure to reform Big Tech's governance structures is starting to build

The strong market performance of Big Tech over the past decade has gone some way to mitigating investor discontent – but pressure to reform these companies’ governance structures is starting to build. In 2020, more than 30 per cent of Alphabet shareholders voted in favour of a resolution to abolish the dual-class shares, on the basis such structures tend to entrench the positions of senior executives and insulate them from external pressure and scrutiny.

Technology firms are gaining more power in society, and rapidly introducing innovations that generate thorny ethical questions. Think of the data privacy issues raised by artificial intelligence and facial recognition algorithms, the debate around the responsibility for moderating hate content and the role of fake news in influencing democratic outcomes, or the worrying lack of safeguards to keep children safe online.9 In this context, good governance, including independent boards to properly hold executives accountable, becomes vital.

The governance issue is related to another key problem: diversity and inclusion. The executives that wield the power in these organisations tend to be overwhelmingly white and male, and, despite improvements in transparency on gender and ethnicity reporting in recent years, progress remains slow. Google’s latest diversity report shows that, as of 2020, only 3.7 per cent of its US employees, and 2.6 per cent of its leaders, identified as black; of the leaders in its global workforce, only 26.7 per cent were women.10

Investors need to be clear-eyed when assessing the ESG implications of Big Tech

Each of these issues warrants further study among investors. We cite them here not because we have all the answers, nor because we think investors should shun the industry altogether.

The point is that investors need to be clear-eyed when assessing the ESG implications of Big Tech and, where possible, engage with these firms to improve their practices. After all, progress was never achieved by turning a blind eye to difficult problems.

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