The $1.3 trillion clothing industry employs more than 300 million people, making it one of the most important sectors in the global economy.

Driven by a growing global middle-class population and increased spending in developed economies, clothing production has exploded, with the ‘fast fashion’ phenomenon of quickly turned around styles being made available at ever-lower prices playing a big role in its rise.

However, low prices may mask environmental and social costs. Take waste, for instance. The proliferation of inexpensive, low-quality garments means it’s often cheaper to buy a new outfit than get clothes repaired. This has led to mountains of discarded clothing either being burned or ending up in landfill.

What’s more, to meet supply goals, outsourcing of production has led to a range of harmful outcomes, including suppressed wages, poor working conditions and child labour.

Now, while some consumers are willing to pay a premium for products made under ethical and environmentally friendly conditions, the vast majority remain highly price sensitive. 

We believe there are five key ESG considerations for the fashion industry.

Human rights

Scrutiny of human rights abuses of workers has increased in recent years. Regulators around the world have responded by placing restrictions on products that are linked to human rights issues or forced labour, including jewellery containing conflict minerals, all the way up to outright bans on imports.

Human capital

Human capital considerations include talent management, staff retention, promotions and respecting the artisans and indigenous cultures involved in producing some fashion items. Companies need to have strong promotion and retention programmes to incentivise autonomy in the creative process – something that is not considered ‘ESG’ in the traditional sense, but that undoubtedly plays a role in the sustainability of a company’s business model.

Sustainability

There’s increasing pressure on fashion firms to limit the amount of waste they produce and make product packaging more eco-friendly. The industry has faced criticism for overproducing, burning unsold materials, linear rather than circular production and greenwashing. To be deemed sustainable, fashion companies need to consider the entire supply chain and lifecycle of a garment, from where and how it is made to whether it ends up in landfill.

Governance and management

Around 90% of fashion companies are founder-led, family-owned enterprises. In Europe, half of family-owned companies have a chair aged over 70 with an average tenure of more than 30 years, while gender diversity at senior levels is sadly lacking. As we have explored previously, gender diversity on corporate boards is correlated with higher equity returns and better environmental outcomes.

Product safety

Better oversight of and transparency about product safety and quality could drastically improve companies’ social capital. Product tracing, openness about the use of harmful chemicals in the product lifecycle and strategies to reduce emissions have proven successful for companies that are serious about social impact.

We examined the universe of companies that are classified as members of the Textiles, Apparels and Luxury Goods (TALG) industry as part of the Global Industry Classification Standard and explored their ESG exposures, scores, and material issues, as reported by MSCI and Sustainalytics.

We found that both rating providers recognise the significance of social factors for the industry. In fact, MSCI assigns on average twice as much weight to social issues as environmental factors in calculating its ESG ratings.

There are over 1500 companies listed on Bloomberg in the TALG industry (as of 9 March 2023), with the biggest 25 accounting for around 80% of the industry’s market capitalisation. It’s worth noting that Western Europe alone accounts for around 60% of the $1.8 trillion fashion industry, according to Bloomberg data. The US dominates the footwear market, while the textiles segment has a major presence in Asia Pacific. At the country level, France accounts for around 47% of the industry’s market cap.

Western Europe is a clear leader in terms of ESG ratings. Five of the top six companies with the highest MSCI ESG ratings and 10 of the top 15 companies are from Western Europe. Asian companies lag, with firms from the US in the middle. Similarly, four of the five firms with the top Sustainalytics ratings and 10 of the top 12 are from Western Europe.

Let’s take a look at why two European firms – Burberry and Kering – are highly rated by both MSCI and Sustainalytics.

Burberry Group leads its peers in terms of supply-chain management, including strong labour practices. It enforces a supplier code of conduct and makes efforts to reduce the impact of any restructurings on its workforce, with measures such as severance pay and reemployment. Burberry issued a sustainability bond in 2020, setting out its environmental and social objectives.

Kering leads the way in terms of its product carbon footprint practices, including evaluating its suppliers' carbon emissions. Kering’s chemical safety measures are also better than the industry average, and it has adopted sustainable practices such as farm-level traceability for leather and organic cotton.

We went on to analyse the extent to which credit markets are responding to individual fashion firms’ ESG credentials. We found that, in Europe at least, there seems to be a correlation between firms’ Credit Default Swaps (CDS) spreads and their ESG ratings.

The average CDS spread for a Western European company with an AAA or AA MSCI ESG rating company over the past three years has been lower than for firms from the region with worse ESG ratings. This suggests that credit investors may be factoring ESG criteria into their assessments of European fashion firms’ creditworthiness.

Average CDS spreads (basis points): Western Europe (MSCI)

Beyond the industry’s ongoing efforts to improve its environmental performance, the human angle represents an opportunity for fashion companies to showcase their ESG credentials. One way they could do so is by issuing social bonds, whose proceeds could be used to provide access to essential services for employees and their families, generate employment and advance socioeconomic empowerment.

The industry could also move towards sustainability-linked bonds, incorporating key performance indicators such as:

• Percentage of supplier facilities that have been audited according to a labour code of conduct and percentage of total audits conducted by a third-party auditor
• Priority non-conformance rate and associated corrective action rate for suppliers’ labour code of conduct audits
• Amount of priority raw materials bought, by material, and amount of each priority raw material that is certified to a third-party environmental and / or social standard.

We strongly believe there are opportunities for firms in the fashion industry to make a lasting impact on the world. What’s more, with rating agencies focusing more and more on social factors, we believe that industry leadership is up for grabs, so firms need to equip themselves with the right tools to effect positive change. This includes using more data, engaging more with locals, and innovating more to identify and optimise social capital.

To learn more about how sustainability factors can affect your financial strategy, get in touch with your NatWest representative or contact us here.