ESG Emerging Markets

What To Know About ESG and Cannabis

Apr 14, 2022 | By JOSEPH CIOFFI

Investors and lenders focused on environmental, social and governance (ESG) principles will find opportunities for “green” financing in cannabis, but risk abounds as the truthfulness of ESG claims and disclosures are on the SEC’s radar. Last month the SEC put out a proposed rule that if adopted could lead to increased climate-related disclosures for companies subject to SEC oversight.

While cannabis businesses can improve their prospects for funding by emphasizing their ESG-related activities and achievement of ESG standards, financiers must do their diligence before incorporating an issuer’s or borrower’s ESG claims in their own disclosures.

At a high-level, cannabis may be viewed as ESG-friendly given its natural benefits to both mind and body, but each element of E, S and G must be considered to determine if a given project or company is holistically meeting ESG goals.

To help discuss the issues and best practices going forward, we talked with Anthony Coniglio, President and Chief Investment Officer at NewLake Capital Partners Inc., a leading provider of real estate capital in the multi-billion dollar cannabis industry.

Cultivating the “E” in ESG

The environmental impact of cannabis-related operations requires careful management and monitoring. Climate change will likely heighten sustainability issues further and investors and regulators will increasingly take note. Challenges must be addressed related to water usage, soil contamination, energy consumption and waste management.

Indoor cultivation, used by many in the industry, provides benefits in controlling against pests and weather, but these facilities require tremendous amounts of energy that, in turn, create a greater carbon footprint. For example, a group in Massachusetts reported that indoor cannabis cultivation generated 10% of the state’s industrial electricity use.

LED lights and outdoor growing could reduce the dependency on electricity. The benefits must be weighed against any increase in other negative factors, such as increased use of pesticides.

Whether grown indoors or outdoors, however, the cannabis plant requires water (about the same amount as tomatoes). Given that 19% of the contiguous United States faced severe to extreme drought conditions in 2021, and 36% faced moderate to extreme drought, water use could become a greater concern as the industry scales up and agricultural industries battle over resources. Hydroponic cultivation could help ease the concern.

When it comes to potential contaminants, such as chemical fertilizers and pesticides, which can have a downstream impact on water and land, purveyors may need to consider growing their cannabis under higher-cost organic principles, using less pesticide and fertilizer.

Other environmental issues include cannabis’s emission of natural volatile organic compounds (VOCs), which some fear impact air quality and lead to pollution, and waste issues related to regulatory child-proofing requirements and single-use plastic medical packaging.

Identifying these issues and then responding to them are key. Anthony Coniglio believes that the impact of cannabis on energy consumption is a potential blind spot for the cannabis industry.

“Not every location currently with cannabis operations is hospitable or sustainable to cannabis cultivation, utilizing wasteful processes, increased energy consumption, and higher carbon emissions,” Coniglio notes.

During its underwriting process, NewLake considers these factors and the long-term sustainability of a company’s operations. As such, “NewLake is selective in partnering with the highest quality operators and assets,” says Coniglio.

Opportunities To Repair Social Harms

Reparations

Many states are prioritizing cannabis business licenses based on social equity criteria. For companies that qualify, this may help to align ESG investor and lender values in social principles with their company values.

For example, in New York proposed regulations provide that the first retail licensees will be people who have been convicted of a marijuana-related offense themselves or who have a family member who has a prior offense. This is to ensure that those who benefit from legalization are the people from communities most affected by the war on drugs.

However, as always with regulated industries, companies must follow the rules in their respective fields by, among other things, making accurate disclosures in state licensing applications, especially with respect to social equity criteria in the space.

Health Claims

Cannabis’s negative perception in some communities and skepticism about its health benefits can make it difficult to satisfy investor criteria required to prove that a cannabis business benefits society. For example, though the impetus for so many states to legalize cannabis was the medical benefits, one of the drawbacks of cannabis being federally-illegal is the struggle to conduct scientific studies.

It is possible that there are untold positive health benefits that more research could unlock. But it’s also true that, with more research, health harms could be discovered. There are still questions surrounding the risks of vaping cannabis products. Companies and investors will need to carefully watch for changes in research findings that could impact their ESG disclosures.

Even where the state has legalized adult recreational use, negative perceptions can lead to a “not in my backyard” mentality at the local level, limiting location options and impacting the profitability of dispensaries and other operations. But cannabis companies can change the paradigm by focusing on the health, safety and welfare of customers, communities and employees.

This requires, among other things, closely monitoring and following regulations related to pesticides, labor practices and occupational hazards.

Anthony Coniglio acknowledges that “while many studies demonstrate the benefits of cannabis to treat certain conditions, more research is necessary to provide the significant empirical evidence necessary to demonstrate to investors the long-term positive impact on society that legal cannabis can provide."

Good Governance

In some ways, cannabis is ideally positioned for positive governance.

As there is more investor activism around Equality, Diversity, and Inclusion, board composition and company practices should be reviewed for EDI factors. Cannabis companies need to approach their lobbying efforts ethically.

Putting best practices in place and being responsive to an ever-changing regulatory landscape will be important. Understanding the unique requirements of each state’s laws and regulations and maintaining good compliance practices will be necessary.

“Given the investment community’s often negative perception of the legacy cannabis industry, it is of paramount importance for companies in the sector to embrace strong corporate governance,” Coniglio emphasizes. “Furthermore, while social equity, diversity and inclusion has been a strong focus of the cannabis industry since its inception, incorporating good governance into a company’s DNA will enhance a company’s ability to attract capital and differentiate itself in the eyes of the consumer.”

Looking Ahead

For ESG-minded lenders and investors, the cannabis space offers an attractive opportunity with the added bonus of funding the growth of an emerging industry. Likewise, for cannabis-related companies, conducting operations with ESG principles is good for business and can help attract funding.

As laws regarding ESG disclosures take shape, we can expect enforcement to focus on whether companies are actually doing what they say they are doing. For cannabis companies and their financiers, the evolving nature of the industry and the laws that govern it pose additional challenges to compliance. A careful eye is needed on regulations relevant to operations, health and safety standards of the product and the concerns of local communities.

Coniglio points out that “the legal cannabis industry was built upon many of the foundational principals within ‘ESG’. As the industry continues to scale up, redoubling our efforts in advancing environmental, social and good governance objectives will only serve to attract more capital, allowing a multiplier effect on all the positive impacts the cannabis industry provides to the communities it serves.”

Nicole Serratore, an attorney in the Insolvency + Finance Practice Group of Davis+Gilbert, assisted with this post.