Tackling ESG: Disconnected boards face greater risk
In this final part of the series, we explore the disconnect that remains with boards on ESG-related issues, the ‘fear of risk’ that drives shareholder engagement and the danger of producing a sustainability report that lacks substance. Our conclusions are derived from a recent Curley Global IR (CGIR) study of asset managers representing a total of more than $17 tn in assets under management.
A recent Harvard Business School study finds that 82 percent of investors surveyed consider ESG information when investing, most often because they find it material to performance. This helps to explain the strong push internally for asset managers to address investors’ growing need for ESG information and related offerings.
So why is there still a disconnect being reported between board perceptions of ESG as a fad and investor appetite for ESG? This is surprising, particularly because investors tell CGIR their desire for more ESG disclosure is being driven by an assessment of risk.
It is clear now that ESG is not a fad, but rather an investor-led focus that is here to stay. Investors now expect boards of directors to be able to convey how ESG factors affect the business and have been incorporated into company strategies, as investors believe ESG factors are long term in nature – that is, that ESG is strongly indicative of sustainability and mitigation of risk.
The United Nation’s (UN) 17 sustainable development goals (SDGs) are driving this trend as member states look to these targets for inspiration in shaping their agendas, objectives and political policies over the next 15 years. Companies and investors are using the UN SDGs to establish common frameworks for monitoring and reporting on ESG metrics. As a result, investors, consumers, directors and the business world at large are digging deeper into company value chains and business models than ever before.
The US federal government has tried to provide its own guidance. In late April, a field assistance bulletin was released by the US Department of Justice’s Employee Benefits Security Administration (Ebsa) to clarify that the Employee Retirement Income Security Act (Erisa) does not ‘necessarily require plans’ to adopt policies with an ESG approach. The bulletin states that Erisa plans ‘may not routinely incur significant plan expenses to pay for the costs of shareholder resolutions or special shareholder meetings, or to initiate or actively sponsor proxy fights on environmental or social issues.’
As soon as Ebsa released the bulletin, several large investors and institutional investors pushed back, issuing their own statements on the materiality of ESG disclosures and research, substantiating their positions in favor of ESG considerations.
Although public pension plans are not subject to Erisa, most adopt Erisa provisions as best practice for fiduciaries. Undeterred, Hermes Credit issued a statement that a company’s failure to consider ESG factors can impact credit risks. JPMorgan recently released its own ESG bond index to attract investors. A huge financial institution such as JPMorgan knows it is good business to offer economically targeted investments and provide a product investors are demanding.
As we mentioned in the first article of this series, ISS states that although shareholder proposals for mainstream corporate governance best practices have subsided, the number of ESG-related proposals designed to force companies to disclose more information is increasing. A newly announced collaboration between the Government Pension Investment Fund (GPIF) of Japan and the World Bank Group may help provide additional metrics surrounding materiality.
According to Hiro Mizuno, executive managing director of GPIF: ‘We especially value the World Bank Group’s unique convening power and expertise to improve breadth and depth of ESG data, especially of social criteria such as human capital and healthcare, and to refine pricing and cost mechanisms for the green and other labeled bonds so that such products can become mainstream investment products. GPIF is committed to working with our external fixed-income managers to integrate ESG.’
The puppy index
One investor tells us that it hurts companies when he reads a corporate sustainability report and sees all ‘flowers and puppies’. He refers to this as the ‘puppy index’, and says it raises red flags in his mind as to what substance is behind the company reports, and how seriously the company takes its CSR reporting responsibility.
‘We glance through them. With us, a lot of time is spent pre-meeting, and typically that would start with the annual report and maybe CSR reports. You learn how to skim past the fluff. You can get some insights as well as to how [the company is] presenting it. If it’s just all fluff, then it raises concerns. It’s the puppy index. The more cute puppies I see in the report, the more concerned I am about the company.’
Research conducted by Kellogg School of Management underlines this point: it finds that when a company devotes resources to a CSR program, it sends a signal to investors about the overall health and financial performance of the company.
Issuers need a comprehensive network
Our research shows it is time for public companies to create and manage a comprehensive ESG program, with a proper audit-controls framework and communications plan. The program should yield data that is justifiable – ie, pertinent – for the company and its industry, repeatable and auditable. SASB’s disclosure quality report gave low marks for boilerplate language without metrics to support a company’s unique innovation strategies, without betraying privileged information for competitors.
It is not enough to give the impression of an ESG/CSR program; investors are demanding enhanced public disclosures that must be backed up by fact.
An investor comments:
‘Across the world, investors are becoming more interested in the integration of ESG considerations in their portfolios in pursuit of better risk management and sustainable, long-term return generation. This reflects a developing global interest in sustainability issues more generally, as well as a growing desire (especially among the millennial generation) to invest in companies that manage positively the material impacts of their operations and products on society.’
Investors thirst for corporate disclosure on ESG issues, and appreciate transparency. Let’s face it: investors only have so much bandwidth to engage companies on a host of issues.
A company that provides significant disclosure of its risks, long-term strategies and governance controls may be less of a target. We know IR professionals never forget that investors will also have their eyes on the makeup of the board of directors. Board members who are well versed and able to emphasize their roles in adopting long-term ESG strategies to enhance the company’s interest may ultimately garner shareholders’ support.
Corporate leaders should identify which tools they need to advance ESG initiatives, with a goal of improving financial performance, and should consider four key areas when developing CSR/ESG plans and making them publicly available:
- Conduct an assessment of what is important to the company’s employees, customers, investors, suppliers and other key constituencies. Identifying those areas of importance, then further defining them into materiality categories, will provide the guideposts for a company’s internal goals as well as public disclosures
- Consider the adoption of one of the established reporting frameworks to use as a framework for public disclosure. SASB, ISO 26000, UN Global Compact, the OECD Guidelines for Multinational Enterprises and Global Reporting Initiative have emerged as the most commonly used. Many companies, however, also take into consideration guidelines from the National Association of Environmental Managers, make public their Carbon Disclosure Project reports, leverage third-party environmental assessment reports and validation, and use well-known surveys such as Sustainalytics, MSCI and RobecoSAM (Dow Jones Sustainability Index) for input into what is considered material
- Create a cross-functional internal committee that continually shares information, evaluates existing and new data for accuracy and importance, and ensures proper reporting to C-suite and board-level individuals
- Ensure whatever ESG-related information is made public is done through a lens of materiality and importance to various constituencies, including investors. Customers may wish to know how the company is compliant against a vendor code of conduct. New employees will want to understand the ethical underpinnings of the company they join, and investors are increasingly asking about a company’s ESG programs and oversight to better understand the risks and opportunities associated with that investment.
As one head of sustainable investing tells CGIR:
‘We look at ESG [factors] as they pertain to material risks to the company. We look at how [companies] are managing environmental risks, and ultimately in the lens of that broader sustainability. The same goes for the S and G.’
IROs take heed, and prepare
CGIR postulates that a particular asset management firm’s ‘hot buttons’ may be driven by the composition of its clientele. One with a majority of its clients based outside the US may feel more pressure to focus on climate change and labor rights, for example, based on CGIR’s study findings. Therefore, understanding the asset manager’s client base as a determining factor for shareholder engagement creates another level of complexity for issuers and IROs.
A respondent states:
‘In the US, SRI/ESG is behind… As a large asset management shop, as fiduciaries, we take a pragmatic approach, and we will not take a stand on particular issues but we go where the data goes. Even then we are knee-deep in ESG.’
ESG issues, backed by trillions of dollars in assets, will continue to dominate the conversation. Although a one-size-fits-all approach has not been championed by investors, policies from organizations such as the International Corporate Governance Network, the Council of Institutional Investors and SASB provide a road map for boards and management.
Whether a company’s approach is sector-specific or leaning more toward a social or environmental perspective, the bottom line is clear. Investors want to see a company provide clarity to its employees and, ultimately, to all investors. IR officers need to be prepared to educate both the internal and external audiences on the proper framework, data and plan to accurately and consistently address the growing need for ESG information and disclosure.
Sally Curley is founder and CEO of Curley Global IR. Carol Nolan Drake is president and CEO of Carlow Consulting