Is ESG a ‘nice to have’ or an integral part of corporate strategy?

GoodCorporation was delighted to welcome Dame Helena Morrissey to the House of Lords to open our final debate of 2019 which posed the question, is ESG a ‘nice to have’ or integral to corporate strategy and business success?

Dame Helena began by suggesting that ESG considerations are coming of age for the following reasons:

• investors need to trust the companies they invest in and ESG is regarded as a proxy for taking risk seriously,
• according to the latest Edelman Trust Barometer, two thirds of the institutional investors believe there is a positive correlation between a company’s financial performance and ESG disclosures, and
• the assets flowing into ESG funds are rising rapidly: Morningstar data on UK flows shows that over the first 10 months of 2019, £4.4bn has been invested in ESG funds up 53% on the previous year, and, over the past five years flows into ESG finds have increased by nearly 2500%.

However, despite the significant increase of assets into ESG funds, there is still a big gap between words and deeds, particularly when it comes to climate issues as the recent criticism of BlackRock’s voting record (FT- Paywall) on climate change proposals revealed. This inconsistency plays into end-investors mistrust and means the pathway between good intentions and actually changing behaviours remains unclear.

There are also lingering doubts about whether delivering financial returns for shareholders AND doing the right thing really are compatible; does the financial logic compete or complement the social logic when it comes to socially responsible investing? While these doubts remain, we are unlikely to see a joined-up approach from end-investor to institutional fund manager to investee company.

ESG investing is not a new concept, Dame Helena traced the origins of socially responsible investing back to biblical times and references to sets of rules to correct the imbalances that humans cause, together with the premise that ownership carries responsibilities as well as rights.

These are big aspirations which are reflected today in the aims of organisations such as the UN.  However, while the goals of initiatives such as the United Nations Principles for Responsible Investing (UN PRI) are meaningful, with its 2,300 signatories and $80trn assets under management, the impact is too small.

The majority of asset managers champion the importance of responsible investing, while carrying on as before with the effect that ubiquity has diluted accountability. Will better monitoring deliver change? From January the UK Stewardship Code will require UK pension funds and asset managers to disclose their voting records and explain the rationale behind their decisions, but is this enough?

It was suggested that to save capitalism from itself we need more responsible, fairer capitalism. The attempts to date have been well-intentioned but quickly institutionalised. The industry around ESG, for example, is in danger of missing the point. To be successful, the jargon and acronyms should be abandoned in favour of rephrasing the benefits of high ESG standards AND delivering consistent responsible investing. This should lift standards within companies, improve capitalism and show the social logic complementing the financial logic.

The next phase should be to celebrate and support those companies that drive the change we need. As Sir Christopher Hohn put it: “investing in a company that doesn’t disclose its pollution is like investing in a company that doesn’t disclose its balance sheet”.

In the ensuing discussion the following observations were made.

• None of the companies present felt they had fully integrated ESG into their corporate strategy – however, the majority felt that it is an issue being discussed seriously at board level and had plans to move forward with embedding ESG into their business models.
• ESG teams need to be evangelical and bring staff with them. One way forward would be not only to focus less on how the negative aspects of a company’s activities are being mitigated (e.g. carbon footprint) but to concentrate more on the activities within the business that evidence the positive impact the company has on society. Companies can afford to be more vocal about the positive contributions they make and should have the confidence to speak up.
• A young workforce will tend to be pre-disposed to advocating an ESG/values-based strategy which chimes with their own personal values. In some sectors there is a sense that personal values need to be left at home in order to do the job – this can have a negative impact on recruitment and retention. However, properly embedding ESG values into such organisations can have a positive impact on corporate culture, staff retention and ultimately productivity and profit.
• Companies that really care about their sustainability and ESG credentials can steal a march on their peers by communicating these to the investment community, using their own assessment models, rather than waiting for any standard reporting systems to emerge. Where this is happening, there is a positive response from investors.

The Challenges

• ESG is not always properly understood below board level – some companies found that within the wider employee group there is little interest in or understanding of it, but rather business as usual. In other companies, employees were enthusiastic adopters of ESG initiatives and providing impetus to change. Another company recommended using the communication techniques proven to be effective by the advertising industry in getting key values adopted by stakeholders.
• Would investors be better engaging with companies to help change behaviours for the greater good rather than divesting? Divestment should be a last resort, with investors Ideally working with businesses to help them become the best they can be. Will we see more business and investors working together with this aim? How should companies engage effectively with investors to ensure that they have all the relevant facts and minimise the likelihood of divestment?
• Is the term ESG a problem in and of itself? Would it be better to talk about sustainability and purpose rather than ESG? Creating a sustainable business makes good business sense; much of what is on the sustainability/ESG agenda is what makes for a good corporation. Although there are some who feel that the case still needs to be made that sustainability adds value, and this should continue to be addressed.
• Trust is an important factor and businesses need to understand what it takes to earn customer, investor and wider stakeholder trust
• Mixed messages from the investment community make it unclear as to what investors really want from companies to evidence ESG. This is compounded by different levels of maturity when it comes to the reporting of ESG data, which can make it hard to compare the data. The investment analysis model was described as out of date and this inconsistency needs to be addressed.
• The current model of ESG and financial data analysts working separately needs to change so that they work together to produce an overall, joined-up company picture.
• There is currently very little verification of ESG data – this may change as it is important that investors are comfortable with the information they are getting. However, the hope would be that we move quickly to the point where ESG analysis does not need to be separated out but becomes embedded in the business and finance models.

Significant changes driven by ESG objectives

• Some companies are changing their articles of association to focus on purpose which puts ESG issues at the heart of the organisation. This has required a complete re-evaluation of company culture and has involved stakeholder engagement exercises to explain the changes, the rationale and resulting benefits.
• Some companies have incorporated ESG related KPIs into staff performance goals as a means of embedding ESG strategies into their organisations.
• Businesses can drive change through their relationships with each other, with some incorporating ESG considerations in their new product design with requirements then being passed to suppliers, giving procurement a significant role to play. The tender process can be used to require suppliers to consider ESG factors as part of their bid in order to raise standards more widely. The change will obviously vary from sector to sector, but some progress is achievable through such means.

International outlook and trends

• Investors such as the French and Dutch pension funds, are obliged to consider ESG performance in their investment decisions. In addition, the forthcoming wave of EU regulation will reinforce reporting and disclosure obligations and should reduce any ‘greenwashing’ around ESG reporting and data.
• ESG is talked about more in the UK and the EU than in the States but even in the US statistics point to $1 in $4 being invested with SRI goals.
• There is a danger of toxifying the debate when it comes to certain sectors such as oil and gas where there is talk of starving the sector of cash.

The GoodCorporation view:

Evidence of long-term sustainability is critical to investment decisions. Properly compiled and verified ESG data can provide investors with key information about management quality, risk exposure, growth potential and future viability. Businesses that are serious about being able to access these funds are making meaningful changes within their organisations. We are working with clients to help them analyse their businesses and produce verifiable evidence of ESG performance in order to facilitate access to ESG capital. Not only will these changes support investment strategies, they will also enable businesses to meet the growing demands from society at large for a fairer, more responsible approach to capitalism and corporate behaviour.