A more joined-up approach to ESG – an opportunity not to be missed

Attending a breakfast event at the Ritz Hotel in London last November at which Hanneke Smits, CEO of Newton Investment Management was offering insights into how Newton manages the challenges presented by environmental and social governance (ESG), I was struck by just how attentive guests were to the subject. Part of the BNY Mellon Depositary Receipts series of Ritz Breakfast Briefings, Hanneke was in conversation with Peter Swabey FCG, Policy and Research Director at The Chartered Governance Institute, sharing her thoughts on the outlook for the asset management industry in 2020, but pretty much all of the questions asked by attendees focused on ESG. Clearly this is an issue that is keeping investor relations teams up at night.

Academic evidence shows a clear link between ESG and investment performance. In the past, companies have not always been good at advertising the good work that they are doing, but this is changing as companies are more acutely aware that investors are looking with greater interest at their ESG credentials. Engagement helps to drive financial returns and companies are being much more open about what they are doing. Samsung, for example, is being much more transparent about the steps it is taking in the Democratic Republic of Congo to ensure that child labour is not used in the extraction of cobalt, which powers the company’s mobile phone batteries. This is important not only from a reputational aspect; being more transparent can have a positive impact on a company’s ratings.

Ratings are not always the best indication of a company’s ESG credentials, however. Having a good ESG score does not necessarily mean that a company is effective in all areas. Most companies with a good ESG score have traditionally been rated more on the G and the S and less on the E. In all likelihood, this is because governance has been an area of focus for longer, but that does not mean that companies can rely on their prowess in this area to carry them going forward. A company’s carbon footprint and its record on labour practices, risk and supply chains are also of importance.

Unequal weighting in different jurisdictions can also be an issue. For example, companies paying the living wage is important in the UK, but this might not influence a company’s global rating if the UK is only a small part of the business. Furthermore, ratings agencies can be notoriously subjective and this makes it difficult for investors to gain a clear picture of which companies they should invest in. Tesla, for example, is rated at 0% in terms of its environmental credentials by the FTSE, but receives a 100% rating from MSCI. Many asset management firms, therefore, create their own ratings systems based on ESG.

Historically, it has been far easier to get financial information from companies than other types of information, for example about diversity and inclusion and ESG. This will need to change, however, particularly as the new Shareholder Rights Directive in Europe is bringing in change with signatories having to say how much they rely on advisors and how much work they do themselves.

This presents a huge opportunity for investor relations teams. Companies are currently too fractured in terms of the information that they provide. There is a disconnect between the information that analysts ask for, ie the financials, and the information that people interested in ESG ask for. Integrated assessment is what is required and companies that are serious about improving their ESG engagement will need to know what matters most to their key stakeholders/shareholders. They will also need to avoid greenwashing. If their stated principles say that they are environmentally friendly and they then print out great reams of paper when presenting to asset managers, this will send out a warning flag to those asset managers considering whether to invest in them or not. Being green and purporting to be green are not the same things.