ESG in the age of activism

Earlier this week I had the pleasure of moderating a fascinating panel discussion about how ESG issues are impacting on companies, investors and the relationship between them. Sponsored by Morrow Sodali, this was one of the Chartered Governance Institute’s regular series of evening events on topical issues.

This particular event was made even more topical by the publication a couple of weeks ago of the new UK Stewardship Code for institutional investors and their advisors by the Financial Reporting Council. The new Code states very clearly that the aim of stewardship should be to 'create long-term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society'.

This sort of language will be very familiar to many company secretaries, mirroring as it does the 2018 UK Corporate Governance Code and the Section 172 disclosure requirements, both of which companies will start to report on in 2020. The Stewardship Code is just the latest example of regulators asking companies and investors to demonstrate that ESG factors are an integral part of their thinking.

It isn’t just regulators that are applying pressure. More significantly, society is as well, whether it manifests itself as a company’s stakeholders, an investor’s clients and beneficiaries, or in the recent school strikes and other public campaigns.

That pressure is having a real effect. Driven by client demand, ESG has now become part of mainstream investment, not just a niche interest. Globally, ESG investment is now estimated at over $20 trillion. The investors on the panel confirmed that this was reflected in their own approach to investment and how they assessed company value.

This trend is having an impact on engagement between companies and their shareholders. On a show of hands, roughly one-third of the audience said that they had been asked questions about environmental or social issues by investors this year. When asked to put their hands up if they had been asked similar questions three years ago, only two people did so.

All the panelists felt that, in principle, this was a welcome change. Broadening discussions beyond ‘pure’ governance should help to make them more strategic, addressing issues like the company’s business model not just executive pay and compliance with the UK Corporate Governance Code (as important as those issues will continue to be).

It is not going to be straightforward, though. David Shammai of Morrow Sodali made the point that governance was now sufficiently well established as a topic of engagement that both companies and investors have a pretty good idea of what issues are likely to be on the agenda. In addition, the principles of good governance are not sector or size specific but applicable to all companies, even if the way they are implemented needs to be tailored to fit the company’s circumstances.

This isn’t the case for the E an S elements of ESG, though. The mantra that ‘no one size fits all’ applies even more here. Every company is unique, as are its stakeholders and the impact it has on them. Similarly, every investor will have their own list of priorities and concerns.

This has created some practical problems. The market, regulators and standard-setters have responded to these developments in the way that they typically do, by developing ratings products, indices and reporting frameworks. In the absence of a common set of criteria, these have proliferated. A 2016 report identified over 400 ‘sustainability reporting instruments’ around the world; the number is undoubtedly higher now.

Attempting to satisfy these often conflicting frameworks would require feats of contortion beyond even the nimblest company secretary. Importantly, it could result in the company losing sight of what really matters to its strategy and its stakeholders. All our panelists agreed that – while companies should obviously familiarize themselves with relevant ratings and voting policies – it was essential that they told their own story.

For a story to be told it first has to be written, and it often falls to the company secretary with the company secretary to acting as a sort of commissioning editor. Carolyn Ferguson, Group Company Secretary of The Go-Ahead Group, told us how she had worked with colleagues across the organization to develop what they called their ‘Board Mandate’ - a set of documents describing the company’s purpose and objectives that are used as reference point by the board when taking decisions.

Carolyn explained that developing the mandate and integrating Section 172 and other ESG factors into board papers and policies had required a much greater degree of co-ordination across the company than had previously been required. Her view was that this would be the ‘new normal’ for company secretaries.

Another challenge in telling the company’s story is finding somebody who is willing to listen. Companies frequently complain that they find it difficult to get their shareholders to engage with them directly.

To some extent this is inevitable. Philip Vernardis of State Street Global Advisors explained that they invest in roughly 12,000 companies worldwide. Therefore, prioritization is essential to the effectiveness of their stewardship activities. To maximize impact they use a risk based prioritization process to identify thematic and company specific issues that are important to their clients.

Kalina Lazarova of BMO Global Asset Management suggested that companies might be able to alleviate the problem by thinking differently about which investors they seek to engage with.

Kalina pointed out that the relative importance of a company to an investor in terms of their own portfolio did not always correlate with their position on the share register. Rather than just reaching out to the five or ten largest shareholders, she encouraged companies to look further down the register where they might find investors who had undertaken their own analysis of the company who could provide some useful insights.

Resource constraints apply to this post as well, and it isn’t possible for me to do justice to what was a very thought-provoking discussion in just 1000 words. But what came through very clearly is that ESG is increasingly going to be at the front and centre of both boards and investors’ thinking, and that the company secretary’s role in ensuring effective internal and external engagement will be even more critical than it is already.