Why is it Difficult to Develop Better ESG Case Studies?

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Introduction

Does Environmental, Social and Governance (ESG) management bring financial returns to companies? That is the common question that from companies when they are encouraged to go beyond reporting compliances.

Whenever companies are being asked on the limitations to uplift their sustainability management, one of the common responses is budget restrictions. To them, investing in environmental protection or in the workforce wellbeing or other social issues would bring no or little financial profits to shareholders.

Failure to present convincing insights on the financial outcomes, will make getting companies on board to focus on sustainability issues to always remain a challenge. But since the Covid-19 pandemic has impacted business around the world, only now companies have started to realise the severe effect in putting sustainability risks on the side-line.

It is in fact not a new discovery that integrating ESG considerations into business strategies is not only important to mitigate external risks, but also profitable as well as important to customer allegiance and protecting against the rising number of major threats to social stability, vibrancy, and inclusivity.

 

But why is it difficult to build sound and comprehensive ESG business case?

Variations of ESG reporting – Companies around the world, in different sectors as well as different regulations, are self-reporting using different ESG metrics. Particularly for early reporters, the majority of ESG reporters disclose data and information that are not audited hence the accuracy and credibility of the disclosure are not determined. Hence, it is a challenge to validate and compare ESG performance clearly.

Limited standardisation of ESG ratings by third parties – Third-party ESG data providers are organisations outside of reporting companies. These third parties would normally use different data and rating systems, resulting in a substantial deviation of assessments.

Unclear linkages of the reporting ESG metrics to the effectiveness of ESG strategies – Many companies tend to report on whatever they have, including based on the operational initiatives in place pertaining some material matters but not directly derived from the companies’ overall ESG strategy. This restricts companies to gauge the effectiveness of the ESG strategies as the data they are monitoring is not exactly the data that they need to focus on to deliver value creation, rather than the data that they have for annual reporting purposes only.

Clear segregation of ESG metrics with financial metrics – As mentioned earlier in the article, qualifying the financial outcome of ESG initiatives could be difficult. To date, only few companies are able to track the return of ESG initiatives to their overall business revenue, and even lesser companies can provide comprehensive and consistent data.

Intangible ESG values are not easily measured – Companies often find that accounting is not the best tool to measure ESG performance as there are a lot of variables to monetise ESG values that are intangible that to date is over 80% of companies value.

To work on building a good business case, we also first need to understand the relationship between ESG and the overall business financial performance.

Companies by now should understand that integrating ESG into business operations is not just mere through corporate social responsibilities programmes. ESG integration should be aligned and centred together with business corporate strategy. A few research has found that companies that have integrated ESG into their core business outperform companies that have not in financial performance as well as stock market performance. This is because these companies strategically focus on managing the material matters that truly have impact on the business and stakeholders. This kind of research is widely available, but it is not good enough to be considered as sound business case for ESG. This is mainly due to the fact that there are still inadequate presentations on the details of how the management strategies or efforts actually work in making performance enhanced or profitable. This is why top leaders are not able to be relate and be convinced the ESG management levers that push towards financial performance.

Case studies on financial performance from sustainable investment on the other hand, have been rather complex due to various investment strategies having different performance profiles. For instance, in reference to negative screening (avoiding investment in industries, such as tobacco or weapons, that work against certain values or social goals) may limit performance as it reduces portfolio range and diversity. But currently, negative screenings that omits coal portfolios are doing well.

Regardless of these research complexity, the trend of ESG performance is showing that there is positive correlations between good ESG performance, stock price, cost of capital, and operational achievements.

 

Conclusion

A clearer business case on ESG’s financial impact are still needed to provide companies to relate and get inspired to make the move towards sustainability excellence. The business case will pave way for companies to scale up their investments in ESG in the face of pandemics like COVID-19, as well as other pressing issues such as climate change, inequality, and many other perceived or real challenges to their bottom lines. The companies’ commitment to meet its fiduciary duties as well as overseeing ESG performance should go hand in hand.

 

All views and opinions expressed on this site are by the author and do not represent any particular entity or organisation  

 

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Firming Up on ESG Management. Here’s Why Companies Should Not Delay it Any Longer?

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Introduction

Not many years ago, Environmental, Social and Governance (ESG) agenda has always been sidetracked by companies. The importance of ESG back then was not clearly understood and only observed as an addition to regulatory obligations. The lack of awareness by the Board and management of companies also didn’t help to overturn this mentality. However, companies across various sectors nowadays have started to give more attention to its ESG management and performance. More and more companies have shown unique approaches in ensuring ESG plays an integral part of companies’ corporate strategic agenda. With the impact of COVID-19 pandemic, companies are pressured to step up their ESG management and reporting. This article will briefly highlight the approach that companies need to consider in order to meet the increasing ESG expectations.

 

Multi-Stakeholder Management

Stakeholders are affected and also affecting all of the ESG criteria – Environmental impacts, Social impacts and Governance impacts. But as a ‘Stakeholder’, social issues have always been the central focus, ranging from community engagement to subjects related to human rights. Though till now it is difficult to quantify the financial values generated from social issues, but the impacts posed by the mismanagement of these issues are severe as companies would lose the confidence and trust from its stakeholders and eventually have reputational and financial implications to companies. 

Talking about reputation, there is never the best time compared to now for companies to adhere to its corporate principles and progressively revamping its risk management processes and advances reputation. Just by meeting the current demands of internal and external stakeholders is no longer acceptable particularly to key stakeholder groups that are looking at long-term values and gain from companies. So, the demands on future ambition and performance are also vital. For example, COVID-19 has heavily impacted (and still impacting) companies’ workforce across sectors pertaining areas of health and safety, income stability, and overall workforce morale and motivation. Stakeholders are observing how companies deal with these challenges and assuring the best solution are being provided to benefit them during and after the pandemic crisis.

Specific stakeholder groups such as regulators and investors as well as other market participants that include rating agencies, will continue to press companies to place paramount attention to social issues and how companies shows resilience in the competitive and challenging business landscape.

What can be learned from the recent COVID-19 crisis is that the immediate focus on social issues creates an opportunity like never before for companies to relook and improve on its overall stakeholder management and engagement to all of its key stakeholder groups such as its workforce, community, regulators, investors, and also those across its value chain such as the suppliers.

That being said, in allocating the efforts and resources towards managing the critical social issues, companies should not lose control of the continuous enhancement of environmental and governance issues. At the end of the day, ESG issues are interconnected. Apart from that, environmental issues such as climate change imposes great threats and impacts for companies. The impact of COVID-19 pandemic should provide companies the lessons that their business should be prepared at all times of all ESG risks that may affect them in the long-term. 

 

Effective ESG Strategy

ESG is no longer something that is ‘nice to have’, but are now considered as an imperative component of companies’ financial performance and evaluation. For instance, there was an estimated increase of USD$70 billion investment pumped in the 2019 ESG funds. This supports the prediction that ESG investing to top USD$50 trillion in the coming two decades. This trend points out that ESG investing will one day become mainstream and there is a clear opportunity for companies to reap the benefit if they prepare for it from now.

An effective ESG strategy is not only important to help companies to achieve the desired sustainability ambitions, but also provides a clear direction on how they can consistently improve their performance, manage and mitigate its risks and enhance market position.

The progress and outcomes of companies’ ESG strategy should also be communicated to all stakeholders to enable companies to gain the trust and confidence especially from the investors for long-term value creation.

In reaching towards the development of an effective ESG strategy, companies should oversee in a diligent manner on five key components; the companies’ material issues, roles and responsibility of the governance structure, comprehensive policies and innovative programmes, metrics and targets, and ESG communication.

To come up with strategic focus areas, companies should analyse issues that have the most interest, as well as impactful on and towards the business and the key internal and external stakeholder groups. Focusing on financial matters are now redundant as more and more ESG related issues are gaining the interest from stakeholder groups. It is definitely difficult to meet the demands from all stakeholders, as it is also not viable for companies to neglect the business needs. So, companies should have a structured and robust process in place to derive the key issues that have balance significance on the business and also the key stakeholder groups. These are considered as the material issues that should be in reference to companies’ ESG strategy development.

A sound governance structure should also demonstrate accountability and awareness on ESG management from all levels especially the Board and management. The Board and management should be aware of all ESG risks and opportunities relevant to the company and the industry the company is in. There is no template approach in ESG management as companies varies from one another. So, it is absolutely important that the governance structure to carefully formalise the roles and responsibilities that maximises the implementation and monitoring the robustness, effectiveness and the performance of companies’ ESG strategy. It is also important to note, that even though there might be specific functions or personnel that are responsible to oversee ESG management of a company, the ideal approach is for the collaboration of different functions to come together and work on ESG management as one whole unit and to ensure regular and beneficial exchanges of information are feasible. This would allow better risk and opportunities management particularly once companies have define the material matters to companies.

The development of ESG policies and programmes should be well-coordinated and strategically planned out. In order to do so, companies should not envision the short and medium-term outcomes but to also evaluate the long-term outcomes for the companies and stakeholders. In undertaking this evaluation, companies must see the areas that are feasible for them to optimise and capitalise in the specialties and strengths that are unique and aligned to the companies’ values. Most importantly, companies must anticipate the potential changes in the business landscape including the political, regional, regulatory, social and environmental trends that would likely to occur within the proximity of companies’ operations and influence. This would allow the companies to reap the long-term financial returns and remain competitive at all times. Having these understandings, companies should be in a good position to allocate the investments, resources, timeframe to implement the relevant plans for its ESG strategy.

The success of any strategy, including ESG strategy depends on various factors that are controllable and uncontrollable. Companies should always monitor the performance of the developed strategy to analyse the value it brings to be desirable or would actually cost additional effort and unnecessary investments to the companies in the long run. Companies must adapt and be flexible to changes and also must know when. The results from the materiality assessment (to identify the material matters of a company), should be referred to in developing the relevant metrics, KPIs and targets that are achievable and realistic to place companies in a higher ESG management position. Setting metrics, KPIs and targets that are too ambitious immediately may result in early failures that would lead to demotivation to oversee ESG management as a whole. The overall objective is essentially to measure companies’ ESG performance, so companies should be mindful to develop metrices, KPIs and targets based on its ability to improve and that are manageable to monitor over a sustainable period of time.

The progress of companies’ ESG performance provides important data and information for companies to readjust and restructure on improvement approaches. It provides important data and information for stakeholders as well. It is already well known that the access to transparent information on companies financial and ESG performance is key to gain stakeholders’ confidence, trust and loyalty. Communicating ESG performance may come in various ways via companies’ Annual Reports, Sustainability Reports, websites, AGMs and companies may even create specific events to solely discuss and share on their ESG performance and obtain instant feedback from the stakeholders. This would not only provide insights on the rationale and ambition of companies ESG strategy to stakeholders but also provides solid and concrete responses on how certain stakeholders value the ESG strategy that are affecting them. These exchanges of information will further assist companies to develop or redevelop better ESG strategies.

 

Conclusion

Companies’ ESG strategies or framework for continuous value creation should by now be driven by the Board and management that oversee ESG management and reporting as not merely a voluntary approach to one that in some jurisdictions is increasingly subject to mandatory reporting. Companies that have not embarked on ESG integration into their business operations, or companies that have started to, or even companies that have somewhat fully integrated ESG must all understand that the current landscape demands them to always be ready to improve and adapt. There is no room to be comfortable with the current establishment and practices in place would eventually be obsolete without them even realising it.

 

All views and opinions expressed on this site are by the author and do not represent any particular entity or organisation 

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COVID-19 Has Taught Us that Conventional Risk Management is Obsolete. Here’s Why.

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Introduction

The COVID-19 pandemic has indeed shocked the world and are putting many business in a fragile state in being able to sustain in the long term. COVID-19 as the current biggest threats to organisations regardless of their industry and locations, has pressured businesses to reevaluate their priorities and business strategies to strive in the already challenging world but companies has taken a step back to assess whether its current risk management process is robust enough for the business impact from COVID-19 or other external risks.

 

The Rise of Environmental, Social and Governance Risks

The World Economic Forum in one of its recent reports has shared that the biggest risks businesses will face in the next year (up to 18 months) is the prolonged recession of the global economy.  Organisations should be aware that external risks, including the Environmental, Social and Governance (ESG) risks are categorised beyond the fallout of the pandemic; economic risks, societal risks, technological risks and environmental risks and should raise concerns amongst businesses.

Organisations by now should have already looked at the approaches to feasibly integrate ESG risks into its business risk management. Just like the business threats imposed from COVID-19, these ESG risks are not expressed using financial metrics. But as from what has been vivid from the pandemic, they certainly pose great financial implications. Climate change has been under the focus of many businesses nowadays as not only it has gained tractions from regulators, but it has caused social unrest and physical disasters or transition and physical risks to organisations. This also has caused the risk landscape to be changing, and changing drastically. The rise in not only economic, but health, social and environmental crises we all are facing today could only mean that organisations must reevaluate the corporate strategy, reframe their business future ambition and revamp the risk management framework as a whole.

 

New Approach to Risk Management

It has taken the detrimental effect of COVID-19 to coerced organisations’ Board directors and managements to scrutinise external risks (including ESG risks) as the core subject, and relook at the areas lacking in management and monitoring of external risks.  

Just weeks before the pandemic, the result from a survey of 500 Board directors and Chief Executive Officers (CEOs) found that only around one-fifth of Board directors were “very satisfied” with their effectiveness in overseeing changes to the risk landscape and resulted in adjustment in organisations’ risk appetite accordingly. This is also the same ratio that represents that Board directors were “extremely confident” in risk reporting from management on a range of significant issues.

These findings signifies the point that conventional risk management processes should change and improve, and companies are paying attention. The World Economic Forum also provides insights from a published paper on integrated governance that noted the necessity for businesses to also improve in stakeholder engagement in order to manage risk strategically.

One of the six recommendations is to internalize material ESG & Data factors in enterprise risk management and Boards must gain more in-depth understanding of rapidly evolving environmental, social, governance and data stewardship risks.

Recently, COSO launched a report that focuses on the integral components of the Enterprise Risk Management (ERM) framework, the Risk Appetite Framework. The report by COSO highlights the approach on transform business ‘to anticipate and understand their risk when change happens and to better embrace change and be more agile in challenging conditions’.

This is mainly because in complete absence of a good governance of risk management of both from the internal and external stakeholders’ perspective, organisations will not have the necessary resources and capacity to set up a robust external risk management processes. This will also come hand in hand with the fallout from the lack of trust with organisations’ stakeholders. External or ESG risks management do not only require organisations to look at how they can protect shareholder interest but it’s about being prepared and responsive to the societal and environmental needs as a whole.

 

The Limitations of Conventional Risk Management

The survey by EY global risk also shows that close to 80% of Board directors indicates that organisations are unprepared for significant events such as the COVID-19 pandemic. This is probably due to the lack of governance practiced in conventional risk management as only 40% of Board directors and management explained that ERM are effective in managing atypical and emerging risks.

This is contributed due to data management and analysis. We have now seen that the majority of the current risk management processes have become obsolete and are not built to manage the abundance of critical data generated. Without efficient data management and analysis, the typical risk management process may not succeed in extracting meaningful insights and apply the necessary steps to gain the value and benefits from data analysis.

50% of financial leaders concur to the statement that they spend more time gathering and processing data than they do analysing it, yet alone the decision-making process based on through risk data analysis.

Apart from good corporate governance practices, the Board directors have imperative roles in ensuring risk management practices in organisations run efficiently. The power of data should not be overlooked. Obtaining and most importantly, utilising a continuous stream of valuable and latest data and information is paramount in order to gain buy-in at the Board level. Evaluations and understanding of emerging trends, and prioritising the needs and demands of stakeholders are key considerations to ensure organisations to improve in the overall risk management processes and improve the organisations’ performance. Thus, it is absolutely essential for Boards directors to have the support via data analysis to gain the awareness and insights of the impacts of poor external and ESG risk management on the business.

 

Technology is the Solution

The current business environment requires organisations to meet stakeholder demands and expectations. The question is; Do organisations have enough resources and capabilities to meet the demands and expectations? One of the pressing matters to get internal management’s buy-in is the investment in technology. Organisations cannot be both timely and accurate in producing information from data analysis without the very latest technology. Organisations need a defensible, technology-driven process to back that up and to monitor the risk landscape as it evolves.

The business world we are in today are exposed to complex external risk environment that make organisations vulnerable to broader, complicated and often indirect risks that are very challenging to manage and monitor. As mentioned earlier, effective risk management presses organisations to be focus on data-driven approaches that allow organisations to mitigate the external landscape and focus on the risks that are the most material. These insights will provide with strategic considerations to enable a more dynamic business decision making.

Organisations should start to reinforce risk governance and internal controls and these need to be aligned with the areas that are deemed critical to be improved and transformed. Together with adoption of sophisticated technology software and infrastructure, organisations will possess the systems in place to utilise extensive range of data into something useful and viable information to develop business strategies and profitable business making processes, where and when it matter most.

If we revise the impact of the pandemic, organisations should have already anticipated the drastic response from regulators, governments, peers and wider society. According to Datamaran that tracked regulatory and corporate responses to pandemic more broadly by applying Artificial Intelligence (AI) to analyse the COVID-19 specific responses in real-time, the access to information are more accurate and obtained faster that are imperative for data analysis to give the edge to strive during and post COVID-19 crisis.

AI does not only save laborious time for data consolidation, but it is extremely useful for consistent monitoring. This would be beneficial in order for organisations to identify, structure and prioritise specific risks that are the most impactful to them during a specific period of time. With this, organisations will always be flexible and responsive to any external risks impacting them.

 

Communication on Data-driven Approach in Risk Management Processes

Responding to risks is the defensive approach for companies to be resilient. Proactive approach can be taken with embracing data-driven strategies for other external risks that at the moment are unclear, undetermined and uncertain. Leveraging on data with the right systems and technologies should facilitate organisations to be ready when these external risks emerge and impacting the business and the stakeholders within the operational boundaries and value chain.

Organisations’ plans should not be based on subjective judgements. Acknowledging that risk management is core to organisations, investment in resources and capacity needs are crucial to ensure overall business operations are robust and responsive. Organsations should also focus on communicating the outcome of data-driven approach are being taken to its stakeholders. Organisations should provide more information in the content of the annual reports, that include the risk factors and the forward-looking statements (should) be based on and rely on the risk analysis realised through the risk management framework and corresponding processes. Organisations are also encouraged to express how the Board directors and management determine the risk level organisations are ready to accept that are based on data-driven approach (Risk Appetite Framework). Stakeholders that are made aware of when data feeds into organisations’ decision making, will be assured that the overall business’ risk management processes are more robust, thereby increasing confidence in the organisations. 

 

Conclusion

As we look past lockdown to the rest of 2020 and beyond, robust external and ESG risk management is going to be increasingly vital for building resilient businesses and improving the trust of their stakeholders. Organisations should place the right governance and strategies to ensure data-driven approach are integrated into the current risk management processes to ensure responsiveness to the challenging risks to the business.

 

All views and opinions expressed on this site are by the author and do not represent any particular entity or organisation 

 

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The G in ESG Determines the Success of the Overall ESG Performance. Here’s why.

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Introduction

When it comes to discussions with companies on Environmental, Social and Governance, everything was thought to be heavy on the environmental and philanthropic matters. It seems that the ‘G’ topics have always been less focused as compared to the ‘E’ and ‘S’ topics. Well, that may all change and here’s why.

 

Environmental and Social Performance Are Linked to Good Corporate Governance Practices

Companies have now started to pay more attention to climate change (E element of ESG) issues that not only include how their businesses impact to the greenhouse gas (GHG) emissions level, but also how climate change poses risks to their businesses as well. Now that businesses are striving to sustain during the current pandemic crisis due to COVID-19, the focus on the S element of ESG such as healthcare, wellbeing and employee management has risen. What companies need to be aware of is that whilst they are concentrating to manage the E and S elements better, they simultaneously would need to revamp on the G element of ESG; Governance.

According to the Chief Operating Officer (CEO) to one of the world leaders in the food producers industry, Danone, structurally integrating Environmental and Social responsibility in companies Governance is the approach to be more strategic on the E and S elements.

Now that there has been a surged in meeting the demands to better communicate and manage companies’ stakeholders during the current COVID-19 pandemic, there have even been expectations on the potential establishment of new, and more agile corporate governance standards and models. This claim is supported by a project undertaken by the UK’s Institute if Directors with an independent body pertaining the key issues of corporate governance affecting Boards as companies striving from the impact of COVID-19, and at the same time to be able to meet the ongoing expectations such as the United Nation’s SustainableDevelopment Goals (SDGs), stakeholder engagement and transparency as well as investment in new technological infrastructures.

Governments across the world have also been playing their role to reduce the stress of private companies during COVID-19. Capital allocations in the form of bailouts, loans, grants, tax concessions and equity purchases from governments are a precursor for institutional investors to make quick and smart shifts in corporate governance to be aligned and integrated with environmental and social goals as well as in stakeholder management as a whole.

 

Poor Corporate Governance Practices Have Financial Implications

These shifts would realign corporate governance as the reference point of strategic asset allocation (SAA) due diligence and approach. As mentioned in a recent published research by the Principles for Responsible Investment (PRI), sound corporate governance is imperative in the cases studies presented from the investment management industry. In one of the case studies, Aberdeen Standard Investment highlighted that “We think that corporate governance is often largely ignored by SAA. Investors focus on economic growth and valuation, without asking enough about whether the aggregate quality of governance will affect the ability of companies to translate that growth into shareholder returns.” The case study clearly indicates that the global financial crisis was directly due the systematic failure of sound corporate governance in the global financial services industry that include the mis-selling, lax risk controls, and over-reliance on short-term wholesale funding. The global financial crisis resulted in the enforcement of tougher regulations, lower relative returns in the sector, and a steep learning curve for those involved in the business of SAA.

The case study focuses merely on sectorial performance rather than individual companies’ corporate governance practices, where it has been understood by its SAA within the Japanese equity market, an arena where the shareholder returns had been dreary for the best part of 30 years. This is partly resulted from the poor corporate governance practices showcased particularly in stakeholder management. It is said, just 15% of Japanese corporate boards had independent directors to represent the interests of minority shareholders in 2011, most Annual Grand Meetings (AGMs) were held on the same (and limited) days each year, causing the challenge for shareholders for effective and productive engagements with directors.

Apart from that, due to the poor corporate governance practised, it was observed that the effort to promote value for shareholders was inadequate, on top of extremely low profit margins, cash hoarding, and low pay-out ratios. In the end, Aberdeen’s SAA to Japan was relatively low in comparison to its international equity holdings.

In 2015, the necessary shift to adopt a new corporate governance code was established. In turn, 4 years later, around 90% of Japanese companies had appointed independent directors. Apart from that, the scheduling of AGMs were organised to ensure no clashes of events occurred. The rise of shareholder activism was also seen, as well as in the large domestic pensions funds where special attention was paid to regarding shareholder returns. All of this had fruitful consequences where the return on equity has increased due to equity buybacks and payout in dividends. 

Aberdeen’s researchers also noted that Japan isn’t special for this case. It’s is just a mere example. “Governance quality materially affects our assumptions about margins, buybacks, and valuation multiples for several equity markets. And it doesn’t stop at equities. We see governance as a key part of our evaluation of default risk and recovery rates for credit portfolios,” they added.

 

Focusing on Sustainability Budgets

According to another case study from Schroders, ‘sustainability budget’ is the answer to imbed ESG in the SAA process and one element that anchors the process is through corporate governance.

Director of Investment Practices of the PRI, Toby Belsom stated that; “Good governance has been demonstrated to ‘make a significant incremental difference to value creation as measured by long-term risk-adjusted rates of return’. The further along the sustainability spectrum that assets are managed, the larger the governance budget required to manage those assets in a sustainable way.”

And, as the number of asset classes managed sustainably increases, a larger governance budget will need to be assigned. “There is the need for a new framework… a ‘sustainability budget’, alongside a risk budget, so that real-world outcomes might be incorporated into SAA decision-making.”

It’s also interesting to note the highlights made by S&P Global’s Kelly Tang in a study on corporate governance in ESG. She mentioned; “There is already substantial empirical evidence to suggest that the G aspect of ESG ultimately yields better corporate returns. Governance data, unlike environmental or social data, has been compiled for a longer period of time and the criteria for what comprises good governance and its classification has been more widely discussed and accepted.”

 

Conclusion

Companies will soon realise that disintegrating each element of ESG, or placing one element more important than the other, will no longer be ideal to meet future demands and expectations from stakeholders. We have widely seen companies excel in its social and environmental performance, but with limited information on how they are being anchored by a strong and responsible good corporate governance practices. In light of COVID-19, the severity of the pandemic was more related to national and global governance failures, not taking companies accountable. However good corporate governance practices of private companies is much likely to influence returns for decades.

 

All views and opinions expressed on this site are by the author and do not represent any particular entity or organisation  

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Why Should Companies Engage on ESG Issues to Its Investors?

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Introduction

Environmental, Social and Governance (ESG) has unquestionably becoming the centre of attention in corporate strategy for organisations across industries and regions. Not that we have come to the desired maturity of adopting ESG in the overall business decision making process, but the increase ESG commitment should be taken positive and applaud. However, how can companies excel in communicating their ESG progress to one of their most important stakeholders i.e. investors?

 

Investors are Assessing Companies ESG Management

Recently, the world’s largest asset manager, BlackRock in a report had identified 244 companies that have not showcased their mitigation plans on climate change adequately enough through their business practices as well as corporate disclosures to their stakeholders including investors. Subsequently, BlackRock has drastically voted against directors at 53 out of those 244 companies while assuring to vote against the directors from the remaining companies in the following year if the companies fail to demonstrate ‘significant progress’ within a year.

This action would have ripple effect for other managers for sure. It’s important to be reminded that even before the COVID-19 pandemic crisis, ESG issues have already been gaining interest from asset managers worldwide. Now that the pandemic has shown great impact on a large group of stakeholders, and have cause constant social unrest, it would only mean that companies are pressured to not only initiate to reaching out to institutional investors and stakeholders on ongoing and future ESG risks and threats that could (and will) impact the entire value chain of all businesses regardless of their size.

Following is the overview of some key voting results for 2020 according to the report:

• 2020: 5 environmental proposals passed (0 in 2019), including three    large-cap companies i.e. Chevron Corporation, J.B. Hunt Transport  Services, and Dollar Tree 
• 2020: 55.1% increase in support for employment diversity proposals (38.5% increase in 2019), including for Fastenal Company, O'Reilly Automotive, and Fortinet.
• 2020: 32.5%  Increase in average support for Board diversity proposals (18.7% in 2019)
• 2020: Increase in percentage of political contribution-related proposals proportion i.e. 24 out of 27 (37 out of 60 in 2019).

Due to time restrictions because of the requirements for investor and shareholder proposals submission, the majority of the ESG items for 2020’s ballots were issued on quarter 4 or late 2019 i.e. prior to the COVID-19 crisis as well as the recent racial tension and economic inequality issues had peaked. All of these global developments have and will continue to require companies to see the rise in proposals related to diversity and inclusion, racial justice, socioeconomic inequality, health and safety, climate change and other ESG-related factors in the 2021 proxy season.

Understanding and responding these changes is one thing, but communication is another thing. During a pressured time like this, it’s important to stress repeatedly that if stakeholder engagement with investors are not being conducted strategically, frequently and quickly pertaining these emerging issues, companies could be swamped with proposals but most severely, with frustrated investors communicating their agitations through formal and informal channels. Thus, the responsible parties from the companies such as the Board, Senior Management, and particularly investors relations, public relations and legal will face excruciating pressure to address convincingly the companies’ responses to these issues. If not, the repercussions will turn out to be more complicated that could only mean companies will be affected financially.

 

How Should Companies Approach Investor Engagement Process?

Communicating ESG Issues to Investors

Regardless of the size of the investors, many investors nowadays are well-informed on current and arising ESG issues. Some of them also care about the companies’ efforts in ESG management. Questioning of companies’ ESG or Sustainability agenda has becoming more common and confirms the investors’ keen on the issues. So, when companies conduct engagement with investors on ESG issues, it is absolutely critical for companies to be aware of the best approach to take, what metrices are appropriate and easy to understand in order to monitor ESG performance and also to evaluate the level of acceptance of the responses by the investors. Making progress in ESG performance is certainly good to be transparent with the investors but it is also very important to ensure that investors obtain the most information on how effective the companies manage their ESG agenda.

A good place to start is for companies to assess the specific processes and resources that all relevant investors undertake to assess the ESG policies and practices. The assessment should cater to all investors, hence there should not be one generic approach for this. BlackRock for example, are observed to be focused on ‘corporate purpose’ as well as ESG-related topics. This trend is accelerating as investment firms with a stated ‘core’ emphasis on ESG would most like consist trained and specialized function to conduct their own company evaluation.

For some other investors on the other hand, may not be as robust as they would normally involve ESG-related engagement to regular and unspecified portfolio management teams. This will change, as it is demanded in the future that asset managers are to be familiar with embedding ESG as their mainstream investment portfolio.  

 

Understanding ESG Risks

To achieve productive and effective engagement with institutional investors, companies must first establish high level of knowledge and vision pertaining ESG trends and issues as well as its impacts towards business, including across the value chain, affecting all relevant stakeholders. Companies should be able to equip themselves with the resources to manage material ESG risks and opportunities particularly that represents the substantial ‘risk to value’ issues to the business and should be strategic in communicating on these issues with investors.

Conventionally, it is well understood that personnel from the investor relations would undertake the duty to engage with the investors. Not that this should be necessarily changed but it is important to note that personnel that drive and support ESG-related functions (within the organisation and across different levels) would possess the most valuable input pertaining the ESG issues that the investor relations personnel may be restricted to, or facing difficulties to convey the response effectively. In specific ESG issues, ESG personnel should be the key representatives to address these issues so that more insights and transparency could be presented to investors. 

 

Oversight and Reporting

As covered earlier, investors are keen to substantiate companies’ ESG performance and progress through an appropriate, suitable and standardised ESG performance tracking metrices, normally via reporting. From the companies’ point of view, it is agreeable that this is not an easy task especially taking account that there are widely different services and frameworks that provide ESG-related measurements and ratings including the widely referred to such as the Global Reporting Initiative (GRI), the Sustainability Accounting Standards Board (SASB) as well as the Task Force on Climate-related Financial Disclosures (TCFD) standards, that has been gaining attraction in developed markets. Recently, the GRI and SASB had announced a collaboration to standardise the two standards for better and effective adoption. This is just a proof or subsequent effect of how complicated these various frameworks is to reporting companies.

However, companies are still required to find the solution to ensure they can improve their reporting on ESG performance so that it meets the full expectations and understanding of the investors. Before adopting a framework, reporting companies must analyse which reporting frameworks are best suited for their institutional investors. At the end of the day, as long as the investors could maximise the input from the ESG reporting metrics, companies would be on the right track.

 

Now is the Time for Companies to Respond

Another matter that needs the attention from companies is on the most appropriate time to engage with institutional investors on ESG-related issues. Companies should never delay on the opportunity to engage so that communication on ESG matters are always up-to-date and observed as always one of the priorities by companies.

However, as stated, companies need to be mindful that prior engagement, they should be prepared and equipped with ESG issues and future trends as well as its impacts to the business explicitly on issues that have the highest level of priority and interest by each investors.

Rather than immediate financial returns, more investors are eager seeking long-term value creation from ESG risks so providing them the related information and would portray the companies are established with robust risk management process, market expertise, business resilient and overall, considered as sustainable companies to invest in in the long run. This being said, communicating with them on these information as quickly as possible, would increase confidence to the investors as they would view the companies as reliable and as future (or/and current) industry leaders.

 

Conclusion

It is a difficult time for public and private companies to strive in balancing financial and non-financial sustainability in this current disrupted economy due to COVID-19. The focus on ESG risks and opportunities is becoming more evident as all key stakeholders including customers, community, suppliers and governmental bodies are impacted. Investors should now be engaged more strategically than ever. Companies need to reset the traditional mentality on short and long-term targets and must incorporate ESG issues in the long-term targets – and educate and communicate the investors on the companies ESG ambition. Companies need to ask themselves, is the current investor engagement process still relevant and meets the demands for the future?

 

All views and opinions expressed on this site are by the author and do not represent any particular entity or organisation

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ESG Disclosures Will Become the New Mainstream, and How COVID-19 Will Accelerate it?

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Introduction

Environmental, Social and Governance (ESG) disclosures is definitely going to remain essential for businesses and the pressure from stakeholders to enhance ESG reporting will increase over time. Now that it is firmly becoming a regularity in ESG reporting, the market demands for higher standards and quality of disclosures. This is typically due to the response of interests on specific ESG issues and topics amongst different groups of stakeholders. A recent study that has assessed the regulatory landscape for ESG disclosures summarised that ESG reporting is becoming more influential and common across the world, that could be considered as the mainstream reporting on the overall organisational performance.

The annual report published by Carrots & Sticks, covers the analysis of the current trends in reporting, encompasses over 600 resources and requirements across over 80 countries, which 75% represents the world’s biggest economies. The analysis also incorporates the findings from the context collated from policymakers that have shared their perspective on the best practices pertaining to the requirements and standards of ESG reporting.

The overview of the assessment recorded in the report includes the following:

• The Sustainable Development Goals (SDGs) has become one of the key reference points for ESG reporters in focusing on specific material risks and opportunities that are applicable for organisations. In general, not all 17 SDGs are commonly linked. Responsible Consumption and Production (SDG 12) , Decent Work and Economic Growth (SDG 8) and Peace, Justice and Strong Institutions (SDG 16) are regularly linked compared to Good Health and Well-Being (SDG 3) and Quality Education (SDG 4) – however this is predicted to change significantly following the current COVID-19 pandemic crisis.
• It is also obvious to observe the variations of the volume ESG reporting throughout the world.  Across continents, the dominance of Europe in ESG reporting agenda remains, with 245 reporting instruments. In Asia, the trend is progressively increasing with 174 recorded reporting instruments. North America on the other hand recorded a distinguishable low number of reporting instruments (47) due to the lower number of national jurisdictions as one of the factors. Amongst countries, the highest number of ESG reporting provisions was observed from the United Kingdom, Spain, the United States of America, Canada, Brazil, Columbia and also China.
• Since 2016, the reporting provisions has increased around three-quarter to almost 400 and this is from the issuances by governmental bodies. The increase in trend is also impacted by engagements made by financial market regulators and central banks. Main and listed private sector companies comprised about 90% of the ESG reporting provisions. However, the SMEs and public sector generally remain the same since 2016.
• As one of the ongoing issues critical to ESG reporters is that there are no streamlined requirements on the framework in developing ESG disclosures. When it comes to the authenticity and credibility of data, there are still gaps in determining a reliable format and structure that has been established and made available. Though partnerships have been ventured in the past, there is still the need for more collaborations amongst all key stakeholders that include standard setters, regulators, policymakers, academicians, reporters and users.

The current regulatory landscape not only reflects the perceptions in identifying key material categories in ESG reporting, but also drives it. This furthermore creates disorientation for the most suitable platforms to disclose ESG performance for different groups of users.

According to Senior Lecturer Extraordinaire of University of Stellenbosch Business School (USB), "Stock exchanges and central banks are becoming more active in pursuing non-financial reporting requirements”. This indicates that diverse ESG issues are have direct implications on the economic and market.

The focus on climate-related issues are one of the leading demands in ESG reporting, and with the current pandemic crisis, the issues revolving public health and infrastructures will very much likely to take central focus from this point onwards. The Global Reporting Initiative (GRI) Chief External Affairs Officer highlighted that "As the pandemic focuses the attention of policymakers on how to achieve resilient and climate-friendly economies, the importance of measuring the impacts of companies and encouraging sustainable practices increases. It is positive therefore that both the range and depth of ESG reporting provisions around the world has grown substantially.” 

"Yet questions remain on how to address gaps, particularly in the context of the SDGs, and improve coordination to support more consistent disclosure. To address this twin challenge - spreading the practice of disclosure and driving up the quality - needs strengthened reporting requirements, for which GRI will play an enabling role." 

As we all are aware, there are growing environmental, social and political pressures around the world that require businesses to play a crucial part to supply innovative and sustainable solutions towards the SDGs or sustainable development in general. The pandemic has also urged companies to amplify transparency and report on how companies address complex supply chain issues and how companies throughout its value chain are responding to the pandemic and other ESG risks such as climate change, as depicted in a special report by AmBank Research firm. The report also said that there is a need for companies to be responsive and most importantly, know the most effective way to respond to these issues now and in the future – and these should all be addressed (on certain level) in the companies’ reports. This would not only assure stakeholders that the companies remains resilient in facing various risks but also understand the accountability when it comes to ESG concerns.

Conclusion

Companies are evaluated and pressured to be leaders in responsible business while managing ESG issues that are present and predicted in the future in a holistic manner. This being said, it is expected for companies to not only demonstrate but also disclose on how they manage and monitor their ESG risks and opportunities. ESG reporting will need to be extensive and critical in responding to all material topics that are affiliated to companies. Hence, it has now come down to bringing renewed attention to the importance of corporate transparency as well as quality of ESG disclosures.

 

All views and opinions expressed on this site are by the author and do not represent any particular entity or organisation

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COVID-19 and ESG – Why it is Important for Asset Managers

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Introduction

Financial sustainability is the central focus for all businesses and individuals in light of the COVID-19 pandemic. This has also required the Wealth and Asset Management industry to stringently scrutinise the Environmental. Social and Governance (ESG) agenda in the current and future investment strategy. Many companies believe that the attention towards ESG integration can be delayed amid to the current crisis, but experts would disagree because they view that the pandemic is the catalyst to push businesses to dissect their business model and values like never before.

 

ESG is Profitable during COVID-19 Crisis

Recently, the European Union has hired BlackRock which is one of the largest investors in the world with over $7tn in assets under management on 31 December 2019 prominently in the financial services and fossil fuel companies to conduct a research on the ways partnerships and alliances could encourage the integration of ESG issues into its banking supervision. The biggest percentage of assets under BlackRock’s management are in products that track equity and bond indices; hence they control large stakes in many of the world’s biggest companies. This means that verdicts made by European banking regulators on ESG issues will pay a substantial impact on significant number of companies under BlackRock’s portfolio.

In March this year, records have shown that responsible or sustainable investments outperformed other conventional investments up to 5.7% when markets are heavily impacted by the current pandemic. Asset managers should now start making important decisions pertaining ESG. What asset managers should learn from this is that ESG integration is not only vital to ensure long-term sustainable business resilient, but also provides great opportunities during volatile periods. ESG integration would open up doors to more innovation, and targeted solutions that are meaningful and purposeful when conventional investments would not.

 

What is Expected from Asset Managers?

Asset managers that are advanced in incorporating ESG into the investment portfolio are in the advantage in identifying companies that will outshine others during and after the COVID-19 pandemic. Asset managers would need to dig deep on how companies embed ESG into their business models, including in supply chain management, to evaluate better of the imminent effect of the current pandemic crisis and eventually predict the long-term impact on the companies. According to a paper by J.P. Morgan Asset Management (JPMAM) and BNP Paribas Asset Management that studied on the evaluation of the importance of ESG integration in companies operations, apart from better financial performance, companies that have invested in human capital management prior the COVID-19 crisis have showcased greater resilient during the pandemic compared to its peers.

There is a high possibility that asset managers that are not equipped with ESG expertise and guidance will be left behind.  From the investors’ perspective, it is much likely that from now on they will reevaluate the affiliation with the companies they invest in. ESG issues and its impacts to all stakeholders in the long run will be further considered and not just focusing just on short-term financial returns. Though that ESG is relatively ‘new’ in the current overall investment trend, it has certainly getting traction each year and coupled with COVID-19 pandemic (and other ESG issues), this will eventually be the new norm in the market. In his opening keynote speech, the State Street Global Advisors CEO, Cyrus Taraporevala had confirmed this. He also predicts that in the next decade, ESG integration in the investment market would be seen as the mainstream strategy rather than an alternative.

Another lesson we could take from COVID-19 crisis is that digitalisation is key for the future. Advanced technological infrastructures have now been pushed to a greater extent as means of engagements. The pace of sustainable investment would demand in robust ESG data and analytics to be a vital part of asset managers’ tools and investment decisions.

Asset managers should examine the alignment of ESG of the overall corporate goals of companies. According to the World Economic Forum survey, 61% from 20,000 emerging leaders view business models must only be pursued if it creates positive financial as well as societal impacts.

Asset managers must start (if they have not yet) looking at companies’ ESG ratings or social index scores on their financial performance and credit rating. This should form one of the compulsory components in investment decisions. Asset managers should evolve to be a well-rounded ESG expert that furnish their portfolio with ESG risks and opportunities.

Though the world is focused on COVID-19 issues, this certainly does not mean that asset managers should swift their attention away from other pressing ESG issues; climate change in particular. The impact from climate change should be as or if not, more severe compared to the COVID-19 pandemic. Hence, asset managers should keep up and equipped themselves on their positive and negative screening skills to ensure the vision to invest in companies that would persevere or even be in the advantage when climate change has extended its impact to businesses worldwide. They need to be able to identify the companies that embrace low carbon economy, circular economy and renewables and should be able to distinguish with those that are currently and are very much likely to be under ESG scrutiny.

This being said, asset managers should also anticipate to engage or be engaged with various unfamiliar groups of stakeholder as well as fresh capital allocation issues. Asset managers will be expected to cater their investment from specific ESG issues that are unique to the companies, industries as well as regional presence.

Conclusion

Asset managers of the future would function similar to the present; to achieve maximum profit and generating long-term fruitful returns. However, the only difference is that they would need to incorporate ESG not merely to remain resilient, but as the new norm to create sustainable long-term value.

All views and opinions expressed on this site are by the author and do not represent any particular entity or organisation

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