This analysis of ESG and sustainable finance issues originally appeared in GreenFin Weekly, our free email newsletter. Sign up here.
As we begin another year of what's being referred to in climate circles as the "decade to deliver," it is being defined by ESG, driven by shareholders and aided by new disclosure requirements on climate risk and human capital management.
"The bottom line is that businesses now actively compete for capital based on ESG performance, and that competition needs to be open, fair and transparent," Allison Herren Lee, acting chair of the Securities and Exchange Commissioner, said.
A lot of the information that investors want is not included in company financial filings or sustainability reports, which in the U.S. currently rely on voluntary ESG reporting standards and frameworks, said Anne Simpson, managing investment director for board governance and sustainability at the California Public Employees' Retirement System (CalPERS), the largest U.S. pension fund.
As a general matter, U.S. companies would be wise to take note of ESG developments in Europe. European Union legislation on sustainability reporting and disclosures far exceeds what the U.S. has in place, and European Central Bank regulations on ESG are in the process of being implemented.
With a little help from my — shareholders?
Companies need to take stock of what investors are telling them and devoting their time and energy to enhancing their ESG reporting, said Hannah Orowitz, senior managing director at Georgeson, which provides strategic shareholder services to corporations and shareholder groups. This needs to be done before completing a sustainability report and keeping in mind that ESG factors directly influence investors’ proxy voting decisions. Every company needs a climate transition plan based on Climate Action 100+ benchmarks, added Andrew Behar, CEO of the shareholder advocacy nonprofit As You Sow.
Several officials expect a pivotal 2021 shareholder season. According to Tomas Otterström, KPMG’s partner and head of responsible investment and sustainability services in Finland and Sweden, climate change, biodiversity and diversity/inclusion issues appear to be this year’s top proxy issues globally. In the U.S., racial equity, political spending and policy influence activity influence also will factor highly.
The bottom line is that businesses now actively compete for capital based on ESG performance, and that competition needs to be open, fair and transparent.
As U.S. companies become more willing to make substantial changes to their policies and practices, the expectation is that fewer engagements will need to be escalated to shareholder resolutions. "The companies that listen and follow shareholders’ advice are reducing risk and will outperform over time — that’s why companies are becoming more receptive" to addressing ESG issues, Behar said.
"Companies need to realize that shareholders that engage them and escalate to file resolutions are their best friends. We are showing them ways to reduce risk, improve brand recognition, attract the best and the brightest and generally be more competitive ... Shareholder advocacy is like a McKinsey for free."
Already, some companies, such as Union Pacific Railroad and the online travel provider Bookings Holdings, are being asked to put their carbon transition plans to a vote at their 2021 annual general meetings, according to Rob Berridge, director of shareholder engagement at Ceres.
The regs are coming
Often, ESG investment strategies end up more closely aligning the objectives of a company with those of its long-term institutional investors. Essentially, three forms of capital are long-term drivers of value and sources of risk — financial, physical and human capital.
To properly access risks requires complete, accurate and reliable information. "That starts with public company disclosure and financial firm reporting and extends into our oversight of various fiduciaries and others. Investors also need this information so they can protect their investments and drive capital toward meeting their goals of a sustainable economy," SEC commissioner Lee told the Institute on Securities Regulation Conference in November.
All indications are that mandatory climate risk disclosure requirements for public companies are on the way. The Biden administration’s decision to rejoin the Paris Agreement cements this view. For countries to meet their Paris targets, they’ll need companies to transition toward net-zero goals and to measure progress using standardized, auditable and reliable corporate data.
But measure how? The proposal by the International Financial Reporting Standards (IFRS) Foundation to create a new sustainable standards board is the leading pathway to making climate disclosure mandatory, Mark Carney, former governor of the Bank of England and current United Nations Special Envoy for Climate Action and Finance, said in a comment letter.
Others that commented on the IFRS Foundation’s consultation overwhelmingly supported the formation of a sustainability standards board. In their comments, many also highlighted the extent of the IFRS’s reach; the organization’s financial reporting standards are mandatory in 144 countries. Carbon Tracker Initiative pointed out that putting a sustainability standards board under the same umbrella as the International Accounting Standards Board, housed within IFRS, would help integrate sustainability and financial reporting.
There’s no shortage of prep work on how a sustainability standards board might operate. For example, there’s the paper by five leading NGOs on how their voluntary frameworks, standards and platforms could be used together, and another seminal white paper on converging the various ESG reporting standards.
Companies need to realize that shareholders that engage them and escalate to file resolutions are their best friends.
U.S. companies’ reporting on sustainability has been coalescing around the Task Force on Climate-related Financial Disclosures (TCFD) and Sustainability Accounting Standard Board’s (SASB) reporting frameworks.
According to Steven Nichols, head of ESG capital markets for the Americas at BofA Securities, the investment banking arm of Bank of America, many companies are setting annual goals and measuring their progress on ESG metrics such as those related to climate risk. A new Conference Board report on corporate disclosure and performance data across North America, Europe and Asia-Pacific found that major corporations last year increased their sustainability disclosures in key areas, including climate-risk reporting, human rights and water stress exposure.
Under European Central Bank guidelines, which at this stage are non-binding, European banks must get their climate risk disclosures together this year. The ECB will be reviewing banks’ practices next year, with a view to conducting stress tests on climate risk next year.
At French investment bank Natixis, credit decision-makers already use two sets of indicators — one that looks at the environmental impact of a transaction and another that estimates the profitability of that transaction after taking into account material environmental impacts.
Natixis’ internal capital allocation tool, the Green Weighting Factor, already is changing origination. "A few years ago, environmental issues were not discussed in the credit process. Today, it’s a systematic part of the decision," Karen Degouve, head of sustainable business development at Natixis, said.
Perhaps its greatest impact so far, however, has been the effect on the level of strategic dialogue the bank is having with clients, she added. Because the tool has been used internally only since September 2019, it is too early to say if it is changing client behavior, too.