If the phone call inquiring about your company’s environmental, social and governance (ESG) criteria has yet to arrive, it likely will soon—even for mid-size and smaller companies. And given investors’ snowballing concerns about ESG issues, corporate finance executives had better be prepared to answer their questions to maintain and grow their capital bases.
The most recent indication of the rising importance of ESG among investors is the March 1 launch of Morningstar’s ESG ratings for 20,000 funds globally, distinct from its traditional ratings. Jon Hale, head of sustainability research at Morningstar, noted that the new ratings were prompted in part by institutional investors’ inquiries about whether Morningstar could score investment portfolios on an ESG basis.
In addition, the firm’s research has revealed that younger investors and women, both of which are becoming more prominent investors, appear to have a “very high level of interest in sustainable investing,” Hale said. Investors’ ESG push is partially fueled by concerns about climate change, while social and governance issues, whether factory disasters or a mostly male C-Suite and board, can present unanticipated risk. Recent research, in fact, suggests that prioritizing ESG benefits investment performance.
More pressure on corporates
Greater ESG awareness among fund managers means more pressure on corporates and their treasury departments, who must increasingly be prepared to field investor questions related to ESG criteria on roadshows to sell their companies’ bonds and equities. In some cases, insufficient attention paid to incorporating ESG policies in a company’s business practices can result in shrinking the universe of potential capital sources and even losing existing investors. Global insurer Allianz, for example, was until a few years ago one of the biggest investors in the coal industry and now it is shifting to investments to the renewable fuel sector.
The report notes that ESG strength can take several forms for companies, ranging from engaging in energy storage, to supplying the renewable energy markets, to simply incorporating ESG-friendly policies. It adds, for example, that food giant Kellogg is aggressively reducing emissions and improving resilience to the effects of climate change on its supply chain, while L’Oreal has pursued measures such as adopting lower-emission transport options and increasing energy efficiency as a way to strengthen its brand.
The need for standards
The big challenge for investors and issuers is the lack of standards for disclosing ESG-related information. Doug Morrow, associate director of thematic research for Sustainalytics, a research firm specializing in ESG analysis, noted that securities laws typically require disclosure of ESG information that can materially impact a company financially, as do many stock exchanges around the world, especially in developing countries such as South Africa that are seeking foreign capital. U.S. companies seeking listings outside the U.S., including on European exchanges, are likely to find ESG disclosure requirements that don’t exist for domestic listings.
However, those disclosures vary widely country-by-country and exchange-by-exchange. Sustainalytics makes use of those disclosures and essentially seeks to normalize them by industry. It uses third-party sources to verify the information as best it can, and follows up with the companies themselves to update and confirm the content of disclosures and seek additional information. Morrow noted that the disclosure initiatives such as the one headed by Bloomberg should significantly improve that that information. The International Integrated Reporting Council (IIRC) in Europe and the Sustainability Accounting Standards Board (SASB) are also seeking to promote ESG disclosures.
The SASB is nearing the end of developing disclosures by industry sector, and its goal is to incorporate them in financial statements. Until that time, the disclosures will be voluntary. Morrow said that despite ESG disclosure initiatives that have emerged in recent years, the breadth and quality of such disclosures remains far from adequate to meet investors’ needs, and there is evidence that the rate of ESG disclosures is slowing.
“What that signals to me is that in the future we may be moving away from voluntary disclosures to more mandatory ones,” he said.
A longer version of this article will appear in an upcoming edition of AFP Exchange.