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Investors Demanding Public Companies Come Clean on ESG Performance

by M&Co. Staff

BlackRock CEO Larry Fink has said repeatedly that “climate risk is investment risk” and that there is a strong correlation between Environmental, Social, and Governance (ESG) and investment performance. He’s not alone in thinking that. As Covid-19 spread across the globe, from January through November 2020, mutual fund and ETF investors globally poured $288 billion into sustainable strategies—nearly double the amount invested in 2019.

As ESG becomes mainstream, investors like Fink are now bringing increasing pressure on public companies to provide more corporate disclosures on their impact on the environment and society at large, and how that exposes them to material risks. Notably, this is often being done through direct engagement with the company’s C-suite. To achieve this, investor stewardship teams are pushing public companies to pay more attention to sustainability in their financial reporting. First, by making clear commitments to ESG performance targets, such as net zero carbon emissions by 2050 or increasing women and underrepresented groups on boards and in senior management. Second, by measuring their company’s operations against various ESG standards, such as SASB and TCFD.

Investors have a toolbox of tactics at their disposal to encourage a public company to adhere to their ESG demands. CEOs and CFOs are being peppered with questions by the stewardship teams’ “engagers” on ESG performance factors and asked to update their reporting standards and investor relations materials to reflect this information. In cases like Berkshire Hathaway or Exxon Mobil, where the company fails to meet the investors’ requests, the stewardship teams take a more public approach through proxy votes at shareholder meetings, open letters to the board, and using the media to expose ESG failures. Combined, all those tactics pose reputation risks for companies.

In the worst-case scenario, the stewardship team may even recommend that its portfolio managers divest from a company if ESG transparency standards are not being met, due to the perceived risk that investment poses, relative to its peers.

In responding to this groundswell of investor activity on ESG, public companies must develop a well-rounded strategy for transparent ESG reporting that addresses these issues in a clear and factual way. With all of the momentum, resources, and regulatory backing, investors have to demand transparency. It’s critical for companies to show that are walking the ESG talk.

Understanding Reporting Frameworks

Key to this is a strong transparent ESG reporting strategy that communicates a company’s goals and objectives, initiatives, and achievements to stakeholders. Investors that are vetting sustainable investments are demanding access to consistent, high-quality data and information about the environmental and social impacts a company has on the world.

Companies are finding that ESG reporting can be tricky to navigate. One of the challenges is a proliferation of different ESG reporting frameworks. Investors are gathering information from a variety of different sources to better understand a company’s commitment to ESG, including from more than a dozen different ESG reporting, disclosure, and ranking platforms. These platforms fall into three categories:

  • Voluntary frameworks relate to policies, practices, and performance ESG data transparency. One example is the Dow Jones Sustainability Indices (DJSI), an index of top-performing companies in terms of economic, environmental, and social criteria, which serves as a benchmark for investors.
  • Third-party aggregator frameworks assess performance based on publicly available data, such as company websites, annual reports, and sustainability and/or corporate sustainability reports. Some examples of third-party aggregators include MSCI, Sustainalytics, and Bloomberg Terminal ESG Analysis.
  • Several guidance frameworks also provide recommended methodologies as to how organizations might identify, manage, and report on sustainability performance.

There is growing support to move to a single global ESG reporting standard that will make it easier for investors to compare and benchmark public companies and make more informed investment decisions. Although there is no universal reporting standard as of yet, there are best practices emerging that focus on recommended methodologies in guidance frameworks. In particular, many firms are aligning reporting with recommended guidance from the Task Force on Climate-related Financial Disclosures (TCFD) and the Sustainability Accounting Standards Board (SASB).

Tips to Enhance ESG Reporting

Guidance from the various reporting frameworks helps to provide a roadmap for information and key performance indicators that companies should be collecting and reporting on related to ESG transparency issues. However, there is a myriad of other steps that public companies can take to improve the transparency of their ESG reporting.

  • Create a dedicated section of your firm’s investor relations website for ESG that clearly reports data and information on various ESG commitments. Some examples of ESG categories to consider include:
  • Corporate governance
  • Sustainability and climate change
  • Ethics and human rights
  • Diversity, equity, and inclusion
  • Community engagement
  • Include a section in earnings and financial statements on ESG, which condenses the material on your website to report on key data for analysts (e.g., emissions, board independence, diversity, ethics).
  • Hire a consultant to work directly with the engagers at investment companies to answer their in-bound questions on ESG and strengthen your reporting.
  • In some cases, it may be prudent to develop a media campaign around what your company is doing to address climate change or other ESG issues, to highlight the commitments and progress you’re making.

ESG platforms are playing a bigger role in decision-making by both retail investors and large institutions. Companies also are finding that strong ESG platforms and high peer ratings on indices and industry benchmarks are getting rewarded in the investment marketplace.

For their part, companies need to be mindful of the potential risks of creating a backlash from investors for miscommunication, or not taking sufficient actions to meet ESG goals and objectives. Some companies have been met with cries of greenwashing in their attempts to paint a too rosy picture, unsubstantiated by facts. As such, it is more critical than ever for companies to develop an overarching ESG strategy, identify specific initiatives to help reach goals, and report on progress and performance at each step along the way.