Institutional shareholders investing in accordance with environmental, social and governance (ESG) principles have shown that they can radically influence corporate behaviour, having achieved some notable successes this year. Oil majors Chevron and ExxonMobil have both lost battles with shareholders over their climate strategies, for instance. In the latter’s case, an activist hedge fund even managed to oust two recalcitrant board members.
But such headline-grabbing triumphs have been rare so far. Campaigners know that many more such actions are needed for the burgeoning ESG movement to make a lasting difference. They are therefore ramping up the pressure on all parts of the investment ecosystem to encourage companies to adopt sustainable business practices.
In theory, each time someone puts money into an ESG investment, it starts a chain reaction. A retail investor with concerns about climate change and other ethical issues raises these with an intermediary such as a financial adviser or wealth manager. The intermediaries adjust their portfolio goals to reflect their client’s views, then select fund managers whose ESG investment practices best align with them. Sometimes, their practices entail screening out companies with unsustainable business models, such as oil extraction. But, increasingly, they involve engaging with such firms in a bid to change their behaviour.
James Alexander is CEO of the UK Sustainable Investment and Finance Association (UKSIF), a body representing fund managers and other investment organisations. He explains this approach by arguing that “you can’t divest your way to sustainability. That would simply mean that you’ve sold those shares to someone who cares less than you. That’s why stewardship, also known as engagement, is crucial for our members. They will vote at AGMs and work with companies to push towards sustainability.”
Businesses ought to respond to investors’ concerns by cooperating with such engagement, Alexander adds. They should, for instance, set ESG performance targets, report on their progress towards these and enable shareholders to vote on issues concerning climate change. Recent research by FTI Consulting indicates that this type of stewardship is effective, given that most of the world’s largest investors have adopted climate-related voting guidelines. This has persuaded more companies to give shareholders a “say on climate” – and many others will follow, FTI predicts.
The Chevron and ExxonMobil stories made a splash because of the conflict they involved, but many equally effective interventions by ESG activists attract less media coverage because the boards of the companies involved don’t oppose them. Under pressure from a £140bn shareholder coalition in May, Tesco pledged to stock more healthier foods and drinks, for instance, while in the same month HSBC agreed to phase out financing for coal-based industries after lobbying from a £1.74tn investor group.
Therese Niklasson, global head of sustainability at fund management firm Ninety One, notes that pressure groups often start ESG investment trends by engaging with asset managers. Organisations such as the UKSIF and the UN-backed Principles for Responsible Investment (PRI) network then become platforms for further work on these issues.
The recent trend for investing in biodiversity, for instance, came from several sources, including research by environmental scientists, economists and the PRI. This developed quickly into a reporting framework proposed by the new Taskforce on Nature-Related Financial Disclosures – a consortium of financial institutions, companies, governments, regulators and NGOs. The fast development of this initiative illustrates how the ESG investment infrastructure has developed to accommodate new ideas.
Louisiana Salge, senior sustainability specialist at wealth management firm EQ Investors, says that influencing companies to improve their practices can be difficult. One of the most effective ways for fund managers to encourage them to change is to form partnerships with academics and respected think-tanks.
“Say you want to start a biodiversity fund,” she says. “All of the best practice is grounded in academia, because investors want to act on research. Your job is then to ensure that everyone you work with integrates that practice. Asset managers are important here, because they have the resources to engage with investee companies.”
But the engagement efforts of most institutional investors have generally been “terrible”, according to ShareAction, a charity promoting responsible investment. This is because most of them don’t file resolutions, vote against boards, set deadlines for companies to take remedial action or react when targets are missed, it says. ShareAction’s research indicates that, while some asset managers are showing leadership in the ESG field, managers responsible for £26tn in investment funds are still turning a blind eye to the ecological damage caused by their investees.
Given that many fund managers in the latter category are members of both the PRI and Climate Action 100+, an investor coalition aiming to ensure that the largest corporate CO2 emitters take effective remedial action, this is a real concern for ShareAction. It believes that a large number aren’t walking their talk on ESG.
“It’s hard to tell what actions some Climate Action 100+ participants are taking to advance its goals,” says ShareAction’s campaigns manager, Michael Kind. “We don’t just want a list of collaborative involvements; we want evidence of real outcomes.”
Kind would urge other members of the investment ecosystem, such as consultants and even retail investors, to demand higher standards of responsible investment from fund management firms.
“This has started, with more asset managers building their ESG stewardship teams and disclosure practices,” he says. “It shows that the quality of stewardship is becoming a business issue for them. But there is a long way to go.”
Fiona Reynolds, managing director of the PRI, offers the following response: “We are a big-tent organisation. Responsible investment practices are at various stages around the world. So too are our members. We are not responsible for individual investments in our 4,300 plus signatories’ portfolios. Investors must monitor this.”
For its part, Climate Action 100+ acknowledges that “there is more to be done on companies aligning capital expenditure with the goals of the UN’s Paris agreement on climate change. We remain committed to working with investor signatories to secure these commitments from companies.”
One key challenge that its members face in achieving their goals is a lack of resources. ESG investing is complex – and all the big fund managers are struggling to recruit enough researchers and analysts from a relatively small talent pool.
Another problem is a lack of standardisation in corporate ESG reporting. “As disclosure frameworks become more standardised, the situation will improve,” Salge predicts. “For example, requesting exactly the same carbon data reporting has led to real impacts.”
If the investment ecosystem can overcome such barriers, it can strengthen its influence, bringing more corporate practices in line with shareholders’ views.