In my last post I pointed out some signs that ESG factors are being included in mainstream investment decisions. The decisions theoretically play out like this. Say there are two stocks, A & B, in a sector with broadly similar commodity outlooks. If stock A is exposed to downside ESG risks, it is downgraded. Consequently, all other things being equal, some investors are more likely to buy stock B over the medium to long term than stock A.
It is unclear if the “some” today constitute a materially high or vanishingly low percent of investors. It is also unclear if these investors actually have enough information to make such decisions confidently.
This fuzziness raise three questions.
(1) How would you know if stock A is exposed to significant downside risk over stock B?
Generally speaking, unless it’s painfully obvious, you wouldn’t. There is a reliance on disclosure by companies of these risks. Over the last few years, securities commissions in some larger countries have acknowledged that the disclosure is important. Further, the lack of disclosure, or false disclosure, can be pejorative to investors.
In Australia, in 2013, Regulatory Guidance 247 was published by the ASX. It recommended that companies disclose their “environmental, social and sustainability” risks, and how they are being managed. In 2014, the Australian Securities and Investment Commission produced its Corporate Governance Principles and Recommendations. Aimed at directors, it recommended a similar disclosure.
While these should not be confused with actual laws or regulations, they publicly set some reasonable expectations of companies.
In the USA, in 2015 and 2016, the Securities Exchange Commission began legal proceedings against ExxonMobil and Peabody Mining for failing to adequately disclose their exposure to climate change risk. Peabody Mining settled out of court in 2015. Their share price plunged from $25 to $2 as their exposure to coal and coal prices hit. The Exxon Mobil investigations continue.
The EU in 2017 introduced a new law for compulsory ESG disclosure for companies with more than 500 employees or revenues over Euro 40m. Post-Brexit vote, the London Stock Exchange in 2017 introduced ESG disclosure guidance for listed companies.
The trend to expect fair disclosure is not a passive one, nor is it paying lip service. “Adequate disclosure” is highly contestable of course, but prudent company directors are not in the habit of risking too much contestability.
So the groundwork is being set for investors to gain better access to more relevant ESG information about companies. It doesn’t feel like a fad.
(2) Do investors use these ESG disclosures?
The short answer is yes. But not all investors do, and not all investors that do so actually practice their usage diligently.
The UN Principles of Responsible Investment has identified the latter problem. While funds in excess of $60 trillion are managed by investors in its signatory ranks, those investors often pay lip service to the ESG expectations. In 2017, new rules are being implemented to require investors to report on how they are applying the Principles of Responsible Investment, or be removed as signatories. This could of course backfire on the UNPRI and result in a reduction in the number of signatories it has. However, the UNPRI believes that most signatories will diligently attempt to meet the reporting expectations and respond favourably to constructive encouragement to improve.
There are market signals too. The number of investors subscribing to the services of analysts who specialize in collecting ESG information on companies and providing advice on ESG risk exposures has grown dramatically in the last five years. Where there is supply growth, there must be demand growth, so there must be a thriving market. A quick look at institutional investors on any major listed company’s shareholder list in the UK, US or Australia shows that the majority of larger investors pay for and subscribe to some kind of ESG advice.
(3) What are companies doing about it?
There are four recognisable types of companies. I should stress that this is my view, and any offence caused by the following characterisations is entirely attributable to me.
(1) The Just-Enough Crew: These are companies that follow strict legal doctrines, and disclose only what the law compels them to disclose. In 2017, among top listed companies, this constitutes a relative minority at around 30% or less depending on whether we are looking at the US, the EU, the UK or Australia.
(2) The PR Merchants. These are companies that have been disclosing various ESG issues for a while, including non-legally binding disclosures, but usually with a broad PR tinge to their narrative, and continue to do so. This comprises the majority.
(3) The Serious Followers: These companies have matured their risk recognition over time. They provide a more balanced view of ESG risks (ie the good and the bad). Still, ESG risks are not always managed and reported with anywhere near the same rigour as financial risks. These companies are in a minority, but the numbers are increasing.
(4) The Strategists: These are companies that recognize that businesses survive and thrive in a societal, stakeholder-centric, ecosystem. They manage their ESG risks and report in an honest, balanced and transparent way. These comprise a very small minority.
While there is robust discussion about how fast the investment community is moving in this area of risk, there is little disagreement that it is moving. Since 2015, the issue of Climate change risk has moved much quicker than others. But other risks are following suit. Philippe Joubert, former CEO of energy giant Alstom and its 65,000 employees, points out that “water is the language that climate change speaks in”. The investment community also uses the term “social licence” increasingly, reflecting the notion that businesses that keep stakeholders on side are more likely to prosper. I’m often surprised when an investor comments to me on company issues raised in social media. I suppose I shouldn’t be surprised. After all, investors are people too.