A discussion with our Head of Business Development
ESG investing isn’t just due to the kindness of people’s hearts. It’s a solid investment philosophy that can help investors mitigate risk.
Investor Update is a shareholder intelligence consultancy with a mission to be the most professional, timely and creative investor relations consultancy for its clients. Investor Update offers corporate IR teams and their advisors up-to-date shareholder intelligence to help decision-making in their IR strategy. For bankers and advisors, Investor Update supplies information on clients’ investors to help them deliver the right advice.
Andrew Archer is a Partner at Investor Update and Head of the ESG Advisory business. He has over 25 years of experience in Financial Markets, with a background in Fund Management, Equity Analysis and Corporate Broking with extensive knowledge on the Resources and Utilities sectors. In his latest published paper, ‘Staring Down the Barrel of ESG Activism’, Andrew speaks to some key figures and highlights the opportunities that arise from ESG Activism. We speak to Andrew about his new role at Investor Update and his recent paper.
I lead the ESG Advisory Team at Investor Update and together we advise companies on many aspects of ESG including reporting & disclosure, data selection & targets-setting, executive compensation, board competency and ESG narrative & communications. We do this by identifying and modelling best practice through a process of ESG Benchmarking which requires a detailed interrogation of share ownership of the client company and that of its peers.
“ESG is growing and changing very rapidly, but in this phase, there isn’t an established best practice. From our point of view, the challenge is in trying to work out what the right behaviours are and how to emulate those practices.”
There is a tendency to defer to third-party rating agencies to judge ESG performance but this is a flawed approach and riddled with inconsistencies. By contrast, our approach is to focus on investor behaviour as the greatest amount of due diligence is carried out by the buy side. We are able to evaluate, on a real-time basis, where excellence lies. We look at what the best performing companies are doing to improve and advance their ESG capability. We are the only company taking this approach and demand for our specialist services and our research has intensified over the last year.
In the move from financial markets to consultancy, the notable change has been the time to think and reflect and consider the challenges of industry, rather than having to react immediately to events and developments. This critical time pressure is evident on the trading floor, in the research department and within ECM and while there are differences, the pressure to react and respond is equivalent.
“When I reflect on that, I realise that too much of industry is knee-jerk in the way that it deals with these dynamics. The decisions that you make, particularly about reporting disclosure, stay with you for so long so it’s important to instead take the time that is necessary to get the right answer first time round.”
Shareholder intelligence has always been core to everything I’ve done. I was either on the buy side trying to model investor behaviour or I was on the sell side trying to influence it. This aspect and that of research has been the common thread all the way through. My role is hybrid in nature, in that I am writing thought-leading research while also providing consultative advice.
Having covered energy for so long, I saw a number of companies across natural resources that were facing more pressing and material challenges earlier as the sustainability movement gained pace. My relationship with those companies was either modelling for them or advising them directly. These challenges related primarily to their sustainability, their responsibility in terms of their operations, and how they were dealing with stakeholders. These have been issues for these types of companies because of how they operate, certainly from an environmental perspective, and always from a governance perspective. Social has grown in significance more recently. As I focused more and more on understanding companies and how I would advise them, I found that the larger part of my advisory role was around ESG. In my transition from investment banking to advisory roles, it was clear that ESG would gain more momentum and relevance.
Coming into ESG, from an advisory point of view, I had still thought my addressable market would remain the same, and it would be ESG advisory to those particular Energy and Materials industries. Immediately, that proved to not be the case, with large, new clients from all kinds of sectors.
“The reason is that the nature of ESG is truly universal. Of course, there are individual challenges in each sector, but largely ESG is about understanding the greater principles behind regulation and the agendas of stakeholders. If these challenges are well understood, then it is a universal need within business.”
Activism has always been about proactive shareholder engagement in order to create value in its own right. It is often associated with change either in strategic direction or changing influence within board structure. Activism isn't new, but being able to focus on issues which have strong understanding and backing gives a different impetus to the opportunity set that an activist might bring. In order to create this change and value, you need to see a gap between what a company does and what it could do. With ESG, the opportunity is to say we can now mobilise significantly more funds and create alignment among shareholders to create change, rather than having to go head-to-head with the board. It is that mobilisation of capital and will, against the board, which I think is accelerating.
“ESG Activism is not about building or shaping public opinion, but it is high-profile opinion that gets mobilised and that's what creates change.”
Applying ‘ESG’ to Activism, immediately softens the tone of the name, making it more sympathetic, just because of its prefix. To a degree this relates to why a number of activists prefer to be referred to as ‘constructionists’. This feels like a more engaging and virtuous route, even though the outcome is often the same. An Activist can take a constructionist approach all the way until the campaign goes public and hence, adversarial. In this sense, the wording really matters because of how you build and sustain opinion, as well as the positive predisposition towards what you're trying to achieve.
There are 3 vulnerable categories that I discuss in the paper and the ‘ineffectual communicators of ESG’ are the third of those. The leaders in ESG are already doing a great job in terms of the way they have conceived, deployed and executed their ESG strategy. They use strong metrics to set meaningful targets and clear goals with effective communication. The vulnerable categories we identified include companies that may be either complacent about what they're doing or ignorant of the risk.
The third category of companies are those that have sub-optimal disclosure or communication. These companies may well be doing a great job in terms of the business, culture, board integrity, and improving their metrics, but a gap has developed between that and how they're communicating it and hence how they are perceived; this is a very real risk. To change the efficacy of their communication is easier to do than to change a whole portfolio or improve an operational approach, but it is also something that an activist can put in place.
“When the external picture isn’t strong, an activist may recognise this ineffectual communication and argue that the target company is underperforming in terms of ESG.”
Changing the strategic direction or operational focus of a company represents a significant challenge to activists and brings with it high execution risk. By contrast, when the focus is purely about just recognising that a company is performing well but now needs to have a clear narrative and more explicit engagement with its audience, there's real opportunity for activists and, clearly, a very real and potentially existential risk for corporates.
I think that companies have traditionally been more farsighted than the near-term pressures of shareholder interests. Companies are more likely to plan on a 5 to 10-year time frame versus an investor group looking for performance in a 1,3,5-year perspective. This has been the source of tension between the two groups in the past. Activists have traditionally targeted opportunities in which a specific course of action could release value immediately or certainly in the near-term. Companies have often responded by arguing that such an action would destroy value over the long-term. The interesting thing about ESG activism is that, by definition, the consequences of a certain action will have a longer term consequence or require a long-term perspective to create the desired outcome. To achieve that, activists need the sponsorship of the investment community, many of whom would be operating on their own time horizons.
ESG Activists understand that by taking into account the longer term, and putting things in place that would create sustainable positive impact in the long-term, that there will be a near-term impact in the form of rating or cost of capital etc. In the report we explore how ESG activists can still operate on a short-term horizon for the value benefit because they expect to see a collapse in the timeline of the benefit that they might be directing the company towards.
One of the things we highlight in the paper is the persistent deficiency around disclosure of carbon emissions within certain sectors. This is surprising given the current focus of stakeholders on industrial decarbonisation and should be a priority for companies. Many companies believe that they are in the minority of being slow to rise to the challenge of ESG, but the reality is that most corporates still have a long way to go to be truly effective. In the paper, we look across industry groups and the percentage of companies that disclose their emissions in their own right and compare that on a sub-sectoral level with those companies that have set targets that relate to those emissions.
“72% of companies that don't have targets that relate to the emissions that they are disclosing which reflects the aggregate nervousness within industry around the consequence of increased disclosure, setting targets and then having to stick to them.”
Some of the worst offenders are oil and gas, mining, coal, utilities, and transport companies. The companies that are naturally the biggest emitters, are lagging in their disclosure of emissions and lagging in setting targets that relate to it. This appears surprising given the greater scrutiny and higher risk of investor exclusion from portfolios, that these companies face.
The other finding is the big gap in the ‘Social’ area because of the difficulty of empirical measurement. A company could choose to disclose a range of criteria, but that won’t necessarily mean that everything material to the business is being covered; this is consistent with the feedback we have received from investors. Companies might disclose aspects that relate to their business but find that they’re not being specific enough or do not have meaningful targets, both in magnitude and time.
On the flipside this is a material opportunity for companies, investors, and if it is successful, the environment. I see massive change and acceleration in this area - there will be greater disclosure and better target-making in the next few years.
There is significant invested pressure for it to happen. This is seen in the way that the investors are challenging and proactively engaging and there are also other stakeholders who are lobbying for greater disclosure.
We are also seeing this shift through the increasing impact of regulatory frameworks that have come into fruition. For example, in recent times, the Sustainable Finance Disclosure Regulation (SFDR) in March. We’ve also got the Securities and Exchange Commission (SEC) Task Force which will mean that the US will be mirroring a lot of what happens in Europe.
“The genesis of new frameworks and new standards means that companies are suddenly having to adhere to more and more stringent regulations. It all leads to greater scrutiny on new issues within the whole of the ESG area. The success of lobbying and public opinion has served to drive change and improvement in standards and regulation and that is what is going to continue to drive the change.”
The third reason is the initiative of companies. There has been a period of strong correlation between acting in a sustainably responsible way and the revaluing of shares because of how that plays into the scarcity of opportunity and inclusion in specialist and generalist funds. Companies are increasingly aware that by developing initiatives in their business, which are consistent with these external drivers, they will be value creating in themselves in this initial phase. However, this relationship may not always be consistent which is why the regulation is so necessary – to ensure high standards are retained irrespective of the economic benefit to companies and shareholders.
We have a great deal to achieve here. I think the initiatives that we've made around benchmarking are really subversive in the way that they change the control dynamic for corporations, in terms of assessing their own performance. Benchmarking returns ownership, both of the inputs and of the conclusions, to the company so that it may be able to self-evaluate while being transparent, ambitious and accountable.
We aim to take consultancy away from an opinionated approach, to one which is evidence-based and rooted in diligent, investigative research. I strongly believe that this is what companies are crying out for because there’s too much conversation in this area and not enough urgency about creating and enabling real change, for industry, for shareholders, for the societies we live in and the environment we all depend on.
In all honesty I don’t think we need to – ESG Activists have got all the encouragement they need in the context of the impact they can have and the value they can create. However, in terms of encouraging engagement in investment strategies and impact investment, it is important to make clear the benefits of what the positive outcomes are likely to be. Those benefits are virtuous for the world, a commensurate value created for the company itself, the shareholders who own it, and the stakeholders who are relevant to its success.
“Being more explicit about what the benefits will be, requires greater transparency and inevitably more regulation. These all lead to enhanced comparability and the degree to which you can compare companies that are or aren’t disclosing the right metrics. It also allows investors to discern which companies are genuinely leading in this area and those that are lagging their peers.”
In ESG activism, if you have greater transparency and more explicit comparability between companies, then you can construct arguments that are explicit about the change you want to create and the outcome that can be achieved. If this can happen through transparency, then there will be no stopping the trend of ESG activism.
ESG investing isn’t just due to the kindness of people’s hearts. It’s a solid investment philosophy that can help investors mitigate risk.