Posted on July 13, 2011 by Christopher Davis
Institutional investors, including pension funds, insurance companies, foundations and university endowments, own about 70 percent of the stock of the world’s largest companies. As part of their fiduciary duty to maximize the long-term, risk-adjusted value of their investments, more institutional investors are becoming “active shareowners,” pressing companies whose shares they own to adopt sustainable business practices on a variety of environmental, social and governance (ESG) issues. This trend has important implications for corporate management and their advisors.
Recent events including the BP Deepwater Horizon oil spill, the Massey Big Branch mine explosion and the TEPCO Fukushima Daiichi nuclear power plant meltdown highlight the potential for poorly managed environmental and safety risks to result in destruction of shareholder value. By contrast, there is evidence from Sustainable Asset Management, and from investment consultant Mercer, that companies with superior ESG performance also have superior financial performance. Thus, how companies address these so-called “nonfinancial” business risks and opportunities is of increasing interest to investors.
Indications that institutional investors are paying greater attention to ESG factors include:
- The Investor Network on Climate Risk now has 101 asset owner and asset manager members with aggregate assets under management of $10.6 trillion, and the United Nations-affiliated Principles for Responsible Investment has 850 signatories representing assets of over $25 trillion, signaling the growing strength of the “responsible” or “sustainable” investment movement.
- In 2011 US investors filed 109 shareholder resolutions seeking corporate disclosure or action on climate, energy, water and other sustainability issues, of which 44 were withdrawn when the company agreed to take the requested action, and the average percentage vote on such resolutions has been steadily increasing.
- CalPERS and CalSTRS, the nation’s largest public pension funds, announced in May that they are integrating ESG factors into all aspects of their investment processes across all asset classes, as part of the newly launched Investor-Business Roundtable on a Sustainable Economy.
- 31 investors representing $1 trillion in assets recently sent letters to each of the 1000 largest (Russell 1000) companies based in the US, urging them to adopt sustainable business practices as outlined in the Ceres 21st Century Corporation Roadmap for Sustainability.
- Recent reports by leading investment consultant Mercer found that climate change contributes 10% of overall risk to institutional investors’ portfolios and that most institutional investors regard climate change as a material risk that they address in their investment practices.
- Investors are working with corporate, academic and accounting profession representatives on developing standards for “integrated reporting” of material ESG information in companies’ financial reports—a trend to watch.
In recent years there has been a proliferation of research, data and ratings of companies’ ESG performance. One example is the scores that the Carbon Disclosure Project gives to companies based on their reporting and management of greenhouse gas (GHG) emissions. Financial data provider Bloomberg now offers ESG data on a wide range of companies on its terminals. Analysts at both socially responsible investment (SRI) funds and increasingly at mainstream investment firms analyze and report on companies’ ESG performance, and companies are ranked and selected for their ESG performance for indexes such as the Dow Jones Sustainability Index. The net result is that ESG factors are starting to be incorporated in corporate valuations, and this trend is likely to accelerate.
Given increasing investor interest in these factors, it behooves corporate management and boards to focus on, improve and report their ESG performance.
A company should communicate the “business case” for its sustainability strategy to shareholders, customers and other stakeholders with whom the company engages, as a key driver of the company’s competitive positioning, risk management, reputation and brand. Managing ESG risks and opportunities, on issues ranging from climate change to workforce diversity, should be integrated into companies’ business strategy, and not merely assigned to the environmental, human resources or corporate social responsibility (CSR) departments.
Institutional investors’ attention to these issues is likely to increase, as “sustainable” or “responsible” investment becomes more widely accepted as fundamental to the fiduciary duty of asset owners and investment managers. Counsel can add value by helping their corporate clients recognize this trend, better assess and manage their ESG risks and opportunities, and review and revisit their mandatory and voluntary disclosures of these issues.