The meteoric rise of environmental, social, and corporate governance (ESG) investing in recent years has been accompanied by a surge in demand for sustainable investment products. However, this trend has been met with skepticism from some investors who demonstrate that ESG criteria often come at the expense of financial performance. The ESG investment momentum has slowed in recent months, with investors withdrawing billions from ESG funds and some firms rebranding or even closing their ESG-focused offerings.
According to data from Morningstar, investors withdrew $2.7 billion from ESG funds in Q3 2023, marking the fourth consecutive quarter of outflows from these investments. The Wall Street Journal reports that in 2023 investors have pulled out more than $14B from sustainable funds.
Climate change continues to be top of mind for corporations’, consumers, and regulators. The range of key influencing groups include U.N., the WEF and other spokes entities for climate continue to urge we are in a crises and business as usual approach will no longer work.
ESG has been a hot button topic for many years now. Asset managers globally are expected to increase ESG-related AUM to $33.9 trillion by 2026, up from $18.4 trillion in 2021. While ESG focused investing continues to be more popular than ever, there has also been a rise in an anti-ESG counter movement. An anti-ESG ETF debuted in 2021 so called “B.A.D”.
Increasingly the importance of ESG is becoming centric to the American consumer psyche. Millennial and Gen Z cohort have become the largest group with the most purchasing power.
The ESG landscape in 2022 is more difficult than ever to navigate; executive leadership teams have the challenge of balancing the interests of their shareholders, employees, customers, and community.
We are in the era of the “conscientious consumer” where more than ever before, a wide range of stakeholders care deeply about ESG and a growing percent of consumers are willing to pay a premium for healthier, safer, more environmentally and socially conscious products and brands.
According to a survey conducted by PwC, 83% of consumers think companies should be actively shaping ESG best practices, 91% of business leaders believe their company has a responsibility to act on ESG issues and 86% of employees prefer to support or work for companies that care about the same issues they do.
Companies have woken up and realize that strong ESG practices are a “must have”, not a “nice to have”.
It is critical that companies take meaningful and industry appropriate steps to set and achieve ESG goals and that the progress is measured in a programmatic, factual, and consistent fashion.
Being labeled as a company that engages in “greenwashing” can deeply fracture the relationship with all your stakeholders and irreparably damage the trust your consumers / employees have in the company.
So, what exactly is “greenwashing”? Greenwashing is the practice of using marketing and PR tactics to overamplify your ESG efforts for the purpose of gaining greater favor from consumers, investors, employees, etc.
A company may not intentionally set out to “deceive” consumers but may fall victim to jumping on a marketing hype train that oversells a well-intentioned initiative that is not yet viable.
To feel confident in your ESG initiatives, first and foremost, it is imperative that the goals set forth are directly relevant to your industry.
ESG is a catch all for how your company pulls together a range of programs: environmental, social, governance. These programs need to be tailored and made relevant to your companies’ industry. Consider assembling an internal team around formulating your company ESG policy that correlates with your business imperative.
Each company must put on their thinking cap and come up with a baseline of general principles and then make these principles come alive. It needs to be relevant to your industry and business.
For example, a major financial services company such as Visa / Mastercard might have, as part of their program, “data for doing good”. You would want to have programs that measure data for financial inclusion and accessibility.
For example, if you are a financial services company, it doesn’t make sense for you to be opining on fossil fuels, it just doesn’t apply the way it would if you were an oil and gas company.
If you are an oil and gas company however, having renewable energy sources will complement and offset the concerns investors would have about you being a responsible fuel company.
Major institutional shareholders will look at your policies on environmental responsibility if you were, say, a fossil fuel company, they will evaluate, select, and invest based on how you are doing on important efforts to offset to fossil fuel concerns i.e., such as focusing on renewable energies.
For a manufacturing company the “social” component of ESG may be more applicable to your business and investors make look for things such as community impact/support i.e., through apprenticeship/vocational partnering programs. This would be more relevant to the manufacturing business than (hypothetically speaking) protecting consumer data or other factors that are irrelevant to the core of the manufacturing business.
Navigating the ESG landscape can seem daunting given the wide array of metrics and reporting options available. It is important to implement an industry specific approach – you need to pick the frameworks that are most appropriate for your industry and pick the rating agency where you will be most rewarded.
More than ever, ESG is a necessary component to ensuring the health, competitiveness, and longevity of a company. ESG investing is surging and now makes up 33 percent of total U.S. assets under management. Investors will increasingly be considering ESG factors when evaluating companies. Having a strong narrative will enable your company to have access to bigger and differentiated pools of stickier capital.
In response to increased investor activity around ESG and the potential for greenwashing, the SEC has formed a taskforce aimed at investigating potential misconduct related to companies’ sustainability claims. Gary Gensler, who took over the agency in April, has said his staff is working on a rule to boost climate disclosures by stock issuers, and that the regulator remains focused on ESG issues.
Boards and executive leadership teams would be well served to stay ahead of potential upcoming increased rules and regulations by proactively reviewing company policies related to environmentalism, human capital management, sustainability, and other ESG topics that are material to your industry.
Having a clear ESG position and messaging in your annual proxy and website are now a best practice. Consider adding ESG oversight to a committee such as Nominating and Governance. There is significant positive impact to being proactive on ESG.
Global corporate boards have all conceptually embraced the need for their corporations to have not only a position and philosophy but to actually begin the journey on implementing ESG programs.
Jamf is an example that is truly unique and differentiated in their approach. They are a newly public, hyper-growth, hyper-scale enterprise software company that went public a year ago.
What has made Jamf differentiated is they are at the leading point of the arrow of companies that are operationalizing and implementing their ESG programs pre-IPO and newly public.
Most corporations merely speak about their philosophy, mission, vision, and purpose, but lag on execution or do empty programs characterized as “green washing”.
So where should ESG leadership reside in a corporation and who is best placed to take the mantle of operationalizing ESG?
Jeff Lendino, Jamf’s Chief Legal Officer, is a great exemplar since he has pulled together the working group across each functional part of the company and created the templates, scorecards, and deliverables across all the functional groups who are involved in this undertaking.
One of the important things to highlight is the importance of getting started early, Jamf had a lot of building blocks in place early, had the culture in place before going public i.e., use of technology focus on philanthropic and local issues as well as governance. Starting their projects and having it be authentic allowed Jamf to make good progress sooner.
When discussing how to implement ESG, it is critical that these discussions begin before the IPO process.
It may be helpful to speak to external experts and advisors who can review your current ESG programs and offer guidance on how to grow and scale them through the IPO process and beyond that. Early conversations can help you think through long term planning and can inform many future projects.
Often the focus for executives who are on the path to an IPO is on the machinery of the IPO…the roadshow…the investors, etc. What happens after the hurdle of going public can be an overlooked factor which is why it is essential to think through long term ESG initiatives before the team is swept up in IPO prep.
Thinking long term about what the next several phases of the company look like can help attract the right investor(s).
In order to do this effectively, you need to have a clear messaging plan to be able to integrate your unique ESG story into the deck / roadshow to attract a differentiated set of investors as part of the IPO process. It is critical to convey who you are as a company and what your identity is apart from just being a great tech company.
Setting the right expectations at the beginning also helps the company properly frame for investors, customers and other interested parties the status of the company’s journey so progress on this initiative can be measured over time. While ESG has become (and will continue to be) a front-page issue, this is not something that is done overnight so a continued focus on communicating the status of your progress is critical.
In speaking with Lendino he highlights the importance of building a core team to launch an ESG program. Lendino shares his view that the goal is not to hire someone who is “just” an ESG person but rather to get the best out of your employees who are already at your company working on issues connected to ESG. As you go through your hiring process, ESG is another capability or skill set worth seeking out in addition to the other prerequisites for the role you are filling.
He suggests pulling in a key person from finance to be able to convey a compelling story to investors. There should be a governance overlay in your ESG reporting and you need a key team member that can speak to topics such as data privacy and security concerns. There should be a team member focusing on environmental concerns which can include things such as the company’s carbon footprint, energy use, etc. And of course, included in this core ESG team it is important to pull in a key member from your PR team that can think through how to knit together these varying threads into a compelling narrative from an IR perspective.
Once the core team has been established, it’s important for the team to understand exactly where the organization is in their journey before they can determine where they want to go. Conducting an inventory of all ESG related activities and mapping it to an established framework like SASB or GRI is a good first step. Jamf utilized smaller working groups to help gather this information. These groups included subject matter experts and employees that were passionate about ESG issues. Engaging internal stakeholders from the start brings the right people to the table and helps foster engagement and ownership.
ESG is no longer a box checking exercise that is only addressed once a year as a footnote in the annual report. ESG must be woven into the company’s overall strategy and should be factored into all decision making. More than ever, ESG is a necessary component to ensuring the health, competitiveness, and longevity of a company.
This could be the year of reckoning for climate change as politicians, investors and stakeholders-at-large are pushing for big change.
As a key ESG issue, directors need to come up the learning curve and understand the terms used to describe climate commitment, including the implications as well as the definitions.
To make informed business decisions with both fellow board members and management, directors must understand the different costs and tradeoffs of various climate commitments and how climate issues apply to their industry.
Larry Fink of BlackRock recommends and endorses the Task Force on Climate-Related Financial Disclosures as well as Sustainability Accounting Standards Board frameworks. Fink further highlighted his commitment to climate in his annual letter to CEOs, in which he discussed the opportunity of a transition to net zero emissions — an economy that emits no more carbon dioxide than it removes from the atmosphere.
Fink noted in his letter that in order to meet the Paris Agreement goal of containing global warming to less than 2 degrees Celsius above preindustrial averages by 2100, scientists say human-produced emissions must achieve net zero by mid-century. He called on all companies to “disclose a plan for how their business model will be compatible with a net-zero economy.”
BlackRock currently has $9 trillion in assets under management, making the investor highly influential among publicly traded companies.
Companies also should be sensitive to their stakeholders and be responsive to employees, customers, investors and communities, which are all deeply interested in corporate positions on climate.
In addition to institutional investors, millennial and Gen Z consumers and employees demanding more transparency, a new presidential administration is also prioritizing climate risk.
President Joe Biden has made addressing climate change one of his key initiatives for his first 90 days and has already appointed John Kerry as his climate czar. Biden has issued two executive orders addressing climate change policies, which include a moratorium on new oil and gas lease permits on federal lands and waters. He has rejoined the Paris Agreement and revoked the permit for the Keystone XL pipeline. Companies should expect more action and regulation to follow over the next four years of this administration.
There is also an increased pull for additional ESG disclosures and transparency around climate policies. Boards should anticipate climate as a priority from shareholders this year and be prepared to clarify their companies’ position on climate.
External ESG reporting gives your customers and employees insights into your brand’s mission, vision and values; it is an opportunity to tell your story and augment your brand “halo.”
Strong ESG reporting is also a positive when/if you are seeking funding either privately or on the public market. Investors will value a strong ESG stance, and you will be granted access to larger pools of stickier capital.
Making a difference
Do the research and consider how climate issues could be a business asset and accelerant rather than just an additional cost.
Here are some companies that are making notable progress in addressing climate risks:
IKEA
Patagonia
UPS
There are significant differences between real-economy companies and services-economy companies. Real-economy companies, such as oil and gas companies, have very significant challenges but are surprisingly ahead of many other industries on climate reporting because of the scrutiny they receive.
The typical carbon starting point for an oil and gas company is 60 million metric tons of carbon emitted a year. Compare that with a company like Amazon, which has retail, delivery fleets and miscellaneous services. Amazon’s starting point is 42 million metric tons of carbon a year. On the other hand, Microsoft starts at 16 million metric tons and has pledged to be carbon negative by 2030.
Services-economy companies are typically able to offset their emissions by purchasing carbon offset credits, and they have made some impressive achievements. For example, EY was carbon neutral in 2020, particularly because of a “COVID bump” that eliminated much of the carbon a services company like EY generates through air travel.
Oil and gas companies look to lower their carbon emission by innovating in areas such as carbon capture. Manufacturing companies can retrofit equipment like long-lived boilers with renewable solutions.
Additionally, companies can buy “green energy” utilities and look at green bonds, all of which contribute to their climate positioning.
Next steps
Here are some calls to action for the year of climate governance:
Remember, every company will be asked what its position is on climate issues, and this is no longer just an EU topic. Assess your company’s readiness and have the information to disclose the company’s carbon footprint as a starting point.
Directors need to be informed and ready. Climate impacts our companies’ access to capital and talent.
Your company’s position on climate will also influence your brand perception. Now more than ever, consumers want to support brands that are transparent about their vision, mission and values. It is no longer an option to adopt a “wait and see” approach when it comes to climate issues.
There is a common misconception that ESG is just for public companies. However, private companies would be well served to integrate ESG into their overall strategy. This initiative can set them apart from their peers.
Betsy Atkins is a three-time CEO and founder of Baja Corporation and author of Be Board Ready. Betsy is a corporate governance expert and is currently on the board of directors of Volvo Car Corporation, Wynn Resorts and SL Green Realty.
In 2020 Catalyst reported[1] that there were 29 women who held the CEO position in the S&P 500 – this means that 5.8% of companies in the S&P 500 have female leaders. In 2021 it has been announced that 3 more women will be coming into the CEO role in Q1 & Q2. In 2020, just 4 CEO’s in the S&P 500 are black, and it has been announced that 2 of the 4 are stepping down from the role in 2021.
Looking at the numbers in 1993, according to Catalyst, women held 8.3% of board seats[2]. In 2020, 28%[3] of board roles are held by women. While there has been a concerted focus on increasing gender and ethnic diversity on boards, progress has been slow and there is still a ways to go before we reach gender parity in the board room.
However, it is important to avoid putting people in role simply to check a box and reach a quota. The foundational first step in adding a new member to the board is to create a skill matrix and identify what functional expertise is required as you refresh the board for the next 5-9 years of the company’s journey.
For example, when you look around the boardroom table, ask yourself what are the areas of expertise that can be augmented such as technology skills in AI/ML and data lake analytics, cyber/digital transformation, etc.
Once that functional need is established, then look for candidates in a rich and diverse slate and be sure to pull from historically underserved talent pools.
However, do not overlook other avenues of diversity which include generational diversity, people who bring different global perspectives, as well as people who come from different economic backgrounds. When sourcing candidates for a role it is critical to tap into a broad talent pool to get to true diversity.
An important but often overlooked component when it comes to increasing diversity in the boardroom and in the C Suite is developing the diverse talent at every level of the company so that there is a strong diverse talent bench in the company ready to move into more senior roles.
Boards can ask management to pull together what percent of people at every level of the organization from middle management to senior management are diverse.
Challenge management to identify what they are doing to improve the numbers not just in the board room and C Suite but at every level and ask what programs the company has invested in to consciously tap into interns and apprentices in underserved communities to create a pipeline of future qualified individuals.
Here are a few facts: 51% of the population is female, and about 40% of Americans identify as racial or ethnic minorities, per the latest census data. Millennials make up 40% of the working age population, this means many of your customers are made up of millennials.
Legacy brands are especially vulnerable to marketing to their baby boomer base and not revitalizing their positioning for millennials and Gen Z.
Augmenting your board with generational diversity is an opportunity to bridge this gap and attract a broader range of consumers and employees
How the company measures culture can be quantified in set targets and the specific things that are done to ensure we have a pipeline of female and ethnically diverse candidates who are moved into general and middle management and line operating opportunities. This is a topic that can be added to the annual committee calendar for specific focus in the year ahead.
Boards can also ask management to specifically identify if/how the company is tying compensation to improving the numbers across the organization.
Diversity and inclusion is an important component of ESG; ESG investing is estimated at over $20 trillion in AUM—about a quarter of all professionally managed assets around the world.
Boards and management should expect continued and increased focus from their investors on ESG topics; management and the board should expect an increase in communication to be ready to capture and share the quantitative data on what the company is doing regarding ESG.
Companies are best served to get out in front and lead and embrace building a diverse board and a diverse executive leadership team. If boards do not actively embrace this, we will see regulations and mandates as evidence by the state of California and the state of New York putting in quotas for diversity and inclusion.
The major passive investors, the index funds like Vanguard, State Street, Fidelity, etc. all have strong policies that value and reward diversity and inclusion. Companies will be graded on this and it can impact how you are valued during annual proxy voting or make you vulnerable to an activist.
Diversity at every level is important to drive engagement, debate, and to arrive at the best ideas and business outcomes.
[1] https://www.catalyst.org/research/women-ceos-of-the-sp-500/
[2] https://catalyst.org/wp-content/uploads/2019/02/1998-catalyst-census-female-board-directors-of-the-fortune-500.pdf
[3] https://www.bloomberg.com/news/articles/2020-05-15/female-board-participation-rises-in-s-p-500-index-in-april
As we enter 2021, environmental, social and governance (ESG) continues to be a top priority for boards and management teams. Karen Snow, Senior Vice President and Head of East Coast Listings and Capital Services at Nasdaq, interviews veteran board member Betsy Atkins to get her insights on how to operationalize ESG.
What specific advice do you have for public company directors?
Directors can start the process by looking at the many good policies your corporations already have in place. The opportunity is to communicate your existing excellent practices in your HR organization which are of course equal pay, inclusion and diversity, wellness, safety.
Likely all your companies are good corporate citizens and are efficient with water and energy and don’t pollute. Your supply chains likely are not using endangered species/rare wood or child labor. Likely, your policies on cyber are in place to do appropriate oversight software patching and updating and you have anti-corruption and anti-bribery policies. You likely have appropriate data privacy policies.
Start by capturing the information you already have in house and communicating this in your annual report, CEO letter, website and proxy.
There are many ESG frameworks. The stock exchange data seems to show that the SASB framework in combination with the MSCI rating agency seems to correlate to very high returns. Additionally, Larry Fink of BlackRock endorses SASB and MSCI.
Pick the frameworks that are most appropriate for your industry / business and the rating agencies where your companies results will be rewarded.
Start by quantifying what you’re doing by organizing, measuring and communicating your data. It’s the first step as boards look to embrace E.S.G. and communicate it.
Is ESG something private companies should do or only public companies?
ESG reporting is not a one and done. It should be part of your company’s annual reports to your different stakeholders that show your progress towards its ESG goals.
ESG is not just for public companies. Private companies are well served to integrate ESG into the overall strategy as it can be extremely advantageous and a positive differentiator.
External ESG reporting gives your customers and employees key insights into your brands mission vision and values; it is an opportunity to augment your brand halo.
Strong ESG reporting is also a positive when/if you are seeking funding either privately or on the public market. Investors will value a strong ESG stance and you will be granted access to larger pools of stickier capital.
What external influences will speed ESG adoption?
First and foremost, the regulatory landscape will of course help drive and speed up adoption. Companies would be well served to try and get out ahead of the inevitable regulation coming from both public and private sectors.
Also, the evolving view of what exactly a boards fiduciary duty will also speed ESG adoption. Canada, Sweden, and the UK have taken steps to expand the scope of the concept of a fiduciary duty. Will Martindale, head of policy at Principles for Responsible Investment (PRI), even said that “Failing to integrate ESG issues is a failure of fiduciary duty.”
Another factor that will speed ESG adoption is the market. Customers want to shop at businesses whose practices align with their values and employees want to work for a company that is a good corporate citizen and has clear purpose and value.
You mentioned some of the regulatory steps taken in Europe to expand the definition of fiduciary duty. Is Europe ahead on ESG? It seems to be.
Well, regulatory trends tend to start in Europe and then make their way across the pond.
The EU was ahead of regulating platform giants and focusing on consumer data privacy (GDRP) and we see that topic trending now in the US. In 2012 the European Commission put forward a law aiming to accelerate the addition of more women on boards to reach gender parity and of course now in the US gender diversity (among other forms of diversity) is a topic that is on everyone’s mind.
When it comes to ESG, 85% of European investors compared to 49% of US investors say they are incorporating ESG factors into their investment analysis.
ESG is gaining momentum in the US and companies should expect an influx of activity and interest in the coming year from all their various stakeholders (shareholders, customers, employees, communities, etc.).
Do some industries lead in ESG? If yes, which ones?
Whichever industry you are in, it is important to begin the process of ESG reporting so you can see where you stand relevant to your peers. You don’t want to fall behind the bell curve and become a laggard.
It is also important to be sure you are reporting on ESG factors that are material to your industry sector. A software company reporting on their water usage is perhaps not as strong an indicator of their ESG practices as what their consumer data privacy policies are.
Across all industries there are leaders and there are laggards when it comes to ESG; evaluate where you are relative to your peers and focus on areas where you can improve and show measurable growth.
Are all industries adopting ESG at the same pace?
No, and that is ok. It may be easier to adopt ESG practices if you are a services economy company i.e. an agile growth SaaS company that really doesn’t have high carbon emissions or high water usage, etc. compared to a company in a so called real economy heavy industries such as oil and gas or mining.
However, adopting a “wait and see” approach to ESG is not going to cut it anymore no matter what your industry is.
Investors and all your other stakeholders want to see that you have set thoughtful, measurable goals that are relevant to your business and that you can report and show progress towards these goals along the way. ESG is not a one and done exercise – it is an ongoing journey and is something that needs to be interwoven with the overall strategy and direction of a company.
Has COVID-19 impacted company commitments to ESG?
It is well known that Covid has sped up digital transformation and tech enablement by 5-10 years, but it has also sped up ESG adoption and many companies have ramped up their commitments to ESG.
This global crisis has been an opportunity for companies to operationalize their culture and has highlighted the need to focus on employee wellness and reevaluate how to best meet the needs of customers.
I believe that companies with strong ESG policies in place will outperform their peers in this strained economy.
Consumers are increasingly interested in whether the companies they support are good corporate citizens with values that align with their own. Consumers (particularly demographics such as Millennials and Gen Z) are eager to support companies with good external messaging around their ESG practices.
Are all stakeholders equally influential in driving ESG adoption? Which stakeholders will have the most impact: employees, customers, investors, community?
ESG is more important than ever to all stakeholders.
Having ESG be an integral part of the company strategy will enable you to attract and retain the best talent. Highly skilled employees are desirable, and they want to work for a company that as clear values and a mission driven purpose.
Your customers will be loyal to your company if you have positive brand halo and a strong reputation.
Investors will increasingly be considering ESG factors when evaluating companies. Having a strong narrative will enable your company to have access to bigger and differentiated pools of stickier capital.
Will companies be penalized for incomplete ESG reporting?
You will be penalized if you don’t have anything you are reporting re ESG programs.
Your various constituencies will reward you for starting the process even if your implementation of your goals is incomplete.
You need to pick the frameworks that are most appropriate for your industry and pick the rating agency where you will be most rewarded. For example, if you’re a high emitting real economy industry like oil/gas, mining, etc. reporting a climate goal is especially an important focus, the TCFD (Task Force on Climate-related Financial Disclosures) would be a framework you would want to look at.
Start by quantifying and measuring the things your company is already doing and set measurable goals. Don’t hesitate to share these goals with your various constituencies even if you are not there yet in terms of being able to report on progress.
Investors want to see that you have an ESG narrative and a plan that has specific quantifiable metrics they can get behind.
What should boards expect in this upcoming proxy season? Will activists be using ESG?
In the past, financial under performance made you a target for activist activity.
Now ESG is the trojan horse for activists who are citing issues such as lack of diversity, poor environmental policies, etc. This year Elliott suggested in a public letter to Evergy that they consider reducing their carbon footprint. Third Point send a letter to Prudential saying that having a London HQ for their American and Asian businesses creates an excessive carbon footprint.
As a company you can prophylactically immunize yourself from activists by refreshing your board and proactively reviewing policies related to environmentalism, human capital management and other social issues that are material to your business.
When it comes to tackling the complexities of ESG, climate change is one of the highest priority issues for boardrooms across the world. From increased regulations to investor pressures to consumer expectations, it is a topic that is here to stay, and companies will be feeling more pressure than ever to articulate a philosophy and approach.
Brand value is now closely linked to a company’s reaction to environmental issues, and any missteps are likely to be amplified by a combination of social media reaction, press coverage and political point-scoring. Businesses at risk of climate-related litigation could find themselves marked as pariahs. Investors, banks, and insurers will likely choose to reduce their exposure to them. For those reasons alone, climate change must be on the agenda.
While they are unlikely to be in the role 30 years from now, board members must think about what a CEO can commit to today. They need to be demonstrating not just good intentions, but a measured plan of action. Having smaller, incremental goals that serve as measurable milestones on the path to long-term success is an approach likely to meet the expectations of your various stakeholders and constituencies.
While climate change is a challenge that all board members should be thinking about, first we must understand certain key terms:
Depending on which route a company chooses, there are different costs and different levels of resources and commitment involved.
Additionally, as boards think about climate needs, they also need to be aware of the demands of all groups – from investors and communities to employees and customers. Each will hold certain values, and it’s essential that those different perspectives and voices are heard. Today 90% of S&P 500 companies publish a sustainability report.
Voices to Consider
When considering a path forward for your company, it is important to also look backward and examine the history of what has driven the climate movement. The first and largest proponent was Norges Bank (the second-largest single sovereign pension fund with 1.2tn AUM).
Norges Bank has since been divesting its position in coal and oil sands. Dutch, Swedish, French, and other European investment funds have also followed suit. The big change happened around four years ago when Japan’s GPIF, the largest sovereign fund in the world at 1.4tn AUM, adopted an ESG governance framework similar to Norges.
There is interesting cognitive dissonance when you look at Norges. The bulk of Norway’s GDP derives from oil and gas and yet they have been the earliest and most stringent adopters of climate initiatives. They have gone so far as requiring that any oil and gas platforms that use diesel to operate are rewired to use electric cables instead – a move that has driven up the cost of oil and gas extraction.
Norway and now Japan’s sovereign funds have an outsized influence on US investors, like BlackRock, SSGA, and Vanguard, who have all adopted ESG principles to sell their index funds to these sovereign fund clients. It is fair to say that ESG has become a compelling business catalyst.
Oil and gas managers – both active and passive – are demanding companies embrace ESG. The focus on climate has been particularly strong in real economy companies in the oil and gas, chemical, and mining sectors.
Most public companies have over 70% of their stock held by index funds, of which the average amount dedicated to ESG is believed to be between 0.5% and 3%. There is an opportunity to have these investments increase, potentially, up to 5% in the next 12-24 months. This is significant. If your company can lead its peers by articulating a tactical, measurable plan on climate, as part of a subset of ESG initiatives, you will be rewarded with greater shareholder investments.
Different Industries, Differing Commitments
Let’s say that you’re a high-growth company with high profit margins. Spending 1% of profit to commit to being “net zero” (the way Microsoft has done, for example) can be viewed on a relative basis. It’s an easy undertaking when compared to companies in industries like oil and gas, chemicals, or mining. These companies are founded on a business model based on the consumption of energy, water or other natural resources and, by the very necessities of the business, they emit carbon. Apple, for example, announced in 2018 that its global facilities (this includes retail stores, offices and data centers) are powered with 100% clean energy.
“Real economy” companies with a focus on manufacturing face bigger challenges when aligning company strategy to climate and ESG initiatives. In this instance, boards can evaluate their response to investors, embracing ESG in a measurable way, and encouraging continued investment. For example, BHT, the second-largest global mining company in the world, has made a clear commitment to reducing operational greenhouse gas emissions by at least 30% from adjusted FY2020 levels by FY2030.
Additionally, there is a climate push in some consumer-centric companies who want to refurbish their reputation. VW (still recovering from the emissions scandal) has adopted a group-wide comprehensive decarbonization program with the aim of reducing CO2 emissions by 30% by 2025 and of transforming the company into a CO2-neutral company by 2050.
Light industry companies who manufacture parts and components that go into the supply chain can look at possible solutions too (for example, committing that 10% of their energy use (i.e. electricity) will be supplied by renewable sources.) When looking at a typical light industry company, the average amount spent on an annual basis for electricity to support manufacturing is ~1% of the budget. If 10% of that 1% comes from renewable energy, then a company is committing to a tenth of a percent. Utility companies typically offer an option for corporations (or consumers) to purchase renewable entry at a cost premium of typically 10%-15% more depending on your state.
Capital expenditure in infrastructure is another area that manufacturers should consider for review. A boiler that runs the manufacturing plant typically has a life span of 20-30 years. Most boilers run on oil or gas. They are very costly, so it doesn’t make sense to rip out and replace working boilers.
However, companies can begin by looking at boilers in need of replacement or retrofit and evaluate new boilers that run on other sources such as renewable fuels like hydrogen, biofuel, or innovative next gen solar.
An example of a utility company taking incremental steps is Xcel Energy. Providers of energy to customers in Colorado, Michigan, Minnesota, New Mexico, North Dakota, South Dakota, Texas and Wisconsin, Xcel has a goal of providing 100% carbon-free electricity by 2050.
Other companies that are focused on emphasizing climate as part of their positioning have included BP – ahead of the market by some 20 years. In 2002 BP rebranded itself from “British Petroleum” to “Beyond Petroleum,” committing to hold emissions constant and to be a steward to the planet. However, the company was unable to deliver on such a large promise. In March 2006, a BP oil pipeline caused one of the largest oil spills in Alaska’s history. Under financial strain, BP sold off many of its solar and wind assets, quietly deserting the “Beyond Petroleum” rebrand.
In 2019, Repsol announced it would be carbon neutral by 2050, making it the first major oil and gas company to make a pledge of this magnitude. To achieve this goal, Repsol has announced they will cut their dividend and invest in renewables. The investor response was a 5% decline in the stock price.
Despite this, BP followed suit in 2020 and reinvigorated its commitment to climate by pledging to go carbon neutral by 2050.
Exxon is clear in their view that there will be an ongoing need for oil and gas in the future. They are taking a “wait and see” approach, looking for more proof that their investors will reward a push toward renewables.
For the oil and gas industry, a key question remains: are you better off focusing solely on oil and gas, or should you pivot towards being an integrated energy provider with a greater focus on renewables?
The auto industry also has a similar consideration of how much of a commitment to make to climate, especially with electric vehicles. Tesla is a great example; their extraordinary market cap has been bolstered by ESG funds who want to invest in the automotive sector. However, the broader industry is still measured in assessing how strong consumer demand will be. While electric vehicles have captured attention, they currently only make up about 4% of the market.
Consumer-driven ESG wellness themes have also gone mainstream. We see this in the popularity of organic fruit and vegetables, and vegan beef alternatives, such as the next gen protein Beyond Meat. AgTech is emerging as a significant part of ESG. Smithfield Foods, the country’s largest pork producer, harnessing the methane from manure ponds at swine farms to supply gas to fuel homes is an example of how some companies are investing to make their corporate positioning more climate-friendly.
ESG Is Here to Stay: Questions to Ask on Climate Change
ESG will continue to be an important topic and board members should expect to see more climate-specific issues raised this proxy season. It is important to gather all relevant data and start the process of framing the discussion, as well as asking your management to gather some facts in preparation for the Q1 board meeting.
Here are some questions that you may want to ask management to research:
The conversation around ESG has progressed from disclosure to needing ESG programs with measurable targets. The climate discussion will likely follow the same pattern.
For companies, the climate change discussion will only gain more momentum and visibility. We should all expect that we will need to have a thoughtful and well-informed corporate philosophy as part of our vision and mission going forward.
How we embrace both the near-term, mid-term and long-term climate initiatives as part of our overall ESG umbrella for all our stakeholders will be critical to our future success. As such, boards and management must seek to clarify an agreed way forward with all stakeholders and representatives. Doing so will ensure alignment and clear expectations for our companies’ future.
2021 will be a pivotal year with the climate as an increasingly important topic. Companies will be well served to be proactive.