Ethical Boardroom Spring 2019

Commentary | ESG

ESG INVESTING:

Truths, half-truths and lies Over the past decade, environmental, social and governance (ESG) investing has arguably emerged as the most fashionable concept in the world of finance, surpassing the widely popular ‘BRICS’ (Brazil, Russia, India and China) at state level and ‘FANG’ (Facebook, Amazon, Netflix, and Google) at corporate level.

To be sure, as a philosophy, ESG has the fangs and the potential to embrace both government and corporate spheres.

Herein lies its danger. Contrary to popular perceptions, ESG is not merely about investing in well-governed enterprises.

And, contrary to common discourse, the actual impact of ESG-focussed policies on the bottom line is far from guaranteed.

Indeed, a number of ESG regional and country-specific investment indices have not necessarily been correlated with positive financial performance and have generally attracted minimal investor following.

Perhaps more importantly, the purported adoption of ESG policies by corporate boards has, in many instances, focussed shareholder attention on immaterial, philanthropic policies and away from critical governance questions. A myriad of corporate annual reports boast positive ESG impact without reference to any methodology, all the while skirting key governance issues, such as board independence.

In the absence of a substantive, comparable methodology, the ESG movement – as it is currently defined – has the potential to seed confusion, creating a ‘corporate saint’ intended to address how companies are governed, what imprint they leave on the society and how they treat the environment.

While these might indeed be mutually reinforcing, they need not be and, in many cases, they are not. One can easily imagine a corporation which, while having a board of directors dominated by insiders, deeply cares about the community it operates in.

And while institutional players have wholeheartedly jumped on the bandwagon

12 Ethical Boardroom | Spring 2019

What investors want and what they get from environmental, social and governance data Alissa Amico

Managing Director, GOVERN of ESG investing, questions ought to be asked about the implications of their enthusiasm on the investing public and on the corporate world. Th is is especially critical following a significant shift of ownership in public equity markets from retail to institutional actors, today estimated to control more than 50 per cent of total investments in developed markets. It is no wonder that following the financial crisis, a soul-searching regarding institutional investor responsibilities as stewards has been underway.

International governance guidelines, such as the OECD Principles of Corporate Governance, have been revised to encompass

In the absence of a substantive, comparable methodology, the ESG movement has the potential to seed confusion, creating a ‘corporate saint’ intended to address how companies are governed investor responsibilities and conflicts of interests. The UN Principles for Responsible Investment (UNPRI), arguably the most famous stewardship standard, have on several occasions been criticised for not having tangible impact on investor behaviour, creating a pop culture of enthused signatories.

The same scepticism has met national stewardship codes, such as the UK code, until it grew some teeth, categorising investors according to the level of their adherence.

Th is transition of stewardship responsibilities to institutional investors has

resulted in their gradual creeping and trespassing in the domain of government policy and also of corporate enforcement. As such, institutional investors have become not only the new kid, but also the new cop on the block, policing governance and ethics of the largest corporations. Th is represents an arguably dangerous shift of decision-making powers from elected governments to unelected investors, who now control the savings of entire countries.

Th is shift may be acceptable in Norway where these are administered by a sovereign actor whose motivations are not purely financial. As a government investment vehicle, Norges – Norway’s central bank – has been able to make bold decisions, divesting from coal and tobacco companies at a financial loss to its portfolio. In recent months, this has generated a vigorous internal debate in Norway and within the leadership of the fund about its performance and governance.

The same bold actions by private institutional asset owners, who are judged by purely financial metrics, can less conceivably be envisioned. Indeed, they would be difficult to justify, given that many institutional investors have a fiduciary duty to protect the savings entrusted to them.

Nor are senior executives leading these investors incentivised to be tree hugging, child labour-protecting folk. The focus of executive remuneration schemes in the financial services sector has in past years shifted to avoiding financial short-termism, not – or, at least, not yet – to ESG metrics.

Under the guise of better stewardship, the gradual devolvement of responsibility from governments to institutional investors has been in turn mirrored by a corresponding delegation of institutional investor responsibilities to corporate boards.

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