Anthony Carey Partner - Head of Board Practice - London
Mazars, with the Institute of Directors, hosted a panel event for investors (including proxy advisers), companies, and influencers to discuss the challenges around effective engagement and how each group could contribute to the long term sustainable success of companies for the benefit of stakeholders.
With Climate Week in the background, the focus of the participants was very much on sustainability with questions such as what motivates investors, how closely does rhetoric match action, and to what extent are investors willing to accept short or long term costs in choosing to invest sustainably?
An informal survey of attendees revealed that macro issues such as executive remuneration and inequality, as well as climate change, affect the day to day decisions investors make. At a practitioner level, data is a major focus area: both its quality and availability and this encompasses its consistency and potential for reliable comparison. Shifting sustainability from a box-ticking exercise- and with each key investor having a separate survey to be filled in- to a consistent cultural approach was highlighted as a priority, if embedding behaviours and fully embracing meaningful change were to be to the fore.
From company owners to prominent thought leaders to major investors, there were two themes commonly identified as keys to unlocking the next stage of success in sustainable investing. These were genuine and consistent engagement, and a fresh approach to measurement and reporting.
The reporting debate is underscored by one uncomfortable truth: there’s no consensus on what sustainability actually is. Accentuated by the lack standardised guidelines for reporting on ESG and the use of sustainability as a marketing tool rather than fully embedding it into the business mode, companies produce extensive reports which are of little value to decision makers.
With annual reports sometimes stretching to 400 pages, alongside a string of other specific reports including sustainability, gender pay gap, carbon emissions reporting and so on, the level of disclosure can be overwhelming. Furthermore reporting on ESG is often criticised for accentuating the positive rather than providing a balanced review, by including individual good news stories rather than a review of performance across the business.
Nonetheless, investors do need access to the insights locked away in this tidal wave of disclosure: a reporting approach which acknowledges the end user and offers information in a practical and digestible way would be an asset in advancing engagement. One of the challenges is that the education of fund managers has traditionally led them to have a very strong orientation towards expected future cash flows. A more systematic approach to valuing the impacts in the area of ESG is therefore likely to lead to a recognition of its importance by them and close the gap that often exists between fund managers and heads of corporate governance at investment houses on the necessary focus on these issues.
When it comes to the auditors, it was agreed that they also have a role to play in this debate, most notably in considering the scale and scope of the factors they report on. This isn’t done in isolation: as a profession, reporting standards should be under the microscope, driven by the question; “are these fit for purpose?”. There is a strong argument, articulated by those in attendance, that auditors could offer a more holistic and representative picture of a company if they were to report on a broader range of factors.
According to attendees, the underlying engagement trends are strong. Companies are starting conversations more often, and there is widespread acknowledgement that sustainability is higher up the list of priorities. However, there is consistent feedback from investors that engagement does not always go beyond filling a tick box, and this presents a challenge. The gap between rhetoric and action is real and must be bridged for meaningful change to happen.
Driving further engagement remains high on the agenda, and the panel shared various strategies for encouraging positive behavioural change in this regard. Two particular factors stood out during the discussion: the role of trustees and financial incentivisation. On the former, a growing focus on the role of trustees and increased accountability for them around governance could bring about a holistic approach to ESG. Financial incentivisation via market valuation is already clearly in evidence. Markets currently reward companies which seem to address sustainability with generous – some attendees felt potentially inflated – valuations not having full regard to likely future financial performance. Conversely, traditionally ‘unsustainable’ stocks such as those in extractive industries are ‘punished’ with depressed valuations. These trends are very likely to drive behaviour and sustainable practices.
The roundtable suggested that engagement with companies differs depending on the nature of the investor and the needs of their stakeholders. The sheer volume of companies making up the portfolios of index linked funds make it impractical for managers to engage extensively. This raises the questions around the motivations and expectations for engagement by passive investors; Is the current engagement approach – which is in many cases a combination of internal and external research – sufficient to support the fulfilment of voting rights? And would further engagement impact fees to a point where these funds become unattractive to stakeholders.
On the other hand the view around the table was that activist investors act as good sounding boards and actively challenge boards. This raises the issue of whether passive and active funds should be expected to have the same levels of engagement, given the likely different interests of those investing in them. .On the other hand, is it fair that much of the engagement is coming from activist shareholders and will it be enough to collectively meet the needs of wider society?
Reframing the debate would be helpful – some investors in attendance felt that this would start by acknowledging that on a short-term horizon, ESG or sustainable investing is likely to generate lower levels of returns in the short term. This poses a challenge for companies and investors who are judged, above all else, on generating returns. Put starkly, one attendee noted that: “the sustainability crusade is detached from economic reality”. This tension could be resolved by refocusing on longer term horizons. Sustainability factors have a profound and transformative effect on societies and the companies that operate within them, and will inevitably impact the performance of investment over the long term. The identification of methods of reflecting these longer term impacts in investment strategies will be critical.
It was in this context that participants discussed the need to collectively put some thinking and effort into addressing the issues which a transition period may pose to the economy and society as sustainability becomes embedded. This will impact different companies to a different extent but will broadly translate into higher costs, lower returns and a fundamental change in culture and thinking of our society. All of which are unavoidable as we move towards a more sustainable future but which potentially create a conflict between immediate individual needs and the wider good.
Alongside an engaging and far-reaching conversation on the current state of play, participants were keen to share their views on where we go from here: aspirations and opportunities presented by the ongoing advancement of the sustainability agenda.
Culture leads to behaviour, which leads to long term results. Participants felt that articulating the terms and objectives of sustainable investing in a clear, direct and consistent way is one of the keys to greater understanding and adoption.
It is clear that there are no easy answers or quick fixes. Attendees drew comparison with separate but related corporate debates, such as the ‘accountability dream’ whereby executive behaviour should be constrained by remuneration, yet this has not been effective in practice. Similarly with the sustainability agenda, a ‘silver bullet’ does not exist. Consistent, direct and practical engagement undoubtedly contributes to long term behaviour change but sustainable growth at a global level calls for a fresh-thinking approach.
With the focus of sustainability on people, planet and profitability, it is clear that meeting the requirements of the current generation as well as facilitating the future for the upcoming ones is a must and calls for going beyond purely financial conversations, towards a concept of alternatives such as “Triple Bottom Line” which contemplate the development of the social and environmental value of a business.
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