Material issues: ESG in the age of activism

December 2021  |  COVER STORY | BOARDROOOM INTELLIGENCE

Financier Worldwide Magazine

December 2021 Issue

Environmental, social and governance (ESG) is a subject increasingly on the lips of today’s corporate world – an expansive topic encompassing a range of issues, including climate change and resource scarcity, diversity and inclusion, safety issues and data security, board diversity, executive pay and tax transparency.

Moreover, engagement with ESG is an increasingly popular way for investors to evaluate companies in which they may want to invest, thus pushing ESG issues as a business imperative and a core component of companies’ policies and strategies.

In its ‘2021 Consumer Intelligence Series survey on ESG’ global report, which polled consumers, employees and business leaders about their expectations surrounding key ESG issues, PwC found that 83 percent of consumers think companies should be actively shaping ESG best practices, 86 percent of employees prefer to support or work for companies that care about the same issues they do, and 91 percent of business leaders believe their company has a responsibility to act on ESG issues.

The PwC report also notes that 57 percent of consumers said companies should be doing more to advance environmental issues, such as climate change and water stress, 48 percent want companies to show more progress on social issues, such as diversity & inclusion and data security and privacy, and 54 percent expect more from companies on governance issues, including complying with laws and regulations and addressing widening pay gaps.

In the US, the focus on ESG issues has been given a major shot in the arm by the Biden administration’s plans to address climate change. This includes a move by the Securities and Exchange Commission (SEC) to make it mandatory for public companies to disclose their greenhouse gas (GHG) emissions and impact on climate change in their annual 10-K filings.

“Such disclosures have been advocated by the private equity (PE) and financial sectors over the past several years,” says David South, senior principal and sustainability team lead at West Monroe. “Without it, they believe their investments are at risk due to the cost of climate change mitigation and the cost impact from climate change, such as increased storm frequency and severity, disrupted business operations and supply chains.”

Given this heightened focus on ESG, it is no surprise that both shareholder activists and activists from campaigning NGOs are increasingly targeting companies they contend have not met ESG standards. “Today, we are seeing more activist engagement in more detail on a wider variety of issues,” observes Peter Swabey, policy & research director at The Chartered Governance Institute UK & Ireland (CGIUKI). “In many cases, activists will be very well informed on their particular issue and companies need to ensure that they have the relevant information prepared and at their fingertips.”

Also on the radar for activists are social and green investments, such as green bonds and renewable energy projects. “Funds are being redirected to companies that have good ESG values as a business, including looking at the sustainability of the products and services they offer their clients,” notes Umera Ali, global co-head of financial services at DWF. “Investors are also looking at all stakeholders involved in a company, not just the company itself.”

Further serving to embolden ESG activism is the devastating impact of COVID-19 over the past 18 months. “The pandemic has exposed the issue of global inequality, so one of the key trends we are seeing among activist NGOs is a greater focus on human rights as well as unequal access to healthcare,” observes Robert Blood, managing director of Sigwatch. “Activists are increasingly intertwining traditional campaigning topics, such as climate change, with issues such as indigenous rights, community impact and workplace safety.”

Curiously, however, it should be noted that despite burgeoning levels of ESG activism, many companies are yet to grasp how ESG-minded activists have become. In its 2021 ‘Activist Investing in Europe’ report, Skadden reveals that just 28 percent of corporates agreed with the suggestion that activists will increasingly prioritise ESG issues in their campaign demands. Conversely, every single activist surveyed did accede to this view, including 67 percent who agreed strongly.

Moreover, as the policy agenda continues to evolve, so too will the positions taken by activists. The mix of legislation at one end and the growth of ESG-related funds at the other means European and US activists will target these issues.

Activism defences

Fundamentally, companies need to be proactive in defining their ESG policies, strategies and roadmaps to effectively manage and mitigate ESG-related activism. According to Norton Rose Fulbright, when satisfied they have the right ESG-orientated oversight structure and composition, companies should consider setting up the following protocols.

First, identifying and categorising ESG factors is a key initial step in helping companies to discharge their duties. This enables them to map out areas that need particular attention and decisions that might require further reflection. Many of these factors will have been flagged through issuers’ legal compliance or risk management systems.

Second, once various factors have been mapped, companies should weigh them carefully and determine their impact on the organisation in a given situation, and on various stakeholders. In some instances, the motivation to prioritise certain factors will be influenced by legal requirements or the management of specific risks. Conflicts are to be expected when weighing such factors.

Third, after weighing various ESG factors and their expected impact on the corporation, companies and their directors should determine which course of action is in the corporation’s best interest.

Finally, as directors remain accountable for their decisions, and different stakeholders might have conflicting views on what is in the company’s best interests in a given situation, directors should maintain accurate and adequate records of their decision-making process.

In the experience of Charlotte Moore, head of research at Sigwatch, when companies get into difficulties with ESG activism, it is usually because they are taken unawares by new or reviving ESG risks, or they have underestimated the degree of that risk and what is expected of them to mitigate it.

To stay abreast of ESG risks, Ms Moore advises companies to: (i) appreciate how their organisation might be exposed, either directly or indirectly; (ii) engage with non-governmental organisations, think tanks, customers and suppliers to understand their concerns; (iii) monitor what their peers are doing, and likewise, what companies in other sectors that are similarly affected are doing, to learn potential mitigation strategies; and (iv) ensure they are not bereft of allies.

Boiled down, a company needs to be prepared to engage, and to do so on an informed basis. “Activists will be well prepared, and the company needs to be as well,” suggests Mr Swabey. “Also, a well-prepared activist may well know more about a particular ESG ‘hot topic’. So, a company needs to be prepared with its corporate position on the subject, and for the activist to introduce new information which will have to be absorbed quickly and addressed.

“That said, keep things in proportion,” he continues. “An activist will often be focused on their specific area of interest, while a company will need to consider the whole breadth of shareholder and stakeholder interests, and these do not always coincide. There may be occasions when the right thing to do for the company is not what the activist would wish and the importance of clear board minutes, prepared by a qualified company secretary, recording decisions and the reasons for them cannot be overstated.”

Activism in action

While ESG activism levels dipped amid the upheaval and uncertainty brought on by the COVID-19 pandemic, the fall was relatively negligible, with activists still managing to launch a number of high-profile ESG-orientated campaigns.

Perhaps the most visible and well-reported cases of effective ESG activism in recent times were those faced by US oil giants ExxonMobil and Chevron in May 2021. Both involved shareholder rebellions from climate activists and disgruntled institutional investors over the companies’ failure to set a strategy for a low-carbon future.

In the ExxonMobil case, the resolution was filed by activist hedge fund Engine No. 1 and backed by members of Climate Action 100+, an investor coalition coordinated by non-governmental organisations (NGOs) such as Ceres, Principles for Responsible Investment and Asia Investor Group on Climate Change.

Aware of the influence of this NGO-led network, Engine No.1 presented its case to Climate Action 100+ ahead of the annual general meeting to garner member support. Ultimately, Engine No. 1 successfully replaced two ExxonMobil board members with its own candidates to help drive the oil company toward a greener strategy.

In a similar fashion, fellow oil giant Chevron saw a similar rebellion over a resolution filed by Dutch campaign group Follow This to force it to cut its Scope 3 GHG emissions. The outcome saw a majority of Chevron shareholders rebel against the company’s board by voting 61 percent in favour of the activist group’s proposals.

“The success of these campaigns can be attributed to several years of ever more intensive activist targeting of the oil and gas sector, combined with vocal fossil fuel divestment campaigns designed to ‘revoke the sector’s licence to operate’,” explains Mr Blood. “As the need for action on climate change makes financial links to oil and gas majors increasingly risky, activists have been able to convince investors and shareholders of the need to act on ESG concerns.”

Ms Ali has observed several cases where companies have changed their strategies due to ESG activism. “In the UK, for example, the Lloyd’s market has committed to quitting fossil fuel insurance by 2030,” she attests. “The Financial Conduct Authority (FCA) has also provoked a change in mindset by issuing guiding principles for companies wanting to get into the ESG market. Anecdotally, a large number of companies are saying they have lost work due to ESG issues within the business, so companies need to act fast and proactively on ESG.”

Post-pandemic activism

The victory of Engine No. 1 over Exxon Mobil in the first ESG-flavoured proxy contest makes it clear that ESG activism has truly arrived and is here to stay. Indeed, ESG activism – particularly the rise of ‘E’ and ‘S’ in activist campaigns – has been building for some time and seeking an outlet.

“The principal driver of the ‘E’ part of ESG is climate change – environmental campaigners now see every issue through the prism of its contribution to emissions of greenhouse gases,” says Ms Moore. “They are also increasingly sceptical of firms’ net-zero pledges and are demanding tangible and immediate reductions.

“For the ‘S’ part, the key issue is inequality – not just within companies or countries but globally,” she continues. “The pandemic has exposed huge gaps in wealth and access to vaccines and economic precariousness often linked to factors such as ethnicity, gender and socioeconomic status. Companies will be expected to show how their activities are making this better, or worse.”

Furthermore, while the ‘G’ part of ESG is the component least influenced by campaigning groups, activists are certainly concerned about corporate accountability and regulation, as it affects the willingness of companies to respond to ‘E’ and ‘S’ issues. “The trend towards extreme personal wealth and PE ownership of very large companies is likely to heighten their concerns,” notes Ms Moore.

As a means of redress, the 26th United Nations (UN) Climate Change Conference of the Parties (COP26) in Glasgow will encourage many companies, both domestic and international, to position themselves to address ESG issues. The summit, which takes place from 31 October to 12 November 2021, is designed to accelerate action toward the goals of the Paris Agreement and the UN Framework Convention on Climate Change.

“Activist investors anticipate action to be taken at COP26 that might impact company valuations, so they are proactively realigning their board of directors and C-suite to be responsive to ESG criteria,” says Mr South. “ESG activism will be determined by the outcome at COP26 as well as the SEC order regarding mandatory disclosure by public companies of their GHG emissions. Companies are being more proactive regarding ESG, as they are feeling pressure from investors, customers, communities, NGOs and their employees.”

Whatever the long-term impact of COP26 proves to be, the future trajectory of ESG activism provides considerable food for thought. “I am unsure how far ESG activism is a function of the post-pandemic environment rather than a natural focus of the younger generation,” muses Mr Swabey. “Research has shown that younger professionals regard ESG issues as far more important than did previous generations and, importantly, are prepared to behave accordingly.

“We are consequently seeing increased pressure on companies to follow ESG good practice, whether it be from customers demanding assurance about their supply chain, investors pressing the company to operate sustainably or single-issue groups advocating their own specific agenda,” he concludes. “Companies will need to be more agile in how they respond to ESG activist activity and accept that this is the way of the future.”

© Financier Worldwide

BY

Fraser Tennant