The new normal - Investors demand more ESG disclosures

Sustainability has come a long way since its infancy. It was once thought of as a buzzword or simply “nice to have”, often represented by an underfunded, volunteer-organized committee. Now, ESG (Environmental, Social, Governance) considerations are growing into a focal point for companies and their employees, clients, and increasingly, investors.

In fact, ESG disclosure is becoming universally important. In a survey¹ by Ernst & Young, 91% of institutional investors consider nonfinancial performance core to their investment decision making process over the past year.

An ESG growth spurt

The last few years have seen a massive spike in the adoption of ESG disclosure and sustainability reporting by both private capital and public equity funds. This is well demonstrated in Canada, where 2017 to 2019 saw an almost 50% increase in responsible investment assets under management, according to a report by Canada’s Responsible Investment Association (RIA).

More stringent ESG regulations are becoming more common in Europe as well. Earlier this year, the European Union published two new benchmark standards targeted towards decarbonization²: the EU Climate Transition (CTB) and the EU Paris-aligned Benchmarks (PAB). Many experts believe that increasing regulation and public demand for stewardship will lead to an increase in sustainable investment. An effective corporate governance policy is crucial to staying on top of these standards.

ESG in action in 2020

The timing couldn’t be more appropriate. E, S, and G factors are inextricably linked. In recent years, we’ve seen several examples of environmental, social, and governance complications, issues, and risks threaten the stability of governments and businesses alike.

According to the United Nations³, the 2010s were the warmest decade ever recorded. Major disasters like wildfires, floods, and hurricanes, directly resulting from rising global temperatures, are expected to become more severe. When Hurricane Maria slammed Puerto Rico in 2017, it crippled Baxter International’s ability to produce saline⁴, an essential resource for hospitals. This was a clear example of a lack of ESG preparedness. Companies must thoroughly evaluate their supply chains, policies, and contingency plans for when (not if) they are faced with a major challenge or disruption. The worst drought in the Middle East in 900 years saw Syria engulfed in civil war⁵, leading to devastating loss and strain on peoples and countries across the globe. Inevitably, where environmental challenges exist, social challenges follow.

In 2020, social unrest has been the norm, and companies without an effective ESG plan are falling behind. The COVID-19 pandemic has led to “minor” challenges like effective remote workplace communication, accessibility, and security, and to major challenges like layoffs, racial and gender inequalities, brand damage, and associated public accountability and boycotts. Having the right policies and strategies in place allows for resiliency and the ability for businesses to adapt and mitigate these risks.

Investors and stakeholders have started asking companies the same questions we ask our governments, such as:

• What is our level of preparedness in the event of a national or local climate emergency?
• Is there equal representation in our population in positions of power and decision making?
• Do we have flexible options for those with preexisting conditions?
• How can we improve our paid sick leave policy?

The list goes on.

Fit for success: Transparency & robustness in ESG disclosures

A core concept in exercise is the F.I.T.T. principle. In order to improve health, exercise should be done Frequently, Intensely, for a long Time, and a variety of Types. It’s an apt analogy for ESG reporting.

Investors want to see frequent reporting, with many feeling frustrated by the lack of real-time information available. Investors want to see robust and thorough information. Are companies and their assets prepared for the long run? Is there a healthy balance of leadership perspective and background that would be prepared for a unique social circumstance?

In fact, Morningstar will start integrating ESG factors into investment analysis⁶, making investment research even more robust to the average stakeholder. ESG factors are inherently a part of the long-term (and often short-term) success of any investment. At the end of the day, investors are looking to protect and grow their assets sustainably into the future.

Perhaps it would be easy to write off the rise in ESG investment as a part of a moral collective awakening. But ESG is more than just the right thing to do; it’s proving more and more to be crucial to successful investing.

In the RIA report⁷ referenced earlier, “Survey respondents reported the top four reasons for considering ESG factors are: (1) minimizing risk over time, (2) improving returns over time, (3) fulfilling fiduciary duty, and (4) fulfilling mission, purpose or values.” Poor ESG leads to poor performance. In McKinsey’s Delivering through Diversity report⁸, companies in the top quartile of diversity were 21% more likely to outperform while companies in the bottom quartile were 29% less likely to achieve above-average profitability compared to the rest of the data set.

A historic precedent

With enough pressure and demand from investors, a significant milestone passed on December 1st of this year: Nasdaq is now requiring all companies listed on Nasdaq’s stock exchange to publicly disclose transparency statistics about their board of directors. Additionally, “the rules would require most Nasdaq-listed companies to have, or explain why they do not have, at least two diverse directors, including one who self-identifies as female and one who self-identifies as either an underrepresented minority or LGBTQ+.”

Getting your company prepared for the future

A local or national crisis should not be the impetus for implementing preparedness and resiliency measures. It is better to prepare for environmental, social, and governance challenges ahead of time, instead of taking a reactionary approach and being caught off guard by unexpected events. The better prepared you can be for long-term risks, the more resilient and flexible you will be, and the easier it will be to adapt. Here are some key questions to consider as you build out your ESG strategies and policies:

Understand stakeholder expectations
Ask investors which ESG factors are important to them. Incorporate employee opinions and ideas into decisions. Often there is massive potential for improvement at the ground level. Who better to ask then the people who are there?

You can’t manage what you don’t measure
Tracking your environmental performance data will allow you to see where you can improve and show investors your attention to detail and responsibility.

Have a clear responsibilities and processes internally
Avoid ad-hoc or volunteer committees. Set clear responsibilities and resources to ESG performance.

Communicate clearly
Create open channels of communication to help investors understand your goals, strengthen your client’s perception of you, and get your employees invested.

Report in-depth & often
People don’t like what they don’t understand. Make your investors’ lives better, and thus yours, but making robust information readily accessible. Give them the information they need to put their trust in you.

Have a plan in place for all elements of ESG
Sustainability is more than just resource stewardship. Enable your team to be prepared and successful in a myriad of situations.

Even more ESG disclosure soon to be required

With the election of Joe Biden as the next president, the Securities and Exchange Commission (SEC) will see a greater focus in ESG disclosure. Companies will likely be asked to show how factors such as climate risk, corporate governance, diversity, and more will impact their bottom lines. A number of proposed climate disclosure bills will soon have the support of the incoming president, and President-Elect Biden has vowed that the U.S. will rejoin The Paris Agreement⁹ on his first day in office. Following that, expect to see more pressure on ESG disclosures and measures from Washington.

ESG materiality assessments

With investors inquiring more and more frequently about what your company is doing in regard to responsible investment, how you treat employees and vendors, your dedication to sustainability initiatives, and other activities that fall under the ESG umbrella, it’s important to have answers to these questions.

An ESG materiality assessment empowers you to easily report on your current state and outline future initiatives while taking into consideration your business goals and risks. Download our guide to creating and extracting the maximum strategic value from an ESG materiality assessment.

Download guide

References:
¹ https://www.ey.com/en_gl/news/2020/07/esg-disclosures-take-center-stage-as-investors-raise-stakes-to-assess-company-performance
² https://www.etfexpress.com/2020/11/27/292798/esg-investing-no-longer-exception-rule
³ https://www.un.org/sustainabledevelopment/climate-change/
⁴ https://www.bloomberg.com/news/articles/2020-07-16/hurricane-season-could-threaten-saline-solution-production
⁵ https://weather.com/forecast-change/news/2019-06-04-how-the-middle-east-drought-and-flood-cycle-will-probably-lead-to
⁶ https://www.triplepundit.com/story/2020/morningstar-esg-factors/708756
⁷ https://www.riacanada.ca/research/2020-canadian-ri-trends-report/
⁸ https://www.mckinsey.com/~/media/McKinsey/Business%20Functions/Organization/Our%20Insights/Delivering%20through%20diversity/Delivering-through-diversity_full-report.ashx
⁹ https://unfccc.int/process-and-meetings/the-paris-agreement/the-paris-agreement

Helee Lev

Helee joined our team in 2012, overseeing strategic account management, new business, and industry alliances. In 2015, she participated in raising $5M of venture capital funding. She leads sales, business development, and Conservice ESG's strategic consulting group.

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