The message from investors on environmental, social and governance (ESG) disclosure is clear and unambiguous, Sally J Curley, CEO, Curley Global IR, writes. Treating this as a public relations exercise and producing a ‘fluff’ CSR report raises red flags for investors.

There is no shortage of increasing evidence demonstrating the link between returns on investment and companies’ ESG efforts. The Harvard Law School Forum, the Forum for Sustainable and Responsible Investment, numerous accounting firms and other organisations have published data showing the increasing number of assets under management that are ESG-focused, or use ESG screens to identify investments. Research conducted by Curley Global IR, LLC (CGIR) adds to this data and provides – perhaps for the first time – an internal peek into the ESG-related resource allocation process. From December 2017 through March 2018, CGIR spoke with portfolio managers involved in sustainable and responsible investment (SRI) decisions and/or their corporate governance counterparts. Because of strong relationships, robust conversations occurred with most. Where appropriate, CGIR expanded the dataset by incorporating public statements into its research. Twenty-four asset management firms are included in the dataset; 14 investors were interviewed and the remainder of the information was derived from press interviews and/or directly from public statements, most from company websites. More than US$17 trillion in assets under management are represented by these 24 firms. CGIR asked questions of research participants that focused on trends, internal resource commitment, engagement approach and use of third-party data sources. The goal was to identify whether the use of ESG factors in investing had risen and, if so, had internal resource commitments increased accordingly. Other research goals centred on determining how public companies were handling any increase in requests, and what trends are emerging in definitions, content and clarity.

The survey findings

What emerged from the data were five key, and we believe new, insights.

1. There is no single definition of sustainability.
2. Asset management firms are heavily investing in, and/or creating, SRI vehicles.
3. There is a significant need for companies to outline what they believe is most material to disclosure; however, several participants mentioned a fear of overregulation in the US from the Securities and Exchange Commission (SEC).
4. Investor relations is clearly the first point of contact for these investors and, in many instances, is the preferred point of contact based on existing relationships.
5. There is an intense desire for clarity and consistency in measuring metrics and defining terms.

We’ve delved deeper into each insight, starting with definitions.

1. Defining sustainability

There were nearly as many specific definitions of sustainability as there were participants in the survey. However, one key thread ran through each commentary: sustainability wasn’t solely a focus on environmental aspects, but rather what factors would affect the long-term, sustainable performance of an organisation. Similarly, while there was consistency on ESG being ‘environmental, social, governance’, some participants used this as an adjective and some as a noun. As one research participant indicated: ‘We believe we were the first firm to use the term sustainability, as opposed to ESG. Our view of sustainability is how the company sustains its business model and cash flows into the foreseeable future for the long term.’ In other conversations, ESG was viewed as those factors used to generate SRI. The impact of social media, and the pressure on investment firms to now provide an ESG/SRI product in order to differentiate themselves for millennial and baby boomer investors, has only enhanced the variety of definitions. CGIR did find that the concepts were close enough in context to be viewed as a trend.

2. Expanding investment in ESG

Our second finding is that asset management firms are investing heavily in ESG. CGIR’s data shows a significant commitment of human and financial resources related to ESG, and deciphering materiality as it relates to the asset manager’s investments. The collective focus of the institution, particularly as stewards of their clients’ capital, is perhaps the biggest sign that ESG investing is here to stay. Nearly all asset managers continued to heavily emphasise ESG when investing and/or have significantly increased SRI-focused internal resources. Some created a new position – Head of Sustainable Investing or a similar role – within the past 12 months. Nearly all asset managers use some form of screening, positive or negative, when assessing investments. ‘We have a large sophisticated group that’s been staffed up … ESG is very important to us,’ commented one respondent. A few asset managers rolled out ESG firm-wide. ‘The responsibility is carried out by all investment professionals. More of a firm-wide [policy] as opposed to a public-speaking person,’ commented another respondent. Other asset management firms have developed their own sophisticated models and screens. ‘The team has developed a proprietary ESG scoring system … to assess current and projected ESG conditions in various countries, and to facilitate macroeconomic country comparisons around the world,’ was another comment our survey received.

3. Understanding materiality

CGIR’s third finding yielded concern about overregulation in the US, but a strong need for the companies themselves to identify and disclose what ESG-related factors are most material. We use the US SEC’s definition of materiality here. An increasing call from investors for issuers to provide clear and transparent disclosure has given rise to ESG-related organisations attempting to set standards. These groups – Sustainability Accounting Standards Board (SASB), MSCI, Global Reporting Initiative (GRI), to name a few – also attempt to help create a framework of disclosure for issuers. However, because each of these organisations varies in the specifics, a lack of a consistent framework still exists. Companies face growing pressure to demonstrate to investors their compliance with certain criteria, including disclosure around diversity and inclusion, gender equality related to pay and climate change, and are left to navigate their own path, or ‘pick one’ reporting framework. All of this stems from the asset manager’s need to identify and minimise risk for their constituents – the asset owners. However, this increased pressure on issuers to disclose ESG-related ‘material’ items, without a consistent framework or guideline, has created an open field for ESG. As one Head of Sustainable Investing said in CGIR’s research: ‘There are two things that [go] hand in hand. [First], the quality of disclosure by issuers of ESG performance data. As you know, all other financial reporting data is codified under regulations. But on the ESG side it’s unstructured and unregulated data, and to get the quality data out of issuers is the biggest piece of that. And [secondly] closely related … is issuers trying to understand which of these performance factors companies should focus on.’ Another asset manager made a point to say: ‘The Sarbanes-Oxley Act stuff is overdone … Generally speaking, what I hate about governance is that it’s so rules-based as opposed to principles-based.’

4. The role of investor relations

With respect to CGIR’s fourth finding, the Investor Relations Officer (IRO) plays a significant role as, at a minimum, a first point of contact for ESG-related questions. This stems from the IRO’s existing relationship with portfolio managers, as well as their relationships with most heads of corporate governance. Interestingly, several firms specifically mentioned that they did not wish to speak with a Chief Sustainability Officer (CSO) or a Head of Corporate Communications, saying their experience had not been productive when doing so. Typically the outreach to the IRO takes one of three paths:

1. stops with the IRO if that spokesperson is savvy enough about the company’s ESG-related policies and disclosures
2. is escalated to a Head of Business or the CEO, and/or
3. is escalated to a member of the board of directors who is in the best position to address the ESG-related issue.

‘I’ve been reaching out to Investor Relations (IR) to get its assessment of ESG from a company standpoint. Each team should treat this as another component of traditional fundamental analysis, so it would be IR. Because we are [United Nations–supported Principles for Responsible Investment] signatories, one of the initiatives is to get assessment from IR teams as to how they are progressing with integrated reporting, as well as pushing SASB standards. We don’t deal with a CSO at all. I’ve never really understood what they do,’ one research participant stated. Another comment received was: ‘We typically go through IR first, but who we speak with depends on the different types of conversations. If it’s a governance issue, we will want to speak with a board member, independent director or chairman. If it’s an environmental and social risk issue, we will want a country head or someone who does product quality work. We’re happy to have people from sustainability functions, but it’s also a worry if that function sits within a marketing or communications department. These guys try to face off on all constituencies and they aren’t expert enough for investors.’ While asset managers are reaching out to IROs, IROs are also going to asset management firms to seek input regarding what is most important to disclose. This outreach seems welcome by some asset managers and somewhat troubling to others. One study participant indicated that: ‘IR teams are struggling with what is most important to disclose to investors.’

5. Establishing consistent metrics

Our fifth finding revealed an intense desire for clarity and consistency in measuring metrics and defining terms. There are numerous frameworks that exist, as mentioned earlier, however, one clear set of guidelines has not yet been adopted. So what can companies do? One of the most interesting pieces of feedback from CGIR’s survey was that issuers should take heed when publishing a ‘fluffy’ corporate social responsibility (CSR) report. In fact, a few ESG-focused asset managers specifically mentioned that when they see a report that lacks in detail, clarity and focus, they are more sceptical that the company has a real ESG framework in place to minimise risks. As one survey participant put it: ‘We glance through them [the CSR reports]. With us, a lot of time is spent pre-meeting and typically that would start with the annual report and maybe CSR reports. You learn how to skim past the fluff. You can get some insights, as well as how [the company is] presenting it. If it’s all just fluff, then it raises concerns.’ CGIR surmises that a perfect storm of factors has created the proliferation of requests and need for ESG-related disclosure. Those factors include a millennial generation (and baby boomers) seeking to invest in companies that ‘do good’; the rise of passive investments, which by some counts now comprise 60% of all assets under management, and thus the need for differentiated investment offerings that are actively managed; the proliferation of social media, which serves to ‘out’ public companies who aren’t acting as good fiduciaries; and, as a result, the enhanced risk asset managers perceive to exist and the belief that the use of ESG-related screens will help to mitigate that risk.

Quality disclosure

CGIR research shows that it is time – perhaps beyond it – for public companies to create and manage a comprehensive ESG programme, with a formal audit-controls framework and communications plan. The programme should yield data that is pertinent to its industry and the specific company, and which is reportable, repeatable and auditable. Companies take heed – the trend toward ESG investment looks to be enduring. Those issuers without a plan to adequately disclose information and address asset manager questions may find themselves – and their boards – dealing with ESG-related shareholder proposals instead. Sally J Curley is founder and CEO of Curley Global IR, LLC (https://curleyglobalir.com), an investor relations, ESG and corporate governance consultancy.