The increasing demand for investment products that embrace ESG factors has been relentless. MSCI recently reported that assets under management in products linked to its ESG and climate indexes increased by 208% from Q4 2019 to Q4 2020. MSCI’s investor day also highlighted that total global assets with an ESG mandate are forecast to exceed US$100 trillion by the end of 2028.

Disclosure requirements for asset managers, and demand from investors, are in turn pressuring listed companies to demonstrate that they are serious about ESG performance to attract capital and retain investors. Already, we have seen the world’s largest companies on all major stock exchanges incorporate ESG requirements into executive pay (see HERE).

Australian companies already face a range of local ESG reporting guidelines from ASIC (see HERE), APRA (see HERE), the ASX Corporate Governance Council (see recommendation 7.4 HERE), ACSI (see section 5 in ACSI guidelines HERE and their report HERE) among others. Proxy advisers, too, are increasing their scrutiny of companies’ ESG performance when assessing remuneration reports for reporting to their clients.

Disclosure requirements are increasing for issuers and asset managers in the EU and US:

• The EU regulation on sustainability-related disclosures in the financial services sector, or SFDR, will take effect from 10 March 2021. The SFDR aims to protect investors by allowing them to make informed decisions about their investments. It does so by requiring organisations in the financial sector to be transparent about how they integrate sustainability risk in investment decisions. The impact of the SFDR will, however, be felt beyond the financial sector. The SFDR requires supervisory authorities to verify whether financial institutions are providing “more specific and standardized” ESG information to end-investors. In order to do so, the financial institutions will need to obtain ESG information from companies in their capacities as investors, borrowers, and issuers.
• In the US, there has already been increased scrutiny of investment funds by the Securities and Exchange Commission (SEC). If there is a mismatch between what investors are told their funds are invested in and what the funds are actually invested in, the SEC tends to bring enforcement actions – ESG investment products are no exception. The SEC’s ESG subcommittee, formed in 2020, is actively exploring if disclosure practices need to be improved. What this means is that US investors are likely to become better at seeking and requiring information from issuers on ESG matters.

Index fund providers such as BlackRock and StateStreet are also stepping up the pressure on companies to disclose more on climate and diversity (as detailed in our article last month, see HERE).

It is not only the index funds that are getting serious about ESG. Europe’s largest activist investor, Cevian Capital, released a statement on 3 March saying that it is seeking to accelerate and secure meaningful progress on ESG matters. In order to avoid piecemeal and half-hearted progress, Cevian is calling for “significant, measurable and transparent ESG targets” to be included in compensation plans for senior management in all European public companies (see HERE). To advance progress, Cevian stated that they will hold companies and directors accountable through engagement, and, if necessary,  voting on director elections and compensation plans.

What can companies do to meet these regulatory requirements and investor expectations?

In our report “2021 and Beyond: Global Executive Incentive Trends”, which can be accessed HERE, we find that companies are already demonstrating their commitment to a broader definition of value than that defined by financial results, and that a corporation needs to create real substance in three areas:

1. Strategy and culture: create a plan of action to improve on non-financial value, and foster a culture that values and drives toward such improvements.

2. Measurement and reporting: measure progress by setting clear and quantifiable goals, and then report externally on progress against those goals so constituents have robust mechanisms by which to judge the corporation and its value.

3. Incentives and other pay levers: hold the organisation and its executives accountable for achieving ESG goals, and align the interests of executives with those goals, whether it be through performance management, pay, promotions, personal recognition, or other means.

As one director in the global survey said, “It is important for the board to have a serious discussion about what are the right strategies, measures and accountabilities, and who should report back to the board on these things. The board must be engaged in determining stakeholder measures, and must align with what measures the company and investors think are important.”

We know that ASX 200 boards are actively engaged in considering how ESG factors should be prioritised, weighted, measured, disclosed and incorporated, if at all, in executive pay plans. While we know how this is being done here, and overseas, the extent and variety of application are so numerous that they defy an easy basis for summarising. However, we also know from experience that solutions are better not off the shelf, but tailored to align with value conservation, accretion and enhancement specific to each issuer. Some examples may arise in our forthcoming Forum with CGI Glass Lewis (see HERE).

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