From company owners to prominent thought leaders to significant investors, two themes are 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.
One uncomfortable truth underscores the reporting debate: no consensus on sustainability exists. Accentuated by the lack of standardised guidelines for reporting on ESG and using sustainability as a marketing tool rather than fully embedding it into the business mode, companies produce extensive reports 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 performance review across the business.
Nonetheless, investors need access to the insights locked away in this tidal wave of disclosure: a reporting approach that 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 solid orientation towards expected future cash flows. Therefore, a more systematic approach to valuing the impacts in the area of ESG will likely lead to a recognition of its importance and close the gap between fund managers and heads of corporate governance at investment houses on the necessary focus on these issues.
It was agreed that the auditors 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, consistent feedback from investors shows that engagement does not always go beyond filling a tick box, which presents a challenge. The gap between rhetoric and action is real and must be bridged for meaningful change to happen.
Driving further engagement remains on the agenda, and the panel shared various strategies for encouraging positive behavioural change. 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 evident. Markets currently reward companies that address sustainability generously – some attendees felt potentially inflated – valuations that do not have full regard for 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 index-linked fund portfolios makes it impractical for managers to engage extensively. This raises questions about the motivations and expectations for engagement by passive investors. Is the current engagement approach—which is often a combination of internal and external research—sufficient to support the fulfilment of voting rights? Further engagement would 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 comes from activist shareholders, and will it be enough to meet the needs of the 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 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 investment performance over the long term. Identifying methods of reflecting these longer-term impacts in investment strategies will be critical.
In this context, participants discussed the need to collectively think and work on addressing the issues that 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 our society’s culture and thinking. These are unavoidable as we move towards a more sustainable future, but they potentially create a conflict between immediate individual needs and the broader 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 clearly, directly, and consistently is one key to greater understanding and adoption.
There are no easy answers or quick fixes. Attendees drew comparisons 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, a ‘silver bullet’ does not exist with the sustainability agenda. 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 on sustainability on people, the planet, and profitability, it is clear that meeting the current generation’s requirements and facilitating the future for the upcoming ones is a must. This calls for going beyond purely financial conversations and towards alternatives such as “Triple Bottom Line,” which contemplates developing a business’s social and environmental value.
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