Tracing the chain of influence in ethical investing

Insti­tu­tion­al share­hold­ers invest­ing in accor­dance with envi­ron­men­tal, social and gov­er­nance (ESG) prin­ci­ples have shown that they can rad­i­cal­ly influ­ence cor­po­rate behav­iour, hav­ing achieved some notable suc­cess­es this year. Oil majors Chevron and Exxon­Mo­bil have both lost bat­tles with share­hold­ers over their cli­mate strate­gies, for instance. In the latter’s case, an activist hedge fund even man­aged to oust two recal­ci­trant board mem­bers.

But such head­line-grab­bing tri­umphs have been rare so far. Cam­paign­ers know that many more such actions are need­ed for the bur­geon­ing ESG move­ment to make a last­ing dif­fer­ence. They are there­fore ramp­ing up the pres­sure on all parts of the invest­ment ecosys­tem to encour­age com­pa­nies to adopt sus­tain­able busi­ness prac­tices.

In the­o­ry, each time some­one puts mon­ey into an ESG invest­ment, it starts a chain reac­tion. A retail investor with con­cerns about cli­mate change and oth­er eth­i­cal issues rais­es these with an inter­me­di­ary such as a finan­cial advis­er or wealth man­ag­er. The inter­me­di­aries adjust their port­fo­lio goals to reflect their client’s views, then select fund man­agers whose ESG invest­ment prac­tices best align with them. Some­times, their prac­tices entail screen­ing out com­pa­nies with unsus­tain­able busi­ness mod­els, such as oil extrac­tion. But, increas­ing­ly, they involve engag­ing with such firms in a bid to change their behav­iour. 

James Alexan­der is CEO of the UK Sus­tain­able Invest­ment and Finance Asso­ci­a­tion (UKSIF), a body rep­re­sent­ing fund man­agers and oth­er invest­ment organ­i­sa­tions. He explains this approach by argu­ing that “you can’t divest your way to sus­tain­abil­i­ty. That would sim­ply mean that you’ve sold those shares to some­one who cares less than you. That’s why stew­ard­ship, also known as engage­ment, is cru­cial for our mem­bers. They will vote at AGMs and work with com­pa­nies to push towards sus­tain­abil­i­ty.”

Busi­ness­es ought to respond to investors’ con­cerns by coop­er­at­ing with such engage­ment, Alexan­der adds. They should, for instance, set ESG per­for­mance tar­gets, report on their progress towards these and enable share­hold­ers to vote on issues con­cern­ing cli­mate change. Recent research by FTI Con­sult­ing indi­cates that this type of stew­ard­ship is effec­tive, giv­en that most of the world’s largest investors have adopt­ed cli­mate-relat­ed vot­ing guide­lines. This has per­suad­ed more com­pa­nies to give share­hold­ers a “say on cli­mate” – and many oth­ers will fol­low, FTI pre­dicts.

The Chevron and Exxon­Mo­bil sto­ries made a splash because of the con­flict they involved, but many equal­ly effec­tive inter­ven­tions by ESG activists attract less media cov­er­age because the boards of the com­pa­nies involved don’t oppose them. Under pres­sure from a £140bn share­hold­er coali­tion in May, Tesco pledged to stock more health­i­er foods and drinks, for instance, while in the same month HSBC agreed to phase out financ­ing for coal-based indus­tries after lob­by­ing from a £1.74tn investor group.

Therese Niklas­son, glob­al head of sus­tain­abil­i­ty at fund man­age­ment firm Nine­ty One, notes that pres­sure groups often start ESG invest­ment trends by engag­ing with asset man­agers. Organ­i­sa­tions such as the UKSIF and the UN-backed Prin­ci­ples for Respon­si­ble Invest­ment (PRI) net­work then become plat­forms for fur­ther work on these issues. 

The recent trend for invest­ing in bio­di­ver­si­ty, for instance, came from sev­er­al sources, includ­ing research by envi­ron­men­tal sci­en­tists, econ­o­mists and the PRI. This devel­oped quick­ly into a report­ing frame­work pro­posed by the new Task­force on Nature-Relat­ed Finan­cial Dis­clo­sures – a con­sor­tium of finan­cial insti­tu­tions, com­pa­nies, gov­ern­ments, reg­u­la­tors and NGOs. The fast devel­op­ment of this ini­tia­tive illus­trates how the ESG invest­ment infra­struc­ture has devel­oped to accom­mo­date new ideas.

Louisiana Salge, senior sus­tain­abil­i­ty spe­cial­ist at wealth man­age­ment firm EQ Investors, says that influ­enc­ing com­pa­nies to improve their prac­tices can be dif­fi­cult. One of the most effec­tive ways for fund man­agers to encour­age them to change is to form part­ner­ships with aca­d­e­mics and respect­ed think-tanks.

“Say you want to start a bio­di­ver­si­ty fund,” she says. “All of the best prac­tice is ground­ed in acad­e­mia, because investors want to act on research. Your job is then to ensure that every­one you work with inte­grates that prac­tice. Asset man­agers are impor­tant here, because they have the resources to engage with investee com­pa­nies.”

But the engage­ment efforts of most insti­tu­tion­al investors have gen­er­al­ly been “ter­ri­ble”, accord­ing to Share­Ac­tion, a char­i­ty pro­mot­ing respon­si­ble invest­ment. This is because most of them don’t file res­o­lu­tions, vote against boards, set dead­lines for com­pa­nies to take reme­di­al action or react when tar­gets are missed, it says. ShareAction’s research indi­cates that, while some asset man­agers are show­ing lead­er­ship in the ESG field, man­agers respon­si­ble for £26tn in invest­ment funds are still turn­ing a blind eye to the eco­log­i­cal dam­age caused by their investees.

Giv­en that many fund man­agers in the lat­ter cat­e­go­ry are mem­bers of both the PRI and Cli­mate Action 100+, an investor coali­tion aim­ing to ensure that the largest cor­po­rate CO2 emit­ters take effec­tive reme­di­al action, this is a real con­cern for Share­Ac­tion. It believes that a large num­ber aren’t walk­ing their talk on ESG. 

“It’s hard to tell what actions some Cli­mate Action 100+ par­tic­i­pants are tak­ing to advance its goals,” says ShareAction’s cam­paigns man­ag­er, Michael Kind. “We don’t just want a list of col­lab­o­ra­tive involve­ments; we want evi­dence of real out­comes.”

Kind would urge oth­er mem­bers of the invest­ment ecosys­tem, such as con­sul­tants and even retail investors, to demand high­er stan­dards of respon­si­ble invest­ment from fund man­age­ment firms.

“This has start­ed, with more asset man­agers build­ing their ESG stew­ard­ship teams and dis­clo­sure prac­tices,” he says. “It shows that the qual­i­ty of stew­ard­ship is becom­ing a busi­ness issue for them. But there is a long way to go.”

Fiona Reynolds, man­ag­ing direc­tor of the PRI, offers the fol­low­ing response: “We are a big-tent organ­i­sa­tion. Respon­si­ble invest­ment prac­tices are at var­i­ous stages around the world. So too are our mem­bers. We are not respon­si­ble for indi­vid­ual invest­ments in our 4,300 plus sig­na­to­ries’ port­fo­lios. Investors must mon­i­tor this.”

For its part, Cli­mate Action 100+ acknowl­edges that “there is more to be done on com­pa­nies align­ing cap­i­tal expen­di­ture with the goals of the UN’s Paris agree­ment on cli­mate change. We remain com­mit­ted to work­ing with investor sig­na­to­ries to secure these com­mit­ments from com­pa­nies.”

One key chal­lenge that its mem­bers face in achiev­ing their goals is a lack of resources. ESG invest­ing is com­plex – and all the big fund man­agers are strug­gling to recruit enough researchers and ana­lysts from a rel­a­tive­ly small tal­ent pool. 

Anoth­er prob­lem is a lack of stan­dard­i­s­a­tion in cor­po­rate ESG report­ing. “As dis­clo­sure frame­works become more stan­dard­ised, the sit­u­a­tion will improve,” Salge pre­dicts. “For exam­ple, request­ing exact­ly the same car­bon data report­ing has led to real impacts.”

If the invest­ment ecosys­tem can over­come such bar­ri­ers, it can strength­en its influ­ence, bring­ing more cor­po­rate prac­tices in line with share­hold­ers’ views.