An impassioned debate about environmental, social, and governance (ESG) issues took center stage last week, when the Department of Labor downgraded the economic relevance of ESG investments—just as companies and investors gathered at an event to discuss their importance.

On April 23, the U.S. Department of Labor published new guidance cautioning financial managers that investments based on ESG factors may not always be a “prudent choice.” Specifically, the Labor Department said, fiduciaries of private-sector employee benefit plans covered by the Employee Retirement Income Security Act (ERISA) “must not too readily treat ESG factors as economically relevant to the particular investment choices at issue when making a decision.”

“Rather, ERISA fiduciaries must always put first the economic interests of the plan in providing retirement benefits,” the guidance stated.  “A fiduciary’s evaluation of the economics of an investment should be focused on financial factors that have a material effect on the return and risk of an investment.” The Trump administration guidance is distinct from the Obama administration, which encouraged plan fiduciaries to consider ESG factors in their investment decisions.

For many investors and forward-thinking companies that see ESG risk and opportunities as being material to long-term financial performance, the guidance doesn’t make sense. “I think it’s concerning and confusing,” said Jamie Martin, executive director in Morgan Stanley’s Global Sustainable Finance group, speaking on a panel last week at Ceres Conference 2018 in Boston.

The literal bottom line for companies is that global sustainability challenges—like climate change, the growing scarcity of natural resources, poverty, human rights abuses, and more—are factors that affect economies and, thus, are material issues that companies must think about. For companies that depend heavily on natural resources, for example, it’s difficult to understand how looking at the utilization of resources is not relevant to the long-term success of the business.

“Environmental, social, governance factors drive the long-term success of businesses,” said David Blood, co-founder and senior partner of Generation Investment Management, an asset management firm with more than $18 billion under management. “I’m disappointed that the administration has taken a different point of view.”

Many in the United States still question whether ESG practices are a business initiative, or a political one.  “We have to keep going back to the business case why this is relevant,” Blood added.

“Environmental, social, governance factors drive the long-term success of businesses. I’m disappointed that the administration has taken a different point of view.”
David Blood, Senior Partner, Generation Investment Management

Moreover, sustainability investing is on the rise. In 2017, more than $8 trillion under management in the United States was screened by investment firms using ESG criteria, a number that has grown by 33 percent since 2014, according to the U.S. Sustainable Investing Forum.

In response, an increasing number of companies are keeping investors apprised of their sustainability efforts. According to a recent report conducted by non-profit sustainability organization Ceres, 43 percent of the close-to 600 companies that were analyzed proactively inform investors about their sustainability efforts.

Companies’ level of engagement varies by sector. Industrial companies, for example, engage investors on both sustainable business risks and opportunities. Sixteen companies in the industrial sector indicated they “present sustainability as a business driver for product innovation, driving investment in new technologies that reduce greenhouse gas emissions and energy and water use,” the Ceres report stated.

The Ceres report also found that investor activism is driving changes in the oil and gas sector. In this sector, 23 oil and gas companies disclosed sustainability information in their annual financial filings, and 52 percent informed investors about their sustainability efforts.

Investment giant factoring in ESG

In January 2018, BlackRock CEO Larry Fink, whose firm manages $6.2 trillion in assets, issued an open letter to the CEOs of all publicly traded companies, in which he warned that BlackRock will be asking officers and directors some tough questions around how they integrate ESG principles into their long-term strategy and management.

“I want to reiterate our request, outlined in past letters, that you publicly articulate your company’s strategic framework for long-term value creation and explicitly affirm that it has been reviewed by your board of directors,” Fink wrote. “This demonstrates to investors that your board is engaged with the strategic direction of the company. When we meet with directors, we also expect them to describe the board process for overseeing your strategy.”

Would you take into account a company's environmental, social, and governance policies before investing in that organization? Or are ESG initiatives immaterial to your investment choices?

— Compliance Week (@complianceweek) April 30, 2018

 “A company’s ability to manage environmental, social, and governance matters demonstrates the leadership and good governance that is so essential to sustainable growth, which is why we are increasingly integrating these issues into our investment process,” Fink added. To further emphasize its commitment to this approach, BlackRock in March released its first set of questions it will ask senior management and board members concerning human capital management.  


Below are examples of a few companies that actively engage their investor base, and how they do it.
Intel relies on consistent investor engagement to guide its strategic priorities. To reach a broad range of investors, companies should share their sustainability messages across a diverse group of engagement forums. In the opening statement to shareholders at Intel’s 2017 Annual General Meeting, the company explained to investors how it integrates sustainability into strategies, management systems and goals across its supply chain. Throughout the year, Intel holds additional investor engagement sessions across the country to capture feedback on corporate responsibility practices. Intel’s outreach team—a collaborative effort of the corporate responsibility, investor relations, and corporate governance teams—gathers feedback from leading ESG research firms and socially responsible investors on reporting practices and topical issues of concern. Intel’s annual SEC filings describe how the company incorporates this investor feedback into its actions and plans.
Jacobs Engineering engages investors on its plans to tackle water scarcity in the United States. The rapid growth of Ceres’ Investor Water Hub, which now includes more than 140 investors representing $20 trillion in assets under management, demonstrates increasing interest in the critical issue of water scarcity. At its 2016 Investor Day presentation, architecture firm Jacobs Engineering identified water as a high-growth area for its business practices due to increasing water scarcity and the United States’ aging water infrastructure. In 2017, Jacobs Engineering announced it was acquiring CH2M, an engineering consultancy with expertise in water infrastructure, nuclear energy and environmental remediation. Jacobs’ presentation to investors highlighted CH2M’s leadership in wastewater treatment and desalination, which will help Jacobs grow its water services business, creating new opportunities in building smart urban infrastructure.
Jones Lang LaSalle’s investor engagement leads to increased CEO involvement and oversight for sustainability. Sustainable business leaders are defined by the strength of their management systems. Through its efforts to engage investors, JLL found that many of its shareholders were concerned about environmental sustainability issues, such as energy use and GHG emissions, as well as corporate sustainability innovation and thought leadership. This additional input, including feedback from clients and other stakeholders, helped lead the company to establish CEO and other executive oversight of the company’s sustainability program. According to Jones Lang LaSalle, “embedding sustainability into its operations improves its investment returns to its investors and also helps attract sophisticated investors to LaSalle’s investment platforms.
Source: Ceres

 A recent client alert by law firm Womble Bond Dickinson highlights the magnitude of Fink’s letter: “These actions are virtually ‘quasi-regulatory’ in nature, since BlackRock’s assets under management (at $6.2 trillion) are larger than the GDP of many nations. In fact, if BlackRock were a country and its assets under management were the country’s GDP, BlackRock would be the third largest economy on the planet—and that’s a trading partner that is too large to be ignored.”

Compliance risk

From a regulatory and compliance standpoint, the United States is not on the same page as other countries. France, for example, in 2015 became the first country to mandate climate change-related reporting for institutional investors. Article 173 of France’s “Energy Transition for Green Growth Act” requires that French asset management firms and institutional investors disclose information on how they incorporate ESG—and particularly climate-related—criteria into their investment portfolios.

In the United States, investors and companies are collaborating to drive similar efforts. In June 2017, the Task Force on Climate-related Financial Disclosures (TCFD)—founded by former New York City Mayor Michael Bloomberg and established by the Financial Stability Board—developed voluntary recommendations on climate-related financial disclosures.

The Task Force structured its recommendations around four key themes: governance, strategy, risk management, and metrics and targets. The four overarching recommendations are supported by recommended disclosures that build out the framework with information that will help investors and others understand how reporting organizations assess climate-related risks and opportunities.

Since the recommendations were published, more than 237 companies with a combined market capitalization of over $6.3 trillion have publicly committed to support the TCFD. These companies represent a variety of industries—construction, consumer goods, energy, metals and mining, and transportation—across 29 countries. All of this is to demonstrate that there is a growing global push toward—not away from—more transparency around the quantity, quality, and availability of ESG-related disclosures.

Blood, who served as a member of the TCFD, said that in thinking about financial disclosures, it’s more than just disclosing raw carbon statistics and the company’s carbon footprint. Rather, it’s how the company thinks about risk and opportunity and how that permeates through the company—starting with the board, how those efforts are supported by senior leadership, and how it’s translated into business strategy.

For other companies interested in implementing its recommendations, the TCFD announced plans to launch a Web-based platform, the “TCFD Knowledge Hub,” which will provide tools and other implementation resources, as well as references and links to other climate-related disclosure frameworks that have incorporated the TCFD recommendations.