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ESG on the Ballot

Dr Rory Sullivan, CEO of Chronos Sustainability, identifies four priority themes for asset owners in 2024.

Corporate governance, climate change, biodiversity and nature, and human rights are all still jostling for attention at the top of the ESG agenda for asset owners. With presidential or general elections scheduled in many countries (including South Africa, India, Pakistan, Indonesia, and the US) and a general election expected to be called in the UK, there are four areas where long-term investors need to pay particular attention.

Corporate governance and listing rules

Global competition to attract new IPOs, in particular in the tech sector, has led to policymakers and/or stock exchanges in several jurisdictions hosting major financial centres – including the European Union, Hong Kong, Singapore, China and the UK – altering, or considering altering, their laws or listing rules to permit applicants to adopt dual class shares. In these structures, the class with limited, if any, voting rights is normally offered to the general public. The classes with more voting rights are typically only offered to insiders such as company founders, executives and family members, allowing them to retain control of the company.

The potential loosening of requirements around the use of dual class shares raises important questions for investors concerned about the integrity and operation of capital markets. Research that Chronos Sustainability conducted in 2023 for the Investor Coalition for Equal Votes – Undermining the Shareholder Voice The Rise and Risks of Unequal Voting Rights – suggested that the potential financial advantages of dual class share companies recede over time (usually within a few years of the IPO). It also demonstrated that dual class shares structures make it more difficult for shareholders to ensure that boards are appropriately structured, to challenge capital expenditure decisions or to access robust financial and other information about the company. Furthermore, the research suggested that the growth in the prevalence of dual class share structures may mean that companies are less willing to engage with investors and that, as a consequence, investors are less willing to engage with companies.

Climate change and climate change policy

In recent years, many countries have adopted potentially transformative environmental and social policies; examples include the US Inflation Reduction Act, the European Union’s Green Deal (including its Fit for 55 package and REPowerEU), Japan’s roadmap for the transition of high-emitting sectors and China’s 1+N programme. These programmes have shown that well-designed policy can catalyse at scale private sector investment into the low carbon transition.

With asset owners likely to face increasing pressure to support the low-carbon transition, they need to ensure that public policy is structured in a way that enables them to meet their fiduciary duties to clients. What does this mean in practice? It suggests that effective climate policy frameworks should:

  • Contain clear commitments to action on climate change by governments.
  • Contain clear short-, medium- and long-term targets, underpinned by comprehensive, enforceable legal mechanisms for delivery.
  • Be comprehensive and at scale, covering all major areas of the economy, and all major carbon-intensive sectors. That is, a whole-of-government approach is needed.
  • Provide the right incentives to encourage changes in the real economy and to encourage investors to provide the capital needed to enable these changes.
  • Be socially just (i.e. enabling a just transition), ensuring that efforts to green the economy are as fair and inclusive as possible, creating decent work opportunities, and leaving no one behind.

From a macroeconomic perspective, such policy frameworks should reduce policy uncertainty, thereby minimising the likelihood that investors will look for larger incentives to invest and increasing the likelihood that they will invest sooner rather than later. If policy frameworks with these characteristics are adopted, the cost of transition should be significantly lower than it might otherwise have been.

The quality of ESG data

Investors need high-quality data if they are to set credible net zero targets, to report on progress towards these targets, to assess the effectiveness of their actions and interventions, and to assess the effectiveness of the actions taken by the entities in which they invest.

In 2023, we worked with the Principles for Responsible Investment (PRI) to analyse what investors need from climate change-related data, and the supply of data from companies and from third-party data providers. The analysis, presented in the PRI’s report, Climate Data and Net Zero: Closing the Gap on Investors’ Data Needs, recognised that improving the quality of climate data is as much a demand-side as a supply-side issue. Many of the issues identified (e.g. data gaps, difference in calculation methodologies) are a direct result of the lack of consistency in how investors define net zero and in the specific data points they ask for in order to assess company and portfolio performance.

The report also stressed that investors need to focus on the real-world impact of their actions on climate change. It cautioned that investors need to understand the respective contribution of changes in actual emissions (e.g., energy saving, changes in business activity, changes in grid electricity carbon intensity), changes in emissions accounting processes (e.g., changes to the scope of reporting), and changes resulting from the actions of other parties (e.g., changes in the energy mix of the electricity grid). Without this analysis of the factors that drive changes in reported emissions, we risk perpetuating the situation where companies and investors report reductions in their emissions but global greenhouse gas emissions continue to rise.

Policymakers are likely to pay increased attention to ESG data and ESG data providers in 2024, although their motivations are likely to differ, with some wanting to make better quality data available and others likely to want the opposite. Long-term investors need to be vigilant and ensure that changes do not weaken investors’ ability to hold companies to account for their social and environmental performance.

Investor duties and obligations

Asset owners are likely to face increased scrutiny of the investment and engagement decisions that they have made. They will need to demonstrate that they have taken full account of the financial implications of these decisions and actions and that they have instituted formal processes for assessing and reviewing these implications.

UK pension scheme Brunel Pension Partnership’s climate change stocktake provides an interesting model for asset owners. As part of its climate change policy issued in 2022, Brunel committed to a full stocktake of the policy toward the end of the year, to review its effectiveness and its continued relevance to Brunel and its clients, with a view to setting updated policy objectives and targets from 2023. The results published in early 2023, described the actions Brunel had taken in the period 2020 to 2023, the outcomes achieved (both in climate and financial terms), and the progress made against its overarching goals of delivering or supporting systemic change.

The  commitment to a stocktake reassured Brunel’s clients that if any of its commitments had undesired or unforeseen consequences, there was a structured process for reviewing and, if necessary, changing course. The stocktake also provided a structured process for all stakeholders to critically and objectively review successes and failures, to identify and discuss assumptions and concerns and to identify how implementation can be made more effective, and how outcomes can be delivered more efficiently.

Work together

Given that so many of these challenges relate to public policy, asset owners need to work together to ensure that their interests as long-term investors are protected.

The UK Asset Owner Roundtable which in 2023 focused on alignment of voting between asset owners and asset managers is a model for how asset owners can work together to analyse a problem of common interest and identify potential actions and interventions. Other important initiatives that tie to the themes presented in this article include:

  • The Global Investor Commission on Mining 2030;
  • The Investor Statement on Unequal Voting Rights;
  • Assessing Sovereign Climate-related Opportunities and Risks (ASCOR) Project; and
  • Climate Action 100+.
The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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