ESG+ Newsletter – 10 October 2024

This week’s ESG+ covers the evolving views of EU investors regarding ESG shareholder proposals and the shunning of COP29 by global financial leaders. We look at whether the political backlash against ESG in the US is overstated; academic research into the relationship between ESG and financial returns; and how AI could be used for ESG reporting. However, we begin with a review of the publication of the UK’s Investment Association updated Principles of Remuneration.

The IA publishes its updated remuneration principles 

Earlier this year, the UK’s Investment Association (IA), a representative body for UK investment managers, committed to updating its remuneration principles following feedback from companies and views of its members. The focus was on simplifying the principles with a specific focus on remuneration quantum and the use of restricted shares (long-term incentives without performance conditions), which will support a competitive market and deliver the right outcomes for investors. The IA published its updated Principles of Remuneration earlier this week and, as promised, they are simpler (reflected in the page count decreasing from 22 in the previous version to 17). The guidance on levels of remuneration underscores the importance of the pay for performance principle, considering the delivery of sustainable value for shareholders and wider stakeholders. Regarding long-term incentives, Remuneration Committees have the option to use performance shares, restricted shares, or a combination of both; but the Committee should clearly articulate its rationale for selecting a specific incentive structure. Moving from performance shares to restricted shares is still expected to be accompanied by a 50% discount to the maximum pay level, though the guidance mentions that different discounts may be applied in specific circumstances. 

Given the increased flexibility signaled by the new Remuneration Principles, it is no surprise that the section on shareholder engagement has been moved towards the beginning of the document. While higher pay levels and non-conventional LTIP structures may become less contentious in the future, shareholders will continue to expect that companies consult them prior to any major change in pay. 

European investors’ shifting sentiment on ESG shareholder proposals

Responsible Investor has reached out to European stewardship professionals for insights into the volume and quality of sustainability-focused shareholder proposals. Large US asset managers have long voiced concerns about the relevance and over-prescriptiveness of such proposals, resulting in their declining support for ESG resolutions. This shift has contributed to a noticeable divide between US and European investors, underpinned by a recent ranking by UK-based ShareAction which found that the top 26 supporters of sustainability shareholder proposals were European based. However, some European asset managers are beginning to express reservations. In the article, a London-based stewardship professional questioned the value of shareholder proposals as an engagement tool, while a European asset owner called for a more balanced approach, noting that proposals from smaller shareholders may be “too prescriptive”. This sentiment is shared by Tara-Jane Fraser, a senior portfolio manager at APG Asset Management, who argues that the increasing volume and complexity of shareholder proposals creates administrative burdens for companies and investors. Fraser called for a more robust review system to ensure the quality of proposals and prevent misuse. These conversations highlight growing concerns over the efficiency and effectiveness of shareholder proposals, underscoring a need for more thoughtful, well-crafted resolutions that foster meaningful engagement without overburdening stakeholders. 

Finance leaders snub COP29 in favour of other climate-focused events 

Despite being branded as the ‘Finance COP’ by organisers, with over 200 nations set to discuss a new global financial target to support developing countries, the Financial Times reported this week that prominent financiers are expected to skip this year’s summit. Citing logistical difficulties and fewer client networking opportunities than at COP28 in Dubai, major figures from across the financial sector are planning to sit this one out. It would appear that executives from across banking, asset management and insurance are opting to go to COP30 in Brazil which promises to be more business-oriented and are also focusing on other climate-related events such as COP16 UN Biodiversity Conference in Colombia, or New York Climate Week last month.

If New York Climate Week was the sustainability party of the year, COP appears to be the hangover. As reported in a recent addition of the newsletter, this year’s summit is giving many people a headache, as Azerbaijan’s hosting of COP29 has come under fire for not placing a focus on the transition away from fossil fuels that was pledged in Dubai; as well as for its human rights record and reliance on oil and gas exports. With the UN aiming for a smaller gathering this year to reduce distractions and keep negotiations on track, many non-profits and academics have struggled to secure passes, further fuelling debate over the effectiveness of this year’s summit.

ESG showing signs of resilience against backlash in the US 

It is widely accepted that anti-ESG sentiment is sweeping through the US, impacting the US ESG market, with its politicisation forcing companies and investors to row back on public commitments. However, there is evidence that, despite these political headwinds, sentiment towards ESG remains strong across key stakeholders. A recent Harvard Business Review survey revealed that 77% of US investors believe that environmentally responsible companies are more likely to succeed financially, and 70% believe that energy transition is a growth opportunity. Additionally, only 2% of anti-ESG resolutions during the recent US proxy-voting season passed, with 10% of bills at state level making it into legislation, indicating that ESG’s resilience is perhaps greater than anticipated. On the company side, a survey of over 700 CFOs from the world’s biggest companies highlighted that they believe sustainability initiatives add to a company’s bottom line and align with the interests of their shareholders. While a recent HSBC report of over 300 CFOs and more than 500 senior treasury professionals across the globe revealed that 67% have already incorporated ESG guidelines and policies into their financial investment decision-making.

Indeed, one could argue that the political backlash against ESG issues in the US is overstated, and that their animus towards ESG is an indication of the latter’s success to date – perhaps closing the stable door after the horse has bolted. Continued regulatory and stakeholder scrutiny may well prove a boon for ESG, ensuring investors and companies refine their focus to address material issues, and use ESG more effectively across investment and operational decision-making.

Academic research highlights similarities between traditional and sustainable investing   

The relationship between ESG and financial returns is the focus of new research published by  the London Business School and London School of Economics. Based on the perspectives of 500 portfolio managers, both traditional and sustainable focused, the research has found significant similarities between the approaches of the two groups. Central is the overarching emphasis on financial returns as the primary aspect of fiduciary duty, with environmental and social factors viewed through that lens. Sustainability investors do not prioritise non-financial performance over financial, while traditional investors recognise that there are non-financial aspects of performance that are financially material – particularly in negating downside risk. Interestingly, asset managers noted that E and S performance are analysed as an indicator to broader corporate health, and are interlinked to further value drivers, such as competitive positioning. 

The concept of fiduciary duty throughout the research is a constant, with support for resolutions and broader engagement based on whether action will lead to stronger returns. From a constraint and exclusion perspective, asset managers must adhere to client requests on strategy and the fund mandates. This is highly impactful in how ESG relates to stock selection and asset allocation. The third consideration is firmwide policies, which are influenced by regulation and relationships with asset owners. The research also underscores a point that this newsletter has routinely highlighted, that E and S performance should be embedded into the broader analysis of companies by investors. These factors should influence investment decision-making and risk assessment and how that may impact returns, rather than solely focusing on positive E and S outcomes.

Levering AI for ESG reporting  

ESG reporting is a complex task due to the vast volume of data involved and the granular detail needed – ranging from carbon emissions to employee metrics – that come from a wide variety of systems, teams, and formats across an organisation. With the EU’s CSRD legislation and SEC’s climate disclosure rules increasing the need for precise ESG data, SIA Partners highlights the potential benefits of AI in streamlining the ESG process. AI can search internal databases, extract relevant ESG metrics and classify them into standardised categories, all while ensuring data integrity and accuracy. Generative AI expands those opportunities as it not only extracts metrics and data, but also drafts narratives and predicts trends to support companies with their sustainability goals.  

However, while AI offers numerous solutions, it is not a panacea. Companies must establish clear rules and plans for how they will leverage AI and define the parameters for its use both at a strategic and technical level. Human oversight remains essential: people need to verify the logic AI follows, ensure it is accessing and prioritising the right information and confirm that the conclusions drawn are appropriate to the organisation. While AI can assist in crafting narratives around technical data, it cannot replace the need for businesses to develop their own messaging tailored to their own style and stakeholders. Moreover, risks exist, such as the possibility of AI unintentionally including confidential or personal data in its reports or not adapting to ever-changing regulatory obligations. Therefore, companies need to implement robust governance structures that assess the risks and opportunities of AI’s adoption in ESG reporting and also ensure proper oversight. 

ICYMI 

• Achim Steiner, a United Nations Development Programme administrator, has stated in a Reuters report that some countries are being forced to prioritise debt burdens over investments, hindering their progress towards achieving sustainable development goals.  
• The UK government has launched a new scheme to unlock investment into long-term renewable energy storage. Energy storage developers will be guaranteed minimum revenues, which will remove some of the upfront costs which are a barrier for investors.
• New research from the World Meteorological Organisation has revealed that 2023 was the driest year for global rivers in more than thirty years. According to Edie, the reports indicate that river flows and reservoirs have recorded below-normal levels for the past five consecutive years.