2019 was an inflection point for investor commitment to ESG and the advent of COVID-19 has seen it propelled to the forefront of investor preoccupations.
With social issues dominating most recently – given furloughing, corporate responses to this crisis, questions of remuneration and balance sheet strategy / investor returns – never has it been more crucial to know the challenges and be well placed to address them. In tandem with continued pressure from leading institutional investors and the need for corporates to report in line with TCFD this year, it’s time to focus and be able to communicate effectively not only with investors, but with customers, employees and regulators.
Montfort held a Conversation attended by over 30 heads of IR and fund managers on 28th May to discuss these issues, with presentations made by Nick Bastin and Alison Allfrey from Montfort, Fabiana Fedeli, Head of Global Fundamental Equities and Senior Portfolio Manager Emerging Markets, Robeco and Ian Brown, Head of Investor Relations, Qinetiq. Below are the key elements of the discussion and questions raised.
ESG has been rising up the IR agenda over the last 12 months
- Asset Managers are under pressure from their clients and this is devolved down through their asset portfolios to corporates. Corporates are also under increasing ESG pressure from other sources of financing such as banks, as well as regulatory and societal audiences
- Capital will be scarce going forward particularly given rising government ownership of companies; corporates need to make it easy for a wide group of shareholders to own them by understanding their ESG triggers or barriers to investment
- The enhanced performance that ESG can provide during a crisis has been noticed and ESG’s role has gone beyond risk mitigation to generating alpha signal
- Sustainability is absolutely aligned with shareholder value creation and is in the long-term interest and viability of corporates
- Investors are taking an increasingly sophisticated approach and using ESG as a key way of trying to understand corporate risk
Focus on the S of ESG
- COVID-19 has propelled the S of ESG to the fore, as a company’s purpose becomes more important
- S has traditionally been difficult to quantify, however COVID-19 has made it a litmus test of operational viability and credibility
- S is now being prioritised with a focus on culture, responsible remuneration, appropriate balance sheet policy and engagement with employees
- Government and society feel they have more of a stake in how companies are run, especially if they have benefited from government support
Human Capital Management has been key
- COVID-19 has increased the focus on human capital management, Health & Safety, flexible working and supply chain management – elements that are aligned with long-term sustainability of companies
- Companies are trying to ensure they act with integrity, make sure employees are looked after, that safety and well-being are paramount, and that WFH is possible and used as a suitable option
- Employee rights have come to the fore as people realise that key workers are often at the lower end of the income scale. Stakeholder responsibilities therefore become more important, for investors and society at large
- The action of companies in relation to executive pay and furlough has been watched closely, but it is not a case of one size fits all and different sectors have differing priorities. The preservation of dividend payments in sectors that are less affected or indeed boosted by the crisis, has been key to protecting income streams for pension holders
- When deciding to postpone a dividend, some management teams have taken a pay cut, ensuring that all stakeholders are ‘in this together’
But E & G are also important and will return
- The question for government is how you build an economy with environmental concerns at its very heart
- As we have become used to clear skies and low traffic, the Environment and Governance elements of ESG will return post the COVID-19 crisis, so people must focus on all three elements
- What is acceptable in terms of balance sheet strategy will change, with efficiency no longer being enough and companies needing to show that they would be able to ride out further shocks. The conversation as to what constitutes an appropriate balance will evolve further
Question 1 – Are there any specific post-COVID-19 engagement themes for 2020?
- The usual engagement themes will continue; everything from board composition to climate change
- Specific COVID-19 related initiatives include agreements with other healthcare investors to drive collaboration in developing an affordable response to the virus and affordability of goods more broadly will be a key issue going forward
- Companies across emerging markets have been asked to continue paying employees, particularly in the garment industry, in the interest of longer-term sustainability
- There are questions particularly around corporate supply chains – investors want us to do the right thing and there is a much greater focus on the impact companies have on society
- Things are moving away from a tick box, quantitative approach to ESG, with investors now asking for much more qualitative assessments. This shows investors what well run companies look like, whereas previously this has been hard to codify
Question 2 – How could a company show that COVID-19 was taken into account for executive remuneration in practice? We have seen a lot of noise regarding executives being overpaid (despite taking a pay cut) as a company still laid off and furloughed people (e.g. Disney).
- The issue of remuneration is complicated, as many bonuses and the awarding of share options took place before people realised the magnitude of the virus and its impact – and by definition remuneration is always retrospective. So, the focus is on what management have done since realising the impact of the virus and how they have coped with and responded to its consequences, including demonstrating fair treatment of employees
- Some people feel management teams had filled their own pockets before they considered furlough etc. and there has been negative sentiment from this
- Investors must realise that bonuses are historic, and even though they are being paid now they reflect past performance. There is a balancing act between paying for performance, and not jeopardising the future sustainability of the business. The balance is between not paying too much, and not paying enough
- Good management teams have volunteered to take pay reductions, fostering a shared approach to taking the pain of the virus, and shareholders and employees are part of that
- Scrutiny will continue
Question 3 – We have to be more sophisticated when raising the profile of S issues. It is depressing that it has taken a global pandemic for corporations to realise worker issues matter. The interconnectivity of ESG issues has become obvious, with other systemic risks being highlighted. The customer and the employee are the future pensioner, so stakeholders have to think much more systemically about the impact of this and how we build back better to create a new model of stakeholder capitalism.
- It is not just the S, all facets of ESG have to be looked at
- Companies have to be prepared – on a number of different fronts – to survive the challenges that lie ahead
- It is not just about data and quant, the qualitative piece is important. This has to be about making better decisions and representing more than just the people whom Financial Services serve. Investors want more outcomes, not just discussion, their standards are changing and the new stewardship code has certainly raised the bar
Question 4 – Does this discussion imply that the influence of proxy advisors will be lessened? I have long seen them as a box-ticking exercise, and their recommendations seem to be poorly researched. This is a barrier to good engagement. Direct engagement and discussions are required, especially where judgements have to be made.
- We would like to see a higher level of direct engagement between companies and shareholders on ESG. Candidly, until such time as portfolio managers have a lot more responsibility for ESG themselves, or if the ESG analyst is in the room with you, there is much scope for improvement in the quality of engagement
- In the last 12 months, employee engagement and questions referencing third party data have increased. Some of the more qualitative decisions require a degree of understanding of the business – just looking at the company at a single point in time before the AGM doesn’t always give the full picture
- Some of the advice proxy advisers give is not well researched. We publish how often we vote against proxy advisers. It does happen. They will not become irrelevant, but what they are used for will change. We cannot physically be present at all the AGMs where we need to be, so we have to be practical on what we vote on. We will still use our proxy advisers for routine votes, but for important votes we will be there in person and will always make the final decision on how to vote
Question 5 – Do you think that Emerging Market investors are less interested in ESG during this time, especially when it comes to employee salaries or even letting them go, with the focus currently on cash flow and retention?
- There is a lower level of connection with ESG issues in EM among investors. However, this is changing rapidly and the rate of progression is far quicker than what we saw in the earlier days in Europe
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