In December 2019, Responsible Investor organized its 11th annual NY conference during Sustainable Finance Week. During a panel discussion on “Corporate governance, reputational risk, and why ESG matters”, executives shared their views on the current trend towards disclosure, an emerging regulatory environment and its risks, and how litigation is one available tool to keep companies honest. Attendees included institutional asset managers, asset owners, as well as ESG vendors.
Among the professionals on the panel was FactSet’s Senior VP of Regulatory Solutions, Ali van Nes, alongside Ken McNeil of Susman Godfrey and Alberto Thomas, founding partner of Fideres Partners LLP. Below are some of the key takeaways from the event.
On the investor side, the two main strategies used to enact change are divestment, and engagement, with active ownership through engagement being the best way to push for change.
The current trend reflects a balance between an investor’s demand for data and the risk mitigation efforts of issuers and companies who prefer to reveal as little as possible.
An emerging regulatory environment (with few formal requirements right now) leads companies to take the easy route via low-risk, low-exposure disclosures, leading to gapped disclosures that are difficult to compare across companies and industries.
Disclosure and information will eventually lead to better risk analysis, which includes details that would influence a reasonable investor’s decision to buy, sell, or hold the corporations’ securities.
Reputational Risk & Litigation
Risk managers cannot ignore the seriousness of identifying, mitigating, and reporting material ESG exposures: practical and operational risks (e.g., the physical risks of climate change and the economic risks of energy transition) as well as governance risks (reporting what is expected or required; acting to address shortcomings).
All industries face litigation exposure; litigation is a tool in the kit that can be helpful but should be a last resort.
Various studies point to a lack of long-term planning strategies across the S&P 1500.
Firms with long-term strategies tend to be rewarded and outperform with lower volatility than others without it.
Class-action lawsuits tend to lead to lower return on damages that are already done; i.e., litigation has a positive impact but tends not to satisfactorily cover the damage that was done.
There may be a cycle where litigation insurance premiums are now based on the expectation of no more than 5-7% recovery of damages.
Pushing for more and better disclosure of long-term planning could lead to less future litigation and could also prompt better ESG planning and outcomes.
Case study: The U.S. has a class action lawsuit mechanism and fined VW more than $14 Billion for Clean Air Act violations in its emissions cheating scandal. In the EU, which has no class action mechanism as well as multiple sovereign jurisdictions, the damages were much greater (10x the number of “cheating” cars sold) but no fines imposed to date and thus no compensation to most of the consumer victims of the company’s fraud.
Litigation in the U.S. achieved some equitable outcome that has not yet been possible in Europe; however, litigation is expensive and wasteful and would be better treated as a last resort.
Shareholder resolutions are also on the rise, demanding corporations to disclose long-term and ESG planning.
Why ESG Matters
ESG factors are now a key inputs in investor decisions so they must also become a part of companies’ long-term planning or else there will be risk of litigation.
As new regulatory standards emerge, investors will begin measuring what is being disclosed; measurement leads to management and ESG-related quantitative data will become increasingly available and be used to pressure firms to alter their behavior.
At this time, it appears the “E” is easier to measure than the “S,” and may show more positive change in the near term. By some standards, all of this comes down to governance or “G”
As ESG regulations come into force, there will be new governance exposures for companies that fail to incorporate ESG in their long-term planning.
Failure to integrate ESG factors can lead to increase exposure to various risks (including reputational risk) for public corporations and
Boards of Directors are wary of ESG concerns and acknowledge that ESG-related issues require planning and real change,not checklists.
Integration of ESG factors can help investors, asset managers, and firms align their interests to create a better portfolio and ultimately, an improved world.