How To Fashion An ESG Role For Your Investor Relations Team

It used to be that investors judged public companies on a relatively narrow set of financial value drivers.

The gestalt of this investing era was best characterized by the late American economist Milton Friedman who said: “There is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.”

Those days are gone. Urged on by the United Nations, global investors began to ponder the relevance and importance of Environmental, Social and Governance (ESG) factors in generating long-term returns and evaluating corporate risk. The year 2006 was pivotal in this new era as it marked the launch of what's known as the Principles for Responsible Investment (PRI).

Today, integrating ESG into investment processes and decision making appears to be on the ascendancy among many of the world's largest investment houses. Public company regulators are also taking notice. Canadian Securities Administrators (CSA) published a review of climate change risk disclosures a year ago and found significant disparities in practices between corporations and industries and says it plans additional work to develop new guidelines to help companies comply with disclosure rules. (The CSA found that 56% of issuers it examined provided specific climate change-related disclosure in documents required by regulation, with the remaining issuers either providing boilerplate or no disclosure.) More recently, on August 1 the CSA published Notice 51-358 to assist companies in improving their disclosure of material risks posed by climate change. Although it does not create new legal requirements, the notice does clarify existing legal requirements.

With so much attention focused on ESG from so many investors with so much capital (the 2,300 signatories to the PRI have over US$80 trillion in assets under management), it is imperative that IROs understand ESG basics and fashion themselves a seat at the corporate table in shaping ESG disclosures.

In this issue of IR focus, we examine some of the ways Canada's IROs are meeting the challenges and opportunities present in the ESG world.

Mapping What Investors Want to Know

One of the fundamental roles IROs can play is to ensure their company's Board and C-suite recognize the ESG factors that investors use in making their assessments.

The main reason investors integrate ESG in their processes is risk management. Investors want to price future outcomes into present-day decisions. As IROs know, most investors start by evaluating market context. If a company is in oil and gas, and operates in the Middle East, investors will identify ESG risk factors (including country risk) that are most likely to impact corporate strategy, growth and value. Conversely, if a company operates in the financial services sector in North America, a different set of ESG risk factors (including cybersecurity/reputational risk) will come into play that investors will investigate and monitor. By engaging with investors, you can learn what ESG factors they consider most relevant to your company.

For general use, it's helpful to think of ESG in three buckets. Under each, investors may look for data/disclosure on a number of topics. While not an exhaustive list, we present the following examples:

Environmental: climate change/carbon emissions, energy use/conservation, natural resources/raw material/land use, waste management, water quality.

Social: diversity, labour standards, employee relations/health and safety, production quality/safety, business continuity/cybersecurity, community impact, political advocacy, taxes/tax policy.

Governance: Board independence/diversity, voting rights, employee versus executive pay, culture, risk management.

IROs we spoke to (outside natural resources) indicated that the G in ESG used to be the only factor that investors would probe, but that the other letters in the acronym are gaining importance. Consequently, more internal effort is now placed on (externally) describing policies and procedures related to ESG subjects.

Thinking broadly about the possible lines of investor inquiry means your company will be better prepared in the future for informational requests. It also means IROs can cast themselves in two important roles.

IRO As ESG Thought Leader

IROs do not set policies governing the ESG behaviours of the companies that employ us. We also do not gather and monitor data on ESG factors. We are not among the growing ranks of ESG analysts. We do not conduct ESG materiality assessments. These responsibilities reside elsewhere. However, IROs can fashion a role for themselves that is part ESG thought leader and part ESG promoter.

Thought leadership involves first staying current with the evolving methodologies investors, rating agencies and regulators use in assessing ESG factors/disclosures. This is not an easy task because investor/rating agency methodologies are often proprietary, which can lead to (frustratingly) wide variations in ratings.

To underscore that point, the CFA Institute and PRI recently published another installment in a series of reports to help investors learn from their peers about best practices for ESG integration across different asset classes. Among the findings: there is no single form of best practice to enable ESG integration in investment decision making.

The report also noted that while portfolio managers and analysts are more frequently incorporating ESG into the investment process, "they rarely adjust their models based on ESG data." The IROs we spoke to did not use this as an excuse for inaction. Reasoning that ESG factors are likely to have a greater influence on investor decision-making processes in future – particularly as younger members of society begin to exert more control over capital flows – and pressure to combat climate change mounts, they keep close tabs on the policies/positions of the major ESG ratings provided by Moody’s Investors Service, S&P Global, MSCI ESG Research, Bloomberg, ISS and Thomson Reuters.

Knowing your assigned ESG score, disputing it if it is inaccurate, monitoring your competitors' ESG ratings and analyzing the ESG disclosure regimens of peers are all worthwhile pursuits for IROs, but so is providing the information your investors and their advisors need in the first place.

In this area, IROs can lead by familiarizing themselves with the different ESG frameworks in use by organizations such as Carbon Disclosure Project (CDP) (which sends annual ESG questionnaires to companies worldwide), the Global Reporting initiative, the Task Force on Climate-Related Financial Disclosures, the Sustainability Accounting Standards Board and the Committee of Sponsoring Organizations of the Treadway Commission.

In future, it is likely that regulators will attempt to standardize ESG reporting because without standardization there is a lack of comparable ESG data. (It's also important to note what the CSA has to say about disclosure: "Although securities laws in Canada do not impose specific requirements in relation to the disclosure of climate change-related information, the general requirement to disclose material information requires disclosure of the material climate change-related risks and impacts for an issuer's business in the same way that they require disclosure of other types of material information.")

IRO As ESG Promoter

Internally, IROs can play a meaningful role in shaping ESG disclosures that align with investor informational needs/assessment models and in guiding their companies toward greater transparency. At present, this role is not being performed as broadly and consistently as it might be in the IR departments of many companies. This may be because some management teams "have not yet seen the light," as one IRO put it, or because corporate managers are reluctant to publish data on factors such as annual waste volumes/energy use for fear of being held to account.

Helping your Board and executive team assess the pros and cons of ESG disclosures – in part by showing them that ESG can become a platform to positively engage with investors and in part because motivated investors will demand/find information on your practices in any event – should be a key priority for IROs.

Once decisions have been made about disclosure, IROs should be sure to promote ESG facets of the corporate story, particularly progress that is being made. Tapping into new investor money by identifying institutional accounts that place a premium on ESG factors can be a rewarding part of any IRO's job.

Of course, this needs to be done mindfully. Responsible investors want to see that there is no daylight between ESG and corporate strategy. It is easy to spot public companies that walk the talk by reviewing disclosure materials for signs of integrated thinking/reporting.

The Bottom Line

While many companies continue to take a 'check the box' approach to ESG, a growing number of corporate leaders are recognizing ESG as an important screen through which they need to assess risks/opportunities, manage corporate affairs and create shareholder value.

For the IRO of tomorrow, being an ESG thought leader and promoter will likely be another part of a varied and exciting career.

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