Where theory and practice meet: Sustaining and impactful, and especially for governance fiduciaries.
First, an activist hedge fund has successfully waged a proxy contest to elect climate activists to Exxon’s board. We have long said that despite hedge funds’ typically “short-termist” orientation, that skills in investor activism could be applied in a constructive way to sustainability.
For the first time a court of justice has ordered emissions reductions; a Dutch court ordered Royal Dutch Shell to reduce emissions by 2030, 45% below 2019 levels.
https://www.cfainstitute.org/en/ethics-standards/codes/esg-standards
Yesterday CFA Institute published the exposure draft of the ESG Disclosure Standards for Investment Products. This is a significant milestone on a mission-driven path to establishing global disclosure requirements for investment products with ESG-related features.
Biden issues executive order on climate:
And drought in California and the West:
Paradoxically, ESG data methodologies are generally considered flawed, inaccurate, and unstandardized, yet its capital markets’ utility has broadened and become increasingly more influential.
Optimizing ESG disclosures and its corresponding narrative, if executed properly, provides far more benefits over the long-term, despite the various short-term implementation headaches. That said, let us call out the notion of ESG for what it is. Few participating in the capital markets really enjoy ESG, and many understandably struggle to identify, much less agree upon, its material characteristics. They may appreciate ESG, but it is probably not a stretch to assume sheer amusement is few and far between.
That does not mean it is a bad thing, it just means that ESG strategy, disclosure and conveyance is just one more task we all must add to our daily schedule, like compliance training or financial reporting. Additionally, it seems the ESG goal posts are constantly moving, which they are. The data is generally considered inconsistent, there are far too many frameworks and everyone operating in the ESG space seems to be doing their own thing. “Why bother?” is a reasonable question, especially as COVID-19 has generally instituted a much more difficult set of macro dynamics for management teams to oversee.
The complexity of the ESG landscape undoubtedly presents a variety of recent challenges, but effective and efficient execution can assist in attracting quality incremental capital, augment competitive differentiators, and allow a management team to regain control of the investment narrative.
From a strategic perspective, the decision tree associated with ESG disclosure offers two discernable avenues – “check-the-box” v. optimization. In the short-term, check-the-box may alleviate a variety of the angst and relative inconveniences related to non-fundamental disclosure. However, check-the-box is very much a band-aid, and a poor one at that. As ESG continues to evolve, management teams who opt for short-term ease will continually find themselves hitting reset, probably on an annual basis. On the other hand, the optimization route requires a little more time and attention, yet those efforts yield much higher returns on invested time and provides companies with a solid foundation they will be able to build upon in the future.
Building blocks of ESG are important to consider when sketching out an ESG implementation strategy. Unfortunately, if management teams do not attempt to proactively convey a set of guiding rules and context, the relative infancy of ESG data allows other entities, including detractors, to establish them. When organizing a strategic approach, it is fair to assume the following attributes of ESG:
1) The staying power of ESG is not going to wane over the foreseeable future.
2) As ESG data and frameworks continue to evolve, trend analysis will not only materialize, but receive a heavier weight within conventional financial analysis.
3) Investors are increasingly finding a variety of unique uses for ESG data that spans across risk management, insurance underwriting, credit evaluation, competitive assessment, and valuation.
ESG strategy and implementation should center on “disclosure optimization,” defined as the ability to present an ESG profile in a fashion that quantitatively highlights the specific nuances of the business model, objectively conveys economic reality, and complements the long-term strategic directive of management.
Piecing together the ESG puzzle
ESG implementation is not necessarily hard, but it is time consuming and incredibly complex. Incorporating a material ESG narrative within a traditional investment thesis can be arduous for any sector, but the difficulty is probably most evident within the traditional energy and energy transition network. Energy transition, at best, is a multi-decade undertaking. And regardless of what detractors think or say, traditional energy will continue as a global economic necessity for quite some time. Ultimate success will only be able to be determined in literally decades, which essentially flies in the face of a conventional capital markets mentality that is generally fixated on months and quarters.
If a reasonable proxy for materially significant and impactful innovation can derive from actual green patent production, then empirical research suggests that we should first look to oil, gas, and energy producing firms.
It is safe to assume that ESG’s influence will only mature and the notion of it being a fad is yesterday’s news. Approaching ESG as a “check-the-box” exercise also happens to be yesterday’s news and will most likely result in further headaches for management teams. Outlining the blueprint for successful ESG integration is a function of three key milestones:
1) Ensuring the discrepancy between ratings data and economic reality is mitigated to the greatest extent possible.
2) Ensuring external stakeholders are aware of and provided the appropriate context for evaluating a company’s respective ESG profile.
3) Ensuring the ESG disclosures, narrative and data points are mapped to the specific nuances of the business, especially as it relates to the fundamentals, strategic directive, and unique competitive differentiators.
The good news is that ESG, for the time being, remains in its relative infancy and no clear-cut winners have been named. There are some groups that are obviously winning, but that status certainly does not ensure future success and is also predicated on materiality perspectives and data points that will inevitably change.
Corporate Social Responsibility (CSR) as we knew it pre-pandemic is gone if not in rapid decline.
In many cases, CSR has now been replaced with Environmental, Social, and Governance (ESG) criteria that analyze and reward more strategic corporate performance on a range of sustainability issues. The ESG frenzy is upon us and ramping up. The reasons for stronger market and stakeholder interest in ESG reporting and performance are compelling but challenges have emerged along with opportunities for issuers, investors, and raters.
However, the ESG frenzy is also placing demands on quantifying the impact of investments. Fortunately, the emergence of digital technologies, such as satellite data and analytics, IoT devices, and artificial intelligence (AI) solutions, provides the opportunity to measure impact on a real-time basis. These technology solutions when coupled with credible, transparent sustainability-related practice improvements will lead to best-in-class ESG performance.
First the good news.
The pandemic and glaring social inequity issues have, in general, caused companies and their brands to step up to address ESG issues. Consumers and investors are now more or less keeping score on which brands are investing in ESG performance. Increasingly consumers are making buying choices based upon ESG performance, and investors are showing a preference for high-performing ESG companies. Recent research indicates that companies with strong ESG performance have improved financial and brand performance.
As the Dow Jones Industrial Average shed some 34 percent during Q1 of this year with the Covid-19 pandemic spreading, Morningstar reported that 51 out of 57 of its sustainable indices outperformed its broad market counterparts. At the same time, MSCI reported 15 of 17 of its sustainable indices outperformed broad market counterparts.
For example, a recent report by Blackrock, ESG Resilience During Coronavirus Downturn, probed how ESG-focused investment funds have fared versus their peers. According to Blackrock, “In the first quarter of 2020, we have observed better risk-adjusted performance across sustainable products globally, with 94 percent of a globally representative selection of widely-analyzed sustainable indices outperforming their parent benchmarks. In particular, we believe companies managed with a focus on sustainability should be better positioned versus their less sustainable peers to weather adverse conditions while still benefiting from positive market environments.”
And while Blackrock’s commitment to ESG investments has dominated the news cycle in this space, even The Carlyle Group, famous for defense industry investments, is reshaping its broader portfolio to account for ESG and sees the way to high rates of return through impact investing.
The challenge.
The challenges to the demands of ESG performance and reporting are the absence of a common lens to review corporate claims verification and the need for quantitative performance data and information. The lack of a common framework or proxy “standards” for filtering through corporate ESG reporting is a concern for transparency and comparability of performance. The need for quantitative performance data and information has now become critical as investors and consumers want proof of performance claims.
Let’s focus on the challenges and opportunities for quantitative performance and use water risk as an example. The process of collecting, aggregating, and reporting ESG data remains largely a labor-intensive and analog process. Analog tools can’t meet the needs of current and projected ESG reporting. Despite the adoption of digital technologies in many aspects of our lives (e.g., entertainment, mobility, healthcare, and education), environmental and social data has lagged behind in adopting digital technology solutions.
However, this is changing. For example, the intersection of increasing awareness of water as a critical environmental and social issue for businesses illustrates the opportunity of digital technologies to meet the needs of companies, investors, NGOs, and consumers in ESG performance.
The opportunity.
One of the most significant trends with respect to water as a critical resource is the adoption of digital technologies. Digital solutions are being applied to water resource applications to determine real-time water quality within a watershed using satellite data and analytics, AI solutions to more effectively manage water, energy, and carbon emissions in manufacturing operations and to vastly improve agricultural productivity and resource use.
The ability to collect and analyze data on a real-time, or near real-time, basis greatly enhances the quantity and quality of environmental data for improved operational performance, tracking progress against goals, and external reporting. The increased value placed on ESG performance is driving demand for improved data collection tools to seamlessly link internal and external reporting. We also believe digital tools can unveil gaps between perceived ESG performance and actual quantifiable performance. The ability to increase transparency, in addition to rationalized ESG reporting, will benefit corporations, investors, and other stakeholders. The emergence of digital tools coupled with proven corporate sustainability best practices ensures that the right actions are implemented at the right places to achieve locally meaningful environmental improvements (in other words, context-based targets informed by science).
Many ESG investors, asset managers, and rating agencies struggle to understand what constitutes “good” corporate water stewardship performance and thirst for better, more credible data upon which to refine their comparability analyses of issuers. Water stewardship happens in local contexts and plays out on a watershed-by-watershed basis. Yet, most corporate ESG reports that address water-related risks and performance aggregate local water-related data across regions (such that it even exists) and asset classes thereby losing a nuanced, accurate picture of local water stewardship performance. Even worse, most reporting frameworks inadvertently tell an incomplete story on water stewardship often focusing on corporate efforts on water efficiency and general issues of water security in the value chain.
Compounding the generally ineffectual nature of corporate reporting on water stewardship performance is the fact that many corporates are new to water stewardship. Many corporate sustainability practitioners bring a “carbon” mindset to developing a water strategy and setting meaningful goals and targets. The problem is that water is not fungible in the same way a ton of carbon is across a global value chain. It requires a combination of art and science in determining overall water-related risk and setting an enterprise-wide strategy for water stewardship that is executed across a portfolio of sites.
The solution.
Real-time, credible water data from a portfolio of sites is critical to bridging the gap between corporate water stewardship reporting and transparent, meaningful site-level water stewardship performance. This digital transformation in the water profession will improve overall corporate water stewardship performance, improve the credibility and transparency of water-related ESG reporting, and most importantly, via better ESG water-related rating methodologies, reassure stakeholders that “rated” and “actual” water-related performance are aligned. The digital water transformation will optimize understanding of water-related risks and site-level performance thereby leading to real-time feedback loops that improve “actual” corporate water stewardship performance.
Several digital water technology companies understand that they are not only providing real-time data for improved resource and asset management performance but also improved reporting capabilities. These digital water technology companies range from satellite data acquisition and analytics (www.gybe.eco), to AI for operational excellence (www.plutoshift.com) and AI for water quality predictions (www.trueelements.com). The data and insights provided by these companies are essential for Sustainable and Resilient Corporate Water Strategies.
This is the future of water management and stewardship – real-time data and “frictionless” internal and external reporting.
Conclusion
ESG reporting is gaining momentum, but the need to transparently and uniformly quantify impact remains a challenge. Standardization, regulatory and certification requirements, and seamless integration with real-time data and analytics are not where they should be just yet. The convergence of digital water technologies, credible water related-data generation from the use of the site-level Alliance for Water Stewardship Standard, and rigor in ESG reporting provide a path to vastly improved transparency and accountability.
This article was co-authored by Matt Howard and Will Sarni.
Matt Howard is Vice President of Stewardship at The Water Council. He also serves as the Director for the Alliance for Water Stewardship – North America.
Will Sarni is the founder and CEO of water strategy consultancy, Water Foundry, and is the founder and a general partner of the Colorado River Basin Fund.
The Study is the first of its kind and is being done in conjunction with Chris Merker and Fund Governance Analytics (FGA). FGA is a pioneer in the field of empirical governance research and evaluation of asset owners and operates in partnership with Marquette University. Their governance diagnostics are derived from decades of research and evaluation and have been used extensively to analyze the governance practices of public pension funds. This is the first time that these tools will be applied to higher education endowments.
No 2030 or 2040 pledges today, just a poem for reflection on this 52nd Earth Day.
Life is the simple thing we neglect every day. A day contains the time as we travel on our way. Time is the thing we lack in our lives. As we yearn to find our way through this phenomenon called life. We grow old in wisdom, yet are fragile in youth. We cannot escape the perils that seeks us with each move. We can embrace the seconds that the clock has, Or be the pawn forced by the master’s perilous hand.
– walkinverse (1/3)
https://www.wsj.com/articles/carbon-capture-is-key-to-companies-net-zero-pledges-11615975780
Many companies’ plans to reduce their greenhouse-gas emissions to “net zero” rely heavily on technologies to capture carbon. Some are more speculative than others.
Nearly 1,400 companies have promised to cut their net carbon dioxide emissions to zero over the coming decades. So-called carbon offsets, where the gas is removed from the atmosphere, are central to many of these plans. The latest of the almost daily announcements: French oil giant Total said on Tuesday that it will plant a 40,000-hectare forest in the Democratic Republic of Congo to sequester 10 million tons of CO2 over 20 years.
Starting this week, Sky News will get deadly serious in its coverage of climate change by highlighting every night the time we have left until the planet overheats.
The figure is already less than 12 years, and the on-screen ticker will be counting down, second by second, as we head towards the ominous limit of 1.5°C hotter than when the Earth’s temperature was first comprehensively measured in 1880.
The figure is already less than 12 years, and the on-screen ticker will be counting down, second by second, as we head towards the ominous limit of 1.5°C hotter than when the Earth’s temperature was first comprehensively measured in 1880. That ceiling was set in Paris at COP21, the 2015 UN Climate Change Conference, and Sky News has made its bold statement as we approach COP26 in Glasgow in November.